Just recently PitchBook reported a new $600M round for DoorDash at $12.6B valuation. And Amazon put $575M into DeliveryHero. Venture capitalists predict cloud kitchens will take over restaurants. Investors and early employees of delivery companies open up interesting public discussions on the future of the industry. And pundits are concerned our society will become even more atomized. So much attention to a relatively old service — getting prepared food to your door. Why? What is actually going on? And who benefits most from all this hype? Let’s take a closer look to better understand the dynamics of the industry and to see where it’s all headed.
There’s few key stakeholders in the game: delivery companies themselves, their investors, their employees, their customers and their restaurant partners. We’ll talk about all of them and pay a closer attention to the last group — restaurants — that are affected by the phenomena in a few non-trivial ways.
Delivery companies (marketplaces) like DoorDash are mostly business model and not technology innovations. They rely on a set of existing platforms, from cloud computing to GPS and mobile phones, and, as it often happens with business model innovations, disrupt business models of other players.
The business innovation ideas revolve around creative ways to subsidize scaling efficiently. Efficient scaling is also the basis for fierce competition and rapid market share moves when one of the companies figures out a better way to do it. Venture capital is the major source of scaling subsidies, but also treating delivery employees as contractors and charging both consumers and restaurants for a match. This is essentially the Uber model, applied to an adjacent vertical. It’s no coincidence Uber Eats is a natural extension of the main Uber service.
How is venture capital paid back for the subsidies? Scale delivers billion dollar valuations and hundreds of dollars in revenues. That opens doors to IPOs. Retail and professional investors buy out venture capital investors at a hefty premiums under a promise of further scale and valuation growth and even profitability (maybe). Amazon pioneered this model in early 2000s and it’s been working ever since for the ever-growing list of venture backed unicorns.
How are delivery employees compensated? They aren’t, really. People get some income source, but they agree to a hard job with an underpayment compared to traditional jobs that have social security, pension and other benefits and protections. This agreement often comes from having very limited employment and income opportunities.
What about consumers? Seems almost like a fair deal here. The service is expensive — you have to pay the restaurant price and the delivery fee, maybe even add tips to make it a bit more fair for delivery guys. And you don’t get the full service from a restaurant you paid to, and you miss on the social experience of dining out, and you risk getting the food in a not very consumable shape, because restaurants still have a hard time adjusting their menus to delivery conditions. All that balances out if you believe you have better/more valuable things to do with your time while waiting for the delivery. And that’s apparently the case for more than 50 million Americans these days.
Finally, where do restaurants stand? This one is tricky. The promise of delivery marketplaces to the restaurants is very clear — get more customers and more revenues at no extra fixed cost. But profitability of this new revenue streams is extremely opaque for the restaurants.
The scale of delivery marketplaces is the key here too — their huge operations dictate high revenue share fees (up to 30% and sometimes even more). Marketplaces don’t know (and, frankly, wouldn’t care) how their fee structure affects restaurant profits.
Unfortunately, neither do most of the restaurants. Except for the largest chains that have data infrastructure and data science teams to figure out contribution margins down to every menu position in every location, the rest of the restaurant industry is having another “Groupon Moment”: “Everybody’s doing it, my top line is growing insanely, and that’s all that matters”. More often than not, as Groupon days show clearly, earning proportional extra profit from this growth is very hard.
Moreover, restaurants have no access to their delivery customers. Customer relationships and data are fully owned by delivery marketplaces. Restaurants have to compete blindly, passing their destiny on the platforms to algorithms than maximize revenues and fees for the marketplaces and, sometimes, for the their largest partners like McDonalds. The problem of misaligned incentives may become really big, as we all know well from the examples like Amazon and their suppliers or iTunes and the music labels.
Surely, restaurant can benefit from delivery revenue streams. They just have to properly address tens of complex business questions about their own operations as well as delivery channels and their customer flows, like “What are contribution margins of my menu items?”, “What are those margins after delivery fees?”, “What about margins from the brunch menu vs. dinner menu?”, “Are we cannibalizing high margin sales when people dine in less?”, “Who are menu preferences on GrubHub different from Uber Eats” etc. With proper analytical tools available only to large chains, it’s fair to assume that the gross benefit of the restaurant industry as a whole is limited if not neutral.
Restaurants can try to offload the burden to landlords by trying the new cloud kitchen model. No dine in service means cheaper rent, less labor costs, no dine in vs. delivery cannibilization, and menus optimized for delivery. The new cost structure has almost the same net margins as traditional restaurants have, because now delivery fees apply to all your customers, not just a smaller portion of them. But it brings the ability to scale your operations much more easily, so the dollar value of profits has a much higher potential. The big caveat of the model is that a restaurant is not in much control of its destiny with delivery platforms having too much power over the business and misaligned incentives.
Another trick for the restaurants would be to build their own delivery operations. But that has its own obvious tradeoffs — doings things that are not in the core competence and are very hard to scale to meaningful ROI. A few players will be able to pull it off, sometimes merging it with the cloud kitchen model, but the approach doesn’t sound like a universal solution.
So this it then, the same zero sum game again — venture capitalists make a lot of money by fueling companies that cater to the population obsessed with convenience. A few hundreds of people (founders and early employees of delivery companies) get rich along the way, hundreds of thousands get some additional cash to pay the bills. The rest of us mostly pay for it, enjoying (hopefully) our growing productivity and/or leisure time.
Here at Agnoris we try to improve business results for the restaurants. Hopefully others will step in and help find better solutions for delivery employees and consumers, so that the “zero sum game” transforms to a “growing the pie game”.