How Online Ordering, Delivery Commissions Are A Flywheel of Death

It’s been said that a rising tide lifts all ships. Does a falling tide sink what’s left?

The US restaurant industry is overbuilt. Saturated. Economically speaking we’ve reached the land of perfect substitutes. The nominal top line growth seen on charts is mostly an industry grappling with inflation, not new economic demand.

Chicago, February 14, 2018 ─ The U.S. restaurant count reached 647,288 in fall of 2017, a  two percent decrease in units from a year ago, based on a recent restaurant census conducted by The NPD Group, a leading global information company.  The primary source of the decline in U.S. restaurant units was a three percent drop in independent restaurant units compared to a stable restaurant chain count, reports NPD’s Fall 2017 ReCount^®, a census of commercial restaurant locations in the United States compiled in the spring and fall each year.

NPD

Desperate times call for desperate measures. And since we’ve learned Groupon was a horrible business idea we’ll try something new.

Enter the third party ordering and delivery companies.

These companies predicate their offerings as something that brings new, incremental customers to restaurants. Their reasoning is that there are willing consumers who have few restaurant choices when it comes to dining off premises. These people are not willing to dine at your restaurant for any handful of reasons. By offering online ordering and delivery, these customers can transact with your business, thus bringing you customers you wouldn’t have otherwise served.

There are several problems with this theory.

First, customers have plenty of to-go options. As we opened in this article, the US restaurant market is saturated. Most restaurants have to-go options, and some even have their own delivery services.

Second, nobody has even proven these are net new or “incremental” customers. We’d bet that these ordering and delivery options are actually cannibalizing in-store sales. We have the sales data to prove this, and will work on a separate report so this becomes more concrete than a simple conjecture.

Third, these third parties are usurping the online presence for restaurants. Customers that might have been ordering directly from a restaurant website previously are now being routed through a third party app that comes with 20%+ commissions at the restaurant’s expense. This can be proven with customer card data but the third parties intentionally won’t share this data, we suspect, because they know it’s highly likely to be against their best interests (i.e. card data would prove that there are no net new customers and that customers who used to dine at a restaurant are using the third party as their touchpoint instead.)

But nobody ever accused merchants of being rational actors.

So what happens is that merchants on the far end of the bellcurve of rationality (i.e. irrational) view these third party ordering/delivery companies just as their 2008 forebears viewed Groupon: a panacea. Because the secret to success is putting all your eggs into a black box that promises unicorns and rainbows, right?

As these irrational actors throw money at the third parties the rational actors can’t simply stand on the sidelines. Why? Well, the restaurant market is saturated. So if a competitor is willing to offer their food for a 30% discount (which is effectively what these online ordering and delivery companies are doing) the rational actor with a full-priced menu is going to lose customers. (Remember, the restaurant market has perfect substitutes in its current state.)

So now the rational actor must figure out how to participate or attrit customers to his irrational competitors that he knows are not making any money. Talk about a dilemma.

And just like that a flywheel starts: irrational merchants throw money into a third party vacuum that eventually sucks in dollars from the rational actors. And since the barrier to starting a new restaurant is so low it can be stumbled over, there’s no shortage of dumb money to keep the flywheel turning.

Now you’ve got an industry roiling in a downward spiral where nobody is making any money except for the third party ordering and delivery providers.

It’s the Groupon story all over again.

Because it’s so unsustainable the market will eventually correct, but it takes time to work itself out of the system. We’re talking years. It took Groupon about 5 years before merchants learned their lessons. Unfortunately for the industry this time, there’s an absurd amount of private capital that has propped up these business models; Groupon raised $1.5B while DoorDash has raised $2B, Postmates $678M, and Uber $25B. That’s a literal order of magnitude difference.

The restaurant industry will be hurting for a long time, we suspect.