This article comes from Keith Pascal, a long time operator and entrepreneur. He’s a partner at Act III Holdings, a restaurant PE group founded by Rob Shaich. Our commentary on this is that last-mile delivery is hugely unprofitable due to the human driver. Per Forbes, “Even though Eats is arguably Uber’s most profitable division, driving revenue of $734 million in Q4 2019 — a 68% jump from a year prior — the food delivery platform lost $461 million during the period. Last year Eats shelled out 45% of its revenues, or $1.13 billion, on excess driver incentives (which denotes when Eats pays drivers more than its earning from the delivery) and driver referrals (payments made to existing drivers for referring new drivers to Eats). It spent $319 million in Q4 alone on these payments.”
This Music Will Stop. I realize this puts me outside conventional wisdom, but I do NOT believe that the third-party delivery model, as we know it, is sustainable. Here is why:
The third-party delivery providers don’t seem close to profitability. GrubHub took its perfectly good business model and messed the bed getting into delivery. Uber lost $8.5B last year and its head of UberEats stepped down yesterday. The Postmates IPO is not looking good post-WeWork. DoorDash is burning huge sums to buy share and making tons of enemies. As of today, they have begun the process of going public and obviously in need of capital to fuel the burn. (Will be good to see under the hood on their economics when there S-1 comes out.) Surely, we would expect to see this group consolidate to one or two players, but will volume even matter? In a desperate bid to build market share, the delivery companies have recently resorted to the shady practice of listing brands in their marketplace even when they don’t have a contract with those brands to do so. The delivery companies cover the fees for this by marking up the menu pricing. Deceiving customers and undermining potential suppliers is not the way to build a trusted and lasting business.
The big dogs aren’t in the game yet in a serious way. They may never dive in, but one always has to wonder about Google and Amazon. Google is quietly building itself into a kingmaker through Google Maps. If you missed it, take note of the fact that consumers can now order from restaurants via the Maps app. For restaurant brands, please check your Google Analytics to see how many searches are occurring on your locations in Maps. It’s A LOT in terms of number of searches relative to number of transactions. It’s very possible that Maps may one day become the default app that most consumers use to place their digital orders. Wisely, they will stay out of the low margin operations of delivery and simply sell high margin advertising. And, of course, Amazon hasn’t made its move yet in any real way in the US aside from dabbling in some marketplace attempts. But let’s not ignore Amazon’s $575mm pending investment in Deliveroo (one of Europe’s leaders in the space) or the nearly 500 “ghost kitchens” it could light up tomorrow called Whole Foods Market. Such efforts above could certainly make a dent in the industry and further pressure the current model.
The days of free/cheap delivery are ending. At $1.99 – $2.99, the consumer hasn’t appeared bothered by paying a small delivery fee for the service (however, we know demand shrinks when delivery fees exceed $5). Investors had been quite happy to heavily subsidize the whole effort, but now they want to see a path to profitability. Restaurants certainly can’t afford to pay more, so who’s going to pay the true costs for delivery? According to a NYTimes story out yesterday, hidden charges and elevated menu prices in some cases represented as much as a 91% premium over actual menu prices from the restaurants. Delivery companies may be getting away with that in the short term, but we shouldn’t expect consumers to stay that naive forever. Restaurant companies are now resorting to increasing their delivery-only menu prices to cover the fees if it means they no longer have to bear the cost of offering delivery. But let’s face it, eventually that menu premium is going to go away.
The consumer will only be willing to pay a $5 fee/premium and it’s not clear the delivery companies can get their costs down to earn a healthy gross margin:
- Assume transactions average between $20-30
- With a 15% commission rate, at best, on all the big brands that equals $3.00-$4.50 in commissions.
- Add a $5 fee and that gets to $8-$9 or so in income collected by the delivery companies (assuming no menu price premium).
- By my simple math, that suggests for a driver to be willing to get in their car, they will need to earn around $15/hour, so depending upon tips, that means a driver may need to get 3+ delivery runs per hour before anyone’s making money….which is not an easy task outside a very dense, tight delivery radius). Threatened regulations (1099 wage issues in California, fee caps in NYC, etc) are going to raise costs and pressure margins further. That’s not a lot of room for error.
It’s tough to be in a business where you’re killing your suppliers…and those suppliers really really really dislike you. I’ve heard few examples of restaurant companies (large or small) that are happy with their choice to let the third-party delivery companies market their brands.
My friend, Mats Lederhausen, once gave me a good metaphor for decisions with only short-term gain:
Keith, it’s like peeing in your pants: At first it feels really good, but after a while it gets very cold and uncomfortable.
That’s where restaurant companies are today.
Desperate for comp sales increases or out of panicked fear of losing market share, restaurant chains rushed to sign deals to hand over their brands and customers to the delivery companies…and now they regret it. Even worse those brands are stuck paying fees but no longer enjoying the demonstrable sales bumps they may have once temporarily experienced.
It’s not really working well for the brands, but it’s going to get worse: the delivery companies will be coming for restaurants’ market share. GrubHub has acquired loyalty provider LevelUp, providing GrubHub access to even more data about Level Up restaurant brands’ end-customers and buying patterns. Delivery companies already know more about consumer demand and preferences, so I see two things happening to the restaurant brands:
- The delivery companies can weaponize my own data against me. The third parties like Grub Hub can for example understand that I might sell high volume of burritos on Thursday’s at 5pm and then turn around and auction my customers’ demand to the highest bidder (which is the restaurant willing to pay the highest commission for that order).
- I believe we will see vertical integration with delivery companies owning ghost kitchens and eventually their own “delivery-only” brands (more on this below). In this latter case, the third parties will simply keep the demand for themselves in a bid to finally capture enough margin per transaction to make sense of all this.
Large restaurant brands have only themselves to blame. They’ve led their enormous customer bases to the third-party marketplaces and now have no easy way to defend or extract themselves. My partner, Ron Shaich, while still at Panera, was the only CEO willing to do it the hard way: by hiring and mobilizing 10’s of thousands of w-2 drivers and building his own national delivery system to profitably pursue delivery business and control the customer experience. More brands should be following Ron’s example if they have the resources and believe the market share gains are up for grabs.
Lastly, and perhaps most importantly, most delivery experiences remain fairly unremarkable and undifferentiated from the consumer’s perspective. Pizza companies have had decades to develop the delivery experience, and the product also travels extremely well. But most restaurants weren’t built for delivery, their food isn’t as robust, they don’t have special production capacity and the packaging isn’t optimized. Order accuracy remains a top problem, the tech is not special purpose built….and there are other issues such as stories of drivers sharing in your meal, poor customer service, low food quality, food safety, etc.
Consumers are good at adjusting over time to flaws in restaurant experiences and if the food, packaging, cost structure and experience aren’t well tuned for the offering, then someone or something else will come along and better meet the consumer need states.
If I had to predict:
- Already, we are seeing small mom and pops getting knocked out by this. It will likely get worse as they have become addicted to the third-party sales while seeing their margins drop. Fees will need to go up and larger brands will be better protected with contracts. The weakest players will get screwed the most.
- As a general statement, the less differentiated brands will continue to get “middle’d” by craft players above them and cheaper options below…Third party delivery will only accelerate the commoditization of their businesses and drive down their margins with increasing fees. We should expect to see more restaurant bankruptcies of mediocre brands.
- We will see consolidation of the third-party delivery aggregators and this will come down to two players (logic would suggest that Uber and DoorDash will eat Grub Hub and Postmates). It’s also possible one of the giants from Europe comes this way in search of consolidation (or vice versa).
But I think the real big move is that third-party delivery companies need to vertically integrate to survive. It’s the only logical answer to me. The above-mentioned issues suggest that the margins in the status quo will not sustain the desired profitability and growth of the surviving players.
Ron Shaich has been saying this to me lately so I’m stealing it (but with full credit to him): To ultimately achieve a differentiated high-quality delivery experience, winning will require a focused “delivery-first” business model. This requires an offering that is optimized for the delivery experience including menus, recipes, packaging, the production system for making it, technology, etc. It can be done. But it has to be an integrated whole. Doing delivery half-cocked out of the back of a restaurant kitchen as a bolt-on to another business isn’t the way to succeed. A kitchen may share the same menu but that doesn’t mean delivery is the same business.
If the third parties adopted this type of thinking and could muster the operational excellence to launch vertically integrated offerings, then they might finally solve the problem and capture an awful lot of margin to go with their already large market share. Today’s ghost kitchens, as a stand-alone business, are not a particularly interesting business model (they are just shared real estate with little value-added to their tenants….no more a tech company than WeWork is).
After companies like Kitchen United and Cloud Kitchens burn through a ton of cash to expand, it seems inevitable that this capacity will logically end up in the hands of the large delivery companies. IF that happens, then it’s possible the above view comes to reality if they take the final steps of acquiring or developing their own successful delivery-first brands.
This is already happening in UK w Deliveroo. That is what I believe it will take in the US market to truly succeed in a sustainable way.
I see a lot of this as a race to the bottom. Not unlike the consolidation and commodification of the POS as a whole. The smaller players will get screwed and the larger players will win by sheer scale. Like Microsoft putting Netscape out of business way back, by simply giving the product away, this is a viable strategy to gain market share, but at that point we are playing monopoly, and as things are sizing up right now, it seems that way with restaurants giving up hard fought after margin for no tangible benefit and even in some cases to their detriment. I think the Panera model is smart but of no benefit to small, one ups.
Definitely a lot more of this given that the market has so much dry powder to put to work. Toast hasn’t won on better product, service, or value: they’ve literally just spent $500M buying marketshare.
Perhaps the thing we are missing here is, this is the new normal. Buying market share is becoming as legitimate winning with superior product/performance and service. It rings hollow to me. Because when you put a bow on a box of sh#%, you still have a box of the aforementioned. I keep trying to tell myself merchants aren’t as stupid as they act. No one can prove me wrong.
Hi JT… great article and as I read it, couldn’t stop thinking about (now closed) Sprig which I was a fan of when they were open. They made/delivered the food and were very much ‘delivery first’ oriented. Besides running out of money, what else could have helped them be more successful?
It may have been VC largesse that killed Sprig. VC wants you to grow 500% a year or die. It’s just the model they’ve built for themselves. Hard to really know what killed Sprig without having the underlying data. Maple was another similar concept which held lots of promise but just couldn’t get off the ground.