The economics of food delivery

There is a spurt in startups that provide food delivery services via an app. Besides the known names like Food Panda and Justeat, Zomato recently announced its decision to play in this space. Then there is TinyOwl, Swiggy and a host of others. While for a consumer, it is definitely convenient, but I struggle with the economics. It’s still early days and much can change though.

First, the reason for the interest; the food delivery market in India is estimated to be $1.6 billion today with growth rates of ~30% projected. So it is definitely a large market. The product is food. So unlike other categories, repeat orders are to be expected. With DINK families, and the rising middle class with surplus disposable incomes, eating out or ordering food from restaurants is growing. So it is a large addressable market waiting to be captured. The place where I am skeptical is the margins.

From a customer perspective, the value proposition is convenience. Instead of looking up yellow pages and calling your restaurant, and then placing the order you can place it directly via the app. So the consumer could be charged a convenience fee. In a price sensitive market like India, it will be interesting to see how much of a convenience fee a consumer would be willing to pay particularly because

  1. Lot of restaurants provide free home delivery
  2. It is not THAT big a trouble to lookup a restaurant’s number and order by phone
  3. The cost of being on multiple apps for a customer is very low

So customer churn is expected unless a player is able to differentiate itself either via customer service or something else.

Some of the players are trying to differentiate and generate value by promising better delivery times, making sure food reaches you hot and so on (which is not very different from pizza delivery). However, since they are not the producer of the end product, they have little control over the quality or the time. It will be difficult to convince a restaurant to prioritize your order because you have committed to 15 mins delivery. At peak times (which is when the order delivery times have enough value for a customer to pay a convenience fee), the restaurant will prioritize orders to maximize its revenue. This in case of most quick service or fast food restaurants is through a high turn rate on occupied tables. So in all probability, orders to customers seated on premise will be prioritized.

So, the end consumer is going to be subsidized and the service will probably be free.

The other way to make money is to charge restaurants, which most players are doing. You can charge

  1. Commission on the sales value
  2. A fixed advertising fee to promote the restaurant on the app

Now, since this is a hyperlocal play, the catchment area is limited. It is not practical to expect someone to order from a restaurant that is an hour away. In India labor is relatively cheap. The amount of commission an intermediary will be able to extract will depend on

  1. Whether it is cheaper to outsource the delivery
  2. Whether association with the platform leads to higher volumes

Most local restaurants have a low wage employee as a delivery boy, who also doubles up as a waiter or a cleaner when there are not enough delivery orders. This helps them manage staffing. So the commissions paid out will be compared to this alternative which is definitely very cost competitive.

Again, since it is a hyperlocal play, most people, would know their neighborhood restaurants, the quality, the food items etc. So again, there is a cap on the amount of incremental or new orders or increased volumes a platform like this would be able to generate. Thus limiting the amount a restaurant would be willing to pay for advertising, since it is already known in the neighborhood.

Reducing the cost of customer acquisition or outsourcing the delivery all together is a value proposition that works for large food chains that advertise on television and have a fleet of delivery boys but not for the local neighborhood restaurant.

So unless a player is able to differentiate, and provide some unique value proposition, it is difficult to extract a premium price.

Power of suppliers and consumers is higher.

Coming to costs, you can own or lease the logistics and distribution network. Hire or contract delivery boys. Then there are technology and marketing costs. Given that this is food we are talking about, efficiencies would be possible only at sizeable scale. Unlike other categories, one can’t wait and club orders without effecting your time promise. Owning your distribution network has its advantages but comes with the cost of higher initial capital investment.

Hence it becomes a volume game with low margins. So though network effectsplay a part, it is the pressure to realize economies of scale, is what is forcing players to grow and scale up quickly. For a customer, the cost of being on multiple platforms is low and hence the market is not going to be dominated by just one player. Realizing economies of scale is what is going to limit new entrants.

Some new entrants are trying to change the game by maintaining control of the delivery by owning the delivery infrastructure and they may in search of scale leverage this to other types of hyperlocal delivery like groceries maybe.

Some others target restaurants that currently do not deliver or cloud kitchens which by definition do not promote dine-in.

It’s still early, but at the end of the day, the competition is not just with other food delivery services but with other food tech plays like delivery of meal-kits, dial-a-cook and plain old dine-in.

So it is definitely a tough market and success will depend on scale and developing a unique value proposition that is difficult for others to replicate.

What do you think? Would love to get your thoughts