Secret Sauce
How strategic investors can “deliver” for meal kit startups
Co-authored by Deborah Zajac and Will Geiger
If you haven’t noticed, technology has made it’s way to the food industry and is changing the way we discover, prepare, and consume meals. It’s happening fast, in unexpected ways, and without warning. This summer, two major events occurred that will have a profound impact for the foreseeable future: Blue Apron became the first meal-kit company to enter the public markets and Whole Foods became the first grocery chain owned by a technology company. Both transactions represent fundamental shifts from traditional grocery, and may be the catalyst for a new era in food. While more and more startups will emerge with aspirations of disrupting ever facet of the ecosystem, the importance of a well rounded strategy will become increasingly more evident.
Today, there are ~150 meal-kit and food delivery startups that provide easy access to a vast array of food offerings directly to our doorsteps. These are made up of direct-to-consumer subscriptions (Blue Apron, Plated, HelloFresh), on-demand meal delivery (Delivery Hero, Postmates), and corporate food services (Eat Club, Zesty). Some have launched to provided fully-prepared meals (Freshly, Thistle), while others are aimed for “quick-cook” ingredients and recipes (Gobble for instance, guarantees 10–15 minute prep time for all meals). There is a premium on food quality and healthy ingredients, with differentiation emerging in cuisine and category, such as vegan ( Purple Carrot), organic (Green Chef), paleo (Sun Basket), and non-perishable (Takeout Kit).
Three main trends are driving the appeal of meal-kit and prepared meal businesses:
1. Changes in consumer lifestyle and taste are powering trends that make meal discovery and planning simple and efficient while introducing attractive new recipes and ingredients. Don’t worry, your grandmother’s recipes are safe, for now: It is not the baby boomers or their parents changing their dinner menu. It’s their children and grandchildren. More Millennials cook at home (95%) and use meal kits (9%) than 45–59 year old’s do, and are far more likely to use meal delivery (36% vs. 19%). GenX’ers, on the other hand, cook at home less often than those younger and older, but use the most meal kits (10%).
2. Ecommerce has come to food: Long predicted but slow to arrive, food and beverage purchasing is transitioning from physical stores to ecommerce and digital platforms. Today, just 1% of food is purchased through online channels. Mark Alexander, President of Campbell Americas Simple Meals and Beverages, anticipates ecommerce sales of food and beverage will grow at a compound rate of 38% per year between 2016 and 2021, reaching $66 billion in 2021. Underscoring this, Denise Morrison, CEO of Campbell’s Soup, predicts “ecommerce will transform the food industry as it’s already done with entertainment and apparel.”
3. “Contextual commerce” provides consumers with opportunities to purchase and transact without interruption or change of location. Gone are the days in Web 1.0 or 2.0 where you had to move to a desktop or app, select from seemingly hidden aisles of food online, order and wait. Now, subscriptions, chatbots, dash buttons, and tools like Alexa make purchasing as simple as ever. These improved consumer experiences are increasingly core driver of customer experience and satisfaction.
Targeting these shifts, VCs have now invested more than $650 million into meal-kit startups and billions more have gone into other food delivery businesses. Today, with less than 10% of consumers subscribing, companies collectively carved out about 1% of food spend, or $1.5 billion last year. Investors are among those who project the category has plenty of room to grow.
High growth though, does not come at a low price. As legacy food and food service companies know, the food supply chain is complex. Many entrants into the meal-kit and food delivery space are going at it on their own and beginning to show cracks, while others have outright failed.
- Sprig, an online app providing healthy organic meals delivered in 15 minutes enabled by running its own kitchens and drivers, shut down in May 2017 after citing “complexity of owning meal production through delivery at scale…despite incredibly high demand.” This, after raising almost $57 million in venture funding from top-tier VCs.
- Maple was also forced to cease operations in May after its attempt to “redevelop the food supply chain” through owning the entire process from food sourcing, to food preparation, to food delivery was deemed cost prohibitive.
- Munchery, a provider of prepared dinners handmade by local chefs, was also recapitalized during 2017 and had its valuation slashed from $300 million to $80 million after reportedly having 650,000 prepared meals go unsold over the last two years.
This is only be the beginning of such news. Even for those startups not attempting to reinvent the supply chain, the meal-kit and delivery industry has underlying issues to overcome:
1. Intense industry competition: From a handful of competitors five years ago, the meal-kit and delivery space has grown to over 150 participants. The paradox of choice has shifted from recipes to services: while there is some differentiation (lunch vs. dinner, prepared vs. meal-kit, subscription vs. on-demand), the number of choices available are plentiful for a customer base who tend to only consume this format a couple times per week or month. Amazon’s recent patent applications and Whole Foods acquisition added a champion heavyweight to the category, validating consumer demand while adding higher hurdles for emerging startups.
2. High subscriber churn: The number of alternatives in the market compounded by free offers to entice new customers and no prepayment or cancellation fees makes switching between service providers extremely easy, cost-efficient, and for some, as fun as trying the newest restaurant. While Blue Apron has achieved high retention (92% of revenue from repeat customers) and gaining leverage from low cost customer acquisition referrals, the norm for meal-kit companies is reported to be grim: up to 50% subscriber churn after one week, with only 10% of customers remaining loyal to the brand after six months.
3. Low margins: Meal-kit and food delivery businesses are challenged with unit economics, but that’s not unlike many other ecommerce businesses. The underlying issue with meal-kits is the product is food, which based on the grocery model, have traditionally been one of the lowest margin items. Blue Apron’s margins were 33% during 2016, up from 23% in 2015 and 7% in 2014, and Blue Apron is the market leader in terms of awareness and scale. It is not hard to predict a high cash burn for others to reach enough scale to cover overhead and turn a profit.
So, what happened?
Did the excitement about the meal kits and delivery overwhelm the opportunity? Or are there fundamental challenges in the food industry that startups struggle to solve on their own? The recent failures and investments in the category suggest the latter, namely the potential for strategic value-add investors to help these startups survive and prosper.
- In June, Nestle led a $77M round into Freshly, a startup that delivers fresh prepared meals to consumers via subscription. Nestle will help set up an East Coast Kitchen and distribution center in 2018 and trim sourcing and distribution costs. This investment came just a couple weeks after 3 other corporate investors announced investments in meal kit and prepared meal startups.
- Unilever led a $9 million Series C in Sun Basket, a meal kit startup focused on healthy and organic recipes. Sun Basket’s customer loyalty is reported to be 3x its competitors’, and Unilever’s funding will expand marketing and scale operations to reach 98% of US households.
- Sodexo led a $30 million Series C in Eat Club, a company that delivers prepared meals to corporations for lunch. This funding will be used to open the New York City market for Eat Club, and generate additional corporate customer leads.
- Campbell’s Soup led a $10 million Series B investment in Chef’d, a meal kit startup that partners with well-known chefs, restaurants, and food media to deliver “famous” recipes to consumers without subscription.
Will startups with ties to CPG and food service companies fare any better? There are many benefits to corporate venture capital, but it is not a magic bullet (as we’ve written previously, however, the best active corporate investors are particularly good at bending bullets). Still, we believe startups with the right relationships, focus and execution on the part of both the corporate and the startup have an edge.
The right ingredients are critical for every startup-corporate relationship
Most startups in this space have a handle on food trends, consumer experience, and menus — the demand side of the equation. CPG and food service companies have the size, scale, and history of optimizing the complex, regulated aspects of the supply side of this equation. Put together, you can find the “secret sauce”. The key to success is designing the “right” commercial deal that marries the needs of a startup with the expertise of a corporation — ideas include:
1. Brand building & Marketing: Remember your favorite food jingle from your childhood? Make no mistake: lasting branding, marketing, and media campaigns can both distinguish you and sink your startup under the weight of the ad cost in a highly fragmented, competitive market. Direct to consumer business models need not rely solely on growth hacking and free mailer promos to reach consumers. Learn from the greats. Co-marketing relationships, branding and marketing advice, or even reduced advertising spend by leveraging a corporations existing relationships and ad buys are all options of how to get ahead of the pack at a cost that keeps the startup in business.
2. Supply Chain & Distribution: Accurate demand forecasting and inventory planning, procurement of fresh food and ingredients in bulk at favorable costs, maintaining a cold chain, USDA certified kitchens, and optimized delivery routing are each complex in their own right. Large CPG, food, and food service companies have the expertise and scale to serve as either an adviser or vendor to outsource some of these capabilities, lowering costs, risks, and time for the startup to scale.
3. New channels to market: Think about which customer segments strategics serve, and how you could mutually benefit from selling your product through their unique channels to market. The strategic could benefit from new and novel products added to their lineup, and the startup through new channels and possibly new customer segments. Revenue sharing or licensing are common structures in commercial agreements here.
The takeaway: Corporate investors can be the missing piece of the puzzle for meal-kit startups.
The way we are purchasing and consuming food is shifting. Entrepreneurs, investors, and large food and food service companies have just begun to innovate and capitalize on these changes. Yet as grocery stores, restaurants, and food companies have known for decades: food businesses are competitive, easy to copy, and difficult to execute profitably. We are at the stage where business models have matured enough to make them appealing to large food companies, and the startups have grown large enough where corporations deliver value and benefit as well.
This development bodes well for both financial and strategic investors as they look ahead to opportunities to exit. While IPOs may work for a select few market leaders, options could run dry for startups who fail to grow fast enough or grow profitably. Startups which cultivate the right strategic relationships early on can benefit from becoming stronger businesses with more and better options for their future exit.
Brett Kadesh, Deborah Zajac, and Will Geiger are early stage investors at Touchdown Ventures, a Venture Capital firm that partners with corporations to launch and manage their corporate venture capital efforts.
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