Cloud Kitchens and The Art of Food Delivery

#WaterBridgeVentures #FoodTech #Perspectives

If you are one of 300 Million internet subscribers in urban India and own a smartphone, then chances are that you have ordered a meal on Swiggy or Zomato in the recent past and will continue to do so at-least once every week.

The online food delivery market in India is estimated at $4 Billion (Jan 2020) and is expected to grow at a CAGR of 25–30% to reach $8 Billion in the next 3 years¹.

This whopping growth is attributable to positive macro growth drivers such as rising disposable income, growing digital infrastructure, increasing smartphone penetration on the one hand and changing consumer demographics such as rising number of women in the workforce, desire to explore new cuisine varieties, preference for discounts and convenience on the other hand.

The massive growth in the space is associated with the large levels of funding in these delivery platforms, which account for the largest slice of the whole food-tech pie²

This infographic, sourced from ‘Demystifying the Online Food Consumer’, Jan 2020 — BCG & Google

While food delivery platforms have taken the centerstage, one of the emerging business models which rides on the growth of food delivery is ‘Cloud Kitchens’.

What are Cloud Kitchens

For those of you who have been living under a rock, cloud kitchens (also known as dark kitchen or virtual restaurant) are delivery-only restaurants with no dine-in facility. These kitchens (for the most part) accept orders through online food aggregators like Swiggy and Zomato.

Considered to be a low-investment, low-risk and high profit format, cloud kitchens are seemingly the answer to increasing real-estate prices and decreasing space availability. But, are they really?

WaterBridge Ventures, with our VC lens on(and that too as an early stage, first institutional investor) went out on a hunt to form a view on the business models, scale and profitability potential and what that means for emerging cloud kitchen companies.

Different formats of Cloud Kitchens³

There are 4 main sub-formats that exist:

1. The single brand, single kitchen — small footprint (~500 square feet) of a kitchen

2. The Multi-brand Cloud kitchen — or as is popularly known, the Rebel Foods (erstwhile Faasos) Model — single kitchen, multiple brands, multiple outlets

3. The Hybrid Cloud kitchen — Single brand, single kitchen, multiple outlets with a storefront. Freshmenu has a few outlets where customers can see the quality of the kitchen for themselves

4. The Delivery-App owned Shell kitchen — or the Swiggy Access model, wherein the aggregator (Swiggy) takes care of the leasing, construction and setting up of the facility. A shell of a kitchen fitted out with gas, drainage and ventilation systems greets restaurant partners, who are invited to move in their operations and take responsibility for the menu, kitchen equipment and staff, while Swiggy takes care of delivery and fulfilment.

Key Success Factors for Cloud Kitchens

There are 4 primary factors which will decide success or failure of the cloud kitchen model.

1. Brand Power — Without a physical restaurant or storefront space, brand recall and recognition become all the more important in the case of cloud kitchens. A high recall in the mind of the consumer, along with associated value recognition such as cuisine, unique packaging, value for money etc. will help the cloud kitchen business thrive
2. Cost-structure efficiency — Having done away with the cost of prime real estate for a storefront and wait & service staff, there is not much room for these kitchens to manoeuver from a cost-structuring point of view. Ingredient cost is the only cost in the kitchens’ control, with discounting and delivery costs being decided by the aggregator platforms. This cost has to be balanced with the quality of ingredients sourced, which will ultimately affect the final product and thereby the entire customer experience.
3. Supply Chain management — Industry leader in food delivery — Domino’s, with 1,200 stores across 271 cities — credits its operational success to its state-of-the-art supply chain infrastructure. Efficient management of the supply chain, including fresh produce, raw ingredients and cold-storage items will play a key role in determining the longevity of the cloud kitchens’ business.
4. Food Quality & Pricing — In the absence of service level associated with in-restaurant dining, food quality and pricing become key determinants in maintaining customer satisfaction. The kitchen will be in competition with all food delivery joints in the microcosm of the neighbourhood. Given that cloud kitchens appeal to customers for the convenience of delivery and repeat purchase, the kitchen cannot price its’ food at a premium and average price per meal will have to hover in the INR 200–300 range.

Leading cloud kitchen operators

1. Rebel Foods (formerly known as Faasos)⁴ — The 800-pound gorilla in the Indian Cloud Kitchen Industry, Rebel started as Faasos in 2004 in a QSR format with storefronts. After shutting down the outlets and 4 pivots later, Rebel today boasts of being the largest cloud kitchen company in India with 11 different brands under its umbrella — the more popular ones being Behrouz Biryani, Faasos, OvenStory and FirangiBake. It has a presence across 18 cities in India with 325 kitchens. The multiple brands, with focus on different cuisines, capture a larger share of the wallet across different days of the week, seasons & occasions.

Rebel Foods Cost Structure

• Revenues — INR 3,100 M in FY 19 (100% growth over FY 18)
• Losses — INR 1,300 M (75% increase over FY 18)
• Contribution Margin — ~1%
• Advertising & Promotions — INR 729 M

Clearly, ongoing marketing expense on each of the brands is needed for them to have continuous recall and recognition.

According to various sources, majority of the marketing money right now is being spent on Behrouz Biryani, Faasos and Oven Story. It is not an accident therefore that beyond these 3, the other 8 brands do not come to immediate recall. Rebel has already started expanding into South-East Asia and Middle East, as the picture is becoming clearer that with scale, costs in India are only going up.

Rebel has raised total funds of $300 Million, with investors like Goldman Sachs, Coatue, Gojek, Sequoia, Evolvence India, Lightbox Capital coming on board during different rounds.

2. FreshMenu⁵ — FreshMenu has kitchens in Bangalore, Mumbai and Delhi NCR — 38 kitchens, 900 delivery executives and currently delivers around 21,000 orders per day. FreshMenu clocked revenues of INR 1,400 M in FY 19, showing a flattish growth over the INR 1,200 M revenues in FY 18. This could be attributable to lesser marketing & promotions (INR 124 M marketing spend in FY 19, down from INR 154 M in the previous year).

FreshMenu seems a lot more capital efficient having raised funding of $25 Million and its investors include Lightspeed, Zodius, Brand Capital and GrowthStory.

3. Box⁸⁶– Box8 was founded in 2012 by two IIT grads who wanted to bring Indian food to the delivery market. Today, they serve over 22,000+ meals per day across their 100+ outlets in Mumbai, Pune, Bengaluru and Gurugram. Box8 had revenues of INR 820 M in FY 18 with advertising expense of INR 41.5 M

Box8 has raised total funding of $27 Million and investors include Mayfield, ReDefine Capital Partners and IIFL Wealth Management.

Other notable companies are Eat.Fit (the food delivery and subscription arm of cure.fit — the integrated health & fitness platform, which has raised $400 Million and operates the Cult Fit fitness centers) and Swiggys’ own The Bowl Company and Homely.

Key Metrics Comparison⁷

• Eat.fit has a large number of subscription members, hence the high number of orders. Its delivery costs are lowest in the industry due to large number of subscription meals and slots which help with better supply chain management.
• Delivery costs are in the range of 20–25% for all players, except Eat.Fit due to efficient supply chain management
• Delivery costs are high for The Bowl Company and Homely as all orders are catered by their own fleet

Average post-discount order value is INR 210. Companies are constantly running promotions to drive sales. Further discounting by the aggregator leads to high volume of sales, which dip when the discount is taken away.

Funding Raised by Cloud Kitchens⁸

The funding raised by the leading cloud kitchen players cumulatively stands at one-fifth of the total funding raised by aggregators Swiggy ($1.6 Billion, with the latest round of $113 Million in Feb 2020) and Zomato ($ 900 Million), indicating a much lower level of VC interest in the cloud kitchen space.

This infographic, sourced from The Ken (https://the-ken.com/wp-content/uploads/2019/10/Faasos_2-1-810x676.jpg)

What is even more interesting is the non-classical VC fund raise that most of the cloud kitchen companies have undergone (small amounts raised over frequent, multiple rounds), which is a function of evolving business models and multiple pivots these companies have gone through.

Key Takeaways & Conclusion for Cloud Kitchens

There are about 450 start-ups (publicly available information) under the business model “Internet First Restaurants in India”, of which 222 are not operating anymore and 8 have been acquired. Of the remaining 222 companies, only 26 are funded and of the 26 funded companies, only 5 have raised Series B+ funds.

Scale and profitability in the cloud kitchen space is a challenge and the jury is still out on whether any of the market leaders will become profitable in the foreseeable future.

Struggling profitability has to be the main reason behind a 50% failure rate for the start-ups in the space (which is, coincidentally, similar to the traditional brick-and-mortar restaurants failure rate). When the scaled-up market leaders are not near healthy contribution margins including industry leader Rebel (with 325 kitchens, 11 brands has a CM of 1%), it is possible to understand the fate of emerging & fledgling cloud kitchens.

Big ongoing spend required for brand building and recall — It is a bit of a vicious cycle — that unless a cloud kitchen operator has multiple brands, it will be difficult to scale. But while multiple brands might not need multiple separate kitchens, they will need individual marketing spends, further driving down profitability

Staggered Funding — Of the 26 funded companies in India, only 5 are at Series A & B rounds and 5 in Series C and beyond. The multiple fund raise rounds accompanied by small amounts of money being invested indicates a lack of strong VC interest in the space

Global Analogs lacking — There are no cloud kitchen players of significant scale around the world. Of the top 10 companies worldwide by total amount of funding, 4 are Indian companies and 3 are deadpooled/acquired. The two deadpooled companies in US had raised significant capital before they shut shop:

• Munchery (SFO) had raised $124 Million from Menlo Ventures, Sherpa Capital, Greycroft Ventures and others. https://techcrunch.com/2019/01/21/munchery-shuts-down/
• Sprig (SFO) had raised $58 Million from Greylock Partners, Social Capital, Accel and others. It shut down due to heavy losses from the business model which made them unable to pay workers, premises bills and for necessary products. https://techcrunch.com/2017/05/26/on-demand-food-startup-sprig-is-shutting-down-today/

It is the food-delivery-aggregator companies that have managed to amass funding over the globe also. Some examples are Deliveroo (UK, $1.6 Billion), Delivery Hero (Berlin, $1.8 Billion), Door Dash (USA, $2 Billion).

Our conclusions

• There is limited scalability for single brand cloud kitchens
• To differentiate, companies will need to spend on setting up larger kitchens to house multiple brands. They will then, have to build and sustain each of those brands
• To drive volumes and compete, companies will have very low manoeuvrability to increase pricing. They will also be squeezed by the larger aggregators on discounting and delivery pricing
• Business model is not friendly for profitability at scale
• VC funds have been wary of the space and therefore other avenues of investment have to be pursued but those are not obvious either, given the high failure rate in the restaurant industry in India

Having said that, demand for online food delivery is not going anywhere. It is safe to say that cloud kitchens will only form a part of this industry as a supply side enabler. Scaling with profitability seems to be elusive for stand-alone Cloud Kitchen business models.

With inputs from Manish Kheterpal

Sources:

1. Demystifying the Online Food Consumer, Jan 2020 — Google & BCG
2. Demystifying the Online Food Consumer , Jan 2020 — Google & BCG
3. www.limetray.com
4. Tracxn, The Ken (Rebel Foods’ appetite for the overseas cloud kitchen pie)
5. Tracxn
6. Tracxn
7. WBV Internal Analysis
8. The Ken (Rebel Foods’ appetite for the overseas cloud kitchen pie)