Restaurant delivery: expect some growing pains.

Jonathan DeVito, Managing Principal | jdevito@pivitasresarch.com

Mathew Mandeltort, Principal Consultant | mmandeltort@pivitasresearch.com

Todd Ruddick, Principal Consultant | truddick@pivitasresearch.com

 

Delivery to the rescue?

The 2019 novel coronavirus (COVID-19) has radically impacted the food industry. That’s obvious.

Perhaps one of the biggest shocks has been the pandemic’s impact on the restaurant sector. Full-service dining in particular has taken a direct hit since operators around the country cannot engage in on-premise dining due to social distancing and stay at home directives. This is a big deal. The foodservice industry is (or at least was as of the start of the pandemic) a trillion dollar industry, with full-service dining account for about $350bn in annual sales and employing millions of Americans.

Limited service dining isn’t off the hook either. For example, even though McDonald’s has non-on-premise dining options, such as drive-thru and takeout (in addition to some delivery), the firm still reported a 15% decline in diluted earnings.

With everyone spending more time apart, the big topic that appears to be emerging is delivery foodservice. After all, if people can’t go to restaurants to get their food, restaurants will need to find new ways of getting food to their customers.

But what does this really mean for the business of restaurants and foodservice? How will the industry adapt?

We may find that transitioning the industry to delivery isn’t a straightforward proposition.

 

The costs of delivery are undeniable. Willingness to pay more isn’t.

The desire to have things, really any category of “things”, available for delivery is an important development in consumer behavior. If we look at retail, about 10% of the market was e-commerce in 2018 with 40% of e-commerce being dominated by Amazon (or 4% of the entire US retail market). Figures have probably gone up since then.

However, delivery, especially the “last mile” is expensive. From packaging to route complexity, it has hard to execute while balancing margins and pricing. For instance, according to the Capgemini Research institute, 97% of retail executives surveyed in a recent study said that current last mile delivery strategies are not sustainable.

And the issue of balancing costs and pricing is arguably more severe in the food industry than non-food retail. If we look at disposable personal income (DPI) in the United States, food spending as a percentage of overall DPI drastically declined since 1960. In 1960, Americans spent about 16-18% of their DPI on food. By the late 2010s, this was well under 10%. In other words, the slice of the spending pie that Americans allocate towards food, in relative terms, is shrinking. This may mean that willingness to increase spending is weaker in food than other categories. This is concerning since the costs of delivery will need to come from somewhere and, as will be discussed, restaurant margins are already remarkably thin.

Stuck in the middle.

Margins are often slim in the restaurant industry.

Profitability dynamics vary widely by restaurant operator type, sophistication, and positioning, with margins often correlating inversely by operator price-point. In other words, fine dining operators frequently have some of the lowest margins while quick service operators typically have some of the highest. However, when we talk about absolute profitability, high-priced operators have large ticket items that can offset low margins. For example, a fine dining operator may incur 25% food cost on a steak, but this is offset by the fact that a steak might be $50. Conversely, a QSR might have more options for very high margin items, like soft drinks or french fries, but many of these items are only a few dollars.

These are simple examples and do not represent actual operating margins or absolute profitability after accounting for things like labor, waste, and energy usage. Generally speaking, however, many restaurants are ultimately pulling single digit pre-tax margins. And of course, many others aren’t making any money at all, which is probably why we have shows like Kitchen Nightmares.

Delivery puts many in an even more precarious position. For example, a restaurant exploring delivery may need to hire deliver drivers, invest in takeout packaging, and pay for additional insurance liabilities. And if consumers are not willing to foot the bill, operators are faced with pressure on margins.

Many have turned to third party delivery due to preexisting delivery infrastructure, but this has been anything but a silver bullet. The pricing market for third-party delivery is scattered, but across the board it tends to be expensive. Fees can often exceed 25% which is far more than the single digit margin tight walk that operators are often faced with.

A GrubHub pricing example. Source: GrubHub

Also, delivery may be the “way of the future” in some cases, but that doesn’t mean the average operator can wait for this future. A recent Wall Street Journal article highlighted that most restaurants have only 16 days of days worth of operating cash on hand at any given time. This figure should not be surprising given that many restaurant expenses are paid on terms that generally hover around 10-15 days, meaning that the restaurant business truly is a day to day industry. In other words, two weeks of operating cash doesn’t constitute an actual reserve, it is money that has been accrued in advance of paying bi-weekly bills. Piling cash into a space to aggressively build a new model and/or acquire share, despite initial losses, isn’t a feasible strategy for many operators, especially independents.

 

Delivery breakfast?

Delivery works for some operators and not for others. Thousands of restaurants are being impacted by COVID-19 and the switch to delivery will be much easier for fast casual and quick service restaurants than full-service operators. The reason for this is that a major driver for visiting a full-service restaurant is experience and sociality. For example, breakfast is a daypart that is often built around social elements, like breakfast meetings or gathering with friends for breakfast on a weekend. Having full-service breakfast restaurants convert to delivery defeats the point in many cases. This is also true for fine dining or destination restaurants.

 

Execution.

Food is perishable and some types of food hold better than others. For example, fish often “holds” well and soup can be reconstituted with liquid in the event that it dries out or becomes overly thick. An 8oz filet mignon, on the other hand, may irreversibly lose flavor and texture during transit to a consumer’s home. Fried foods, often a classic delivery category, are another challenging category since these foods can easily lose their “crunch” or become soggy while in transit.

In addition, the concept of holding time adds another layer of complexity in regards to route and fulfillment strategies. Since different foods hold for different time periods, some customers may need to have their food delivered earlier than other customers, regardless of whether or not that customer was first in the ordering queue. For example, a driver may pick up multiple orders at once from a restaurant, including a steak order and a sandwich order. Even if the sandwich ordering customer has been waiting longer than the steak ordering customer, the latter may need to be served first to ensure food quality. Aside from the logistics, a the sandwich-ordering customer may become angry due to slow service while also being unsympathetic to the restaurant’s need to serve its steak ordering customers first.  If this sounds confusing, that’s because it is. If there were a perfect world for delivery, customers would only order foods that hold well like soup and fish, but in the real world, demands are much different.

Food  safety is another concern. Aside from the perishability of food, one study showed that up to 30% of drivers admit to tasting or trying food prior to customer delivery. That statistic in and of itself should be a cause for pause amongst restaurant operators and consumers alike.

 

Looking to the future.

COVID-19 has functioned as an important catalyst for the rise of restaurant delivery. However, despite growth prospects, delivery does come with a variety of economic and operational considerations that those in the industry should be aware of. Some of these considerations relate to balancing margins and pricing while others are more execution-based, such as food safety issues and holding times.

One final development that is mentioning is ghost kitchens. While this topic could constitute an entire article on its own (and perhaps we might write one, hint), ghost kitchens may allow operators to scale the number of customers they serve without paying for the overhead of maintaining an on-premise dining area. For example, a ghost kitchen-based delivery model isn’t limited by seating capacity and the operator doesn’t pay for on-premise space, which may be severely underutilized or completely empty due to COVID-19. However, in the longterm, ghost kitchens and delivery will need to be weighed against lost experiential opportunities, since on-premise dining allows operators to sell experience and service in ways that are difficult to replicate through remote foodservice. In short, operators, especially full-service operators, sell more than just food to their on-site guests.

As we look to the the future, it’s easy to predict that delivery is here to stay. Adjusting to the growing pains may prove to be a bit more challenging.

 


About the authors

Jonathan DeVito: Jonathan is the Founder Managing Principal at PIVITAS. As a believer that there is no substitute for hands-on experience, he maintains tactical food industry expertise by working at restaurants in the Chicago area. His opinions are those of PIVITAS LLC only, and do not represent perspectives of any other person or organization.

Mathew Mandeltort: Mathew is a recognized convenience store foodservice operations expert. He has held numerous culinary and business leadership roles, most recently serving as Vice President of Foodservice Strategy for Eby-Brown, one of the largest convenience store distributors in the United States.  Mathew received is JD from the Chicago-Kent College of Law at the Illinois Institute of Technology, his MBA from the Lake Forest Graduate School of Management, and his BA from Macalester College.

Todd Ruddick: Todd is a Principal Consultant and growth strategist at PIVITAS. He is also an active restaurant industry investor and operator. Trained as an aeronautical engineer, Todd received his MBA and MS degrees from MIT.

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