Restaurant Delivery: Are the “ODP” the Industry’s “OTA”? Part I
By Christopher Muller
The entire restaurant industry, from the simplest quick service joint to the most complex fine dining jewel, is caught in a veritable frenzy of delivery. It may be, unfortunately, a very risky path to travel for the uninitiated restaurant operation, but delivery is driving the investment community to a fever pitch. [1] We have entered into the time of the restaurant On-Line Delivery Provider (ODP) which mirrors in many ways the On-Line Travel Agent (OTA) which has so disrupted the lodging industry.
In two complimentary BHR articles here, we present a look at the 8 different models of restaurant delivery and how they are affecting both senior management and customer choices.
A Quick Lesson From Pricing History
For observers of the global Hospitality Industry this should send up warning flags. In a galaxy far, far away, the Lodging industry managed revenues by using simple seasonal or attribute pricing models (On-, Shoulder- and Off-Peak rates, or premiums for “A Room With A View”) and sold some limited excess inventory through a network of independent Travel Agents (at an onerous 10% commission!).
Then, as the Internet expanded, and the travel market imploded after the 9-11 tragedy, a new and exciting model emerged – the On-Line Travel Agent (OTA) acting as a third party aggregator appeared. Hotel companies willingly gave open access to all of their unsold room inventory to the OTAs (Expedia, Travelocity, Priceline, Booking.com, Kayak, Trivago, etc.) to sell directly at deep discounts, often between 25 and 30% off posted Rack Rates. Occupancies rose, but Average Daily Rates plummeted, and profits quickly diminished. Hotels, relying on the old pricing models were caught competing “with themselves” and watched as formerly loyal customers switched their buying habits and loyalties to the OTA that gave them the best rate. Customers could scroll through pages of prices, often for the exact same room in the same hotel, searching for the cheapest rate. Hotel rooms, instead of being unique destinations became interchangeable commodities.
It has taken almost twenty years, but through brand consolidation and a total system-wide transformation into a Revenue Management based pricing model, the hotel business has been transformed and the OTAs are being aggressively challenged for dominance. This should be a lesson for the restaurant owner/operator, the OTAs drove nothing but price as a decision attribute, the ODPs are poised to do the same thing with both price and convenience, unfortunately restaurants probably won’t have decades to recover.
Today’s Restaurant Delivery Frenzy –The Rise of the ODP
Whether it’s the savvy but shape-shifting Millennial, the rapidly aging Baby Boomer, or the rising young digital native from the i-Generation, it seems that customers in all shapes and sizes just want to have their meals brought to them at home, the office, or somewhere in between. Breaking the code of the delivery model—becoming the customer’s choice of who serves up breakfast, lunch or dinner at home, work or play—has emerged as the Holy Grail of the foodservice business. But it may be more like the other mythic Dark Ages metaphor, the Plague, potentially killing upwards of 30% of existing restaurant units.
So, what exactly is “delivery” today, how did it evolve into such a big, expanding component of the restaurant offering and what are the implications going forward for the industry? Just how do the On-Line Delivery Providers, the ODP, dominate the market?
We can begin by agreeing that delivery is a distinct and rapidly growing distribution channel, although it has been around in one form or another for a very long time. And while not exactly a new technology, nor necessarily a profitable one, the exploding market for the delivery of food is poised for an inevitable shake out as it quickly approaches a mature phase consolidation.[2]
In late 2018 delivery is all about instant gratification, not just for the diner but some would suggest for the restaurant as well. At first glance, it all feels so simple and easy. But like so much in restaurant management, there is more than one way to get something done, even the simplest of things.
Emerging Key Success Factors
Like so many emerging business models in the on-line digital age, food delivery is developing its own metrics and factors to be considered and mastered. While still evolving, among these now are:
- Addressing the profit challenges of “The Last Mile” in the delivery chain
- Minimizing the high cost of Customer Acquisition
- Developing an integrated APP, website, tablet and smartphone ordering platform
- Designing the most effective delivery driver fleet system
- Establishing an attractive and competitive user fee basis
- Creating positive and immediate Brand recognition
- Building a proprietary Knowledge Base of data storage, analytics and access
Delivery of food, especially from a restaurant to a consumer, has become a multi-billion dollar segment of the industry. Some are predicting that it will overtake the traditional dine-in segment completely within a decade, although the complexity of getting it right and turning a profit while doing so, can still be elusive even for the largest players. And of course, no one should forget that Amazon is over in the corner waiting to see how things evolve in an online delivery world they basically invented.
Traditional and Controlled
As noted, the delivery of food from a restaurant directly to a local customer is not a new idea although traditionally the customer came to the restaurant and picked up or carried out their food order. Both delivery and carry-out were best suited to a restaurant with a simple, easily transported menu. Where a significant amount of the value of the meal was the dining experience and table service, meals to go were often comprised of a package of leftovers or the long gone term “doggie bags.”
Here is a look at four models with some measure of control for restaurant owners and operators over the quality and profitability of their offerings.
1. The Independent – One Shot
As a service provider a restaurant may decide that in order to meet the needs of its local customer base it should provide a delivery option. At one time, only a few restaurants in an urban core would have delivery offers and these might typically be delicatessens or Chinese restaurants with few seats and a very strong focus on offering takeout options. The food can be cooked, boxed, wrapped and brought quickly to an office or apartment within a few blocks on foot or by bicycle.
This model is the most basic – a caller, the kitchen, and an employee bringing hot food directly to the customer. The restaurant controls the quality, manages the relationship with the diner and absorbs the full cost and all the revenues. It typically comes with higher operating costs for labor (primarily from an in-house paid delivery driver fleet) and with premium rent from the need for an attractive customer-facing retail space. On the plus side, all local customer information may be controlled by the restaurant and there are no fees to share with an outside third-party service.
But as the independent operator reaches for the brass ring on the delivery merry-go-round, they also need to be careful not to lose their grip on their existing ride. A new distribution channel can be much more challenging that just taking a customer order. As noted by Jennifer Marston:
…restaurants are under pressure to adapt…More and more, that means altering the physical restaurant space so it can better accommodate this influx of new orders. Extra meals require extra bodies to cook and package the food, after all, not to mention extra space for third-party devices, and somewhere to put completed orders waiting to be picked up by a delivery driver.[3]
An interesting twist on this single restaurant model of trying to find a way to both control and expand the delivery system while maintaining some measure of profitability is one recently proposed in the restaurant trade magazine Restaurant Business Online:
He (CMO Nabeel Alamgir) explained that Bareburger is already striving to convert customers ordering through third parties’ apps into users of the chain’s own channels. Patrons of an Uber Eats or Postmates might be offered a 10% discount on their next order if it’s placed through Bareburger’s website. The chain can afford a discount that deep because the financial impact is still less than the 20% or 30% discount an outside service typically charges.
Alamgir noted at the start of the panel’s presentation that a service started by restaurants for restaurants would have been an attractive alternative to some of the third-party giants. “Let’s make our own platform. Let’s make our own Grubhub,” he said.[4]
2. The Cloud Kitchen – A Hub & Spoke System
It can be argued that today’s focused delivery channel began in earnest when Domino’s offered up a “30 Minute or Free” guarantee in 1973. In order to make this guarantee effective, the company created a hub and spoke system, in effect building a series of franchised units in low cost locations. They were characterized by being geographically market-centered but with no need for a “High Street” customer facing address. This was directly in contrast to the overwhelming market advantage owned by Pizza Hut and its network of “Red Roof” full service pizzerias with their focus on dine-in and takeout service. But the competitive advantage that came from having units with no dine-in, limited customer carry-out, and which were serviced by a central commissary set in motion the shift away from the traditional eat-in model.
“The reality is, when the red roof restaurant was created, the idea of delivery wasn’t part of the concept,” said Pizza Hut chief executive David Gibbs, a 26-year veteran at parent company Yum Brands…”so in many cases, our business has outgrown the capabilities of those restaurants…”[5]
Now, four decades later Domino’s is the world leader in delivery, pizza or otherwise. It has done this by controlling the entire process or what is called the “full stack” in the delivery cycle. Now describing itself as an IT and logistics company that sells pizza, the backbone of the system is that they control the customer ordering process, the production quality process, and through a vast franchise network the delivery process.
Next to come, using new GPS and AI technologies, Domino’s predicts that it will be able to make deliveries not just to a formal building address, but to anywhere a customer can be located by tracking their cellphone, even if that is a park bench or a blanket on the beach.
But Domino’s is not the only leader to be expanding its Cloud Kitchen delivery system. Already designed on a commissary production system model, giant fast casual leader, Panera Bread, tested delivery in Boston and then announced an expansion across the United States in early May, 2018 with a system based upon using its own delivery drivers. [6] Following the trend in October the largest chicken sandwich chain, Chick-fil-A, announced it was beginning to test the hub and spoke model of delivery in Nashville, TN and Louisville, KY.
Chick-fil-A is opening two new restaurants that don’t have something you commonly associate with the chain: seats.
Chick-fil-A, the Atlanta-based chicken sandwich chain, is testing catering and delivery locations in Nashville and Louisville, Ky., that will open this month.
The locations, according to an announcement on the chain’s website, have no dining rooms or drive thru’s and are designed to be hubs for catering and delivery orders. The restaurants will not accept cash, either.[7]
The Cloud Kitchen model can be very effective for restaurant companies with large enough scale, whether in a single city or across a region, to take advantage of a single production kitchen site with remote staging kitchens. Ultimately the “full stack” control from order to front door can come from as few as three restaurants or as many as 3000. This also means that the foundation is laid for vast proprietary customer data collection and eventually data mining by the most forward-looking operators.
It can be argued that the Food Truck movement of the past decade is a subset of the Cloud Kitchen model. By most local health code laws, food trucks must have a “home kitchen” or commissary for their bulk production that meets all health and sanitation code requirements. In many urban centers, to be successful a food truck company needs to have multiple trucks on the road acting as a distribution network. While this is also a classic Hub & Spoke model, it comes with similarities to a model in the next article, #6 The Consolidator, with distribution on a bus stop route and not a one-to-one last mile taxi route.
3. The Ghost Kitchen
One further refinement of the Cloud Kitchen is the Ghost Kitchen. As delivery becomes more of a threat to the traditional dine-in restaurant option, some suggest that this model, in fact, is the future of restaurants—basically a highly efficient hybrid of menu concepts, specialized production and logistics, and low labor cost with no eat-in customers.
In that way, this model is identified by three key components.
First, it removes the dining room or takeout from the restaurant completely, working out of a kitchen whose location is based on nearness to its core customer market yet in a typically low rent out-of-the-way space.
Second, it does not hire any paid employees to deliver, instead making use (through partnership or agreement) of the many third-party delivery companies like GrubHub, Postmates or Doordash.
Third, and possibly the most important, because of the flexibility of only needing an APP, website or traditional telephone ordering system, more than one cuisine can be produced in the same kitchen space. Easy to prepare, cook and deliver foods such as salads, sandwiches, Asian and other ethnic dishes, or gourmet pizza can all be offered while cross-utilizing similar ingredients in creative menu offerings.[8]
This can best be described as an “order only” restaurant. The most prominent or well-known of these Ghost Kitchens would be Green Summit (see transition to #8 Dark Kitchen in Part 2). While garnering a good amount of press, the celebrity chef David Chang’s Maple, closed its operation in 2017 with some assets moving to London and the delivery company Deliveroo.[9] Chef Chang sold the physical kitchen space, Ando, to Uber Eats after ceasing operations in January, 2018. [10]
Because no customer ever sets foot through the front door the owners can put all of their investment in kitchen equipment and the technology of ordering. A Ghost Kitchen offers customers large menu choices, and just as its cousin the Cloud Kitchen, has the option to keep track of its own proprietary customer data set through the direct ordering process. The tradeoff is that ownership sacrifices the customer interface at delivery of the Cloud Kitchen model. Operating and start-up costs are low and efficiency can be very high. The risk is that a large portion of the margin (sometimes up to 30%) from market-driven menu prices is taken by the delivery partnership, who also control the brand image when customers receive their orders off-site.[11]
4. Virtual Restaurants
Along with disrupting the taxi business, Uber Eats is about to globally disrupt the restaurant delivery business. As of October, 2018, Uber Eats had over 1600 “virtual restaurants” around the globe, with almost 1000 in its US partnership portfolio. The majority of these are not the Cloud or Dark Kitchen models mentioned above, but are existing restaurants with new brands that only exist through Uber Eats. This model, while charging very high fees to the restaurant, allows them to technically not compete with themselves in the home delivery marketplace. Uber Eats gains more menus to offer, and limits any need for an investment in a commissary space.
For SushiYaa, Kim says the virtual restaurant concept has been transformative. “Because this concept worked so well for us, we actually changed one of our restaurants from a sushi buffet concept to a regular restaurant with 8 different virtual restaurant brands inside it. The buffet sales weren’t doing so well and the delivery side was doing better, so we thought — let’s change it completely so we’re focused more on delivery.” From a sales standpoint, he says it’s “almost as if we have another restaurant without paying additional rent and labor, even though [Uber Eats] takes about 30 percent.”[12]
One other type of Virtual Kitchen involves the licensing of existing restaurant recipes and menu items in a curated virtual model. The start-up concept Good Uncle is using this to compete in the university meal plan segment, offering a range of pricing options for higher quality prepared meals, delivered by their own delivery fleet using the bus stop common drop off method. This is a limited menu, limited target market, which benefits from a direct marketing approach, lower operating costs, and uses both a subscription and premium fee based pricing system.[13] It is a Virtual Kitchen because there is no restaurant or other customer facing facility, it exists only online.
Part One – Conclusions
Delivery models, some traditional, some evolving, offer many opportunities for restaurant operators, especially those in the QSR and Fast Casual segments, where speed and price and convenience are the drivers of consumer choice.
The challenge in today’s delivery market is how owners and operators can maintain both high quality and long-term profitability in the products/services they offer. For many meals, the time and distance from kitchen to table can be more than 30 minutes or multiple miles. Quality of presentation and flavor may quickly diminish. More importantly, where the medium annual profitability for restaurants across all segments in the USA is considerably less than 10%, losing up to 30% of top line revenues is not a path to a successful future, (even if total sales increase by 20%).
Christopher C. Muller