Why Your Favorite Restaurant Struggles
In Part I of our series, we wrote about the “Winner-Takes-All” strategists and how they fuel their company’s growth with venture capital to acquire market share at any cost. Will they be able to sustain their strategy now that venture capital is drying up? No, they won’t. In fact, they’ll need to turn a profit by increasing the cost of their service, which is unsustainable for restaurants. Let us explain!
We all know monopolists can charge any price, right? Well no. They can’t. They can charge any price as long as it doesn’t exceed the maximum range that their customer is willing to pay. In practice, many service delivery platforms have established market dominance by rapidly growing their company with the help of venture capital. At the same time, they’ve been turning a loss year after year.
Now that venture capital is drying up, they need to increase their profitability by increasing their revenues. They’ll be out of business if they don’t! This means that they have to increase the prices of their services, becoming more expensive for the restaurants that use the platform to advertise their business. The reality of the situation is that for many restaurants even a slight increase will mean the delivery service becomes unaffordable, and unsustainable.
How food delivery & takeaway platforms make money
To better understand why, let’s zoom in on the five major revenue streams for platforms in the food delivery & takeaway space:
- Commission fee per order, depending on whether it’s a delivery or takeaway order (15–30% per order)
- Delivery fee if the platform facilitates the delivery ($2–5 per order)
- Customer service charges, subscription models (variable fee)
- Administration costs for the restaurants ($0,21 per order surcharge)
- Optional: in-app advertising (variable fee)
In some cases, the tip given to the delivery driver is the main source of income for said driver. Because of this, platform services can afford to pay a lower wage to their drivers. Whilst this doesn’t directly impact the restaurant business, it goes to show how even tips are further inflating the prices at which consumers can get some food on their table, and to which extend the base unit economics of the delivery model do not work.
How is the value of an order and its premiums divided between the participants of these transactions?
Effectively, a 47% premium is paid for the delivery service and platform transaction by the consumer.
But a merchant receives about 61% of the value that is paid by the consumer to place the order. About 24% of this value (consisting mostly of the tip paid) ends up over at the drivers. That leaves 15% for Doordash for its business revenue. 39% of the amount paid ends up over at Doordash & it’s drivers.
With this significant premium being paid by the consumer, you would expect that there’s enough room to make a profit. Think again.
Below, we will start with the core participant of this process, being the restaurant merchant. A detailed breakdown of the unit economics and cost structures of ‘Winner takes all’ platforms is covered in one of our future blogs.
So, how much margin does a restaurant make?
It is clear that the delivery commissions take up a large portion of the restaurant’s business. It is the most commonly criticized side of the business. Of course, it wouldn’t be an issue if restaurants had a healthy margin to start with. Sadly, that is not the case. To demonstrate this, let’s dive into the three major cost drivers that restaurants face:
- Food: 28–32%. Ingredients come at a price.
- Labor: 28–32%. Chef’s need to prepare your meal.
- Housing: 22–29%. To have a kitchen.
This means that on average a restaurant spends 78–93% of the money paid by customers on these three simple necessities. To put it differently, a $30 meal costs the restaurant $25.65 on average leaving $4.35 on average in profits. That is, if it wasn’t for the 15–45% commission & delivery fee per order that comes on top or the service fees and advertising fees. The reality is, restaurants are losing money on platform & delivery fees.
For this specific mathematical example, we calculated with a flat 30% platform & delivery fee for explanatory purposes but as you can see in the DoorDash segment above the actual amount of value that ends up with the platform and its drivers can go up to 39% (or sometimes even higher).
Restaurants lose money on take-out, because of the steep platform & delivery fees. So why don’t they just give up on it? Restaurants are reluctant to give up on delivery, because they need economies of scale in order to offset their fixed operating costs. Continuing takeaway and delivery services at a minor loss can still be beneficial. And they probably will so long as the fees don’t increase, and the amount of online orders versus in-store orders stay fixed at current levels. However, in the preceding years we’ve seen that the number of online orders is only growing, and so are the commissions.
Where do we go from here?
In the next episode, we dive into why restaurants have been putting up with losses as a result of third-party delivery services. Furthermore, the percentage increase of commission fees coupled with the growth of online orders sets the stage for either restaurants to abandon delivery services in the future, or the massive increase of restaurant prices.
However, there’s also a move towards sustainable platform services facilitating online food ordering against lower fees that could usher in a change in the food delivery & takeaway industry.
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Bistroo is a peer-to-peer marketplace for food & beverages, powered by the BIST Token. Bistroo is a pioneer in the blockchain-based food industry, building protocols that empower the merchants in an ecosystem that also benefits the customers.
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