Food Delivery – How Appetising is this Market?

Social distancing measures ushered in to prevent the spread of COVID-19 have resulted in a crisis for the hospitality industry, in particular indoor dining. With restaurants scrambling to mitigate their losses, they have resorted to outdoor dining, in-store pickup, but most commonly, food delivery. By partnering with the likes of Deliveroo, this has allowed restaurants to stay afloat. As a result, the already-growing foodservice delivery market (estimated to be worth around £8.5bn in 2019) received a boost in a slowing economy.

Deliveroo has had 11,500 new restaurant partners join its platform since March and have increased its riders from 25,000 to 50,000 over the course of 2020. With Deliveroo announcing “a potential IPO”, however, is the pandemic enough to change consumer behaviour to create a new norm for dining? More importantly, what does this mean for investors?

The coronavirus crisis has meant that a transformation that was projected to take several years has now been fast-tracked to just months, as digital and delivery penetration in the restaurant industry was already gaining momentum before the pandemic.

John Glass, an equity analyst from Morgan Stanley, says that: “we see total online food delivery—through online delivery platforms and restaurant self-delivery—of $45 billion in 2020, vs. our prior estimate of $41 billion in 2021…”

Glass’s estimates show how the growth of food delivery platforms has accelerated, and a migration to mobile app orders also means the industry will benefit, since mobile usage can result in better margins, and also the collection of consumer data.

Evidence of the growth in food delivery can also be seen in one of Deliveroo’s competitors, UberEats. Operating in over 6000 cities, gross bookings of Uber’s delivery business were at $8.55 billion in the third quarter of 2020, growing by a significant 134%.

Food delivery apps have also been placed highly in terms of market valuation, with American leader DoorDash (NYSE:DASH) recently valued at $16bn. Deliveroo, following its Series G funding in August from American multinational Amazon, to the tune of $575 million, has raised $180 million in new investments, pushing its valuation to $7 billion ahead of its potential IPO.

Despite all the promising statistics and evidence of digital progression in the restaurant industry, we cannot neglect the potential drawbacks of food delivery apps.

One of the major questions surrounding delivery services is profitability. This issue boils down to the fact that delivery via smartphones is a venture-capital-funded sector, meaning that profit maximisation is not a necessary condition for its initial operating years. Deliveroo itself has been loss-making for several years, but its CEO, Will Shu, has stated the growth during the pandemic has made it profitable at the operating level for the last six months.

Profitability is also hard to achieve when we analyse the competition within different apps themselves. Food delivery apps are very undifferentiated, with only 36% of diners exclusive to one platform. Moreover, low average order values make it difficult to deliver food profitably, with the majority of transactions being $6-7 per person. Hence, leading aggregators use aggressive discounts and free delivery to lure diners, leading to negative earnings.

Disputes between delivery apps and restaurant owners over commission also pose a problem, with owners stating the need to lower the amount of commission they take on each delivery as they struggle to alleviate their losses. Deliveroo takes up to 35% commission plus VAT and seeing how American policymakers passed emergency bills to cap the apps’ commissions, a similar path may be taken by Britain, which means higher prices for consumers and lower profits for the delivery apps.

A potential saviour for profits is drone and autonomous delivery, but it will largely depend on the development of these technologies.

Food delivery has become one of the most closely watched sectors, with a boom in activity during the pandemic. However, whether the demand for delivered food will remain in a post-pandemic world will depend on whether a new norm for dining has been created. If there is a continuation of growth in this sector, and food delivery firms can achieve profitability, then this market is definitely one to watch.