Food delivery: understanding the evolving business model

There have been several key structural drivers accelerating the trends towards online food ordering with high levels of funding activity, change in consumer behaviour and technological advances driving an evolution in the landscape. These factors are providing a significant runway for growth.

Changing habits are driving growth in food delivery supply and demand economics benefiting verticals such as food delivery. Consumer behaviour is evolving with the structural offline to online shift in combination with consumer preferences with an increase in the proportion of income spend on food delivery. Technological advances have also been important to the expansion driving down costs, improving the user experience (especially in quality, reliability, and speed) and increasing adoption.

Online penetration has really taken off in recent years as part of the shift online, a theme across many verticals, further accelerated by Covid-19. This has many benefits opening up a wider choice of food and restaurants, faster and easier access with less room for human error and easy accessibility to online menus. These dynamics presents very large TAM’s with high growth opportunities.

The Covid-19 crisis accelerated the structural shift of online adoption increasing order frequency, acquisition of new customers and acquisition of new restaurants, propelling the flywheel and increasing sales.

Figure 1. Source: McKinsey & Edison Trends

The Covid-19 crisis accelerated the structural shift of online adoption by consumers and businesses further driving online penetration growth in local services. In figure 1, you can see the pandemic-related lockdowns accelerating the trend where momentum still continues into 2022. These are the four most mature delivery markets; Australia, Canada, the UK and the US, where they are four to seven times larger than in 2018. This has increased order frequency, acquisition of new customers and acquisition of new restaurants, propelling the flywheel and increasing sales as seen in figure 2.

Figure 2. Source: Deliveroo IPO prospectus

Evolution of the business model: from pure marketplace model to an integrated model

Online food delivery is not new having existed since 2000 with Just Eat (founded in 2001 in Denmark), Takeaway (2000 in the Netherlands), Grubhub (2004 in the US).

The first generation to be digitialised was the search and ordering process through a restaurant-fulfilled marketplace, aggregating the restaurant listings similar to online classifieds. This encompassed mainly integrated business model restaurants that performed deliveries. The pure marketplace model was based on a 10-15% take rate or commission of GMV (Gross Merchandise Value) with costs mainly on building brand recognition to drive customer acquisition. This is a highly profitable model based on low capex and customer stickiness and at scale the network effects create high barriers to entry or more appropriately high barriers to success, resulting in a winner takes all dynamic.

The high profit margin attracted new players, Deliveroo (founded in 2012 in the UK), Postmates (2011 in the US), Caviar (2012 in the US), DoorDash (2013 in the US), UberEATS (2014 in the US), Glovo (2014 in Spain), Foodora (2014 in Germany) and Amazon Restaurants (2015 in the US). These new players differentiated themselves by expanding the offering integrating delivery for restaurants that previously didn’t deliver, creating a logistics-enabled marketplace model, evolving with a higher focus on last-mile delivery. The integrated model had a higher take rate of 22-30% of GMV and in some cases a delivery fee to the customer.

The overall trend has been towards more vertically integrated marketplaces which earns a higher commission or take rate but with more operational risk.

The integrated marketplace model brings advantages from the end-to-end service:

• Optimise and scales network effects with an increased supply side

• Technology increases efficiencies in logistics with faster delivery times and reliability

• Enhancing consumers experience by enabling tracking of their orders in real time

The overall trend has been towards more vertically integrated marketplaces which earns a higher commission or take rate but with more operational risk. In recent years the last-mile delivery has become an increasingly important foundation of business models leveraging the delivery infrastructure by expanding the offering with deliveries from other verticals such as supermarkets and the pharmacy. Broadening the offering the last-mile delivery increases the utility of the delivery for a bigger TAM for additional revenue streams.

Broadening the offering the last-mile delivery increases the utility of the delivery for a bigger TAM for additional revenue streams.

Source: Glovo app homepage (May 2022)

Business model - low barriers to entry but high barriers to success

There are many attractive features of the online food takeaway business model with similar characteristics to that of the online classifieds; low barriers to entry with scalability, high profitability, low capital requirements and highly cash generative. However, new entrants struggle to challenge the market leader as a result of low barriers to entry but high barriers to success. There is a high degree of fragmentation in the market, where there are large number of consumers and suppliers with consumers wanting a broad range of options before making a choice. New well-funded private companies are entering the market with differentiated strategies and business models adding to the competition. With a ‘winner takes most’ attribute once a market leadership position is established moats are created to defend the position from new entrants. Market leadership is generally measured in number of restaurant partners.

Factors for success:

Local network effect

The business model for take-away benefits from local network effects which increases in value with more users and restaurants using them. Strong network effects increase customer loyalty and retention. With more restaurants the utility of the platform for users increases by providing more options driving consumer engagement, while more customers enhances the utility for restaurants, increasing their sales. The logistics element of the model adds in riders as an additional factor creating a three-sided network effect.

Once a national merchant footprint has been established critical mass of restaurants and riders can be achieved by replicating through new market launches, driving consumer adoption. Cost synergies can then be achieved through geographical expansion where the playbook of launching can be shared and the technology can be leveraged.

Economies of scale:

As more consumers engage on the platform this drives order volume and therefore sales for local businesses and more opportunity for riders to increase their earnings. The greater volume of orders in high density areas increases frequency and number of orders for riders, incentivising earning potential and driving efficient fulfilment and performance.

Increasing brand affinity:

The combination of local network effects and economies of scale result in more restaurants, more consumers, and more riders utilising the platform. In parallel, investment into the technology to enhance the service and create innovative features will increase brand affinity and awareness, which will drive down the high acquisitions costs of capturing consumers attention. Scaling of the logistics platform can additionally be a major competitive advantage. Brand is a barrier to entry and is important to create moats to head off new entrants which are often well funded companies.