Covid-19 has changed the world as we know it. Personally, every aspect of my daily life has changed from how I work to how I shop—and I know this is true for many of you.

One industry that has seen a massive surge in demand is food delivery, facilitated by apps like Door Dash, Uber Eats, and Skip the Dishes, among others. We've seen the stock price of food delivery apps rise dramatically in the last few years. If you've used any of these apps in the last few months, I'm sure you've also experienced the sticker shock of your total once you've completed your order, which made me want to investigate this business model.

 

How Do Food Delivery Apps Make Money?

 

So, you may be wondering "how does Uber Eats pricing work?" or "what is the food delivery industry growth based on?" Let me caveat by saying that I've made some assumptions for my investigation; not every restaurant is the same, and every food delivery app is structured differently. For this article, I've used a popular food delivery service in Toronto to benchmark costs based on their pricing and commission structure.

Recently, I had a craving for fish tacos, so I decided to order from one of my go-to lunch spots. They sell three tacos for $10 plus tax. In Ontario, tax is 13%, bringing my total spend to $11.30.  As a customer, $11.30 seems to be a reasonable value for three tacos.

The restaurant can expect to make between $0.50 and $1.50 of profit on my order (depending on how sharply they manage costs). I've come to this conclusion by assuming a 32% food cost, and benchmarking that most restaurants make between 5% and 15% margin after all other expenses (rent, labour, utilities, packaging, etc.)

Good Great
Cust. Cost $11.30 $11.30
Tax $1.30 $1.30
Price $10.00 $10.00
Food Cost $3.20 $3.20
Other Cost $6.30 $5.30
Margin $0.50 $1.50
Margin % 5.0% 15.0%

 

Comparatively, when I order via my food delivery app, the first thing I notice is that the price is $11.50 for the same three tacos. Clearly, the restaurant is trying to offset the commission the app charges. In addition to the $11.50, my order has other extra charges, including:

  • $2.00 small order fee
  • $1.15 service fee
  • $0.99 delivery fee
  • $1.73 tip (optional, but in light of COVID-19 seems reasonable)
  • $2.03 tax (all of the fees less the tip are taxable)

All this included, my total is now $19.40 for the same three tacos!

For those of you doing the math, that is a 72% increase in cost for the customer. 

Good Great
Cust. Cost $19.40 $19.40
Tax $2.03 $2.03
Tip $1.73 $1.73
Delivery Fee $0.99 $0.99
Service Fee $1.15 $1.15
Small Order $2.00 $2.00
Price $11.50 $11.50
Commission $2.88 $2.88
Food Cost $3.20 $3.20
Other Cost $6.30 $5.30
Margin $(0.87) $0.13
Margin % -7.6% 1.1%

 

On the restaurant side, it's not looking much better. Assuming the app takes a 25% commission on the order, the restaurants swings 12% to 14% in margin, making it almost impossible for the restaurant to make a profit using the app. Even with a higher price point, the 25% commission eats up the margin. It is also important to note that 25% is a conservative estimate for the commission; some apps charge up to 35%.

All this math left me wondering if I were to review the current food delivery app model critically, would it still be an attractive option for getting lunch? (or any other meal).

 

Food Delivery Industry Analysis

 

From a value standpoint

Is there value for end customers? Notionally yes, especially in the current situation of Covid-19. The customer is getting food delivered without little to no human interaction. Long-term is there value for the customer to pay an incremental 72%? Probably not. Note that even if I were not to tip and the small delivery fee is waived, my cost is still 36% higher.

Is there value for the restaurant? Short term, yes, it can help keep them in business during these difficult times. Using food delivery apps CAN be a good auxiliary revenue source for restaurants. However, it doesn't seem like a feasible primary revenue driver.

It is important to note that of the $8.74 collected by the food delivery app, $6.54 goes to the delivery driver creating incremental employment. Still, the value of the $6.54 to make the delivery is subjective.

 

From a financial standpoint

The model is not sustainable as the only revenue driver for most restaurants unless they have top tier cost management. Of the $11.30 I would spend by walking into the restaurant vs using the app, the restaurant would keep 88.5% of the dollars coming from me, the customer. 

When I order through a delivery app, they only keep 44.5% or about half of the margin pool they would otherwise capture (the delivery app would end up with 11.3% after compensating the driver).

 

From a market standpoint

If customers start analyzing their spending, they will inevitably migrate away from delivery apps post-COVID-19. Other, cheaper options are available, and an opportunity presents itself for new market entrants, such as: 

  • Food delivery apps which offer more competitive fees. These are already popping up, they take lower fees closer to 10% for restaurants, and provide low cost or free delivery for end customers. The big players are taking note by also beginning to offer discounted delivery fees at times.
  • Restaurants will begin adapting. Smaller staff, eliminating dining rooms (take out only) and having a smaller physical footprint can lower the operating costs for restaurants making the food delivery model more profitable and attractive. Small, take out only operations are already popping up in neighbourhoods across North America.

The current climate has created a unique dynamic for restaurants and food delivery services and has brought cost and value to my attention. 

Will I continue to use food delivery apps after Covid-19? Probably not. Paying a 35% to 75% premium isn't worth it for me, I would much prefer to get out, get some exercise and help support local restaurants in recapturing the margin pool that app delivery erodes.

ABOUT THE AUTHOR  Michael Stanisz is a Principal and Founder at Revenue Management Labs. Revenue Management Labs help companies develop and execute practical solutions to maximize long-term revenue and profitability. Connect with Michael at [email protected]