By Lior Ronen (@Lior_Ronen) | Founder, Finro Financial Consulting

At first glance, food delivery is a great business idea that allows all parties to benefit. Clients can order meals from their favorite restaurant and have them delivered to their doorstep quickly and efficiently; the restaurants have no need to maintain an expensive and often loss-making food delivery operation in order to cater to those clients who prefer to eat at home; the orders are delivered by freelance couriers who work as sub-contractors of the delivery companies; and the delivery companies charge restaurants a 15‒30% fee on every order, on top of the delivery fee charged to the hungry customers. 

The delivery company is supposed to be the biggest winner in this model because its fixed costs are very low and it takes a nice cut from every transaction. So, how can we explain the fact that the stock price of Grubhub (NYSE:GRUB) – one of the biggest food delivery companies in the US – has crashed by more than 80% since its peak in September 2019?

The food delivery companies’ business model is very simple; it connects clients, restaurants, and couriers while using the benefits of our mobile devices. But that very simplicity is also a great threat. The biggest disadvantage of the food delivery business model is the absence of any substantial barriers to entering the market. All you need is an ordering system, a good app, business relations with restaurants that are willing to participate, and a team of couriers willing to work with the new service. The ordering system and app are developed at relatively low cost, so the biggest costs are in logistics: implementing the ordering system in the restaurants, implementing the infrastructure in new locations, and massive marketing to the public. 

From the restaurants’ perspective, the food delivery companies provide access to more clients (although their service fees reduce the unit profit). They have no reason to prefer one delivery service over another, and they prefer to work with them all. From the couriers’ perspective, working with the delivery services is convenient and rewarding. They get to work in the area and at the times of day they prefer, and their having no commitment to one delivery service enables competitors to set up in the same location and compete with the existing players. From the delivery companies’ perspective, all there is left to do is to convince the end client to use their service and no other. In other words, they must invest a great deal in marketing, and this investment increases as the competition increases. 

Recently we witnessed how the low barriers to entry harm the delivery companies. Grubhub reported disappointing financial results (compared to the market’s expectation) for the third quarter, and lowered its guidance on revenues. In an unusual letter to shareholders, Grubhub – which is one of the largest in this niche in the US  and is worth around $3B – mentioned the intensifying competition in the company’s main business segment. The company said that due to a sharp increase in competition, lately coupled with low customer loyalty, it will not be able to continue to grow at the pace expected by investors. Following this message, the stock plunged and lost around 40% of its value in one day.

In a response to Grubhub’s results, Nat Schindler, a Bank of America analyst, said to clients: “the food delivery market is increasingly irrational as competitors flood the market with rewards and incentives, making online diners less loyal”. Grubhub’s operating margin is only 2.5%. The intensified competition from relatively new players such as DoorDash, Postmates and UberEats will necessitate higher investments in marketing and in expanding to new locations, which will have further impact on the company’s bottom line. 

Grubhub is one of the oldest and most experienced food delivery companies in the US, and during its 15 years in the business it improved and perfected the business model. If a market leader of that magnitude slashes its revenues guidance, the situation might be significantly more serious at other companies that are mostly privately held. 

Grubhub’s situation shouldn’t come as a surprise when looking at recent events in the food delivery market. Early in October, Postmates announced that it had postponed its IPO to an unspecified future date. In Europe the two delivery giants, Takeaway (AEX:TKWY) and JustEat, are to merge in a deal estimated at £9B that will create the biggest food delivery company in Europe. The European market has many players, including Delivery Hero (XETRA:DEHR), Takeaway, Deliveroo, JustEat, Wolt, and many more. However, in Europe even the market leaders are losing money due to the high marketing costs and high costs of adjusting the service to the language and culture in every new location, either by developing a system in the local language or adjusting their business model to the model already accepted in those new locations. 

An alternative to culture adjustment is to acquire a local company that knows the market and the target audience. These acquisitions should enable delivery companies to increase their market share in the crowded food delivery market and to lower the need for aggressive marketing, which could increase margins in the long run. This is exactly how Grubhub expanded over the years after acquiring small competitors such as Eat24, LevelUp, and Tapingo.

The current market situation, where food delivery companies generate single-digit profit margins, is not sustainable. The market is probably at an important inflection point. Last year, Postmates and DoorDash could not agree on merger terms, but in today’s market conditions it seems that the point at which they have no other choice is getting closer. The competitive pressure in the US pushes the main players to grow through mergers and acquisitions, and the next food delivery giant will probably evolve soon from the upcoming deals. 

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