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Food delivery feeding friends and investors alike

By Francesco Biondo 

Initially posted on the BSPEC blog

The gig economy, which comprises all the businesses offering “on-demand” and temporary jobs for people to carry out according to their availability, has taken off. The concept is both simple and exceptional: online platforms match individuals willing to offer their time and expertise with consumers and employers in need of a specific tasks. Thanks to its flexibility, the strategy is able to capture value by sourcing labor within minutes of a tap on a phone displayThe prime feature of this novel business model is that the workforce no longer requires traditional employment contracts with fixed time schedules. Instead, workers perform their job when they are available and are paid for each performance. The use of this business model is kaleidoscopic, with practitioners ranging from Uber drivers, freelance professionals of platforms such as Upwork, to the so-called riders working for food delivery companies such as Just Eat.

The business of food delivery has grown astonishingly over the past decade, reaching a global valuation of €83bn in 2016 ($87.5bn). Prompted by advancement in hi-tech, the industry players gained vast popularity thanks to their streamlined apps and broad variety of restaurants users may choose from. Initially, most of these services only functioned as aggregators that allowed consumers to access the menus of nearby restaurants and to choose items which were then delivered by the restaurants themselves. Nowadays, third-party riders distribute food directly to customers’ doorsteps.

With characteristically low barriers to entry, the business has beckoned a host of competitors who attempted to scale up the market by developing their own apps. The goal is to differentiate oneself from the opposition and to realize profits in a sector defined by razor-thin margins. In fact, despite the likelihood of red figures in early days, the industry is captivating both market entrants and financiers alike as testified by surging competition,

VC in food delivery

As with many start-ups, venture capital kindled the food delivery hype, and while a few players eventually went public, most delivery platforms are still privately held. Pockets remain deep for the disruptive tech as figures for capital issuances show. The amount of funding is growing substantially over the last decade, reaching an all-time high of $8bn in 2018. Several start-ups became unicorns over quite a short time span. Given the rapid pace of growth of these companies, the industry appears to have entered a relatively mature stage as inferred by the opposing tendencies of falling deal count and rising capital raised. Players that survived in the early years are now expanding and require resources to extend their operations and consolidate their position in a crowded market, after which they eventually enter a new stage and go public, such as Germany’s Delivery Hero and America’s Grubhub. However, newcomers have not yet been entirely eliminated from the market with successful challengers drifting into the slipstream including Glovo and Wolt.

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Example: Deliveroo

Formally Roofoods Ltd, Deliveroo was founded by former Morgan Stanley investment banker Will Shu in 2013 and is specialized in delivering meals. Based in London, the company has expanded in several cities with operations in thirteen countries. It made recent headlines for an attempted takeover by Uber, and earlier this year for a series G round of funding of $575m – backed, amongst others, by Amazon, Fidelity and Greenoaks – which combined for a total of $1.53bn in capital raised. The deal incremented Deliveroo’s valuation to more than $2bn. The participation of Amazon in the company, however, triggered an ongoing antitrust inquiry from the UK competition watchdog over possible harm to consumers resulting from the deal.

Deliveroo is one of the most heavily funded start-ups in Europe, and it has invested massively to expand its presence worldwide. Nevertheless, despite its remarkable growth in revenues, the firm is still a loss maker.

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Source: Bloomberg

Given the current trend, it is difficult to assess what will transpire for investors. Excess expenditures are attributable to the aggressive expansion Roofoods has undertaken so far, which have been an indispensable embattlement for the British start-up to maintain a competitive edge. Today, Deliveroo is a recognized and well-established player in most of the cities in which it operates, and has been pursuing new strategies to enhance profitability. Methods include signing exclusive partnerships with popular restaurant chains and developing ghost kitchens: restaurants (owned by Deliveroo) intended to serve only takeaway orders to improve efficiency. Deliveroo is not the only player adopting this cost-saving approach.

Arguably, at this stage, Roofoods has set a basis of sustained growth which will eventually turn profitable in the near future. Several doubts persist around the capacity of the company to survive the fierce competition in an industry defined by slim operating margins; other uncertainties are related to the legal status of its workforce. The lack of stable employment contracts triggered protests in several countries, while policymakers’ responses in future remain opaque.

Industry uncertainties

The path followed by Deliveroo and its competitors resembles a standard Silicon Valley trope: an aggressive expansion intended to capture market share, fueled with venture capitalist funding, in hopes of exploiting the noteworthy growth margins that food delivery has to offer. However, competitors and their backers face similar uncertainties as well. Research conducted by McKinsey in 2017 pointed out profitability risks associated with the current business model adopted by most of the meal carriers. Variable costs per delivery are substantially high and restrict profit margins. In addition, due to the inevitable waiting times at restaurants, riders rarely manage to fulfill two to three deliveries per hour. Imposing fees on restaurants is one of the solutions many companies opted for in order to raise revenues. Furthermore, companies may leverage ghost kitchens to reduce delivery time.

Another common issue within the industry concerns the quintessential element for the business to exist: riders. Given the industry’s lean operating profitability, the compensation riders receive per delivery is meagre and barely justifies the dangers of driving through traffic. Furthermore, riders lack the benefits and safety granted by traditional employment contracts. It is worth noting, however, that the aforementioned McKinsey report illustrates that as food delivery businesses grow in size, they could eventually reduce marginal costs by issuing fixed contracts. Average costs tend to diminish due to economies of scale if expenses such as wages are fixed. Therefore, we may expect a revision of the workforce structure, hence eliminating the legal risks of suspension of business and eventually benefitting the companies’ public images, which have, in some cases, severely been undermined by rider protests.

On-demand services engrossed consumers this decade and are quickly becoming staples of society in all facets. So while its future growth is unquestionable, food delivery must implement better strategies to ensure sustainable profitability over the long term.

Big businesses are getting bigger

Given the strong competition in the industry, together with the almost absent switching fees for users, businesses have been pursuing consolidation to obtain a critical mass to boost margins and gain a competitive advantage. An ongoing case of such a deal is the merger of Takeaway.com targeting the UK’s Just Eat – one of the earliest player in the sector – yet subject to a hostile bid by South-African Naspers. Combining businesses may prove beneficial in terms of cost saving and capturing a wider customer base. For example, a key differentiating feature among food delivery services is exclusive partnerships with beloved restaurant chains. By merging with a rival, the new entity enjoys the combined portfolio of supplier contracts.

Another recent transaction involved Delivery Hero’s expansion in South Korea with the $4bn acquisition of the local player Woowa Brothers. The German group, financed amongst others by the start-up builder Rocket Internet and Naspers, has grown exceptionally and consolidated its position by pursuing several acquisitions.

Is the food delivery industry ready to go public?

Food delivery companies are scaling, and the largest players have far surpassed unicorn status, begging the question: is this time to go public? Some of the field already listed publicly yet it is seems conditions are unfavorable for the industry to face the challenges of equity markets – negative trends have been observed. Following the rails of Uber’s IPO, which turned out to be substantially overvalued, Grubhub, one of the main players in the US, saw its shares fall by almost 40% due to earnings below expectations.

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Similarly, shares of Just Eat fell by 7% recently due to slowed sales growth. Given the uncertain environment surrounding the food delivery business, it is difficult to address public markets with confidence, and companies are exposed to obstacles which can be very costly. Nonetheless, IPOs themselves are costly and present a set of problems that the industry may be unprepared to face effectively. Players must consolidate profitable strategies to offer to the market, otherwise the massive capital invested may be at risk.

Editor: Eric Peghini

Author: Francesco Biondo

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Bocconi Students PE Club
The Bocconi Students Private Equity Club (BSPEC) is a student-led organization at Bocconi University. The club publishes articles related to private equity and venture capital, conducts interviews with active PE professionals and hosts events featuring funds and advisors. BSPEC is one of the oldest and most active student associations at Bocconi University and its alumni are currently employed at top tier investment banks and PE funds. Learn more at https://bspeclub.com/

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