#3 - Food Delivery FAQ - Do food delivery companies have moats and competitive advantages?
In today’s post I hope describe what I think are the moats and competitive advantages within the food delivery industry; economies of scale, network effects, the chicken-and-egg problem, process power, switching costs, economies of scope, and brand.
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Economies of Scale
Driver costs are the primary driver of leverage in the food delivery business. Delivery companies have a target earnings per hr that is required to service demand. As order density and driver utilization goes up and their hourly earnings stay flat, your cost per delivery go down. In most high income countries, deliveries per hr (DPH) range from 1.5 to 2.5 and average ~2.0 , with higher numbers for bikes in urban centers. As you can see in the chart below, even at the lower part of the curve there’s a material difference in cost between 2.0 DPH at $7.00 and 1.0 DPH at $14.00 assuming a $14.00 per hr earnings target. Scale this $7.00 delta up to millions of orders per month and most well capitalized start-ups would burn through all their cash in a short period.
The other source of economies of scale is leverage from R&D and marketing. DoorDash’s Q3 annual run-rate spend on R&D was $460M and $1,784M on S&M (bulk of that being marketing). As food delivery companies continue to grow, they’re able to amortize these fixed costs over a larger base, driving down the cost per user and order which is hard for new entrants to match.
As a three-sided platform, food delivery have two cross-network effects:
As orders grow, driver utilization and earnings also go up, which attracts more drivers and reduces ETAs and improves reliability, which attracts more users
As orders grow, restaurant utilization and revenues also go up, which attracts more restaurants and provides more variety, lowers prices, and faster ETAs, which attracts more users
Source: DoorDash IPO Prospectus
The network effects on the driver side are stronger than the restaurant side. Drivers have a real opportunity cost to being on the platform while restaurants can still operate their dine-in and takeout. It’s also much easier for restaurants to use multiple delivery platforms whereas this is a lot less practical for drivers.
One final point, network effects are incredibly powerful when coupled with commoditized products and services. In the absence of real product differentiation, network effects become amplified. Differentiation allows for new entrants to create beachheads by targeting underserved segments. So assuming new entrants can get to feature parity but cannot create any compelling differentiation, users will opt for the platform with the best supply network.
Online marketplaces exhibit something called the “chicken-and-egg” problem at their formation. To attract and retain users you need a sufficient amount of supply (drivers and restaurants). And to attract and retain supply you need a sufficient amount of users and demand. Delivery platforms will often “bootstrap” supply by providing guaranteed cash bonuses for being online during the initial launch. This coincides with marketing and promotional campaigns to acquire users and kickstart the initial flywheel. The coordination across product, sales, marketing, and driver acquisition is complex. It can cost a few million dollars in bonuses and promotions to get a mid-sized city to a self-sufficient scale (DoorDash is in 7,000 cities as an example)!
Food delivery is what I call a “schlep” business. There are a lot of tedious and boring operational details that one needs to work at for years in order to provide a great experience. Setting up large call centers in the Philippines, monitoring driver supply during New Years, optimizing closing hours for large QSRs, etc. This schlep work coupled with the operational and technological complexity of delivering McDonald’s fries in under 20 minutes means there’s a lot of institutional knowledge and infrastructure that needs to be built over years just to compete.
It’s true that downloading a new food delivery app is only a few clicks away but recently we’ve seen the rise of subscriptions within the industry. Similar to Amazon Prime, users pay a monthly fee and in return get free delivery. Over 30% of US gross bookings are from subscriptions. Users feel like their monthly fee is a sunk cost, so they’ll often stick with one platform to maximize the value of that subscription.
Economies of Scope
Delivery platforms are able to reduce costs by leveraging shared resources and assets with additional products and services (grocery, convenience, etc.). Specifically, leveraging existing technology platforms (driver, user, and merchant), marketing, and G&A. If you think of a driver network as an asset, there’s also cost efficiencies from higher utilization. Extending into new verticals also creates new opportunities to acquire users who wouldn’t typically be interested in food delivery but can be converted later. All of this leads to a lower cost of operations and acquisition.
The four major global players have spent an enormous amount of money on marketing and brand. In many markets such as Canada, the US, Australia, many players have built brand awareness at levels quickly approaching titans like Visa, Coca Cola, and Apple. This is no easy feat, they’ve been investing $100Ms a year in integrated brand campaigns for half a decade. On top of the capital requirements, there’s real challenges in scaling marketing organizations, technology and infrastructure, and partnerships.
I’ll end on one important note; when evaluating the defensibility of food delivery platforms it’s helpful to zoom out and view everything in totality. No single moat or advantage will prevent incumbents or new entrants from taking share, it’s the layering of all them together that makes this difficult.