Can online food delivery ever be profitable?

For many of the world’s biggest online food delivery platforms, being profitable in a thin-margin space remains elusive. But China’s Meituan-Dianping seems to prove that it’s entirely possible.

After weathering some rough waters after its initial public offering, Meituan-Dianping recorded close to US$400 million in net profits for 2019, with more than half of the company’s revenue coming from food delivery. Meanwhile, its US counterparts Uber and GrubHub are still striving for profitability.

But the Chinese company’s success raises this question: Can others replicate its success in markets other than China? Meituan-Dianping benefits from some advantages, such as the country’s densely packed megacities, highly developed infrastructure, and even relatively lax parking regulations.

These same factors can also be found in Southeast Asia. That said, the region’s food delivery space is in its early stages and remains unprofitable – a new Reuters report says that GrabFood’s Thailand business is still making a loss.

Densely populated megacities

On the whole, food delivery is typically an efficiency game. Margins are thin, and the traditional path to profitability lies in attaining high volumes while keeping costs down.

Therefore, the denser and more populous a city is, the more efficient it is for food delivery platforms. A delivery rider can fulfill more orders in a shorter span of time if they’re covering a smaller area.

“The market size at a country level is not important; the market size across top cities is what matters,” says Sangeet Paul Choudary, founder of Platformation Labs and author of the book Platform Revolution. “Delivery economics are impacted by route optimization. Density and parking [regulations] are the biggest factors there.”

Chinese cities are generally much more densely populated than American ones. As Bloomberg points out, China’s urban areas have 2,426 people per square kilometer, almost eight times the comparable density. The US has 10 cities with a population of over 1 million, but China has over 100. For example, Liuzhou, China’s 50th largest city, has 2.1 million people.

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Cities in India and Southeast Asia also tend to be densely populated megacities, which should give them a similar demographic advantage. Metro Manila in the Philippines has a population density of 21,000 people per square kilometer, while Indonesia’s Jakarta has 14,464 people per square kilometer. The latter does not even include the surrounding areas that make up Jakarta’s metropolis, which is home to an additional 20 million people who mostly spend their days within the city limits.

Of course, some of the biggest American cities like New York City or Chicago have comparable population densities. But ultimately, the US doesn’t have as many as China or Southeast Asia do.

Efficiency can go beyond demographics, however. It matters where a city’s restaurants are located, according to Jianggan Li, founder of venture builder Momentum Works and a former managing director of Foodpanda in Singapore. Delivery is always more efficient with streetside establishments because couriers can leave their bikes directly out front. In comparison, restaurants inside shopping malls require couriers to park in a designated area first before they can make their way into the building.

A street in Barcelona, Spain / Photo credit: Unsplash

“At Foodpanda, we saw that deliveries were very efficient in Barcelona,” he says. “Most restaurants front the street, and so do most apartments. A courier can just park in front and, at worst, run up a couple of stories without needing to go through security or present IDs.”

This ties in with another factor Choudary has pointed out, which is relatively lax parking regulations.

“In the US, you can’t exactly ride a scooter, leave it on the sidewalk, and run upstairs into an apartment. There are parking regulations, parking tickets to [pay for],” says Jeffrey Towson, a professor of investment at Peking University. “This is not the case in China and other Asian markets.”

There’s also the matter of labor. It is most expensive in the US, while Asian countries such as China and Indonesia have significantly lower labor costs and a ready supply of delivery workers from lower-tier cities.

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Singapore is one Asian country where labor is relatively more expensive despite a lack of across-the-board minimum wage regulations. That said, Li says labor is not as readily available in the city-state, leading to a reliance on foreign sources, which means complying with government quotas.

“It’s a chicken-or-egg problem,” he says. “You need large density and order volume to be efficient, but on the other hand, you will [also] need a lot of investment to get there.”

Low “multihoming” costs

There are even more factors at play, such as Meituan-Dianping’s ability to make money from advertising. Restaurants can pay Meituan-Dianping for a more favorable positioning in the app and in other marketing initiatives, which gives the platform more revenue at no additional cost. These, in turn, can be used as customer subsidies.

After Meituan acquired the food review app Dianping in 2015, its user base broadened to include dine-in consumers, which has led to more efficient user acquisition for deliveries. Momentum Works’ Li points out that this development encouraged the merged company to go into bike-sharing and powerbank rentals, which allow them to gain and retain customers at cheaper costs.

This strategy, however, would have different ramifications for the US and for Southeast Asia. In the US, advertising is mature enough that restaurants can promote themselves through Google and Facebook. China’s advertising networks, on the other hand, do not have the same maturity, wrote Sheji Ho, a former chief marketing officer at the ecommerce enabler aCommerce. Hence, platforms have turned to the super-app model as a way to build customer acquisition channels.

Ho points out in his article that unlike in the US, Facebook and Google don’t have a strong hold on Southeast Asia’s local advertising market yet. This means adopting China’s super-app model could work in the region, though some say the delivery volume is still not big enough for restaurants to see the value of advertising.

Like Meituan-Dianping, Grab employs a super-app strategy. / Photo credit: Grab

In 2019, Meituan-Dianping recorded 15.8 billion yuan (or US$2.2 billion) from online marketing services. Its total user base equaled 6.2 million active merchants and 450.5 million transacting users.

For comparison, Gojek’s GoFood announced that for 2019, it had 20 million users ordering from 500,000 merchants.

Yet even at Meituan-Dianping’s scale, most of its revenue still comes from commissions. In 2019, commissions, including those from food delivery and other services, made up 67.2% of total revenue while online marketing made up 16.2%.

The same goes for Delivery Hero, the Berlin-based parent company of Foodpanda and a host of other brands. Present in over 40 countries, Delivery Hero claims to be the largest food delivery company outside of China, but its volume is still much smaller than Meituan-Dianping’s. The German company announced that it passed the 500,000-restaurant milestone in January 2020.

For 2019, Delivery Hero recorded 75.3 million euros (US$85.4 million) in revenue from “prime placings” – what it calls its online marketing service – which made up just 5.1% of revenue. On the other hand, commissions and delivery fees made up 86.9%.

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Another advantage that Meituan-Dianping has is its commanding market share, which helps it overcome what Choudary says is a big issue in food delivery: low “multihoming” costs.

“It’s very easy for users to use multiple platforms and switch whenever it suits them,” he explains.

China has two main food delivery players: Meituan-Dianping, which has about 65% of market share, and Alibaba’s Eleme. Conversely, the current US leader GrubHub does not have majority market share and has to contend with more than one competitor.

Things are more fragmented in Southeast Asia, where the competition varies from country to country. GrabFood, which is present in eight markets, is the player with the widest regional presence. Foodpanda operates in five, while GoFood is only in three markets, although one of them – Indonesia – is the region’s largest.

But ultimately, neither the US nor Southeast Asia can compare to China in terms of scale, which has helped its food delivery platforms drive down prices. The size of China’s online food delivery market is estimated to be worth US$51.5 billion in 2020, according to Statista estimates – almost twice as high as the US’ and almost 15x compared to Southeast Asia’s in aggregate.

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But in a sign of China’s more mature market, compound annual growth rate (CAGR) for 2020-2024 equals just 7%, whereas all of Southeast Asia’s markets have double-digit rates, according to Statista. China’s 410.8 million online food delivery users also represent 29.3% of its population. That’s higher than every Southeast Asian market, except for Singapore’s (42.1%). Malaysia has the second highest rate with 21%, while Indonesia has 14%.

There’s also the question of wealth distribution. China has multiple economic centers while much of the economic power in Southeast Asia is still concentrated in the capital cities. This can mean that in lower-tier cities, food delivery is more of a luxury.

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A good omen for the super-app model

Fundamentally, food delivery platforms are locked in a tug of war between keeping prices down in order to earn a profit, and not overdoing it to the point of alienating restaurants.

Li thinks that Covid-19 aside, “platforms would prefer to keep the price as similar as possible to dine-in [prices] so that it remains competitive.” He adds, “If the price difference becomes too high, then people just go the old way.”

As for restaurants, Li explains that when delivery is not their main source of income, they have an incentive to raise prices on the app, especially because they don’t have to pay a commission for dine-in customers. The idea is to reduce the burden of commission while still attracting people to dine in.

With Covid-19, commissions can eat up the margins of restaurants because delivery has inevitably become their main source of revenue.

“If a platform has negotiation power, their option is to squeeze the restaurant – but not a lot, because it will still cause unhappiness among the restaurants,” Li says.

Meituan-Dianping, for example, takes different commission rates, depending on the restaurant. Bigger restaurants have more negotiating power.

A Deliveroo Editions cloud kitchen in Singapore / Photo credit: Deliveroo

When taking into account the entire revenue pie, though, restaurants ultimately have the largest share. That’s because the biggest component of a delivery order will always be the food itself, and almost all of the proceeds go to the restaurant. This explains why platforms such as Deliveroo are going into cloud kitchens, Choudary says.

Cloud kitchens let platforms improve margins by renting spaces in less strategic locations while also leveraging data to determine which cuisines or dishes do well. And because the space is fully used for online deliveries, there is less incentive for restaurants to raise prices.

However, this is a nascent strategy that can still evolve. We’re already seeing platforms launching their own food brands – and keeping all of the income for themselves.

Restaurant chains have long offered in-house delivery. McDonald’s is an example, along with pizza places like Domino’s or Pizza Hut (which operates a delivery-only offshoot called PHD in Indonesia). These restaurants include delivery in their cost structure, and their delivery riders are not on-demand “freelancers.”

McDonald’s outlets are also located strategically. Its riders need to serve only one branch of one restaurant instead of multiple ones over the course of an hour, which lets the restaurant plot out the most efficient delivery path for each rider.

But McDonald’s did end up partnering with UberEats in several markets. One reason may be the trouble of overseeing their own delivery fleet in markets such as Singapore, where managing manpower in general is not easy, according to Li.

Labor in the city-state is not as available as in other markets, and the government sets regulations for foreign worker quotas. McDonald’s still offers its own delivery service in Singapore, however, while also being present in platforms like GrabFood. A restaurant business of McDonald’s scale would also have more negotiating leverage.

All in all, this bodes well for the super-app model espoused by Grab and Gojek in Southeast Asia, but with caveats. Peking University’s Towson says that Meituan-Dianping was shrewd in pairing a high-frequency, thin-margin service like food delivery with low-frequency yet higher-margin services like hotel bookings. Food delivery helps with the app’s stickiness, but it’s the other services that bring home the major cash.

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This is apparent in Meituan-Dianping’s financial statements. While food delivery brought in 56.2% of the company’s 2019 revenues, it made up just 8.6% of gross profits. Meanwhile, its in-store, hotel, and travel segment brought in 61.1% of gross profits.

For Southeast Asian players, copying Meituan-Dianping by also going into travel may not be realistic. Traveloka, for example, is already a large operation, particularly in Indonesia – though Covid-19 has since led to much uncertainty in the industry. The answer, for now, appears to be fintech.

This article was featured on Deep Dive, a series under Tech in Asia’s Startup Snapshot podcast. Listen to the episode on SpotifyApple Podcasts, or wherever you listen to podcasts.