Why are online food delivery prices so inflated ??
This is the first part of a two part article. For part 2, click here
Recently a post by an user regarding the price differential between a Zomato order and offline order caught my attention. The user quoted a ~35% cost escalation in Zomato as compared to the offline Menu price from the same restaurant for the same items and quantity.
Now it is obvious that the restaurants keep different prices for online orders and offline orders. The primary reason is to cover the additional commissions and other expenses charged by food delivery aggregators. It is estimated that Food aggregators in India charge anywhere between 18–25% of the order value. Hence most if not all the restaurants end up charging additional prices to customers on online orders.
The thing to be noticed here is that these additional charges via price increases exclude the delivery and packaging costs charged by the Food aggregator to customers. The delivery and package costs are more independent of order value and depend on distance, demand/supply for delivery partners and no of items orders. On a average ₹30–35 is charged for delivery and ₹15–20 is charged for packaging of the food. With an Average order value of ~₹400, this translates to additional 12–14% costs to customers. And all of this excludes the taxes that are applicable and charged to customers.
Yet intriguingly, even after costing 30–40% more for online orders, the food aggregators are not yet profitable as publicly known (Zomato which is publicly listed reported a EBITDA of -1.8% in FY22 for food delivery business separately). Thus, the question that arises is that even with a margin of 40%, why are the Food aggregators not profitable.
People might expect the delivery costs or fees paid to the delivery partner to be the main cost that leading to this. But this is not completely true. If you look at Zomato’s IPO Prospectus, they quote an average delivery cost of ~₹45 while charging the end customer of ₹27 resulting in a shortfall of ₹18. This translates to 4–5% of the total order value and does not completely explain the additional 20–25% charged by Food aggregators.
This is what perplexes one, fundamentally speaking Food aggregation like Taxi aggregation and others should be a platform layer that manages Demand and Supply very efficiently. In such an ideal aggregation platform, technology will match the user/customer with partner passing through the cost/charge of the partner to user/customer along with a small additional fee for running the platform.
Instead, what we have is an aggregator whose cost of aggregation is today higher than the cost of the delivery partner (₹80–100 aggregator costs vs ₹40–50 delivery cost). The question that raises is that can the Food aggregators really justify this additional price. Yes, Food aggregators do provide services to customers, from easing food discovery to seamless delivery along with customer support. However, is the cost incurred to deliver these services optimal and efficient?
And this is an important question, a suitable peer Jubilant Foodworks Franchise owner of Dominoes has been in the business of online ordering and home delivery of Pizzas. They do provide some of the services that Food aggregators claim to provide, and they have been profitable indicating that they incur lesser costs than these Food aggregators. In fact, given the Food aggregators scale and nature of aggregation, they should have been more cost effective than a single food restaurant chain with higher profits. That does not seem the case.
Hence there is a need to deep dive into why Food aggregators are incurring higher costs and what is driving these inefficiencies. Luckily for us, we have a publicly listed Food aggregator with detailed annual reports which we can investigate to understand the cost structures.
And there are a few things that stand out. Zomato has high employee benefits expense. It accounts for 35% of the total revenue. Now Zomato includes multiple lines of business in addition to Food delivery including B2B supplies (Hyperpure) and others. However currently Food delivery accounts for 80–85% of total revenues. It seems logical that a significant share of employee benefits expenses would also accrue to the same business.
Let’s for arguments sake assume that 80% of employees are involved in managing Food business and at 80% share, employee expense of Food delivery stood at ₹13,065 millions in FY22. Dividing this by total no of orders in FY22 535 million, we get a per order cost of ₹24. Thus, in this example for every order placed, there is a cost of ₹24 just to cover the costs of employees who are managing the aggregators. (Note these are not the delivery partner costs as they are not employed by these aggregators).
I have computed the various costs incurred by Zomato at assumed apportion of 80% to Food delivery business and the same at a per order level basis the IPO Prospectus for FY21.
For a technologically driven business, the tech (hardware costs) is a measly ₹5 per order (this makes sense as technology at scale should result in low costs). A bulk of the costs are human resources (employee cost + outsourced support costs) and marketing costs. Now let us exclude the marketing costs as short-term necessary costs for user acquisition.
And it is not a matter of scale any longer that these employee costs will be normalized in time. The food aggregators are already effectively reached their current addressable market given India’s per capita income. Any growth will be more linear driven by macro factors rather than than the S-curve exponential one. A 10 x growth will take years not months to fructify.
The question remains, are food aggregators really the technologically driven algorithmic platforms driven efficiently with minimal costs that they were envisioned to be or are they giant operational leviathans that operate within the veneer of a technological veil. Whatsapp was a true example of technologically driven platform where with only 55 employees, it built a mass and effective peer to peer messaging platform. Now that is technological innovation at the finest (Even today Whatsapp has 50 engineers to maintain a platform of 900 million users).
Where did it all go wrong? And the answer I believe to this question is covered in the part 2 of the article series.
