What are food delivery platforms? What is their role within the wider restaurant industry?
Food delivery platforms are a fast-growing segment of the restaurant industry, with capitalization estimated at more than $150B worldwide. Their staggering growth rate in the last several years was amplified as a result of the pandemic, but does not seem to be slowing down even as life returns to pre-pandemic normal. The value proposition of these services is to connect customers seeking restaurant-quality food without going to the restaurant to restaurants that lack access to delivery infrastructure.
What problems do restaurants owners have with these platforms?
While food delivery platforms indeed increase demand for restaurants by giving them access to otherwise unattainable delivery customers, many restaurants are not satisfied with these relationships. There are two main reasons for this.
First, the common contract that platforms and restaurants sign is a revenue sharing contract according to which the platform takes a cut on every order that it delivers. These commissions vary by restaurant, but tend to be quite large, between 15-30%. Given the small margins in the industry, such commissions decrease restaurants’ margins and may even cause some restaurants to operate in the red.
Second, the additional influx of delivery customers may cause significant strain on a restaurant’s limited capacity which in turn diminishes the service experience that dine-in customers face and may in fact lead to fewer dine-in customers. Especially in small restaurants, it’s not uncommon for dine-in customers to experience significant delays due to the additional congestion imposed on the kitchen. This additional congestion and its influence on dine-in customers illustrates the fundamental problem with the revenue sharing contract.
Because with a revenue sharing contract the platform does not profit from dine-in customers, it lacks the incentive to account for the deterioration of service that its delivery customers impose on dine-in customers. This results in dine-in and delivery prices that are too low, low dine-in demand, and high delivery demand, all to the detriment of restaurants.
What solutions do you suggest to help resolve the conflict between these platforms and restaurants?
Attempts to resolve these issues in practice have not been successful so far. Aiming to protect restaurant margins, recent regulations in some US cities and states, like New York and California, have capped platform commissions to 15% at most. Originally the regulations were intended to provide restaurants with temporarily relief during the pandemic, but lawmakers are now considering keeping these regulations permanent.
While these regulations do help protect restaurants margins somewhat, it’s important to realize that they do not solve the issue with the revenue sharing contract. Regardless of the commission level, the structure of the revenue sharing contract makes the platform ignore the congestion that delivery customers impose and leads to the same problems.
What we need is a new industry contract that incentivizes the platform to account for the increased congestion that delivery customers create. The solution is surprisingly simple. We propose a contract that not only resolves the conflict, but does it in a very practical way.
In addition to a commission, the contract should include a fixed fee that the restaurant charges the platform per-order. The role of this fixed fee, if constructed appropriately, is to make the platform internalize the congestion imposed by delivery customers in the right way and therefore choose the optimal delivery price. This contract is similar to the current revenue sharing contract (it involves a commission), but also different (it involves a fixed transfer). By merely adding a fixed fee, this contract solves the industry conflict, because if constructed intentionally, it aligns the incentives of platforms and restaurants.
This relatively simple and implementable solution makes us hopeful that restaurants and platforms can resolve their conflicts in a way that will make all parties happy to engage in these relationships.
