The runway for online food delivery is long, given an annual $350 billion U.S. restaurant spend, but challenging dynamics have led to a cash-burning contest among competitors.
Investors and diners are showing increased interest in online food delivery as the rise of aggregator apps makes it easier for consumers to chow down on take-out. Two-thirds of Americans now order food delivery online, and growth opportunities are vast given extremely low penetration of the possible $350 billion U.S. restaurant spend, including fast food.
The total addressable market for online delivery is set to grow from $260 billion in 2017 to $325 billion in 2020—and possibly $470 billion by 2025.
However, a look under the hood reveals a more nuanced story. On one hand, online food delivery spending in the U.S. could grow at an eye-catching 18% annually, jumping from 6% penetration today to 13% in 2025 according to Morgan Stanley estimates. But among leading delivery aggregators, the size of the opportunity has led to a cash-burning promotional battle among aggregators seeking to win diners and orders. This activity has pressured potential earnings and made a high-growth story slightly less appealing.
In a recent report from Morgan Stanley Research, the firm’s U.S. Internet and Restaurant teams detail the state of online food delivery and outline scenarios that could help both aggregators and restaurants capitalize on the growth of online spend.
“Consolidation and rationalization among food delivery aggregators will be key to improving—and arguably generating—higher overall profitability," says Brian Nowak, equity analyst covering the U.S. internet industry. In 2020 and beyond, “a rational environment with lower promotional activity and ad intensity coupled with improvements in delivery efficiency and customer service will be key to improved earnings."
Online Delivery Penetration Could Rise from 6% (~$19bn)
in 2018 to 13% (~$60bn) in 2025.
With so much room for growth, the online food delivery market is enticing. A survey by Alphawise, the proprietary survey and data arm of Morgan Stanley Research, found that 65% of respondents have ordered food delivery online in the past six months. Meanwhile, food delivery via phone orders is forecast to shrink by 3% annually through 2025, suggesting a migration to digital.
One of the reasons for the migration is the influx of restaurant chains. Not long ago, the lion’s share of restaurants on online delivery platforms were local full-service restaurants and small regional chains. That has now changed. Nearly every major fast food chain is now partnered with at least one aggregator and most with more than one.
Given this wider net for delivery, Nowak and his team has raised the total addressable market (TAM) from $260 billion in 2017 to $325 billion. Further, they forecast that the TAM could grow at a compound annual growth rate of 5% through 2025—roughly $470 billion.
A $350 Billion Addressable Market for U.S. Food Delivery
However, the arrival of chains is complicated. Chains have been key to bringing diners online but the economics are more challenging since lower Average Order Values (AOVs) make it more difficult to deliver food profitably.
Although fast food is the largest segment of the restaurant industry, it is also the most price-sensitive, with two-thirds of transactions under $6-7 per person. In addition, chains have the muscle to pressure aggregator “take rates,” which are the percentage of the transaction that the aggregator retains as revenue.
The other challenge is that leading aggregators continue to use aggressive discounts and free delivery to lure diners. “While our data show this makes sense strategically since promotions and deals play a role in 58% of diners’ decision-making, it’s also leading to negative earnings in every region except New York,” says Nowak.
The AlphaWise survey found that younger, digitally adept diners ages 18-34 are the top users of delivery aggregators—but they’re also the most promotion-sensitive, with 63% checking for promotions and deals before ordering or only ordering with a promotion.
Aggregators have also struggled to create platform exclusivity. Overall, only 36% of diners are exclusive to one platform, preferring to follow deals or free delivery, inviting a question on whether the promotional spend results in greater favorability for any one app.
What will drive the profitability of food aggregators? Nowak says a more rational environment is key, namely a decline in private players’ willingness to aggressively spend to order to acquire customers. This will require lower promo and advertising intensity and greater efficiencies, which would lead to more deliveries per courier per hour.
Another potential cost saver could be drone and autonomous delivery. Nowak estimates that every 1% of autonomous food deliveries, through drones or other devices, could lead to a slightly more than 1% increase in company-wide earnings, and could possibly cut delivery times. One aggregator/chain team up has been testing the use of drones to deliver food to a designated landing site for expedited delivery from delivery person to the customer with the aim of decreasing delivery times to under ten minutes.
Consolidation in the industry could also narrow the competition and help usher in a détente in the cash-burning promotions war. Last year some of the top players in the U.S. market discussed various merger permutations, however no progress came from the discussions according to news reports. Globally, however, other regions have already seen moves toward consolidation with a number of mergers and acquisitions between aggregators.
Finally, there are the restaurants themselves. Although almost every chain has now added delivery, only a few can point to demonstrable sales lifts—so far. That said, previous attempts at self-delivery for chains have been mixed. As popularity of chain food delivery continues to grow, aggregators allow restaurants to tap new customers and new occasions—and through a relatively low-risk model for the chains themselves.
For more Morgan Stanley Research on online food delivery, ask your Morgan Stanley representative or Financial Advisor for the full report, “U.S. Online Food Delivery: How Will the Next Five Years Be Delivered?" (Nov 12, 2019). Plus, more Ideas from Morgan Stanley thought leaders.