The U.S. is one of the most competitive markets globally, with four main players competing for market share: DoorDash, Grubhub, Uber Eats and Postmates. “There is competition throughout every part of the process,” says Anmuth. “Customers have to choose between promotions from different operators. While some restaurants prefer exclusivity with one platform, others choose to be present across several. Drivers operate for multiple companies. When you look at these pieces together, fewer market players would create a more rational space as the focus shifts to profitability.” In a low-margin industry, M&A has been one strategy to attain market share gains.

Anmuth expects the Uber-Postmates acquisition to generate synergies for Uber Eats. For example, consolidation across complementary locations (e.g., Los Angeles, Orange County, Phoenix and San Diego), and an expanded restaurant line-up that includes local favorites such as L.A.’s sushi standout, Sugarfish. Additionally, Postmates’ batching and chaining capabilities should help drive further delivery enhancements for Uber Eats. “We believe Uber should be able to leverage greater scale and operating efficiencies to gain market share in online food delivery, as well as in adjacent opportunities such as grocery and essentials delivery, accelerating Eats’ path to profitability,” says Anmuth.

In May 2020, reports surfaced that Uber was in talks to acquire Grubhub, but it was later announced that Just Eat Takeaway.com would acquire Grubhub through an all-stock merger valuing Grubhub at $7.3B. The lock-up would deliver expanded presence in four important locations: U.K., Germany, the Netherlands and the U.S. “We are surprised by this move given the competitive environment in the U.S. and limited immediate revenue and cost synergies,” says Diebel. “In our view, the U.S. market needs first of all further consolidation by reducing the number of food delivery operators from four to two.”

Key ingredients: customer loyalty, technology and volume

“The increasing penetration of e-Commerce has accelerated the rise of the online food delivery industry,” says Anmuth. “The more restaurants that join the marketplace, the more of a network effect it creates and that has pulled adoption forward the past four years.” This dynamic became more pronounced during COVID-19.

This network effect has drawn in most publicly-listed restaurant chains with globally recognized brands. This includes Starbucks, where orders tend to be smaller and delivery fees comprise a large portion of the total cost. Food delivery operators are generally seen as providing incremental sales to restaurants versus in-store dining or drive-through service. “Since this incremental transaction is well above break-even, most restaurants are willing to accept a lower margin selling through delivery platforms, as opposed to having customers visit the restaurant themselves,” says John Ivankoe, Restaurant Equity Research Analyst.

The weak economics of the industry continues to be a challenge in reaching profitability. “When you look at the food delivery space, it has seen a lot of top line momentum, but the bottom line has always been in question,” says Diebel. Attracting customers, who aren’t typically loyal to any one operator, is a particularly expensive aspect of the business model. High marketing spend on customer incentives, promotions and vouchers for delivery fees make it difficult for companies to expand margins.

In some markets, consolidation can help to effectively “switch off” marketing spend. For example, in 2019 Dutch online food operator Takeaway.com acquired Berlin-based competitor Delivery Hero’s German assets. The deal doubled the scale of Takeaway.com’s existing operations, reaffirming its top position in the region. In addition to reduced operating expenses, the deal significantly decreased marketing spend.

Diebel notes that volume is what makes the economics of consolidation come together, and achieving higher volume is largely driven by better technology. Food delivery players tend to consider themselves as technology companies rather than logistics companies, but Diebel argues the two are interconnected. “Sophisticated technology will help enable them to control the entire chain, and that’s why this industry has staying power,” he says. For example, enabling a driver to arrive the moment a pizza leaves the oven speeds up the process and means hotter food for the customer.

He notes that “daily delivery”—where it’s cheaper to order than cook—could become the norm, but it will depend on whether online food operators can slash delivery fees. “This would not only be good for acquiring market share but would also improve affordability for customers. If affordability goes up, then volume will likely go up, and this is the path to profitability,” says Diebel. “This is a winner take most industry, not because you have more restaurants on the platform, but because you have the right restaurants. If operators can create an established network with efficient delivery logistics, this will be the key growth engine for the industry.”

Uber is in a unique position compared to its peers, with the scale advantages of its Rides and Eats businesses that are built on the same tech stack. Uber Eats grossed ~$14B of bookings in 2019, only four years after launching the Uber Eats app. Uber restructured its app to combine both businesses, enabling customers to view options and interact with them in one environment. It also launched a suite of subscription products to build customer loyalty. “We believe the ability for Rides and Eats to work together to acquire and retain customers will prove to be a competitive advantage,” says Anmuth. “We expect that Uber’s push to bring all services within one app will help cross-promote Eats and other services to Rides’ customers, and vice-versa, amplifying the overall platform effect.”

COVID-19 increases appetite for food delivery

According to Diebel, penetration and frequency are the biggest growth drivers in the industry. He notes online penetration is between 5-30% in most markets. “While some limitations exist, I keep a strong view that the overall growth opportunity is significant,” he adds.