The Huge Problem With Online Ordering That Nobody Talks About

10 Aug

The convenience engendered by the on-demand economy is here to stay. We’ve seen a small pullback in on-demand financings lately, but as millennials and future generations demand more convenience it’s hard to see the on-demand share of the pie shrinking.

In fact if we look at the general growth curve of on-demand businesses, it’s only going up. BIA/Kelsey estimated that 2015 saw revenues of $18.5B for the local on-demand economy, representing 3.9% of the addressable market. They also project a 13.5% annual growth rate through 2030, which looks like the below chart

This might even be more conservative than reality if we look at Postmates’ (an on-demand delivery provider) growth.

Part of the on-demand economy is driven by online orders: the ability to order something from your desktop or mobile device and have it delivered as needed. Naturally it’s no surprise that funding in restaurant online ordering has also seen the same growth trends over the past few years.

Now comes the rub

In the restaurant (and presumably retail) world of online ordering, the merchant foots the bill for the pleasure. Unlike delivery costs, which are sometimes transparently passed on to the consumer, our low-margin merchant bears the cost of online ordering.

How much is a merchant paying? It ultimately depends on the provider. However, the biggest distinction is whether the online ordering service is simply creating a plug-in to the restaurant’s own website, or if it’s doing demand generation.

In other words, if the online ordering service is also marketing your business on other platforms, you pay more.

I’ve compiled a table of providers and their pricing.

What I want to point out is a worrying trend with new, large entrants Uber and Amazon: namely, their fees are astoundingly high. To me, this is a trend that online ordering providers Grubhub and Seamless started, and it’s horrible for the operator. Let me explain with math.

If you remember the calculus we went through with Groupon, we made it abundantly clear that daily deals were terrible for operators. In summary, it would take a customer visiting 14 times at full price before a merchant would break even on their daily deal promotion.

The exact same thing is happening to merchants again with online ordering, only this time it’s even worse.

Online ordering is only growing as a percent of a merchant’s overall sales. The growth in on-demand convenience have analysts prognosticating that as much as 30% of a restaurant’s business will come from online orders in the next five years. According to Bob O’Brien of NPD, “Carry out represents 30% of consumer spend, with delivery comprising another 4% on aggregate.” Using these numbers it’s not hard to fathom how online ordering replaces the entire carry out category, and possibly grows beyond its volume of 30%.

This means, unlike the daily deal promotions, restaurants will have a hard time turning off the online ordering spigot – it’s 30% of their revenue!

Now here’s where the math comes back into play. Restauranteurs and retailers do not make much money. In fact, the relationship mirrors the relationship in credit card processing: the card network (Visa) makes all the money and the reseller (merchant acquirers) make nothing comparatively. A restaurant would be lucky to make 2% profit while their suppliers – InBev, Pernod Ricard, Hormel etc. – have a much higher profit margin (InBev’s profit margin hovers around 60%).

The problem, which should be clearer now, is that a restaurant is LOSING MONEY on every online order where the transaction fee is higher than their margin. And since the merchant is much less likely to turn off their online ordering than they are to continue running loser daily deals, they’re stuck between a rock and a hard place: lose 30% of their revenue immediately or lose the entire business over time.

To give the argument some teeth, let’s take a merchant that earns $1,000,000 in annual revenue with a profit margin of 5% (which is the high end of the spectrum). Assuming online orders account for 30% of their revenue, the below chart details how much money the merchant is losing with online ordering activity, and the impact that’s having to their bottom line.

It’s now obvious just how detrimental online ordering can be to a merchant. Considering most merchants don’t have a 5% profit margin, these numbers can get ugly really fast. To put it into more tangible numbers, this merchant is going to pay upwards of $10,000 per month for the privilege of online ordering.

Unless the rates change, what is a merchant to do?

The answer, we think, is coming soon enough.

The high cost of online ordering middle men stems from a few places.

1) Making merchant order data accurate. Merchants receive orders from a fax, email or tablet. Then the merchant must transpose the order information from the fax, email or tablet into the POS and make sure their menu and pricing is accurate on all the provider websites. More often than not, this means a merchant has to buy a stand-alone tablet to manage orders from a provider. If that merchant wants to use multiple providers, they have to buy and manage multiple tablets. Just imagine being a hostess who’s managing guests on a busy night while having to run five competing tablets to handle your online orders and deliveries.

2. Marketing. Another large expense for the middle men is marketing your business. Seamless and Grubhub spend millions buying TV time and getting consumers to download their application. They must also manage their own consumer applications. All of these costs are passed onto the merchant.

We see these two headaches disappearing with the progress being made by cloud POS.

Cloud POS already has data injection capabilities. Unlike legacy POS, where someone must deploy and maintain a software agent at the merchant’s site to collect and inject data (a process Micros and NCR gleefully charge $50,000 for), cloud POS can easily inject order data. This:

  • Eliminates fat-finger errors in transposing orders from a fax to the POS
  • Automatically updates POS pricing and menu changes
  • Significantly reduces time staff spends inputting data

Chowly, an online ordering POS integration company, has quantified this value already.

Cloud POS can also syndicate online ordering to a multitude of places that do NOT charge high amounts for orders but are still highly marketed. Google. Bing. Amazon. Connected cars. Yelp. The list is very long.

Over time, it will be really hard for a Grubhub to justify a 13.5% cut when the merchant can syndicate their online ordering on Google for far less.

That’s not to say these services are mutually exclusive either. A merchant can keep Grubhub and use their cloud POS provider to syndicate online ordering. Each time an order comes from Grubhub the merchant pays 13.5%, and each time it comes from their POS network they pay far less. This way the merchant doesn’t lose Grubhub orders by shutting them off completely, but slowly watches their Grubhub demand shift to other ordering platforms – all while paying less each time.

Cloud POS companies will naturally takes cuts of each transaction – creating new revenues for themselves – but this will be far less than the amounts charged by other online ordering providers since big costs (data consistency and marketing) are being eliminated.

Who knows what online ordering fees will look like in five years, but they will be a lot lower than they are today. That’s good for the merchant, their cloud POS provider, and the consumer. It’s only bad news if your business model revolves around gouging merchants today.