Photo: Chipotle Mexican Grill
Chipotle battles escalating delivery costs
Many local restaurants have openly griped about the exorbitant fees charged by third-party delivery providers such as Grubhub, Uber Eats or DoorDash. Even a national chain like Chipotle isn’t immune to the problem of rising costs.
Chipotle’s same-store sales climbed 8.3 percent in the third quarter as digital growth catapulted 202.5 percent to represent 48.8 percent of sales, as online orders offset indoor-dining restrictions. Operating margins, however, eroded 130 basis points to 19.5 percent due to higher delivery costs. Online orders were split between delivery and take-out.
Restaurants that use the “Big Four” delivery apps — Postmates, Grubhub, UberEats and Doordash — pay commissions of 15 – 30 percent per order, and those services represent an estimated 95 percent of third-party delivery volume, according to The Texarkana Gazette.
Margins were also depressed to lesser degrees by fewer sales of high-margin beverages — because fewer drinks tend to be ordered for delivery — as well as by increased beef prices.
Margins are expected to remain depressed in coming quarters.
“It all depends on delivery,” CFO Jack Hartung said on last week’s quarterly call. “If delivery shifts into in-store and shifts into order-ahead and pick-up, then I would say our margins, for sure, are headed on the way up. If delivery stays the same or increases, we’ll have some challenges.”
Chipotle is using a few strategies to manage margins:
- Eliminating freebies: Chipotle began eliminating free tortillas, leading to some customer complaints on social media.
- Encouraging take-out: The majority of new stores are featuring its new order-ahead Chipotlanes that are generating about 10 percent higher sales than locations without pickup lanes and also seeing fewer low-margin delivery orders.
- Higher prices for delivery orders: Chipotle is testing seven percent, 13 percent and 17 percent price increases for delivery menu items. The chain reduced the service it charges customers to $1 from $3 at the pandemic’s outset, offsetting some of the jump in menu prices.
At Raymond James North American Equities Conference in September, CEO Brian Niccol said Chipotle has to weigh three factors — the meal’s price, the delivery fee from third-party delivery providers and Chipolte’s service fee — in making pricing adjustments for delivery. Charging a higher delivery meal price upfront was seen as a better option than surprising the customer with a higher service fee at the end of an order.
Mr. Niccol admitted, “We’re in the early stages. We’re still learning what the customer response is going to be over a longer period of time.”
- Chipotle Announces Third Quarter 2020 Results Q3 Digital Sales Tripled Year-Over-Year And Accounted For Nearly Half Of Sales – Chipotle
- Chipotle Mexican Grill Inc (CMG) Q3 2020 Earnings Call Transcript – The Motley Fool
- Chipotle Mexican Grill, Inc. (CMG) CEO Brian Niccol Presents at Raymond James North American Equities Conference – Seeking Alpha
- Chipotle’s Delivery Margins Aren’t Delivering – Restaurant Business
- Chipotle price target raised based on long-term growth potential but shares fall as delivery becomes a headwind – MarketWatch
- Chipotle shares fall despite earnings beat, as robust delivery growth weighs on profits – CNBC
- Chipotle reveals it killed the free tortilla side because people were ordering too many during the pandemic – Business Insider
Discussion Questions
DISCUSSION QUESTIONS: Does increasing menu prices for delivery seem like the best path for Chipotle and other restaurants to offset higher expenses tied to delivery? What short or long-term solutions might be more appropriate?
Poll
BrainTrust
Adrian Weidmann
Managing Director, StoreStream Metrics, LLC
Ken Morris
Managing Partner Cambridge Retail Advisors
This is the dilemma faced by both retailers and foodservice companies alike. Consumers want and often expect free delivery, but delivery has a cost attached. So companies subsidize the delivery cost to the detriment of their margins. While this may help boost market share and drive sales, it is not sustainable over the long term. Retailers and foodservice players need to balance out these costs. Pushing consumers to other methods of receiving products, such as pickup, is one option. Trimming costs elsewhere is another. Introducing some kind of subscription fee for free delivery might be a consideration for some. But, ultimately, there is a need to reset consumer expectations about the costs of delivery – and that is far easier said than done!
I think it could be close to too late to reset consumer expectations on delivery charges. We’re all used to free now and this is a deal breaker for some. I see some restaurants that charge for delivery offering free delivery about one out of every four weeks, so customers are trained to wait for the free week.
Baking the cost of delivery into price is a good strategy for pure-play online retailers — but not restaurants. As long as they are using third-party delivery services they should let the consumer see the cost of delivery and associate it with the delivery service — not the restaurant.
The customer is clearly the end beneficiary of the convenience, so the payment will eventually come from there, one way or the other – limited menu for delivery services, higher prices on some items, minimum spend, delivery fees, etc.
In the short run, other players in the value chain are making up – the restaurants by foregoing margins, the delivery services by giving coupons and waiving delivery fees, drivers by doing a lot for less than minimum wage in many cases.
It is a huge optimization problem for the restaurants, particularly national chains in balancing sales, profitability and customer experience.
At some point we knew we were going to see increasing menu pricing to compensate for the higher costs it takes to operate businesses in the pandemic world. I think as with anything else, Chipotle must be transparent about the cost increases and not try to hide them. I believe people will appreciate the honesty in having to increase pricing.
I honestly think consumers expect there to be a premium for delivery. The delivery services are transparent about their charges. I think it makes sense for the restaurant to charge more for delivery as well. It would make sense for them to line item delivery fees instead of trying to manage two menus, and would give customers the transparency they would like to make decisions about ordering in or going out for pick up.
In the spirit of transparency, I would clearly show the added on delivery charge for using one of the big four delivery services. Most customers don’t know the delivery charge the big four are taking from restaurants. It is a convenience for home delivery, with a cost, and the customer should know this. I like Chipotle taking a multi-pricing approach and giving customer options.
Surprising the customer with a higher than expected charge is never a good thing. Letting your customer know about the additional service fees upfront AND making certain that the service is exceptional and worth the extra charge will always be the most successful option. I believe that the best long-term option for the restaurant sector is developing an amazing BOPIS experience. Designing and implementing an ordering experience followed by a pick-up process that caters to this is the future of restaurants. This includes not only the on-location experience but food presentation and packaging – throwing items in a styrofoam clam-shell is NOT the answer.
Every time I hear restaurants complaining about delivery I just have to ask, what about pizza? Pizza restaurants have been delivering since the beginning of time — c’mon, figure it out. I don’t want to know how, just do it.
Pizza is a different animal. Much simpler actually compared to an average restaurant. Pizza chains are delivery-first operations as opposed to restaurants which are dine-in first. Flat packaging, common base and ingredients, customers that are trained to give tips, limited to no dine-in – all these factors mean pizza is made for the pandemic. Pizza delivery is a well-oiled machine that the restaurants perfected over years.
Exactly, and they got well oiled over the years out of competitive necessity, just like other restaurants have to now. I’m not buying the logic of why restaurants can’t adapt to everything you just listed in order to compete — we have some in our market that have. Even Target delivers here and they were store first for a century. I think it’s the inability to change that’s the hindrance, which includes operating as dine-in first for so long, that’s creating the fiction. In the era of fail-fast or die, those are called “excuses.”
The best path for Chipotle and other restaurants is to convert these guests to pick-up. The up to 30 percent cost is unprofitable and unsustainable. The customer is owned by these delivery services and that is the biggest challenge. If you don’t own the customer you are destined to lose. The life time value (LTV) of the customer demands that you own the data. Converting to pick up and order orchestration solutions that are both technology- and process-based is the only way to make this work. You must own the data!
The final mile in foodservice and food retail continues to be logistics and profitability issues. While price increases may be expected, Chipotle needs to consider other options to offset delivery costs. How about a subscription service that would include X meals and delivery bundled together? How about a discount (less than the delivery charge) for pickup? How about larger order incentives (sides, desserts, etc.) to increase order size to share delivery cost? The only limit is one’s imagination.
This is an inevitable outcome of both the pandemic and the costs of third-party delivery options. I would suggest, however, that restaurants forego separate menu prices and instead include a “Grubhub” fee listed on the order so that consumers can see how the costs are derived. My sense is that many people will look for cheaper options, including take-out/curbside. Curbside does add some expense to the restaurant, but far less than third-party commissions.
We have to ask ourselves, do these high commissions taken by ordering platforms represent what an economist might call “super-normal profit” whereby new entrants should be entering the market to undercut and take part of the market share?
Is there an option for collaboration between large restaurant groups to have their own platform? We see similar collaboration in other industries – a number of car manufacturers each hold a stake in “here” the mapping company – that has benefits for all of them but offers cost advantages without them being tied in.
Ben’s right: don’t bake the delivery fee into the price of the product. Customers may want free delivery, but they understand that there’s a difference between picking it up themselves or having someone bring it to them. It’s just common sense.
Unless they own the service, this will always be an issue for retailers of low priced items like food and they will be held captive by suppliers who are captive to cost variations. Brands like Chipotle can help with profitability by charging more for this premium, “gotta have it now” service, but they also need to be investing in a better pickup experience to drive even a small percentage to the location for people that truly do not need the convenience (at a cost) and will consider a secondary distribution model like store pickup. But not an experience where you have to get out of your car and go stand in the restaurant to get your order. Zero experience. Zero benefit.
The current business model makes no sense at all. I am reading that many restaurants actually lose money on delivery through the delivery services. If so, why do it? You don’t make it up in volume.
If the charge by the delivery services is the true cost of delivery, why isn’t the user of the delivery service paying for the service? The user is not the restaurant. Why should those people who choose to pick up pay the same as those who want the convenience of delivery?
Whatever service was the first to sell this idea to the restaurants must have had a great salesman.
My first economics professor in college talked about TANSTAAFL: “There ain’t no such thing as a free lunch.” But as consumers we’ve been trained to expect free delivery – including for lunch. This is what has and will continue to burden the entire e-commerce model. It either needs to be solved, or expectations must be changed.
I often quote Seth Godin and one of my favorite quotes in this regard is “the problem with a race to the bottom is you might win. Or even worse, finish second.” As with many things related to e-commerce and home delivery, we’ve created a monster and it’s all been made worse by the pandemic. Free (or low cost) delivery is rapidly becoming a customer expectation and unfortunately the marginal economics of local home delivery are generally pretty bad, whether we are talking prepared food or groceries. While there is some ability to leverage scale to lower the average unit cost of delivery, digital technology does little to leverage the simple reality that you still need to pay for the “windshield” time of the driver or courier. Making matters worse is the low average profit contribution from many orders and an escalating marketing war among the services to build market share. Something has to give.
There are a few things we know for sure: 1.) Drones and robots aren’t replacing cars, bikes and people any time soon. 2.) You can’t reasonably pay labor much less. 3.) Customer acquisition and activation costs are unsustainable. 4.) There can’t be much upside in charging consumers more and not lowering demand, particularly as more restaurants (hopefully) get closer to normal operations during the second half of next year. I expect a massive shakeout very, very soon.
The first step, agreeing with Ben Ball, is that restaurants should be completely transparent about the delivery charge from the third party. This will help those delivery providers feel the competitive pressure that will naturally drive prices down. Second, it seems that restaurants should reward pick-up/take-out by providing some kind of incentive, maybe a small incentive for the first trip (free non-alcoholic drinks) and an incentive for returning for pick-up. Additionally, make it a great experience! Experience matters. Third, restaurants need to consider the cost/benefit of having their own dedicated delivery capability. A couple of our local restaurants have done this and it seems to be working well — they even advertise that it helps them provide better price/value for their customers. For some that will be an option, although not for others.
Chipotle needs to be transparent with their customers about WHY they are increasing menu prices. Customers appreciate that and this also helps build trust with them. Another way to appease the customers is to incorporate free delivery benefits or other types of rewards as part of their Chipotle Rewards program.
The key is to be transparent on why the costs and fees are what they are. Restaurants should be clear that delivery fees are due to using the delivery services. Raising menu prices can backfire and cause customers to seek out lower-cost menu items instead – which brings us back to reduced margins for the restaurant. Delivery has value, and most consumers know that. For that matter, use multiple delivery services and highlight the difference in fees the customer pays in your marketing materials, website, and app wherever possible. That way, make the delivery services compete for your customer vs. giving your customer away to the delivery services.
Consumers’ expectations on the real cost of food and associated services needs to be reset. All through the supply chain — from farmers, processors, packaged goods, retailers and the final mile — new financial models need to be developed that reflect true costs and factored into the final retail price.
The dynamic duo of meal delivery — pizza and Chinese food — have always charged for delivery. The extra $3 or so is completely acceptable and expected. (And for the record, I always tip the driver an extra few, because it’s a tough way to earn a living.)
So I’m puzzled as to why consumers would expect free delivery on prepared meals from other restaurants. State the fee right up front when the order is taken. If we’re not OK with that, we can always swing by and pick it up.
The math changes when the “big four” third party delivery services get involved — and not in a good way for restaurants or customers. As a rule, I avoid using these services because they soak up all the margin from local restaurants. I want my favorite independents to survive social distancing, not die a slow death while others eat their profits.
My counsel to Chipotle (and other chains) would be transparency, transparency, transparency. Unless it’s for catering, the size of the order is immaterial — a trip is a trip. Charge a realistic flat fee within a reasonable radius. People will understand the value.
Itemize the DoorDash, Grubhub or UberEats fee too. Why should they get to hide beneath your prices?