Grubhub’s shares fell 42% yesterday following the release of their lackluster third-quarter earnings report. The shareholder letter from Grubhub which followed has tons of insights into the US food delivery market and also how Grubhub is faring vs other competitors like Postmates, Doordash and UberEats. I am sharing some of the key insights below

Grubhub focusses on Adjusted EBITDA per order as their north star

“we believe aggregate Adjusted EBITDA per order is the best way to think about any marketplace’s profitability. In this business, it’s easy to get lazy and focus on just order revenue less driver costs, which is one component of profitability, but we do not think that is a fair way to think about profitability when a business is “at scale.” Marketing, care, sales, account management, driver recruiting, insurance, technology and yes, even corporate overhead, are all real cash costs to run this business. Adjusted EBITDA per order takes into consideration all the cash costs of operating a marketplace - from demand generation all the way through customer care.”

“we’ve increased Adjusted EBITDA per order every quarter - from a starting point of $0.98 in the fourth quarter of 2018, to $1.09 in first quarter of 2019, to $1.23 in the second quarter and to $1.28 in the third quarter. Another way to look at this is that in the last nine months, we increased our profitability per order by $0.30, or 31%”

Focus on takeout. You will see the growth of Takeout mentioned multiple times in the letter

Online sales of takeout have exploded over the last decade as the ease of ordering, diversity of choice, control and transparency for the diner are all far superior to the analog “menu in the drawer.”

Threat of new entrants over the last few years

“Over the last few years, two significant changes on the restaurant supply side temporarily accelerated overall industry growth. First, a new entrant leveraging a national, scaled third-party transportation network brought delivery capabilities to tens of thousands of independently owned and enterprise restaurants that couldn’t or didn’t choose to provide their own delivery services. Second, listing restaurants on platforms without any partnership allowed other players to expand restaurant inventory rapidly. Both of these changes opened up new and unique pockets of restaurant supply and resulted in significant growth in both orders and new diners as previously untapped geographies and additional restaurants in all geographies were now immediately accessible online”

New users are more fickle and have less loyalty. Hence no smile curve

In August, overall DAG growth began trending noticeably lower than our expectations. As we dug into the data, we saw that our newer diners, particularly those in our newer markets, were not driving as many orders as we expected at that point in their lifecycle. While retention of these newer diners was good, their ordering frequency wasn’t “maturing” at the same level as earlier cohorts. Based on our historical experience, we assume that as markets become more penetrated, the “steady-state” frequencies for the newest diners will be lower than earlier adopters; however, this dynamic had become a little more pronounced than we expected, especially for diners that we acquired at the end of 2018 and first half of 2019. At the same time, we also noticed that the retention rates, not just the frequency rates, of our newest diners (those acquired late in the second quarter), were slightly lower than prior cohorts. We spent a fair amount of time digging into the causes of these dynamics. What we concluded is that the supply innovations in online takeout have been played out and annual growth is slowing and returning to a more normal longer-term state which we believe will settle in the low double digits, except that there are multiple players all competing for the same new diners and order growth. Furthermore, we believe online diners are becoming more promiscuous. For years, we saw in our data that a Grubhub diner was extremely loyal to our platform. However, our newer diners are increasingly coming to us already having ordered on a competing online platform, and our existing diners are increasingly ordering from multiple platforms. We find this “sharing” to be greatest among our newest diners, in our newest markets, but believe it is happening to some degree throughout our diner base. We believe this competitive dynamic had a 300+ bps impact on our growth rate for the third quarter

Focus on small/ regional chains for mutual benefit vs getting more enterprise brands

“From the very beginning, our business has been connecting restaurants with diners to help our restaurant partners grow their profits. This has not changed. Our restaurant partners, predominantly independently owned restaurants and small/regional chains, do not have the scale, financial resources, digital marketing acumen or technical expertise to generate demand online as efficiently as Grubhub. Restaurant operators on our network are in effect using Grubhub as their online advertising partner. Our brand and two-sided network have real value they can’t easily replicate. This is a highly lucrative relationship for both parties. Restaurants profit because their incremental sales from Grubhub orders are greater than the incremental cost of food and demand generation fee paid to Grubhub. Grubhub profits because we can generate incremental demand at a total cost that’s significantly lower than the value of those orders to our restaurant partners”

Partnerships with big enterprise brands help bring in volume. But in improving per order economics? Not so much

“In 2015, we added delivery capabilities to enable restaurants that didn’t have delivery to join our platform. We did this as a means to an end - we knew it would be valuable to have those restaurants on the platform. But, we didn’t then, and still don’t believe now, that a company can generate significant profits on just the logistics component of the business. It is a commodity and there are significant variable costs that are hard to leverage even with technology and scale. Extremely large delivery/logistics companies can generate slim margins, but only because of the hub and spoke efficiencies they gain at substantial scale. The point-to-point nature of our business mostly eliminates that aspect of operating leverage. A common fallacy in this business is that an avalanche of volume, food or otherwise, will drive logistics costs down materially. Bottom line is that you need to pay someone enough money to drive to the restaurant, pick up food and drive it to a diner. That takes time and drivers need to be appropriately paid for their time or they will find another opportunity. At some point, delivery drones and robots may reduce the cost of fulfillment, but it will be a long time before the capital costs and ongoing operating expenses are less than the cost of paying someone for 30-45 minutes of their time. Delivery/logistics is valuable to us because it increases potential restaurant inventory and order volume, not because it improves per order economics. Earlier, we talked about the great progress we are making with enterprise brands. We love working with large enterprise brands because they help drive new diners to our platform and keep diners from going to other platforms. That said, the biggest enterprise brands don’t need Grubhub to bring them new diners in the same way independents and small chains do because they spend billions a year on developing their own brands. What they need most is a driver to take the food to their diners. And, as we just noted, that isn’t cheap, or particularly scalable, so the unit economics and long term profit outlook for our business would look very different if a majority of our business was coming from large enterprise brands”

Why the future might not be as rosy for food delivery apps

“we believe the easy wins in our industry are now a lot harder to find. While growth may not be as explosive without large pockets of new restaurant supply, the good news is there is still significant opportunity for long-term top and bottom-line growth in the over $200 billion takeout market which still largely remains offline. We believe the next leg of growth will take place over time, as we come up with new ways to help restaurants build their online business, address different use cases, like pickup, and come up with ways to drive down diner-facing fees. As we highlighted in our last earnings call, high fees and total overall cost to diners will be an impediment to growth in this industry, as the average diner in the United States will not consistently pay over $25 in total cost for a quick service restaurant cheeseburger meal”

Where Grubhub is lacking wrt competitors like Postmates and Doordash

“When we look at reasons why our diners might try other platforms or new diners might choose a platform other than Grubhub, there are really two areas we think are critical given the current competitive environment:

1) Restaurant Inventory. We know from experience the single biggest determinant of diners usage on marketplaces is whether it has the restaurants that the diner wants. Historically, we have chosen to only list partnered restaurants on Grubhub. We still firmly believe this is the right way to build the marketplace and is the only way to drive long term value for all the participants. But it also takes longer to build the network this way - partnering takes a lot of work. Others have chosen to list non-partnered restaurants on their marketplaces and have generated strong diner and order growth despite high diner pricing and challenging economics. Right now, our existing and new potential diners find more restaurants on other platforms - we need to eliminate this difference and speed is paramount.

2) Diner Loyalty. Because of our model, we are confident we have consistently lower all-in prices for diners than any other platform. We also have the best restaurant loyalty tools, direct POS integrations enabling unique loyalty offerings and the deepest partner relationships on the loyalty side. We think there is a meaningful opportunity to establish programs that attract more new diners and create greater diner stickiness through restaurant funded loyalty rewards and incentives. And we think this is extremely important given the trend of diners splitting wallet share. What this means is that we will be moving quickly, spending more and trying many different strategies over the next 12-18 months to increase restaurant supply aggressively while making our diner experience more sticky - effectively taking action to remove any reason for diners to look anywhere else”

What they are planning to do over the next few quarters

“What this means is that we will be moving quickly, spending more and trying many different strategies over the next 12-18 months to increase restaurant supply aggressively while making our diner experience more sticky - effectively taking action to remove any reason for diners to look anywhere else. For restaurant inventory, we will rapidly expand our recent pilots of putting non-partnered restaurants on the platform. For reasons we’ve discussed many times, we believe non-partnered options are the wrong long-term answer for diners, restaurants and shareholders. It is expensive for everyone, a suboptimal diner experience and rife with operational challenges. With that said, it is extremely efficient and cheap to add non-partnered inventory to our platform and it can at least ensure that all of our current and potential new diners have the option to order from any of their favorite restaurants now, even if it’s not the best solution. By leveraging non-partnered options, we believe we can more than double the number of restaurants on our platform by the end of 2020. At the same time, because we know that partnered relationships are critical to the long-term success of this business, we will be investing aggressively in our independent restaurant sales organization to support converting as many of these non-partnered restaurants to partnered relationships as quickly as possible and to take advantage of other innovations in the restaurant space, like virtual restaurants. With the product suite we acquired with LevelUp, including white label capabilities, POS integration and loyalty, we believe we have a considerable lead on providing the best solution to enable enterprise brands to “buy vs. rent” their online diners via data sharing. We will continue to aggressively sell this product suite and also creatively invest behind the strong momentum we have in enterprise sales, with the goal to have every great brand on the platform to help with diner acquisition, order frequency and retention. On the diner loyalty side, we are exploring and investing behind multiple paths to increase stickiness and frequency. We are going to build on the early success we’ve seen with facilitating restaurant loyalty programs and Perks by incenting more restaurants to participate. We are excited about these programs because they result in enduring diner benefits that improve restaurant sales and can be profitably scaled over time, unlike straight discounts and promotions like free delivery”

Link to the full Shareholder Letter which has detailed financials too: Grubhub Shareholder Letter