Is the time up for food tech startups like Foodpanda, Zomato?
According to a January 28 report in The Times of India, Rocket Internet backed Foodpanda has not found a buyer even with a rock bottom price tag of $10-15 million.
The company laid off 300 people in December 2015, about 15% of its workforce. In September 2015, TinyOwl had fired 100 employees in its Mumbai and Pune offices. And in October, Zomato sacked 300 workers.
UK based Just Eat entered and exited the market faster than you would order and receive pizza. Most of the startups are barely surviving. Of course, there are a few that continue to receive funding. Yet, there seems to be ruin all around the segment in which barely 18 months ago there was a scramble to launch business.
How did things come to such a pass? For starters, the prize was too good to resist. The size of the food ordering business over phone is $15 billion and startups waded in, aiming to move the business to apps. Investors were lavish with funds.
In 2015, there were 54 deals in the food startup space with investments totalling $235.66 million, according to VCC Edge. But the deals also created many ‘metoo’ businesses, when the need of the hour was building scale, by carefully connecting the back-end (restaurants) with the front-end (customers). The fierce Darwinian struggle among businesses didn’t help – companies began to woo customers with deep discounts.
“Food is a scale business — optimizing on pricing and managing costs is very important,” says Rajan Anandan, managing director, Google South East Asia & India.
Problem was startups were reckless. Unlike selling T-shirts or mobile phones online, food business needs a deep understanding of the locality to be relevant to the user.
They must be connected to as many restaurants as possible in a city, even neighbourhood, so that they can take orders and deliver food regardless of where the order comes from.
Some of the startups that failed were a victim of underestimating the business. At first glance, the food ordering business is simple. Scores of people eat out every day, right? How difficult can it be to coax them to become customers? The rub is these customers face a problem of plenty.
They not only have more than 20 food tech startups apps to choose from, but also have food directories of their own. Rashmi Daga, CEO, Fresh menu, a cloud kitchen company, says, “Everybody eats food and the opportunity is huge. But the shakeup has come in little faster than in other sectors.”
K Ganesh, a serial entrepreneur and promoter of FreshMenu, says recent months have seen uncontrolled and sometimes an insane amount of funding. “Business models and excesses in the space that have led to the current situation.” Let’s talk about the business models first and how they are faring. Startups typically target three opportunities in the food business. One, a directory of restaurants, with revenues coming from ad sales.
Restaurants advertise on the site and the startup can get about 80% margin. Users come to check out restaurants, menus, ratings and reviews. This accounts for 80% of the business for Zomato, which started in 2008 as a restaurant listing site. Zomato, funded by InfoEdge, Sequoia, Tamesak, and others, is the dominant startup in the segment with 5,000 restaurants in India advertising on the site.
This segment is doing alright. Restaurants are keen as ever to list on such apps and websites. Two, food ordering, which is the largest space and the most crowded segment.
Zomato entered this space in mid-2015 while Tiny Owl, Food Panda, Swiggy and at least a dozen others started as food ordering sites and apps. Says Niren Shah, managing director, Norwest Venture Partners India, “It’s the way Ola, Uber work with cab drivers. Food tech startups use the platform to connect users with restaurants.”
A Menu of Models
The top 25 cities have around 75,000 restaurants, including organised chains and standalone restaurants). The number of daily orders over phone for food (mainly lunch and diner) range between 0.7 million and 1 million. Dominos alone does 1.8 lakh to 2 lakh orders a day and has built a Rs 1,800 crore business in India. Swiggy, which recently raised a fresh round of funding, does about 15,000 orders a day and Zomato does 13,000. Overall food tech startups cater to less than 50,000 orders a day. That’s just 5% of the total daily orders.
Evidently, the potential is huge. Which explains why more than 20 startups entered the space within 18 months, most with me-too models. Desperate to convert users from phone to apps ordering, startups sold meals at deep discounts, upsetting the unit economics and making their business unviable.
Not surprisingly, this is the category which has seen most pain points as well. Companies have laid off staff, cut back expansion plans and have had to shut shop as they ran out of money. Anandan says this space has been challenged due to unit economics.
“You can’t sustain if you sell a Rs 130 meal for Rs 100 and that’s what happened.” Deepinder Goyal, co-founder, Zomato, says companies were buying at 100% prices and selling at discount.
“This led to negative gross margin.” Sumer Juneja, principal, Norwest Venture Partners India, argues companies have not been smart about discounting.
“Restaurant food cost is 30-35% and margin is 60-65%. Startups can manage without discounts, by entering into arrangements with restaurants. Besides, in this space customer experience is important as well as shown by Domino’s and its 30 minute delivery. Customer will pay and give repeat orders if he has a good experience.” Norwest is one of the investors in Swiggy.
The third model is cloud kitchen. Here the startups such as Hola Chef, Fresh Menu, Bhukkad own the food and delivery part of the business. This gives better margins but the challenge is to build scale with an army of chefs in various cities.
Saurabh Saxena, CEO, Holachef, says customers recognize who is making their food and this creates an emotional, personal touch. “The centralised kitchen is an opportunity for our chefs to scale.” Holachef operates in Mumbai and Pune and plans to add two more cities by end -2016.
Fresh Menu operates in three cities — Bengaluru, Mumbai and Gurgaon. It has a central team of five chefs in Bengaluru and the satellite kitchens have two chefs each. This segment is relatively new, with fewer players than its counterparts in the other food tech segments. So these are early days to estimate how it is faring.
As is happening with other e-commerce sectors, many food startups are caught in a vicious cycle. To woo customers, they resorted to offering deep discounts.
If they don’t, they risk losing customers reaching out to restaurants directly. Deep discounts delay profits. That strategy itself might not always pay off because of the fierce competition and customer’s fleeting loyalty.
The food business also has a unique set of challenges. “A new mobile phone purchase or clothes purchased online can be delivered in one, two or more days and it won’t bother people. But in the food business, fulfillment has to be within 30-40 minutes,” says Daga. “Besides, there has to be a very tight control on quality of food and service, else people will reject it. Customer expectations are high.”
Fixing the kitchen
The business came under a cloud when a raft of players began entering the segment in a short span. Soon, many players faced a cash crunch, which eventually led to a massive shakeup of the segment.
Even Zomato was not spared. On January 11, Zomato announced shutting down business in four cities—Coimbatore, Indore, Kochi and Lucknow. It runs a food ordering business in 10 cities now.
“From a management bandwidth view, these (cities) were not viable as we were getting just 2% of business from here. We had a bigger fish to fry in other cities and hence cut back,” says Goyal. Goyal does not deny that it is a tough business. Once the platform is there (app), a startup needs customers and restaurants.
“It’s a chicken and egg problem—customers won’t come if restaurants aren’t on your list and restaurants won’t come if you don’t have enough customers. You have to give choice to users. Some startups used our listing and gave a perception of choice to their users. It doesn’t work that way. Market has had a reality check,” says Goyal.
Zomato, which has raised $225 million so far, says it will break even by June.
Fortuitously for startups, the steady stream of negative news has not driven away investors. According to VCCEdge, January 2016 alone has seen three deals with around Rs 300 crore being raised by food tech companies. The largest was Rs 230 crore raised by Swiggy from Norwest Venture Partners, Saif Partners and others.
Investors have turned wiser. Only the good businesses (those not depending solely on discounts to acquire customers) are getting funds now. The focus has shifted from acquiring customers anyhow to unit economics, much like it has in other e-commerce segments.
Some companies like Swiggy now run on a ‘no discounts’ strategy. “Competition is de-intensifying due to capital and quality issues,” says Sriharsha Majety, CEO, Swiggy.
No one is doubting the potential of the business in India though. Experts point to global companies in the space as evidence.
“In this business being small is trouble. A business needs good unit economics and money to scale rapidly. Startups realize that throwing money at the problem (of acquiring customers) won’t help and they have to focus on unit economics and great service, he says. “This shakeout is good for the sector.”