Appetite for food-delivery apps wanes among small restaurant owners

9 min read
Chi Hongwei, owner of a wonton restaurant, checks stock after business hours. (Image credit: TechNode/Yu Dingzhang)

For the past six years, the lives of Chi Hongwei and her husband have revolved around their 30-square-meter franchise restaurant that sells wontons, a type of traditional soup dumpling.

Located in Songjiang University Town, a suburban district of Shanghai that is home to tens of thousands of university students, they know their business model works: feeding hungry tech-savvy students, who usually use food-takeout apps to order the meals delivered to their dorms. In peak months such as December, the small restaurant is filled with the nonstop sound of notification messages emanating from the cash register, reminding Chi and her husband of incoming orders.

“Sometimes it turns out to be a little too overwhelming for us to handle,” Chi recalls, adding that the restaurant could receive as many as 500 orders in a single day.

The past five years could be considered a golden age for many such small restaurants. Many managed to amass a small fortune by piggybacking on the enormous popularity of the food-delivery apps. Not only did these digital platforms offer a new and more efficient channel to market meals, but their operators were also willing to provide them bonuses in the form of promotional subsidies.

Now it seems those days may be numbered. As Tencent-backed Meituan and Alibaba-backed Ele.me have snatched up most of the market, the idea of partnering with online delivery platforms is not as attractive as it used to be. Some small restaurant owners are turning their backs on food-delivery apps, creating their own WeChat mini-programs to take orders or reverting to distributing paper menus to gain customers.

By abandoning online channels, they can shift their focus back to higher-yield in-store guests, they say.

When Chi and her husband opened a small sushi restaurant in September, just 50 meters away from their wonton shop, they decided not to list it on Meituan or Ele.me. That decision appears to have paid off. “So far, the offline traffic is not bad,” says Chi.

Power shift

In the past, China’s food-delivery market involved several players, but it has since undergone major consolidation. It’s now effectively a duopoly made up of Meituan and Ele.me—combined, the two hold 90% of the market share, according to a report from China Tonghai Securities citing data from research firm Analysys. Meituan led the sector with a market share of around 60%, followed by Ele.me, which had around 35%, according to the report.

Market share changes in China’s food-delivery sector (Image credit: TechNode/Yu Dingzhang)

With the rise of smartphone penetration in China, ordering food online became popular in the early 2010s as a string of startup platforms like Ele.me, Dianwoba, and Waimai Chaoren raced into the emerging sector. Access to almost unlimited capital played a big role in helping those firms to gain early supremacy in the food-delivery market. Hefty subsidies were distributed to entice both merchants and consumers.

Early on, the merchants had leverage. To gain an edge on their competitors, food-delivery apps spent freely to enlist more restaurants, which was a crucial baseline for luring more customers. Merchants enjoyed the freedom to choose among platforms, opting for whichever service offered the most preferential policies or largest subsidies. Moreover, shops that were reluctant to adopt new technologies did not feel they were losing out because app usage rates were low.

That’s no longer the case. Usage rates are through the roof and nearly everyone in the food and beverage industry now offers a delivery option.

The dynamics between platforms and merchants took a gradual turn as market consolidation allowed the tech giants to dominate the booming sector. As subsidy-powered competition weeded out smaller competitors, the battle soon became a proxy war between Baidu, Alibaba, and Tencent.

Between 2015 to 2017, Alibaba-backed Ele.me, Tencent-backed Meituan and Baidu Waimai emerged as the largest players in the sector. The three-way battle ended when Baidu walked away from food delivery to focus on artificial intelligence. Ele.me acquired Baidu Waimai in 2017.

In 2018, a series of events solidified the dominance of Meituan and Ele.me. Alibaba took over Ele.me and merged it with the company’s local services unit Koubei in October. Tencent-backed Meituan raised $4.2 billion in its Hong Kong IPO last September.

With the landscape settling into a duopoly, the food-delivery platforms became the rule-setters, leaving merchants in a weaker bargaining position.

At the same time, the proliferation of subsidies worked to cement new food-ordering practices among consumers, offering discounts to reward them for ordering via apps.

The effect on China’s dining scene has been profound, especially on smaller venues. Restaurants now rely so heavily on takeout orders that many have effectively pivoted from sit-in dining rooms to delivery-only kitchens, or restaurants with little or no seating. Sometimes waitstaff run around filling large orders for delivery, paying scant attention to or even ignoring on-site guests.

“Food delivery is a ‘winner takes most’ market, which is why these companies invest so much in subsidies to buy market share,” said Lucas Englehardt, founder and CEO of the now-defunct food-delivery platform Waimai Chaoren. “Being the dominant player allows them to charge restaurants more, with fees that get passed along to customers.”

Such an arrangement isn’t healthy for the market, says Shanghai-based Englehardt, who is now CEO of Xixilab, a teeth whitening and aligning kits developer. He expects the trend to continue, now that the two leading platforms have gone public. “I don’t see the battle finishing anytime soon, as both have money to spend and different strengths to leverage,” he told TechNode in a recent interview.

Englehardt said that in other countries, it’s less common for companies to rely on subsidies to push out smaller players. But because neither Ele.me nor Meituan is profitable yet and neither player fully dominates the market, the government won’t limit their aggressive behavior, he added.

Commission hikes hit merchants

Chi, the wonton shop owner, said that as recently as 2018, merchants could still find a way to collaborate profitably with the food-delivery platforms. However, the last straw came this January when Meituan and Ele.me hiked the fees they charge restaurants by three percentage points, pushing commission rates to more than 20% in some cases. This means that for every RMB 100 ($15) that a restaurant brings in per order, they may pay up to RMB 20 in commission to the platforms.

For owners of small restaurants in Shanghai, commission rates in mid-February have risen from 16% to 18%—and that applies to vendors who are willing to list their restaurant exclusively on one delivery platform. If they opt to be listed on multiple platforms, it’s common practice for them to be charged higher commissions, usually around 20%.

An Ele.me spokesperson denied that the company is raising commissions, although she acknowledged that the commissions for some restaurants in Songjiang University Town might rise when certain preferential policies expire this year.

“We aren’t raising our commissions,” said the Ele.me spokesperson. “We’re actually reducing them materially in many regions in China, like Guangdong, Chongqing, Jiangxi, Sichuan and Fujian, to support merchants.”

Meituan declined to comment.

From an international perspective, 20% is quite high, according to Englehardt. Overseas commissions range from 5% to around 15%, he said. The platforms in China often provide the delivery as opposed to those abroad where typically the restaurant does its own deliveries, he noted.

Commission fees vary depending on the size and location of the business. Larger restaurants have more bargaining power when dealing with the delivery platforms, according to Zhu Congyang, a hot pot chain restaurant operator in Shanghai.

In Chi’s experience, those commission fees can make the difference between profit and loss. A bowl of wontons sells for RMB 20, but around 45% of that revenue goes into the pocket of the wonton-chain parent company for franchise fees and food supplies, while 15% goes to the online food-ordering platforms as commission. Out of the remaining 40%, they must account for other overhead costs: utilities, the salaries of their three employees, and shop rental of more than RMB 6,000 a month.

Cost breakdown for a bowl of wontons priced RMB 20 (Image credit: TechNode/Yu Dingzhang)

Another burden for restaurant owners is the expense associated with discounts. In order to attract customers, online platforms ask merchants to offer discounts to consumers. For instance, if the customer’s total order exceeds RMB 20, they qualify for a discount of RMB 3.5. Those discounts are subsidized by the merchants.

After all costs have been deducted, the final profit from that RMB 20 bowl of wontons is less than RMB 1.5 for Chi and her husband.

On top of that, some merchants choose to pay the delivery platforms more than RMB 10,000 per month to secure an attention-grabbing placement on the delivery app. If the customer’s home or office is far from the restaurant, Chi must pay an additional RMB 2 per order to cover the distance beyond the standard delivery range. Often, this can wipe out any potential profit from the food order.

“Who would have thought that we might end up losing money because of online orders?” Chi said. “Many of us don’t want to provide discounts, and maybe don’t want to take online orders at all, but we have no other choice.”

Franchisees like Chi are urged to participate in the discount programs; otherwise, they will be punished for not fulfilling sales targets. Even restaurant owners not bound by franchise arrangements say they’re not willing to take the risk of losing customers to competitors. This is especially true for restaurants with an out-of-the-way location.

Zhan Chufeng, founder of the Let’s Soup Party restaurant chain, which operates over 70 outlets in southern China’s Guangdong province, said online orders are an important part of his company’s operations, representing around 70% of total orders.

The commission rates they pay to Meituan and Ele.me vary between 15% and 18%, which is much lower than what the majority of merchants pay. “We got lower fees because we are a premium brand,” said Zhan. “With subsidies provided, the commission fee is still bearable for us. But the ideal rate is around 13%,” he added.

Back to basics

Given the circumstances, merchants who find themselves dependent on delivery orders are left with few options. The simplest way to maintain their current margin is to pass the cost increases on to consumers, either by raising the price or lowering the quality of food. But such tactics can jeopardize the long-term success of the business.

Some shop owners are turning their attention back to the customers who show up in person to the restaurant to consume food on the premises. “We prefer the in-house orders where possible,” says Xiao Hua, owner of a dumpling restaurant in suburban Shanghai. For an order priced RMB 16, dine-in guests pay the full price. However, if that order were being delivered as takeout, he would only get around RMB 12 after the deduction of current commission fees, he said.

Xiao Hua is taking a break at his dumpling restaurant (Image credit: TechNode/Emma Lee)

Zhuang Shuai, the founder of Beijing-based consulting firm Bailian, said that boosting offline store operations to increase the proportion of in-store consumption, and strengthening the development of new dishes and new brands, could also help small- and medium-sized merchants achieve higher returns.

To be sure, while some smaller merchants are feeling the heat as a result of commission hikes, other factors are also weighing down restaurant owners. Increasing competition or rising market costs could also be at play, said Michael Norris, strategy and research manager at AgencyChina in Shanghai.

And it’s not as if the platforms are rolling in cash as a result of their commission income. Meituan’s operating losses surged 57% year-on-year to RMB 3.7 billion in the fourth quarter of 2018. Revenues from the food-delivery segment increased by 66.1% to RMB 11 billion in the same period from RMB 6.6 billion a year earlier. Meanwhile, the company’s food-delivery costs increased 53.6% year-on-year during the reporting period, which management attributed to mounting salary costs for its delivery fleet.

Ele.me’s revenue, which primarily represents income from platform commissions, provision of food-delivery services and other services, totaled RMB 5.15 billion, according to Alibaba’s fourth quarter 2018 financial report.

Friction between on-demand platforms and delivery workers has also been on the rise. Meituan, Ele.me, and Didi—which is scaling back its food-delivery service after launching last year—have all faced disputes with their delivery fleet workers. “In contrast to parcel delivery, food delivery is more time-sensitive and order demand varies hugely during peak and valley hours,” said Zhan of Let’s Soup Party.

The subsidy-fueled growth “spoiled” both users and merchants, according to Esme Pau, an analyst from Tonghai Securities. But ultimately, the core issue facing the industry is its hotly contested nature. “The only way to overcome competition is for Meituan and Ele.me to reach a consensus in setting prices,” she says. “However, we do not expect this to happen in the near term,” adds Pau.

For Chi, mixing technology with food preparation has been a frustrating experience. “The platforms failed to make it easier to do business,” she says. “Instead, I feel more stressed out than ever before.”

Additional reporting by Yu Dingzhang.