Why Uber Eats and GrubHub partnerships are risky for restaurants

Here's how your online grocery delivery options are growing
Here's how your online grocery delivery options are growing

Today, you can get just about any kind of food delivered to your door.

That's great news when you're hungry. But delivery can be a risky bet for restaurants.

To reach customers, gain exposure and build a new channel for sales, restaurants that can't deliver food on their own are signing up with third-parties like GrubHub (GRUB), Seamless, Uber Eats, Postmates and DoorDash.

Americans want their food brought to them at home or the office, and restaurants don't want to miss out. National chains sense an opportunity to grow revenue and are now racing to team up with outside parties, too.

McDonald's (MCD) partners with Uber Eats. Dunkin' (DNKN) uses DoorDash. Pizza Hut, KFC and Taco Bell parent Yum Brands (YUM) took an ownership stake in GrubHub last month. Chipotle (CMG), Red Robin (RRGB), Jack in the Box (JACK), Cheesecake Factory (CAKE) and Outback Steakhouse (BLMN) also rely on apps.

Related: Supersize your takeout: Seamless and GrubHub merge

But these relationships are in their testing stages and can carry unexpected risks, including shrinking profit margins and shifting customer allegiances.

"It's difficult for a restaurant to just flip on the switch," Stephen Dutton, an analyst at Euromonitor International, said. "Navigating the best way to get involved in delivery is a big challenge."

No booze

Turning a profit in the food business is tough.

Partnering with delivery aggregators squeeze margins even tighter.

Restaurants pay the services 15% to 30% fees for each order customers place through their platform. "It is a very large expense for the restaurant chain to absorb," said Jeffrey Bernstein, an analyst at Barclays.

Customers are also less likely to ask for menu items that carry higher margins -- including soda and alcoholic drinks-- when they order in, cutting deeper into profit from delivery.

Domino's (DPZ), the industry's in-house delivery leader, has argued the third-party model is "problematic" for restaurants. Domino's charges its franchise owners just 1% for deliveries.

Related: Why Domino's is winning the pizza wars

Olive Garden agrees that the equation doesn't work. "We're not willing to give up 20% to 25% just to get a sale," Darden Restaurants (DRI) CEO Gene Lee said in January.

Cannibalization

Restaurants risk cannibalizing their more profitable dine-in sales by encouraging customers to stay at home.

Party sizes tend to be larger when customers come in to eat and restaurants don't have to pass off a cut to a third party.

Restaurants say orders that come through aggregators are "incremental" -- sales they wouldn't have gotten otherwise.

McDonald's has reported around 70% of orders on Uber Eats are incremental. Delivery has created new occasions and different times of day, especially late at night, for people to eat McDonald's.

Related: McDonald's to launch ordering app, expand delivery

Sara Senatore, an analyst at Bernstein, said third-party platforms were a cheaper form of marketing and a great way to acquire first-time customers.

But restaurants' returns start to diminish as those new sales become repeat orders through the platform. "It would be much kinder of you to just pick up the phone and call the restaurant" so the operator can avoid paying a commission, Senatore said.

It's even worse if customers decide to replace going out to dinner entirely with ordering in, Stifel analyst Chris O'Cull added. He believes restaurants will start to scale back on third-party relationships if they're cutting into higher-margin dine-in traffic.

Cold food

Integrating third-party delivery into kitchen operations can be a logistical nightmare.

Employees need to be trained how to store, cook, package and handle the food so it arrives at customers' homes hot out of the oven. Delivery services work with several restaurants at a time -- including direct competitors -- and there's no guarantee for the restaurant that their food will be the first stop on the driver's route. The clock is ticking and they can't afford to get it wrong.

If the order takes longer than expected or if the food comes cold and soggy, customers will have a "tarnished image" of the brand, Barclays' Bernstein said. Instead of blaming GrubHub or Uber Eats for the disappointing order, they'll fault the restaurant and may not return.

Related: Grubhub will deliver KFC and Taco Bell. Its stock is soaring

That's why Texas Roadhouse (TXRH) is reluctant to turn to third parties: "We encourage all our competitors to do as much delivery as they can, so they can deliver lukewarm food to the people who order it," CEO Kent Taylor said last year.

Customers also may write a negative review about the wait time or the food, discouraging other people from trying the restaurant, noted Erik Thoresen, a principal at research firm Technomic.

Changing loyalties

Customer loyalty shifts away from the restaurant to the delivery service in third-party partnerships.

"The relationship changes because the restaurant is now one step removed from the customer," Thoresen said. People are "going to a site where they can potentially find something else that's new and interesting."

Analysts also question who controls the customer data on third-party transactions. Restaurants are not able to tailor marketing and roll out new promotions effectively if they don't get those order histories, email addresses or cell numbers.

"You want to know who your best and most loyal customers are," said R.J. Hottovy, an analyst at Morningstar. "You have to make sure you have access to that data."

How to avoid pitfalls

If a restaurant decides third-party delivery is the best way to boost sales, analysts say they can take steps to build a happy marriage.

Restaurants need to negotiate low fees with aggregators to prevent delivery orders from eating into margins and reach data sharing agreements to gain customer insights.

Bernstein explained that restaurants should work with third parties to understand which foods travel well and ensure they are getting priority along drivers' routes.

Full-service operators must "protect occasions they really care about" and "create great experiences around them" to attract diners and defend themselves from the threat of cannibalized sales, said Eli Portnoy, founder of Sense360, an analytics firm that works with companies.

To guard against customers swapping out profitable dine-in meals, restaurants can limit delivery to off-peak hours -- late nights, mid-afternoons and early mornings.

"If you get the munchies at 10:00, and you want to order delivery, there's a good chance that's incremental," O'Cull said.

Investing

CNNMoney Sponsors