A new contract proposed by a researcher from the University of Texas at Dallas and his colleagues could help alleviate major sources of conflict between restaurants and food delivery platforms.
In a study published online March 28 in the journal INFORMS public administrationdr. Andrew Frazelle, assistant professor of operations management at the Naveen Jindal School of Management, and co-authors Dr. Pnina Feldman of Boston University and Dr. Robert Swinney of Duke University examined the relationships between food delivery platforms and the restaurants they partner with.
Other sharing economy platforms, such as ride-hailing and vacation rentals, allow people to sell access to resources that wouldn’t otherwise generate income for them, Frazelle said. The interests of the resource owner and the platform are quite well aligned in the sense that more trades are good for both.
“However, delivery in restaurants is different,” Frazelle said. “Delivery orders represent incremental business on top of the restaurant’s existing eatery. More business sounds good, but it comes at the cost of a commission charged by the delivery platform.”
Platforms such as Grubhub, DoorDash and Uber Eats collect online orders from customers, relay them to restaurants and deliver the orders to customers. While this service helps restaurants expand their markets, the study found that the relationship has inherent flaws.
The most common contractual relationship between platforms and restaurants, where the platform receives a commission or percentage discount on each delivery order, has two main problems, according to the study.
First, the standard contractual relationship offered by most platforms is one of simple revenue sharing. The revenue from each order is split between the platform and the restaurant according to a pre-agreed rate. The platform’s share of revenue is typically about 15% to 30%, leaving the restaurant with only 70% to 85% of its normal revenue for each item sold.
Second, a high volume of delivery orders can put pressure on restaurant operations.
“Delivery orders from the platform can potentially harm the dining experience by clogging and delaying the kitchen, and the expectation of a long delay could deter higher-margin customers from buying,” Frazelle said. “Combine that with the platform only monetizing delivery orders, while the restaurant monetizes both dinner and delivery orders — but different amounts for each due to the platform’s commission — and we have a recipe for conflict.”
Food delivery during COVID-19
Frazelle said food delivery was already growing before the COVID-19 pandemic, but it got a significant boost as people received varying degrees of home ordering.
DoorDash reported that more than 6 million people delivered orders on its platform by 2021.
“During the early stages of the pandemic, delivery and takeout were restaurants’ only revenue streams, and delivery platforms were arguably critical to their survival, especially for smaller, independent restaurants,” Frazelle said. “But given the platforms’ commissions and the already low margins in the restaurant business, delivery orders are often not very profitable, if at all, for restaurants, many of which lack the clout to negotiate more favorable terms.”
Cities, including New York, Seattle and San Francisco, have enacted laws limiting the commissions platforms can charge to protect restaurant profit margins.
The commission caps were well-intentioned, Frazelle said, but they didn’t change the fact that platforms and restaurants serve different purposes.
Resolving the conflict
This motivated the researchers to identify an alternative contract — a variation on the current industry standard — that improves outcomes while granting full price power to the restaurant for the dinner channel and the platform for the delivery channel.
The researchers developed a model and found that several possible pairs of dinner and delivery prices would generate higher or lower total revenue, or the sum of dinner and delivery revenue, with particular prices achieving the maximum possible total revenue, Frazelle said. The optimal solution trades off the incremental revenue from delivery orders against the negative impact those orders have on diner revenue from the excessive congestion they create, striking the right balance between dining and delivery.
“If the same company controlled both the food and delivery channels, it would jointly determine the respective prices to maximize overall revenue,” he said. “But of course prices are usually set by two different companies, and each company tries to maximize its own revenue. The key is to design an appropriately structured contract so that when each party maximizes its individual revenue, the resulting prices also Total turnover.”
The researchers propose that the platform pays the restaurant a percentage of revenue share and a fixed fee for each delivery order. They find that the appropriately chosen values of these parameters yield the maximum total revenue, providing a simple and implementable way to alleviate common problems and improve coordination of the food supply chain.
While it wouldn’t be as ideal as executing the proposed contract, Frazelle said if a restaurant has any influence on the menu price on the delivery platform, it could set that price higher than on the dinner menu to offset the platform’s commission. .
The study also has implications for consumers, Frazelle said. When deciding whether to use a food delivery platform, it’s important to understand the different contributors to the prize and how the revenue is split between the restaurant, platform, and delivery person.
“The app doesn’t always reveal this breakdown,” he said. “It may only show a food total, service charge, and delivery charge. Even if the food total shows $25, the restaurant may receive significantly less.”
If customers notice that menu prices in a particular restaurant are higher on the platform than they are for dining, they should consider that this may be the restaurant protecting its profit margin. Even with the price increase, after deducting the platform’s commission, the restaurant may receive even less than if the customer were dining in.
Frazelle said delivery platforms are widely seen as a necessity for many restaurants, despite the lower profit margin on a delivery order. A restaurant that is not on a delivery platform risks losing an order to its competitors, and that loss could be a repeat customer.
“Time will tell to what extent eating habits are being permanently changed, but delivery is expected to maintain significant market share even after the pandemic,” he said. “This makes it all the more urgent to improve relationships between restaurants and platforms.”