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Delivery Fee Caps Benefit Major Restaurant Chains but Leave Independents to Struggle

Right now, the economics of restaurant delivery are not working for anyone, and it appears that no single piece of legislation can be the difference between a successful delivery industry and an unsuccessful one.

Following the initial outbreak of the pandemic, as consumers rushed indoors to stay safe, delivery orders through third-party aggregators soared.

This rise in order volume widened the existing cracks in the system, with third parties’ steep commissions making it nearly impossible for some independent restaurants to make a profit. However, even after many U.S. cities announced limits on the fees that these services could charge restaurants, the model remains broken.

Zhuoxin (Allen) Li, who has a doctorate in philosophy and is an assistant professor of information systems at Boston College studying the legal and economic factors influencing on-demand delivery platforms, spoke with PYMNTS about how permanent fee caps, such as those enacted by New York and San Francisco, may not be the answer.

“Most restaurants welcome the fee caps as they can keep a larger fraction of the revenue,” said Li, highlighting the findings of a study he and a colleague completed of the effects of 14 U.S. cities’ fee caps. “My research shows that the fee caps might not necessarily benefit restaurants. Surprisingly, chains turn out to be the biggest winner after cities impose the fee caps.”

Figuring out the economics of delivery was not as pressing an issue before the pandemic, when the channel accounted for only a small portion of restaurants’ sales, but now that consumers have grown accustomed to the convenience of the channel, failure to make the model work could hurt delivery services, restaurants and consumers alike.

PYMNTS research from The Bring-It-To-Me Economy report, created in collaboration with Carat from Fiserv, found that almost half of all consumers (46%) are ordering food from restaurants using third-party aggregators more than they were before the pandemic.

Read more: Bring-It-to-Me Economy Ascends as Consumers Embrace Home-Centric Lifestyles

Additionally, findings from PYMNTS’ Restaurant Readiness Index, created in partnership with Paytronix, indicate that 18% of all restaurant sales come from third-party aggregators.

See more: QSRs’ Lagging Loyalty-Reward Investment Hurts Innovation and Sales

The Restaurant’s Perspective

Uncapped fees can be disastrous for restaurants, with the delivery services’ commissions sometimes even larger than restaurants’ profit margins, making the model entirely unworkable. Yet, somewhat counterintuitively, Li’s research found that fee caps could actually make matters worse.

In cities where fees were capped for independent restaurants but not for major chain restaurants with 20 or more locations, independents suffered, receiving fewer orders and experiencing a revenue drop. Major chains, however, saw orders and revenue rise, he found.

Accounting for this disparity, Li explained, “Delivery apps may tweak their filters to promote chains and restaurants just outside a city’s limits, where they can collect their commission in full.”

He added that some cities have even been imposing a “city fee” for consumers in areas where fees are capped. These higher prices can disincentivize consumers from ordering, resulting in fewer sales overall.

“This is, to some extent, a zero-sum game as the fee caps do not create extra value for the entire system,” Li said.

The Delivery Service’s Perspective

Despite the surge in delivery orders occasioned by the pandemic, delivery services continue to operate at a loss, with even the category leaders failing to break through to profitability. From their perspective, permanent fee caps only make matters worse.

“Delivery apps can bear the cost temporarily, but this is certainly not the equilibrium,” said Li.

Earlier this month, DoorDash, Uber Eats and Grubhub sued New York City over its move to make these fee caps permanent, alleging that the law is “driven by naked animosity toward third-party platforms” and that it “interferes with freely negotiated contracts.”

Read more: Restaurant Aggregators Sue NYC Over Fee Caps in Move to Shape the Future of Delivery Economics

Li noted that the high labor cost associated with the delivery business makes it difficult to find a profitable model.

“Unfortunately, so far there are no significant economies of scale that help reduce the delivery cost,” he said, adding that attempts to make drivers’ routes more efficient by pooling orders have been largely unsuccessful.

The Best- and Worst-Case Scenarios

While there may be no win-win option for all involved, Li said he believes that the most promising solution to emerge for the challenging economics of third-party delivery so far are the tiered pricing plans that the top delivery services have been debuting throughout 2021, allowing restaurants to choose whether to bear the fees themselves or to shift the cost to the consumer. Far from perfect though they may be, he argued that some version of tiered pricing may be the only option that can work out in independent restaurants’ favor.

“The worst-case scenario is that delivery apps exit the market, and restaurants lose the delivery channel to reach diners who would otherwise not order from these restaurants,” said Li. “This could hurt many small independent restaurants that do not have the resources to develop their own online ordering and delivery capability.”

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