Billion dollar urban delivery industry to be hit by market fundamentals

09 October 2017 4 min. read

Urban delivery startups such as Delivery Hero, Deliveroo and Takeaway have raised nearly $5 billion in funding in the past three years. Yet while the industry's players are worth a total of $2 billion in revenues in the US market alone, the sustainability of the business model remains uncertain. Despite valuation of hundreds of millions, bottom line forecasts remain an issue.

A report from McKinsey & Company explores the state of the urban delivery market, as well as the likely success of the business model across various segments. By leveraging a low-capital model, the urban delivery start-up market has greatly improved access to delivery services for small restaurants and fast food outlets.

A range of companies in the segment have received considerable funding from venture capital in recent years, with the backing allowing the companies to quickly acquire market share and expand their operation.

VC funding of urban delivery

Venture capital investors pumped around $7.5 billion into the industry over the past decade, with investment ramping up in recent years as the market potential of the companies appeared to show exponential potential. The development of the model, and its rapid expansion was most noted between 2013 and 2014, with total investment increasing from $200 million to $1.3 billion, before peaking in 2015 – when the venture capitalist market was at its height – to $1.7 billion. Last year saw a drop off in investment to levels seen in 2014, while this year has seen around $600 million invested so far - as valuation concerns rose.

The funds raised have largely been put toward urban prepared-food delivery, although the past two years has seen increased investment in urban grocery delivery. In terms of funds raised, Berlin-based Delivery Hero is out ahead at around $1.1 billion since 2014, followed by San Francisco-based Instacart, which has raised about $675 million.

Virtuous cycle of model

Interest from venture capital investors reflect, in many instances, their belief in the virtuous cycle – whereby investment in firms boosts their growth, allowing them to serve more shops, which means more consumers are attracted, which allows them to further increase their reach to shops, which in turn reduces delivery workers’ downtime, which improves efficiencies and driver loyalty, etc. The hope is that, through a virtuous cycle, companies will be able to quickly grow their operations and dominate a regional market.

While there is considerable hope for the delivery market to enter into this virtuous cycle from venture capitalists, analysis of the market by the strategy consulting firm highlights that the market may take a different turn. According to the study, there are relatively different projections for the market as it stands. The total US market value for urban delivery was around $2 billion in revenues in 2016. However, the sustainability of the business model remains uncertain – with bottom line forecasts remaining negative. The industry faces a host of problems, including, among others, high capex and driver churn and client churn.

Market fundamentals

One of the bigger problems for the industry is its ability to meet the actual cost of delivery – a survey of 4,700 US consumers found that only 15% are willing to pay $3 for delivery. On the delivery side, drivers tend to be limited to 2-3 point-to-point deliveries per hour in urban settings. Costs for delivery, according to the firm, range from $7-10 per hour – though prominent names within the UK industry in particular, such as Deliveroo and Foodora, have been criticised heavily for their poor employment practices aimed at undercutting those pay rates. Hundreds of cyclists have signed up to work for Deliveroo, a British company recently valued at $715 million, and Foodora, whose German parent company Delivery Hero claims to be worth more than $4 billion. Business model outcomes

As a result, firms claim that, to generate sufficient revenues for profit, they need to leverage multiple income streams, charging customers and clients alike, and deriving income from other sources such as sponsors. Other concerns have been raised too, including the move of larger retailers, which have already developed large scape delivery models for goods entering the market. These players are well funded, have internal strategy departments and are better able to leverage staffing models that limit churn and poor delivery quality.

According to the study, given the current business environment, concern around the current business model is noted, with the report concluding, “For a broader target market, however, the business model fundamentals of urban delivery start-ups – rapid point-to-point delivery, direct consumer access, and crowdsourced operations – are not here to stay. Unless any of the current start-up heroes can find a new secret sauce, they are bound to remain constrained to niche applications and come up short of the promised mass-market revolution.”