Inside Zomato’s Push Towards Cloud Kitchen – And The Road To Profitability?

Zomato has set up its first Cloud Kitchen in a suburb of Delhi, Dwarka, as part of the pilot phase of its new project – Zomato Infrastructure Services. However, since the announcement was first made in November 2016, the company has been cagey about its strategies – specifically, after facing a rough patch in 2016. It added further fuel to the fire by announcing aggressive growth plans, which were confirmed by roping in Morgan Stanley in a bid to raise fresh funds.

With so much smoke and not enough clarity, Zomato founder Deepinder Goyal took to the company blog to clear the air.

“There has been a lot of confusion amongst our users, restaurateurs, and the media about our “cloud kitchen” service. “Cloud kitchens” is a new phrase which doesn’t yet have a definition and is used for a wide variety of business models,” he begins.

In simple terms, Cloud Kitchens are basically online breakfast and brunch units that do not have a physical restaurant. Their business model runs around virtual websites/apps, via which they take orders. Existing startups such as HolaChef, FreshMenu, and Bhukkad own the food and delivery part of the business in this segment presently.

In an conversation with Inc42, Prashant Mehta, a Partner at LightBox Ventures helped decode the concept. As he explained – there are three different formats in the Cloud Kitchen model. First, is the full stack model, where from kitchen to delivery, one owns everything. In the second model, one gets popular restaurants and asks them to place their chefs in their cloud kitchen and asks third parties to handle the delivery part. The third model is one where one gets together random chefs, those working from home and asks them to work in the cloud kitchen while providing them with delivery and infrastructure.

Zomato is probably looking to go with the second model. As Goyal defines it,

“Zomato Infrastructure Services (ZIS) is a kitchen infrastructure service where we will work with current restaurant business owners to expand their business to more locations without incurring any fixed cost.”

What Exactly Is ZIS?

As described in the post, “Think of these infrastructure services as delivery-only food courts in locations slightly off the premium locations (think much lower rentals, but accessible); we will not have take-out or dine-in at these locations.”

Each location is said to have four or more restaurant brands co-located with each other, leading to shared (and, thus, lower) costs; plus each restaurant brand will reportedly have its own space of roughly 300 sq ft.

Other measures have also been taken to increase delivery efficiencies, and maintaining operations at low cost, at the same time taking necessary precautions. For instance, “To acquire cooking equipment, we are using Zomato data to identify restaurants which have recently shut down in the vicinity and are acquiring this (almost new) equipment at a discounted value. Having said that, we are only procuring the best quality equipment which meets robust safety standards,” says Deepinder.

.. There’s More

“Our initial estimates tell us that with some hard work, we can have a 100 locations by the end of 2018. As of now, we are not sure when and how this model will scale to our other strongest countries of presence.”

Initially, the tech stack, comprising Zomato Base (POS), and Zomato Trace (Delivery Dispatching and Routing), will be provided to the restaurant for free. It will also use its data to help its partner restaurant brands create the right menu at the right price.

Furthermore, Zomato is inclined to opt for only renowned and reliable operators to run these kitchens. Also, it aims to help the partner restaurants instead of competing with them.

“Zomato will not be cooking food by itself in these kitchens – unlike what some of the other aggregators are doing, we don’t want to compete with our own customers (restaurateurs),” says Deepinder.

The Zomato team believes that this strategy will help their closest restaurant partners expand to markets outside their core cities of operation. As Deepinder writes, “For example, we would love to bring (Hyderabad’s) Paradise Biryani to Delhi using Zomato Infrastructure Services.”

Also, the team envisions allowing multiple brands to share the same kitchens. For example, a pizza chain could use a particular kitchen spot during the day, and a burger place could use the same spot at night for late night deliveries.

Plus, it also boasts of a lucrative option for the users. The “front of the house” in these kitchens will be common. As a user, you will be able to select dishes from multiple brands to build a single food order. “So if you want to eat shawarma, and your friends want to eat pizza, that can be done in a single order. How about also including a frappuccino, and an ice cream with your order?”

The blog post further adds, “This is something that’s very new, and is probably the first time in the world that this is being introduced at scale. We are very excited about how our users will use this power feature which will only be available on Zomato.”

Why The Sudden Push Now

Initially, very tall claims were made by the company regarding its growth strategy. However, a recent report released by LiveMint identified that Zomato is chasing a loss of $492 Mn, for the financial year ending March, 2016.

As stated in earlier Inc42 reports, the real troubles for Zomato began with its $60 Mn acquisition of US-based UrbanSpoon in January 2015. Since then, the company was looking to scale back its operations in countries not generating enough sustainable business. In October 2015, it fired 10% of its workforce,and a bitter email from CEO Deepinder Goyal was also leaked to the media, criticising the performance of his sales team and predicting lower revenues for the year.

The situation worsened when, in May 2016, investor HSBC Securities and Capital Markets downgraded the company’s valuation from $1 Bn to $500 Mn. Concerns were also raised surrounding Zomato’s advertisement-heavy business model, growing competition in the food ordering space, and money-losing international operations for the lower valuation.

This led to the rollback of operations from seven countries – US, UK, Sri Lanka, Ireland, Chile, Canada, and Brazil – out of 23 overseas markets, reducing its operating costs to $1.7 Mn, an 81% drop from the earlier $9 Mn.

Since then, Zomato has been aggressively working to reach a certain threshold level needed to monetise each operation. It also claims to be running with positive unit economics in the Indian and UAE markets, claiming a margin of INR 20 in India and INR 50 in the UAE per order, despite outsourcing deliveries.

As Deepinder claimed in an earlier statement, “We are the largest player by GMV, by market share, in the countries we operate in. Our monthly growth rate of delivery business is about 30% and daily average over the last week 25,000-26,000 per day, with an average ticket size of INR 480.”

The Sinking Foodtech Market

Initially considered a sector with high returns and profitable exits, the foodtech market later got slammed due to several reasons. One being the overflow of ‘me-too’ startups. According to a 2016 industry report by Inc42, of the 105 foodtech startups launched in India, only 58 are active. In FY 2015-16, there have been over 37 shutdowns while nine went the M&A route.

This list includes startups such as iTiffin, Eazymeals, Zeppery, Zupermeal, Dazo, SpoonJoy, Tinyowl, TastyKhana and more.

Even the most-talked about players are floundering. Take Swiggy, which is valued at $130 Mn. At a time when raising money has become tough for foodtech operators, it has managed to raise a total of $75.5 Mn funding, till September 2016. But, for the year ending March 2016, the company generated only $23.5 Mn revenue against $137 Mn losses.

Crowd favourite and Rocket-backed foodpanda suffered in a similar fashion. The firm reportedly earned losses of $21 Mn (INR 143 Cr) in FY16. In August 2016, the firm announced that it was in the process of raising fresh capital, with rumours of a possible acquisition by Zomato. In December 2016, the firm was finally sold to Berlin-based online food takeaway service Delivery Hero, one of Europe’s biggest startups.

Other reasons such as chasing user acquisition instead of user retention, fake orders, weak logistics and delivery infrastructure, heavy discount price wars and more, brutally slaughtered the market further.

Touted to reach $78 Bn by 2018, growing at 16% Y-o-Y, the sector is now just a group of pyrrhic startups – who finally have the target audience, right product market fit, and enormous amounts of funding – but have been unable to stop bleeding losses and sustain profitability, nevertheless.

Will Zomato’s ZIS Excel Or Fail?

In Prashant’s opinion, making money is tough in this sector. “The way to think about these businesses is to have the economic breakdown. If you are a good restaurant, then your food cost should not be more than 40%. Now, the question is, what’s the average cost of your product? So if you are selling a low cost product, say a INR 100 product, and the delivery cost is INR 60, then its very hard to make money off it.”

However, he also believes that since it’s a complicated structure, it presents an exciting opportunity to figure out which of these models could become successful. “If it’s the first model, the benefit of controlling everything is that, only you are responsible to manage your growth curve and are not dependent on anybody else. Most important, you control the scale and the quality. When you are working in somebody else’s kitchen and some others are helping you deliver it, there are a lot of things that could go wrong,” he adds.

For instance, if one orders a book from Amazon and receives a torn book, he can replace it. But if a customer gets food late or there’s any issue with the food, probably he will not be ordering from that restaurant again. “So that’s the difference. The risk is very high,” he adds.

Other Players

Foodtech players have always played it safe when it comes to business models – opting for online delivery versus any other model. However, investors have always preferred startups working on restaurant/food discovery, where Zomato has emerged as the clear winner, so far.

However, now startups have started adopting new models, despite their complex nature with Cloud Kitchen being one of the most sought after option. As Jaydeep Barman, co-founder and CEO, Faasos said, “Cloud kitchens are a great way to build a food brand without the uncertainty and cost structure of a typical restaurant set-up. You don’t have to put the kitchen on a high-rent location and you save a lot of money in capex. As a business, you just focus on two things: creating great food and making sure it reaches the customer quickly.”

Then there is Yumist, working on full stack cloud Kitchen model, where the team is preparing food and taking orders on its own platform. However, have opted for both in-house and outsourced logistic services. “The company has been growing 25% month-on-month for the past six months. We enjoy high gross margins even while selling meals starting at INR 100 and will be profitable this year,” stated Abhimanyu Maheshwari, co-founder, Yumist.

Some of the other major startups also working in this space include Twigly, Innerchef, HolaChef, HelloCurry, Petoo.

Conclusion

In a business climate that has investors tightening their purses and startups either pivoting in a bid for course correction, retrenchment, or pulling down their shutters, innovation and disruption are buzzwords that require sensible thinking and a proven use case.

While, in theory, the Cloud Kitchen model promises to be the next big thing in foodtech, execution and consumer adoption will decide its eventual fate. And it is this innovation that Zomato has placed its bet on. Although the model promises better margins, the challenge is to scale up with an army of chefs in various cities. Product pricing is another challenge faced by startups. Indian consumer startups have learnt the hard way that the average Indian consumer is not ready to pay a premium for added comfort, even when they appreciate the technology and concept.

On the other hand, despite unforeseen challenges, Cloud Kitchens are now becoming a widely-accepted model. In January 2017, Swiggy too set up its cloud kitchen, ‘The Bowl Company’ in Bengaluru.

After digging into the Cloud Kitchen model, these are a few initial challenges that the company needs to think about: for instance, with multiple brands in the kitchen, how will delivery be managed? Who will take the onus of delivery? How will different delivery times (due to different food types) be managed in the case of combined orders from multiple brands from one kitchen? What about custom equipments that are required many restaurant brands?

If Zomato is able to answer these questions and scale this across a market like India, it might have just cracked the secret sauce to profitability in the Indian FoodTech space. As Prashant says, we will all be closely watching this development.

An email sent to Zomato regarding ZIS remained unanswered at the time of publication.

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