Investors tend to avoid food companies. At Sherpa Ventures, we’ve spent our careers as investors seeking out business models that:
- Require minimal capital expenditure,
- Facilitate rapid scaling,
- Address a large market,
- Support robust margins, and
- Are defensible against competition.
Most of the great technology companies — think Uber, Airbnb, and Facebook — check all five boxes. And while traditional food businesses, and especially restaurants, may address large markets, they fail on all other counts.
Over the last several years, a new wave of technology-enabled food businesses has emerged. Led by Munchery (founded in 2011), these companies look very different from their predecessors in one important way: they only do delivery. Over a week ago, Munchery announced its Series C of $85 million co-led by Menlo Ventures and Sherpa Ventures (the largest round in its space) to expand this model to many more cities.
It turns out this approach is a game changer. It carries three big advantages. First, it reduces capital expenditure requirements and enables faster scaling by eliminating the need for expensive storefronts. Think Amazon and its massive impact on book stores back in its first wave of disruption. Second, it improves margins by moving cooking out of restaurant kitchens designed to cook individual meals in rapid succession and into large kitchens optimized for volume and high quality. New technologies are now available that haven’t fully impacted the industry yet. And finally, it can create meaningful barriers to competition in the form of route density, similar to Uber and FedEx, and the opportunity for a cost leadership position, similar to Amazon and GEICO.
As we double down on Munchery (Sherpa’s biggest bet since Uber), we’re most excited about the fact that the company is already delivering on all of these promises. By continuing to redefine the cost structure in food, we think Munchery will eventually make getting a high quality chef-prepared meal delivered to your door less expensive than buying the ingredients to cook a similar meal yourself. We expect this to expand the already large market for takeout and delivery food.
The Munchery Model
Munchery is a full stack, end-to-end meal provider that specializes in delivery. It isn’t a restaurant and it isn’t a delivery service. It’s a whole new type of business that provides the quality of restaurant food with the convenience of ordering in. Using Munchery’s app or website, customers order from a daily changing menu. An average day might feature 50 unique items including entrees like spicy clam and chorizo pasta and chimichurri flank steak.
Before Munchery, a restaurant that offered this level of variety and culinary quality would have been very, very difficult to scale. Munchery addresses this by centralizing cooking into a single kitchen optimized for large quantities and investing in the latest cooking technology, such as programmable, WiFi-enabled, high-capacity ovens that use a combination of dry and moist heat. Technology like this automates the predictable, rote parts of cooking, which in turn allows Munchery chefs — drawn from top local talent — to focus on creating the best dishes possible.
We see Munchery as a platform for the creativity of chefs. Chefs are the new DJs. They can now go on tour and serve tens of thousands of people in cities around the world. Their recipes can now scale. And by having normal 9–5 hours they can live wholesome, happier lives rather than slaving away in a physical restaurant at all hours of the night. They have more time with their families. By not having to operate a physical restaurant they are freed to focus on their creativity as chefs.
Redefining the Food Business Cost Structure
Great customer experiences aren’t always paired with great business models, but Munchery’s approach has a dramatic impact across the cost structure, which enables the company to execute a cost leadership strategy.
1. Delivery: Leveraging Technology Creates Big Efficiencies
First off, it should come as no surprise that Munchery is significantly more efficient at delivery than the ordinary restaurant. What’s more interesting, though, is that it’s also created efficiencies beyond other delivery-only services. By offering customers the ability to choose a scheduled delivery window, Munchery can gather all of those orders and optimize route density with its proprietary routing algorithms. Munchery is thus able to send many more deliveries with each delivery team member than other food delivery models. Munchery is also able to leverage the route density from scheduled deliveries to fulfill on-demand orders.
2. Food Cost: Consolidating Buying Power Drives Costs Down
With the average limited service restaurant spending 33% of its revenue on food costs, improving food cost is a huge opportunity. Fortunately, consolidating purchasing power has a significant impact on pricing and terms from suppliers. A few years after launching in San Francisco, Munchery became one of the biggest buyers in the city. While the average restaurant might pay a seasonally fluctuating price of $9–11 for a pound of salmon, Munchery pays $6 year round.
In addition to better pricing, Munchery also receives better terms from suppliers, meaning it gets more frequent deliveries and fresher meat and produce. Better ingredients mean better meals.
3. Labor Cost: Centralizing Kitchens Results in Dramatic Savings
The other big line item in a restaurant cost structure is labor. The average limited service restaurant spends 29% of its revenue on salaries and benefits. When chefs are empowered with technology and processes optimized for scale, our research suggests that labor scales even more dramatically than food costs. As the chart below illustrates, the more cooking operations are centralized into a large, carefully planned kitchen, the lower the labor cost required to produce a complete meal. In the most extreme case, savings can exceed 85%.
While we don’t expect Munchery to attain the same labor cost per meal as a manufacturer (due to its daily changing menu), the company has seen the benefits of this cost curve as it scales.
4. Rent & Facilities: Eliminating Storefronts Has Big Returns
Munchery‘s model enables it to serve the Bay Area out of a single kitchen, which, because it doesn’t offer direct customer access, doesn’t need to be located in an expensive, highly trafficked area. This type of kitchen costs the company in the single-digit millions. A leading fast casual chain restaurant, by contrast, may need to build upwards of 40 stores, for a total investment easily approaching $40 million, to serve the same area and support similar revenue. Whereas the average restaurant invests 5–6% of its revenue in rent, Munchery pays closer to 1%, a number that’s all the more impressive given Munchery’s prices.
While this improves margins, the more arresting consequence is the capital efficiency of the model. Depending on assumptions around margin at scale, we expect return on invested capital (ROIC) to be measured in the hundreds of percent.
Redefined Cost Structure = Opportunity for Real Change
In four short years, we estimate that Munchery has grown to half the size of Chipotle (NASDAQ: CMG) in the areas both companies serve in the Bay Area. At their current rate of growth, we expect Munchery to eclipse Chipotle in the Bay Area sometime in the next year. Chipotle is a $20 billion company. Munchery is growing 9 times faster than Shake Shack (NASDAQ: SHAK) and will be bigger than Shake Shack in 24 months. Shake Shack is a $2.7 billion company. As importantly, by combining the route density of Uber and FedEx with the cost advantages of Amazon and GEICO, Munchery has built a food business that’s highly defensible against competition.
Munchery could use its impressive cost structure to support margins that are significantly above market, but the company’s co-founder and CEO, Tri Tran, has broader ambitions. Tri’s vision is to make real food — healthful, delicious, fresh food — accessible to everyone. In pursuit of that vision, Munchery will continue to leverage its unique approach and scale to drive prices down so Munchery can be an everyday habit for a wider range of people. In a world where the vast majority of multi-billion dollar food businesses are built at a price point of under $10 per person, this was the vision that got us at Sherpa excited.
Let’s feed the world better food.