March 06, 2020

Restaurants - Ghost Kitchen Trend Update

DIN, SBUX, UBER, USFD, WEN, WING
By Bill Becorest

The ghost kitchen trend in the restaurant industry is likely to gain momentum through 2020 as companies seek more profitable delivery businesses, but hidden costs and newly proposed food delivery regulations could limit growth.

Three of six restaurant industry consultants said growth in ghost kitchens -- facilities dedicated exclusively to off-premise orders -- is likely to continue through 2020 as restaurant companies look for ways to increase transactions, mitigate rising labor costs and grow digital ordering. “I’ve got [restaurant chain] clients who I’m currently pushing to open ghost kitchens,” said one restaurant industry consultant. “I really think this is the way to go for delivery operations. [Ghost kitchens] will become the model for delivery efficiency because they are purpose-built for this singular task.” The ghost kitchen (also referred to as a dark kitchen, virtual kitchen, cloud kitchen, or commissary kitchen), is typically characterized as a delivery-only outlet located just outside of high-rent urban areas. “Ghost kitchen growth is being driven by the popularity of restaurant delivery, and it’s a response to the rising costs related to delivery -- whether that be third-party commission fees or costs associated with running your own delivery program,” one restaurant chain operator said. “Operators are struggling to find solutions for pain points like wage hikes and high insurance rates.”

One restaurant consultant said heavy investment in ghost kitchen startups has accelerated interest among restaurant chains like Dine Brands Global Inc.’s Applebee’s Neighborhood Grill & Bar, Wingstop Inc., The Wendy’s Co., Chick-fil-A Inc., Starbucks Corp. (in China), and Sweetgreen Inc. -- all of whom are testing or planning to test ghost kitchens. “Kitchen companies like CloudKitchens Inc., Kitchen United Inc., CloudCooks Inc. and Kitopi Inc. are popping up and making some big bets on this emerging space, basically serving as landlords to restaurant companies who are looking to lease space and outsource kitchen services,” he said. Third-party delivery companies are also testing their own kitchen facilities; DoorDash Inc. operates a ghost kitchen in Silicon Valley, and Uber Technologies Inc.’s Uber Eats opened its first ghost kitchen in Paris last year. (Uber Eats currently provides customers access to more than 1,500 “virtual restaurants,” in the U.S., with the distinction being that their version of “virtual restaurants” offer special online-only menus from a restaurant’s existing kitchen, as opposed to a separate kitchen facility.)

Two restaurant consultants said ghost kitchens can help alleviate throughput challenges. “Typical fast-casual locations now do maybe 35%-40% of sales as pickup or delivery,” one said. “That kind of volume for off-premise can degrade the service experience for in-store diners, so providing a dedicated space for off-premise helps maintain service levels for all customers.” Two others said ghost kitchens are providing better operational control of off-premise orders. “The ghost kitchen provides built-in efficiencies that just can’t be achieved out of the traditional restaurant kitchen,” one said. “Early results that we’ve seen from our clients reveal better order accuracy, less packaging mistakes and improved delivery times.” One said the ghost kitchen model helped his client generate more online and mobile ordering.

Despite the strong momentum around shared kitchens, three restaurant industry consultants said they are advising restaurant clients to move cautiously on plans to operate ghost kitchen outlets, citing doubts over sustainability and uncertainty about newly proposed laws that could limit third-party food delivery. “I am very skeptical of the long-term viability [of the ghost kitchen concept],” one said. “There are too many risks and unknowns with that model. Ghost kitchens -- and third-party food delivery in general -- are highly dependent on a strong economy and expendable income, but there are many potential pitfalls, like the legislation introduced just last week in New York City that proposes a 10% cap on third-party delivery fees [charged to operators]. Delivery companies simply can’t operate at that rate.” OTR Global research has found third-party commission fees ranging from 15%-20% for the largest franchise chains, and up to 30% for smaller operators. (See OTR Global’s November snapshot on third-party delivery trends.) New York City legislators are proposing six bills related to third-party food delivery that regulate licensing, commissions and fees, consumer disclosures, menu pricing and the required use of tamper-evident packaging. “What [New York City] is proposing could slow growth of third-party delivery if similar regulations are adopted in other major cities,” said another industry consultant.

Three consultants said operational costs for ghost kitchens may be higher than expected for many operators. “They see the cost-savings of operating a ghost kitchen versus another dine-in location, but tend to underestimate capital expenditures and overestimate ROI assumptions,” one said. “[Celebrity chef and owner of the Momofuku Group Inc. restaurants] David Chang and his Ando experiment in New York was a good example of a delivery-only concept that looked good on paper, but proved very challenging in practice.” Ando was a delivery-only virtual concept launched in 2016, but closed in 2018 despite an estimated $7 million in venture capital funding. “The ghost kitchen model can work, but only in the right circumstances and for the right brands,” said a senior consultant who specializes in franchise chains. “It requires a densely populated urban area and a well-established brand, preferably with very strong customer loyalty. There is no way to gain any traction if you don’t already have a strong brand presence.”

One restaurant consultant said another unexpected cost may be the relatively new trend toward tamper-resistant to-go packaging. “With so much restaurant delivery going on these days, consumers are expecting higher levels of security as it relates to their food, and that specialized packaging costs more money,” she said. One 2019 survey of 500 food delivery drivers conducted by US Foods Holding Corp. found about 25% of drivers admitted to sneaking food on occasion from customer orders during delivery. Food packaging companies like Novolex Holdings LLC and Elkay Plastics Co. Inc. have developed tamper-resistant delivery bags specifically for off-premise orders. “The cost to produce these bags is about 30%-40% higher than a standard takeout bag,” said one food packaging executive. “We saw a lot of demand for those types of bags in 2019, and expect that to grow through 2020.” The executive also said a less-costly, but less secure option that many operators utilize is a tamper-evident label to seal the bag.

Two restaurant consultants and one restaurant operator said the ghost kitchen sector will continue to evolve during the next few years. “I think the most successful model will be the mixed-use commissary,” one said. “That means shared space, shared kitchens, freezers, shared access to loading docks, etc. Half the space will be utilized for restaurant delivery, and the other half for caterers. Caterers don’t need third-party delivery, and they have a constant flow of business for all types of events. I think this will mitigate the risk.” Another said ghost kitchens that provide more personalized service and fresher food to customers will have a better chance of survival. “We have one ghost kitchen operation in our area that is very restrictive about their delivery zone,” he said. “They do that to ensure the freshness of their food and the timeliness of delivery. I think we’ll see more localized operations that will elevate the quality of the off-premise experience.”