FoodDelivery is an Italian start-up that is developing a service to deliver food at home from a wide range of restaurants, mainly targeting affluent people. Food is delivered by bike-riders and customers can order it through a specific app. The application allows customers to choose the restaurant and the menu, among a selection of restaurants in a range of 3 kilometers from the customer’s position.
The service will be launched shortly in Milan and it will be the first one of this type in the city.
In your opinion, is this business profitable?
Suggested case structure
- Revenues: Calculate the revenues generated by the food delivery service in Milan, identifying the main sources of revenue for the company
- Costs: Calculate the costs associated with the service, identifying both fixed costs and variable ones
- Other relevant aspects:
- Consider possible changes/actions that could impact profitability
- Understand the possible extension of the service to other cities
The interviewee should enquire about the revenues related to FoodDelivery service
The interviewee should be able to:
- calculate the potential market size for the service in Milan
- understand the main sources of revenues for FoodDelivery, which are the fee paid by the customer and the fee paid by the restaurant
Considering the table above, the interviewee should recognize that it is reasonable to assume that the population with income above € 40,000 is the most inclined to use the service.
Considering that FoodDelivery is a first mover in the sector (thus having no competitors), the interviewee should assume that 1/3 of the people within the highest income range would order food through the app once a week. In order to be conservative, we are going to assume that nobody from the other income ranges is interested in the service. This will also compensate the fact that not all people who turned out to be “interested” according to the market research will actually use the service.
Thus, it is possible to obtain the market size for a year
where 52 is the number of weeks in a year.
The interviewee should recognize both the fixed costs and the variable ones associated with the service:
- Maintenance of the app (fixed cost)
- Bike-riders (variable cost)
- Customers acquisition costs, e.g. advertising on search engines (variable cost)
The interviewee should understand that the average capacity of a rider is:
At this point, it is possible to calculate the costs associated to the market size in Milan.
Thus, the profit is equal to
In conclusion, the business is profitable.
3. Potential challenges
- New entrants: How could the appearance of new entrants in this type of service affect the profitability of FoodDelivery? Which would be the consequences? Is there any effective barrier to entry?
- Change in regulation for bike-riders' work: What would be the impact of a more stringent regulation of bike-riders’ work?
- Market growth: What is the growth trend in the market? Is it a growing or declining market?
4. Final discussion
- The interviewee should be able to understand that the hiring of workers and the impossibility of paying them on a “per hour” basis implies that labor costs become a fixed cost (one could argue that they are not totally fixed because they could slightly be adjusted based on demand, but we will consider this factor to be negligible). Thus, as labor costs make up most of the company’s costs, the company’s cost structure would shift to a high-fixed-costs one.
- Looking at possible expansion for the company, it would be much harder to expand into medium-sized cities where demand is not sufficient to cover the high fixed costs. Scenario would be significantly different if all labor costs were variable (as they are in the current example). The interviewee should thus understand that the company should focus only on the major cities (such as Rome, Turin, Naples), evaluating options based on city population and income distribution.
- After having set the target, the interviewee should be able to have an idea of how to draft a preliminary work plan. Starting from the contacts with the local restaurants and the changes to the app, FoodDelivery should hire local bike-riders and increase support staff, whose optimal location would be at the original headquarters, in order to exploit economies of scale.
- The main challenge for the company would be the possible market entry of other competing startups. This would very likely erode the company’s margins because, in order to gain market share, startups in new businesses are usually very likely to offer significant discounts and to price under cost (as it happens for the taxi-like apps). If the business is not profitable, the company would thus require capital injections from investors (who could invest in the hope of driving some of the competitors out of the business and become profitable again in the future).
FoodDelivery will generate an annual profit of about €4 million with revenues of about €31 million in Milan. However, over the short-medium term several risks should be taken into account, including limited barriers to entry and potential changes in regulation for bike-riders' work. In order to leverage its first mover advantage and to build barriers to entry, FoodDelivery should evaluate expanding its service to other big Italian cities after the launch in Milan.