Zomato - Should you order?

Stock Opportunities
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Intro

Started in 2008 as a food discovery and ratings platform, today along with Swiggy it`s the last man standing in the food delivery. When Zomato entered food delivery market in 2017 it was already an overcrowded space with players like FoodPanda, Ola, Scootsy, Swiggy and other VC funded companies battling it out. Over the years after a lot of cash burn, most of these companies have either closed shop or been acquired. Despite its late entry and such fierce competition, today Zomato and Swiggy ARE basically the market.

Lets start with the other sources of revenue and then end with crown jewel-food delivery
Dining out:

Its largest food-focused restaurant listing and reviews platform. Customers can look up restaurants, read and write reviews, and book a table online.

  • 350,174 Active Restaurant Listings from 526 cities (as on Dec 2020)
  • 8,064 Restaurant paid members
  • Revenue Model : AdvertIsing

Zomato Pro

Customer loyalty program which encompasses both food delivery and dining-out. Provides discounts for members at select restaurants for a fee. Pro Restaurants choose and fund the percentage discount available to Pro Members.

  • 1.4 million Pro members
  • Over 25,350 restaurant partners as on Dec 2020**
  • Revenue Model : Subscription based

Hyperpure (B2B)

  • Started in 2019 as a farm-to-fork supplies offering for restaurants
  • 6000 restaurants in 6 cities as on Dec 2020
  • Revenue Model: Transaction based

It is a one-stop procurement solution for restaurants where food ingredients are procured directly from the source (farmers, mills, producers and processors) Eg Vegetables are sourced farmers that donā€™t use pesticides. Poultry is procured from farms that ensure that the chicken is antibiotic-residue-free . Restaurant partners ordering supplies through Hyperpure get a ā€œHyperpure Insideā€ tag on their Zomato page, which is intended to provide customers with an assurance of the quality of ingredients used at the restaurant. Apart from assurance of quality this helps restaurants by making their supply chains more effective and predictable.Any restaurant owner will tell you how much time and energy is spend in sourcing. Now a restaurant can order supplies online. Inventory management becomes easier because you can forecast demand using machine learning and avoid overstocking, Globally this sourcing of food and ingredients for restaurants is a big business but in India it is still at a nascent stage.

Food Delivery

  • Started in 2017
  • 1.31 Lac active restaurants
  • 1.6 Lac delivery partners
  • Revenue Model: Commission and Advertising
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Even though they have 3.5 lac restaurant in its search / discovery business, its food delivery business has a mere ~131k. So there`s room for more restaurant onboarding. It has experienced rapid growth in food delivery in India with their orders increasing by 13.2 times from 30.6 million in Fiscal 2018 to 403Mn in Fiscal 2020 and their GOV growing 8.4 times from ā‚¹13,341Mn in Fiscal 2018 to ā‚¹112,209Mn in Fiscal 2020. Now please remember that Zomato was a late entrant and a lot of this growth is not just because of low market penetration but also due to market consolidation. Players have either exited or been acquired. Zomato acquired Uber Eats in 2020

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Company claims that 9MFY21 GOV has dropped due to COVID-19. People became reluctant to eat restaurant food due to the fear of catching the virus.In the first quarter of Fiscal 2021 they saw a significant impact on their business and their food delivery business in India. However, since then, their food delivery business in India has recovered strongly, with GOV growth of 91.6% and 42.3% in the second and third quarters of Fiscal 2021. Their GOV in the third quarter of Fiscal 2021 was ā‚¹29,810Mn which was the highest GOV that we have achieved in any quarter till December 2020.

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Average order value has gone up last year. This could be due to different members if the household ordering together due to work from home.

Unit Economics: Lets understand the business through its unit economics

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i. Commission and other charges comprises commission from restaurant partner, food delivery related advertisement sales revenue and other revenue

ii. Customer delivery charge comprises delivery fees paid by customers

iii. Delivery cost comprises payout to delivery partners which includes customer delivery charge plus availability fee paid by the company

iv. Discounts comprise platform-funded discounts

v. Other Variable Costs comprises payment gateway charges, support cost, restaurant partner refunds and other variable spends on account of activities like delivery partner onboarding, delivery partner insurance, SMS, cash on delivery handling and call masking, among others

vi. Contribution profit/(loss) is (i) + (ii) ā€“ (iii) ā€“ (iv) ā€“ (v)

So as you can see at a contribution level for 9MFY21 Zomato in finally in the green but this does not include Costs associated with marketing, branding and other fixed operating costs. This is still a loss making company( Generally, Contribution is Revenue minus Variable Cost. Zomato doesnā€™t think of its marketing expense and employee costs as fixed costs)

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Advertisement and sales promotion expenses as percentage of total income have been trending down These primarily include(i) platform funded discounts (to the extent not netted off in revenue) (ii) marketing and branding costs (c) customer appeasement costs and (d) refunds made to restaurant partners.

Industry outlook

According to RedSeer, they have a large total addressable Food Services market opportunity of US$65 billion (ā‚¹4.6 trillion) growing at 9% per annum to US$110 billion (ā‚¹7.7 trillion) in 2025 with highly under-penetrated restaurant food-eating behavior today.
Restaurant food in India is just 10% compared to 54% USA and 58% in China (of the total food consumption). Growth will be driven by changing consumer behavior, reduced dependence of millennials on home-cooked food/kitchen set-up, increasing women participation in labour force higher adoption among the smaller cities. Also Gender stereotypes and health perception of outside food are cultural reasons as to why a lot of indians dont order food are some of them.

NETWORK EFFECT

What makes Zomato flywheel a bit different than that of Swiggy`s is their Dining out platform which consists of Customer generated content. Now more content leads to more customers visiting the platform and more customers attract new restaurants which in turn attracts new customers thus creating a strong flywheel. A lot of these visitors on dining out platform become customers on food delivery platform.
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Word of caution: As soon as most people here networks effects in tech they start comparing it with Amazon, Facebook, Google. Major difference between Zomato and Amazon`s Network effects is that it is somewhat limited by location. A restaurant in Mumbai cannot satisfy a hungry customer in Delhi. 69.3% of our new customers were acquired organically and not through any paid advertisements.

Threats:

Direct ordering platforms. (Dotpe, Thrive, Eatable, Peppo, Airtable etc)there have been a lot of protests by restaurants against the high commissions charged by Zomato and Swiggy without much success. That discontent has led to the rise of direct ordering platforms. These startups provide a platform to take online orders and the commissions are as low as 3% in some cases. Delivery of food can be via own riders or 3rd party delivery agents like Dunzo or WeFast. Besides lower commissions there is another reason for restaurants choosing these startups. Zomato and Swiggy dont share customer data with restaurants, With data restaurants can learn about customer preferences and accordingly tweak their menu. Now of course a customer would naturally prefer ordering through Zomato because of convenience but customers also like low prices and because restaurants are paying lower commissions they can lower prices. Now none of these companies are big enough to threaten the duopoly of Zomato or Swiggy right now and I dont see them as a direct competitor but over time they could take away some market share.

Amazon FoodCurrently its operations are restricted to Bengaluru. It has been one year and it is still testing the waters. They have bundled it with Amazon prime membership. Amazon charges restaurants a much lower commission of 10-12 percent on orders, compared to the over 20 percent commission charged by Swiggy and Zomato, an issue that has been a pain point for restaurants for years. Now of course handling food is not like delivering goods. Last mile delivery is different. Food deliveries cannot be late by 2 hours and Amazon has retreated from Food delivery earlier.So Amazons pan India entry into food delivery is not a given. However if it does decide to take it seriously we may see a prolonged period of cash burn by all the players and this poses a risk to Zomatoā€™s road to profitability.

My Thoughts

To their credit both Zomato and Swiggy have built robust network effect, great customer experience and hyperlocal delivery system. Even though it is a duopoly market Customers will shift to the one with the cheapest options. People call it food tech but Google or Facebook can double their revenues without doubling their workforce but thatā€™s not the case with Zomato. In the developed world no one is making money in food delivery. Meitun in China is different but thatā€™s largely due to its ability to get it into adjacencies. Things could be different for Zomato and Swiggy due to low market penetration and lower expenses on delivery partners. Over time deliveries will become more efficient as Multiple deliveries will be bundled owing to better data(seeing signs of that already). Contribution is unlikely to go up much from here as they are already facing a lot of heat from restaurants and delivery partners but employee cost and marketing expenses are unlikely to scale with revenues so there can be operating leverage at play. They are moving into adjacencies like nutritional products. They are investing in Grofers. In future they may choose to deliver other things as well. Will be interesting to see how this space evolves. I have left valuation out as I dont know how to value these loss making companies but the dean of valuation Ashwath Damodaran reckons its fair value is 41 Rs.

I have a lot more to say on Zomato but have tried to keep this thread as short as possible without ignoring any important details. Please let me know if I can add/edit anything to the original thread.Would be interested in hearing your views

Disc: Tracking with no position

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Just some additional info - a valuation, listing and prospects analysis by Ashwath Damodaran on bloomberg-quint today - https://www.bloombergquint.com/markets/aswath-damodaran-on-the-zomato-ipo-a-bet-on-big-markets-and-platforms

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Hi Blue,

I respect Mr. Ashwath Damodaranā€™s view; and especially after his true prophecy on Tesla stock.

Just one rough used case, onto how Zomato may be able to grow into Fintech space [everyoneā€™s darling for the next 5-10 years]; and starts a altogether new revenue stream; and increase itā€™s valuation in Nifty.

  1. If we add Pareto principle [which applies across almost all businesses], the top 10-20% restaurants serve 70-80% of the orders coming in on Zomato.

Now, Zomato ainā€™t that naive that it doesnā€™t knows the Top 20% performers on its platform.

  1. First leverage would be capital infusion: If I have to grow then my suppliers/partners also need to grow and especially if they are top performers; and if my top performing suppliers/partners have to grow then they have to have high turnover of orders; and for that Zomato would chip in with much needed Growth Capital.

If you are known to concept of Growth Capital infusion through medium of Revenue Based Financing then same concept can be deployed by Zomato.

For those, who ainā€™t aware with how capital infusion in RBF works then for them ā€”> Zomato would provide the infusion capital with safety net; like purchasing the assets [kitchen equipments, talent, building, etc.] and furnishing it to top 20% supplier/partner so that they can grow; and in turn Zomato can grow.

  1. Second leverage would be Analytics: Zomato knows the for preferences of user in specific demographic pockets.

In short, a) Zomato will give 1) Growth Capital 2) Analytics, so that partner can grow and in turn Zomato can grow plus b) Zomato will also claim the assets back if Growth is not as per Zomatoā€™s expectational ROI.

Now, the first lag is done for growing your suppliers/partners but how I can execute second and important lag of collection???

Adding some hypothesis on thisā€¦

  1. Zomato fulfilled 32.1 million orders in FY 21 and by rough estimates of mine, 30% of that orders were prepaid.

In above statement, there are some grey areas in my hypothetical scenario on pre-paid orders.

  1. As Zomato controls the flow of money, so Zomato will deduct itā€™s EMI [For Growth Capital as well Analytics plus Order Value, and margin on order value] and pay back to restaurant.

Just to add onto this:

Zomato can optimise the listing of top performing supplier/partner so that they receive more money in terms of orders. I can also run some campaigns for pre-paying these supplier/partners.

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There are many ways a company can grow, or fail spectacularly. However, at the end, that is dependent on the Management. (consider ITC for example, or the various discussion on IndiaMart). Issue is, if we are outside the decision making circle, then all we can do is opine. The call and the execution is for the management to take.

The growth path you outline, however, is an interesting option. Perhaps you can communicate with Zomato mgmt and let us know if they respond.

Edit : Forgot the disclosure: Not Invested, May invest if corrects a bit.

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Wow, 20 percent and more of total order value in terms of commission is a huge number. I am surprised that even after such gigantic commisions to the extent of causing pain to the main reason of its existence so far - restaurantsā€¦that these delivery focussed tech companies are still making losses!! Indeed, the race to gain scale is making such beautiful economics business a long term question mark and also ripe for more disruptions because the roots i.e. the restaurants are in painā€¦

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please explain your formula for RoI and your views on Zomato changing its revenue recognition policy mid year.

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Great resource to understand the business by Aswath Damodaran.

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its true that for a lot of restaurants 80% sales come from 20% customers but i have enough friends in the restaurant business who ll tell u that it doesnt apply to their business. So the pareto principle isnt sacrosanct.it needs to be validated in each case. Its best to think of it as an aphorism than a mathematical law

This involves credit risk,will put a lot of strain on the B/S and doesnā€™t seem like the best use of capital for a company that just raised capital for growth

This is true and this is where zomato and swiggy will have an edge over an new potential entrant.
I couldnt understand rest of your message. Hope this helps :slightly_smiling_face:

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Interesting write up. Apollo Finvest wrote a a very similar piece, with Zomato example recently.

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Very True @Investor_No_1 but I donā€™t see what other choice these restaurants have. . As we all know the restaurant industry is highly fragmented which makes it very difficult for any sort of joint effort against Zomato. The NRAI has voiced itā€™s opinion to CCI but to no avail. More proof of the fact that Zomato and swiggy are here to stay. Plus cloud kitchens with lower fixed overheads really benefit a lot more from Zomato/swiggy. Doesnā€™t matter how unhappy a traditional restaurant is. Thereā€™s always a cloud kitchen ready to replace it.
I like the business. In a country like India with low labour costs and huge under penetration of non home food Zomato and swiggy should do well over the long run.Itā€™s the valuations that donā€™t make sense to me.itā€™s not like have an aversion to so called expensive stocks but these prices are factoring in too many positives with no room for suprise

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This was a thought in my mind as well, that what choice do the restaurants haveā€¦and precisely thats why Zomato & Swiggy exist despite exorbitant commissions as mentioned by someone above. The choice may not be with the restaurants but would certainly be with a new disrupter in a form we have not known before - if the roots are in pain.

Secondly, imagine the restaurants having no choice and would soon become an unviable businessā€¦this would mean lesser runway for Food delivery companies and need to look at adjacenciesā€¦

A part of this is already happening. This pandemic has already closed down numerous fine dining restaurants. QSR will lead the way going ahead and the likes of Jubilant are becoming as food tech as these food delivery companies. They have pricing power with the delivery companies as they generate their own pull by their own apps etc. Ppl are lining outside McDs etc for takeaways. A QSR would eventually not need Food delivery companies and if they do, they will control the pricingā€¦

So, I think it is in interest of Food delivery companies that fine dining companies should not be in pain.

Regarding Cloud Kitchens - once a Cloud Kitchen becomes the name of the town, they can very well launch their own apps and employ cheaper delivery agents of companies like Dunzo or some new disrupters who just deliver for a smaller fee and not generate businessā€¦

So, in all probabilities, I do not see a Food delivery company prosper unless the roots i.e. restaurants which need them for both generating business & delivering business, prosperā€¦

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i agree but the pain is transitory. no business likes someone else talking a huge chunk of their revenues and hence the pushback.A lot of retailers dont like amazon but its the customer who decides whre to shop.Mcdonalds,dominos n some other cloud kitchen chains have their own app but most customers dont want 20 different food apps on their phones when they know they ll be ordering from a particular restaurant once in a while. sure some chains are increasing their customer reach thru their app but loyalty to any restaurant chain is temporary in most cases(ppl get bored) however customer stickiness on a zomato or swiggy app that provides more convenience,variety and better customer experience is high. truth is most restaurants have benefited immensely from the likes of zomato n swiggy. there are so many people who order a lot more today(specially in tier 2 tier 3) just because of them. moreover a dine-in restaurant caters to delivery orders on marginal cost basis(might need an extra hand or 2 in the kitchen to cater to deliveries).so think of delivery as bonus to a restaurant which is mostly focused on dine in revenue. just my thoughts :slightly_smiling_face:

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So for whatever value this might haveā€¦

I had a ice cream franchise tell me that zomato and swiggy has got them a lot of sales.
So even though he didnt like the higher comissions of zomato, he waa okay with it as it gave a boost to his sales
ofcourse he on his own could never be able to fulfill ao many of home deliveriesā€¦

I have also observed that restaurants have a different priced Menu for zomato and Dine-in.
So, the zomato one is definetly priced higher and probably prices in the comission that zomato charges so that the restaurant protects its margins.

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Completely agreed. For example, I ordered on Zomato from restaurant. The restaurant dine in rate (budget restaurant) was Rs. 125 versus Rs. 160 on Zomato menu. So when I inquired to Hotel, he said, Zomato charges 20% commission is added.

But there is also other restaurant (premium restaurant) which had same price for dine-in as well as for online delivery. But major trend was differentiated prices.

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This

This answers questions and complaints on Zomato/Swiggy commission. Itā€™s end customer who is paying up most of the commission not restaurant. Chains like MCDonalds and Pizza Hut add ā€œpackaging and service chargeā€ for Zomato orders. They have same priced menu. Others simply increase item price.

Customers know it and are still willing to pay for the convenience. Thatā€™s the effect of habit that food delivery apps have created.

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Indeed, its strange psychology of customers who would not pay Rs 30 extra for delivery charges of their monthly groceries or even for their favourite cuisine from favorite restaurant BUT willing to pay 20% extra total order cost in this case just because it is not clearly evident to them or thats what they see in the menu card via delivery apps!
Although not directly related, but this also reminds me to why expense ratio is not a big deal to most ordinary investors as that cost is not directly evident. Similarly travellers are fine in booking tickets at higher original costs but not willing to shell out extra 100 Rs for luggage feesā€¦

Finally, it reminds me of famous saying - there is no free lunch! :slight_smile:

Disc: Above discussions for academic purposes only

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Zomato - Q1FY22.pdf (5.1 MB)

A very good note from deepinder goyal - must read https://www.bseindia.com/xml-data/corpfiling/AttachLive/47aa2394-0e3a-415d-ac77-ce10d2b7f1de.pdf

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Zomato Q1 Result Analysis:

100 Cr order completed. It took 6 years.
10 cr order completed in last 3 months = 11 lakhs per day
If we consider 15 hours / day its comes to 75000/hour = 1250/minute

Adjusted revenue (AR) is 1160 cr Q2Q growth is 26%
Loss 359 cr which was 134 cr last Q
310000 delivery partners
GOV ā€“ Gross order value 45.4 b = 4540 cr
GOV includes everything like taxes, discounts etc.
AR is revenue minus delivery charges

Fin statements: Revenue 916 cr, expenses 1259 cr Losses 360 cr

Disc: Invested - a small part of PF. Views are biased.

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Cloud kitchen seems one plausible way zomato will take in the future. The same is explained in the video.
I like hence sharing.

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Indeed cloud kitchen is something to look out for but the way the video was made looks like they mean to say that Zomato would be the next Amazon or the likesā€¦

With already at mcap greater than jubilant + BK + Westlife + devyani + BBQ nationā€¦ Zomato today is more of a gold itself than a gold mineā€¦

Having said above, it can certainly compound handsomely if the moves play right and not disturbed by further disruptorsā€¦

Somehow, I am not fully convinced with the June oven and biryani exampleā€¦it needs to be seen yet how indians typically react to their best taste bud suiting brands vs a disrupter cloud kitchen from Zomatoā€¦

Also kitopia model looked like they pay 7% brand loyaltyā€¦is any QSR part of their contract? Because in India, all the QSR themselves pay 4-8% royalty now or eventually to their parentsā€¦so if via kitopia model they get just 7% of sales as revenue then it would never be a viable model for any QSR in India to operate via Zomato cloud kitchensā€¦and in order to beat all QSRs in their game, Zomato cloud kitchen must make better pizza, burger, fries, biryani, coffee etc. than the best of each worldā€¦and if we think they can do thatā€¦then even Amazon can be left behindā€¦as it is today Zomato already has mcap greater than all listed Indian QSRsā€¦

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