The Big Flaw in Grubhub's Business Model Just Became Wildly Obvious

Restaurant delivery is only getting more and more popular among customers, which ought to be great news for Grubhub (GRUB). But the service provider's third-quarter numbers were plain awful, and its guidance was ugly, too. In this segment of the Oct. 29 MarketFoolery podcast, host Chris Hill and Motley Fool Asset Management's Bill Barker dig into precisely where it's all going wrong -- its costs, competition, the value proposition for its partners, and one key difference between a delivery customer and a dine-in patron. They also weigh questions of customer loyalty, and whether the stock looks like a buy after this latest steep plunge.

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This video was recorded on Oct. 29, 2019.

Chris Hill: Let's move on to Grubhub. Third quarter and coinciding guidance for Grubhub... I'm going to just use the word disaster, because that's what's happening to Grubhub's stock today. Their sales were weak. Their guidance for the fourth quarter was somewhere on the range of disappointing to terrible. Shares of Grubhub the last time I checked were down 43%.

Bill Barker: Yeah, there was no good news for owners of Grubhub here. The competition continues, it continues to drive down prices, it continues to drive up costs, and it continues to erode market share for Grubhub. I think that, of the many questions that can be asked about Grubhub, is are you sure that you can convey how you are helping the businesses you partner with? That really is not coming through on any of their calls. They have started out with a pretty high price for the delivery service, and that is eroding through competition, and restaurants are not making enough money on the incremental meals that they're needing produced to serve what Grubhub is able to provide, in terms of possibly new customers, possibly just customers that are therefore not going to the restaurant. And if they're not going to the restaurant, they're maybe eating the same amount of food, but they're not purchasing alcohol. And that's where, as you know, restaurants make all their money. I'm just saying that because you know so much, not that I'm alluding to --

Hill: [laughs] Not that that's always my go-to move when I go to a restaurant. I'm reminded of what's playing out now with delivery services, is somewhat analogous to what we saw play out with credit card companies and restaurants over the last 25, 30 years. American Express charged a bit more, and with the rise of Visa and MasterCard taking a smaller cut from restaurants for their transactions, they became a more popular choice. So, whereas American Express as a card was very much a status symbol, and I'm sure some would argue, on some level, may still be, in terms of restaurants and increasingly retailers, as Visa and MasterCard became more ubiquitous, they basically went to American Express and said, "No, we're not interested in paying you more for transaction costs, so we're no longer accepting your card."

Barker: Yeah. I think that's true. Over time, the price will find itself for what the service that Grubhub is actually bringing is. In that vein, what Grubhub pointed to in the call, and has been highlighted in more than one article that I've seen, is that Grubhub referred to the consumers as being more promiscuous with their choice of food delivery services, implying that they understood that there was a monogamous relationship that they had with customers.

Hill: This is in the letter, it's attributed to CEO Matt Maloney. "We believe online diners are becoming more promiscuous." And let me just suggest that either they were trying to be a little cheeky with the humor there, to try and soften the blow of this abysmal report, or, on some level, they actually believed that; they believed that the value proposition that they were offering restaurants and diners was so amazing that they thought, "Well, once you try us, you're never going to do DoorDash or anyone else." 

Barker: Uber Eats.

Hill: Yeah. And, by the way, both of those are bad ideas. Going for the humor or actually deluding yourself into thinking, in 2019, when consumers have more choices than ever before, someone is going to "get married" to Grubhub.

Barker: As to using humor, and that being a bad idea, you may be correct in that that draws attention to itself. We are guilty of trying to use humor to lighten up situations, or cover the fact, when we don't know what we're talking about, just go to humor. I think that, in this particular case, it's the combination of humor and the word promiscuous, which connotes sex, right? 

Hill: Yes.

Barker: That's what grabs attention.

Hill: And, let me go back to something you just said, which is using humor to cover the fact that we don't know what's going on --

Barker: Why didn't they just use non-sexual humor, I say. Next time.

Hill: Do better, communications team at Grubhub. 

Barker: It ends up not being worth the quality of the laugh. Perhaps they got some laughs on the call and they used that. But here they are, stuck with us talking about this rather than the business, although they don't really want us talking about the business today either. 

The other point that you have brought up is, they may believe -- and I think that is part of the business plan -- "Hey, how do we get people to really be married to our business, and to not use the competition? How do we create brand loyalty? How do we stop people from going anywhere else? And if we can do that, then we're going to have a great business." And to date, they have found they cannot do that. And the reality is probably that it's just an app on people's phones. They don't have that much loyalty to Grubhub vs. DoorDash vs. Uber Eats. The person bringing the food to them is always going to be somebody different than the last time, so they don't have a personal connection. They do with the end restaurant, but they're not going to have it with the middleman.

Hill: Yesterday the stock was $59 a share. Today it's in the low $30s. Do you buy it at this price? Or are there more than enough questions that this is in the don't touch zone?

Barker: I don't think they've provided the answers that an investor would want to have to know where this thing shakes out against the competition. They are talking about spending more money. They're talking about their costs going up. We already see that their market share is eroding. Where do the profits end up being? Are they able to survive, keep the level of profitability that they need to satisfy their debt covenants? If the margins decline further, the answer to that is, they will not. They need to provide answers to that.