One out of ten people reading this article will have food delivered to their home this month via their smartphone. Data from shows 38 million people in the US now use food delivery apps at least once a month, up 21% from last year. Private company DoorDash is the largest player in the delivery space, closely followed by Grubhub (GRUB) and Uber Eats from Uber Technologies (UBER 1.58%).

Man delivering food to woman

Image source: Getty Images.

Restaurants are turning to these delivery apps out of necessity. Comparable sales measure repeat revenue at existing locations; traffic measures repeat customers. And for years both metrics have repeatedly disappointed in the restaurant industry.

Year Comparable sales Restaurant traffic
2016 -1.1% -3.1%
2017 -1.1% -3.2%
2018 0.7% -1.9%

Data from TDn2K. Table by author. 

Seemingly unable to entice more customers into restaurant locations, the industry is turning to what is commonly called "off-site" transactions, primarily fueled by these delivery apps. This industry change and rapid adoption has created a new set of problems. For restaurants, it improves sales, but delivery fees negate a significant portion of the profits. And for delivery apps, necessarily competitive pricing impacts their profits as well. 

Companies are handling these new problems in different ways.

Negotiating better terms

Wingstop (WING 0.85%) delivery orders can be placed either with Wingstop or its exclusive partner DoorDash. It had predicted that the majority of orders would come through, but in the second quarter the company noticed more orders were coming through the DoorDash platform. That caused Wingstop to pay more in commissions than planned.

So Wingstop simply reached out to DoorDash immediately and negotiated a better rate. The new commission deal was implemented at the end of the third quarter which means the benefit won't be seen until next quarter.

Wingstop successfully negotiated a better rate likely because of its exclusive relationship with DoorDash. While many restaurants partner with multiple delivery services, that's not the route Wingstop plans to go. It's unlikely that restaurants with multiple partners could work a deal like this. As we'll see, delivery companies are in stiff pricing competition with each other, and aren't likely to want to negotiate their restaurant commissions lower.

Are you cheating on your app? 

When a delivery order is processed, restaurants pay delivery partners an individually negotiated commission, typically about 20% of the transaction. Grubhub in it's third quarter averaged a 22% commission on orders processed through its app, up from 20% in the third quarter last year.

A delivery commission isn't easy money up for grabs. In a recent shareholder letter, Grubhub called its users "promiscuous", alluding to consumers shopping around for the best deal. Grubhub, in its third quarter earnings call, clarified its belief that it already offers the best value among its peers, and therefore has no plans to attract customers through further discounts and promotions.

In a competitive pricing environment I believe Uber is better positioned than its peers. It has other business segments like ridesharing contributing to revenue, so it can afford to discount its delivery service in order to gain market share. And indeed that's what it's doing. In Uber's third quarter call management mentioned how Uber Eats is now included in its subscription service. Subscribers to Uber Pass will get free delivery on food, and Uber can absorb that cost for now. Its competitors might not be as flexible.

This might be the winning solution

When El Pollo Loco (LOCO 0.27%) reported its third quarter 2019 earnings  the stock popped about 30% as it beat expectations in both revenue and net earnings. For the quarter, comparable sales were only up 1.1%, but comp-sales surged 4.2% in September alone. One of the primary drivers for September's surge was delivery. El Pollo Loco had previously partnered with just DoorDash, but during the third quarter it added Postmates and Uber Eats. Soon it will also add Grubhub and in November it even plans to add ordering via Amazon's Alexa to make delivery simpler. 

El Pollo Loco is clearly going all-in on the delivery strategy to boost sales. But it's tackling the commission problem in a different way that could be a win-win scenario for both restaurant and delivery services. Fielding questions in its earnings call, management said that it's created a special delivery menu with special pricing. Small ticket items aren't available for delivery and prices are raised 13% to 15% compared to its regular dine-in menu.

In this way, El Pollo Loco aims to maintain the profit margin it wants without the delivery service losing out on its commission. The customer is asked to essentially pay a convenience fee. And so far, those customers haven't pushed back. This is a good creative move for El Pollo Loco and ultimately the model we could see more restaurants emulating over time.