In October, Noodles & Co. (NDLS 2.50%) initiated a 10% premium on its delivery orders, a growing part of its sales. While the impact of the added cost has yet to be determined, CEO Dave Boennighausen commented that he was happy with the early results. He noted that when the premium delivery fee was rolled out during testing, there was very little reduction in sales -- even though the expected consumer reaction would be a drop in demand.

Let's look at why Noodles added the delivery fee and what it means to its bottom line.

Delivering is the way to go

Restaurants are facing challenges with declining guest visits and sales. In contrast, meal delivery has been growing. According to eMarketer, 38 million Americans have used a food delivery app at least once a month, an increase of 21% from the previous year. Given the declining in-store results, more restaurants are looking at delivery opportunities.

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Noodles sees delivery opportunities as a path toward growth in its off-premise sales -- sales represented by to-go orders or catering. In Noodles' third quarter earnings call, Boennighausen reported that digital sales -- which are often used to place to go orders -- increased 47% from the previous year. Off-premise sales grew to represent 54% of all sales. Given that its catering is only 2% of sales, a lion's share of Noodles' off-premise sales comes from to go orders. The growth of digital and off-premise sales had a similar impact on delivery. Noodles currently has its delivery handled by third party service providers -- which include DoorDash and GrubHub (GRUB).  Delivery represented 7.6% of Noodles' third quarter sales, up from 6.6% in the second quarter.

Bornninghausen further added that Noodles continues to look for growth opportunities for its off-premise business, including incorporating windows that make pickup easier and designing smaller footage stores that cater more for off-premise orders.

But delivery comes at a cost

While delivery can boost off premise sales, the service does come at an additional cost and cuts into restaurant margins. Third party delivery companies like DoorDash, a private company, and GrubHub charge restaurants a commission for its services. GrubHub averages a 22% commission for orders placed through its app.

Noodles is not immune to growing delivery costs. While Noodles' margins have actually improved 17.1% in the third quarter, compared to 16.4% in the same period last year, management noted that delivery fees dragged down the other operational and cost improvements. It reported that third party delivery fees grew by 1.7%.

To mitigate the delivery fees' impact on Noodles margins, management announced an added 10% to the cost of delivery order. The premium is Noodles' passing its delivery costs to customers, betting that delivery customers will accept the additional service charges.  

Noodles is also exploring direct delivery. Direct delivery, while still handled by third parties, will be ordered through Noodles' own digital platform instead of using a delivery app such as GrubHub.  Third party delivery services take an additional charge for handling the a restaurant's order if the order is made on the third party's site instead of the restaurant's. It also further separates the restaurant from its customers. Noodles expects that direct delivery will help it get a better handle on its costs and connect the restaurant closer to its customers.

Like Noodles, other restaurants have to manage third party delivery costs carefully. For example, Wingstop saw an unanticipated increase in orders coming through the DoorDash app, resulting in additional commissions for the delivery company and thus cutting into Wingstop's margins. Fast casual chain El Pollo Loco had to create a special delivery menu, which removed smaller ticket items and has higher prices than dine-in prices on the remaining items.

Does passing the costs help deliver results?

Noodles is seeing a majority of its sales come from off-premise orders and, by extension, a growth of its delivery orders. While delivery costs impact its margins, Noodles is mitigating the delivery cost impact by passing the cost to the customers in the form of a 10% premium on the order.

While it remains to be seen if the added delivery costs will make customers hesitant to continue ordering, management is pleased with the initial results. If customers accept the premium and Noodles continues to double down on its off-premise sales, Noodles will be able to keep its future margins from lagging.