Olo (OLO 0.11%), whose name is short for online ordering, went public last week, quickly topping a $4 billion valuation. The platform is designed to help restaurants customize and manage their entire digital-ordering process. But despite seeing massive adoption due to the pandemic, Olo still appears to be in its infancy. Let's take a look at why its future is so bright.

What does Olo do?

Olo doesn't just target mom-and-pop shops; it also attracts larger restaurant chains like Wingstop, Shake Shack, Cheesecake Factory, and plenty more. Large restaurant chains need scalable yet personalized solutions that many point-of-sale solutions struggle to provide. That's where Olo fits in. 

Man eating a hamburger.

Image source: Getty Images.

Olo generates revenue in three different ways, each designed to help restaurants optimize and efficiently process online orders:

  1. Online ordering: Olo's most popular feature. Restaurants subscribe to this solution in order to build an intuitive digital ordering program for their customers. Whether it's mobile, desktop, or phone orders, Olo's customers are able to easily receive and process everything in one place. Customers can also personalize and manage their menus as availability comes and goes.
  2. Dispatch: Olo is able to help its customers select the best delivery platform for any given order. Whether it's an in-house delivery team or a third-party service like DoorDash or Grubhub, Olo customers are able to optimize their delivery process based on a range of factors, including time and cost. Since these third-party couriers can also take a toll on a restaurant's profits, Olo also allows its customers to simply deny service to delivery platforms, which helps prevent predatory pricing in competitive areas. 
  3. Rails: Rails is designed to optimize the partnership between restaurants and third-party ordering services. As services like DoorDash and Grubhub have gained traction, it's become more and more important for restaurants to utilize those services as a customer-acquisition tool. In order to do that, menu items and pricing have to be up to date, and the ordering process has to be seamless to prevent food delays. Rails integrates all third-party orders directly into a restaurant's order book to make sure it doesn't miss anything.

Unlike online ordering, Dispatch and Rails both generate revenue on a transactional rather than a pure subscription basis. Similar to an application programming interface (API) provider like Twilio, Olo charges a small take rate for each time its Dispatch or Rails feature is used. This helps Olo's customers minimize fixed costs and only spend money when they take in an order.

A look back at 2020

As COVID-19 took its toll across the U.S., restaurants began adopting digital solutions to help process off-premise orders. This tailwind certainly helped accelerate the adoption of Olo's solutions but not as much as one might think. While less in-person dining boosted digital ordering, it reduced restaurant spend as a whole. From 2019 to 2020, consumer spending on restaurants fell 24%. 

However, despite the overall volume decline, Olo delivered incredible financial results for 2020. Olo generated $98 million in revenue for the year, up 94% year over year, with an 81% gross margin. If installation revenue and professional services revenue weren't included, that gross margin would be even higher. In 2020, Olo also turned the corner to profitability, generating an 18% operating margin and positive net income. 

Customers showed their dependence on Olo's services this year as well, with 71% of Olo customers using all three solutions -- up from 44% in 2019. As customers began relying on these three solutions, they helped Olo deliver a dollar-based net revenue retention rate above 120%. This demonstrates not only the stickiness of the platform but customers' willingness to spend more with Olo over time. 

What does the future look like for Olo?

It's worth noting that Olo isn't alone in providing online ordering software. Both Wix and Square help businesses accept digital orders as well. However, Square and Wix were both designed to assist small and medium-sized businesses as opposed to national restaurant chains. Creating a scalable and branded solution that works in several locations simultaneously is difficult and likely the reason why Olo reports a 99% average retention rate among its enterprise customers. 

In short, the future looks bright for Olo. Chances are there will be some form of reversion in dining trends back to in-person, but all in all, digital ordering is here to stay. The convenience of delivery was obvious well before the pandemic, and I see no reason why that will go away. 

While there's a lot to love about Olo's business, the stock trades at a steep valuation of more than 40 times trailing 12-month sales. Despite the strong performance, the premium valuation means Olo is going on my watchlist for the time being.