In this week's episode of Industry Focus: Tech, host Dylan Lewis is joined by Motley Fool contributor Jason Hall. Their focus today is on exploring how mobile apps fit into the direction and strategy for companies in a variety of spaces.
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This video was recorded on September 24, 2021.
Dylan Lewis: It's Friday, September 24th and we're talking tech without talking tech. I'm your host Dylan Lewis, and I'm joined by fool.com's Jason Hall. Jason, how are you doing?
Jason Hall: Happy Friday, Dylan. It's interesting, I'm sitting in a hotel that's about a half a mile from a house that I used to own and it's for a good reason because we're in the middle of a move. I'm really happy you asked me to come on because this is a really fun topic and I think for investors, it highlights something really important.
Lewis: Yeah. Happy that you're able to carve out some time even with some of the chaos going on in your life.
Hall: A thriving chaos to us.
Lewis: Thrilled to join us. The angle for today's show is interesting. Our producer behind the scenes, Mac Greer, often says lead with your strongest statement. This is my best wing for this one. Mobile apps are a wildly underappreciated look at where a company stands in owning the relationship with a customer and future proofing themselves from competition. The genesis for the show, Jason, I don't think I told you as we were planning it out was, I was in my living room the other night and I had one of those aha moments where you know something to be true, but you've never really put it in those terms before. I have a wired-up smart house. All the bulbs in my house and lights and everything are smart. You can control it with your phone. I can control my TV with my phone when I'm playing media. I had that moment of the phone is basically the remote control for my life.
Hall: For your life, right?
Lewis: For my life, right. Everything funnels through there. Whether it's interacting with my house, interacting with my friends, interacting with financial institutions, restaurants, you name it, it's there. It sounds like an obvious statement when you start exploring it a little bit, but it's the reality and I think that's why I wanted to zoom in on the app landscape in particular and strategically, how important it is for a couple of different industries. We're going to talk about restaurants, we're going to be talking about e-commerce and we're going to be talking about fintech through that lens.
Hall: I think it's easy to forget it's like a tree. We think of a tree as what we see. It's the trunk coming up and it's the branches extending over with the leaves, how big it is. We miss and don't think about the fact that there's just as much tree that's just as large under the ground in its roots. The tech that's driving so much, like you said, whether it's retail or restaurants or financial services, all of the tech stuff is just as big and it's there and it's right under our feet and we don't even see it.
Lewis: Yeah. Today, we're going to try to see it. I think we can maybe start with some of the more visible and tangible elements of this conversation. I think the restaurant space is one that folks are super familiar with. They probably have a decent idea of where the mobile strategy fits into how companies are approaching the relationship with their customers. There are two, I think, poster childs in this space. That's Chipotle (CMG 4.49%) and Starbucks (SBUX +0.30%), Jason.
Hall: Right. They're the ones that have certainly led this and for investors that have followed these companies, it's been pretty clear. I want to start with Chipotle because between the two this is the one that's more recent. Brian Niccol was brought in as CEO in early 2018. He came from Taco Bell; it's part of Yum! Brands. He was the Taco Bell CEO and he had been at Yum! Brands, he'd been at Pizza Hut for a while. He was part of their marketing, moved forward to move forward and took over at Taco Bell. The company was really lagging when he took over. Their menu was pretty stale. There was a lot of the same legacy stuff that I remember when I was a little kid and their menu just blew up and some of the weird crazy things that you saw, like flaming hot cheeto, burrito, all the stuff that they did, it's gimmicky got a lot of the press, but at the same time he was there, he was really driving a lot of innovation in terms of better leveraging technology. It wasn't just about gimmicks and so-called food innovation. But at any rate, when he was brought in at Chipotle, the idea was he was going to drive menu innovation. That was going to be the big thing he was really going to push. We've seen things. The queso, which is terrible.
Lewis: Actually, Jason, the menu innovation thing I think is an interesting point because at a restaurant like Chipotle in particular, it's something that I think a lot of people saw as a major growth lever for that business. There's been so much speculation about when they would offer breakfast, when they would be introducing new features and things like that into that assembly line approach. I think it's happened to some extent but it's not really where the growth and revival of that company started.
Hall: Honestly, the cadence of new menu items is not significantly different than it was in the three years before or the five years before Niccol came on board. Because again, this is a food integrity company. They're focused on their core menu, which is sourcing ethically raised food, trying to source organic whenever possible, a simple menu, so the least amount of ingredients to deliver great food is possible. That's one thing they struggled with, the queso, to get that melty, cheesy thing in that environment where you need to have it for 10 or 12 hours to serve somebody that might want it and deliver without some food additives, it's hard to do. But then there have been some great things. I love the sofritas, which are tofu-based. It's what I order every time I go in. But here's the thing, this was when Niccol took over, Chipotle was still dealing with the overhang of its food-borne illness crisis. It was really a crisis that took a good year, and a year-and-a-half to play out.
His first full year, Chipotle only opened a net of 83 stores. This is a company that was typically opening 200-300 stores a year. They actually closed 50 restaurants during that first year. There was a lot of refocus on Chipotle. Now, I'm just going to quote some numbers here as we go through this and remember, this was just a refocus on the brand and there wasn't a bunch of menu innovation happening. The first quarter after he was hired, and it was a few weeks after he was hired that they reported earnings, comps were up 2.2%. Comps are sales growth at existing restaurants, restaurants that have been open for a year or more. It's organic growth I guess is the best way to think about it so It's not growth coming from new locations, 2.2% is terrible. It really is, especially if you're a growing restaurant.
Lewis: If your restaurant valued the way Chipotle was at the time, right?
Hall: Yeah, entirely. It's not good because at that point, 2.2% is barely keeping up with the increase in their food costs. His first full quarter, that was the second quarter of 2018, 2.8%, so a little improvement. Now the fiscal third quarter, so by that time he had been there about seven or eight months, comps grew 4.4%. You're seeing a little bit of a cadence of improvement here. Chipotle also did something it had never done before. It broke out in its release digital sales results. Digital sales results in the third quarter of 2018 were 48% higher than they were year over year and accounted for a double digit portion of sales, 11.2% of sales. Now, let's fast forward two years. The third quarter of 2020, so this is last year's third quarter, digital sales have grown to almost half of revenue. I must say, digital sales accounted for almost half of the revenue. In two years, it went from 11% to half of the revenue. That's pretty impressive.
Lewis: I think perhaps some of the best place investments they could've made. We know that the industry was moving in this direction and that restaurant businesses that had incredibly strong mobile offerings and rewards programs were generally going to be the winners. But to have that coincide with a period where the pandemic is dictating that there is far more pickup and go in delivery type food consumption, they couldn't have anticipated it, but it was where the puck was going anyways.
Hall: Exactly, it's interesting. If you look at that period from his full quarter, there was enough time for the things he was pushing to start working their way through the business. Chipotle's only had two quarters when comps grew less than 4.4%. They were the first and second quarters of 2020, which is the COVID lockdown period. You think about that first quarter comps, the first two months, January and February, were double digit comps growth. Then March happened, of course, and it was negative comps. Then in the second quarter, comps fell about 10%. But during those periods, again, because at this point it was a couple of years of pushing out, really focusing on the app. Customers ordering from the app inside their stores using those second make lines, the prep lines basically in the back of the store. Bringing in technology to push those orders that people were doing on their phones or on their website, to push those orders to make ready lines in the back, so that it's not affecting everybody. It's 12 o'clock, everybody's hungry and there's 30 people in front of you in your line. You don't want to be another 10 people digitally in line in front of you that you don't know. It affects the throughput, it affects the customer experience. They are leveraging that second make ready lines a lot more using technology to do that, but here's the key. The only two quarters we saw comps fall below that 4.4% growth were the two quarters of the pandemic. But like you said, Dylan, because of the timing, obviously they couldn't anticipate this. But in this first and second quarters, pandemic, digital orders made up over 60% of sales. I almost said it saved the business, that's too hyperbolic. But it certainly generated substantial cash flow that the business probably would not have gotten otherwise.
Lewis: Yeah. I think Chipotle and Starbucks, I said before, they're the poster child of early innovation in tech and mobile ordering. You identified before, they have to be because of the nature of what they do and when people are going to them. There are surges for both of those businesses. Chipotle, it's going to be launched at dinnertime. Starbucks is going to be in the morning rush. To be able to effectively manage and maintain the throughput that you want to and deliver on the customer experience, you need to nail the technology.
Hall: Yeah, exactly. It makes a massive difference. The other thing too is because these are two businesses that if you look at the restaurant industry, there may be one or two other brands that just deliver restaurant-level economics that are on par with what they do in terms of the operating margins they can get at a restaurant. If you start a restaurant, Dylan, you're happy if you can get five% operating margins. You're ecstatic if you can get that. These are brands that get double digit operating margins at the restaurant level consistently. It's because they keep a simple menu, they're really lean with how they operate, and they leverage those peak times.
As much as we've seen Starbucks try to do more, try to expand lunch, try to add things like beer and wine in certain locations to be that third place, as they say, for more dayparts, they're still a morning business. They really, really are. Chipotle is largely a lunch business. They do some dinner, but lunch is really their core. The key here is that Niccol has focused on using technology, to leverage what they're already really good at and get even more out of that.
Lewis: Yeah. Jason, I think both of these businesses are habit forming businesses to some extent.
Hall: Absolutely. The app ties into that, right?
Lewis: Yeah, it has to. You mentioned the pivot to digital and what we saw in terms of sales over on Chipotle's side. I think there's a pretty compelling data story there with Starbucks as well. If you look at their mobile orders as a percentage for overall transactions, single digit percentage in 2016. It is, I think, about a quarter of their transactions in 2020. That's a pretty massive scale. That probably does not include some digital orders that are not happening through their mobile app, but when you think about how people are using this every day, you want it to be frictionless and you want it to be as easy as possible. Otherwise, it's going to be something that they don't include as a habit anymore. It has to be quick because to some extent, the expectation is more than anything else.
Hall: Yeah, exactly. It's interesting, I don't want to say it's in the far east. Here's my mini rant, I'll get this out of my system. I hate it when companies make their mobile sites. I don't want to say they do this with intent, but I'm going to say they do this with intent. Their mobile websites are a little crappy. You download the app, which is slick and fast and awesome. There's a reason they do that because they create a captive audience when they do that. When you use their app, you're going to spend more money with them. It's inevitable that you're going to spend more money with them. There's also the benefit of the data. You think about being more effective with your marketing dollars, promotions where they can target because they know so much more about their relationship with you and how they can leverage that. I think it's brilliant and it's smart. I'm being a little tongue in cheek complaining about it, but it is a powerful example of how data about your customers can be leveraged to grow your business and to be more profitable.
Lewis: Jason, in prep for the show I was looking at app rankings using AppAnnie, checking out the iOS rankings for various categories. Looking at food and drink, Starbucks and Chipotle are there. They are contenders, for sure. But there are some names ahead of Starbucks in the iOS app. I'm curious if you have any idea who those names might be.
Hall: I'm going to guess one. I'm going to guess Domino's. There's two or three that I can think of that might be on there too, but I'm just going to guess Domino's here.
Lewis: Yeah, I think if there was a third name that we had omitted, Domino's would probably be the one that the listeners are like, "Oh, come on. You've got to talk about them, the tech investments." and you're right. Domino's is one. The other one is even higher up on the list. Shockingly, McDonald's.
Hall: That's surprising, but it's also not surprising. At this point, they're on defense, I think.
Lewis: They've made heavy investments in the last couple of years. You see it in-store with them with being able to interact with the menu without actually talking to the cashier, it's all touchscreen. But they have made a huge, huge push into mobile apps. They've tied a lot of their promotion, they've used some star power in recent ads. They partnered up with BTS, the K-POP group. They have a meal out now, The Saweetie Meal. They've used collaborations with Travis Scott, J. Balvin, all these custom meals. The ad spots are driving folks to their app and to their rewards program. They count more than 40 million active app users in the six biggest markets, and they have delivery in more than 30,000 restaurants. They've achieved an incredible scale in short order. I want to talk a little bit before we go to the next category here, just about exactly why this is so important for the restaurants. I think we've touched on it, but I want to bold and underline it, Jason.
Hall: Okay, go ahead.
Lewis: I think it's about the app, but it's really about how the app and the rewards program work together, to create engagement opportunities for customers.
Hall: Absolutely. Again, I touched on a little bit before, but the key here is an app is not going to get you there. It's handy. Maybe you throw a discount the first time you use the app or something like that. But you have to continue because it's all about creating a relationship this rewarding for the user. Starbucks, they call it Starbucks Rewards. There's a reason that they have that name because you reward your users when they continue to come back. They can build points up and things like that. It's such a valuable way to leverage that dataset in a way that you just can't do with any of the traditional ways that companies have tried to market. Right, Dylan?
Lewis: Yeah. I think that's true. I mean, it gives you a direct line to the customer. If you were to tell people 20 years ago, hey, you will be able to send a notification to someone's pocket to get them to engage with your brand, maybe it's an offer to be able to pick up something for free. Chick-fil-A is a brand that is also making heavy use of this with, hey, it's been a little while since you've come to our restaurant. Here's a free sandwich or something like that next time you come by. That's an incredibly compelling offer for marketers. Tracing back to what we were saying before with throughput, all of these names we've talked about, there might be a little bit of a Pavlovian desire for the food where you have a certain craving for something, but at core, I think what they really offer is convenience and the investment in the technology and really having a seamless app experience gets you there where it's pretty crowded field, Jason.
Hall: It is. The other part of it too is it's just human nature. Some of the things we talk about with investing is developing the long-term mentality. We get past all of our human nature of short-term fears and greed. At the end of the day, because we're creatures of habit, and there's a little bit of honesty, Dylan, how much is it that [...] Just you pull open the app you're familiar with and you order the food that you know is going to be good and you don't put any more thought into it than that. It makes people in order of magnitude more likely to reuse that brand or shop from that company or order from that restaurant if they've downloaded their app, because again, you create that captive audience.
Lewis: Yeah. I think the lesson here before we head over to the e-commerce space is, I think the app relationship is increasingly important because it's a relationship that those brands own. I didn't mention this when I first gave the rundown of the iOS rankings, but two non-chains are No. 1 and No. 3 in the category, and it's DoorDash, UberEats, respectively. I think the restaurant brands very correctly identify that they run the risk of having a middleman step in and divert demand if they aren't the ones that own that mobile relationship.
Hall: Yeah. There's no doubt about that. We've seen DoorDash, for example, has taken substantial market share in this space over the past couple of years and UberEats is No. 2 right in there, as Uber has made that part of its business nearly as much of a priority as it's made its right share. It's incredible. Again, the key is like you said, it's having who controls the access to the customer. That's the key.
Lewis: Yeah. It's going to be a very similar story in the e-commerce space. I'll kick us off just with a quick rundown of the iOS rankings in that category. No surprise, No. 1, Amazon, No. 2, Shein, which might be a new name for a lot of people, but if you follow the TikTok hauls and the social media viral e-commerce zone, no surprise there. No. 3, Walmart, No. 4, Shopify, No. 5, Target, No. 6, Nike, and No. 7, Etsy. Jason, I think I could do an OK job of explaining why people want a killer mobile app in this zone, but I think I'm going to let Etsy's management team do it instead. This is a quote from their Q2 2021 conference call. "We're seeing significant progress prompting buyers to download the app, which represents our smallest share of visits. It has the highest conversion rate and nearly all of this is coming from product investments rather than marketing spend. We believe success here could lead to more traffic from repeat and existing buyers shifting from paid to organic, which will enable us to spend more to acquire new buyers through higher LTV, as well as improvement to adjusted EBITDA as paid clicks and visits shift to organic." That's basically it. That's the explanation right there. Right, Jason?
Hall: Yeah. We invested in building a great app. We encouraged our users to download the app. When they do, we own them, and we're more profitable. That's basically what he said.
Lewis: It's creating a deeper relationship that you have control over, you're getting better conversion rates, you're able to spend more to acquire customers because you know that the LTV is going to be stronger down the line. Thinking back on that rundown of companies, Etsy is no small name in the e-commerce zone. But if you're trying to insulate yourself from competitive pressure in the likes of Amazon and Walmart, you need that direct line to your customers.
Hall: Absolutely.
Lewis: It's an undeniable part of where we're going. I think it's interesting to see a company like Nike in that top seven too, Jason, because throughout the last couple of years, I think they've had different turns with their relationships with e-commerce players like Amazon, where in the same way that some of these restaurant brands we were talking about before, they benefit from the likes of DoorDash, UberEats and that there's built in logistics and they don't have to worry about getting the food to the customer. There's also someone stepping in with that marketplace and creating other options that people go to. Nike, by selling stuff on Amazon, loses a little bit of control over their brand and the relationships with their customers.
Hall: If you think about a company like Nike, and this is where the term omni-channel comes up, its business is just more complicated in terms of how customers are going to find its product, so it has to be wherever its customers are. It has to be on the shelves in a Foot Locker. It also has to be on Amazon and these other large e-commerce players. It has to have its own retail that it also owns. I think Nike is a really good example of how companies that might traditionally not think about this space, because they're not necessarily thinking about how they are selling directly, realize that, I think for so many newer generations of consumers, their first thought is to go look in the app store, or the Google Play Store to find the app for the brand that they are really interested in. They're not going to go to the website first. They're going to find the app first.
Lewis: I think that's 100% right. This final category that we're going to talk through here is the FinTech zone. I think to some extent, Jason, people have turned to the newer players in the space, in part because of the inaction of some legacy players or the slower movements of legacy players. Just to quickly go through the top downloaded finance apps. We have the CashApp from Square, we have Venmo, PayPal, Truist Mobile, and Zelle in the top five. I can't say I'm surprised looking at that rundown.
Hall: Yeah. The one that jumped out at me was true is mobile. This is true as financial which was formerly too big. Southeastern Legacy regional banks that merged came up with a name Truist and I thought it was just the dumbest name in the world when I first heard it. I think it was really sneaky clever to do it because you take these two legacy brands that might not resonate with younger consumers. If you're a bank, you can spend a thousand dollars or more on customer acquisition through traditional methods where it can be single or low double-digits, for these fintech companies that are acquiring. You create a new brand that is not going to put people off. There's backdoor appeal that they've created. I think it's really smart. It certainly surprises me that a regional bank is above somebody like Capital One mobile, or Bank of America, which I think has done as well as anybody in the banking space to create a great digital platform.
Lewis: I'm curious, Jason. When I think of peer-to-peer payments and just being able to transfer money, it's hard for me to not think of the Cash App, Venmo and PayPal.
Hall: They own the space.
Lewis: They completely do. I think the banks have their offering for that. It is not nearly as popular.
Hall: It's not and part of that is because it's a consortium owned by most of the big banks. Its management by committee, there's nothing that's going to be innovative and it's going to be very hard to disrupt these other products that are owned by companies that are laser-focused on those products and pushing them forward.
Lewis: It's easy to forget with everything that somebody like Venmo does now or like PayPal or the Cash App does now, how laser-focused they were in the beginning, specifically addressing the friction of getting money to your friends. They've built in all this functionality over time but that opening is really what gave them the window to become apps that have tens of millions of users, tens or hundreds of millions in payment volume on an annual basis.
Hall: It's exactly what disruption looks like.
Lewis: Yeah, identify a need, address it, expand once you have the customer relationship, right?
Hall: Right.
Lewis: I think this is a little troubling in some ways if you're looking at the banking sector because banks have to compete on convenience now in partners because physical branches and in-person relationships just do not have the power that they once did.
Hall: If you just think about any of our listeners that are in their 40s or over, you probably remember a time where you asked your parents, who should I talk to? What bankers should I talk to? They said, "Talk to so and so," and you go and you sit down on their desk and you fill out some paperwork and you're there for an hour. That's not how it works at all anymore. You go into the App Store, you find the ones that are highest rated and you pick from that. That is such a complete difference. The ability to just even crowdsource without even talking to another grown up about it. Then within minutes, you've established this financial relationship. If I'm one of these businesses, it's so much more inexpensive to acquire that customer. Then the hard part is of course, continuing to please them. But once you have them, these services are so sticky. Once you set up your bill pay and you get all of these other things set up with any of these large financial services providers, redoing that for another one, sometimes it's just not worth leaving. Once you're there, they have you for decades.
Lewis: Yeah. A huge part of the banking model is identifying, acquiring a customer, being able to roll other products into that customer's account over time. You start out with checking and savings, maybe at some point credit card then some point beyond that, personal loan, an auto loan, perhaps a mortgage, some point beyond that, a refi, perhaps a home equity loan. That's where you're able to justify those very expensive upfront customer acquisition costs. We're seeing increasingly these fintech players are playing in those spaces. I don't think it's any coincidence that Rocket Mortgage is one of the most popular ways for people to get their home loans because it's mobile-first and it's digital-first in the approach.
Hall: Exactly, and the other one is Better.com, which went public not all that long ago as a lender. Same thing, it's an online-only platform, it's super slick, it's easy to use and the same tailwinds are pushing it.
Lewis: Jason, I think we're just about time here, but realize that this is a little bit of a different take than we normally would for a tech show. But it was super fun to talk through. Listeners are excited to hear what you guys think about this. If we should try talking through industries through this lens a little bit more often. Jason, thanks so much for joining me on today's show.
Hall: Yeah, this was great. One last thing I'm going to put in a plug for Marc Andreessen's 2011 article, Why Software Is Eating The World, was in the Wall Street Journal. Google it, Why Software Is Eating The World, and read it because again, 10 years ago talks a lot about what we've seen happen and the basis for this episode. Let's do more on this. I think we can get a lot deeper.
Lewis: Yeah, I think that article required reading or part of the tech investing starter kit.
Hall: Absolutely.
Lewis: It really helps you get a grip on what's going on. It's pressure even now to think through. Thanks for the rec, and listeners always looking for tops for the show. If you have anything we should be reading, anything we should be talking about, [email protected] or @MFIndustryFocus. If you're looking for more of our stuff, subscribe on iTunes, Spotify, or wherever you get your podcasts. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for all this work behind glass today and thank you for listening. Until next time, Fool on.
