(This is a guest post by Applico Head of Platform and Modern Monopolies co-author Nick Johnson.)

McDonald's is not loving it.

This week, the fast food chain announced a fresh round of layoffs as the burger chain struggles to turn around its U.S. business. The company's internal research found that it had lost about 500 million orders to rivals over the last five years.

Part of the company's struggles stem from the rise of fast-casual restaurants and changes in ever-fickle consumer tastes. However, a bigger, longer-term trend has also played a major role: the rise of delivery. In 2017, restaurant delivery sales surpassed $16 billion annually. But according to analysts at Morgan Stanley, that number could hit $220 billion by 2020, which accounts for some 40% of all restaurant sales.

McDonald's executives have called delivery, "the most significant disruption in the restaurant industry in our lifetime." The company has also stated that it sees delivery as a "$100 billion opportunity," and that the average delivery order expands check sizes 50% to 100% compared to their typical customer order. What's more, delivery represents a huge incremental opportunity for McDonald's, as delivery customers are more likely to order McDonald's for dinner than its traditional customer base.

Yet, while McDonald's has invested heavily in digital infrastructure - to the tune of hundreds of millions - the company has lagged behind on this growth opportunity as delivery has exploded.

Curiously, it has no delivery solution of its own in the U.S. Instead, it has chosen to partner with food delivery platform UberEATS, which is owned by Uber.

McDonald's reached out to Uber in 2016 to launch a pilot, and the partnership has expanded since then, reaching about 5000 restaurants in the U.S. by the end of 2017. McDonald's CEO Steve Easterbrook has declared this a big success, claiming last year that the company exceeded expectations on this front. And in the short term, he's right. But longer term, McDonald's strategy is a Big Mac-sized risk.

McDonald's Lost Opportunity

If delivery is truly the massive opportunity McDonald's claims it is, its strategy seems odd. By not owning delivery directly, McDonald's is giving up a significant opportunity to expand its business. Not only does delivery bring new revenue opportunities, but it also brings a huge data opportunity - the kind that might help the company avoid the type of rut it's been in for the last few years.

In the short term, UberEats with its established network can almost certainly do delivery at a lower cost per order than McDonald's can. But McDonald's has the scale to merit building its own delivery infrastructure. It likely wouldn't take too long for it to match UberEATS in size. In fact, McDonalds could build out delivery capabilities with its own restaurants as customer number one. Then it could open up these capabilities to other restaurants to drive additional revenue, while the additional scale would also drive down the cost per delivery for its core business.

This is, in effect, the Amazon Web Services approach to delivery, and it's one that McDonald's is well positioned to execute. By owning the delivery platform directly, rather than merely partnering with one, McDonald's would maintain ownership of its customers, instead of handing them off to a third party. Additionally, it would earn revenue by taking a cut of every transaction that other restaurants complete on the platform. This platform revenue would be a boon for McDonald's stock price, as platform revenue is typically valued at much higher multiple than its core business is.

Additionally, McDonald's would also gain a treasure trove of customer data on what food customers are ordering - and when. With this data, it could more easily adapt its menu at its restaurants, as well as identifying new food categories or restaurant opportunities that it could invest in. Additionally, since food delivery is a hyper-local market, a delivery platform would give McDonald's location-specific data, meaning that it could much better personalize its offerings based on where the store is located.

With the current partnership approach, McDonald's is passing up a huge opportunity to grow its business, as well as an opportunity to build a strong competitive moat that would help prevent future downturns in its core business. With a strong delivery platform business, the company would be much less likely to miss big changes in consumer demand ever again.

Delivery Isn't Easy

The challenge for McDonald's, or other restaurant chains like it, is that delivery is a hyper-competitive market. It may be too late for a company, even of McDonald's scale, to build a successful delivery platform that can compete with the likes of Grubhub or DoorDash, which raised more than $500 million from SoftBank in its last round of funding.

However, there are a number of potential acquisition targets that could help jumpstart a chain's delivery platform. Postmates, for example, has notably been looking for an acquirer. Combining the existing network of an established delivery platform with the brand and scale of a chain like McDonald's could provide an unfair advantage in the delivery space.

Yet, McDonald's and many other restaurant chains seem content to become commodity providers to someone else's platform. This scenario has played out in industry after industry, yet few large food companies seem focused on the threat. The result of this shift is almost always the same: more and more revenue, data and customer loyalty accrue to the platform, while the revenue of the producers like McDonald's gets squeezed and brand loyalty declines.

By not owning the platform for delivery, McDonald's may be getting into the delivery game faster. But at what cost?

Published on: Jun 10, 2018