Charlie McMillan Summons

Under the recent paradigm of the sharing economy we can share our beds and homes (Airbnb) our cars (Uber, Deliveroo, Amazon Flex), now commercial kitchens are being offered the chance to share their kitchen space. This is the new industry of virtual restaurants and ghost kitchens.

Franklin Junction’s ‘Host Kitchen’ platform is one player in the virtual restaurant field. Franklin Junction has a portfolio of food products for which it can provide the training and ingredients to create. Restaurant owners can choose the products they stock while Franklin Junction aggregates the marketing and distribution costs and wraps that into a commission on sales. Let’s use Mariah Carey’s Cookies as an example. A struggling fish and chip shop might be seeking a small profit boost for their kitchen. They can’t revamp their facilities to do anything other than fry fish so they start stocking Mariah’s Cookies. This is much easier than becoming a traditional McDonald’s franchisee which comes with the attendant overhead costs and restrictive covenants.

Really, the term ‘virtual restaurant’ is a misnomer (probably to engender more hype and tech-like funding valuations) and ought to be called virtual dining products. What providers are selling is the comfort that a certain meal, that can be easily made with your pre-existing kitchen set up, will sell due to the pre-promoted brand cachet. It almost allows existing restaurants to dip their toe into the franchise world without being under the thumb of a corporate HQ to the same extent as under traditional franchise relationships.

This model has surged recently in the US due to restaurants which, during the pandemic, had plenty of kitchen space but a dearth of customers. But ghost kitchens have really seen the greatest adoption in China which wholeheartedly adopted delivered food even pre-Covid. This was to such an extent that even in the middle of 2019 Panda Selected, a company specialising in ghost and shared kitchens, opened 103 shared kitchens to keep up with demand.

The too-good-to-be-true pitch is that from the very first sale of the product, the restaurant owner is pulling pure profit minus the ingredient costs. This is because they are already paying for the normal ‘hard’ overheads (rent, utilities, labour costs etc.) running their usual business. Those companies selling virtual dining products conveniently omit the ubiquitous risk in hospitality: no one wants the dish. This could lead to a whole lot of unsold stock and eventually large-scale food spoilage.

Importantly, virtual dining products distinguish themselves from franchises meaning that they can slot in to the restaurant owner’s existing set-up without incurring any further labour or building costs. This is similar yet distinct concept from ‘ghost restaurants’ or ‘ghost kitchens’ whereby a single kitchen pumps out food under the guise of multiple restaurant listings on apps like UberEats.

Importantly also, from the other side of the deal, this concept offers celebrities the opportunity to make their own endorsement deals by leveraging their notoriety. We can see this in Jimmy Donaldson’s ‘MrBeast Burger’, Tyga’s ‘Tygabites’, or Wiz Khalifa’s ‘Hotbox’.

(https://www.intouchweekly.com/posts/tyga-and-robert-earl-launch-virtual-dining-concept-tyga-bites/)

In short, this concept is essentially a ‘franchise lite’. Rather than taking on the design, entire menu, and food practices of a McDonald’s or KFC, restaurant owners can buy the food and preparation instructions for two or three products to slot into their usual offering.

Costs

As mentioned, virtual dining product providers seem to supply the avenue to buy ingredients and provide a varying level of training to restaurant owners. But above all, what kitchens are paying for is a business profile. Centralising marketing costs and strategy as well as preparation R&D lowers capital expenditure for the host restaurant and brand provider.

Currently, fees for restaurant owners are quite opaque. Franklin Junction notes that restaurant owners will pay the usual delivery fee to providers like UberEats, a royalty fee to the brand owner, and a service fee to Franklin Junction for matching the parties and supplying ongoing market intelligence. One estimate is that the virtual dining company’s take is anywhere between 5%-40% of sales plus a fixed marketing fee and an initial franchise fee for the lower end royalty takes.

What the Future Holds

The malleability of virtual restaurants provides a potential opportunity for delivery providers like UberEats and Deliveroo. Using the mass of consumer data that they collect, they could set up their own ghost kitchens or facilitate the integration of products like Tygabites through their network of restaurant customers. If Deliveroo notices that one postcode is lacking burger options based on its customer’s search data, it can recommend a partnered restaurant start selling MrBeast Burgers.

(https://morethanthecurve.com/second-seamless-page-pops-up-with-plymouth-meeting-malls-address-plus-more-on-flavortown/attachment/80431/)

Virtual dining providers like Nextbite already roll this market analysis into their partnerships so that products can be marketed flexibly. The light touch integration into existing restaurants that virtual dining products provide means no restaurant owner is going to be caught out setting up a fish and chips take-away if everyone swears off eating fish. Owners aren’t wedded to one product and could, having sold all their Mariah Cookies, transition to another product very easily. There’s a much lower investment into brand goodwill made by the restaurant owner. If one product isn’t working, try another off-the-shelf dish using your existing facilities at low cost.

Conversely too, this provides potential recurring revenue streams for providers like Franklin Junction. They can justify their ongoing commission fee by providing market intelligence and suggesting new virtual dining products as new products go in and out of fashion.

Challenges with the Concept

Restaurants ordinarily thrive on a consistent theme. This is why most customers will treat a fish and chip shop selling massaman curry with some suspicion. Indeed, this is why ghost kitchens market themselves under multiple digital get-ups. Virtual restaurants could become a hodgepodge of various cuisines or endorsed products.

Separately, there is the issue of consistency. In terms of fast-food, brands thrive due to consistency. If you like McDonalds’ food offerings and you are aware of their consistency, you will feel at ease visiting their stores no matter where you are in the world whether it be Engadine or Edinburgh. This is one important trait virtual restaurants can provide. The royalty fee goes to the training and provision of ingredients for the food sold.

This point goes to what will likely be the larger trend in this space: consolidation. Virtual dining products need to have strong enough brands to stand on their own in a variety of restaurants. Also, restaurant owners will only want to stock the most popular branded products and there can only be so many in the public consciousness. This is the same process that filtered down thousands of American car manufacturers to a handful over the course of the 20^th century and why there aren’t too many very well-known fast-food brands in Australia. Ultimately, the competitive food market will filter out low-quality products and the cream will rise to the top in a Pareto-like distribution.

How You Can(not) Invest

Unfortunately, many of the direct major players are privately held. For instance, Ordermark, the parent company for Nextbite, received Series C funding from Softbank’s Vision Fund (which seems to have a finger in every pie) in October 2020.

But public companies are entering into minor deals to augment their businesses. Simon Property Group (NYSE.SPG) partnered with SBE Entertainment (private) to lease space in a shopping precinct in Nanuet, NY to ghost kitchens. But this precinct only amounts to about 0.4% of the company’s total gross leasable area in the US and so offers miniscule exposure to this trend.

As mentioned above, there seems to be great potential for the delivery facilitators themselves to enter the space or at least to form partnerships with companies with virtual restaurant acumen. Depending on future partnerships, these companies could be a vehicle to gain exposure to virtual restaurants.

Conclusion

It’s quite apparent that there is a crucial tailwind behind virtual dining products and ghost kitchens as more and more people embrace delivered food. But it does seem that the industry is still nascent. In an environment of, as yet, few entrenched players in terms of cultivated brand value, the costs of starting up a new virtual dining product are relatively low, especially for celebrities with a strong social media goodwill.

For restaurant owners, it is advertised as a panacea of high margin possibilities but the centralised control over the virtual dining products sold are not far off from franchise dynamics. This makes individual owners liable to be squeezed just as they often are by delivery companies. However, in terms of virtual dining products, prior to any serious consolidation of the dishes available or serious investment into marketing, virtual dining products are not very sticky. Restaurant owners are in the nimble position of being able to switch between Mariah’s Cookies to MrBeast Burgers with ease which offers some bargaining power.

Charlie McMillan Summons is a Research Analyst for UNIT – University of Melbourne studying a Juris Doctor at Melbourne Law School.