China food-ordering platforms: Stand and deliver

As a business model, an independent online food-ordering platform makes perfect sense. Restaurants can sell more food without adding seating capacity and staff or even investing in the infrastructure required to make the platform work. Consumers are presented with a one-shop-stop for a variety of cuisines that can be tracked en route to their door.

As a practical enterprise, launching an online food-ordering platform is a chicken-and-egg dilemma. A start-up service usually has no customers and no restaurant clients; it must pitch the latter and market to the former - no easy task in a market like China where the concept might not be well understood.

The three founders of Ele.me, which was set up in Shanghai approximately six years ago, focused on a target market of which they were a part. "They were still in school doing their masters degrees when we backed them," recalls Allen Zhu, managing director at GSR Ventures, which provided a Series A round of funding in 2011. "The network was small - around Shanghai Jiaotong University - but we like the platform model and it has grown very fast."

While Ele.me initially focused on the low-end catering market for students, JinShiSong went after corporate customers. The founders decided that restaurants would sign up if there was the potential of selling food by the office-load.

Fast forward several years and food-ordering platforms enjoy a prominent position in China's online-to-offline (O2O) universe. According to internet consultancy iResearch, food will represent one of the largest vertical segments of the O2O market by 2015, with 300 million customers and a value in excess of RMB270 billion ($44 billion). The segment is now a regular recipient of venture capital funding and, in an increasingly competitive environment, the jury is out as to which enterprises will prevail.

The copycats

If China's start-ups are want something to aim for, they need look no further than GrubHub in the US. Founded by two MBA students in Chicago in 2004, the company received its first VC funding in 2007. Last year it went public, raising $192 million.

GrubHub's platform, which covers 30,000 restaurants, handled more than 135,000 orders in 2013 with gross food sales of $1.3 billion. Revenue - a percentage of each order, paid by the restaurants - jumped from $82.3 million in 2012 to $137.1 million last year partly as a result of a merger with rival Seamless Holdings. Net income reached $6.7 million in 2013.

Michael Lewis' inspiration when he co-founded JinShiSong in 2010 was Seamless rather than GrubHub. He used the service when working for J.P. Morgan in New York and, on moving to Beijing, found there was no equivalent. Sherpa's started in Shanghai as early as 1999 and K.K. Rabbit followed in 2008. Both have since expanded to a couple of locations beyond Shanghai, including Beijing, but Lewis says he saw nothing with a nationwide mandate.

By the time Lewis departed JinShiSong in 2012 the company had broken even, been backed by ZhenFund, and was looking to expand into new cities. "We had a system based on the Android platform that allowed us to track orders and the locations of our drivers," Lewis adds. "Now it is easy to find something online that does the same thing but this was early on so it was proprietary. Our rivals were very manual in their approach, relying on SMS and phone calls."

JinShiSong now offers services in Shanghai, but like Sherpa's and K.K. Rabbit, it is not on the brink of a nationwide rollout, nor can it claim a dominant position in its home market. There are several explanations for this. Sherpa's, for example, is said to have remained at the high-end of the market, focusing on the expatriate community. And then all three companies differ from GrubHub in two respects: they charge the customer for delivery, not the restaurant; and they maintain their own delivery fleets. Both could be seen as obstacles to achieving scale.

There are practical reasons for keeping a fleet of drivers. Higher labor costs in the US mean such an indulgence is simply not economical, while China's population density is significantly higher, allowing for greater operational efficiency. But due to the capital-intensive nature of the business, expanding into different geographies is expensive and sometimes complicated.

"Managing the people is the main challenge when scaling up," says Ray Yang, managing director at Northern Light Venture Capital (NLVC), citing the experiences of portfolio company Daojia. "Costs go up and it's hard to attract people willing to do the dirty work, the driving. It is not like hiring programmers out of university; you have to recruit and train people."

The company received a Series A round from Morningside Technologies in 2010, the year it was founded. When NLVC participated in the Series B led by CDH Investments in 2011, Daojia had less than 20 delivery hubs in Beijing and one in Shanghai. It now claims one million users in eight cities, 3,000 restaurant partners and 1,000 delivery staff. Online retailer JD.com led a Series C round last year as well as a Series D last week. The capital will be spent on technology development, particularly on the mobile side, and expanding services to 20-30 cities by 2015.

Critics of the online-platform-plus-logistics-network model point to the costs involved and how these can eat into margins. "Restaurants are busy at lunchtime and dinnertime," says Chuan Thor, managing director at Highland Capital Partners. "It doesn't matter how big the logistics group is, sometimes you have too many customers and you cannot make all the deliveries yourself. But then if you have 1,000 logistics guys what do you have them do after lunch and before dinner?" It is also a difficult operation to replicate, which creates high barriers to entry.

Certainly, other companies in the space that have gained traction with venture capital tend to follow the asset-light GrubHub model. In addition to Ele.me, these include Etaoshi, a food ordering platform that launched in 2012 and received a Series A round led by Highland last November and a Series B led by Hosen Capital last week. The company has partnerships with more than 20 local restaurant chains and wants to sign up a multiple of that number by the end of the year.

It is worth noting that Ele.me and Etaoshi's target market differs somewhat from that of Daojia. While the latter is looking for restaurant customers that can't or don't want to take on the expense of complex in-house logistics operations, the other two companies often work with restaurant operators that are large enough to run their own deliveries.

They are also able to scale up at a much faster pace. When Sequoia Capital led Ele.me's Series C round last November, the five-year-old company was handling about 100,000 orders a day and had 2 million registered users and 20,000 restaurant partners. However, Ele.me is still not taking a commission on each transaction - revenue comes from restaurants paying for prominent positions in search rankings - due to the amount of competition it faces.

Defensive plays

Further competition is inevitable almost regardless of business model. And the contrast between Daojia and Ele.me or Etaoshi is also reflected in the kind of strategic investors that have come on board to help head off rivals.

In JD.com, Daojia not only has a backer with its own platform and user base, but also one that is highly focused on logistics. JD said in its IPO prospectus that it would spend $1 billion on supply chain improvements over the next three years, citing "the underdevelopment of third-party fulfillment services in China in terms of both warehousing and logistics facilities and last-mile delivery services." Ahead of the public listing it already had 24,400 delivery personnel.

Daojia exists within the "last-mile" space, transporting food short distances within urban areas under strict timeframes. NLVC's Yang suggests that Daojia could actually help JD in this area in terms of providing quality services.

For Etaoshi and Ele.me, the onus is on aligning with groups that can expand their platform coverage. In May, Ele.me received $80 million from Dianping, a provider of restaurant reviews, online listings and Groupon-style discounts. They will share user and merchant data and integrate their food ordering services. The alliance with Dianping is also expected to bring more mid to high-end restaurants to Ele.me, whose client base still reflects the low-end, college student offering on which the business was built.

Etaoshi has yet to receive similar strategic investment but partnerships have been formed with search giant Baidu, antivirus software and browser provider Qihoo 360, Alibaba Group's e-commerce platform Taobao and group buying site Meituan.

"These companies are very good at the online side but they aren't as effective in terms of O2O," says Highland's Thor. "We are bringing the offline business online. All the information is real time - when a restaurant changes its prices all the channels are updated simultaneously."

GrubHub has consolidated its position in the US through a string of horizontal acquisitions. In addition to Seamless, the company has picked up businesses that allowed it to address certain market niches, such as food-ordering from college campuses and professional sports venues. While it is feasible that one of China's food-ordering platforms might build up sufficient momentum to go public, the argument is also made that some players - the pure-play platform providers in particular - would be most sustainable as part of larger companies with complementary business functions.

Zhu of GSR says it is too early to be drawn on the exit options for Ele.me and its rivals. But he does expect to see consolidation within the industry.

"When we first invested in Ele.me there were quite a few platforms and some have not survived because execution is so important," Zhu says. "The internet is winner takes all. In pretty much every sub-sector it ends up with only 2-3 people."

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• Topics
• Greater China
• Venture
• Early-stage
• Consumer
• Technology
• China
• Venture
• TMT
• Consumer
• GSR Ventures
• Northern Light Venture Capital
• Highland Capital Management