Is the meal-kit market doomed?

After several years of high growth, is the party about to come to an abrupt halt? Here we explore the unique and not so unique challenges faced by the meal-kit sector heading into a global slowdown and cost of living squeeze.

A brief history of the sector

There was a time not long ago when investors were desperate to put their money into anything to do with tech. Still are, to a certain extent. This is because tech generally gets embedded with the customer. Once you've bought tech, it takes a lot of effort and cost to unpick it. It's what we call 'sticky'. Moreover, it requires ongoing support, for which you should read 'subscription revenue'.

Subscription is not just the holy grail, but the new norm for business, be it software, t.v., cars, flowers, cheese or, well anything and everything really. With repeat revenues it's then all about 2 things: cost of acquisition and retention. Everything the company does [should be] designed and geared toward these 2 things. More about that later.

Unlike almost everything else, food is something we humans are compelled to come back for. In this respect it's a natural candidate for subscription. With every one of us locked in a continuous cycle of food shopping there's a ready made market waiting to be exploited. This opportunity was seized upon some years ago by several visionary start ups like Blue Apron in the States, HelloFresh and others, each growing fast and raising tens of millions of dollars in the process. Pre-IPO HelloFresh was the world's fastest growing company, month after month, for nearly 2 years, marketed primarily as a tech company first, food company second. Investors loved it. Take a snapshot now and there are literally dozens of providers, some serving a particular foodie niche, and few turning a profit but existing in the hope to be acquired by the bigger fish one day - as many of them have been. Again, investors love them. In some cases, old established food companies love them, too, because it gets them into a space they're too big and slow to exploit themselves, and it's exciting.

When Covid hit, and more people found the repeat trips to the supermarket too daunting or restricted, meal kit volumes rocketed. Suddenly, it made a lot of sense to a lot more people to get food delivered, cooked or not. Hot food delivery services like Deliveroo, Uber Eats, Just Eat and others also caught the wave. Happy days, for their founders, at least.

Where are we now?

Now we are 'post-pandemic', the landscape has changed, and changed fast. People are returning to old habits, going to the supermarket again without [as much] fear, and eating out, too. The result is an inevitable depression of sales growth for subscription meal kit providers as the boost from lockdowns has disappeared.

This isn't the whole story though, far from it. Firstly, there's food inflation, much of which has yet to filter through despite everyone's current experience of rising prices. We can expect further huge rises across the board, and supply in certain lines to become acute. Of course, these rises will affect food whether it's supplied via the shelf of a supermarket or contained in a box delivered to your door, so will it disproportionately affect the meal kit sector?

Why food inflation will impact the meal kit providers more

The financial model of the meal kit provider requires that the actual food element to be somewhat less than the total delivered cost. Substantially less, in fact. Quite apart from the delivery charge, there's all the packaging, the assembly and supply chain cost, the overhead cost, the marketing cost and any profits that need to be made to pay back the investors (or to prevent them from divesting).

Sure, the supermarkets all face the same kind of cogs (cost of goods sold) construct in principle, but supermarkets generally have more buying leverage, and more acutely their cost of acquisition, retention costs and packaging costs are way, way lower. So much lower in fact that they'll be making far greater margins on the food - but that's a subject for another day.

So there comes a point where the end consumer ponders their subscription and becomes unwilling to pay such a hefty premium on their meal over the ingredients they could get from the supermarket, like for like. This was evident pre-pandemic where new subscribers were lured in by hefty discounts on their first few boxes, most often sold at a substantial loss to the providers simply to maintain sales. This is happening again now.

Other cost inflation

However, other costs are racking up right now, too. Distribution costs are rising, driven partly by fuel but also by wage growth. It was hard enough recruiting labour to assemble the kits before Brexit, but additional pressure of wage inflation and high labour demand at mostly minimum wage means fulfilment (warehouse) labour is in short supply. The bigger providers always had their eye on automation in the same vein as Ocado to offset this, and god only knows investors love to see their money spent on shiny metal hardware, but Blue Apron served as a salient lesson in this regard (and was a timely and persuasive argument for me to help HF avoid a similar fate).

Meanwhile, distribution in all forms is now a key battleground. Whilst hubs and networks are critical and always will be, 'final mile' is getting a lot of attention because it's where driver availability, wages, fuel and eco-credentials all conspire to make this a daily challenge for every B2C business. It's made all the more challenging when distribution densities are dropping, and the driver has to go further for each drop; the result is that costs have gone up by around 25% in the last 12 months alone, and still heading in the wrong direction.

Finally, we have packaging inflation. Leaving aside the perennial challenge faced by an increasingly intolerant consumer of how to deal with a pile of cardboard, insulation, bags, pots and ice packs, the cost of these materials is rising fast, with no obvious solutions on the horizon. The product integrity (and cool chain especially) has to be maintained, but people are moving away from packaging whenever and wherever they can; where meal kit providers are able to trump supermarkets on food wastage, this advantage is hollowed out when 70% of your delivery is inedible bin fodder.

Simple economics

So stacking up current inflationary pressures on cogs versus customer value perception the scales are weighted against the meal kit providers and tipping faster every week, but do the markets know it?

Although HelloFresh shares are down over 50% in the last 12 months - and this is a well run company opening in new countries all the time, similar company Gousto is attracting money with a valuation close to $2 billion on UK revenues of around $350 million, and it hasn't explored any other markets yet in the same way HelloFresh has done (suggesting significant opportunity for further as yet unrealised growth, perhaps).

To be clear, investors in the early days weren't in it for the dividend on profits at HelloFresh, and it's doubtful those providing funds for Gousto are either - it's pre-IPO and unlike HF it's already making a profit at the same stage. Whether it can continue to do so given the inflationary pressures outlined above, and the lack of any imminent repeat of the lockdown boost, remains to be seen. For insight, we need to look deeper.

Who is the customer now?

Returning to the 2 key metrics for the sector: cost of acquisition and retention, anyone with a post box will see that heavy discounting is one of the main methods to attract a new subscriber, and these discounts are increasing. The marketeers' hope is to offer a deal too good to pass up, combining low cost (to the consumer) with what is hoped to be a generally good product anyway in the form of recipes, great photos, convenience, and so on. Once on the hook with a subscription sign up it's then all about retention - how many will like what they got and be happy to repeat it - preferably at RRP?

One challenge here is continuing to offer variety. With the more generalist meal providers there's more scope for this; the pressure is on to offer more options and meal combinations but this in turn presents a huge headache (cost) for supply chain and operations, driving an increase in cogs - lower volumes per sku for less pricing leverage, more complexity in assembly, higher error rates and so on.

Above all, the consumer has to like what they're cooking and want more. This is where niche providers, such as highly rated Pasta Evangelists, having confidence in its recipes has created secondary opportunities in the dark kitchen market. Now scaling up their operation is less about growing (propping up) e-comm sales than it is about opening up new dark kitchen sites to support rapid expansion with Deliveroo: a pivot I was happy to help support.

The meal-buying consumer landscape changed significantly during covid, and Deliveroo were one of the main beneficiaries in terms of revenue growth. Post-pandemic the volumes are holding up, although average order values are relatively static and Deliveroo is struggling to make their own cost stack make sense, it does mean that providers putting their offerings on the platform are able to see almost instant and fairly predictable sales growth, if not spectacular margins (as the platform itself takes a large slice).

This begs the question as to whether dark kitchens could offer the more generalist meal kit providers a secondary opportunity for sales growth - could their recipes be made and provided over such platforms, are they [the brands] strong enough, or does it suggest that their actual product - the meals - are not exceptional or noteworthy, the very complexity and variety working against such an opportunity which requires more focussed, premium-branded offerings? On the other hand, with the final mile delivery economics already in doubt for companies like Deliveroo, is this a viable long term outlet in any case, or a high risk basket of eggs? Time will tell, but at least for now it's looking like a good bet.

For more detail, explanation, proof of claim, or expertise on any points raised in the article, feel free to to drop me a note directly.

Richard Shipperbottom has been involved in the centre and at the sharp end of final mile e-comm, q-comm and dark kitchen delivery and fulfilment since 2016.