Many different models have been tried. Many different models have failed. The RDS model at first looks very simple, but some core issues seem to continually plague startup RDS’s. It’s nothing a little preventative knowledge can’t solve, however…
Again, to recap… the RDS contracts with the restaurants. The RDS delivers the food, the RDS collects the monies due from the customer, and finally pays the restaurants on an established payment schedule.
Seems simple, right? You may be surprised to learn that 9 out of 10 RDS startups fail in the first 6 months of business. Were they victims of bad luck? Casualties of a bad market? In rare cases, yes…
…. in MOST cases, however, it is because they made one of the TWO MOST COMMON MISTAKES new RDS’s make.
- Inability to manage short term cash flow and reinvest in effective advertising (Farmers call it, “eating your seed corn”)
- Inadequate commission levels from restaurants which result in low or no profit.
Now let’s explore those two line items in some more detail.
- Inability to control short term cash flow?
Just to recap…Let’s review the RDS model again. You (the RDS) collect the revenue. You (the RDS) charge the restaurant a commission/discount for the food. You (the RDS) collect the money from the customer. Read that part again. You are collecting the money from the customer, and paying back that money (minus the commission) to the Restaurant at the end of a typical accounting payables period.
Let’s say you are making $1000 dollars in food sales a day for the first 14 days you are open. This means that at the end of a 2-week period, you will have $14,000 sitting in your business checking account.
You would be amazed at the number of RDS startups that fail to understand that THIS MONEY DOES NOT BELONG TO THEM. If you are on a 30% commission agreement with your restaurants, you have to write a $9,800 check back to your restaurants to cover the costs of obtaining your product. After paying drivers and restaurants, the only other costs are overhead (rent, utilities, etc…) right? Wrong! Especially when you are a start up…you should be putting at least 3% to 5% of your sales back into marketing. That’s typically about $500 per week. Note to new RDS. By cutting advertising, you are cutting your own throat. Although everybody says they will order from you when you talk to them, they won’t actually order until you have hit them multiple times and they have been reminded enough of your service to force them to change their current buying patters. Another crucial thing to remember is that the first time an RDS fails to make a payment back to the Restaurant, the Restaurant will typically stop service to the RDS, thus choking the RDS’s ability to deliver product.
– Low Commission Levels
The MOST COMMON trap in the RDS startup world is the one that sneaks up on them and bleeds their finances slowly.
The vast majority of the RDS’s in the industry (the profitable ones, anyway) agree that a 30% commission rate is one of the CRITICAL MANTRAS in the model. On the AVERAGE, an RDS’s labor and overhead will eat up (no pun intended) approximately a 20-25% commission… which means that 5% to 10% is all you essentially have to work with, and call “profit”. This is average, although RDS’s in our system typically profit closer to 15% because they also have revenue streams from other marketing sources that we implement.
Let’s go back to that $14,000 number as an example, achieved through a 30% commission rate. After you PAY YOUR RESTAURANTS (see the above comments on short term cash flow), you are left with $4,200. After you pay your average bills for office rent, employees (dispatchers, order takers or call center), computers, software, electricity, water, postage and paper clips, you have approximately $1,400 to call profit.
Now, again… every RDS is different, and this example is an AVERAGE. Some people manage operations well and keep their fixed costs very low. Over the years, We have heard of just about every single scheme known to man in an effort to cut costs. Selling ads in the menu guide, getting local retail stores to pay for co-marketing or canvassing, working out of a home office and checkout out drivers out in the field, buying menu guides from China, adding an extra buck here or there to the delivery charge, charging the drivers to rent equipment and charging the customers a merchant service fee for using credit cards.
The bottom line is that if you do not have at least an AVERAGE of 25% commission rate… you have two choices…1. Throw in the towel now and save yourself some money & time or 2. Re-sign the restaurants at a higher rate, sign up new restaurants, sell advertising in your menu guides…because the simple fact is that the math just does not add up.
How does this cause an RDS to “bleed” to death and fail? Let’s say that you begin your enterprise without knowing the average costs, and you sign up your restaurants at 20% commission. Let’s also say you do the same $14,000 in gross food sales for 2 weeks. This time, however, you are at a 20% commission rate, so you will have to pay the restaurants $11,200 instead of the $9,800 from before. Your overhead/labor is STILL going to cost you approximately $3,500 for that time period, regardless of the commission rate you charge the restaurants… leaving you with a balance of NEGATIVE $700.
But here is the GOTCHA… it’s still easy to fool yourself into THINKING you are making money because you are STILL collecting revenue for the NEXT payable period… meaning that you will wind up paying the PREVIOUS restaurant’s outstanding bill with the CURRENT INCOME coming in. (Ever hear of the term, “losing money on every order, but making it up on volume?”).
This typically begins the “downward spiral”. Usually what happens is that an RDS owner will not be able to catch his error, and tries to find new ways to cut costs. In an effort to “buy more time” to find out where the financial leaks are coming from (and not knowing that it’s because his commissions are too low) he will try to raise his delivery fee revenue (which tends to frighten customers away), and subsidize his business unit with personal credit card debt. And as he raises the delivery charge, less people order, and the drivers are tipped less because they are paying a high delivery charge.
Now sales are down and the RDS owner owes restaurants their money. The next thing he does is explain to the restaurants that he’s switching his bank account (or something genius like that) and that he has to pay them next week…You see where this is going. The real sad part is that this guy ends up trying to sell his RDS (which no qualified buyer will buy) and then finally goes out of business owing the restaurants thousands. Here’s where I get frustrated. I have to come in town a year later with a real qualified investor that was smart enough to hire a professional and explain to the restaurants that I not only deserve the 30%, but I won’t stiff them for thousands. Here’s the good news. I’ve been doing this a long time, and I still get an average of 30% discount.
If the RDS owner DOES manage to figure out that the commission level is too low, it’s nearly impossible (but not impossible) to go back to the well and raise the rate. Once an agreed upon commission rate is established with a restaurant, it nearly becomes a commandment in doing future business with the restaurant.
Unfortunately, the first brilliant idea a new RDS owners has just after they realize that they cannot present the value of their delivery service and all of those extra sales correctly enough to justify 25% to 30% commission, they think “I can just increase the prices”. I’ll take my 10% discount (which is less than they are giving joe customer for just cutting a coupon), and then mark up the prices 20%. Genius, right! WRONG! Customers are not stupid, they realized they are being charged a delivery charge and charged another 15% or 20% and they resent that you are insulting them. So because of that, only the desperate order and your sales are minimal, which then means your drivers are not getting many orders. On top of the drivers not getting many orders, since the customer is buying $30 worth of food and paying you $42.80 (upcharge + delivery charge + tax), they really don’t feel like tipping and the driver gets stiffed. FYI…it never works and this is the most common reason RDSs fail.