Delivery service price cap regulations

Ben emails me:

    Could you please consider and comment on some of the unseen consequences of local price caps on restaurant delivery services? (Politico article describing the phenomenon in SF, NYC, etc.) A highly competitive market for such services exists between GrubHub, DoorDash, Uber Eats, etc. Moreover, patrons can always pickup and restaurants can always hire their own drivers. That dynamic market will keep prices down and improve service quality and value. As reported 2 days ago, 5/13/2020, in the Wall Street Journal, “America is stuck at Home, but Food Delivery Companies Still Struggle to Profit.” Yet many locals are considering regulating and limiting the prices that such delivery services can charge.

Here is a NYT article on the same phenomenon, claiming that some apps charge up to 40% of the restaurant’s take.

My first question is why the restaurants do not charge higher prices for customers using the app. That might be illegal in some localities, but surely that is not the general answer to the question. Rather the restaurants are afraid of losing customer good will — “what!? I have to pay 30% more just because I bought it with my phone?” [Plus the apps do not allow it, see the comments, though I do no think the apps could prevent restaurants from giving “extras” and thus lower prices to those who show up for service in the restaurant.]

In this setting, restaurants are losing potential revenue to avoid a reputational hit, and staying in business (rather than closing up) because they believe the value of their future reputational franchise is high. In other words, in both channels the restaurants perceive the value of their future reputational franchise to be pretty high.

That is the good news, although you might wonder how it squares with the generally low returns to running a restaurant. I suspect some restaurants simply know they are good and profitable because they are skilled, and the losers are overconfident and less well-informed.

One efficiency advantage of the apps is that they will put the unprofitable restaurants out of business more quickly.

The next question is whether some surplus from the profitable restaurants should, in the short run (and maybe in the longer run too?) be redistributed to the app company.

The apps should increase the demand for the food from the good restaurants (easier to order and arrange delivery), but lower the profit margin on selling more of that food. If those ingredients and kitchen capacity otherwise would go to complete waste, overall that seems like an acceptable bargain. Kitchens are kept active, which is an efficiency gain, even if some profit is redistributed to the app company.

In this scenario, you can think of the app as doing some of the selling, rather than the restaurant doing that selling, and reaping surplus from that effort. In essence, the business of the restaurant has become more specialized, toward pure food production and away from selling, that latter service now being performed by the app company.

Restaurants that were great at selling in the first place might be worse off. But it is far from obvious that these apps and their prices should be decreasing efficiency. Some other restaurants might be worse off because it is harder for them to carve up or segment the market, but that change likely is efficiency-enhancing.

And if the apps do indeed speed the bankruptcy of the lesser restaurants (presumably what the critics have to believe), over the longer haul prices will indeed go up and the good restaurants will earn back some of what they lost up front.

On net, consumers will have better services, better marketing, pay higher prices, and have a better selection of restaurants. That just doesn’t sound so terrible, or so necessitating government intervention to cap app prices.

Note that informed customers probably need the app least, so they are least likely to see its value, just as “critics” as a class, including restaurant critics, are also least likely to see the value of the app in marketing the restaurants. Of course this class of “critics” are exactly those who are most likely to be writing about the apps.

Delivery service price cap regulations

Originally posted on Marginal Revolution – click to see comments and suggestions.

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