NZS Capital, LLC


Stuff I thought About Last Week Newsletter

Evolution of the Meal

Click HERE to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email

The Evolution of the Meal

If you traveled into the future and brought a newspaper back in your Delorean from the year 2029, what headlines might it contain? With the dramatic wave of disruption coming to the restaurant, delivery, and food supply chain over the next few years, it might contain a story about the death of the grocery store. Americans now spend more money eating out than at grocery stores, so in some sense, the familiar grocery store facade is already beginning to fade like the image of Marty McFly in a family photo.

Besides former Kroger CFO Michael Schlotman, does anyone like going to the grocery store? He made this rather outrageous statement in 2017 as the CFO of Kroger, the world’s largest grocery chain: 

“Part of me refuses to believe that everybody is just going to sit at home and everything is going to be brought to their doorstep and nobody is ever going to leave home to do anything again,” Schlotman said. “I mean, humans are social animals and we thrive on interaction with one another. The good news is food is one of the things that’s at the center of social interaction today.”

Is grocery shopping a social interaction? Is there a single person reading this who wakes up in the morning with a big smile on their face and says “Yes! Today is grocery shopping day, and I’ll get to see all my friends!?" I am sympathetic to people who shop at grocery stores and cook at home, whether it’s for budgetary reasons or simply because they enjoy cooking. In our house, we cook from scratch over 300 nights a year. We go to the grocery store twice a week (more than the 1.6 average American weekly visits), and I’m too embarrassed to say how much we spent at Whole Foods last year. 

However, I think this situation is all about to change. I might not have the year right (as people like to say “Brad is not always right, but he is always early!”) - it could be faster, it could be slower, but the entire trillion-dollar food chain from agriculture to brands to restaurants and grocery is going to completely change. It could make the disruption we’ve seen in retail and media look incremental by comparison. At NZS Capital, we don’t like to predict the future, but we do like to assess whether certain outcomes could be considered a broad view or a narrow view. It seems like a fairly safe bet that the range of outcomes is dramatically widening for food consumption. 

The Size and Impact of the Food Industry

Americans are officially spending more on eating out (including sit-down, takeaway, and meal delivery) than cooking at home. Since March of 2019, food and beverage purchased at restaurants and bars has been pacing ahead of food and beverages purchased at retail stores (using the actual sales, which is not seasonally adjusted). There is an incorrect, but often cited, Quartz article stating that this transition happened back in 2015, but they used an overly-narrow definition of grocery stores, which missed some retail food and beverage sales. If you seasonally adjust the data, as you can see in the following chart, the crossover is happening as we speak. 

grocery image.png

This chart comes from the Census Bureau’s monthly retail trade data, which are frequently used by the market and economists. There are other ways to look at food consumption in the government stats, and it’s easy to get confused. Food and agriculture amount to 5.4% of US GDP, or $1.05T, in 2017, when measured by its value add to the economy. This figure includes agriculture, retail, and service businesses like bars and restaurants. It also includes alcohol and tobacco (tobacco appears to be about 10% of the $1T). Another angle is household spending: in aggregate, US households spend 13% of their budgets on food, including eating out and cooking at home. Spending a growing portion of food budget outside the house does not imply people are eating more meals out than they were 10 years ago. Indeed, the number of meals eaten outside the house has been relatively stable at 4-5 meals/week over the last decade. There appears to be two main drivers of the crossover: inflation in the cost of eating out, and an important demographic shift from Boomers to Millennials. So, let’s dive deeper into this shift away from groceries and cooking at home.

Demographics and Meal Preferences

Personal consumption, which includes money spent on food, is 68% of the US economy. Consumption jumps from $48k/year when people are 25-35 years old to a high of around $60k/year at age 45-54, and then falls to $34k at age 75 and older (source). People at or beyond retirement age also simply consumes less food, and may eat, on average, fewer meals in a given week. This age-related consumption data is relevant in light of the significant demographic shift happening in the population. 

Currently, about one third of Baby Boomers are in retirement, but the remaining two thirds will enter retirement over the next 10-15 years, with the youngest Boomers turning 65 in 2029. Behind the Boomers is Generation X, which is about 10% smaller (currently 66M), and thus will almost certainly have a smaller overall impact on the economy (vs. Boomers during their prime consumer years) between now and when Gen X begins to leave the workforce in a decade. Behind Generation X are the Millennials, who are a little larger in number than the Boomers. 

The data on Millennial food habits are mixed; however, we do know that Millennials are getting married and having fewer kids later in life than previous generations, so, at least for now, there are more households with fewer mouths to feed on a fixed budget, which expands dining options (e.g., so that convenience and time savings can be taken into account, as discussed in the next section). I think we can also agree that this digital-native generation is more comfortable adopting the expanding options for meal delivery; anecdotal evidence (e.g., from the cities with a large meal delivery service presence) supports the notion that Millennials are driving the increase in dollars spent eating out, and on meal delivery in particular. To summarize, the crossover in more money spent on meals outside the house than grocery appears largely driven by a shifting consumer base, as retiring Boomers leave their high-consumption years and the larger generation of digital-savvy Millennials enter theirs. In other words, it’s a generational shift in eating habits.

Profit Anatomy of a Meal: Grocery Stores

How expensive is cooking at home vs. eating out for US families? The average US household (2.5 people) spends around $4000 a year ($77/week) on groceries. There are a few estimates that people eat out 4-5 times a week. Let’s say a family eats at home 16 times a week for an average cost of ~$5/meal. I would guess significantly more money would be spent on dinners vs. breakfast/lunch, so a typical dinner might be $10-12 for the average family ($4-5 per person). The top third of income-earning households spend $5200/year on food at home and $2600 eating out compared to the bottom third, who spend $3380 at home and $867 eating out (2014 data). Given that more affluent households tend to eat out more frequently, the $5200 could break down to an average of $7-8 spent on each meal prepared at home (similarly, I would estimate a typical dinner might be $12-15 per family, or $6-7 per person).  

What about the other less tangible costs of grocery shopping? The average household makes 80 trips a year to the store. With drive time, gas, and time spent pushing a cart around, that’s probably an additional cost of $800-1,000 a year ($1/meal for the average household). I used $10/hour for lost time in that estimate, and I think it’s valid to say that time is an increasingly scarce resource for many households, especially Millennials busy building careers and families. Walmart recently expanded availability of their $98/year unlimited grocery delivery subscription. For the average family, that works out to savings of about $1 per trip to the grocery store! What about the time it takes to prepare meals (for those people who don’t view it as an enjoyable hobby!)? In some ways the current paradigm – driving to the store, pushing the cart around, checking out, driving home, putting groceries away, preparing and cooking a meal, cleaning the dishes – is analogous to how most households operated 150 years ago – maintaining livestock and backyard gardens, canning their own produce, sewing their own clothes, etc. – in that the system seems overdue for a phase shift in outsourcing and optimization; ‘going grocery shopping’ could fast become an anachronism just like going to a department store. 

Grocery stores as large-format, big-box retailers began to rise in numbers in the 1930s and 1940s, with the 1950s and 1960s considered to be the golden era of big grocery stores. The number of conventional grocery stores has declined from 26,828 in 2011 to 26,148 in 2018, with an accelerated 1.5% drop last year. To what extent did grocery stores come into existence because of the suburbanization of America, the ubiquity of the automobile, and other cultural trends? With the rising popularity of ridesharing/on-demand rentals, could declining car ownership make grocery stores less relevant and more inconvenient for some households? Is grocery shopping a cultural trapping left over from the social engineering experiment that gave us the nuclear family and Leave it to Beaver family values?

The Information Age and the advent of online ordering is fast making grocery shopping a choice rather than a necessity. A lot of perishable and non-perishable items can be fulfilled through Amazon Prime or other delivery services (like the $98 Walmart unlimited grocery delivery subscription I mentioned above). Fresh produce, a key product many shoppers say they want to hand pick themselves (maybe they haven’t heard of Amazon’s AI that inspects produce for freshness!) is only about 1/3 of grocery sales for Kroger. As such, smaller “neighborhood market” type stores focused on fresh produce and prepared meals could be one surviving concept. At the other extreme, big-box stores that combine grocery with other revenue sources, like Walmart (which already has 26% of US grocery) and discount “dollar” stores, may continue gaining share in grocery spend. 

Grocery stores operate on razor-thin margins. Kroger made 1.5 pennies for every dollar spent in their stores last year. That’s right, a 1.5% reported net income margin. And, a lot of profits at grocery stores are from payments made by brands for shelf placement and in-store promotions. Even more profits come from pharmacy and gas sales. Food itself seems to be a tricky and very-low-margin business for grocery stores (does selling food even make money on its own?). It will only take small changes at the margin to tumble the grocery store industry given these existentially-low margins. Kroger currently has over $14B in net debt with a ratio of 2.8x debt to EBITDA – it’s a slippery slope.

Profit Anatomy of a Meal: Eating Out and Delivery

Let's turn our attention to eating out (dine-in, takeaway, and meal delivery) and look at the revenue and profit table of various food transactions using a few examples. Using public data from McDonalds, on an average dine-in or takeout/drive-through meal for two people costing around $12, a McDonald’s franchise could expect to earn around 15% ($1.80). For Domino’s, a franchise owner can expect about 15% (~$3.50) from a Large Pepperoni Pizza that costs $18 plus $4.49 in delivery fees (again, excluding any tip involved). For a higher-end chain restaurant like Cheesecake Factory, a tab for two people at $60 (excluding tip) nets around 17% (~$10) in profit. Chipotle Mexican Grill also had operating margins around 17% back in 2015 (before the company stumbled due to food contamination issues). So, there seems to be a fairly narrow range of mid- to high-teens percentage operating profit, whether restaurants are fast food or sit down. Food and labor are a big component of costs; however, advertising, franchise fees, and fixed location overhead add up as well.

Now, let’s take a look at delivery through a service like Uber Eats (Uber fees aren’t completely transparent, but the following estimates are approximately correct). Typically, there is a $3-6 delivery fee and a 10-20% “service fee” for orders over $10. If I order a pizza from a local restaurant, for example, it might cost me $16 for the pizza plus $5 delivery fee plus $2 service fee (~$23). Uber Eats also charges the restaurant a 20-30% commission. This commission is said to be much lower for chains like McDonalds or Starbucks, which Uber is using to drive customer adoption and generate a larger network effect for their platform. In total, Uber would take ~$11 ($7 from me, $4 from the restaurant) in revenue for the pizza delivery, which, in 2018, drove an average net revenue across all Uber Eats business of 10% after paying drivers. Another example with Uber Eats and chain restaurant PF Chang’s yields the following: a $55 tab might drive a $5 delivery fee, an $8 service fee, and $14 commission for a total of $27 to Uber. It seems like there’s a lot of money extracted in these transactions, which suggests that there’s opportunity for a more efficient system. Looking at China, we know that it is certainly possible to achieve a high degree of system optimization; according to this FT report, there are 338M delivery-app users in China, and Beijing alone sustains 1.8M meal deliveries a day.

From the restaurant’s perspective, by partnering with Uber Eats, they can run higher utilization of their fixed-cost facility while saving on advertising and service labor. For most well-run restaurants, delivery should drive higher absolute profit dollars up to the point that it causes a location to sacrifice on service or wait times for patrons who come to eat at the restaurant. In some ways, delivery is a shift of the labor burden from a restaurant's own waiters to the delivery people of Uber and others. In some cases, it might be the same employees who are choosing to work as delivery drivers (and, I don’t mean to ignore the significant labor issues that the rideshare and delivery companies are facing – it’s a critical issue that is going to require higher wages and more benefits). Restaurants are grappling with increasing employee turnover, which is very costly in terms of downtime, training, and manager attention, not to mention customer service. Panera recently explained they lose 100% of their employees a year in restaurants.

From a convenience and potential cost-savings standpoint, it seems like delivery may be at the early stages of a massive rise in popularity; however, could delivery ever be competitive with the cost of cooking at home, or will it be stuck serving only the most affluent households? And, if delivery were to take off, would it be accompanied by environmental costs like more wasteful packaging and traffic congestion? How much share would delivery need to take before grocery stores would fold like Sears, K-Mart, and department stores? If delivery becomes more popular that sit-down restaurants, how might that change the restaurant landscape? Let’s take a look at all of these questions next.

Cloud Kitchens and Subscriptions – the Asteroids Hurtling Toward the Food Business

The above analysis on restaurant and delivery economics is based on the current, status quo restaurant landscape, but let’s take a look at the relatively new phenomenon of cloud kitchens. Cloud kitchens are centralized food prep facilities that allow multiple types of food or brands of food to be prepared efficiently for delivery. Uber is currently investing in their own cloud kitchens as well as partnering with others. In a cloud kitchen, you can have your own brand of “Luigi’s Pizza,” street tacos, gourmet burgers, etc. – the situation is analogous to private label brands in grocery stores – and the sky’s the limit. And, space in cloud kitchens could also be leased to brand-names, like Taco Bell or Starbucks.

With cloud kitchens, there are numerous opportunities for cost savings: 1) the real game changer is lack of overhead for prime real estate locations with sit-down or take-out facilities; 2) staffing is much reduced (especially if you have automated kitchens with robot sous chefs!); 3) virtually no advertising needed to support a restaurant brand; 4) food ordering and delivery point-of-origin can both be centralized; 5) kitchens could be shared to maximize utilization by time of day.

What benefits can the cloud kitchen off the consumer besides passing on a percentage of cost savings? I can think of a few: 1) food could be systematically prepared and packaged in a delivery-friendly way to keep it fresh; 2) typical “grocery” items, beverages, and (depending on state laws) alcohol could be bundled with food delivery; 3) Cloud kitchens could specialize in fare such as kosher, gluten free, vegan, organic, etc.; 4) centralization would enable multiple food brands or types in the same delivery order (great for families with picky eaters!); 5) subscription services. 

With regard to subscription services, I think there are huge opportunities for all ecosystem participants. Uber is currently testing a $25/mo subscription that includes free delivery (that $3-6 fee discussed above) as well as discounts on car rides, or scooters/bike rental across their platform. Let’s have some fun exploring some possibilities: what if there were a bundle for five dinners a week for a family of four with a set delivery window? Bundles and schedules would drive the cost to deliver down to a couple dollars per house, similar to what last-mile services like UPS achieve. What if insurance companies and employers got involved to subsidize meals to treat conditions such as offering 10 heart-healthy meals a week or meals with nutrients balanced to help those predisposed to certain medical conditions? Indeed, diet company Whole30 launched the first delivery-only restaurant with Grubhub in Chicago for customers interested in the strict food regimen. Would these options be more broadly appealing than going grocery shopping?

Vertically-integrated cloud kitchens, bundles, subsidies, schedules, and routing combine to drive the flywheel for Uber (or whoever else takes this strategy in the US or other countries – I could easily see Amazon leverage its massive Prime membership base, Whole Foods kitchens, and Amazon delivery service to offer a Prime Meal bundle) to generate a huge user base to densify their cloud kitchens. With one (or two) winners serving a given geographic location, the advantages of centralization, along with scheduling, could also greatly cut down on the number of drivers out on the street. 

Are there other potential environmental benefits to cloud kitchens? What if, in addition to delivery, the driver also picked up last night’s food packaging for wash and reuse? What about increased vertical integration? Many big restaurant and grocery chains are already heavily involved in the agriculture side of their ingredient supply chain. Why wouldn’t a chain of cloud kitchens vertically integrate farming? Warehouse-sized kitchens could dedicate space to hydroponic fresh ingredients and maybe even lab-grown meat down the road. This type of on-site sourcing would significantly decrease the need for food transportation and packaging. With all the environmental costs of factory farming, food transportation, waste, trips to the grocery store etc., it seems plausible that vertically integrated food supply chains, prep, and delivery could be a greener solution, or at the very least no worse than the current system. 

The appeal of cloud kitchens seems fairly overwhelming. If only a small fraction of the population – 5%? 10%? – switch to cloud kitchens for the majority of their meals, would that be enough to tip the scales and start a cascade of grocery store closures? 

It leads to the question of just how many restaurant locations are needed to serve the immediate need for food (such as drive-throughs), how many for special occasions, how many for social gatherings etc.? If cloud kitchens and delivery bundles take off, it’s possible we will see far fewer restaurants of all types and a major composition change of those that survive.

What happens to those trade promotion dollars if food consumption shifts to delivery subscriptions? What happens to pharmacy sales (9% of Kroger’s 2018 sales) as Amazon enters that market with same-day prescription delivery? What happens to gas sales (12% of Kroger’s 2018 sales) as cars go increasingly electric and higher fuel efficiency?

Brand affinity, or nostalgia toward food brands, could become more important. For example, a Starbucks in every cloud kitchen could more than make up for lost business elsewhere as consumer preferences change. Recently, fast food has seen a resurgence in popularity with clever Millennial marketing combined with delivery. 

We can only speculate as to how cheap it could get to deliver a meal for a typical middle- or upper-class household. But, hopefully, by walking through this potential dramatic shift in the preparation, sourcing, and delivery of food you can start to see what’s possible. Could vertically-integrated cloud kitchens with subscriptions, bundles, subsidies, etc. deliver food for a few dollars a meal? It seems with the realm of possibility over the next decade or two.

Conclusion and Outlook

My intention in this thought piece is to be provocative. The truth is I don’t know what will happen to grocery stores and restaurant sales over the next 10-20 years – no one does. But, what we do know is that the range of outcomes is widening dramatically. I also have no idea who wins the delivery market. It seems likely to be a couple winners taking most, similar to ridesharing or cellular service. At NZS Capital, when we see a situation like this with a widening range of outcomes, we expect the unexpected and we act like good Bayesians – maniacally consuming every new data point as objectively as we can to tilt our credences one way or the other. We do know that the world is becoming platformized. That means Informational advantages are taking over from Industrial Age advantages. What investors previously considered moats are becoming vulnerabilities. Consumer needs are changing and increasing. Therefore, long-term focused management teams that have a culture of adaptability who can either become platforms themselves or plug into larger platforms without losing their economics will find a way to survive. Most importantly, we will be looking for companies that have the most friendly platforms that drive the most win-win, or positive non-zero-sum outcomes for consumers, drivers, food providers, animal welfare, the environment, etc. I think that is likely to be a vertically-integrated delivery network with cloud kitchens. It strikes me that there is potential out-of-the-money optionality for Uber (Uber Eats had $3.39B in bookings Q2 2019 and adjusted net revenue growth of 56%), but there is a lot that can happen between now and then, so it’s anyone’s guess.

When I was a young analyst nearly 20 years ago, I covered a discount retailer called Ames. Folks in New England might remember the name. A portfolio manager asked me “does Ames have a reason to exist?” I thought the question absurd at first. Of course they have a reason to exist – they had billions in sales and millions of customers. So, I set out in a rental car on a tour of New England, stopping at every Dunkin Donuts along the way, visiting Ames stores (this was before Google Maps!). Guess what? They didn’t have a reason to exist. There were plenty of Walmarts, K-marts, Sears, etc. to sell stuff cheaply if Ames went away. I then spoke to their suppliers, who were pulling all of their vendor financing, which crippled their inventory supply chain. And, that was it. Soon after, Ames filed for bankruptcy. Ames was a canary in the coal mine; a decade later other discount retailers, and then department stores, would also learn they had fewer reasons to exist. Department stores have seen a 30% drop in sales over the last two decades and thousands of locations have closed.

Similar to what we’ve seen in retail over the last 20 years, I would argue most grocery stores – as they are conceived today – and many restaurants simply won’t have a reason to exist in the future as the Information Age consumes yet another legacy industry that isn’t fulfilling the changing needs of consumers.

All this said, for anyone who is a fan of Demolition Man, we all know that Taco Bell will win the restaurant war!


The content of this newsletter is my personal opinion as of the date published and are subject to change without notice and may not reflect the opinion of NZS Capital, LLC (“NZS”).  This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. I often I try to make jokes, and they aren’t very funny – sorry. 

I may include links to third-party websites as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by NZS Capital, LLC (“NZS”). If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which NZS Capital has no control. In no event will NZS be responsible for any information or content within the linked sites or your use of the linked sites.

Nothing in this newsletter should be construed as investment advice. The information contained herein is only as current as of the date indicated and may be superseded by subsequent market events or for other reasons. There is no guarantee that the information supplied is accurate, complete, or timely. Past performance is not a guarantee of future results. 

Investing involves risk, including the possible loss of principal and fluctuation of value. Nothing contained in this newsletter is an offer to sell or solicit any investment services or securities. Initial Public Offerings (IPOs) are highly speculative investments and may be subject to lower liquidity and greater volatility. Special risks associated with IPOs include limited operating history, unseasoned trading, high turnover and non-repeatable performance.

jason slingerlend