Surge pricing is coming to food delivery

If you think that paying 6x for Uber is a bitter injustice, brace yourself: surge pricing is coming to on-demand food delivery. The delivery companies cannot afford their driver fleets without making this change. It’s sheer economics and a trend that will shape the future of online food ordering.

Surge pricing may seem obvious given that Sprig introduced it in 2014. But consider this question: Why didn’t the other deliverers follow suit back then? Well, Sprig makes and delivers its own food whereas the majority of on-demand deliverers partner with restaurants – often, the exact same restaurants. They kept delivery fees artificially low in order to win the biggest possible slice of the $70 billion take-out and delivery market. For several reasons, the deliverers can’t compete this way anymore.

First, acquiring drivers is stupidly expensive. Last spring, Harvard Business School students Amit Arora and Nimi Katragadda estimated that on-demand companies spend an average of $650 to acquire one driver. Transportation companies, food deliverers, local shippers, and others in the on-demand space all compete for the same drivers. Big upfront incentive payments aren’t enough. They all face pressure to raise wages so that drivers don’t opportunistically hop from company to company, soaking up signup bonuses.

Second, in addition to commanding higher wages, drivers are taking legal action to demand benefits. Shannon Liss-Riordan, a Boston-based labor lawyer, is spearheading class-action lawsuits against 11 on-demand companies, which include food deliverers. She alleges that on-demand companies misclassified employees as independent contractors in order to save money. Deliverers are on the defensive. In April, Uber agreed to pay out $84 million to drivers in California and Massachusetts. Lyft, another one of the besieged companies, upped its proposed payout to $27 million after a San Francisco judge turned down $12.5 million.

The implications of these lawsuits are murky. Lyft, for one, can still classify its workers as independent contractors as long as the company provides certain protections (i.e. it will be harder to fire a Lyft driver). Other on-demand companies may not get off so easily, and new entrants to the space will think twice about crossing Liss-Riordan given her success in these cases. The lawsuits will raise the cost per driver.

Third, VC funding has dipped from its peak in 2015, investors are concentrating capital in fewer deals, and tech companies have slammed the break on IPOs. This means that food deliverers can no longer depend on investors to subsidize growth. They need to become (or remain) profitable.

That brings us back to surge pricing. Food delivery companies need to somehow compensate for rising driver costs. They can’t increase restaurant commissions. Most delivery companies take between 10 and 30 percent of each order depending on their model, and restaurants already operate on slim margins. Consumers will have to make up the difference by paying variable delivery prices.

Much like Uber and Lyft surge pricing, food delivery surges will respond to events and weather. When the crowds descend on Chicago every July for Lollapalooza, I expect to see surge pricing. Likewise, when the Windy City gets hit with -15 degree temperatures and 40 mph gusts this winter, people here will be happy to pay surge prices.

The food deliverers will probably introduce their own equivalent of UberX, uberSELECT, and so on. Do you want your bánh mì sandwich in 30 minutes, or in an hour and 30 minutes? The food deliverers will monetize speed and demand with tiered delivery rates.

In any dynamic marketplace, tech-enabled companies have the ability to adjust pricing in real-time. However, when enough companies in a space do this, customers become less loyal . Although they might prefer to order from one deliverer, they can’t justify paying an extra $10 or $20 in the name of loyalty. In the wake of surge pricing, delivery companies will probably build more sophisticated loyalty programs. But, it’s too soon for that discussion.

The economics of delivery mean that surge pricing is inevitable in online food ordering. As prices fluctuate and loyalty erodes, food deliverers will find new ways to stand out from their competition. In the meantime, keep a close eye on those delivery fees.

Michael DiBenedetto is cofounder and CEO of food delivery search engine Bootler.