Why cloud kitchens turned dark

Written by Abhishek Sanwaria, Nikhil Kedia and Akshaya Vijayalakshmi

It is likely that one of the several times you ordered from Behrouz Biryani or Faasos, you remarked that one day you would visit their restaurant and eat over there. It may then come as a surprise that these online restaurants do not have a traditional physical space where one can dine-in. These restaurants, known as cloud kitchens or ghost kitchens, are merely commercial cooking spaces without a dine-in option. These are usually catering hubs for online pick-ups.

Cloud kitchens were pegged to be one of the most lucrative business segments in the food-tech industry, as they received more funding than food delivery businesses in 2019. But the COVID pandemic upended several priors. The faith in the cloud kitchen has taken a hit. Take the case of Swiggy Access. The cloud kitchen arm of Swiggy opened with much fanfare in 2017 and received hundreds of crores in investments. But the pandemic led to Swiggy shutting down many of its cloud kitchens.

This begs the question: Do cloud kitchens still have the potential to disrupt the food-tech ecosystem?

There are two cloud kitchen models. One, a food-tech partner offers retail kitchen space to chefs and restaurants. The kitchen space is to be shared by six to eight restaurants. The chefs are charged a membership fee covering rent, infrastructure, commercial equipment, and for added services like dishwashing and storing. Each restaurant/chef is responsible for handling their business. The food aggregator partners, in turn, prioritise these brands in their search metrics. This system allows food aggregators to control the supply of food and reduce their dependence on third-party restaurants.

The second model is where one restaurant operator sets up a shared kitchen space where multiple cuisines under different brand names are prepared. This restaurant operator takes care of all the operational and promotional aspects of the business.

Dubbed as the future of the eating-out industry, cloud kitchens have been sprouting across India. Located in low-rent areas, they maximise a restaurant’s ability to service online orders while not causing inconvenience to diners in traditional sit-down restaurants. Typically, the initial investment for a cloud kitchen is around Rs 10 lakh and could vary depending on the sophistication and area required. With an average order value of Rs 300 and 750-800 orders/day, a cloud kitchen could break even in the first year.

Though the cloud kitchen model looks lucrative on paper, it comes with its problems. While they have lower setup costs, their revenues are lower as well. Customers expect lower prices since there is no ambience to pay for, making it difficult for cloud kitchens to raise their prices easily.

We spoke to users across India to understand their preference for cloud kitchens. Because of the COVID pandemic, many consumers preferred to order online rather than visit a restaurant. Consumers prioritizing health and hygiene prefer to order from a restaurant with a well-known brand name, good ratings, and reviews, even if it is slightly more expensive. More specifically, 53 per cent of the 120 respondents suggested that they prefer ordering from a restaurant they visited or planned on visiting. It appears that physical visibility helps in building trust in the consumers’ minds.

The shared insight from Rebel Foods’ (formerly Faasos) cofounder and the ex-VP operations of FreshMenu was that it is a myth that cloud kitchens save money. The money saved on rent and infrastructure is lost in commission. Further, the cloud kitchens are reliant on Zomato/Swiggy for demand and delivery service generations. They are no different from people who sell stuff on Amazon. The main criterion that differentiates one seller from another on Amazon is the price. For cloud kitchens to survive and grow, they need to build brand equity, which is costly and physical presence is one way to create the same.

Based on our conversation with food-tech investment professionals from venture capital firms, we find that they are no longer focused on cloud kitchens. As per the investors, cloud kitchens are challenging to build and scale. Building infrastructure/kitchen relies on capital arbitrage. Moreover, physical capital is not easy to scale. Next, finding the right quality workforce to deliver quality food consistently is not an easy task.

Anyone can start a restaurant — that was the promise of a cloud kitchen. The novelty is gone since most restaurants are cloud kitchens today, as people are reluctant to eat out. Experts say that COVID-19 has been a blessing in disguise for the food-tech industry. The cloud kitchen, overall, has not proven to be profitable or easy to scale.

Abhishek Sanwaria and Nikhil Kedia are 2nd Year MBA students and Akshaya Vijayalakshmi is Assistant Professor (Marketing). They are at the Indian Institute of Management Ahmedabad.