The casual reader will look at articles describing Nestle‘s recent investment in Freshly and get no further than the intended message: “The $240 billion global conglomerate has invested in an emerging, US meal-kit delivery startup!” It’s all top-level stuff, which is exactly what Freshly’s PR Department wanted: An attention grabbing headline highlighting the Nestle brand, garnished with an eye-catching investment figure. Come to think of it, it’s kinda like Freshly’s own Grilled Chicken Risotto . . . a popular, hot American entree with a rich, European-style base.
Sounds wonderful, so why do I have an odd taste in my mouth?
Less than one year ago Freshly raised $21 million in a Series B Round. One can only assume that the company has blown through that money . . . hence the need for this $77 million Series C Round. Twenty one million dollars spent in just eleven-plus months, now that’s an impressive burn rate! It will only increase from here. Nobody ever suggested that home food delivery was a low-cost undertaking.
Who suggested it would be very profitable?
The prices for Freshly’s meal plans range from $8.99/meal to $12.50/meal, depending on the number of meals one commits to buy each week. Free delivery is included. They seem to be attractive deals. Maybe, too attractive. I, for one, am having a hard time seeing how those meal prices will ever yield profit margins that would justify the $107 million investment to date.
It’s time to do some math.
Restaurant industry data for 2016 show (full service) restaurant meals averaging $15/each. Food costs represent 32% of that sales “ring.” With Freshly’s meal prices averaging only $10, and given Freshly’s insistence on superior product quality, I would expect its food costs to be a somewhat higher percentage. Let’s peg them at 40% of sales. The good news is that Freshly will have labor costs that are much lower than those of the average restaurant (a daunting 33% of restaurant sales last year). The bad news? Freshly will incur packaging and delivery costs that restaurants do not. For the purposes of this example, let’s estimate Freshly’s direct labor, packaging and delivery costs at 25% of sales. I think that’s a generous estimate . . . as delivery costs alone can easily be $1.50 to $2.00 per meal, or 15%-20% of sales in this case. Now, let’s plug in something for basic G&A expenses. According to the census bureau, US industry G&A expenses ranged from 10-25% of sales last year. For this analysis we’ll assume no executive suite extravagances; let’s take a mid range G&A estimate of 18% of sales.
Now, where’s my calculator . . . ?
So far, my estimates of Freshly’s unit costs have reached 83% of sales. That leaves only 17% to cover Sales and Marketing expenses and, of course, profits. Freshly’s is an e-commerce sale with no need for costly retailer marketing-support plans, but digital marketing is not cheap, especially when competing in a crowded home-delivery field. Blue Apron, Chef’D, Sun Basket and others are all chasing the same consumers with comparable products and services. Freshly will have to spend money to drive customers to its site and to keep its churn rate low. It’s hard to imagine Freshly reaching break even in the short term.
A true pessimist might even question where Freshly will ever find the volume efficiencies that would generate profit margins sufficient to justify investor returns of, say, 10x their investment. I’m not such a pessimist. There will be one (at least) big winner in the home delivery arena; it could be Freshly. I also believe the venture capitalists are intelligent and have their exits covered. Nestle is one such exit. Letting a strategic investor participate in a deal at a relatively early stage could be seen as limiting the potential to attract other strategic acquirers later. A textbook no-no. In this case, Nestle would be privy to confidential Freshly information and could prove problematic should another industry player become interested. Why do it?
Beside obvious PR value, Nestle offers the VCs a potential safety net, another exit. Should Freshly stumble, the VCs may still be able to sell to Nestle at a price that, in a classic make vs. buy analysis, makes sense for Nestle . . . while still offering a positive return for the VCs. It’s a potential win win. It may also explain why Nestle isn’t disclosing its actual investment. While noted as the lead investor in this $77 million Series C Round, Nestle is joined by a large number co-investing VCs. The risk is well spread out. So, a $15 million investment may have been sufficient to be the “lead” in this case. That’s a relatively low cost place-holder in an attractive market category. It’s certainly not a partnership, likely not even a strong commitment. Right now, let’s consider it a lottery ticket.
Freshly has raised $107 million in total since launching in 2015.