The one bright spot for the restaurant industry amid the pandemic is big restaurant chains. To get a handle on the industry and its newest trends, including ghost kitchens, GLG spoke with Steven Buckley, principal and senior advisor at Profit Objective LLC and former COO at BurgerFi International. The following Q&A has been edited for length and clarity.

What are the latest developments in the fast-casual space?

The fast-casual space, like the entire restaurant space, has been in the midst of continuing upheaval. When the attempt to reopen throughout various markets was met with the current resurgence of COVID-19, it took the entire industry for a spin. The strongest positioned to weather this storm is probably the quick-service restaurant sector because up to 70% of its revenues can go through drive-through. Fast-casuals are in the second position because they, like QSR, have developed effective digital strategies over the past five years, with intensified activities in the past six months.

Digital is the secret sauce for the fast-casual world, and chains are bolstering the percentage of their revenues that are coming in through digital channels: mobile apps, websites, and third-party marketplaces that funnel orders directly to the fast-casuals. Fast-casual used to look at about 50% to 60% of business as dining in restaurants. That’s now shifted to up to 90% takeout and delivery. That’s a complete inversion of the dynamics of generating orders. The question is how this will play out post COVID-19?

How much margin erosion do you expect the fast-casuals to experience, as they’re heavily reliant on third-party delivery?

The most profitable transaction in a restaurant, whether it’s QSR or fast-casual, is the transaction where the consumer picks up the product. Delivery is a much less profitable transaction, given the fact that there is a significant cost associated with it. That’s whether they pay a third-party delivery service partner a fee that ranges from 15% to 28%, or a native delivery approach, which is a difficult and expensive proposition.

I would estimate that the immediate-term mix for fast casual will continue around 70% to 80% takeout, which may include some in-store dining, and 20% to 30% deliveries. That could potentially produce a near-term margin erosion on a weighted average basis of anywhere from a 5% to 10% decrease in operating profit margins, as a result of the heavy reliance on third party delivery. This is why there is an attempt to divert consumer purchases to pickup and curbside, like Chipotle’s push to add drive-through capability to its locations. Additionally, chains are increasing their prices on the delivery portion of their menus in an effort to offset the hit to margins.

What is a ghost kitchen?

Ghost kitchens, also sometimes known as cloud kitchens, dark kitchens, or virtual kitchens, are terms used to describe a food production facility that houses one or more brands, and  uses delivery as its principle business model. It is removed from prime real estate locations, such as central business districts or shopping districts, that would be considered grade A real estate sites. These cloud kitchens would be in B and C real estate. One of the key factors in determining a site for a ghost kitchen is, can the kitchen produce a meal and deliver to the target market in about 10 minutes?

How aggressively are national brands adopting this new trend?

The concept of bigger brands versus smaller regional brands flocking to ghost kitchens is an interesting question. It has a clear answer in my opinion. Legacy brands will not go quickly to ghost kitchens, aside from testing the concept, like Wingstop in Texas, and Chick-fil-A’s single-unit test inside an aggregated complex. National brands, particularly legacy ones, don’t need additional kitchen facilities at this point, and they could be concerned that their brands would suffer by being surrounded by lower-grade operators. There are also franchise considerations.

Can you walk us through a sample P&L for a ghost kitchen? Could you identify the areas that can improve or the areas that you think will change the most moving forward?

On the side of the operator, the P&L for the brand is simple. You’re taking a limited restaurant operation and placing it into a ghost kitchen environment, which is a 250- to 350-square-foot kitchen facility with varied support services and an infrastructure that creates order and efficiency through delivery. You then run your restaurant kitchen and have variable costs and fixed costs. Variable costs, like any restaurant operation, are food, paper, direct labor, and delivery fees. There are fixed expenses of management labor and rent, which can go as high as $100,000-plus for a unit adjacent to a prime business district. Additional administrative expenses are also fixed. Those costs, labor, rent, and administrative expenses total about $300,000. The break-even point approaches $750,000 in revenue to cover fixed expenses. Operating a ghost kitchen successfully is not as easy as it sounds.

How do ghost kitchens shake up the competitive landscape? Can smaller brands use ghost kitchens as an affordable way to push their product?

Absolutely. Smaller brands can jump into a ghost kitchen with ease. The cost and the commitment are low because ghost kitchen developers are dangling limited-term leases until they validate their overall model. That could backfire on the ghost kitchen operators, because if they start to see turnover of brands, that’s a real problem. Overall, ghost kitchen success requires more aggressive marketing to create traction within a new market. That generally would be through social media, but there’s a cost attached to doing a good job there, all of which puts in question the scalability of these ghost kitchen developers, who are rapidly competing for new space and hoping to fill it with the right kinds of tenants.

What are consumers demanding from cloud kitchens and ghost kitchens? What is the value proposition from the consumer side?

There should be ease of ordering and a quality product. There has to be a consistent delivery of product without errors. Delivery and order fulfillment errors are common in off-premises activities because the consumer can’t go to the counter and say, “You made a mistake.” If a brand makes a mistake on a home delivery, it’s in trouble because the consumer will be mad, and that generally finds its way to social media and becomes a black eye.

Ghost kitchens enable multi-menu opportunities so the consumer can order something in the chicken category, burger category, and the pizza category, as an example. That’s what many of these developers are trying to do, to curate it in a way that they get that mix of products. But they’re also rushing to allow brands to come in that are not established, including brands that are being created for the sole purpose of being in ghost kitchens. Ghost kitchen operators are overall not worrying about profitability now. We’ll have to watch this model closely to see if it works.

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About Steven Buckley

Steven Buckley is currently Principal and Senior Advisor at Profit Objective LLC, a consulting firm that provides strategic and operational guidance to senior-level executives using innovative formats that merge advanced leadership skills with synergistic technological platforms. Prior to that, Steven served as Chief Operating Officer at BurgerFi International. Steven also held executive roles at Gianna Rose Atelier, National PetCare, and AMF Worldwide, and was Chief Operating Officer of Nathan’s Famous.

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This article is adapted from the June 26, 2020, GLG teleconference “Fast-Casual Restaurant Update: Emergence of Ghost Kitchens.” If you would like access to this teleconference or would like to speak with Steven Buckley, or any of our more than 700,000 experts, contact us.

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