The Microeconomics of Cloud Kitchens: Efficiency or Exploitation?

When you order from a food delivery app, do you really know where the food is being prepared? One innovation that has emerged with the proliferation of online food ordering for delivery is the cloud kitchen, also known as the ghost kitchen. These are commercial-grade kitchens without a storefront or restaurant attached, with food created solely to be delivered. Frequently, cloud kitchens are situated near areas of high food delivery demand, allowing for more rapid completion of delivery orders. Large cloud kitchens can also be rented by multiple entrepreneurs and create food for multiple “restaurants” simultaneously.

Economic Benefits of Entrepreneurs Using Cloud Kitchens

No Costs to Accommodate Sit-Down Patrons

Cloud kitchens have proliferated in the past decade due to cost efficiency. Because there is no restaurant or storefront, cloud kitchens are highly efficient at preparing food. Entrepreneurs looking to sell food via delivery app do not have to spend extra money on seating space, wait staff, cashiers, et cetera. Because almost all of the employees are cooks and know they will be working in a cloud kitchen, less money needs to be spent on limiting food odors or cooking sounds that may be unappealing to sit-down guests.

Creating a commercial-grade cloud kitchen is expensive, but not all entrepreneurs are cooking and delivering 24 hours a day. Therefore, a single cloud kitchen can be rented by one digital restaurant for breakfast and lunch, such as a brunch restaurant, one digital restaurant for dinner, and even a third one for late-night snack fare. Or, similar restaurants can rent space on different days, with one selling Monday through Thursday all day and one selling Friday through Sunday all day.

The owner of the cloud kitchen can maximize revenue by keeping the kitchen rented all days of the week, and potentially 24 hours a day. To attract enough entrepreneurial renters while still making enough revenue to turn a profit, the owner of the cloud kitchen may reduce the hourly rental cost. This may make renting time in a 24-hour ghost kitchen a better financial deal for entrepreneurs than paying to build a kitchen of their own.

Economies of Scale

Some renters of a cloud kitchen may even agree to share some supplies, allowing them the economic benefit of economies of scale through buying in bulk. Or, these basic cooking supplies could be provided by the owner as part of the rental cost. Instead of each entrepreneur having to provide his or her own dish soap, flour, sugar, salt, and other widely-used necessities, buying smaller units at higher per-unit prices, these items could be purchased in bulk at a deal.

Economic Struggles of Entrepreneurs Using Cloud Kitchens

Lack of Branding Hinders Consumer Demand

Cloud kitchens may be efficient, but they are also relatively anonymous. This can make it difficult for an entrepreneur to build a brand that attracts consumer loyalty - and commands higher prices. Users of cloud kitchens often rely entirely on the delivery apps themselves for advertising, limiting brand development. These relatively unknown entrepreneurs will have to charge lower prices for their food.

Because these cloud kitchen entrepreneurs are relatively unknown, and can be great in number in large cities, they create a market that is close to perfect competition. Due to lack of brand recognition, consumers treat them as entirely interchangeable. This forces sales prices almost to the point of average total cost, limiting profits. Thus, costs are lower for entrepreneurs to use cloud kitchens…but revenue will also be lower.

Intense Competition Can Drive Down Wages

If cloud kitchen digital restaurants cannot easily compete on price, due to the market being close to perfectly competitive as a result of high supply and anonymous producers, they must compete on reduced costs. This often creates pressure to keep wages low. Critics claim that cloud kitchens’ low wages and high efficiency will drag down wages for workers in traditional restaurants as well.

Cloud kitchens and ghost kitchens often operate on a gig economy model, with workers taking brief, rapidly-scheduled shifts and being treated as independent contractors rather than traditional employees. This model typically features low wages, as workers rarely last long enough to develop enough experience and tenure to demand raises. Observers often opine that cloud kitchen workers are exploited and that digital restaurant owners can mistreat these workers due to lack of public view.

Anonymity May Harm Productivity in the Long Run

A cloud kitchen operating a relatively anonymous brand may struggle to retain talent, including its entrepreneur, due to lack of branding and customer interaction. Many entrepreneurs who start digital restaurants may become disillusioned over time due to lack of interaction with appreciative customers and patrons. Workers may become disillusioned with relatively low pay because there is no prestige associated with their un-branded employer. Owners and employees of traditional restaurants may remain motivated and productive due to public support for their restaurants’ brands and reputations.

Implications for the Restaurant Market

Intellectual Property Challenges

Cloud kitchens and digital restaurants can be controversial due to their low operating costs creating what is sometimes seen as unfair competition for brick-and-mortar rivals, especially when it comes to intellectual property. Critics of cloud kitchens argue that these digital restaurants frequently copy menu items from established, well-known restaurants. Due to their fly-by-night ability, ghost kitchens are allegedly more able to engage in copycat behavior to lure customers than brick-and-more restaurants, which can easily be hit with lawsuits. Investigators can easily walk into a physical restaurant and detail decor and image choices that are evidence of copyright infringement, while digital restaurants can change their app settings with the tap of a touchscreen.

In rare situations, cloud or ghost kitchens may be outright fraudulent operations pretending to be established restaurants. Sometimes, fraudulent ghost kitchens can even use fare from fast food chains to substitute for more expensive menu options from local restaurants in an attempt to fool delivery app users. In some cities, popular local restaurants that do not subscribe to certain delivery apps are impersonated on those apps by ghost kitchens, which deliver substandard products.

Competition Can Hurt Brick-and-Mortar Establishments

A cloud kitchen can allegedly easily copy the most popular menu items of a brick-and-mortar rival, and then also undercut on price due lower costs of operation. Critics consider this unfair competition. They also argue that the rapid proliferation of cloud kitchens make them difficult to regulate and inspect, allegedly resulting in some unsanitary cloud kitchens. The difficulty to find and inspect these easy-to-create cloud kitchens may result in some intentionally skimping on meeting regulations, giving yet another cost-reduction advantage.

Quality Variations May Drive Customers Back to Brick-and-Mortar

However, high quality variation among food output and fears of dirty kitchens may drive customers in some markets back to brick-and-mortar restaurants. Having a negative experience with an unknown cloud kitchen brand can drive a consumer to only rely on trusted, brick-and-mortar restaurants in the future. Thus, even though cloud kitchens can typically offer food delivery for lower prices, they are unlikely to replace popular brick-and-mortar establishments. Too many customers will likely remain wary of unknown brands to trust them, especially when delivery fees can reduce the percent cost differences between cloud kitchens and brick-and-mortar rivals.