Editor’s note: This is the second installment in a regular series from Kitchen Fund, “A Seat at the Table,” distilling the growth equity investor’s experience into insights for restaurant operators. For the first installment, click here.

Seen a ghost lately? We’ve seen lots. Ghost kitchens, or commercial kitchens that aggregate multiple restaurants under one roof, have become the subject of recent enthusiasm, speculation, and trepidation as they begin appearing in cities throughout the country.

Recent economic trends have created an environment ripe for the emergence of ghost kitchens. Declining instore foot traffic, rising labor costs, a tight labor market, rising rents, and an increased customer appetite for delivery have led restaurants to turn to delivery to generate growth. Ghost kitchens serve as a centralized pick-up point for these online delivery orders. The size and recent growth of the delivery market has attracted the interest of entrepreneurs and venture capitalists alike; over the past few years, VC funds have poured nearly $1 billion into ghost kitchens in the U.S. alone. If we include Reef Technologies, a North American parking network with a ghost kitchen component, the number is closer to $2 billion. 

Are these ghosts the real deal, or just an illusion? We interviewed a multitude of ghost kitchen operators and restaurant brands in order to cut through the fog and assess the opportunities.  Our resulting proprietary model has enabled our brands to quickly determine the best decisions for them. We are happy to share our insights with you in the latest installment of “A Seat at the Table.”

Ghost kitchens 101

There are two primary types of ghost kitchens: The first is a turnkey space within a commercial kitchen (think “WeWork for restaurants”), and the second is a licensing agreement, in which restaurants outsource their brand and food production in exchange for a 6–10 percent sales royalty.

While turnkey kitchens provide restaurants with ventilation, sinks, storage space, lockers, cleaning and expediting resources, and, sometimes, kitchen equipment, the turnkey model is typically more expensive than it initially appears. Rent and labor are the two largest fixed costs in this paradigm, and they are both substantial. Rent in major urban areas runs between $8,000–$12,000 per month, with a minimum one-year contract commitment for a 250-square-foot space. The size of the kitchen space can be limiting for brands attempting to generate meaningful volume during one daypart (for example, lunch) to break even, necessitating expansion to a second kitchen and thereby doubling rent and equipment expenses.  

Labor can also be expensive. Brands will need two or three employees to operate their kitchen during the hours needed for food preparation, delivery window operation, cleanup, and inventory management, regardless of volume. In major metropolitan markets, three employees each earning $17 per hour to operate a ghost kitchen 10 hours a day, for example, will cost $150,000–$210,000 annually to operate five or seven days a week.

There are other hidden costs to turnkey kitchens to account for, too, including onboarding fees, a security deposit, and marketing expenses. Some turnkey kitchens also require that brands provide their own kitchen equipment upfront, costing up to $100,000 per kitchen. It is also important to bear in mind that in addition to these costs, brands rely on third-party delivery platforms to fulfill their deliveries. Brands must account for the 25 percent sales commission on average that third-party delivery platforms charge for their services.While the licensing model does not involve the same startup expenses as a turnkey kitchen, it does present its own set of risks. Brands remain responsible for providing their own marketing and are required to meet certain minimum demand quotas and food-cost hurdles. There is also substantial reputational risk associated with entrusting a third party to execute your recipes and meet your brand standards. A negative experience risks alienating a long-term customer across all platforms.

Ghost kitchens could also spell trouble for restaurant franchisees navigating franchise agreements. Logistic opportunities presented by ghost kitchens, such as expanded delivery radius and hours of operation, can lead to inadvertent sales cannibalization and expose both operators and brands to potential lawsuits.

So, who’s not afraid of ghosts?

Turnkey ghost kitchens are best suited for restaurant brands with customer demand outpacing supply, and that cover multiple dayparts and have a more economically affordable sales channel, either through a direct channel or a highly negotiated rate with a third-party delivery platform.

Demand outpaces supply

Because ghost kitchens are expensive, they are best suited for strong restaurant brands currently unable to meet customer demand for delivery. Brands with existing customer demand can generate incremental sales while creating more bandwidth for the in-store experience; a restaurant trying to balance serving diners and delivery orders during a busy lunch period could risk negatively impacting the in-store experience or turn delivery off altogether.

Exactly how much demand are we talking about? With rent and labor expenses alone running at $250,000, a brand will need about $650,000 in annual sales to break even. (For our ghost kitchen economic template, please email info@kitchenfund.com.)

Think you can do it? Our current operating assumption, confirmed by several leading ghost kitchens, is that strong restaurant brands that use ghost kitchens in a new neighborhood within an existing market could generate about 50–75 percent of the delivery sales that they do out of their existing brick-and-mortar stores. While each brand and situation is different, this is a good back-of-the-napkin figure to work with to assess potential opportunity. Bear in mind that brands without brick and mortar should expect to do less; a storefront location is an inherent form of marketing.

Multiple dayparts

Ghost kitchens work best for brands with demand over multiple dayparts. Because brands must produce within a 250-square-foot space, a brand experiencing a strong demand spike during only one daypart will need multiple ghost kitchens to effectively optimize cost structure and maximize sales, and will therefore have to earn an equivalent multiple on the $650,000 in sales needed to break even. A brand with a single strong daypart will have trouble making this pencil out and should consider alternative strategies.

Preferred delivery arrangement sales channel

The third-party delivery platforms that ghost-kitchen brands rely upon for deliveries and demand generation assess a 25 percent fee, on average, for their delivery services. This fee, coupled with the upfront costs of membership and operation, makes ghost kitchens cost-prohibitive for upstart brands. Successful ghost kitchen brands will either conduct significant business through their own proprietary direct sales channel, like an app, or have the bargaining power to negotiate reduced rates with at least one major third-party delivery company. We would caution that while the latter strategy can work in the short term, operators should aim to own their sales channel in the long term, to insulate themselves from the risk that a third-party delivery company does not renew a contract or increases rates. Positioning and marketing on third-party delivery platforms can also make or break performance; successful brands relying on these marketplaces are likely to have preferred placement and marketing arrangements in place as well.

As Ahmed Abouelenein, CEO of The Halal Guys, says, “Without a storefront, it is really difficult to generate enough delivery volume in a ghost kitchen to succeed. For operators tempted to test a ghost kitchen, finding a provider who can help with marketing and demand generation is critical.”

Who else might work well with ghosts?

Ghost kitchens provide an attractive means for operators or chefs to quickly bring new test concepts to market and analyze customer receptiveness and demand. Ghost kitchens provide detailed metrics, including delay times, order volume, and reviews, which could help inform future locations, platforms, and promotions. A brand could use this data to strategically build a brick and mortar around customer preferences. Companies can rotate multiple concepts through one ghost kitchen space to learn what resonates with customers.

Ghost kitchens could also provide a useful means to dip a toe in a new market and assess potential opportunity without committing to a full store buildout. We believe that ghost kitchen performance in a new market is not determinative, however; a concept’s failure as a ghost kitchen does not mean a brick-and-mortar store would necessarily fail, but success is a good indicator that stores will likely succeed.

The licensed ghost kitchen model also presents opportunities to expand a brand’s presence in new markets, access food deserts, and establish an international presence.

Ghost of kitchens yet to come

While today’s ghost kitchen landscape presents challenges for all but the strongest brands, there are several potential changes coming to market that would increase the attractiveness of ghost kitchen opportunities.

Ghost kitchens can embrace on-premises foot traffic in addition to delivery to create a modified food-hall environment, which would reduce reliance on high-fee third-party delivery platforms and thereby lower the cost of sales. Use of digital-ordering kiosks and mobile ordering solutions, for instance, could enable ghost kitchens to seamlessly offer dine-in and on-site pick-up to their existing operation. Ghost kitchens appear to be moving in this direction, with operators like CloudKitchens and Kitchen United adding pick-up or dine-in options.

Ghost kitchens can offer a technology platform for customers to order directly from restaurant brands, creating a more affordable delivery sales generation tool than the third-party delivery platforms. Consumers also can benefit from the ability to order from multiple different restaurants and provide groups or families a variety of options to eat.

Alternatively, restaurant brands can consider partnering directly with ghost kitchens run by third-party delivery platforms, such as DoorDash, to take advantage of their ability to generate demand and marketing. Using one provider for kitchen space and delivery can help reduce costs through negotiated delivery rates, although the restaurant may need to agree to exclusivity.

Ghost kitchens could also present a useful group and batch ordering solution for third-party delivery companies. By coordinating orders from their central pick-up locations, ghost kitchens could help reduce the last-mile and logistic costs of delivery for both restaurants and consumers. This would make ghost kitchens a less expensive sales channel and lends itself to adding additional revenue streams, such as catering. 

While ghost kitchens can haunt brands unprepared to meet their demands, they present unique opportunities for the vigilant. Are ghost kitchens coming to your neighborhood? We’ll be watching.

Greg Golkin is managing partner at Kitchen Fund, a source for strategic capital for emerging restaurant brands. Its job is to provide targeted capital, connections, and know-how to help restaurant brands bring their story, ethos, and recipes to eaters everywhere. Its team includes world-class food and technology entrepreneurs, finance experts, and hospitality veterans. Together, they have carefully assessed thousands of restaurant concepts. From team building to technology, branding and marketing to new geographic market entry, they help brands stay one step ahead in the ever-evolving restaurant marketplace. Their experience provides them with a unique understanding of today’s restaurant industry landscape, where the terrain will shift tomorrow, and how to successfully navigate those transitions.