Cloud-Kitchens in High-Density Cities: Economies of Scale Through Co-Location

Delivery platforms have recently ventured into "cloud kitchens" (also called ghost or virtual kitchens), which are delivery-only facilities, built typically in locations with high population density, that provide commercial space to multiple restaurant kitchens for preparing their menu items. A cloud kitchen's central location allows for better access to customers, enabling the delivery platform to provide a lower delivery-time guarantee to customers -- this increases profitability for both the delivery platform and the restaurants. A potential second advantage accrues from the ability of the delivery platform to consolidate its driver capacity if multiple restaurants co-locate at the cloud kitchen -- this increases the delivery platform's profitability as it can use the same set of drivers to deliver orders for multiple restaurants. Cloud kitchens, however, come with high rental costs that are directly passed down to the restaurants. We examine the conditions under which a cloud kitchen benefits the three primary stakeholders, namely, the restaurants, the delivery platform, and customers. Our game-theoretic analysis is based on a stylized model consisting of two restaurants and a delivery platform. The two restaurants simultaneously decide whether to stay at their initial (extreme) locations or relocate to a cloud kitchen at a central location. Given the location decisions of the restaurants, the delivery platform decides the delivery-time guarantee for customers and the proportion of the market to serve. Our findings show that both the population density of the city and the economies of scale provided by the cloud kitchen play a significant role in driving the restaurants' location decisions. In line with current industry trends, we show that as the population density increases beyond a threshold, co-locating at the cloud kitchen is first a Pareto-dominant equilibrium for the restaurants and then the unique equilibrium. This equilibrium is also preferred by the delivery platform and the customers, leading to a win-win-win for all the stakeholders.