A Virtual Happy Meal: McDonald's Redbox a Smashing Success

Dec. 1.06 | About: McDonald's Corporation (MCD)

It’s hard to believe that the concept of Redbox started out 4 years ago, but what was initially a series of radical experiments by McDonald’s (NYSE:MCD) has turned into an undeniable box office success for the company. McDonald’s may have first come up with the concept in 2002, but it wasn’t until 2003 that they tested their first unit. Initially, they had a very modest beta launch of only 6 DVD kiosks in their Las Vegas restaurants and another 11 in their Washington area stores.

Redbox

Early on, there was a lot of doubt as to the real viability of the project. Analysts, insiders and consumers all expressed concern over whether or not they would ever see the machines gain acceptance. When McDonald’s pulled their experimental Tik Tok kiosks, which sold items like milk, eggs, pantyhose and even diapers, many thought it would be curtains for their experiments with DVD as well.

Luckily for them, McDonald’s stuck with their Redbox venture and by the summer of 2004, the company started a 2 year test launch by expanding their DVD experiment to 100 machines in the Denver area. After gaining traction in Denver, Redbox quietly began opening up kiosks in four other markets and pretty soon a few grocery stores started signing contracts with Redbox as well. By the end of 2005, Redbox reported that they were renting 1.1 million DVDs a month at about 800 total locations. Realizing the potential for expansion beyond just McDonald locations in late 2005, McDonald's sold 47.3% of the company to Coinstar (CSTR) in exchange for $20 million in cash and another $20 million in 2006 if everything went according to plan.

Well if a recent announcement by McDonald’s is any indicator, I think it’s safe to say that things have gone much better then planned. Not only are there now 800 Redbox kiosks in McDonald’s alone, but there are another 1,000 locations in non-McDonald stores as well. In an press release issued on Thursday, McDonald’s announced that they now plan on expanding their relationship with Redbox and plan an aggressive rollout in the first half of 2007. This rollout will not only add more machines to McDonald’s locations, but will also introduce the DVD rental machines to new markets in the US.

When I contacted Redbox to get clarification on the scope of the McDonald’s rollout, Redbox Vice-President of Marketing, Greg Waring said that “to begin with, we anticipate more than doubling our presence in the first half of next year. Exact markets and locations will be announced in the coming weeks.”

With McDonald's set to add at least another 800 kiosks in the first half of 2007 and with Redbox currently in beta testing at both Walgreens (WAG) and Walmart (NYSE:WMT), the future for DVD kiosks may be looking very bright indeed. What may have started as a hairbrained idea to diversify McDonald’s revenue beyond fast food has turned into a full blown DVD revolution. With McDonald’s having now rented over 15 million DVDs in the last 12 months at just their own 800 DVD locations, the economics of this expansion appear very compelling.

From prior publicly released information, we know that Redbox is paying Solectron Corp. (SLR) $21,000 for their indoor units and $23,000 for their outdoor units. On top of this, we also know that they pay another $1,000 in software costs for the units. At an average of 1.25 million rentals a month this means that Redbox gets somewhere between 50 - 55 DVD rentals per day at their McDonald’s locations. Considering that an average rental period is 1.5 days, the rental traffic at a McDonald’s Redbox location should pay for the kiosk in just 9 - 10 months, not including content costs. After 10 months, the machine turns into a profit center that fuels growth all while still contributing to intangible benefits like being able to offer McDonald’s customers something other restaurants can’t, as well as serving as a mechanism to encourage repeat customers.

When I was a kid, I remember how excited I was when my parents took me to McDonald's to get a Happy Meal. It wasn’t the meal itself, but the toy inside that I always looked forward to. By incorporating dinner with a movie through their Redbox venture, McDonald's and Redbox have teamed up to create the equivalent of a Happy Meal for adults. The toy may not be a Malibu Barbie Doll or a Hot Matchbox car, but you can still rent Barbie in the 12 Dancing Princesses or Pixar’s smash hit Cars if you want to re-live your childhood all over again.