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McDonald's hopes DVD rentals boost profits

The big red vending machine at the McDonald's whirrs and hums and spits out rental DVDs of Chicken Little and King Kong — and maybe, if McDonald's is lucky, profits.
Chris Kliner and his daughters Olivia, 5, right, and Annaliese, 4, select a rental DVD from a Redbox before heading in to eat at McDonald's in Apple Valley, Minn. The fast-food giant is hoping the convenience of renting DVDs at its restaurants will turn into handsome profits.
Chris Kliner and his daughters Olivia, 5, right, and Annaliese, 4, select a rental DVD from a Redbox before heading in to eat at McDonald's in Apple Valley, Minn. The fast-food giant is hoping the convenience of renting DVDs at its restaurants will turn into handsome profits.Janet Hostetter / AP
/ Source: The Associated Press

The big red vending machine at the McDonald's whirrs and hums and spits out rental DVDs of "Chicken Little" and "King Kong" — and maybe, if McDonald's is lucky, profits.

Machines run by McDonald's Corp. subsidiary Redbox Automated Retail have popped up in hundreds of Golden Arches restaurants in six cities in an experiment to see whether they drive more customers into the stores. Rental chain Movie Gallery is experimenting with DVD rental machines, too, saying the machines will make rental transactions easier for customers and make its stores more efficient.

The spread of DVD rental machines comes as rental stores are struggling under a business model that hasn't changed much from the mom-and-pop video stores of 20 years ago. The rental business has suffered from the sale of cheap DVDs, rent-by-mail services like Netflix Inc., and expanding video-on-demand from cable companies.

"We think it's a tremendous opportunity," said Greg Waring, Redbox's vice president of marketing. "We think we're providing a new model for the industry that is going to be difficult for the traditional retailers to compete against."

About the size of a soda machine, each "Redbox" holds 500 disks and includes a touch screen so customers can pick a movie, and a credit-card reader for paying the $1-a-night fee. They don't take cash. Customers return the movies at the machine.

Signs near the machines promote its movies — kids' titles down low, movies for grown-ups on top. Redbox staffers load newly released DVDs each Tuesday. Redbox workers at the headquarters in Oakbrook Terrace, Ill., can monitor which titles are renting the most in each machine and adjust their selection accordingly. Generally there are 50 to 60 individual titles.

McDonald's came up with the idea in 2003 as it looked for ways to draw more people into its restaurants. It began experimenting with the machines in Denver in 2004 and now has 750 machines in restaurants in five cities, including the Twin Cities. It's measuring their popularity and whether they draw more people into the stores.

Its subsidiary Redbox isn't waiting to see how the McDonald's experiment turns out. It has placed the machines in 75 grocery stores, and has signed agreements for 400 more grocery locations, including Stop & Shop and Giant stores owned by Royal Ahold NV in the Northeast.

This summer, the company plans to let customers go online to check title availability in a particular location and rent a movie on the spot for pickup at that machine later.

Waring said their market share of all DVD rentals in Denver is in the low- to mid-teens, and that includes Netflix customers. Redboxes there average about 1,200 visits a week, including both the rental and return visit, Waring said. He said he didn't know how many of those customers ended up buying food rather than just stepping in to rent or return a movie.

"We have some very aggressive projections in terms of our growth, led by McDonald's locations," Waring said. "There's over 13,000 McDonald's restaurants in the U.S. We foresee a day when we're in the vast majority of those."

In Apple Valley, a suburb of the Twin Cities, Chris and Teresa Kliner stopped at a McDonald's for both a meal and a copy of Chicken Little for their daughters to watch during a visit with relatives in the Twin Cities. The Kliners, of Kenosha, Wis., used the machine to avoid signing up at Blockbuster to rent a single movie.

"With kids, it's easier this way, because they're not running all over the store," Teresa Kliner said while daughters Olivia and Analiese played on the slides at the restaurant's indoor playground.

While sales are growing fast, Redbox doesn't appear to be profitable yet, according to comments made by minority investor Coinstar Inc., a vending company based in Bellevue, Wash.

Coinstar spent $20 million in December to buy a little less than half of Redbox, while McDonald's retained a majority stake. Coinstar also loaned $4.5 million to another DVD vending operator, DVDXpress, and sales at those two businesses combined grew more than 85 percent between the third and fourth quarters of last year, Coinstar CEO David Cole told analysts in February.

But Coinstar also predicted Redbox would lose money this year — $4 million to $5 million for Coinstar's share of the company. That works out to $8.5 million to $10.5 million. Waring declined to comment on Redbox's losses, other than to say the machines themselves are profitable. Coinstar declined to comment on Redbox's profitability.

Movie Gallery, the rental chain that bought Hollywood Entertainment Corp. in April 2005, is also experimenting with DVD rental machines. Chief Financial Officer Tim Price told analysts on Nov. 10 that its machines will hold at least 1,000 disks, and some hold as many as 5,000, and can be used 24 hours a day.

"We're very early in the results, but still very, very encouraged," Price said. Movie Gallery declined to comment for this story.

Wedbush Morgan Securities analyst Michael Pachter said he believes Movie Gallery is aiming to see if it can cut store hours, leaving the machine to rent movies even when the store's doors are locked. Movie Gallery hasn't offered any clues about how well the experiment is going, or how many stores have rental machines, he said.

DVD kiosks can probably grab spur-of-the-moment customers, but Pachter questioned whether they can dent the business of stores like Blockbuster Inc. and Netflix. Most customers rent new releases, but they still like the idea of a wide selection at a store or from Netflix's 55,000 titles, he said.

If Redbox gets into every McDonald's in the country, he said, "maybe they'll get up to 5 percent market share. Maybe."

Blockbuster Inc., the nation's largest movie-rental chain, has operated vending machines in some international markets but has no plans to do more, spokesman Randy Hargrove said.

"They don't generate significant rental volume or significant revenue," Hargrove said. "They just don't have the capacity to do that."

Jeff Smith, a McDonald's franchisee who owns seven restaurants and runs a cooperative that buys advertising for Twin Cities McDonald's, said he doesn't know whether the DVD machines are bringing in more customers because so many other variables, like the weather and promotions, affect whether people eat out.

But he says his customers love the machines.

"The only thing I invest is my space," Smith said. "We don't get paid anything, and it doesn't cost us anything to have it."