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STRATEGY

Losing McDonald's

Inventor Hettie Herzog scored a major coup when McDonald's came calling. Then the fast-food giant bailed out, leaving Herzog with tough decisions to make.
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Hettie Herzog was eating lunch at an upscale restaurant in suburban Washington, D.C., when she learned she was being dumped. There was someone else, she was told, and unless she was willing to make some drastic changes, her partner would walk. It was disappointing. The relationship had begun with such promise, but had barely lasted a year.

The coupling in question was not a love affair, but something arguably more serious: a partnership between Herzog's tiny vending machine start-up, Automated Distribution Technologies, based in Exton, Pa., and fast-food behemoth McDonald's Corp. The two had been collaborating on ADT's Shop 2000--an eye-catching 18- by 9-foot vending machine that offers some 200 products. The machine, designed to compete with a typical convenience store, was still in development and Herzog had yet to sell one. But McDonald's had formed a special innovation task force that was exploring new technologies and lines of business, and Herzog had hoped that the company's marketing muscle and real estate savvy would propel the Shop 2000 out of the prototype stage and into the big time.

Instead, the McDonald's executive informed Herzog that his company had purchased the U.S. rights to similar technology from a Belgian firm. McDonald's, he suggested, was interested in combining Herzog's technology with the Belgian company's--a step that the entrepreneur, who had worked for four years on the Shop 2000, was unwilling to take. All of a sudden, ADT was back at square one, and a stunned Herzog was left to plot her next move.

Under the terms of her arrangement with McDonald's, reached in November 2001, no money changed hands. Herzog simply agreed to give McDonald's the Shop 2000 for a six-month test and provide technical support. Once the test was over, McDonald's could buy the machine or walk away. It wasn't the most lucrative deal, but the timing was great. Herzog, who had previously founded a successful packaging company, had been marketing the Shop 2000 to convenience stores and gasoline companies for use at service stations. Then, September 11 hit. By the time McDonald's called, Herzog, ADT's sole investor (she declined to say how much money she has put into the company), had just laid off all six of her employees. "This was the chance of a lifetime," she says.

Herzog put three of her employees back on the payroll and began working around the clock, preparing the Shop 2000 for its debut. McDonald's, meanwhile, scouted for the perfect location. In August 2002, the company found it: a busy spot in the trendy Adams Morgan neighborhood of Washington, D.C., where it was stumbled upon by a reporter for The New York Times. Suddenly, Herzog's tiny company found itself on the paper's front page, triggering requests for interviews from all over the world. In November 2002, Time magazine named the Shop 2000 one of the coolest inventions of the year.

The machine performed well, Herzog says, handling tens of thousands of transactions. But with McDonald's out of the picture, she had some big decisions to make. Because the idea of an automated convenience store is foreign to most Americans--such technology is commonplace in Japan and parts of Europe--she had always planned on partnering with another company. The idea was to have ADT sell the machine and the technology, while relying on the partner to help generate buzz and demand. Clearly, the six-month test with McDonald's had accomplished that. The question was what to do next.

The McDonald's test had resulted in loads of valuable data and user feedback, about everything from the ease of paying with cash versus credit cards to how often the machine was used at various times of the day and night. Incorporating such information into a new prototype would make the Shop 2000 a stronger product than ever, Herzog believed. The feedback also suggested new markets to target. But with no revenue and three people on the payroll, it would be hard for ADT to do everything at once.

The Decision

Herzog sees her time with McDonald's as a "high-profile" beta test and is thankful for all the free publicity.

But that's precisely what Herzog set out to do. First, she and her staff began making changes to the Shop 2000 based on the input they had received. They split the machine into modular units, which makes it both easier and cheaper to move around and more customizable. The new prototype also is easier to put into indoor settings like building lobbies, where it's less vulnerable to foul weather and vandalism. They also retooled the Shop 2000's software to make it more user-friendly.

As for marketing, Herzog figured her best bet was to target the university and hotel markets. After all, both provide access to large groups of captive customers--a typical state university campus houses thousands of students, who often need to make small purchases at odd hours and who don't want to get into the car to pick up a disposable camera or a 12-pack of Diet Coke. She hired a freelance sales rep familiar with the college market, and says she expects to have as many as 25 machines up and running by the end of 2004. Office parks and corporate campuses are another potential market, since many tend to be in isolated locations. She's also returning to the gas station market. Back in 2001, Herzog had conducted a six-month test of the Shop 2000 at a gas station convenience store near ADT's headquarters. But the location never generated enough traffic to make the machine pay off. After the McDonald's test, Herzog knew that the technology works at busier locations.

Despite such plans, Herzog has yet to close a sale. But she remains optimistic and does not seem the least bit bitter. Of course, it helps that several months after her break-up lunch, Herzog learned that, in a major corporate shakeup, McDonald's disbanded its innovation task force. What's more, in November 2003, after testing the Belgian machine at four different locations in greater Washington, the company announced that it was ending the experiment altogether. A McDonald's spokeswoman declined to comment. Herzog, for her part, looks at her time with McDonald's as a "high-profile beta test," and remains thankful for all the free publicity it generated. After all, she says, "you don't necessarily marry everyone you date."

The Experts Weigh In

Richard Atnip

Founder and President
Atnip Co., a vending supply company based in Fullerton, Calif.

The idea clearly has a lot of merit, which is why a big company like McDonald's looked at it in the first place. Given how small ADT is, it definitely needs to find another partner--maybe a convenience store chain, grocery store chain, or gasoline company. Americans are still a bit behind when it comes to the acceptance of an automatic machine like this, but it's clearly the future. In a way, it's just like the ATM. There was resistance to that, too.

Michael Kasavana

Professor
The School of Hospitality Business, Michigan State University

This technology has promise. The vending market is $29 billion to $40 billion and I think this type of technology has the potential to capture 10% to 15% of that market. Obviously, losing McDonald's was a significant setback. Should Herzog have tried to find another big partner rather than "going back to the drawing board"? No. A big partner can be deceiving. While McDonald's is dominant in its marketing channel, there is no reason to assume expertise in an unrelated channel. Having the right partner is far more important than having a big partner.

Paul Kelly

Founder
Silvermine Consulting Group, a retail consultancy in Westport, Conn.

In targeting a new national partner, ADT needs to recognize that a vending machine with 200 items requires a fair amount of time just to take in what's available--no less make a buying decision. An optimum location should be a place where consumers are stuck with nothing to do. Anything automotive--oil-change stores, dealer service areas, car washes--fits the bill. The health care system also keeps people waiting. And gas station convenience stores have a terrible time encouraging customers to come in from the self-service pumps. A strategically placed Shop 2000 might be an attractive supplement to the store.

Last updated: Mar 1, 2004




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