Vending Machines Look Like a Great Business for the Future. So What Is Really Going On With Them in China?

It is not what you might imagine, and the tipping point the industry is waiting for may not have arrived yet.

At 11 a.m., on the ground floor of the 37 Games Building on Baihe Road in Guangzhou's Tianhe District, workers in the uniforms of eight catering companies, among them Kungfu, Ducheng Fast Food and Guang'an Noodles, are deftly sliding boxed lunches into transparent compartments lined up as neatly as mailboxes. Two staff members sit at computers, checking the status of every compartment and confirming the counts with the delivery workers.

An hour later, a crowd surges in. Each person uses an app on their phone to unlock an assigned compartment and takes out the lunch they ordered earlier that morning, or the day before. The six-storey office building has more than 1,000 employees, and about 80% of them get their lunch here. At this hour you have to watch out for getting bumped; there are simply too many people.

The "canteen" on the ground floor of the 37 Games Building

This is not a staff canteen. The thousand-plus neatly arranged compartments are in fact 20 vending machines, or, more precisely, a "Ubox Convenience Store," run by the Shenzhen company Ubox. If you happen to visit the Yintai.com office or the Civil Aviation Information Center in Beijing at noon, you will see people buying Hehegu fast food from vending machines in the same way.

This looks nothing like Japan, the country where vending machines are most developed. We recently reported on the power of Japan's vending machines, and one reader commented: "In Shizuoka there was once an intersection with 15 vending machines (within a 50-meter radius). I felt surrounded by robots." As of last year Japan had 5.03 million vending machines, one for every 25 people.

In Japan, vending machines are everywhere, and although convenience stores abound, the machines still hold their own. In China, most vending machines are where you cannot see them. More than 50% are in factories and about 28% are in schools; only the rest stand on streets, in subway stations, in office buildings and the like.

Besides Ubox, vending machine operators include Shanghai Miyuan, Suzhou Lemei, Beijing Youlihui and others. China's first vending machine appeared in 2000; after 15 years, the country still has fewer than 100,000. Ubox, founded in 2010, owns about half of them: 38,000 machines, by its own count.

The "Ubox Convenience Store," a cluster of vending machines, is a format Ubox launched in 2013. It targets corporate customers like 37 Games, mostly tech companies or call centers, which share a few traits: frequent overtime, relatively closed-off premises, and nothing good to eat nearby.

In short, this is very far from the bustling Japanese vending machine scene we imagine.

"Take a 30-year-old Japanese office worker as the benchmark: one vending machine costs as much as he earns in a month. A machine costs 300,000 yen, so what you would pay one employee in a year buys you 12 vending machines," Huang Ronghui, Ubox's operations director, told QDaily. The arithmetic is crude, he said, but given Japan's high rents and labor costs, vending machines are clearly the better choice.

That, in Huang Ronghui's account, is one reason vending machines caught on in Japan. Another is that Japanese law treats 60 square centimeters of space under the eaves as private property, which is why you also see many slimmer machines "stuck" to the outside of houses. Beyond drinks, Japanese vending machines sell more than 6,000 kinds of goods, from rice balls and hot udon to underwear.

The rise of mobile payments and today's O2O (online-to-offline) fever have convinced Ubox that its big chance to grow has arrived. That does not mean giving you a new place to shop on the street, though. Instead, Ubox wants to keep taking over factories and schools in third- and fourth-tier cities. Its newer ideas include putting a machine in hospital infusion halls to sell medical supplies that patients pay for out of pocket, and placing machines in entertainment venues where customers scan a code to order. In other words, it still may not make vending machines feel like they are everywhere.

In July 2015, Ubox raised 530 million yuan from the Carlyle Group, the largest single financing in China's vending machine industry to date. "For us, it means vending machines in China are starting to win recognition from global capital markets," Ubox CEO Wang Bin told QDaily.

The deal was seen as a sign that the industry was turning a corner. In 2014 Ubox's revenue approached 1 billion yuan. It still lost more than 30 million yuan, but mostly because of management and R&D spending, and the loss shrinks every year. That narrowing loss is also why Carlyle was willing to invest. It, too, sees this as a good business for the future.

The vending machine combines fashionable ideas and new formats: convenience, no labor costs, endless possibilities for what to sell. All of these seem like reasons it could take off. Yet in China there never seems to have been a tipping point that made it truly popular. Why? And why does the biggest player in the Chinese market now seem to be steering it in a different direction?

Are new opportunities arriving for vending machines in China?

"Demand explodes once GDP per capita reaches US$10,000, and 7 of China's 35 provinces and municipalities have already reached that level. Ubox, which holds the largest market share, has multiple patents on smart vending machines, focuses on an O2O model, has room to profit from interactive advertising, and has a franchise model it can replicate quickly. Ubox has created a distinctive model combining retail and internet advertising," Gui Zhaoyu, managing director of Carlyle's Asia buyout team, has told the media, citing this as a key reason for the investment.

On Taobao's "Double 12" shopping day last year, every Alipay-enabled vending machine in subway stations, hospitals, campuses and office buildings joined a "buy a drink for one fen" promotion, covering 18 vending machine brands, including Ubox, Miyuan and Yichu.

"The vending machine (market) is definitely going to take off. A new technology has arrived," said Wang Bin. By new technology he mainly means mobile payment (the more detailed explanation later in this article will show why it is so disruptive for the whole industry).

Take Ubox. Its mobile payment partners include WeChat, Alipay and Baidu Wallet, and even carriers such as China Mobile and China Telecom take part through points redemption. As these big companies push resources into O2O businesses, offline purchasing, once a closed channel, has begun to change fast.

The mobile internet boom has stretched everyone's imagination, and traditional industries like vending machines have found some new directions. Beyond changing the front end of the purchase through mobile payment, Ubox has built a smart networked system into its machines to make operations more efficient. It tracks in real time the quantity and type of goods in each machine, so restocking staff can read the back-end data and restock accordingly, instead of relying entirely on experience as before.

Consumers can also browse or buy goods through a companion phone app, which gives them more ways to interact with the machine. Ubox can use incentives such as cash-back to gather more data on what consumers want and pass more feedback to beverage suppliers.

Networked, touchscreen vending machines are not just good-looking. They also let a machine work better as a medium, carrying interactive ads and promotions. According to Mintel, 500 new drinks were launched last year. New products usually depend on offline retail to get onto shelves and test consumer reaction, and vending machines are a cheaper channel for that than convenience stores.

Why is China's vending machine market different from what we imagine?

Global Entrepreneur once profiled Huang Heng, a 24-year-old from Hubei. In early 2011 he quit his job as a migrant worker in Guangzhou and went into the vending machine business. He bought six machines and placed them on a workshop floor at a Great Wall Motor factory in Baoding, Hebei. The site was remote and hot, which was enough to keep this small business going.

A machine is like an unstaffed shop, and, as with any shop, location matters most; the industry calls it the "point." Factories and schools, crowded and barely commercialized, are fairly closed places to shop, which is why most of China's vending machines sit there. One result, not necessarily a good one, is that the industry's idea of success leans too heavily on the data these "points" produce. Li Shu, Ubox's marketing director, said the company once tried selling to office workers too, "but we lost heavily." The reason may be that it carried its factory playbook straight into office buildings, where the customers were in fact different.

Huang Heng may have used connections to get into that factory, but once a business grows, finding new points becomes extremely hard. Rents no longer come at a discount, and the costs of logistics and buying machines start to bite. According to people in China's industry, a machine takes at least three years after purchase to turn a profit, and in every peak season even the most experienced delivery workers make wasted trips.

"This industry is strange. With a few dozen or a hundred machines you make good money; past 500 machines, you stop making money," Wang Bin said.

Nankai Gode, the first pioneer of China's vending machine market, died of scale. Fifteen years ago, within three years, it placed and ran nearly 30,000 machines in dozens of cities and raised nearly 1 billion yuan. But a heavy financial burden, the cost of managing staff and poor execution gradually dragged the company down. Toward the end it even depreciated its machines over eight years to manufacture the illusion of a thin profit and obtain financing by deception.

"China's market is enormously deep: first-, second-, third-, fourth-, fifth- and sixth-tier cities, too many areas to develop. Japan basically has two. One is Tokyo and Yokohama, called the Keihin industrial belt; the other is Kansai, the Hanshin industrial belt (Osaka and Kobe). Seventy to 80 percent of Japan's population lives in those two places, so once you have covered them you are basically done," Huang Ronghui told us. A market this vast makes it harder to manage vending machines centrally.

Another big reason machines struggle to earn back their cost is breakdowns. In university dormitory areas, subway stations and on street corners, you still occasionally see someone kicking a machine, a pained look on their face.

Most Chinese consumers are used to vending machines swallowing their coins. Because most operators were too small, makers of imported machines such as Fuji Bingshan (the Chinese joint venture of Japan's Fuji Electric) would not work with them, so domestically made machines dominated in the early years.

"In 2004 and 2005 we bought domestic equipment, and we spent basically every day doing nothing but fixing breakdowns. If one bottle won't come out, the customers behind can't buy anything either, and that is how you lose money," Huang Ronghui said.

Why do China's vending machine companies, compared with Japan's, feel they have strength they cannot use?

In Japan, the best-selling item in a drinks vending machine is the 500-milliliter bottle, usually priced at 150 to 180 yen.

The decade from 1970 to 1980 was the golden age of Japanese vending machines; their number jumped from 1 million to 4 million. Many forces drove this: rising incomes (the working time needed to buy a can of drink fell to a few minutes), government support for sole proprietors (small businesses paid almost no tax in their first few years), and the entry of beverage makers. Of the 2.56 million drinks vending machines in Japan today, more than 70% belong to beverage makers such as Coca-Cola, which earn more by cutting out middlemen.

"Coca-Cola treats vending machines as an indispensable part of its global channel management, and that is really because of its success in Japan; the US headquarters rethought and redefined the channel," Huang Ronghui said. That is why you see Coca-Cola doing so much vending-machine marketing around the world. Thanks to the strength of vending machines, Coca-Cola has more than 100 drinks in Japan, far more than it sells in the US.

In April 2014, Japan raised its consumption tax from 5% to 8%, and Coca-Cola promptly announced a 10-yen price rise on some drinks sold through vending machines. To meet the sudden surge in demand for 10-yen coins, Japan's Ministry of Finance raised its 2014 coin minting by 36%, and the major soft drink maker Suntory announced that "since April, we have increased the stock of 10-yen coins in our vending machines." A policy change that hit the industry hard was quickly absorbed. Li Shu, Ubox's marketing manager, sighed that if China issued a 5-yuan coin, it would help the industry enormously.

Japan has six coin denominations: 500, 100, 50, 10, 5 and 1 yen. In China, if you feed a 20-yuan note into a vending machine to buy a 3-yuan cola, you get 17 one-yuan coins back, which is maddening. For Chinese operators, after a few such sales a machine may stop working because it has run out of change; a machine can hold only so many coins. Another problem: sometimes your 5-yuan note is so worn that the machine cannot even recognize it.

There are many more examples like this, where something as small as coins becomes a major obstacle for the industry.

The vending machine business is built on standardization, and so are the drinks it sells. Japanese drinks come in wildly different package designs, but their bottles are all roughly the same size, so that they can easily go into vending machines. In China, drink bottles come in all sorts of odd shapes, and very few fit a machine's product slots. Some unusually shaped ones cannot be loaded at all, such as Nongfu Spring's funnel-shaped "Da Nai Cha" milk tea, which tends to jam if forced in.

What these oddly shaped drinks have in common: they were launched in the last few years, cost more than 4 yuan, are mostly juices and teas, and target white-collar workers. The industry consensus is that drinks priced above 4 yuan basically do not sell in vending machines. Carbonated drinks and juices make up 90% of sales and stock, said Li Shu, Ubox's marketing director. "You may see lots of different products in a machine, but there may be several times as many slots behind the cola as for any other drink."

Why will the vending machine of China's future be something different from the traditional vending machine?

At the start of this year Ubox opened up franchising. In its words, the goal is to "turn former competitors into partners" by renting and selling machines as cheaply as possible to people who control good points. Ubox makes almost nothing on the machines; what it is really selling is software.

Of the six banner ads on Ubox's homepage, the first three are about franchising. One reads: "Franchise must-read: an in-depth look at WeChat Shop Watch." WeChat Shop Watch is the back-end system Ubox calls "smart operations." It lets an operator monitor machines by phone and see, in real time, each machine's stock level, whether it is short of coins and whether it needs restocking.

The benefits of managing by data are obvious: you can restock at the right time and save money. When a delivery truck carries 70,000 cans a month instead of 60,000, average output per machine rises. "We have made the vending machine foolproof and turned it into a business anyone can replicate," Huang Ronghui said, explaining why the technology matters. "In six months, a newcomer can do about as well as someone who has worked with me for ten years."

Wang Bin is proud of the system too. "Japan's vending machine industry is actually quite traditional as well (in how it operates). Next month the Japan Vending Machine Manufacturers Association is inviting us over for an exchange, because they want our technology." This is the biggest difference between Ubox and other vending machine brands, and what Wang Bin sees as its strongest competitive edge. Ubox has spent heavily on the software. According to figures from Wang Bin, the company's R&D spending last year was about 100 million yuan, a large share of it on this system.

The app developed by Ubox

Ubox now calls itself a technology company first, and it is eager to sign up more partners and put machines in more places. "We still focus on building the system and making everything modular, so it will be easier to plug in all kinds of things later." For the company's future, Wang Bin wants an asset-light software platform, because "once the platform is big, I can sell advertising; an individual operator with eight or ten machines can't." The purchase data from mobile payments lets Ubox give beverage makers more feedback, and even build targeted advertising services. "This year our advertising revenue will be around 100 to 200 million yuan, which was unthinkable in this industry before," Wang Bin said.

So now you can probably make sense of the scene at the start of this article: the new vending machine is an entirely different thing from the traditional one.

Looking back at Japan's success with vending machines, people in the industry like to point to the 1970 Osaka World Expo as the tipping point.

The Expo drew a record 64.22 million visits; one in every four people in Japan went to the site. It amounted to introducing the vending machine to the whole country.

But by then the purchasing power, the technology and the demand were all already in place. In 1970 Japan had risen to become the second-largest developed economy in the world, with GDP per capita of US$1,996.

In China today, all of these conditions may already be in place. It looks like a good business for the future. In a city like Beijing, short on convenience stores, both office buildings and residential compounds need better retail. China's labor costs keep rising, which also works in its favor.

Even with Carlyle's backing, though, the tipping point the industry hopes for may not have arrived yet.

Note: An earlier version of this article wrongly described the vending machine manufacturer Yichu as an operator. This has been corrected, and we apologize to readers and the companies concerned.

Graphics: Lin Yuyao. Liu Ximing also contributed to this article.