Coca-Cola: How did "happy fat house water" become the favorite of the "stock god"?

Coca-Cola: How Did "Happy Fat House Water" Become the Favorite of the "Stock God"? $Coca Cola(KO.US)

To this day, if we talk about the "leader" in the global non-alcoholic beverage industry, Coca-Cola undoubtedly takes the crown. With over 500 non-alcoholic beverage brands under its belt, its lineup is truly luxurious, and its products are sold in more than 200 countries and regions worldwide, garnering countless fans wherever it goes. This time, Dolphin will transform into a "business detective," digging deep into the "hidden tricks" behind Coca-Cola's success, to see how it has remained unshakeable in the fiercely competitive soft drink industry and firmly holds the throne of industry dominance.

This article serves as the first part of a series on Coca-Cola, focusing on a "historical review," qualitatively sorting out how Coca-Cola overcame challenges in its early years in the U.S. and the clever strategies it employed to gradually expand its market share and solidify its soft drink empire on its journey toward globalization.

In the next part, Dolphin will delve more into the quantitative aspects, exploring what factors have quietly driven Coca-Cola's valuation to rise over different stages of development, and looking ahead to where this "giant ship" can sail next and how much growth potential remains.

1. What Kind of Company is Coca-Cola?

1.1 A Deep Dive into Coca-Cola's Business Landscape

As investors, you are surely familiar with the name Coca-Cola. However, when it comes to the vast and complex business landscape it encompasses, many may still only have a superficial understanding. Today, Dolphin will guide you to re-recognize this legendary company from a business perspective, laying a solid foundation for further in-depth analysis.

According to Coca-Cola's 2023 financial report, the company's total revenue for the year was $45.75 billion, with a net profit of $10.71 billion. The gross margin and net margin reached 60% and 22%, respectively, making it a ceiling existence in terms of revenue and profit among soft drink companies (although Pepsi's total revenue is higher than Coca-Cola's, its food business accounts for 59%, translating to soft drink revenue of $37.5 billion).

In terms of business categories, Coca-Cola is truly an "all-rounder," spanning major categories of soft drinks. It dominates the fields of carbonated drinks, juices, ready-to-drink tea, and bottled water. While its sports drinks are slightly behind Pepsi, ranking second, its ready-to-drink coffee is weaker than Starbucks, coming in third, and its energy drinks, backed by a 16.7% stake in Monster, can still hold the position of "Dragon Two" after Red Bull.

From the perspective of Coca-Cola's own category share, although the awakening of consumer health awareness in recent years has somewhat "held back" the growth of the carbonated beverage category, it still contributes 64% of Coca-Cola's sales, making it a solid cornerstone business for the company. Based on its commitment to the carbonated beverage core business, the company has also timely seized the trend of rapid growth in non-carbonated beverages, gradually transforming towards a full-category soft drink model. As shown in the chart below, water, sports drinks, and ready-to-drink coffee have seen significant growth in recent years.

From a regional perspective, Coca-Cola can be described as a "master of balance," with operations across all continents, truly embodying the characteristics of a multinational giant. The North American market accounts for only 37% of its domestic business. In recent years, thanks to the advancement of Coca-Cola's full-category strategy, the company has continuously expanded its product categories in North America, increasing its business layout in non-carbonated beverages, leading to a recovery in revenue share from its "home base."

Considering all this information, it is not difficult to see that Coca-Cola is a "soft drink aircraft carrier" with global operations and diversified categories, large in scale and high in profit, truly deserving the title of "soft drink leader."

2. What transformations has Coca-Cola's business model undergone?

When it comes to Coca-Cola's business model, it firmly holds the lifeblood of the industry. Coca-Cola's unique franchising model is at its core. In this model, Coca-Cola focuses on product research and development and brand building, while the production and sales of these capital-intensive segments are managed by franchised bottlers.

Specifically, Coca-Cola is dedicated to producing concentrate, which it sells to bottlers. The bottlers then bottle the product according to the high standards set by the company, adding water, carbon dioxide, sweeteners, and other substances before pushing it to various market channels. This clever design lays a solid foundation for Coca-Cola's global expansion:

On one hand, the company can strictly control the production and sales processes of its numerous products, ensuring that all products meet the company's brand image and quality standards, allowing consumers, regardless of where they are, to maintain a relatively consistent quality and taste when purchasing various beverages under the Coca-Cola brand.

On the other hand, the use of the franchising model allows Coca-Cola to avoid the need to invest in building a large number of production plants and sales channels, significantly reducing production and operational costs, and enabling more flexibility in responding to local market changes. Moreover, most importantly, from the perspective of value creation, the concentrate is the core of the value chain, with production profit margins frighteningly high, reaching 50% - 60%. Compared to the bottling segment (10% - 15%) and downstream distribution (around 40%), the bargaining power is firmly in hand, easily allowing control over the entire franchising network.**

Source: Company announcement, Dolphin Research

Understanding Coca-Cola's franchising model is at the core of our analysis of its business model. However, Coca-Cola's journey has not been a static one. In the process of globalization, it has undergone two significant shifts between asset-light and asset-heavy models, with the core difference being the adjustment of the franchising ratio at different stages.

Before 1980: Asset-light + Franchising propelled Coca-Cola's rapid global expansion: In 1920, Coca-Cola began franchising overseas. By collaborating with local bottlers, Coca-Cola quickly established an efficient brand communication network globally. However, the quality of the bottlers varied, with some small bottlers lacking in quality control and financial capacity. This stage can be understood as Coca-Cola's period of wild growth in globalization.

1980-2015: Gradually reclaiming franchising rights and establishing a bottling investment department. In 1980, facing fierce competition from Pepsi, Coca-Cola began acquiring and integrating small bottlers to gain stronger control over production and sales, enhancing its competitiveness.

The proportion of bottling businesses owned by Coca-Cola increased from 18% in 1981 to 66% in 1998 (in 1986, Coca-Cola spun off its previously acquired North American and Western European bottling plants to list Coca-Cola Enterprises (CCE)).

In 2006, Coca-Cola established the Bottling Investments Group (BIG) and continued to acquire underperforming bottling plants for renovation, ensuring the continuous output of high-quality products. During this stage, the company shifted to a heavy asset operation model by strengthening control over bottling plants, optimizing production and sales processes, and improving operational efficiency. However, large-scale investments in bottling plants also led to a significant issue—capital return rates dropped sharply, with ROE falling from around 40% to about 24%.

From 2015 to present: Reconstructing the franchising system, returning to an asset-light operation. With the previous improvements in bottler operations and efficiency, in 2015, Coca-Cola proposed a strategy to reconstruct the franchising system, divesting most of the bottling investment department's businesses and further integrating the bottling system, returning to an asset-light operation model.

This time, the asset-light model is different from the earlier "wild growth" phase. After integration, the remaining bottlers are large, well-funded, and have significantly improved internal collaboration capabilities, with ROE returning to above 40%.

Source: Company Announcement, Dolphin Research

From sales-driven to profit-driven, highly binding with bottlers. In addition to the significant transformation of the asset operation model, the adjustment of the concentrate pricing model also hides secrets. Previously, the price of concentrate sold by Coca-Cola to bottlers was fixed, and revenue growth relied entirely on sales "holding up."

Entering the 21st century, as the growth of carbonated beverages slowed, the company had a brainwave and signed a new pricing system with bottlers, changing the concentrate price to a floating system based on the percentage of revenue contribution from bottlers. With this adjustment, the interests of Coca-Cola and bottlers are more closely bound.

II. What are Coca-Cola's competitive advantages, scarcity, and growth potential?

In the previous article, Dolphin 君 analyzed Coca-Cola's business landscape and business model. It must be said that an excellent business model is the cornerstone of Coca-Cola's success. Next, let's delve deeper into the secrets of Coca-Cola's enduring success from the three factors of consumer goods companies (product, brand, channel).

1. Product strength: "Three axes" forge core competitiveness

1) Unique taste + light addictiveness, the repurchase "engine":

Any consumer goods company that can stand firm undoubtedly relies on solid products. Coca-Cola is no exception; its core product is the mysterious concentrate. The concentrate formula is exceptional, with a clever blend of various special ingredients that interact to create Coca-Cola's unique flavor, aroma, and taste.

Moreover, since Coca-Cola's inception in 1886, this formula has been treated as a top commercial secret, kept tightly under wraps and never disclosed. Additionally, the clever addition of caffeine in the ingredients not only refreshes and relieves stress but also carries a slight addictiveness. Once consumers have tried it, they are easily "captured," leading to a soaring repurchase rate, naturally extending the product lifecycle.

Furthermore, Dolphin 君 discovered while researching the soft drink category that soft drinks with caffeine and addictiveness seem to carry a halo effect, inherently possessing the potential for blockbuster success. Not only do they have long lifecycles, but they are also particularly easy to create big-selling products. According to Euromonitor data, brands like Coca-Cola, Pepsi, and Red Bull easily surpass 10 billion in sales for a single brand; in contrast, juice brands see consumers' tastes fluctuate, with loyalty being pitifully low, and there are only a handful of single products that can exceed 500 million in sales, with lifecycles that are fleeting. (Here, the sales situation in the Chinese market is used as an example.)

2) Affordable Pricing, a Representative of American Consumer Goods.

In terms of pricing strategy, Coca-Cola has been determined to be a mass consumer product since its inception, with a very precise positioning. When it was launched in 1886, the price was only 5 cents, significantly lower than the mainstream beverage price of 7-8 cents at that time, which instantly attracted a large wave of consumers to "join in."

Moreover, for the next 70 years, Coca-Cola maintained the price of 5 cents, and this long-term stable pricing strategy acted like a "calming pill" for consumers, allowing them to form a strong price expectation, which in turn increased their trust and loyalty towards the brand.

Stepping out of the American market, Coca-Cola did not "drop the ball," fully considering the income levels and consumption environments of different regions, and setting retail prices according to local conditions.

A glance at the prices in various countries shows that they are generally positively correlated with local per capita disposable income. In economically developed regions like Europe and America, prices are generally higher than in the Asia-Pacific region.

1. Flexibility and Diversification to Break the Deadlock, From Cola to Carbonated Drinks, From Carbonated Drinks to All Categories. Looking back at Coca-Cola's development history, the company focused solely on a big product strategy for the first 70 years. However, in the 1930s, with the onset of the Great Depression, Pepsi-Cola took the opportunity to initiate a price war, proclaiming the slogan "Same Price, Double Enjoyment," capturing a large number of price-sensitive consumers.

Additionally, in the 1960s, by focusing on the youth market and creating a youthful brand image, Pepsi attracted countless fans. Between 1940 and 1970, Pepsi-Cola's market share soared from 10.8% to 23.6%, while Coca-Cola's market share fell from 53% to 35%.

In the face of competition from Pepsi, Coca-Cola launched a diversification strategy to consolidate its market share, splitting its efforts into two paths:

a) One was to expand the carbonated beverage brand matrix. In 1955, 1962, and 1963, it successively launched orange-flavored Fanta, lemon-flavored Sprite, and low-sugar Tab, and in 1982, it extended its flagship product Coca-Cola's product line for the first time by launching Diet Coke.

This series of operations not only stopped the decline of the company's market share in carbonated beverages but also drove the entire American carbonated beverage market to expand significantly, with sales growing nearly tenfold from 1950 to 1998.

b) Secondly, entering the non-carbonated beverage sector: Coca-Cola acquired Minute Maid in 1960, successfully opening the door to the juice market, marking the official start of its diversification journey. Since then, the company has adopted a dual approach, focusing on both external acquisitions and internal research and development, gradually entering multiple segments such as juice, coffee, sports drinks, and bottled water.

Entering the 21st century, the growth rate of carbonated beverages slowed down, while the functional beverage and bottled water markets thrived. Coca-Cola seized the opportunity to accelerate its diversification efforts. In 2017, it boldly declared its ambition to become a full-category beverage company, and today, the revenue share of non-carbonated beverages has risen from 11% in 2000 to over 30%.

Source: Company reports, China International Capital Corporation Research Department

In summary, Coca-Cola is based on super flagship products, expanding its brand and product categories, and finely honing its approach from multiple dimensions such as demographics, taste, and consumption scenarios, achieving full coverage of target demographics, with performance steadily improving, successfully navigating the market cycle's challenges.

2. Brand Side: As the saying goes, "Good wine fears no alley." If unique taste and mild addictiveness have built a product moat for Coca-Cola, then its world-class marketing power is the key "code" for it to become a century-old brand that endures. To describe Coca-Cola's marketing strategy in one sentence: Continuously create and maintain conditioned responses, firmly grasping consumers' minds.

1) High-profile branding, strong marketing. From the day Coca-Cola was founded, it has never been low-key in marketing, always taking a high-profile approach. Reviewing the advertising investments in recent years, except for the pandemic in 2020, which forced a reduction in advertising spending, other years have seen "big investments," with advertising expenditures easily exceeding $4 billion, and the advertising expense ratio surpassing 10%. Compared to Pepsi and other fast-moving consumer goods companies, it is simply "financially extravagant."

Whether in traditional advertising venues like television, newspapers, and magazines, or in emerging channels like social media and search engines, Coca-Cola's advertisements can be seen everywhere. Moreover, it not only focuses on the volume of advertisements but also pays special attention to the return on investment. According to WARC statistics, during the period from 2019 to 2021, for every $1 spent on advertising, Coca-Cola's profits increased by 7%, demonstrating impressive marketing effectiveness.

2) Marketing is just a gimmick? In fact, it's real skill. Dolphin carefully sorted out the marketing focus of Coca-Cola at various stages and found that it is very good at "catering to the situation," always closely integrating with the characteristics of the times, social hotspots, and mainstream consumer groups to conduct targeted marketing, while continuously updating its marketing model. But no matter how it changes, the core remains a deep connection with consumers, firmly occupying their mindset.

1920-1940: After World War I, the U.S. economy recovered, and people's work and life rhythms accelerated, with a focus on pursuing happiness and escaping pressure. Coca-Cola seized the opportunity, emphasizing "relaxation and joy," highlighting the product's functionality of "refreshing and invigorating." In television advertisements, Coca-Cola was the absolute "main character" in joyful scenes such as parties and holidays, with a very high appearance rate. By the time of the Great Depression in the 1930s, it further deepened the "happiness" brand image and created the classic image of a white-bearded, smiling Santa Claus, successfully embedding the brand image of "happiness" in consumers' minds.

1940-1970: With the outbreak of World War II, the then CEO quickly seized the business opportunity to cooperate with the military, turning Coca-Cola into a military necessity. They promised that no matter the cost, soldiers in uniform would be able to buy a bottle of Coca-Cola for 5 cents. In advertisements, Coca-Cola was seen everywhere in the military, igniting patriotic feelings among the domestic populace, and Coca-Cola seamlessly integrated into American culture, cultivating global consumers' taste habits and brand recognition as the U.S. military spread around the world. After the war, global expansion went smoothly, and brand influence grew exponentially. The slogan "Only Coca-Cola is the real cola" highlighted its uniqueness and leadership position while further tightening its connection with American culture.

1980-1989: The U.S. entered the era of quality consumption, and Coca-Cola kept pace with the trend, focusing on the personality and lifestyle of "positivity and happiness," vigorously promoting the brand, repeatedly tying the brand to the American national image through slogans like "America's real choice" and "Look up, America," firmly rooting itself in American culture.

1990 to present: After 1990, American consumption became more rational, and Coca-Cola adapted accordingly, using slogans like "Always Coca-Cola" to consolidate its position as an industry leader, continuously conveying feelings of happiness, authenticity, and enjoyment to consumers.

Source: Company reports, Zhongjin Company Research Department3. Channel Side: Building the World's Largest Distribution Network

After more than 130 years of trials and tribulations, Coca-Cola has created the world's largest beverage distribution system, with a presence in over 200 countries and regions. "Everywhere" is the core essence of its channel strategy. So where does this deep and solid sales network come from?

1) Partnering with Bottlers for Comprehensive Support

Overall, Coca-Cola's channel distribution heavily relies on deep cooperation with bottlers, providing comprehensive support throughout the channel development process. In the early stages, they assist bottlers with market research, digging deep into consumer preferences and purchasing behaviors in various markets, while also helping to select reliable distributors and logistics providers to build an efficient sales network. In the mid-stage, they customize promotional strategies and advertising plans based on the characteristics of different market channels, ensuring that materials and financial support are well arranged. In the later stages, they do not forget to regularly provide professional training for the sales staff of bottlers to enhance their business capabilities and service levels, making channel maintenance and development smoother.

In addition to the channels developed in partnership with bottlers, Coca-Cola also establishes its own direct sales stores or points in certain specific markets or regions. For important clients such as large chain retailers and restaurants, Coca-Cola directly signs finished beverage supply agreements. Taking North America as an example, Coca-Cola's sales channels in North America can be divided into traditional retail channels, food service channels, vending machine channels, and e-commerce channels.

As early as the 1970s and 1980s, the company reached strategic agreements with major fast-food giants represented by McDonald's, Subway, and Burger King, which helped Coca-Cola achieve rapid expansion in the food service channel as these fast-food giants expanded their stores in the U.S. and international markets. In 2019, Coca-Cola's market share in the food service channel in the U.S. carbonated beverage market reached 57%, far exceeding the second-place Pepsi's 17%.

2) Flexible and Adaptable to Local Conditions

Another major advantage of Coca-Cola's channel model is its flexibility! The channel management strategy changes with different periods; channel policies can also be innovatively adjusted according to the national conditions of each country.

Taking the Chinese market as an example, in the early 2000s, the domestic market had a single and fragmented channel. If Coca-Cola relied solely on its own logistics distribution to serve those scattered, low-sales terminal customers, transportation and warehouse costs would be frighteningly high. Thus, the company came up with the idea to launch the 101 system: bottlers find a first-level distributor as a partner (101 customer) in the region, allowing the 101 customer to be responsible for product distribution, while the bottler sends salespeople to promote business across all channels.

This model is equivalent to regional cultivation, and compared to the traditional channel model, it eliminates the second-level wholesaler link, positioning the first-level distributor as the distributor. This significantly reduces Coca-Cola's own logistics and distribution costs, and in the early stages of channel development, they can rely on salespeople to directly control the terminals, achieving refined management.Later, as the Chinese economy took off, the channel terminal formats became increasingly diverse, with KA channels such as chain supermarkets and convenience stores, as well as immediate consumption and specialty channels like restaurants, KTVs, and bars all emerging. Coca-Cola responded quickly, shifting its channel strategy from regional cultivation to channel cultivation, and the division of labor among salespeople was adjusted from being region-based to channel-based, greatly increasing the level of specialization.

Source: Company reports, Dolphin Investment Research

Summary: Coca-Cola - Always being studied, very hard to imitate

After sorting out Coca-Cola, one clear feeling is that "Coca-Cola is very common, but Coca-Cola is also very unique." It is commonly seen as a global consumer product, and the company's name is directly synonymous with a category of consumer goods. However, it is also unique or has such deep barriers that, within such a large category of consumer goods, there is no decent non-American brand selling cola.

As a necessity for mass consumption, it has two very unique characteristics: the mysterious "concentrate" and the highly specialized business design (the precise division between product research and development, production, and distribution).

Firstly, the control of the concentrate makes it very difficult for Coca-Cola to be imitated (except for one local player, Pepsi; no overseas competitor has emerged regardless of how big they grow), having educated the market, it can also maintain its market position.

Secondly, the essence of the beverage concentrate is separated from the entire production process, and after strong self-control, the cooperation with bottling plants and distributors allows it to quickly expand globally at localized costs (local materials, local labor), and pricing can also be sufficiently grounded.

These two designs basically ensure that a. the product is hard to imitate; b. the same product has different prices in different locations, with pricing being sufficiently grounded, building a complete brand marketing, manufacturing, and channel capability using the super large category of carbonated beverages.

With a solid foundation in carbonated products, traffic, and marketing capabilities, expanding into multiple categories globally, whether through independent research and development or external acquisitions, is a natural progression.

In contrast, most consumer products that Dolphin has observed, after successfully expanding their categories, have countless competitors rushing in, and these competitors often do not perceive significant differences in the products during blind tastings.

Although it has long passed the growth stage, among the consumer products currently observed by Dolphin, Coca-Cola is not only equipped with a powerful core but also possesses capabilities that make it a versatile warrior, making it a rare consumer goods company with deep barriers.

In the next article, Dolphin will lead investors to explore the valuation drivers of Coca-Cola at different stages from a quantitative perspective and attempt to discuss whether it is still worth investing in at present. Stay tuned!