Transcript
Tip (0:00)
You're listening to Tip.
Kyle Grieve (0:03)
Coca Cola might just be the most iconic business in history. Not only is Coke one of the most recognized brands in the world, but it's also one of the most consumed brands worldwide. Its products were drunk over 2.2 billion times yesterday. And that's not hyperbole. It just speaks volumes to the reach and staying power Coke has built over decades. When I started digging into Coke's rich history, strategy and leadership, I began to understand why it's created so much value for shareholders and how it's managed to embed itself into everyday life in nearly every corner of the globe. In this episode, I'll examine Coca Cola through a few key lenses. We'll explore the remarkable leadership of Roberto Goizuera, the chemical engineer turned CEO who helped right the ship when the business had lost its way. Under his tutelage, Coke became a more focused business. It scaled intelligently and embrace capital allocation to its fullest extent. His use of economic value added to just guide decision making is an absolute masterclass in financial discipline from which I think any investor or business owner can draw insights. Next, we'll examine Coca Cola's enduring competitive advantages, from its untouchable brand and secret recipe to its economies of scale and its network effects that rival those of some of the world's biggest tech companies. We'll also examine why it's nearly impossible to replicate Coke's unique taste, distribution and or mental real estate inside customers minds. Coke is the gold standard when discussing moats, and I'd like to help explore exactly why that is. And last but not least, we'll revisit Berkshire Hathaway's investment in Coke to better understand Warren Buffett and Charlie Munger's obsession with it in the 1980s. We'll walk through Buffett's 12 tenets, which he used to analyze the Coca Cola business and investment opportunity. Plus, we'll closely examine how Munger used a series of just brilliant metal models to imagine Coke as a $2 trillion business. The thought process Munger used here is a masterclass in multidisciplinary thinking. I know fans of metal models will thoroughly enjoy it. This episode is really for investors who want to sharpen their understanding of durable competitive advantages. So if you're a curious stock investor researching legendary capital allocators or just a business owner looking for an edge, this one's for you. Now, let's get right into this week's episode about Coca Cola. Since 2014, and through more than 180 million downloads, we've studied the financial markets and read the books that influence self made billionaires the most.
Tip (2:32)
We keep you informed and prepared for the unexpected.
Kyle Grieve (2:35)
Now for your host, Kyle Grieve. Welcome to the Investors Podcast. I'm your host Kyle Grieve and today we'll be discussing one of the best known brands the world has ever known, Coca Cola. I'll be focused on looking at Coca Cola through a few primary lenses, which are the Roberto Goizueta years, the Berkshire Hathaway connection, and its competitive advantages that have been built out that still exist today. Now, I've spent considerable time reading about Coca Cola over the years. While I admit it's a well entrenched, strong MO business, the potential returns just have never felt attractive enough for me to warrant an investment. And for that reason, my knowledge of Coke has always been focused on its competitive advantages more so than the unit economics. The competitive advantages of Coke are pretty simple. The first one is the brand. Every person listening to this podcast has heard of Coke. Very few businesses can make this claim, but Coke is one of the most recognized brands in the entire world. The second is intellectual property. While Coke has a mountain of imitators and competitors, nothing out there just tastes like Coca Cola. The taste is very distinct and I've yet to find an off brand Coke that tastes nearly as good as the Coca Cola brand. The third one is economies of scale. Coca Cola has unique scale advantages that just really aren't inimitable. Their distribution system is nearly impossible to penetrate and they have set up the business to have tentacles and nearly every area of earth. This share of people's mouths, as Goizuera put it, is sky high and few companies have the capabilities that Coke has. And the last one here is network effects. Most people associate network effects with, you know, tech companies, and it's easy to see why several of the best companies on earth have this competitive advantage. Businesses like Meta, Amazon and Google have some of the strongest network effects in existence. But ask yourself, when was the last time that you walked into a grocery store, convenience store or gas station and didn't see a a Coca Cola product that was prominently displayed? The reason is that as more people want Coca Cola products, it forces retailers to carry their products. Throughout this episode, I'll go a lot more in depth into all four of these competitive advantages now. Like all businesses, Coca Cola has grown into the behemoth that it is today. Throughout its history, it's had periods of great growth, and that is the period that I kind of want to focus on most today. And it just so happens that this period in which Coca Cola delivered outsized returns to its shareholders coincided with a few keys, the most important one being Roberto Goizueta's leadership. We'll be covering many of his leadership skills and how he helped provide so much value to shareholders while he was the leader of the company. Business success can also be a function of being at the right time and place. And I think Goizueta took over when Coca Cola was just ripe for scaling. We'll go over some of the unique setups that Coca Cola had working for them as a tailwind and that are now near fully penetrated. And then finally, it's no coincidence that Warren Buffett invested in Coca Cola right as they were beginning their rapid growth trajectory. Warren and Charlie understood and might still understand Coke better than nearly anybody. So I would be amiss, not to mention some of their great commentary on the business. While their ownership of Coca Cola was excellent for the first 10 years, the returns faded, but they have been beating the index since a massive peak in 1998. We'll review why Buffett has held Coca Cola for as long as he had, but let's start this episode by briefly discussing Coke's origin story and their business model. So I'm not going to get too much in depth here on Coke's origin story, as there are just, you know, full documentaries out there on YouTube that you can watch for free. That does it at a very high level. But I do want to discuss a few things that I think are important. The first one is that Coca Cola has been around for a really long time. So it was initially formulated in 1886 by a doctor named John Pemberton. Funny enough, it was originally an alcoholic beverage and was considered a Coca wine alternative. It was reformulated to avoid Prohibition laws and the alcohol was removed from the recipe. At that time, it was just selling in an Atlanta pharmacy as a fountain drink in those early days. Pemberton eventually sold the business, which was renamed Coca Cola, to a gentleman named Assa Candler. Asa Candler incorporated Coca Cola in 1892, and from then on, you know, the company just grew like wildfire. Once Candler took over, he began expanding its distribution and marketing nationwide. By 1899, the first bottling agreement was signed, which was a major turning point for soda producers. Up until this point, all soda was offered as a fountain drink. Moving forward, bottlers would be taking care of a lot of the distribution, which would obviously allow for a mass distribution. In 1919, Coca Cola was sold to Ernest Woodruff for about $25 million now that's important because Ernest's son, Robert Woodruff, later became the president of Coca Cola and continued with a leadership role as part of the business for nearly 60 years. So Robert Woodruff was also integral into the hiring of Roberto Goizuera. Over the next few decades, the business expanded its products and offerings to things like Fanta, Sprite and Minutemade. International expansion was working and therefore their global marketing force was beginning to mold into the powerhouse that it became. But you know, as with all successful businesses, competition begins heating up. And that's exactly what happened. In the 1970s, Pepsi had been a big competitor. And during this time period, Coca Cola actually started losing US market share to Pepsi. Now I'll end the intro there because the rest of it I think is going to take off once I really get into Roberto Goizuera. But before we transition here, I'd like to share Coca Cola's business model. It might be a little different than you think if you haven't spent much time researching the business. So Coca Cola has two primary business lines right now, today. The first is the sale of its concentrates to its bottlers. This line of business is very attractive as it's asset light and high margin. It's pretty simple. They literally just sell the concentrates in the syrup to their bottlers and to their fountain retailers. In the case of a bottler, they do a lot of the work by adding things like water sweeteners, packaging the product and handling logistics. The second business line is the finished product operations. This is a lower margin and more capital intensive business for this business segment. Coca Cola handles end to end product production. So you know, they're basically doing what their bottlers do on top of offering the syrup and concentrates. So using this model, they make more in total gross revenue per unit, but the margins are a lot lower compared to the concentrates business model. Now when reading about Coca Cola, I always wondered, you know, why do they have this other business line when it's an inferior business to the concentrates? But the reason is basically to solve a problem. And that problem is that Coca Cola needs to have its bottlers working efficiently and preferably all around the world. And if they aren't, Coca Cola is going to feel the brunt of it because that means that they can't sell as much syrup and obviously they don't want that. So in order to fix that problem, Coca Cola has a long history of acquiring some of their bottlers to help assist them get them back on their feet, fix up the operations and then either resell them or they just keep them in house. Now let's get back here to Roberto Goizuera. So Roberto Goizuera's foray into working with Coca Cola was pretty fascinating because he had a pretty comfortable job working for his father, Chris Pula Goizuera, where he was making pretty good money. But after getting some experience under his father, he knew that he just didn't want to go the route of being the boss's son. So his education as a chemical engineer helped him find many different jobs. But he actually settled on a subsidiary of Coca Cola that was located in Cuba. And he actually took a 50 pay cut just to take that job. Now it's important to remember here that Roberto came from a pretty successful line of entrepreneurs. His grandfather instilled some powerful business principles that Roberto brought with him throughout his entire career. These were to be hard working, to be thrifty, understand the importance of cash, and abhor debt. And from his father, he really learned a lot about alignment. So. So his father actually suggested that he buy a hundred shares of Coca Cola when he got the job with them. He told Roberto, you shouldn't work for someone else, you should work for yourself. So his father suggested you buy the shares, which his father then lent him money for. And those shares were reportedly never sold until Roberto's unfortunate passing. Now, Goizuera was forced to leave Cuba during Castro's uprising, but luckily he had this job with Coke waiting for him once he landed in the U.S. goizueta settled in Miami and was well known in the Cuban community there. He was even offered a job that would double his salary outside of Coke, of course. And his wife wanted him to pursue it, but he replied, I love working at Coca Cola so much that I do it for free if I could. This tends to be a great attitude to have in a leader. And while Goy Suetta wasn't an executive at the time, you can tell that he clearly loved Coca Cola very, very much. We now know that Goy Sueta loved Coca Cola. But let's review why everyone else, like their customers, also love Coca Cola. So Coca Cola served 2.2 billion servings of its product yesterday. And this is all the brand under its umbrella, and not just Coca Cola itself. But ask yourself why that is. I'm going to take a few stabs at that right now. So in his excellent book Seven Powers, Hamilton Helmer defines brand as an asset that communicates information and evokes positive emotions in the customer, leading to an increased willingness to pay for the product. He further breaks it down into two parts. The first part he calls effective valence, which is just a fancy way of saying that strong brands build a good association with its customer. This association is so strong that it's distinct from the objective value of the good, which is why people are more willing to pay up for Coca Cola than an alternative. And the second is uncertainty reduction. This is less applicable as you usually get certainty in any beverage you buy. But maybe you've had a bad bottle of Pepsi at some point in your lifetime, which increases your uncertainty of Pepsi. And I've actually had this happen before, specifically with Pepsi. In that case, you might prefer the Coca Cola brand because you've never had had a bad experience with the product, which also is true for me. Now, the final relevant part about branding that Helmer mentions is something called hysteresis. So hysteresis means the longer a brand is around, the longer the period of reinforcing actions. This long term reinforcement causes the brand to become stronger and stronger as it ages. Coke has been around since 1886, which is a huge advantage for the brand. I think Coca Cola has been very intentional as well about how it's built its brand. And today it has the money to continue building its customer relationships. So in fiscal 2024, Coca Cola spent $5 billion on advertising. This figure represents about 11% of the revenue. Spending that much on advertising can be seen as a negative for some companies. The reasoning behind that is that marketing becomes kind of this fixed cost. And if you're spending decreases, like let's say you decide to spend less on marketing, well then in that case, sometimes your revenue will decrease and sometimes at even higher rate of that decrease in advertising spend. But in the case of Coca Cola, I don't really see it the same way because the brand is just so resilient that, you know, would it have decreased growth if it decreased its advertising spend? Probably, but I don't think that it would necessarily lose a lot of its customers. Whereas smaller brands in a similar situation that obviously don't have that track record probably would get punished for decreasing their advertising. So, you know, the point is, is that fixed costs as a percentage of revenue are very valuable to this actual business. And this helps them avoid destroying shareholder value because they have this long, long history, decades long, of launching successful advertising campaigns. Now, speaking from personal experience, I like Coca Cola as a king of Colas because I just think it tastes the best out of all of them. Perhaps subconsciously, with all the advertising that I've been exposed to throughout my whole life. I'm also leaning their way due to the brand's strength. It's pretty hard to say. Now, speaking of taste, this transitions pretty well to discussing Coca Cola's intellectual property. Since I've already leaned on Hamilton Helmer here, we'll be using the term cornered resources and intellectual property interchangeably. Hamilton defines cornered resources as a preferential access at attractive terms to a coveted asset that can independently enhance value. One very valuable part of the corner resource equation is its ability to be transferable. So if we went through a little thought experiment here using Coca Cola as an example, we know that the recipe for Coca Cola is known by a very small group of people. As a side note, there's a myth that only two people know it, but it's a myth. It's not true. But we do know that the group that does know it is very, very small. Now, the important part is that if the Coca Cola recipe were sold to another business, they can then use it and sell the beverage. If they could sell it as Coca Cola and not as a different brand, I would guess it would do very, very well. If the beverage had to be rebranded, it's hard to say if it would do as well because it wouldn't be able to take advantage of all the goodwill and trust that Coca Cola brand has built with its customers over so many years. But as I mentioned before, I personally like Coca Cola because of its taste. So if there was another off brand company that were to get its hands on the recipe, I would have no problem just switching to that brand because I think it's the best tasting Cola out there. Whether it says Coca Cola or not doesn't matter much to me from a business sense. If another company were to buy Coca Cola, the brand and its recipe, I think it would probably do very, very well. There's no reason to believe that this would happen as Coca Cola has had so much success throughout the years. But let's just pretend it was acquired. You could argue that the acquirer would not manage the business as well as Coca Cola has over all these years. And I don't have many arguments with that statement either. But you know, maybe it would be the case of if a business like Coca Cola were acquired, perhaps the acquirer would then just allow Coca Cola to run as kind of an autonomous business unit, which would keep Coca Cola's strengths intact. Now, Coke has a few other competitive advantages, but we're going to touch on those later on in the episode. For now, I want to get back to visiting Roberto Goizueta's journey as Coke CEO and some of the amazing that he did for the company. The business required pretty significant adjustments before Roberto Goisueta took over as Coke CEO. In the Buffet Way by Robert Hagstrom the author mentions domestic and global setbacks that Coca Cola had to navigate. So there were two primary ones here. The first one was domestic issues. The company had to deal with legal challenges and reputational damage from some of its disputes that it had with its bottlers. They had allegations of labor mistreatment at its minute made groves, and they had a backlash from some environmentalists who were criticizing the use of single use containers. Additionally, the Federal Trade Commission also accused Coca Cola of violating the Sherman Antitrust act due to its exclusive franchise system. Let's take a quick break and hear from today's sponsors.
