The Coca-Cola Company

Sector

AgrifoodRetail

Background

Freddie Lait is the Founder and Managing Partner at Latitude Investment Management. We cover Coca-Cola's brand dominance, how its bottling network creates a sustainable distribution moat, and what its innovation pipeline means for the future of beverages.

Cover

Date

November 15, 2023

Episode Number

136

Background / Overview

Founded in 1886 by Dr. John Pemberton in Atlanta, Georgia, The Coca-Cola Company has grown from a single syrup-based drink sold for $0.05 per glass to a global beverage powerhouse serving 2.2 billion servings daily across nearly every country except Cuba and North Korea. The company’s portfolio spans 26 billion-dollar brands, including Coca-Cola, Sprite, Fanta, Minute Maid, Costa Coffee, BODYARMOR, and fairlife, among others. While the flagship Coca-Cola brand remains dominant, it accounts for roughly 50% of the portfolio, with the company pursuing a "total beverage company" strategy by diversifying into sparkling water, juices, sports drinks, coffee, teas, and alcoholic beverages.

Coca-Cola’s business model is distinct in its capital-light franchise structure, where the company focuses on brand management, marketing, and concentrate production, while outsourcing bottling and distribution to independent partners. This network of bottlers, distributors, wholesalers, and retailers enables Coca-Cola to achieve global scale without the capital intensity of owning bottling operations. The company has undergone significant restructuring over the past two decades, refranchising bottling assets to optimize its capital structure and align incentives with bottlers.

Ownership / Fundraising / Recent Valuation

The Coca-Cola Company is publicly traded (NYSE: KO) and is a core holding of Berkshire Hathaway, among other institutional investors. The transcript does not provide specific details on recent fundraising or enterprise value (EV) transactions, but it highlights the company’s unleveraged balance sheet, with a net debt-to-EBITDA ratio of 2.0x to 2.5x, expected to decline further. The company generates significant free cash flow (FCF), estimated at $10 billion currently and projected to reach $12 billion soon, supporting dividends, share buybacks, and acquisitions. Valuation multiples are not explicitly stated, but the discussion suggests Coca-Cola’s stock has faced pressure from concerns about health trends and GLP-1 drugs, potentially compressing trading multiples.

Key Products / Services / Value Proposition

Coca-Cola’s portfolio is organized around its ambition to be a "total beverage company," with products spanning multiple categories. The key products and their value propositions are:

1. Coca-Cola (Trademark Coke): The flagship brand, synonymous with refreshment and cultural resonance, drives significant volume and brand equity. It remains the largest contributor to revenue and is a cash cow that funds portfolio expansion.
2. Sprite and Fanta: Leading sparkling beverage brands with strong global recognition, contributing to the core portfolio’s stability.
3. Minute Maid: A juice brand that positions Coca-Cola in the non-carbonated beverage market, appealing to health-conscious consumers.
4. Costa Coffee: Acquired to enter the coffee category, Costa offers ready-to-drink (RTD) and vending options, with international expansion potential.
5. BODYARMOR: A sports drink brand acquired to compete in the functional beverage space, countering competitors like Gatorade.
6. fairlife: A dairy-based, health-focused beverage targeting fitness enthusiasts and vegan lifestyles.
7. Innocent Smoothies: A premium smoothie brand with strong growth in international markets.
8. Alcoholic Beverages: Emerging offerings like Jack and Coke and Absolut Vodka & Sprite, testing the ready-to-drink alcoholic beverage market.

The value proposition lies in Coca-Cola’s ability to leverage its global distribution network, brand equity, and marketing prowess to dominate categories and capture consumer occasions. The company’s focus on zero-sugar options (35% of its portfolio) and health-oriented brands like fairlife and BODYARMOR addresses evolving consumer preferences.

Segments and Revenue Model

Coca-Cola operates as a single reportable segment but manages a diverse portfolio across categories (sparkling beverages, juices, water, sports drinks, coffee, dairy, and alcoholic beverages) and geographies (North America, Latin America, Europe, Middle East & Africa, Asia Pacific). The revenue model is primarily franchise-based:

• Concentrate Sales: Coca-Cola produces and sells beverage concentrates and syrups to independent bottlers, who add carbonation, water, and packaging to create finished products. The concentrate price represents 21% to 23% of bottlers’ sales, with potential to increase in mature markets.
• Franchise Fees: Coca-Cola earns a revenue share from bottlers, aligning incentives through incidence-based pricing that prioritizes value creation (e.g., smaller, premium pack sizes).
• Owned Bottling Operations: A small portion of revenue comes from the Bottling Investment Group (BIG), which includes 50% ownership in Africa (CCBA), 35% in India, and 15% in the Philippines, slated for refranchising.

The revenue model is capital-light, with Coca-Cola focusing on high-margin concentrate sales and marketing, while bottlers handle capital-intensive bottling and distribution.

Splits and Mix

Geographic Mix

• North America: ~50% of revenue, with steady volume growth post-pandemic driven by trademark Coke and portfolio diversification.
• Emerging Markets (e.g., India, China, Latin America): ~50% of revenue, with higher growth potential due to rising per capita consumption (currently one-third of North America’s 400 servings per year) and economic development.
• Other Regions: Europe, Middle East & Africa, and Asia Pacific contribute to global scale, with varying growth rates.

Product Mix

• Sparkling Beverages (Coca-Cola, Sprite, Fanta): ~70% of volume, with Coca-Cola alone accounting for ~50% of the portfolio.
• Non-Carbonated (Juices, Water, Sports Drinks): ~20%, growing faster due to health trends.
• Coffee and Dairy (Costa, fairlife): ~5%, with high growth potential but smaller scale.
• Alcoholic Beverages: <5%, emerging and experimental.

Channel Mix

Coca-Cola serves 30 million customer touchpoints (retail stores, restaurants, concessions), with a 50% increase in outlets over the past decade. The company dominates meal delivery (65% penetration) and out-of-home consumption.

Mix Shifts

• Historical: Shift from 400 to 200 brands to focus on high-potential brands, reducing complexity and boosting marketing efficiency.
• Forecasted: Increased contribution from non-carbonated and coffee categories, with emerging markets driving volume growth. Alcoholic beverages may add incremental revenue if successful.

KPIs

• Unit Case Volume Growth: 3% annually, consistent for decades, driven by organic growth and acquisitions.
• Price Growth: 2% to 3% annually, roughly in line with inflation.
• System Revenue Growth: 5% to 6% annually, outpacing consumer staples peers.
• EBIT Margin: 30%, trending toward 35% post-refranchising, with potential to reach 40%.
• FCF Margin: ~25% to 30%, with $10 billion currently and $12 billion projected.
• Return on Invested Capital (ROIC): ~30% for Coca-Cola, 10% to 15% for bottlers (15% to 20% cash-on-cash ROIC after adjusting for intangibles).

The business shows no signs of deceleration, with volume and price growth supported by portfolio diversification and emerging market expansion.

Headline Financials

Long-Term Trends:

• Revenue: Consistent 5% to 6% CAGR, with potential to exceed 7% if emerging markets and new categories (coffee, alcohol) outperform.
• EBITDA Margin: Expanding due to refranchising and operating leverage, with fixed costs (marketing, R&D) becoming a smaller percentage of revenue.
• FCF: Strong conversion from EBIT to FCF, driven by low CapEx and minimal working capital requirements.

Value Chain Position

Coca-Cola operates upstream in the beverage value chain, focusing on concentrate production, brand management, and marketing, while bottlers handle midstream (bottling) and downstream (distribution, retail) activities. This positioning maximizes profitability by avoiding capital-intensive operations.

• Primary Activities:
• Concentrate Production: Produces syrups and concentrates, sold to bottlers at 21% to 23% of their sales.
• Marketing and Brand Management: Allocates 25% of sales (15% direct bottler support, 10% global advertising) to maintain brand equity and drive demand.
• Innovation and Portfolio Expansion: Acquires and develops new brands (e.g., Costa, BODYARMOR) to capture emerging categories.
• Supply Chain Overview:
• Suppliers: Sources raw materials (sugar, flavorings) for concentrates; low supplier power due to commodity inputs.
• Bottlers: Independent partners add water, carbonation, and packaging, then distribute to retailers.
• Retailers: 30 million touchpoints (stores, restaurants, concessions) ensure ubiquitous availability.
• Go-To-Market (GTM) Strategy:
• Leverages local bottlers’ market knowledge for tailored distribution and innovation.
• Centralizes marketing to maintain global brand consistency while allowing regional customization.
• Dominates out-of-home consumption (e.g., meal delivery, vending) and convenience channels.
• Competitive Advantage:
• Brand Equity: Coca-Cola’s iconic status drives consumer loyalty and pricing power.
• Distribution Network: 30 million touchpoints create a network effect, making it the preferred partner for new brands (e.g., Monster).
• Data and Analytics: Real-time insights from bottlers inform marketing and product strategies.

Customers and Suppliers

• Customers:
• Retailers and Concessions: 30 million global touchpoints, including stores, restaurants, and vending machines.
• Consumers: Broad demographic, with 2.2 billion daily servings. Emerging markets offer growth as per capita consumption rises.
• Bottlers: Key partners who purchase concentrates and distribute finished products.
• Suppliers:
• Raw material suppliers (sugar, flavorings) have low bargaining power due to commodity nature.
• Bottlers act as both customers and partners, with aligned incentives through incidence-based pricing.

Pricing

• Contract Structure: Long-term agreements with bottlers, with concentrate priced at 21% to 23% of bottler sales. Incidence-based pricing aligns Coca-Cola and bottlers on value creation (e.g., premium pack sizes).
• Pricing Drivers:
• Brand Equity: Allows 2% to 3% annual price increases, in line with inflation.
• Mission-Criticality: Coca-Cola’s dominance in out-of-home consumption ensures low price sensitivity.
• Mix Effect: Smaller, premium pack sizes and zero-sugar options drive higher margins.
• Emerging Markets: Lower price points ($0.50 per serving) ensure accessibility, with room for price growth as economies develop.
• Visibility: High, due to long-term bottler contracts and consistent volume growth.

Bottoms-Up Drivers

Revenue Model & Drivers

How Coca-Cola Makes $1 of Revenue:

• Concentrate Sales: ~80% of revenue from selling syrups to bottlers, priced at 21% to 23% of bottler sales.
• Franchise Fees: ~15% from revenue-sharing agreements with bottlers.
• Owned Bottling: ~5% from BIG operations (Africa, India, Philippines), declining as assets are refranchised.

Revenue Drivers:

• Volume:
• 3% annual unit case growth, driven by organic demand (trademark Coke, Coke Zero) and acquisitions (BODYARMOR, Costa).
• Emerging markets (India, China) offer significant upside as per capita consumption rises from one-third of North America’s 400 servings per year.
• Portfolio diversification into coffee, dairy, and alcohol adds incremental volume.
• Price:
• 2% to 3% annual increases, supported by brand equity and low price elasticity.
• Incidence-based pricing optimizes pack sizes and formats for higher margins.
• Mix:
• Shift toward non-carbonated (20% of volume) and coffee/dairy (5%) categories, which grow faster than sparkling beverages.
• Emerging markets contribute higher growth but lower ASPs, offset by volume.

Revenue Trajectory:

• System sales (~$150 billion) grow at 5% to 6% CAGR, with potential for 7%+ if new categories succeed.
• Coca-Cola Company revenue grows slightly slower due to franchise model, but high margins ensure profitability.

Cost Structure & Drivers

Cost Structure:

• Variable Costs:
• Raw materials (sugar, flavorings) for concentrates; low as a percentage of revenue due to commodity inputs.
• Contribution margin is high, as concentrate production has minimal direct costs.
• Fixed Costs:
• Marketing: 25% of sales (15% bottler support, 10% global advertising).
• R&D: Investment in new products and innovations.
• Administrative: Overhead for global operations.
• Total Costs:
• Operating expenses (OpEx) represent ~70% of revenue, with marketing dominating.
• CapEx is minimal (~$1 billion, <3% of revenue), as bottlers bear $7–$8 billion in capital spending.

Cost Drivers:

• Economies of Scale: Centralized marketing and concentrate production reduce unit costs as volume grows.
• Operating Leverage: Fixed costs (marketing, R&D) become a smaller percentage of revenue as sales scale, driving EBIT margin expansion from 30% to 35%–40%.
• Inflation: Minimal impact on raw materials; marketing budgets are adjustable.

EBITDA Margin:

• Current: 30%, driven by high gross margins and operating leverage.
• Projected: 35%–40% post-refranchising, as CapEx declines and revenue grows.

FCF Drivers

FCF Calculation:

• EBITDA: High conversion to net income due to low depreciation and amortization.
• CapEx: ~$1 billion, declining to <$1 billion post-refranchising.
• Net Working Capital (NWC): Minimal, with short cash conversion cycles due to rapid inventory turnover and bottler payments.
• Taxes: Standard corporate rates, with no significant tax shields mentioned.
• FCF: $10 billion currently, projected to reach $12 billion, with a 25% to 30% FCF margin.

FCF Drivers:

• Revenue Growth: 5% to 6% CAGR drives absolute FCF growth.
• Margin Expansion: EBIT margin growth from 30% to 35%–40% boosts cash flow.
• Low Capital Intensity: Minimal CapEx requirements enhance cash conversion.

Capital Deployment

• Dividends: 75% of FCF, with a 60+ year history of growth.
• Share Buybacks: ~1% of shares annually, with potential for increase given low leverage (2.0x–2.5x net debt/EBITDA).
• Acquisitions: Recent deals include Costa Coffee, BODYARMOR, and fairlife. Future acquisitions likely in coffee, alcohol, and health-oriented categories.
• Organic Investment: Marketing (25% of sales) and R&D to support portfolio expansion.

Synergies:

• Acquisitions leverage Coca-Cola’s distribution network (30 million touchpoints) to scale new brands.
• Costa Coffee and innocent demonstrate successful international expansion, doubling sales post-acquisition.

Market, Competitive Landscape, Strategy

Market Size and Growth

• Total Addressable Market (TAM):
• Global beverage market: Not specified, but Coca-Cola’s system sales (~$150 billion) suggest a massive TAM.
• Developed markets: 10% untapped (90% captured).
• Developing markets: 65% untapped, with potential to triple as economies grow.
• Growth:
• Volume: 3% CAGR, driven by emerging markets and portfolio diversification.
• Price: 2% to 3% CAGR, in line with inflation.
• Absolute: 5% to 6% CAGR, with potential for 7%+ if new categories succeed.
• Industry Drivers:
• Population growth and rising disposable incomes in emerging markets.
• Shift toward non-carbonated and health-oriented beverages.
• Out-of-home consumption (meal delivery, vending) growth.

Market Structure

• Competitors: PepsiCo (2x smaller in beverages), Keurig Dr Pepper (~10% of Coca-Cola’s scale), Nestle, Unilever.
• Structure: Oligopoly, with Coca-Cola dominating due to scale, brand equity, and distribution.
• Minimum Efficient Scale (MES): High, requiring significant volume to achieve economies of scale. Coca-Cola’s 30 million touchpoints and $150 billion system sales create a barrier to entry.
• Penetration: 65% in meal delivery; leading share in sparkling beverages and growing in coffee/dairy.

Competitive Positioning

• Matrix: Premium pricing, broad demographic, global reach.
• Risk of Disintermediation: Low, due to distribution network and brand loyalty.
• Market Share: Gaining share from Pepsi (outspends 3–5x on marketing) and smaller players.

Hamilton’s 7 Powers Analysis

1. Economies of Scale:
• Strength: High. Coca-Cola’s global scale reduces unit costs for concentrate production and marketing, with 30 million touchpoints creating a network effect.
• Impact: Enables 5% to 6% revenue growth and EBIT margin expansion to 35%–40%.
2. Network Effects:
• Strength: Strong. The distribution network creates a flywheel: more touchpoints attract brands (e.g., Monster), which increase volume, lowering costs.
• Impact: Unmatched access to 30 million customers ensures market dominance.
3. Branding:
• Strength: Exceptional. Coca-Cola’s brand is one of the most recognized globally, driving pricing power and consumer loyalty.
• Impact: Supports 2% to 3% price growth and 65% meal delivery penetration.
4. Counter-Positioning:
• Strength: Moderate. The franchise model is difficult for competitors to replicate due to Coca-Cola’s scale and bottler relationships.
• Impact: Deters new entrants, as Pepsi and others lag in distribution.
5. Cornered Resource:
• Strength: Strong. Coca-Cola’s distribution network and brand equity are unique assets competitors cannot match.
• Impact: Enables acquisitions (e.g., Costa) to scale rapidly via existing channels.
6. Process Power:
• Strength: Strong. Real-time data from bottlers (via SAP HANA, Microsoft Dynamics) informs marketing and product strategies.
• Impact: Enhances revenue growth management and category dominance.
7. Switching Costs:
• Strength: Moderate. Consumers have low switching costs, but bottlers are locked into long-term contracts, and retailers prioritize Coca-Cola’s portfolio.
• Impact: Ensures stable volume and distribution.

Strategic Logic

• CapEx Cycle: Defensive, with refranchising reducing Coca-Cola’s CapEx to <$1 billion, shifting burden to bottlers.
• Vertical Integration: Minimal, focusing on upstream concentrate production to maintain capital-light model.
• Horizontal Integration: Aggressive, with acquisitions in coffee (Costa), sports drinks (BODYARMOR), and alcohol to diversify revenue.
• Geographic Expansion: Prioritizes emerging markets (India, China) for volume growth, with North America providing stability.
• M&A: Synergistic, leveraging distribution to scale new brands. Risks include overpaying or slow integration.

Unique Dynamics of the Business Model

Coca-Cola’s business model is unique in several ways, as highlighted by the interviewee:

1. Capital-Light Franchise Structure:
• Coca-Cola outsources bottling and distribution to independent partners, reducing CapEx to ~$1 billion (versus $7–$8 billion for bottlers). This allows a 30% ROIC, far exceeding bottlers’ 10% to 15%.
• The franchise model aligns incentives through incidence-based pricing, ensuring bottlers prioritize value creation (e.g., premium pack sizes).
• Refinements since 2000, including refranchising 40% of bottling assets (2015–2017), have resolved historical tensions and optimized the system.
2. Unparalleled Distribution Network:
• With 30 million touchpoints, Coca-Cola’s network is unmatched, creating a network effect that attracts new brands (e.g., Monster’s 20% stake benefits from distribution access).
• Local bottlers provide market-specific knowledge, enabling tailored GTM strategies while feeding insights to the central company for global innovation.
3. Brand Equity as a Cash Cow:
• The Coca-Cola brand generates significant cash flow, funding acquisitions and marketing (25% of sales). Its cultural resonance (e.g., shaping Santa Claus imagery) ensures pricing power and loyalty.
• The portfolio’s diversity (26 billion-dollar brands) mitigates reliance on trademark Coke, with zero-sugar options (35% of volume) addressing health trends.
4. Data-Driven Innovation:
• Real-time data from bottlers’ systems (SAP HANA, Microsoft Dynamics) informs marketing, pricing, and product development, creating a feedback loop that enhances competitiveness.
• This process power differentiates Coca-Cola from peers with less integrated systems.
5. Emerging Market Growth:
• Developing markets (65% untapped) offer significant volume upside as per capita consumption rises. India and China are key, with India’s bottling assets retained for strategic control.
• Low price points ($0.50 per serving) ensure accessibility, with potential for price increases as economies grow.
6. Portfolio Diversification:
• The shift from 400 to 200 brands focuses resources on high-potential categories (coffee, dairy, alcohol).
• Acquisitions like Costa Coffee and BODYARMOR position Coca-Cola in fast-growing segments, though they remain incremental (<5% of sales).

Interviewee Highlights:

• System Sales Scale: Coca-Cola’s $150 billion system sales dwarf competitors (2x Pepsi, 4x nearest beverage peer), underscoring its dominance.
• Alignment with Bottlers: Incidence-based pricing and 20% ownership stakes in bottlers create a symbiotic relationship, resolving historical conflicts.
• Growth Consistency: 3% volume and 2% to 3% price growth deliver 5% to 6% revenue CAGR, with potential for 7%+ if new categories succeed.
• Health Risk Mitigation: Zero-sugar options (35% of portfolio) and diversification into health-oriented brands (fairlife, BODYARMOR) counter obesity and GLP-1 concerns, with a potential 5% volume hit deemed manageable.
• Qualitative Value Creation: Financials alone understate value due to refranchising; qualitative analysis (e.g., bottler health, distribution moat) is critical.

Market Overview and Valuation

• Market Size: The global beverage market is vast, with Coca-Cola’s $150 billion system sales capturing a significant share. Non-carbonated and coffee categories are growing faster than sparkling beverages.
• Growth: 5% to 6% industry CAGR, driven by emerging market consumption and health trends. Coca-Cola outperforms peers due to scale and distribution.
• Competitive Landscape: Oligopolistic, with Coca-Cola leading Pepsi, Keurig Dr Pepper, and smaller players. High MES and distribution barriers deter new entrants.
• Valuation: Not specified, but pressure from health concerns and GLP-1 drugs suggests a compressed multiple. Strong FCF ($10–$12 billion) and dividend yield (~3%, based on 75% payout) support a premium valuation.

Conclusion

The Coca-Cola Company’s business model is a masterclass in capital-light franchising, leveraging an unmatched distribution network, iconic brand equity, and data-driven innovation to maintain dominance. Its ability to generate consistent 5% to 6% revenue growth, expand EBIT margins to 35%–40%, and produce $10–$12 billion in FCF underscores its financial strength. The franchise structure, refined through refranchising, aligns bottlers with value creation, while diversification into coffee, dairy, and alcohol mitigates risks from health trends. Hamilton’s 7 Powers analysis reveals robust competitive advantages, particularly in scale, branding, and network effects. As emerging markets drive volume and new categories add upside, Coca-Cola remains a durable, high-return business with significant growth potential.