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The Importance of Relevance with Retailers
Posted by: The Science of Hitting (IP Logged)
Date: October 16, 2012 09:10AM

In an article a few weeks ago about the dominance of PepsiCo (PEP)'s snack business, I made the following comment:
Quote:
PAF [PepsiCo Americas Foods] has a go-to-market system that services more than 2 million customers across 50,000 routes; this level of penetration partly explains why this segment is home to seven of the company’s 22 $1 billion brands (they are Lay’s, Doritos, Tostitos, Cheetos, Ruffles, Fritos and Quaker). In addition, the company is the No. 1 supplier to the C&G channel and the No. 1 contributor to C&G growth according to IRI data; this means that when PepsiCo asks for product placement or additional shelf space, retailers have a vested interest in making sure that they do all they can to make it happen.

References to competitive advantages are often thrown around rather loosely (with the most oft-cited example being proclamations of “brand equity” in many cases where the company has little-to-no pricing power or affinity among consumers). To provide some merit for this particular advantage (clout among retailers), let’s look at an example recently addressed by Coca-Cola (KO) chief financial officer Gary Fayard, who was discussing the company’s push to replicate their dominant segmentation in Mexico to the U.S:
Quote:
I would say we are 15% or 20% along that journey. For everyone, my view of the United States and what happened in the famous Cola Wars of the '80s and '90s, the industry basically went to a -- we were consolidating bottlers, we were taking a lot of costs out, and we were, I would say, stacking it high and selling it cheap. And it really went to 2-liter and 12 packs. What that did is started commoditizing and weakening the brands.

What we have realized -- we have to reverse that and we have started reversing that several years ago. The first thing we did is we went -- and this is some detail, but when you get into our business it's is about the details. We took that 2-liter package, which was straight wall and ugly and you couldn't tell any difference from anyone else's product if the label fell off, we made it contour so you knew it was a Coke. We took the price up. But then this past year what we have done is we taught the consumer in the United States that a 2-liter should cost $0.99 and it had been there for 10 years at least. We were able through differentiation in the packaging then to move it up, and we moved in on up much higher. But we have introduced a 1.25-liter at a $0.99 price point to hold that price point so the 2-liter doesn't get promoted back down.

We took the 20 ounce, which if you talk to all the bottlers in the US they would say that is where they make all their money. It was the most profitable and price inelastic package we had and we actually introduced a lower priced 16-ounce bottle at $0.99. And you say why would you do that because you may be cannibalizing your most profitable pack? What was happening was that package was getting priced up to like $1.49. For the consumer that wanted that 20 ounce it was fine, they didn't care. But for the new consumer that just had pocket change, they wouldn't buy it and what we were doing was missing the recruiting of that new consumer. The $0.99 package achieves that. Then this year we have now taken that package and moved it to $1.09 in most retail and introduced a 12.5-ounce bottle at $0.89.You can see how we are trying to move and the pricing architecture moves up you start getting margin, but you are also recruiting new consumers at the same time.

That is just the beginning. So we have gone from probably three primary packages in the US now to seven. Mexico has 31 just on brand Coke. We got a long way to go, but we are on the road to going there because you have to differentiate and earn price from the consumer where they believe they are getting value as well and not just drive straight growth.

Think about this example: Coca-Cola decided that two price points (at home, via 2-liter and 12-packs, and immediate consumption, with the 20-ounce) were no longer adequate for their strategic goals, particularly in the face of rising costs that were due to compressed margins at a price point that was universally accepted (due to the reassurance of time) as the “right” price. What if a smaller player like National Beverage (FIZZ) or Reed’s (REED) wanted to make the same type of differentiated offering to the consumer? The reality is that few companies, namely PepsiCo and Coca-Cola, would have the clout to make such changes without being stalled by retailers.

But this is about more than just diversified product line-ups comprised of a handful of dominant brands: Coca-Cola also reinvests in its business. For example, KO spent more than $2 billion on capital investments in 2010, and $2.9 billion in 2011 (almost half was spent in North America) – with 2012 expected to cross the $3 billion mark. It’s important to recognize that reinvestment goes beyond brand relevance, product development, and route-to-market – Coca-Cola also spends a significant amount of capital on cooling equipment (both design and placement), which goes a long way to keeping retail fresh and avoiding a dilapidated approach to the consumer – with a recent example being the “eKOCool” in India, which operates exclusively through solar energy – a big plus in a country with erratic power supply. The company has also reinvented the experience at QSR, with restaurants noting sizable increases in beverage sales after adding the Freestyle machine; as noted by Mr. Fayard, these investments are targeted at driving immediate consumption – where the margins are much more attractive to Coca-Cola.

These actions, over time, have had the effect of taking Coca-Cola to a point where attempting to catch them, even with a better or cheaper product, is essentially futile (look at how much market share private label has grabbed in the U.S., despite selling at about half the price of a branded 2-liter). The company continues to make investments back into the business at attractive rates of return around the globe, and is working on expanding regional and category specific leadership into a globally unmatched empire (certainly on the right track) that will provide non-alcoholic ready-to-drink beverages to billions of consumers on a daily basis. The competitive position held by the Coca-Cola Company suggests that this is not just a possibility. With enough time and competent management, it appears to be a near certainty.


Stocks Discussed: KO, PEP, FIZZ, REED,
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