In July of 1996, Charlie Munger gave a speech entitled “Practical Thought About Practical Thought?”, which presented the case of a man who is asked to plausibly demonstrate a business plan that will cause a new corporation with an initial investment of $2 million in 1884 to grow to a value of more than $2 trillion over the next 150 years (by 2034), while simultaneously paying out a large portion of its earnings as dividends. With fifteen minutes to make your pitch, how would you approach this problem?
Charlie’s answer to the problem (I highly recommend reading the speech) culminates in the following conclusion: despite many follies along the way (like granting exclusive bottling rights across most of the United States in 1899 to two young lawyers from Chattanooga for the “princely sum of just one dollar”, in the words of Don Keough), the company in question was on track to meet its target by 2034 if it increased its value by just 8% per annum (remember, this speech was made in 1996; at the current valuation, the market cap will need to increase closer to 12% per annum) – that company is the Coca-Cola Company (KO).
Warren Buffett made Coca-Cola a cornerstone of Berkshire Hathaway’s (BRK.B) equity portfolio in 1988, and hasn’t stopped talking about the attractiveness of the business since; for investors, Coca-Cola is a case study in a phenomenal business that has continually created tremendous value for its owners, despite periods of mismanagement (read Buffett’s description of the years after Gouizueta’s death in “The Snowball”).
As such, I’m going to devote my next couple of articles to the history of this company, and its development into the behemoth it is today; with annual reports dating back to the company’s first decade as a publicly traded company nearly a century, I plan on taking readers on a year by year walk-through of the historic developments that have culminated in the creation of the world’s most valuable brand (note – my expectation is for articles to cover five years on average).
1920–1924: “COCA-COLA THROUGHOUT THE WORLD”
On December 31st, 1920, after nearly one full year as a public company (September 1919) under the leadership of President Charles H. Candler, The Coca-Cola Company had just over $40 million in assets, less than half of which were tangible assets; even in the early years, the importance of brand equity was paramount – “Although the Company's good will is by far its most valuable asset, it will be noted with satisfaction that it is rapidly building up its tangible assets.”
In that same year, the company generated $32.3 million in sales, with $4.6 million flowing through to pre-tax income. Of that amount, $2.2 million was taken as a write-down due to a decline in the market value of certain inventory items (sugar, etc), $1.7 million was paid as dividends ($1M to common, $700K to preferred), and $435K was paid in taxes; for the year, $303,000 was added to the surplus (retained earnings) line on the balance sheet.
Even at this early point in time, the company was looking to expand its footprint: “Nineteen twenty-two should mark the beginning of a steady march forward in this business. Aside from two much needed main plants, relocating present inadequate plants, the building of which has been approved by your Board, we are properly and adequately equipped and manned to handle the business in the United States and Western Canada. Your Board is carefully considering and shaping its foreign policy, and, as conditions appear to warrant, the business will expand by first fully occupying those fields closest home. We should be able to carry out this program of expansion with net earnings after reasonable taxes and dividends. Our Sales Department is being deluged with applications to handle Coca-Cola throughout the world.”
As noted by management at the time of writing (1922), the company had only seen two years of sales declines since the product was brought to market 36 years prior (one of those years was in 1918, when a 50% restriction in sugar use by the U.S. Food Administrator took its toll on the largest consumer of sugar in the world); the company’s forward-looking strategy of global domination all but guaranteed that the lopsided recorded of success would continue.
BUILDING A BRAND
Building the brand meant creating a uniform product across all markets, which was reinforced by pricing strategy; as noted in the 1922 annual report, “The cost of manufacture has been reduced to such an extent that our prices to dealers, together with reduced costs to them of doing business, justifies and enables them to retail Coca-Cola at five cents per glass or bottle, as the case may be, which will have a very stimulating effect upon demand.”
As our readers will see, this pricing point on the six-and-a-half ounce serving (particularly the trademark green bottle) would become an area of stubbornness for the company, and cause them considerable pain decades down the road as competitors (management called them “the imitator”) looked to compete as an alternative for the value-conscious consumer (“Twice as much fun for a nickel, too”).
Charlie notes in his speech that the brand (rather than some generic name/product) would be key to the company’s ability to profitability expand for decades to come; in the early 1920’s, the company won an important case that set the stage for perpetual defense of their trademark rights: “An important case has been decided by the Circuit Court of Appeals for the Third Circuit, that court holding that Taka-Kola was an infringement of Coca-Cola. This case is of importance because it rather defines some of the trade rights of the Company.”
The most revealing part of these reports is the CONTINUED focus on the importance of goodwill and reinvestment in all things Coca-Cola to the company’s long-term success; in the words of the 1924 annual report, “A corporation which does not lay a firm foundation for the future cannot build goodwill of lasting nature—truth is the basis of all stable good-will.”
Part of this brand development came in the form of advertising, which “blazed the way for the entire soft drink industry” according to management; at the time, the company had even gone into the glass business, selling 3.4 million glasses to ensure that consumers received a “real Coca-Cola” no matter where they were. In addition, the company had more than 20,000 painted walls and bulletins in the U.S., 2.5 million calendars, and newspaper and magazine advertisements in “millions of copies” around the country.
EXPANDING THE FOOTPRINT
Even at that time, the distribution of the Coca-Cola company was expanding at a rapid pace: “Syrup is sold to more than 1200 Coca-Cola bottlers in the United States, and to bottlers in Canada, Cuba, Hawaii, Philippines, and even in the little island of Guam. Bottlers in the United States in turn merchandise the bottled drink through more than 200,000 retailers. For fountain use the syrup is sold through more than 2300 jobbers, who in turn supply 115,000 soda fountains in the United States. Coca-Cola is also sold in Porto Rico, Panama, Mexico, Australia, New Zealand, England, France and in the Orient.”
In 1924, the company’s current ratio stood at more than 12:1 ($5.6 million compared to $450K) and long term liabilities were practically nonexistent, despite considerable investments in advertisement and sales force expansion in the United States (“One of the outstanding accomplishments in the operation of this company during the past year has been the building of a sales force commensurate with the advertising force previously established, with due regard to the need of systematizing and coordinating our sales and advertising efforts”). While the company’s gallons of syrup sold had stagnated in the past five years, the longer term record showed the explosive growth that had been attained up until 1924:
About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with a handful of positions accounting for the majority of the total. From the perspective of a businessman, I believe this is sufficient diversification.