Coca-Cola's Secret Formula

Mar.19.13 | About: The Coca-Cola (KO)

It is arguably the most recognized brand name in the world. With revenues of over $48 billion in 2012 and a global presence that spans more than 200 countries throughout the world, the reach of this economic giant is very far. It all began on May 8th, 1886 at Jacobs Pharmacy in Atlanta Georgia when the first bottle of what we know today as Coca-Cola (KO) was sold. This was in part a response to prohibition and was originally sold as a non-alcoholic version of French Coca Wine. At the time, it was being marketed as an elixir to heal a myriad of health problems including morphine addiction, dyspepsia, and impotence. We know it today as the common cure for the sweet tooth. Outside of being one of the oldest operating corporations in America, they have proven themselves to be one of the most financially consistent companies over the past 100 years. Since going public in 1919, they have never looked back. The company has declared a dividend every quarter since 1920, and increased dividends in each of the last 50 years. Their return on equity last year was just over 27% and their total assets amount to about $86 billion.

How does Coca-Cola separate themselves from the competition year after year and continue to grow revenues and profits? The first ingredient to their success is branding. The Coca-Cola brand has grown exponentially every year that they have been in business. They were originally marketed as a healing remedy and now you can get a Coca-Cola in almost any part of the world as a refreshing soft drink. It is sold in restaurants, movie theaters, vending machines, grocery stores, convenience stores, and more. It has become a product so prevalent in culture around the world, that if you are selling refreshments and you don't carry Coca-Cola, you will lose sales as a result. Their advertising initiatives have set standards for the industry and have pioneered new ways to reach their customers. Coca-Cola was the first corporation to characterize Santa Claus in their advertisements. The first one debuted in the Saturday Evening Post in 1931 and continues to be a success today. They were the first official sponsors of the Olympic Games in 1928 and have continued to be a sponsor every year after. The overall goal of Coca-Cola's marketing efforts is to make Coca-Cola the preferred drink of everyone in the entire world. This is quite an ambitious goal for the soft drink maker but they are slowly making strides towards it. With the wide reach and branding they have achieved over the past 100 years, there is no doubt their pervasive advertising efforts have paid off.

One area where Coca-Cola has excelled where others have found difficulty is their method of distribution. In larger developed countries, the channels for distribution are fairly simple and straight-forward. There are bottling plants that produce the products and ship them around the country to the locations that sell Coca-Cola. However, there are some logistical problems you can run into when you start distribution in countries with less developed infrastructure such as Africa. It is more difficult to get your product to your customer because the transportation systems are not streamlined and the demand for product is harder to determine in some of the smaller emerging markets. Coca-Cola has developed a great system of distribution to deliver products to these areas. They have developed what is known as a MDC or Micro Distribution Center business model. This business model allows entrepreneurs to start their own MDC, receive business training, and obtain financing if they qualify. These locations have small centrally-located warehouses and typically transport product by either pushcart or bicycle to reach small remote areas and to keep costs down. Coca-Cola currently runs about 2,800 MDC businesses and takes in about $550 million in revenue from these businesses alone each year. Most of the current MDC businesses are set up in Africa including countries like Mozambique, Ethiopia, and Kenya. In Ethiopia, MDCs account for 80% of Coca-Cola products sold each year. The MDCs have a set profit margin that they have to stick to which is usually around 3-5% to drive sales volume and keep prices fairly equal across all MDCs. Even though this section of Coca-Cola's business currently only garners 1% of their total annual revenue, the potential for growth in this sector is enormous and the scope of the brand is expanded by these efforts as well.

With the efforts that Coca-Cola has made to make Coca-Cola the preferred drink of everyone in the world, there are probably few people that have not at least tasted a Coca-Cola in their lifetime. Even fewer people actually know how it is made. The formula has been so closely guarded that Coca-Cola runs an interactive exhibit at their headquarters in Atlanta, Georgia to educate guests on the history of the company and to see where the formula is actually held. The value of it is undetermined but according to the balance sheet, Coca-Cola attributes approximately $15 billion of their $85 billion in total assets to intangibles such as brand names, reputation, and trade secrets. Needless to say, there is good reason to keep the formula a secret. At this point, it would be hard to replicate the Coca-Cola brand and their success, but for many years, that was a very real concern.

Coca-Cola has few competitors in the marketplace that rival the size and economies of scale that they possess in their market share. PepsiCo (NYSE:PEP) is their arch rival and main competitor. For years they have gone head to head to win the hearts and taste buds of the general public. PepsiCo is a formidable competitor with $65 billion in revenue in 2012 and over $6 billion in Net Income. The interesting part is that Coca-Cola's revenue is actually less at $48 billion and their net income is higher at just over $9 billion. Even at this apparent difference, the return on equity is about the same, around 27%. Even though Coca-Cola makes more money after taxes and expenses with less revenue, they are about as equally efficient at garnering a return on their shareholder's equity.

We may never find out what exactly the secret recipe is for Coca-Cola or whether Coca-Cola is better than Pepsi, but the only thing that we know for sure is that public and future profits will decide who will be the winner in the end.

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Business relationship disclosure: This article was written by an analyst at Catalyst Investments.