Warren Buffett, the greatest investor of all time, loves Coke. He famously drinks 5 Cherry Cokes every day. He has been an investor in the Coca Cola Company since 1988, and currently holds 400 million shares (9%). In 2007, he wrote, “A truly great business must have an enduring ‘moat’ that protects excellent Returns on Invested Capital.” He recently said he does not plan on selling his Coca-Cola shares, ever. It looks like his return has been about 21x.

I think Warren Buffett is a smart guy, but can’t just about anybody mix together some sugar water and carbonation and enter the market? In fact, Buffett himself drank Pepsi for 48 years before abruptly switching to Coke one day. Let’s dig into it and see.

Brand Value

Of the many interesting things to understand about the carbonated beverage business, the one I suppose drives Mr. Buffett’s Coke obsession is brand. Coca Cola’s brand was valued at $35 billion last year (44th in the world). Pepsi is 92nd at $20 billion.

Coke and Pepsi have been building their brands for a long time. Founded in 1886 and 1893 as a healthy alternative to alcohol and a digestive aid, the companies started an industry that has relied heavily upon brand building from the beginning. In fact, Frank Mason Robinson may have been the world’s first Chief Marketing Officer. Robinson was the first bookkeeper at Coke and created the Coca-Cola logo in 1885 and was in favor of advertising and free drink coupons.

Later, in the 1930s, Coca-Cola advertising may have created, and most certainly popularized, Santa Claus’ costume in Coke’s own red and white colors. In 1933, Joan Crawford did a pitch for Coke. But in 1955 she married Pepsi-Cola president Alfred N. Steele and became a spokesperson for Pepsi, appearing at events and doing early product placement in her films. Incidentally, Crawford sat on the Pepsico board from 1959 to 1973, the first woman to serve on a major corporate board of directors.

Coke and Pepsi Make the Syrup and do the Marketing

The business model employed by the firms is the same. They make a syrup, and sell it to partners that add water, sugar, and carbonation before they sell it. Some of the partners are bottlers that in turn distribute bottles or cans to retail establishments or vending machines. Some are large food service operations like McDonalds, sports arenas, or institutions like universities or hospitals. The relationship between Coke or Pepsi and these many other businesses is critical to their success.

In addition to producing the syrup, and managing these many relationships, Coke and Pepsi both retain the job of managing their brands and deploying marketing strategies. In the ‘70s Pepsi used their “Pepsi Challenge” campaign to demonstrate that people preferred Pepsi. The genius of the campaign was not that it got people to pick Pepsi in a blind taste test. Quite simply, as the #2, Pepsi only had to get people to accept they could not tell the difference.

In the ‘80s the competition between Coke and Pepsi was everywhere. In popular songs (Billy Joel’s “We Didn’t Start the Fire”) and the Jackson 5’s $5 million endorsement deal with Pepsi. Coke answered back with Bill Cosby and Max Headroom.

Pouring Rights Agreement

For the last few decades however, the cola wars have not been fought at staged taste tests in front of grocery stores, or dueling TV ads, but through exclusive “pouring rights” agreements with just about every venue that could serve you a soft drink. These agreements, which arguably would not be possible without a big brand presence, are indeed moats. Wide ones.

There are 4,360 colleges and universities, 6,093 hospitals, 130,930 K-12 schools, 19,622 airports, 11,642 sports facilities, 5,798 movie theaters, 201,865 fast food restaurants in the United States. In addition, there are 3,007 counties, each with a fair. It’s impossible to know for sure, but there could be about half a million places in the United States where you could be served a Coke or Pepsi product. Most of those places have exclusive pouring rights or beverage marketing agreements in place that determine which product you will be served.

By 2005, according to one survey, nearly half of all public elementary schools and about 80 percent of public high schools operated under pouring rights contracts. The details on these agreements vary, but a sampling reveals that cash starved school districts are monetizing their students at a rate of about $20 per student per year.

In 2021, the Center for Science in the Public Interest surveyed the largest 143 public universities in the US and learned that 80% had pouring rights agreements in place, paying an average of $900,000 per year, or roughly $30 per student per year, for the exclusive right to sell them soft drinks.

Is $30 per Customer per Year a Good Deal?

Beverage Digest reports that per capita consumption of soft drinks in the US averages one 12 oz serving per day. For the sake of this rough calculating, let’s just assume that the consumers in the venues governed by the pouring rights agreements are “average”. If so, the cost of the agreement to Coke or Pepsi would be between 5 cents and 8 cents per serving. Coke and Pepsi probably spend more locking up these customers than making the syrup for the drinks. The total cost of these agreements dwarfs their advertising budgets.

Coke reports that worldwide, they serve 2 billion drinks per day. The Coke worldwide ad budget is $4 billion per year. Therefore, the add budget per serving is ½ cent per serving. One tenth of the pouring rights agreement cost. With Pepsi it is a bit more difficult to sort out. Pepsi’s product mix includes Frito-Lay and Quaker Foods, and their ad budget is about the same as Coke, but their beverage volume is less. So it could be anything – but is probably also a fraction of the pouring rights agreements.

The Chief Marketing Officers at Coke and Pepsi have a lot of messaging to manage with issues of water consumption, plastic waste, and anti-sugary drink movements. And of course, they are rightly focused on enhancing their brand value. However, the mostly unseen job of negotiating thousands of pouring rights agreements is their secret to building a very big moat to prevent competition.

This week I have chosen to leave out our usual cost of growth calculations but wanted to note that they have very similar numbers between .3 and .5. You recall that this means for every dollar they spend on sales, general and administrative expenses, they get back about 30 cents in growth. Instead, here are two charts showing that the US bottled water market is going up and the carbonated beverage market is going down.

Circling back to Warren Buffett. He is right to be comforted by the moat created by Coke’s brand value. But the declining overall market, and the two big, entrenched players with long term exclusive agreements at hundreds of thousands of beverage serving locations is the biggest moat of all.

One More Fun Story

This month for the first time in ten years, Dunkin will start serving Pepsi products in its 9,500 US locations instead of Coke. Well, except they will still sell bottled Dunkin Iced Coffee, which Dunkin makes in partnership with Coke, and also except not Starbucks bottled coffees, which is made in partnership with Pepsi. Whoever is negotiating these exclusives is earning their paycheck!