DS:

Hello, and welcome back to The Breeze, with Beverage Digest. I'm your host, Duane Stanford. This is where we bring you into the kinds of industry conversations that we have, here, every day at Beverage Digest. We dissect what's happening, connect the dots, and ask the most important question, "What does this mean?" Our good friend John Sicher's back with us today to talk shop. As our regular listeners know, John has covered the beverage industry for almost three decades and is a former esteemed editor and publisher of this very publication. More recently, John has consulted for companies including Coca-Cola and BodyArmor, and served as an expert witness in beverage related court cases. John, welcome to the program.

JS:

Thanks, Duane. Very pleased to be here.

DS:

So John, as I reported recently in Beverage Digest, PepsiCo plans to invest $175 million this week in an IPO from online grocery delivery service, Instacart. Now, PepsiCo has been on a mission. It wants to sell more drinks and Frito-Lay chips online. With that, PepsiCo leaders also know that digital retail is a rich source of data about consumer buying habits and a valuable tool in the revenue growth management arsenal. In fact, Instacart isn't PepsiCo's first swig from the digital consumer bottle. The company also has invested, previously, in Boxed.com. Box.com sells both groceries and household staples online. Now, the coming Instacart investment begs a question, "Isn't PepsiCo essentially competing, now, against some of its most important retail customers?" For example, Walmart, which is an aggressive competitor in online grocery delivery, and one of PepsiCo's most important customers. Or Costco, which competes with Boxed.com for bulk grocery consumers. But, PepsiCo isn't alone in a quest for growth that would, on the surface, appear to create friction with an existing customer relationships.

Prior to the pandemic, Coca-Cola acquired UK-based cafe chain Costa Coffee. Now, the question was raised then, too, "Would that eventually put Coke in competition with major customer and takeout coffee purveyor, McDonald's, in the US?" Then there's Dunkin' Brands, which recently announced a hard iced tea that will compete against another hard iced tea distributed by PepsiCo's Blue Cloud unit.

Now, keep in mind, PepsiCo is Dunkin's beverage supplier in the US for its donut shops, after Pepsi replaced Coke this year. Guess what, though? Coke still produces and distributes Dunkin's non-alcoholic bottled coffee as part of a partnership that predates the pandemic. That's not all. Coke, by the way of licensing deals, is a competitor in the alcohol space that Dunkin' is now entering with hard teas and coffees. John, there appear to be no rules in today's modernized and quickly fragmenting beverage industry, at least not the kinds of lines that we traditionally saw. What do you make of that?

JS:

I think that's right, Duane. I think that a lot of what we thought of many years ago as conventional wisdom about relationships and taboos have gone right out the window, and I think that's smart. For example, taking the Coke Costa relationship, I would imagine that McDonald's was probably not happy about that, but I think that Coke made the right decision. Coke needed to be in the coffee business. It didn't have a lot of options. Costa was a good option. I'm guessing there was some handholding necessary between Coke and McDonald's after that deal was announced. I think, today, companies have to figure out ways to get growth. They need to figure out ways to play in different categories. I think Coke was absolutely right to make the investment in Costa. How that pans out is probably too early to tell.

I think the likelihood of McDonald's not having a relationship with Coke is highly, highly unlikely. In the PepsiCo Instacart deal, I think maybe someone at Walmart, or Target, or Costco, did raise an eyebrow over that. I think PepsiCo was smart to make this investment. The way I figure PepsiCo, probably after the IPO, which is about to happen, may own about 2%, or a little less, of Instacart. I think what it does is it gives them a relationship with Instacart management. It gives them insights. It probably gives them a very good investment from a pure investment perspective. People who I talked to, during my years consulting, thought that Instacart was going to be even bigger and more important in the years to come. So PepsiCo, beyond the relationship they have with Instacart, probably has an investment which has a good chance of appreciating in the years to come, Duane.

DS:

Yeah. One of the things that people might not understand about the Coke and McDonald's relationship is this relationship goes back very far. It's, in essence, a handshake agreement from years ago. McDonald's is one of Coca-Cola's largest customers. They sell a lot of soft drinks through that relationship. Diet Coke at McDonald's, some people think that's the best diet Coke around, in terms of the way it tastes. They spend a lot of time caring for that formula, and that relationship, and how those fountains are set. So, that's not a relationship to take lightly. Of course, I wouldn't imagine Coke did when they signed the Costa deal. The question that was raised is, "Will Coke create a coffee chain to compete with, not only Starbucks in the US?" Costa is a major cafe chain in the UK and expanding. But, "Would it compete with McDonald's," which has a sizable business now with its McCafe, all kinds of iced coffees, and hot coffees. It wants to be a destination for people.

Coke basically has said they have no intention to compete with cafe chains here in the US. But, of late, they've actually opened a few cafes that are said to be kind of marketing leads to kind of build the brand here. What they're trying to do is do self-service machines at schools and hotels, and machines that they would sell to corporations that actually create a barista experience in a box, so to speak. So at least for now, they're saying they have no intention of doing that.

I'm sure, as you pointed out, there was plenty of conversations about what this exactly is going to look like. Coke will have to mine that relationship as they go forward with Costa Coffee. I think, one of the key things now, though, is that sort of these old rules aren't necessarily going to hold up anymore because we have a very fragmenting market base. Companies like Coca-Cola are looking for growth in as many areas as possible. So, they're going to have to sort of delicately weave their way through these relationships to make sure they protect their future. That's clearly what's happening here with Coke and McDonald's, wouldn't you say?

JS:

I would of. There have been other cases, too. Back before, I guess 2018, BodyArmor was distributed mainly through Keurig Dr pepper, via the independent bottling system. I think in 2018, it was, Coke and BodyArmor made a deal. Coke made an investment in BodyArmor, and BodyArmor changed from the independent bottling system, or the so-called white bottling system, to the Coke system. Why did that raise some eyebrows? It raised some eyebrows because Coke also has a very important relationship with Keurig Dr Pepper. I guess back then, maybe, was called Dr Pepper Snapple.

The Coke system handles probably 35 or 40% of the Dr Pepper volume in the US. So, there was always somewhat of a hands-off relationship between Coke and Dr Pepper and Pepsi and Dr Pepper. Coke went in and basically cut a deal with BodyArmor, which caused BodyArmor to be removed from the independent system. I happened to be an expert witness in that litigation. I'm not disclosing anything proprietary or confidential. As you said, a lot of transactions have taken place in recent years, Duane, are taking place, and probably will take place in the future, that would've surprised some old hand beverage executives going back some years, and quite frankly surprised me to some degree. I think that looking at deals and relationships in a new light, it's probably good for the industry and good for consumers.

DS:

Well, and one of the things happening within the sports drink category is that you had, for so long, as we've talked about before, this two horse race between Coca-Cola's Powerade and Gatorade at PepsiCo. Gatorade being the market leader for a number of years, approaching [inaudible 00:10:36]. Suddenly you have new players in the market like BodyArmor. You have a very competitive segment. Coca-Cola needs to make sure it doesn't fall further behind in that race. They've got to cut a deal on BodyArmor to kind of protect that over time.

That's where you get into some of these relationships. That all comes back to that consumer, and the fact that consumers now are not just sort of sticking with a category or two, or even sticking necessarily with a daytime routine. That might be in a couple of categories per day. Consumers, especially young consumers, now are all over the place in their consumption. They're drinking cold coffee, chilled coffees. They're drinking sports drinks for different occasions, different kinds of functional waters. Because of that, you've got a very fragmented market, that you, now, have to play in lots of different places, and try to play well. That's part of why these companies, now, are beginning to cross over each other and kind of have some of these more incestuous type of relationships. They are trying to make sure they can compete across the beverage spectrum, compete across various day parts, and try to make sure that they keep customers and their brands over an entire course of a day. So, I think we're going to see a whole lot more of this as a result.

JS:

I agree with you. I think that there was a belief, back around the time that Coke acquired Costa, that to be viable in the coffee category, you needed to have a retail presence. Starbucks certainly created that model, and to my knowledge, probably second to Starbucks is Costa, globally. A lot of people, as you remember, raised eyebrows, were skeptical about Coke acquiring Costa. Whether long-term it works out, or not, is a separate issue, but I think Coke was right to do that deal.

Costa is not well known in the US, but I was in London back in the early part of the summer. There's a huge Costa presence in the London airport. I think Coke has got a brand that they can basically build over time, expand the retail presence globally. It's not going to be Starbucks, but BodyArmor and Powerade are not going to be Gatorade. Pepsi Cola is not going to be Coca-Cola. I think these companies are basically making the right moves, stepping away from what some of the conventional wisdom has been, and basically focusing on what they need to do to grow and have a portfolio that works for their bottlers, their retail customers, and their consumers.

DS:

What's interesting about Instacart and Boxed, turning to that, is that PepsiCo now, for a number of years, even predating the pandemic, but certainly into the pandemic, have been very aggressive about understanding online consumers, online consumer habits, and the online retail environment, and particularly, how to get people to consider their products when they're shopping online. I mean, they've got it figured out in the retail environment. They know what size packs to put at the register. They know how to market to consumers to interrupt them, to either grab a snack or to grab that family size pack of Frito-Lay chips, or the 12 pack of Coke. But, what they have to do is figure out, "How do you interrupt the consumer in the online retail environment," and also, "How do you package products and create a price pack architecture in that arena that is both profitable, but also helps you grow?"

So, they've been on this mission to learn as much as they can. They had their own sort of skunk work, so to speak, in Manhattan, a division that was looking specifically at online retail. I think they've integrated that more into the company now. But, these investments in companies like Boxed and Instacart aren't really about trying to get into that kind of business, at all. It's really about the learning.

What they're trying to do is have an access point to understand, "How are consumers acting within that online space? How are these companies marketing to consumers? What does the cost profile look like when it comes to that kind of delivery? How can we, as PepsiCo," they would say, "play in that environment more effectively and learn the kind of things we have learned in retail to make us the number one effective company in that space?"

In the process, you have to invest in Instacart, and sure, you are now in some ways competing with one of your chief customers, Walmart or Costco. Walmart, especially, are pushing really hard into E-commerce. That's a very important growth endeavor in their business. These days you have to do it. I think, even if you have some difficult conversations around that, everyone, at the end of the day, knows that fragmented marketplace, it means that you have to move in many different ways that are sometimes in conflict with each other. No?

JS:

Right, right. Absolutely. I would believe that Coke is also working very hard in that area.

DS:

Absolutely. I mean, there's no consumer products company that's not looking for ways to learn in that arena. They're doing it in different ways, of course. With PepsiCo having Frito-Lay, they've got a more natural entry point. Chips and snacks are lighter, easier to ship, more cost-effective. Beverages being a water-based product, it's much more difficult. So, it stands to reason that you might see PepsiCo making these kind of moves in a more aggressive way. At least when it comes to the Instacarts and Boxed kind of investments, you might see that kind of movement make more sense for them, quicker. Whereas Coke, they're using other methods to kind of understand those environments.

JS:

Duane, going back many, many years, there was something called the three A's, that were considered an important part of the framework for marketing and selling soft drinks. So, the three A's were availability, affordability, and acceptability. That first A, availability, to your point, is changing. Where consumers buy beverages and buy other products is very different now than it was 10, 15, 20 years ago, and I'm guessing will continue to be different as the years go on. As I said, I think Instacart and other modes of online shopping are going to be increasingly and increasingly important. So, if you basically are focusing on how to make your products available, which is absolutely key to big products like the soft drinks, you have to keep up with the availability. I think that's what these companies are doing with companies like Instacart.

DS:

Another one where there just seems to be no rules these days is Dunkin' Brands. This has been really interesting watching this develop over the last couple of years, Dunkin' brands getting more aggressive about some of their beverage offerings outside of just the cafe itself. This year they've moved to Pepsi in terms of bottling canned products in their stores. Used to be those coolers were filled with Coke products. Well, when Coke was the chief beverage supplier for Dunkin' Brands, they also cut a deal with Dunkin' to manufacture, distribute, and market Dunkin' brand's non-alcoholic bottled ready to drink coffees, which you'll see in stores. That relationship, of course, continues even as Dunkin' is using PepsiCo for bottling cans inside their stores. There was a time when that would've really turned heads and almost would be sacrosanct. Right? Not to do something like that. It shows just how much the environment has changed now.

JS:

Exactly. I mean, I think companies are making decisions based upon rational analysis, much less based upon a traditional way of thinking. I think the Dunkin' thing probably has some more chapters before the end story is written on what brands are going to be carried where and what the Dunkin' name is going to be on. I think you have this odd situation where you have Coke and the Duncan RTD coffee product. Yet, I think you're going to see Coke expanding Costa RTD in the US in the years to come. So, there's another chapter yet to come on that. It's absolutely fascinating.

DS:

It's a great point. So, you might have Coke, in essence, distributing competing brands. Now, what that contract looks like going forward, where that ends up, who knows? I think the point we're making here, today, is that at a time that might've raised eyebrows, but it really shouldn't these days. Frankly, like you say, these companies are rational actors. At the end of the day, "Can we achieve growth," and "Can we do it in a way where we all can benefit in some way?" In order to get to that point, especially in a marketplace that's changing so quickly, and the rules are changing, that's going to create some tension, some conflict, that's going to create some kind of messy situations that you just have to deal with. I think the point is, if you're a watcher of these companies, or an investor in these companies, or trying to figure out what all this means, you have to be able to accept the fact that you're going to have these sorts of situations, and actually embrace it.

JS:

That's right. I mean, let me raise a rhetorical question. Maybe, you know the the answer. I don't. Pepsi took over the RTD business for Dunkin'. Pepsi products are in the coolers of the Dunkin' stores, but as you pointed out, the Coke system is still distributing Dunkin'. Maybe, the Pepsi bottlers couldn't because of the relationship with Starbucks. Maybe, there's a coffee exclusivity in those agreements. I don't know. It still points to the issue you're raising, which is relationships have gotten more complex. Routes to market are really interesting to watch. But, yes. I mean, it's a patchwork of relationships now, which was unlikely we would've seen 20 years ago.

DS:

For those listeners who aren't as familiar, PepsiCo and Starbucks have a joint coffee venture in North America, extremely successful, have been responsible for a lot of the growth that we've seen in RTD coffee in the US. That is a very, very important relationship. You have to believe if Pepsi had developed its own brands and had its own RTD coffee business to whatever extent that that was an important business to them, they would certainly have probably figured out a way to negotiate the Dunkin' coffee deal, either had it previously, or have moved that into their system now. John, I agree with you. I think probably there's no way they can do that. So, the various sides in this have to just live with it.

JS:

I think the prospect of seeing Pepsi bottlers distribute Dunkin' coffee would've given a certain Howard Schultz more than a hiccup.

DS:

That's right. Just a great example of what we're talking about here. Then, you've got Dunkin' Brands, now, they've introduced hard coffees and teas. This is the same time that PepsiCo, through its Blue Cloud distribution unit, is now distributing a hard tea product using another big relationship it has with Lipton in that space. So again, just more crossover, and it's just the kind of thing that we're going to just see so much more going forward.

JS:

But in many ways, the pioneer for all this was the old Dr Pepper Company. Many, many, many years ago, Dr Pepper basically was a Texas Southwest brand. Many years ago, long before I bought Beverage Digest back in 1995, the Dr Pepper management decided they wanted to make it into a national brand. They had a very interesting franchising strategy, and that was, they wanted to pick the best bottler in any geography, no matter what that bottler was. So, you ended up with this fascinating distribution system for Dr Pepper, where about 40% of Dr Pepper goes to the Coke system, roughly 40% goes to the Pepsi system, and about 20% goes to the independent system. In many ways, in my view, that was sort of the grandfather, Duane, of patchwork relationships, and it's been very successful for them. Coke and Pepsi bottlers who have Dr Pepper, their competitor in that market does not have Dr Pepper. It's an advantage to have Dr Pepper in a given market. That relationship, that framework, I think basically, in many ways, set the precedent for what we're talking about today.

DS:

It's such a great point. It was the blueprint for these kinds of crossover relationships, and it's one that's been hugely successful. So if nothing else, it should show the fact, with some creative thinking and some appropriate firewalls, that you could have these kind of crossover relationships and make it work. Now, that was very rare, and it's one of the few instances that you really had of something like that, up until now. Now, that sort of relationship, the point we're making today is it's going to be commonplace. In fact, to that point, John, you're so right, just in terms of the legs of that kind of relationship. You have a bottler like Buffalo Rock, in Alabama and parts of Georgia, that has been a major Pepsi distributor, a top five Pepsi distributor for years. They now also distribute RC products.

These are competitive products, on the same truck. In the same way that you have Dr Pepper on Pepsi trucks in a huge part of the country, as you point out. You've now got a situation where Pepsi and Dr Pepper have agreed, "Yeah. That's okay, Buffalo Rock. You can have both of these products on the truck," because, "It makes you a stronger bottler. It gives you better economies of scale. As people are drinking less soft drinks, even though we're making more money from them," the companies would say. The distributors still need product on trucks to make these routes efficient. So, the companies are all willing to do whatever needs to happen to make that work, given the fact that you are in this fragmented marketplace with lots of other products that you're also trying to send to consumers. So, it just creates an entirely different playing field with different rules in these kind of complex systems. Soft drinks, "Simple product," you'd think, but it's a complex system to make these relationships work. It's just a perfect example of the kind of thing we're talking about.

JS:

Exactly.

DS:

Any parting thoughts, John? Do you think we're going to see much more of this? I mean, are we barking up the right tree, here, that there's going to be a lot more of this? Or, do you think at some point it might shake out another way?

JS:

I think we're going to see more of it. With the decline in carbonated soft drinks volume, and per capita, over the last 20 years, I think that retailers, bottlers, and the companies, are all looking for new paths to growth. I think that's what's driving this. I think that the decline in carbonated soft drinks will continue, unfortunately. I think that that's going to open up the minds and creativity of beverage executives, and their investment bankers, to do all kinds of different deals in the years to come. I think that 15, 20 years from now, the beverage business in the US and globally, it's going to look different than it does now. I think that's fine. I think that's all to the good. The business is an old, old business. It's been successful for many years. It has to change. Part of the change is what we're talking about in this podcast. I think mistakes will be made. Every deal won't work out, Duane, but I think it's all to the good.

DS:

Yeah. It's all about adaptation. The only thing I would add is that the companies aren't doing this just because eh, they feel like it, or they think it's fun, or that they're even necessarily charting an agenda that they just thought out of their heads. The fact is the consumer's driving all of this.

I mean, consumers, especially young consumers who want a variety of products and are willing to buy them in a variety of different places, are driving all of this change, and forcing companies to adapt, and forcing companies to think of these kind of traditional relationships differently, and forcing them to treat those relationships differently. What it comes down to is, "Are these companies and these executives having the foresight and the flexibility and the understanding of the marketplace to understand how to avoid the landmines where they can, take advantage of the opportunities that are there, and to figure out how to make these relationships work in this complex environment?"

Frankly, there's some of the best out there in the world at figuring those kinds of things out and adapting. So, I think what that means for us is that we're going to be able to see a lot of interesting deals and a lot of interesting activity in the coming years. It'll be fun to watch.

John, thank you so much, again, for joining us today. It's always great to talk to you, and we will see you next time.

JS:

Duane, my pleasure. Thanks for having me.

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