The following is transcript of Beverage Digest's podcast, The Breeze, Episode 9. In today's episode, industry expert John Sicher joins Beverage Digest Editor and Publisher Duane Stanford to break down Tuesday's Coca-Cola earnings report, and PepsiCo's results earlier this month. Industry insiders have been surprised by the resilience of soft drink volume sales given the fast pace of rising prices. As pricing returns to normal, what does this mean for beverage makers? Can they stoke demand? Will "the other shoe drop," and if so, how should they prepare?

Please excuse any transcription errors.

DS:

Hello and welcome again 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 every day at Beverage Digest. We dissect what's happening, connect the dots, and ask the most important question; what does this mean? John Sicher joins us again today to pick up where we left off a few weeks ago on a discussion of pricing in the US beverage market. Now, as our regular listeners know, John has covered the beverage industry for almost three decades, first as a former editor and publisher of Beverage Digest and more recently as a consultant for companies including Coca-Cola and Body Armor. John also has served as an expert witness in beverage-related court cases. John, welcome to the program.

JS:

Duane, very happy to be here again. Thank you for having me.

DS:

So John, I'm suffering from a cold this week, so please excuse my rough voice today, but as they say, the show must go on, so that's what we're going to do. So speaking of plowing ahead despite challenges, Coca-Cola reported earnings today that looked pretty solid. Net revenue was up 8% globally, operating income grew, margins were up slightly on an organic basis. North American organic revenue was up 6% and organic operating income was up about 10% in that market. The company also raised its earnings guidance for the company as a whole.

So I asked John to come today and talk to me a little bit about what we're seeing in the market when it comes to pricing and the consumer. Of course, PepsiCo reported its earnings a couple of weeks ago, which we covered in detail for industry folks in our newsletter last week, and we're looking at Coca-Cola today just so we could see if we can glean how these companies are thinking about pricing, how they're thinking about the consumers, and I wanted to get John's take today. So again, thanks for joining me today.

Two numbers that we and investors are paying a lot of attention to right now, John, are pricing growth and volume sales performance in the North American market, which includes the US and Canada. Any thoughts so far on what we're seeing out of Coke today and Pepsi a couple of weeks ago?

JS:

Yeah, I think that I have concerns about the North American business. Coke's North American volume was flat, Pepsi's was down, I think, about 6%. Duane, I started a book recently by a guy named Marty Baron who was the former editor of the Washington Post. And he tells a story about when Jeff Bezos, who was founder of Amazon, decided to buy the Washington Post from the Graham family. And basically what the Graham family decided was that they needed to sell the Washington Post because there's a line in the book that says, "Profitable and shrinking is a short-term survival strategy, but ultimately leads to extinction."

And I think in the last 20 years in the North American market, CSD volume is down about 25%, per caps are down even more than that. If you look at this business before COVID, CSD volume was down, they were getting a couple of points of price, a very small amount of dollar growth. As we move into next year, I don't see why this industry should be any different than it was before COVID. The only thing that's intervened was COVID with all the economic and consumer factors we've talked about. But I think this industry is going to move back to a time next year, Duane, where there's going to be slightly down volume, hard to get much more than a couple of points of pricing, maybe a few points of revenue growth. I don't see any way around that.

DS:

Yeah. I mean we've already seen, as you mentioned, price mix for this third quarter was about 5% for Coca-Cola, volume was flat. I think one of the things that's been very surprising is the fact that with this double-digit pricing that we saw last year, volume hasn't suffered more than it has. Typically, people would expect much more of an impact there. I know you say you're concerned going forward, but what do you think about the fact that that other shoe that we've expected to drop just really hasn't come yet?

JS:

I think that COVID changed a lot, and not just in 2020 and 2021, I think the consumer basically shifted buying. There were shortages of things like cans. I think that, I mean if you look at, for example, what happened to Apple, going into COVID, all of a sudden Apple's Mac sales took off. Now Mac shipments are down about 30% or 40%.

And I think the other factor is that the Wall Street economists talk about COVID money, which made a lot of consumers very flush, is going to run out somewhere between the fourth quarter of this year and the first quarter. I saw a piece on Bloomberg recently, Duane, that said Americans are now more overdoing their car loans and paying their car loans than any time in the last 30 years. So I think that we've had a couple years of exceptional pricing for some pretty unusual and exceptional reasons. I think that we're probably going to go back to what it looked like in 2019. I think we're starting that now and I think probably, as we get into the second quarter of 2024, the results are going to look very much like they did in 2019 and 2018.

Fundamentally, nothing has changed except the intervening phenomenon of this terrible pandemic. But as we get beyond that, hopefully we are beyond that, I think a lot of buying patterns, not just for the soft drink business, are going to go back to where they were before COVID, and that includes pricing, it includes volume growth. I think it's probably inevitable.

DS:

Yeah, I mean in conversations with the CFOs of Coca-Cola today and PepsiCo a couple weeks ago, clearly they're expecting this pricing to moderate going forward. Coca-Cola, again, talking to the CFO today, he said that there won't be any pricing increases this year. They're looking at 2024, working with customers and bottlers to figure out what pricing might look like next year. But whatever happens, it's going to moderate from what we've seen for sure, and the question is, what sort of pain will that cause?

And then at the same time as you point out, consumers, they've got more debt, they're paying off student loans, you've got wages, the power of wages are decreasing. So you've got all those pressures and they seem to be prepared for something to come along in that regard too. All that said, I mean isn't there a chance though that somehow the pricing mentality or the consumer's understanding of the value of these products, because of the last couple of years of work when it comes to pricing and other measures, that they have somehow reset their expectation of pricing and might that somehow carry forward and almost reset the market in some way going forward?

JS:

I mean I don't think so. I mean I think that nothing fundamentally has changed in these categories. Again, I think that consumer buying habits and preferences changed during COVID and lingered for a while. I think people were frightened during COVID. I think things like concerns about obesity from sugar products, concerns about artificial flavors, artificial sweeteners I'm sorry, and the diet products, that probably ebbed for a while, but I think that these are the same products, these are essentially, Duane, the same consumers as in 2019 and I think by sometime next year, the industry is going to look like it did in 2019. I struggle to find a reason why that would not be the case.

DS:

People are paying $9 for a 12 pack of soda now and they continue to pay it. I just feel like that's got to have reset their expectations to some degree. The fact that they, for this amount of time, have paid these higher prices and we just haven't seen the volume declines that we would've expected. And you've got some bottlers who say, "Look, we spent a couple of decades way underpricing these products for the value that they bring consumers and we were afraid to raise pricing and our hand was forced now and we got more emboldened by it and we took price that we should have taken years ago and we should continue to think of that pricing around these products as being stronger than perhaps we once didn't feel more confident about that." Do you put any stock in that argument at all?

JS:

Look, I think that... Look, my concern is that pricing is going to be forced down, but even if the pricing at current levels, if the industry is able to make the pricing at current levels stick, it's going to be very hard to increase pricing year after year in any significant degree. So the best scenario, Duane, would be pricing sticks where it is now so that some of these packages are expensive, as the one you just cited, and that they can get a point or two or three of pricing growth in the future.

Remember, back in 2019, looking at full year IRI retail data, CSD pricing was up about 4.2% and LRB pricing was up about 2.8%. Volume was down on CSD, so you ended up with dollars being up about two and a half percent. Again, I struggle to come up with a reason why, by the second quarter of 2024, results should be much different than that. I don't think they can keep raising pricing to any significant degree. I think maybe a couple of points, but not much more than that.

DS:

One thing that was really interesting about the call with investors today that Coke held was this discussion around, okay, where are the pricing gains and where are some of these market forces coming from right now? And one of the interesting things that Coca-Cola CEO, James Quincey talk about was the fact that about half of Coke's business is represented, talking North America, half the business is represented through measured channels, Nielsen for instance, and the other half, and that's the at-home market. So people go to the grocery, take the products home, and consume them, and that's actually a little less than half is made up of those measured markets.

The rest of it is made up of away from home. And one of the things that's happened is that the away from home is actually still making progress post COVID. There's still gains being seen there. So I sort of took away from that that's, in large part, kind of propping up what's happening in the at-home market. So, there may even be, if you read between the lines, more pressure than we perhaps realize when we look at the full results. Going back to what you said about the measured markets and the kind of declines we're seeing there. I wonder, then, what we can expect going forward when it comes to these away-from-home markets, at what point will consumers start to get pressure there versus now?

JS:

I think that, look, we've always known that the IRI Nielsen measured retail data only picks up about half the business, but where I think its value is it's a very good indicator of what the consumer is buying, how much the consumer is buying, changes in performance and categories, brands and companies. I think that the food service channel was so badly hit by COVID and traveling was so badly hit, I think the food service business is probably still not back where it's going to look like next year or the year after, but again, I just don't see a reason why this overall industry should perform in 2024/2025 differently than it did either in your all channel data, which picks up food service, or in the retail data for 2019.

Again, the products haven't changed, Coke is offering some new flavors for brand Coke, but basically we have the same products being offered, the same kind of marketing, the same kind of distribution. What changed was the consumer, and I think from the data that I see, the consumer is now shifting back to what the consumer was before COVID and there's an old saying and that is, past is prologue for the future. Again, I think that it would take a fairly high level of optimism to think that, as we move into 2024 and 2025, much is going to be different than it was in 2019.

I mean the bottlers were ecstatic about the kind of pricing they got, and they can talk about the products being undervalued, but remember something, I don't think the consumers thought the products were undervalued. The consumers, the per capita consumption of carbonated soft drinks in the US in 2022, according to your data, was 35% less than it was in 2002. That means the average consumer, factoring in volume declines and population growth, the average consumer is drinking 35% less carbonated soft drinks than the average consumer was in 2002. That, to me, is a statement about the value that the consumer's overall place on these products. And the products are terrific, but I think consumer sentiment began shifting away from some of these products around 2000 and I don't see any change in that.

DS:

I do kind of wonder though if we're getting closer to some sort of equilibrium on that, because the fact that you haven't seen the kind of volume declines that we would expect with this level of pricing and the consumers are largely paying the kind of prices that they're paying now, you have to believe that we've gotten to some point that's a little more about the consumers who are in these products, use them, like them, whatever enough to continue to pay these pricing. So that is kind of potentially a reset of that versus 20 years ago.

And I guess the key would be now, what does that look like a year or two from now? If you can sustain some kind of equilibrium there, then basically, okay, you can call it, there's been a reset. Maybe people have some of the concerns about carbonated soft drinks have either abated to some degree or the consumers who were concerned about that have just gone on to other products, including other non-alcoholic beverage products.

I think the other thing that's really yet to be determined, but is going to be very important are efforts of these companies, especially carbonated soft drink companies to recruit new consumers, that's going to be really important and I think there's a healthy debate about the extent to which these companies are effective or not at reaching these younger consumers. I'm probably a little less pessimistic than maybe some other people are about that.

One really interesting note on the call today was that Coca-Cola, according to James Quincey, is now spending about 60% of its marketing and advertising on digital today, whereas in 2019, that was about 30%. So, a lot more in the digital space, which of course, is much harder to see and to consume as people analyzing the industry, it's kind of tough sometimes to see the breadth of some of that marketing because a lot of it is on channels that we may not spend our time on every day. And I do wonder the extent to which that's effective or not. Would you agree that that's going to be a very important part of this in terms of what we see in the next couple of years?

JS:

Before I answer that, may I go back to your reset comments for a minute?

DS:

Sure. Yeah, absolutely. Please.

JS:

So I agree with you. I think that at some point in time there probably is a level to which carbonated soft drinks will decline and it'll probably reach some kind of equilibrium there. But if volume is down 25% in the last 20 years, why do you think that maybe that reset level has been reached now? Why do you think that it won't go from a 25% decline over the last 20 years to a 35% decline over the next 10 years? In other words, what signs are you looking for, Duane, that that reset level has been reached?

DS:

Yeah, I mean I think there's a couple of things. First of all, during the COVID years, people moved back into carbonated soft drinks because that was just easy, comforting. I think there has been sort of a, people have reacquainted themselves with carbonated soft drinks, they love bubbles. We've seen bubbles permeate every beverage category out there. I don't think there's a lack of love for effervescence. And so I do think people have kind of reacquainted themselves with these products and they like them and that there is less of a concern now than there was perhaps a couple of years ago, in part because the debates subsided to some degree over things like sweeteners and obesity, and of course the companies have addressed that. There's lots of other options. The sweetener systems with zero sugar drinks are much better now. So a lot of the impediments to those products have been lifted for people that are looking for really good taste.

And so I think also, the other thing I think is that there was a generation of young people that were raised during this period that carbonated soft drinks were vilified because of obesity, sweeteners, artificial sweeteners, and basically told, those things are not good. They were stigmatized. And I think that generation is kind of moving beyond that now, they're on their own, they're acquainting themselves with soft drinks in a way that they weren't allowed to before. And the extent to which they accept those and they accept carbonated drinks, even like energy drinks, are going to then lead to a situation where they're more permissive than they perhaps were in the past. And depending on how well companies like Coca-Cola and PepsiCo and Dr. Pepper can capitalize on that and how effective they are at the digital marketing and getting young people to reconsider these products that their parents told them weren't something that they should be consuming could actually make a difference in terms of this reset and creating a new stabilization here.

JS:

Look, I think that, I hope you're right, but I look at this third quarter data, Pepsi's beverage data on North American volume was down 6%. Coke's volume, I think overall company wide, was up 2%, but Coke was flat or down in three of five of its global operating units. I think it was flat in North America. Had they not had a 7% volume increase in Latin America, it appears to me that their overall corporate volume would've been down. I think that if and when we begin to see, on a sustained basis, in some of these developed markets Coke and Pepsi beginning to pose volume gains, then I will basically say to myself, "Duane, you're right." Or say to you, "Duane, you're right." But as long as volume is flat or down for most of this industry in most markets, my concern will continue.

DS:

Yeah, makes sense. Although it's interesting because when you compare Coke and Pepsi, they almost have to individually be considered on their own. I mean Coca-Cola with Zero, their volume was flat, but their price mix was only up about 5%. PepsiCo's was up 12%. They were down 6%, as you noted. They said that about two points of that was them just backing away from promotions on case pack water, so bring it down to more 4%. That sort of seems in line with that higher amount of pricing that they're taking in the market.

But again, there has to be some accounting for the fact that these declines, I mean Zero, volume was flat for Coca-Cola despite a 5% increase on top of the increases that have been going on for two years, something different is happening there, something is happening in that when it comes to how they're operating in the market, whether it comes to revenue growth management techniques, what they're doing at retail, how they're marketing, how they're reaching new consumers, something's happening there. Don't you think?

JS:

Look, I think that the companies have been smart and strategic about how they've managed the volume declines and the volume performance. They've been very smart about using channel mix, package mix, product mix to continue to post revenue growth. Pricing, obviously it's not just rate, it's a factor of different kinds of mix.

My concern is that it reminds me, going back again to that comment about the Washington Post, "Profitable and shrinking is a short-term survival strategy, but leads eventually to extinction." I think these companies have to figure out a way, hopefully it'll be things like the digital marketing you referred to, Duane, they have to figure out a way to get consumers consuming more of their product again for these companies to be viewed as long-term financially healthy and long-term growth companies. Otherwise, what they're doing is they're managing, albeit managing well, a shrinking base.

DS:

Yeah, you can't price against zero volume at the end of the day.

JS:

Right, exactly. I remember many years ago, a Coke bottler said to me, I guess I still had Beverage Digest and we were talking about pricing, and he said, "We're not going to be able to get..." Actually, I'm not sure it was a Coke bottler, it was a bottler. But anyway, he said to me that we're not going to be able to sell a thimble full for a dollar, and there are both Coke and Pepsi and KDB have managed package size channels, et cetera well, but there are limits up against they're going to hit eventually.

DS:

Yeah. Today, one of the points that James Quincey made, and he made this at one of the analyst conferences recently as well, this was a point they've been really hitting home because obviously this debate is happening throughout the industry and consumers have already been concerned about what's going to happen here going forward along the lines of, I'm sorry, not consumers, but investors, along the lines of what we've been talking about today. They've been really hammering home the point that one of the core goals of the company is to protect the size of the consumer franchise and to grow it.

So in essence, so basically what he's saying is revenue growth management isn't the end all and be all. We have to continue to grow the number of consumers who are drinking our product. They need to consume more of it more often, and they need, of course, as part of that is pay more for it over time. That's the name of the game here, but it's not lost on them either, it sounds like what you're saying in terms of the risks here, that you have to continue to get new consumers.

And I think a lot of that comes down to what they can do with this next generation of consumers. I mean, that is a real linchpin because as we know, as consumers get older, they tend to drink less carbonated soft drinks. And the reason we're talking so much about carbonated soft drinks, because it's such a huge part of a business like Coca-Colas and it's one of the largest categories in the US and certainly the most profitable, or one of the most profitable. And so they have to continue to recruit new consumers into these brands, and that's what you're seeing a lot with these digital efforts.

JS:

I agree with you totally, and I think each company is a different challenge. I think that Pepsi simply has to basically figure out a way, notwithstanding their very good snack business, they have to figure out a way to do a better job in carbonated soft drinks. I think Coke has to figure out how to do a better job in non-carbonated beverages. And I have no doubt both these companies are managed well, they've got really smart people at the top of the companies who are running the operating units. I think they're trying, I think there's a good decent chance they will, but they've got big challenges ahead of them.

DS:

What do you make of this whole discussion about units? Pepsi had a big discussion, which we wrote about, it's all about units, not volume necessarily. Coca-Cola talks about transactions, which, in essence, it's every time someone comes and makes a purchase of a SKU, whether it be a 12 pack or a 20 ounce, passes that over the scanner, that's a transaction. What do you make of that? And of course, a lot of that has to do with the price mix and your revenue growth management and getting people to pay, in essence, more per ounce for packages that they deem to be more convenient and more valuable to them. That's obviously a big part of the game here.

JS:

Yeah. Look, I think that, I'm not saying that volume is the only metric, I think that whether you call it transactions or units, I think that they can basically increase their level of activity with the consumer and the consumer starts buying more, not just paying more, but buying more of the products that Coke and Pepsi and KDP sell, I think we might see the beginning of a long-term healthier business, but I think that these companies have to figure out more, as you said, a better way and they have to make sure they're recruiting young consumers. They have to simply get consumers more engaged with their big products and brands, buying more of them, whether it's transactions, units, or volume, and not expect that they can keep building revenue long term just with the pricing level.

DS:

I agree with you that we're sort of at, you know what? We've been saying for a year now that the next quarter is going to be really key and the elasticities keep holding up. I mean it's been probably a year that people have been waiting for this other shoe to drop and it still hasn't. I mean you know the old saying; what goes up has to come down. This is so unprecedented that people just really, it's hard to create a model around this because it's happening for the first time ever, probably, that we've seen this sort of environment and these set of factors and it's kind of blowing up everything we know.

JS:

But in North America, the third quarter this year, Coke's all channels business was volume was flat, price was up 5%. If you look at Coke's CSD business in the IRI data for a full year 2019, its volume was up 0.2%, which is pretty close to flat, and its price was up 4.1%. So it's getting back now to a pattern that looks somewhat like pre COVID and-

DS:

But coming off the period we just had, that's actually pretty good, right?

JS:

And let me tell you something, if Coke is happy with that business, if they're happy with flat volume and pricing up 5%, which generates revenues up 5%, and they can sustain that, great. Again, my concern is that it's going to get harder over the next couple of years and that they simply have to figure out a way to increase volume at least a little bit. And I'm sure they're working on it, these are real smart people. But I think, Duane, when we do this podcast at the end of 2025, we're going to have, maybe even the end of 2024 and look at the last couple of quarters of 2024, we're going to have some really good insights about what this industry is going to look like in the balance of the decade.

DS:

Yeah, and it's been fascinating to watch it unfold here. I think as we close, I do think there is this healthy debate to be had here, but the end of the day, 100% agree that they have to continue to get new consumers. And the CEO of Coca-Cola said it today, you got to grow the franchise. And so the question now is, as the pricing abates, as you've got this pricing increases coming off because you don't have this commodity pressure that you had before, as consumers become more stretched than they were before, what can the company do to continue to invest in its brands and get more people to come into these products?

And I would imagine that the hope on their side is that all this work they're doing to recruit young consumers, whether it be through the creations or being much more experimental with brand Coca-Cola, that those are all going to pay off in new consumers and offset a lot of the pain that we've been talking about today in this coming two-year period. So that's, of course, what we'll be watching very closely.

John, thanks again for joining us today. It's been a pleasure to discuss this with you and we'll do it again soon. We'll keep watching.

JS:

Duane, pleasure being with you. Talk soon.

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