The following is transcript of Beverage Digest's podcast, The Breeze, Episode 4. Duane Stanford invites beverage industry expert (and former Beverage Digest publisher) John Sicher to discuss soda pricing power.

Please excuse any transcription errors.

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 daily at Beverage Digest. We dissect what's happening, connect the dots, and ask the most important question: What does this mean? Today I'm welcoming back John Sicher. He's covered the industry for almost three decades, much of that time as a former editor and publisher of Beverage Digest. Since then, he's consulted for companies including Coca-Cola and Body Armor, and he served as an expert witness in beverage related court cases. John, welcome back to the Breeze

JS:

Duane, very pleased to be here.

DS:

Our topic today centers on the roughly $85 billion US carbonated soft drink category, otherwise known as the CSD industry. This is your Coca-Colas, your Pepsi Colas, your Dr Peppers, your Mountain Dew, Fanta. As our diehard industry listeners already know these products are a significant driver of value in the ready to drink liquid refreshment beverage market. They are also extremely important to retailers when it comes to driving store traffic and overall profitability. Now, since the pandemic, a very interesting shift has taken place within this beverage category. For years, as John and I will discuss today, pricing growth was very modest.

For example, I pulled some Beverage Digest market data from years past, and in 2012, CSD pricing at US retail was about 2.2%. They were able to grow what they were charging at retail by about 2.2%. Now, five years later, in 2017, pricing growth was about 1.3%. Jump ahead five more years to 2022 and pricing growth was up about 15%. Think about that. Pricing growth in a decade went from 2.2% in 2012 to almost 15%. This has quite frankly shocked a lot of people and it's been very interesting watching this unfold in the last couple years. And I know John, you've been looking at it quite closely. Let's pull this apart a little. In all your years of covering the industry, have you seen anything like this?

JS:

I have not. Duane. In most of the years that I cover the industry, the CSD picture was this. Volume down a bit, pricing up a little bit, bit more than volume was down, creating modest dollar or revenue growth. For example, in a typical year you might see volume down 3%, maybe pricing up 4% and dollars up 1%, and that was within a few percentage points. As you said, that was the picture until the pandemic hit.

DS:

Let's talk a little bit about why this is happening. Clearly the pandemic was a huge disrupting force through supply chains into chaos. Big softening makers like Coke and Pepsi and Keurig, Dr. Pepper, cut back on the number of products they were putting on shelves in order to be able to have enough aluminum cans, for instance, for their big products. During this time, a lot of activities shifted from restaurants and food service where people were eating out and drinking beverages with that to the grocery store. They were hunkered down at home. They were looking for just little ways of comforting themselves, and it turns out soft drinks became one of those, and consumers were willing to, during that time and after the pandemic, begin to pay more for these. Have you seen anything like this where consumers are moving back into the category like this? Because for a time there was this belief that soft drinks were withering on the vine, carbonated soft drink when it comes to any real growth.

JS:

Look, I don't think consumers are moving back into soft drinks. In retail last year, volume was still down a little bit, if my memory is correct from your data. I think what happened, for example, last year during the pandemic was as you talked about inflation, but I think that all processed foods were up. I saw Wall Street Journal article recently and said all processed foods were up 14%. Fruits were up 18%. Vegetables are up in an incredible 51%. Soft drinks, as you said, were up 13 or 14% in pricing. I think what happened was a couple things happened to soft drinks.

Number one, consumers were used to paying higher prices because they're paying higher prices for almost all processed foods. Secondly, I think during the pandemic, consumers wanted, as you pointed out, some products that made them feel good. It was a hard time for a lot of consumers and brands like Coke and Pepsi and Sprite and Mountain Dew were old brands that people felt comfortable with and they were happy to pay a premium. In addition, I think during the pandemic, Duane, I think some of the concerns that we saw over the past decade or so over things like sugar and artificial sweeteners, they lost some importance in consumer's minds. Consumers had bigger health problems to deal with, namely COVID, so I think the perfect storm was right to see beverage pricing go up for a year or two in that 13, 14% range.

DS:

And after the pandemic and some of those factors, pricing was up. But it's continued to escalate since then, and especially as we moved into this period in the last year or two of rising cost inflation. Bottlers and soft drink companies have been dealing with everything from transportation costs escalating to some of their input costs. Labor of course, has been very challenging for a lot of them. And so, then they moved in 2021 into 2022, into this real period of trying to cover these costs. And lo and behold, they were actually able to do that without suffering the volume declines that people might have expected before. From talking to bottlers, I think they were surprised too.

JS:

I think so. But I think that what prevented soft drink sticker shock was the fact that consumers were used to paying higher for many different foods and categories of processed foods and beverages. But I don't think it's going to last, but I think that you're right. I think that there was an unprecedented period of the soft drink industry's ability to take pricing, and that helped them very much for a few years. The question now, is what happens in the future?

DS:

Well, let's go back a little bit too. There was a long period of time, which you know quite well, where the big soft drink companies were really geared towards chasing volume more so than these dollar increases. Because of the way the concentrate soft drink market was organized, you saw a lot of emphasis on larger packages that allowed the big soft drink companies like Coca-Cola and PepsiCo to sell more concentrate. And based on the revenue models with the bottlers who really needed to cover their cost increases and do more with pricing, there was always this tension between the franchise companies and the franchisees, the bottlers. Talk about that a little bit, about what that period was like.

JS:

Well, I think that a couple of things happened. I think that the financial analysts were basically reporting year after year after year on soft drink volume losses, and that concerned the big soft drink companies, and rightfully so. Since they were getting revenue growth because of pricing, they tried to begin the dialogue so that the world would focus not only on volume but also on dollars. The other thing was at the same time, Duane, there were these growing concerns about calories and sugar. The soft drink business basically tried to introduce for consumers, smaller packages like the mini can. And what those smaller packages did among other things, was they were priced overall lower than, for example, a package of 12 ounce cans, but on a per ounce basis, the pricing was higher. As the industry began to shift slowly to some of the smaller packaging, that shift generated higher pricing. And I think that the software industry benefited from trying to focus consumers and the fact that their revenues were growing and that their revenues were growing in part because of the shift to smaller packaging.

DS:

And then they were able to shift their revenue model with the bottlers to make it based on revenue earned instead of volume tied to the concentrate. And they were able to say, "Look, we can price products together. We can be more strategic as a franchisee and a franchisor, and over time we should be able to achieve more pricing if we're in line with that, and do it in a way that works for both of us." That was a big sea change in terms of setting up what we've seen in the last couple of years, or at least making that even possible.

JS:

Exactly. There was a time where it benefited a bottler to sell 20 ounces. It benefited the franchise company to sell two liter. And I think that, as you said, at least some of the companies and their bottling systems have tried to come into alignment where they are basically benefiting on a more balanced level from different kinds of package growth.

DS:

And so, for a number of years, consumers were beginning to be trained through those revenue growth management models you were talking about. They learned that, "Okay, we're not going to get 79 cents and 99 cents two liters anymore. It's going to be $1.59, $1.69, $2." And 20 ounce as well, you went from the 1.29 to 1.59 and you moved up the scale. Before even the pandemic, consumers were starting to get used to the fact that they were going to get more choice and variety, they were going to pay more for it, and they seemed to be doing that for the most part, yes?

JS:

Yes. But even so, for example, again, looking at syndicated data, if my memory's right, for 2018, I think volume was about flat, pricing was up about three and a half percent. The got a little over 3% revenue growth. That's not huge, but it's basically a way to basically show the fact that they are generating more dollars every year. Now, the flip side of that is through all those years of the early 21st century, and even now, volume continues to fall no matter what the pricing is. And that has real implications for the companies, the bottlers and retailers long term because an industry can't be healthy long, long term if it's selling less and less product, because at some point in time, revenue growth will also stop.

DS:

What's the threshold there, do you think?

JS:

I don't know. I don't know what it is. As you pointed out, the CSD category is still very big. I think that what it looked like during COVID and the immediate aftermath of COVID will begin to change. I think that there's an old adage, which I think is true, and that is if you want to understand the future, look at the past. Throughout most of the early part of the 21st century, we had the CSD business of volume flat to down a bit, a little bit of pricing, a little bit of revenue growth. I don't see a fundamental reason why it won't go back to that, Duane.

DS:

And back in those years when we saw that two, three, 4% CSD pricing growth, we were seeing flattish volume, as you pointed out, to slightly down volume. And you've seen volume more recently, that decline tick up just a little bit, yeah?

JS:

Well, a little bit. I think in your full year, I took a look at some of your data, the Beverage Digest data before the podcast. And if my memory's correct, in your full year retail data, I think volume, CSD volume was down about 2%. Pricing was up about 13 or 14%, so you had revenue growth of about 12%. As I said, I simply don't see a fundamental reason, as COVID begins to fade, how and why that would continue. I think that the model that we saw going back from about 2020 through the beginning of COVID, volume down a bit, pricing up a bit, revenue up a bit is probably going to come back in the next year or two.

DS:

I think there's been this sense of dread over the last even as much as a year, wondering when that other shoe is going to fall. It really hasn't yet. If that's true that this will make a turn at some point, why do you think it's been delayed versus some of the expectations?

JS:

Look, I'm not a macroeconomist, but I've been reading stories. Consumers still have a lot of their COVID funds and that supposedly positive impact on consumers will begin to recede by the end of this year. I think that we are beginning to see a few signs from what I've seen, of promotions, of promotions returning. Well, promotions returning, that means prices go down. I think my view is we're the very beginning now of a return to the norm of the first two decades of the 21st century. Why do I think that? The reason I think that is that I don't see any fundamental reason why it should be different. I think in your Gen Z panel at your conference, I think in the recent note that you wrote about going to that school forum in Georgia where kids were talking about new beverage ideas, I have not heard anything about a fundamental return in popularity of CSDs. And without that, I think what'll happen is pricing will erode and volume will continue to be down a little bit every year.

DS:

I don't have a crystal ball either. I probably differ a little in that I feel like there has been this new period of permissibility with soft drinks. You mentioned earlier some of the concerns over aspartame, artificial sweeteners have subsided to some degree. I think you saw a postponement or a hiatus to some degree in the concern of our plastic waste, but that's not going to... I mean, that'll plastic waste will be a concern and a growing concern, so that's not set aside. But also consumers love bubbles. It's clear because of carbonation coming in so many categories. The hard seltzer craze, the sparkling water craze, all of that shows they like carbonation. And as they feel more comfortable again about drinking some of these products, especially as you have this zero sugar sweetener phase where artificial sweeteners and some of these even natural sweeteners are getting better and better, so you've got products that taste closer to the original than ever before.

I feel like there has been some shift in consumer's minds, though, that some of these products are okay again, especially if they can do it in a zero sugar version, which could help to slow down or not get us to that period or the turning point as quickly, perhaps.

JS:

You're totally right. In my view, I made a prediction diet soft drinks would continue to outperform regular soft drinks and would eventually get so large that they would lift the category back to growth. I was totally wrong. The negative sentiment on aspartame and other artificial sweeteners began to grow at the same time when the negative sentiment about sugar began to grow. If you're right and there's less concern about the sweeteners like surculose, aspartame, and ASK and products like Coke, Coke Zero Sugar and Pepsi zero sugar can continue their growth over time. That could lift the industry back to better volume performance. But the diet segment is still very small compared to the sugar regular segment.

DS:

Well, and there is this talking about younger generations. It's not as if they're flocking to big carbonated soft drinks. I mean, some demographics within the young generation are in soft drinks as much perhaps as they ever were. But you do see now the younger generation doing a moderation that says they can indulge sometimes and cut back other times, and they're more willing to switch between things rather than just wholesale avoid products. And if that continues, that could be good news for the industry as well, and something to perhaps capitalize on. One thing you mentioned that the consumers, I do think there is this concern about this stockpile of cash that consumers built up during COVID, and we've already seen studies from the banks showing that that is beginning to dwindle. That really, I agree with you, that could have an interesting impact in the next year or so when it comes to this discussion as well, and obviously will clearly be something to watch.

There's also this really interesting theory, John, in talking to some bottlers. Some of them believe that because of this period where the bottling... For instance Coca-Cola where the bottlers and the franchise company Coca-Cola necessarily aligned on how they were pricing concentrate. And the bottlers were looking more at price, the company, Coca-Cola, was looking more at volume. That Coca-Cola, which seems to have a lot of pricing strength right now and are making share gains against the challenger PepsiCo, the number two, PepsiCo. There's this belief that even still Coca-Cola has not taken enough price over the years, that they have not made up enough ground that consumers are willing to pay more for these products. It's just that the system was not willing to really go and take the pricing that was available to them and that some people would believe consumers were saying was there.

And so, for instance, it's argued that beer pricing went through the roof over the last decade to 15 years, and soft drink pricing is lagged and that these people would argue that there's no reason for that to have lagged. And so, that they are arguing for a belief that says, "We can price more consumers are willing to pay for it, we deserve it." That might be very interesting if the system and soft drink makers all believe that that's the case. What do you think about that argument? Does that make any sense to you?

JS:

Yes and no. First, one of the problems that the soft print companies, all of them, Coke, Pepsi, KDP had for the early part of this century, the elasticities in the category were very dangerous. They learned that if they raised pricing maybe three or 4%, they could get away with a little bit of volume growth, but if they tried to raise it more, volume would go down more. I think there were concerns about driving people out of the franchise, so to speak, for carbonated soft drinks.

I also think that some of the great marketing that we saw from the soft drink companies, the joy of Pepsi, always Coca-Cola, the Pepsi challenge, I think that I believe, and all due respect to the soft drink companies, that the marketing wasn't as strong in the recent periods as it was in the past and could have been and maybe in the future. And I think that with stronger marketing and enhancing even more the value of the brands, that might help them in the future get more pricing. But again, my belief is that I don't see any reason why by 2024, 2025, we're not going to be back the same pattern we saw in the early part of the 21st century, unless one of two things happens. Unless diets catch fire or the marketing gets much better and even further enhances the appeal of the products.

DS:

In surveying some of the bottlers as we've done, there are some that would agree we're going to get back to three and 4%. A good number see... Well, they don't see the pricing growth that we've experienced in the last couple of years. They still see elevated pricing growth. Do you think that's just wishful thinking on their part or are they seeing something in their markets that perhaps it's tough for us to see sometimes, or what you would you attribute that optimism right now?

JS:

Look, I think the bother is bother is probably know this business better than anybody. And because they've often been in this business not just for many years, but for many generations, and I've got a huge amount of regard for the bothers and what they think. I think that the soft drink business has benefited from consumers seeing higher pricing across the board in stores. As I mentioned, the Wall Street Journal talked about all processed foods were up about 14% last year. I think you said that's what soft drinks were up last year. I think that as overall food and beverage pricing begins to return to normal levels, I think that's also going to probably happen in the carbonated soft drink business.

DS:

And you touched on this a minute ago, but let's say that the optimistic bottlers are right, that those who argue that there is still plenty of pricing growth to be had. Let's say that that's true. I think you did bring up a really interesting warning in all this, and I think there's some concern among some of the people we talked to about whether the soft drink companies are almost too closely doing the revenue growth management model, and paying so much attention to that, and they have so much data and the ability to analyze this data and really fine tune how they price and promote these products in the market, that you run the risk of losing sight of the branding, the brand building part of this, the creating the consumer love for these products, creating consumer love among young consumers. And that's the kind of thing you need to do to be able to continue to achieve the inelasticity that they've seen or to blow those old models out the door.

Do you think, and you touched on this a second ago, but let's dive in a little bit more. You've been around this industry for a long time. Do you think the companies are paying too much attention to rev revenue growth management and really not bringing in the creativity and the foresight and understanding these consumer markets enough to really do that brand building that's going to help sustain this pricing growth over time, without losing so much of the volume and that demand side?

JS:

Look, I think the answer is probably yes to a degree, which is a non-answer. I think the bottlers are right that there's more pricing power left and to be basically reaped in these big carbonated soft drink brands. But my guess, the caveat if they're being very candid would be yes, but the big beverage companies or franchise companies have to do a better job with marketing. Because marketing creates and draws brand value, brand value enables you to hold and raise prices. If you look at what Apple's done with the iPhone vis-a-vis what a bunch of their competitors have done with the Android phones, Apple can basically raise prices and raise prices and raise prices, its marketing has been so good, some of its competitors have struggled. I think the Coke and Pepsi, Acure, Dr. Pepper are public companies. They have a fiduciary duty to their shareholders to grow revenue and grow profits. I think they're doing it right now in a pretty good way, but I think that long term, they're simply going to have to be even better with their marketing.

DS:

John, I'll tell you what we need to do. We need to go out and figure out a way to invent a crystal ball. I think you're right. It is going to be an interesting couple of years. Maybe the bottom line is we'll return to these models, these elasticity models that we're used to or get somewhat closer to that. The question now is just how long that will take and whether the companies can figure out a way to move that curve out as far as possible. And we'll certainly be watching to see what happens on that. Thank you so much for joining us again. Fun as always. Look forward to further chances down the road too.

Speaker 3:

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