Why you need to add some Coca-Cola Syrup to your Business Model

Coca-Cola’s business model is simple:

Our Company markets, manufactures and sells:

  • beverage concentrates, sometimes referred to as ‘‘beverage bases,’’ and syrups, including fountain syrups (we refer to this part of our business as our ‘‘concentrate business’’ or ‘‘concentrate operations’’); and
  • finished sparkling and still beverages (we refer to this part of our business as our ‘‘finished products business’’ or ‘‘finished products operations’’).

Generally, finished products operations generate higher net operating revenues but lower gross profit margins than concentrate operations.

The quote above is cited from page 3 of Coca-Cola’s 2010 Annual Report on Form 10-K filled with the SEC on 02/28/11. This text is referenced within their 10k document at least 10 times to explain the impact of various business decisions made throughout the year on Coca-Cola’s gross profit margins.

With that said, Coca-Cola makes it very clear that the difference between the concentration business and their finished products business is a significant aspect of their business model. Entrepreneurs take heed.

Before I go further I want to disclaim:

1) I don’t own Coke’s stock and
2) I am not a finance expert.

So why, you may ask, did I read through Coca-Cola’s 184 page 10k SEC filing? Well, it all started when the 2011 Fortune 500 list was released several weeks back. The first thing I noticed was that Fannie Mae made the list at #5.

At first glace I couldn’t figure out why. Especially, since Fannie Mae has been a disaster of a company since the real estate market went bust. However, I quickly realized that the Fortune 500 is strictly based on revenue, not profit (Fannie Mae loss 14 billion dollars in 2010).

As a result, my conclusion was that the Fortune 500 is not a true measure of success for a company and my curiosity on what should be the measure was ignited…

I decided to drop the complete Fortune 500 list in to an Excel spreadsheet to do some quick analysis. Revenue and profit were the only two data elements provided at the time, so my rudimentary analysis quickly lead me to profit margin as my favorite measurement of success (I can hear the laughter from the “B-schoolers” reading this…my formal education is in software engineering so bare with me).

Anyway, since I am a technology guy, I then noticed that 6 of the top 10 companies with the highest profit margins in the Fortune 100 were technology companies with a heavy emphasis on software. However, the company with the highest profit margin overall was Coca-Cola (33.63%).

What was even more intriguing was that Coca-Cola beat out Microsoft (#2 with 30.02%). Especially since the Windows operating system is a huge cash cow that is the epitome of a software company’s built- in profit margin advantage of being able to build once and sell an unlimited amount of times with virtually no additional manufacturing expenses.

There was clearly something about Coke I was clueless about.

This brings us full circle to the quote cited from page 3 of Coca-Cola’s 2010 Annual Report. After reading through the 10k a few times I concluded that part of Coca-Cola’s business is very similar to Microsoft’s Windows operating system, and part of Coca-Cola’s business is similar to the computers manufactured by HP (6.95% profit margin) and Dell (4.28% profit margin). This was my “Ah-ha” moment.

Long ago, Coke’s management realized the syrup business was the sweet spot for the company (no pun intended) since it generated abnormally high margins. In addition, they realized that although the bottling business generated a ton of revenue, it was a huge drag on margins.

Thus, with a quick sleight of hand, Coke established multiple bottling companies as independent corporate entities to manufacture and distribute their finished product.

It just didn’t make sense to mix a high margin business with a low margin business when the two could be split up so neatly and profitably. Similar to how Microsoft partners with a HP and Dell to develop the computers that run the Windows Operating system instead of Microsoft building and selling the computers in-house.

What’s more, since Coke’s syrup business requires much less year to year maintenance than a software company (no hackers/viruses to worry about among other things); it is even easier to generate high profit margins than Microsoft.

In my mind, this is Coke’s magic formula.

So to answer the title to this article, “Why you need to add some Coca-Cola Syrup to your Business Model,” let’s end with this basic premise: if profit margins are important to your business (which they always should be) then you must try to find a component of your business to treat like Coke’s syrup and a component to treat like Coke’s bottlers.

Then if you are crafty, revenues from both businesses will be significant enough to franchise out the “bottling” component to third-parties. Truly sweet success…

This may be easier said than done, but surely worth a try as getting it done will almost certainly lead to more profits and get your investors to start treating you like a rock star. Good luck!