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Collection: Mohnish Pabrai - #114 'Charlie Munger's Coca-Cola Speech'



And then, you know, we’re getting to the – to finally the part about what I called the Glotz section. So, how many of you read the Glotz’s paper that I think some of the folks have read, right?

So that was the speech which Munger gave where they told him it was useless. So, Munger kind of inverts logic, so he says, you know, how do you create a $2 trillion dollar company with a $2 million dollar investment, right? How do you create that?

And the way he does it, is he says: “Look, let’s go in 150 years." He says in 150 years, how to take $2 million to $2 trillion? And so he says with 150 years (2034) which is 150 years when Coke is formed, he says that if there are 7 billion humans and they’re consuming the 64 ounces and then half of it is flavoured and then one half of the flavour comes to Coke.

And we’re getting about two cents a serving, let’s say by then with inflation, we’re getting about four cents a serving, you run on the numbers that Coca-Cola at that point is making about a $117 billion a year in profit, which would give you a market cap at $2 trillion. And so he says that’s how we get to $2 trillion.

And he says that, so what are the things we do to create that $2 trillion?

He says first of all, this guy Glotz, who setting up the Coca-Cola Company doesn’t want to call it Glotz flavoured sugared water. He wants to call it Coca-Cola because he likes that name better. And so he creates a name and he does a lot of stuff to promote the name.

And the second is he says in 1884, consumption of sugar and caffeine is well accepted in society, you know, we have coffee, tea and lemonade. So, we’ll use sugar and caffeine because people like that and using sugar and caffeine we’re going to create this product. And not just sugar and caffeine, what we’ll do is we’ll give it a colour like the colour of wine to make it look kind of high end and we will give it carbonation to make it like champagne. Okay, so we’ll put the sugar and caffeine and the colour of wine and carbonated. And now we’ve got a great product and then we sell it really cheap, so that, you know, everyone can buy it.

And then he said, you know, we have a choice, do we create a beverage that’s hot? You know, like coffee or tea or beverage that’s cold and he said: “Well, cold beverages can be consumed in a much higher volume than hot beverages." And when you’re kind of, you know, near the equator and really hot, you can gave an almost unlimited ability to consume cold beverages. So he says it’s a no-brainer you go with cold.

So he says you go with cold and then he says now we go into the mental models of the way human brains are screwed up. And so he says the first is the association tendency, which is that, you know, put it in places where people are happy because when people are happy and they see Coke, then they associate happiness with Coke.

And then we finally get to our next slide – which is my favourite slide – which is the Marilyn’s slide. Right, so the association tendency is if Marilyn is drinking it, then definitely I want to be drinking it too, right. And so the association tendency what Coke did in all its ads for the longest time and even now is they associated with celebrities, right? So, in India, they will pick some of the top Bollywood actresses and the same thing here, they will put these people in because the association tendency, humans kind of do very well with that.

And then you know the social proof tendency of human is another mental model, which is, you know, “Monkey see, monkey do," which is that, you know, when we see other people drinking Coke, we want to drink Coke too. And so, show people having a good time with Coke and all of that.

And then he says, you know, do it both ways, do it with fountains and do it with bottles. And then he says another thing we would do with the Glotz beverage company is that we would basically create this all-around secrecy. So, you know people think there’s something unusual about Coke because of formula secret, it’s in the wall, in the bank.

And quite frankly the secrecy means nothing because he says that he eventually with food science going where to the way it was growing, everyone figured out how to make something close to Coca-Cola.

But by the time they figured it out, we would have had brand and other things come in which would help us kind of keep the competition at bay. And he says the food chemistry that helps our competitors make a product like ours, also helps us by reducing the unit cost, you know, like they went in the U.S., from sugar to fructose which is a lot cheaper. And they just made their whole all their efficiencies in how they got there.

And then you know, then it goes to Jacobi inversion, which is, you know, what not to do. You know, what are the thing that you don’t do to get to the $2 trillion.

So, he says the first thing that you don’t do is avoid losing half the brand name. So, you know with the Coca-Cola brand name has two parts, the Coca and the Cola right? And he says don’t lose either part of it. If anyone came up with anything called Cola, sue it and take them out.

And, so he said that in an ideal world, he would made sure there was no other Cola. They could call it whatever else, you know, Glotz bottled water or whatever or carbonated water but no Cola. Right, so that’s the first thing he said that you won’t lose half of your brand name, you would avoid envied by basically having a standard great product at a great price, which they did.

And then the final thing he said that is don’t change the flavour even if someone comes up with something better. Keep the flavour because not about the flavour, it’s about the brand and that bring us to the Cola war, which very few of you are familiar with, how many of you are familiar with the Pepsi Challenge?

Yeah, that’s usual cast of characters, except you. How do you know about the Pepsi Challenge?

Okay, all right, good!

So some of us lived through the Pepsi Challenge, did you take the Pepsi Challenge?

All right, there you go.

So basically, Pepsi had a problem, in the mid 80s they had a problem. They knew that people preferred Coke by a huge margin to Pepsi by like a two-to-one margin and they knew that their brand was inferior. You know, if Burger King offered Pepsi and not Coke, then people would not think of Burger King as use as well, so everywhere they have to discount stuff and all these things was really hard for them.

So, John Sculley before he went to Apple, you know, he became the one who went to Apple and then ousted Steve Jobs. So before he went to Apple, John Sculley was a Chief Marketing Officer of Pepsi.

So he was brilliant, he said, : “How do I take out Coke?” He said the way I take out Coke is I take away their brand name and the way I take away the brand name is I asked consumers to do a blind taste test.

And in a blind taste test, where you – so you know, if you put in front of someone, a Coke and Pepsi, they’d go for the Coke because all that conditioning for decades, but now if you take away the brand and you just give those, you know, those tasting cups and then have them to taste it. Well, Pepsi is sweeter, it actually tastes better, right? So, in the blind taste test, people said: “Oh, I prefer this one," then they show you that was Pepsi. Right, and so they started taking market share and Coke got rattled.

So Goizueta and Keough who are part of Coke at that time, they got freaked out. They said, you know, basically, these guys have figured out that our product is inferior, and so what they did is they came out with new Coke. And new Coke was sweeter, and it will better than Pepsi and there was a major uproar, right?

So all the die hardcore guy was horrified that how can you change the formula? I mean, it’s all about the formula, I want Coke, I want new Coke, right? So there was this huge fiasco that now they had messed with the family crown jewels right? They took away the one thing that was there, which was that secret formula and all the things about the secret formula.

In reality, Coke had changed their formula many times, but they never told the public that they changed the formula right. They just did it quietly. This was very visible they called it New Coke and there was a huge backlash.

And then they realized – the Coca-Cola Company realized that they screwed up so then they introduce Classic Coke. Okay, so then there was New Coke and Classic Coke, you remember that? We have both, right? There was even more confusing.

Okay, and then they finally realized we got to kill this whole thing, go back to just Coke and that’s what they did. They went back to only Coke and they survived that.

So what Munger says is that, look, this essay I wrote about taking $2 million to $2 trillion, he said in reality, the company started in 1884 and by 1896, 12 years after they started, they had no earnings and there are a $150,000 in total assets. So that much less than $2 million they started with, he says they lost half their brand name, right?

So they were not able to protect the Cola part of the brand name, they lost that. And they also screwed up with the envy of Pepsi and they went to New Coke and all of that right?

So they did all these mistakes and they also had – what they did, I think in 1900, they didn’t think bottling was going to be that big, they thought bottling is kind of a sideshow, so they signed these agreements with these bottlers which fix the price of syrup permanently into the future.

So like in 1900, they said we will give you a syrup with whatever cents per pound, for the next hundred years, fixed price. Okay, completely destroys the model because then sugar went sky-high, and they started losing money. So then they're telling the bottlers, we can’t give it to you, they said: “No, you have a contract." And so, then they had to battle the bottlers and finally they got some leeway from there. So they made that mistake.

And then what they have done is the bottling rights. What they done originally when they gave bottling rights, it was a day's horse ride. So the way they set up was that they looked at how far a horse could go in a day and a back, and that’s how they define the territory of a bottler. Okay, and that didn’t make sense once you got to automobiles and they're – so first they had very big territories because Coke started expanding, so they wanted to reduce those territory. The bottlers didn’t want to give that up.

And the second is that they had some many useless bottlers, right? So these bottlers, I mean this is the license to print money, you got a monopoly in an area, you got the Coke product is going to sell and so you don’t need to be that great of businessman. And so they had to really kind of go through – Don Keough did a lot of work where they bought back a lot of bottlers and did all kind of things to get their model back.

But in spite of all that, Coke from 1884 until now with all the dividends they’ve given out, they’re now at a – Munger when he gave the speech, the market cap was $125 million in 1996.

So he said if Coke’s market value grows by about 7.5% a year, you’ll get to $2 trillion from 1996 to 2034, and if you go to today – of course 1996 I think it was an inflated multiple.

If you go to today, Coke is a $190 billion to get to $2 trillion by 2034. You would need to be at about 14.5% a year. I’m not sure they will do that, but the other thing that could happen by that time is since we get these cycles in stock market, you might have a 30 multiple on the company. You know, Coke was sitting at a 40 multiple in 1999. So, there’s a chance you might get some crazy multiple at that time, and that might get you to the $2 trillion.

So basically, what I wanted to just say is that you can see the work that Warren and Charlie did. So usually, the thing is one is they get a little bit of information edge because they’re willing to dig deep, you know, they’re willing to read a lot and whatnot, which most people aren’t willing to do.

The second is where they get a lot of advantage is the synthesis, you know, when they read, what are they kind of extracting out of that model.

And the third is that they understand that when you have multiple models interplaying with each other. I mean when you put a great manager like Goizueta on top of a great business, you just get phenomenal returns. I mean, those are just exceptional in terms of what ends up happening is great business with a great manager and then we get to some of these other nuances about personal space and all these other things about brand and such, you get to kind of these lollapalooza effect.

So, in the investment business, I think that this is the Holy Grail, you know, this is kind of when you get to this level of analysis on a business, you got it. You know, and then you got it there.

And so they key is to make very few bets, make very infrequent bets and when seven moons line-up, you bet big and such, and the rest of time we don’t do much. So with that, we’ll open up for any questions or comments you guys have?


[YAPSS Takeaway]

Great investors dig deep, real deep. 💎

Also, they're good at connecting the dots.

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