02 May Question: A. One of the most important skills to learn in managerial economics is the ability to identify a…
CASE Study Is Coca-Cola the “Perfect” Business?3 What does a perfect business look like? For and old alike. It would be cold rather than hot Warren Buffett and his partner Charlie Munger, so as to provide relief from climatic effects. It vice chairman of Berkshire Hathaway, Inc., it must be ordered by name-a trademarked name. looks a lot like Coca-Cola. To see why, imagine Nobody gets rich selling easy-to-imitate generic going back in time to 1885, to Atlanta, Georgia, products. It must generate a lot of repeat business and trying all of your friends rich. ensure widesprea to invent from scratch a nonalcoholic beverage that would make you, your family, and through what psychologists call conditioned reflexes. To get the desired positive condi reflex, you will want to make it sweet, rather Your beverage would be nonalcoholic to d appeal among both young than bitter, with no after-taste. Without any after- taste, consumers will be able to drink as much of
continued your product as they like. By adding sugar to make your beverage sweet, it gains food value in addition to a positive stimulant. To get extra- powerful combinatorial effects, you may want delivery trucks, to add caffeine as an additional stimulant. Both capital requirements sugar and caffeine work; by combining them, on invested capital. Moreover, if you you get more than a double effect, you get what price the Munger calls a “lollapalooza” effect. Additional that the enormous profits generated by carefal can also better safeguard its “secret ingredients This also avoids the problem of having to invest a substantial amount in bottling plants, and so on. This minimizes and boosts the rate of return combinatorial effects could be realized if you developed lollapalooza effects accrue to your the bottlers. Of course, you independent bottlers the potentiai for seems like a safe bet. By highly satisfactory profits in order to provide the added to necessary incentive for them to push your product You not only want to “leave something on the To keep the lollapalooza effects coming, you table” for the bottlers in terms of the bottlers’ profit will want to advertise. If people associate your potential, but they in turn must also be encouraged beverage with happy times, they will tend to to “leave something on the table” for restaurant reach for it whenever they are happy, or want and other customers. This means that you must to be happy. (Isn’t that always, as in “Always demand that bottlers deliver a consistently high- Coca-Cola 2) Make it available at sporting quality product at carefully specified prices if they events, concerts, the beach, and at theme parksare to maintain their valuable franchise to sell your design the product to appear exotic. Coffee company, and not to is another popular product, so m safe bet. By highly satislactory protheto us your roduct. so making your want to offer beverage dark in color adding carbonation, a little fizz c your beverage’s appearance and its appeal. wherever and whenever people have fun. beverage in the local area. Enclose your product in bright, upbeat colors If you had indeed gone back to 1885, to that customers tend to associate with festive Atlanta, Georgia, and followed all of these occasions (another combinatorial effect). Red and suggestions, you would have created what you white packaging would be a good choice. Also and I know as The Coca-Cola Company. To be make sure that customers associate your beverage sure, there would have been surprises along the with festive occasions. Well-timed advertising way. Take widespread refrigeration, for example Early on, Coca-Cola management saw the tied to the Fourth of July fountain business as the primary driver in cold carbonated beverage sales. They did not foretell To ensure enormous profits, profit margins and that widespread refrigeration would make of return on invested capital must both be grocery store sales and in-home consumption To ensure a high rate of return on sales, the popular. Still, much of Coca-Cola’s success has charged must be substantially above unit been achieved because its management had Because consumers tend to be least price and still has, a good grasp of both the economics for moderately priced items, you would and the psychology of the beverage business. and price promotions can help in this regard- annual price promotions holiday, for example, would be a good idea. the rate high. ensitive have a modest “price point”, say roughly By getting into rapidly growing foreign markets with a winning formula, they hope to create because water is a key ingredient, and local brand-name recognition, scale economies around this cost-of-delivery difficulty, you advantages like the ones they have nurtured in redient, like syrup, to local bottlers. By selling As shown in Figure 1.4, in a world where per serving. This is a big problem for most verages very expensive to ship long distances. in distribution, and achieve other “first mover l not want to sell the beverage itself, but a key the United States for more than 100 yeans to independent bottlers, your company the typical company earns 10 percent rates of
continued return on invested capital, Coca-Cola earns A. One of the three and four times as much. T rates, let alone operating losses, are unheard of at Coca-Cola. It enjoys large profits, and requires practically no tangible B. Identify and talk about at least four companies capital investment. Almost its entire value that you regard as having is derived from brand equity derived from listed here. most important skills to learn in managerial economics is the ability to identify a good business. Discuss at least four ypical profit and growing characteristics of a good business. the characteristics generations of advertising and carefully C. Suppose you bought common stock in each nurtured positive lollapalooza effects. On of the four companies identified here. Three an overall basis, it is easy to see why Buffett and Munger regard Coca-Cola as a “perfect” business. 9 years from now, how would you know if your analysis was correct? What would convince you that your analysis was wrong?
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