CONSUMER STRATEGIES REPORT June 10 2003

al berrios & co. CONSUMER STRATEGIES REPORT 06.10.03: Bad Marketing Slows Beverage Industry, Focus On Consumer Will Help

QUOTATION OF THE WEEK
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"CSDs are no longer carbonated soft drink companies, but total refreshment beverage companies." - Mike McGrath, President, Dr. Pepper/7up, explaining the positioning his industry has adopted in order to continue to grow.

There were significant events in media last week: The White House will allow government spectrum to be used by commercial wireless companies, a huge leap forward essential for the evolution of technology and services that consumers will hopefully adopt quicker; a U.S. Court of Appeals in D.C. decided to not block an action that will permit wireless number portability, meaning that by November 2003, we will be able to switch cell phone companies to get the best rates, while keeping the same phone number. Although this is expected to increase churn, and consequently marketing to keep replacing lost customers, the best services are expected to prosper. Precedent of what may happen has already occurred in Hong Kong, however, that market is more technologically advanced than the U.S. as a whole, so I anticipate churn to not be as significant.

Last week, I attended Summer Jam X, a hiphop concert hosted by a local New York City hiphop radio station. The event drew 50,000 screaming, dancing, fans, under-the-influence-of-various-substances, in non-stop cold rain and drizzle, in open-air Giants Stadium in E. Rutherford, NJ. The venue was cramped, uncomfortable, and pricey (read: abusive), as plastic bags were being sold as rain ponchos for $5. The mob was so dense, it was literally impossible to move. The lesson: Clear Channel's Gone-From-Home-Network approach of radio and outdoor concert venues and media are effective because not only are consumers being aggregated, but due to the nature of a concert, they're being reached in a relevant and meaningful way.

Yesterday, I attended what many executives consider to be one of the more relevant meetings in the beverage industry. Today's REPORT analyzes the industry, trends, and offers our advise for beverage businesses.

[2] INDUSTRY
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Bad Marketing Slows Beverage Industry, Focus On Consumer Will Help

The marketing departments at non-alcoholic beverage companies wield too much power that they don't how to use. As a result, they're overspending on small-margin areas (i.e. branding and brand extensions) and not realizing full value from the already below-standard R&D they do.

Beverage companies are basically two parts: operations and marketing. The operations manages bottling and distribution; marketing attempts to manage sales and consumer communications. The process worked well for decades, but as consumers discovered and adopted choices from water to milk, marketing failed to adapt. Rather than adjust efforts to spend more effectively via diverse media, they simply upped spending in the same areas they were spending in previously in an effort to out-do each other, copy each other, and in the process, react rather than lead. (Is giving away $1 billion really effective?)

Historically, a strong alternative to spark growth when it has stopped is to buy into some new category or market. However, according to deal experts in the beverage area that I've spoken to, the few deals that remain, won't spark the sort of growth necessary to compete better in a global (or domestic) market. In fact, the only mega-deals left are combinations of alcoholic and non-alcoholic. Anheuser-Busch and Coca-cola? Hopefully, according to Citigroup consumer products investment banking head Andrew Vandenboorg.

Based on my own dealings with executives at beverage company marketing departments, these departments are structured in such a labyrinthine way as to confuse even the most seasoned executive. Divided by region, then brand, then marketing function, and finally consumer demos, these structures make it unusually bureaucratic, unable to act quickly to rapidly changing consumers preferences in taste, color, price, packaging or even temperature and extended shelf-life benefits. In fact, the bottling executives I've spoken to admitted to me that their industry does not fully understand these consumer preferences. (Certain attributes are already known, like orange-colored beverages trigger morning consumption reflex. However, significant studies in this area are still mostly post-transaction, as opposed to pre-production.)

al berrios & co. argued last week that marketing departments of consumer products companies would be optimally structured primarily by consumer segment, then marketing function. An approach like this can guide marketing investment more effectively with decisions ranging from whether or not ethnicity predicts taste trends to whether or not smoother carbonation (like that of beer) can help increase consumption per customer. This is opposed to hyper-sampling or paying trend-setting consumers to try your brands in public, to the point freeloading has become an actual profession. (See READ MORE below.)

Ideally, since generating awareness and interest among consumers is such a critical part of the beverage business, I would advise breaking apart beverage company marketing departments in the following manner: flavors and colors, marketing and media, new product development and pricing, public awareness and policy.

The flavors and colors group would be dedicated to predicting not just consumer preferences, but higher margin or costly flavors and colors. Marketing and media would be focused solely on how to re-aggregate consumer attention, since beverages are not niche products, and it would improve ROI. New product development and pricing would be dedicated to packaging and demographic insights, to optimize distribution and inventories. And with health management and recycling becoming hot-button consumer issues, a public awareness and policy group would be dedicated to forecasting and addressing these concerns. These groups would be structured as back-office resources that consumer segment leaders can tap to assist them in developing profitable relationships with their targets.

A revamped marketing department must spark growth by understanding consumer choices, not simply consumer perception to brands. Upon reviewing al berrios & co. analyses on consumer media habits, it is obvious to see why growth has stalled in major categories like carbonated soft drinks, yet exploded in waters, juices, teas, coffees, and, as I'm sure you read about in yesterday's Wall Street Journal, milk. (A still emerging category, which, although getting significant investment, doesn't even make as big a stir among industry executives as a potentially important profit center.) When consumers adopt a new choice, they rarely withdraw from a previous choice (unless the choice is taken away by force, like how auto manufacturers discontinue certain models). In fact, another choice simply reduces the amount of time (and money) a consumer spends with the prior choice, not, as many think, kidnaps consumers away entirely. For example, when consumers drink less of your carbonated soft-drinks, it isn't because they hate an old brand or category, it is simply that when looking at the big picture, the same limited amount of consumers are being redirected towards another option. This same phenomenon occurs every time a new media format is introduced, from cable television to the CD. Although this is an obvious result of consumer choice, it doesn't necessarily fit into the logical decision-making process model, nor is considered by marketers when marketing their own brands - an unfortunate consequence of poor training.

Before concluding, a few words on pricing strategies. Consumers will quickly diminish the value of your product (not brand), if you fail to price strategically. According to a Merrill Lynch analyst I recently spoke to, in Europe, after having had a longer lifespan among consumer products, value water brands go for around $0.10. If price becomes the strongest weapon against the battle to differentiate, expect non-alcoholic beverage companies to offer value brands in this price range in the U.S. as well within the next 5 to 6 years. And with the recent explosion in line extensions of core brands, rather than entirely new products, premium pricing that historically capitalizes on new product innovation isn't being done. As choices increase, and new categories emerge (carbonated coffee? Mix-your-own, powdered soda - just add water?), and consumers spend less time and money with older categories, if beverage companies cannot control their loss of the perceived value of their product (Hydration? Unique taste experience? Health? Energy? Drug delivery? Meal replacement?) through strategic pricing, they will go the way of the airline industry - unwieldy and unprofitable.

[3] TRADE EVENT REPORT
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Beverage Digest "Wall Street Smarts" 2003

Definitely a more meaty beverage industry meeting than the recent Beverage Forum, it was well attended by more senior executives. Most speakers left generic, pre-packaged comments in the office, as opinions and reality were frankly discussed among the group of about 150 or so.

Unlike my first visit, the Harvard Club here in NYC, where it was hosted, turned out to be friendlier. The service attendants, mostly Hispanic, I found extra courteous upon talking to them in Spanish. The food, mediocre; the facility, cool and accommodating, though not as imposing as you'd expect for Harvard; the beverages, plentiful and various.

The speakers, Pepsi Bottling, Sobe, Coca-cola, Coca-Cola Enterprises, Cott, Tetra-Pak (privately owned, this company sells packaging and packaging equipment), Morgan Stanley, Citigroup, CSFB, J.P. Morgan offered almost identical interpretations of consumer trends and business strategy based on expanding core brands, innovation, and in-store execution. Although all claimed to be focused on the consumer (and when you attend as many industry meetings as I do, you begin to get deeply skeptical about the sincerity of this statement), it's amazing to see how misunderstood they are.

Disclaimer: The recommendations, commentary and opinions published herein are based on public information sometimes referenced via hyperlinks. Any similarities or likeness to any ideas or commentary from any other sources not referenced is purely coincidental. al berrios & co. cannot control any results occurring from advice obtained from this publication nor any opinion(s) conveyed by any reader of this publication.

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