How Will Coca-Cola Leverage Its New Brick-and-Mortar Footprint?

With its purchase of Costa, Coca-Cola (NYSE: KO) gets a leading brand in Europe, thousands of storefronts and vending machines, and the infrastructure to make coffee a substantial part of its top line.

Join the Industry Focus team as they look at all the different ways Coke can build off of Costa's success and the challenges of taking on a physical retail chain -- something new for the beverage giant.

A full transcript follows the video.

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This video was recorded on Sept. 4, 2018.

Vincent Shen: Remember that, we've talked a little bit about this so far, Coca-Cola tapping into the retail footprint, tapping into the Costa Express vending machine system, the distribution of these roasting ground beans into restaurants and cafes where Coca-Cola products are already going, like you mentioned and ready-to-drink beverages, there's more to that.

Dan Kline: You have to almost look at the United States, and the existing coastal markets, and markets that have some cost of knowledge, separately. In the U.S., Coke has said, "We're not going to open a bunch of retail stores." There's a saturation point with Starbucks and other players there. What Coke can do is, they can go to every company that they already sell Coca-Cola products to and say, "Would you like our coffee, too? It'll be cheaper for you and easier for you than having whoever you use now." That's an immediate advantage. It can also go to every convenience store where it has Freestyle, or, Freestyle is in a lot of restaurants -- Blaze Pizza, for example, has Freestyle. A coffee machine would be very logical there. They can go to them and say, "Hey, do you want this?" This becomes a very easy add-on sale.

Coke also has the ability to do it in a way that benefits your business. I used to run a giant retail store. We carried Polar soda instead of Coke because Polar gave me the cooler as long as I signed a two-year contract. The big stand up machine? The local Coke guy wanted $1,000 or whatever it is upfront. I paid for it either way, it was just a question of, did I pay for it over X amount of orders at a slightly higher price? Or did I pay for it upfront? Coke has the ability to go to every Wawa, which have Coke Freestyle machines, and say, "Hey, put in our coffee machine." That part of the business in the U.S. can be very quick growth.

In the rest of the world, where they already have some market knowledge, they could do that part two. They could also ramp up the expansion and the adding shops and adding kiosks, especially where the kiosk business is understood in Europe. In the U.S., coffee kiosks are not yet a thing.

Shen: I know that management has wanted people to see Costa not as a single brand, but as this platform, because of the four pillars that you've talked about. Ultimately, when it comes down to it, you're essentially powering Costa with the scale and the distribution expertise that Coca-Cola very much has.

With the retail storefronts, in terms of what we were talking about before the show, newer products, experimentation. You have this direct feedback now from the storefronts from customers.

Kline: It's the Starbucks model. Starbucks buys Teavana or their juice brand, which is escaping my memory, what the name of it is. You go into a Starbucks. They've figured out which Teavana teas they would sell packaged, which ones they sell fresh-made. They tested all of that generally starting in Seattle and moving to Chicago, for the U.S. Then, they roll it all out. There's no mystery to them, when they put a product into stores, as to how well it's going to sell, for the most part. Coke will now be able to do that. They'll also be able to gauge things like, if I give out free samples of this, do people like it? That's really valuable market research, to be able to say, "The U.K. does not like cherry iced tea," or whatever it happens to be, on the level this market does. They can really now have this consumer lab. It's important, they're keeping all of the retail management. This is not Coke going, "We've never done this! Let's do it!" No, they are buying a ready-made company, and they are going to be involved, but they're going to let the existing people be in charge.

Shen: Yeah, they stress that this is a coffee strategy, not a retail strategy. That allows the management on the Costa side to continue forging their own path there. Essentially, Coca-Cola's management doesn't have to answer the tough questions of, "You guys have zero retail experience, what are you going to do?" It makes sense there for them to maintain some of that ownership.

Kline: There's also a brand strategy here in the U.S. Coke is not going to go to Kroger'sand say, "Let's put Costa on the shelf next to Starbucks, Dunkin' Donuts, McDonald's, all the ready-to-drink coffee." You don't know what it is. What will likely happen first is, you'll see Costa in restaurants and other places where you don't have a choice, where Coke has done the strong-arming. Then, when you start to know the brand, it will make sense to roll it out in ready-to-drink packaging. You've tried it, you're familiar with it. Maybe you like it better than you like the packaged Starbucks. This becomes a multi-year, multi-prong strategy.

Shen: That's a great description of how they're going to approach. It's a gradual process. The company actually lays out an idea, they give you an idea of what their attack plan is. First, they want to build the Costa brand. They're thinking about that through the retail locations, and also taking advantage of the pretty large loyalty program base. They have 5.4 million members. Start working off of that. Then, second, they're going to start integrating Costa into Coca-Cola's very large distribution network. And again, they're going to offer more products, like you've said, to restaurants, cafes, whatever it may be. Third, once they've made some progress with that, they want to start thinking about launching Costa in ready-to-drink form, and then in at-home products.

Beyond that, the company can start with cold or hot ready-to-drink coffee. Then they can branch into these other categories for at-home products. There's also related products, too, like hot tea and cocoa. A lot of paths that the company can take. There's a lot of optionality.

Kline: I was actually really surprised how much they talked about hot ready-to-drink. Hot ready-to-drink isn't a category. It's a category in Japan and a couple of places that have innovative beverage technology. But, think about it. We don't have those cans you open and it's hot. That's actually something they talked about having to innovate, having to create new ways. That's a category that, who knows what the potential is? The vending machine potential of getting a self-heating coffee could be enormous.

Shen: Sure. This optionality means that the company ultimately has to and will tailor its approach by market. We've talked about how, in the U.S., they don't need these Costa Coffee stores.

Kline: I think they said a few.

Shen: Maybe, kind of, to get the brand out there, as a flagship thing. But, whereas, in Asia, where the coffee culture is still very much developing, there's definitely the potential for them to open more stores in that market. Then, within that context, more on the operation side, I'll just mention that Costa has a new roasting facility in the U.K. It provides almost all the coffee the company sells except for some of their Indian market. There's capacity to expand that under Coca-Cola's management.

Daniel B. Kline has no position in any of the stocks mentioned. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool recommends Dunkin' Brands Group. The Motley Fool has a disclosure policy.