Coors Case Study: Regional Economies of Scale

Before we discuss how Coors lost its regional economies of scale in 1975 as it went national by 1985, we should realize another lesson this case demonstrates: not all growth is profitable. Growth requires investment, not all investment earns its required return, and thus, growth can destroy value. Furthermore, Coors was an entrant lacking economies of scale going directly into the regions dominated by a huge competitor Anheuser-Busch (AB). Coors Case Study Hannibal Lechter http://www.youtube.com/watch?v=f33ieCWRWlI SimplifyWhat is the nature of the business? Brewing beer is a business about marketing and distribution. Beer is bulky, heavy and expensive to ship. The cost of transportation from one location, which was not a problem when Coors was a regional firm, increased as Coors distribution territory expanded. Anheuser Busch (AB), with eleven breweries around the country, had shorter distances to travel from brewery to wholesaler and thus, lower distribution costs. The requirements of non-pasteurization increased distribution costs for Coors. Anheuser-Busch and Coors income statements 1977 and 1985 1977 Sales in $mil Sales/barrel COGS/barrel Advertising costs/barrel SGA/barrel Oper. Inc. /Barrel Regional % share Mountain Pacific 1985 Sales in $mil Sales/barrel COGS/barrel Advertising costs/barrel SGA/barrel Oper. Inc. /Barrel Regional % share Mountain Pacific AB 1.68 bil. $46 $36.61 1.99 2.79 $4.62 Coors 0.532 bil. $41.56 $28.98 1.09 2.97 $8.52 37% 24%

100% 70% 3% 7% 20%

$5.26 bil. $77.35 $51.82 $6.93 $7.22 $11.38 Almost a 50% drop in share

1.08 bil $73.40 $49.46 $11.22 $6.39 $6.33 20% 13%

100% 67% 15% !! 9% 9%

Distribution widens, profits shrink. Regional economies of scale in the beer business are strong. Advertising costs tend to be fixed on a regional basis. There are small discounts to the national advertiser (10%) but they do not compensate www.csinvesting.wordpress.com Studying/Teaching/Investing Page 1

Coors Case Study: Regional Economies of Scale

for the difference in advertising costs per barrel between a brewer with a 20 percent local market share and one with an 8 percent local share. Note the huge increase in advertising costs for Coors to go national and--without the density of distribution unlike its major competitor (AB)--the advertising was less effective. Operating income dropped by more than 50%. All of Coors financial metrics declined in 1985 relative to 1975 except for COGS. Meanwhile, Anheuser-Busch was gaining market share and increasing its profits per barrela sign of increasing economies of scale. Strategy Though with no guarantees, Coors should have retreated back to its dominant regional footprint of 1975 which consisted of 11 states versus the 44 states it was operating in during 1985. Institutional imperative and ego might have blinded Coors management from admitting a costly mistake. The company would have had to sell off and write-off assets acquired during its national roll-out, but the there was a chance to improve profitability for shareholders. Coors nation-wide advertising increased 5xs per barrel and costs to distribute per barrel rose about 30% per barrel. The rise in costs to move from a regional brewer in the Pacific/Rocky Mountain states destroyed its local economies of scale, dropping its operating profit by more than 50%. Coors could not match the scale and local dominance of the giant in the industry, Anheuser-Busch. But with s strong regional position, Coors would have been better able to defend itself against AB. Coors beer sold in the region for less than Budweiser, and it could have met any effort by AB to win customers by lowering prices, offering other promotions, and advertising heavily in the Mountain and Pacific states.. If AB persisted, Coors could have contracted with some wholesalers in the Mid-west to sell Coors at a discount. Coors still had hard-to-get mystique, and a price war with Bud on Buds home market would have cost Coors much less than AB.

See a further discussion of Coors by a Value Investor, Burgundy Asset Management (Canada)
http://www.burgundyasset.com/data/newsletter/2004_12_Requiem_for_a_Brewer.pdf

Video of Burgundy Asset Managements Investment Process: http://www.bengrahaminvesting.ca/Resources/Video_Presentations/Guest_Speakers/2011/Roone y_2011.htm January 4, 2005 10:41 pm Molson shareholder hits out over Coors deal A major Molson stakeholder has urged shareholders to vote against a merger with Adolph Coors

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Coors Case Study: Regional Economies of Scale

Burgundy senior vice-president David Vanderwood told Reuters on Tuesday the key problem with the proposed merger is that it fails to recognize the gap in profit margins between the two companies. Vanderwood argues that Molsons five Canadian breweries earn almost four times as much money per hectolitre of beer as Coors does. US-based Coors and Canadas Molson agreed to merge last July, but the deal has faced opposition and has been amended several times in a bid to entice shareholders. In a letter sent to shareholders, Burgundy said the proposed deal between the two brewers is flawed because it does not place enough value on Molsons profitable business in Canada. We believe that Coors and Molson should go back to the drawing board to come up with a new formula, one that reflects Molsons superior economics, Burgundy said in the letter. Burgundy also claims that EBITDA (earnings before interest, taxes, depreciation and amortization) is horribly misleading because Molsons depreciation expense and its need for capital expenditures are far lower than Coors. The shareholder claims a more appropriate measure should be operating profit where Molson is valued at 10.3 times last years operating profit, compared with 11.7 times for Coors. If it proceeds under the last terms discussed, shareholders will have received another valuesubtracting blow at least rivaling the one they suffered in Brazil, Burgundy said in the letter. Molson did not return calls seeking comment on the Burgundy letter but did issue a release that said Fairvest, Canadas leading independent proxy advisory firm, recommended Molson shareholders vote in favor of the proposed merger with Coors. According to Molson, Fairvest performed an independent review of the deal that showed the implied merger valuation is well above most comparable transactions. Also on Tuesday, Institutional Shareholder Services, a shareholder advisor group, recommended Coors shareholders vote for the merger. Coors said Institutional Shareholder Services backed the deal, saying Coors shareholders should gain from the improved scale, better mix of revenues and earnings as well as the financial benefits stemming from cost savings. Molson and Coors will hold a shareholder meeting on January 19 to vote on the proposed merger. If shareholders approve the proposed deal, final court approval will be sought on January 21 with an expected closing date of January 28.
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