Coors Case Study: Regional Economies of Scale

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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 “Simplify—What 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 AB Coors

Sales in $mil 1.68 bil. 0.532 bil.

Sales/barrel $46 $41.56 100%

COGS/barrel $36.61 $28.98 70%

Advertising costs/barrel 1.99 1.09 3%

SGA/barrel 2.79 2.97 7%

Oper. Inc. /Barrel $4.62 $8.52 20%

Regional % share

Mountain 37%

Pacific 24%

1985

Sales in $mil $5.26 bil. 1.08 bil

Sales/barrel $77.35 $73.40 100%

COGS/barrel $51.82 $49.46 67%

Advertising costs/barrel $6.93 $11.22 15% !!

SGA/barrel $7.22 $6.39 9%

Oper. Inc. /Barrel $11.38 $6.33 9%

Regional % share

Mountain Almost a 50% 20%

Pacific drop in share 13%

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

Coors Case Study: Regional Economies of Scale

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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 barrel—a

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 Bud’s 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 Management’s 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

Coors Case Study: Regional Economies of Scale

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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 Molson’s five Canadian breweries earn almost four times as much

money per hectolitre of beer as Coors does.

US-based Coors and Canada’s 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 Molson’s 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 Molson’s superior economics,” Burgundy said in the letter.

Burgundy also claims that EBITDA (earnings before interest, taxes, depreciation and

amortization) is “horribly misleading” because Molson’s 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 year’s operating profit, compared with 11.7 times for Coors.

“If it proceeds under the last terms discussed, shareholders will have received another value-

subtracting 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, Canada’s 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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