Monday, March 1, 2010

Coca Cola, PepsiCo and the Postal Service

First PepsiCo and now Coca Cola have decided to buy out their bottlers.   In doing so, both companies have decided that the long term health of the beverage industry requires integrating the syrup producing business (i.e. Coca Cola or Pepsi) with the bottling business (i.e. Coca Cola Enterprises, Pepsi Bottling Group, and Pepsi America).

These two companies have both decided that it does not make sense to separate the "last mile" in the soft drink business (bottling and store distribution) from the "first mile" (syrup production and marketing) of the business.   Why would they do that?   There are four reasons.
  1. The customer in the soft drink business is not just the consumer. Retailers, and in particular Walmart, Target, Costco, Supervalu, Safeway, Kroger, and Ahold require attention as customers as they determine the amount of shelf space available for both myriad of new products that Soft Drink makers want to bring to market.  Soft drink manufacturer's profits depend more and more on the relationship between bottlers and the retailer, the producers of the soft drink cannot afford poor execution by bottlers in handling retailer customer service.

  2. Customer preferences now require a wider range of products and product sizes than ever before.  To reach consumers, soft drink companies need bottlers to make substantial investments in many different machines to handle shorter runs that the increase of product variety requires.   As a low growth business, bottlers do not have as ready access to capital as faster growth soft drink manufacturers do slowing the ability of Coca Cola and Pepsi to introduce the products that consumers want and bottle shapes and sizes that marketers dream up.

  3. The shift in consumer preference and the rise of mega-retailers have shattered the model of the bottler as a low-margin, low-growth utility that need not be integrated with the creator of products and designer of packaging.  This model worked as long as the demands on bottlers were within the financing capabilities of an industry with high capital costs and low operating margins and the transaction costs of contracting with bottlers were less than the costs of integration and the heat from investors of having a division with lower financial margins.

  4.  The volumes that bottlers handle on their traditional "soda" production lines are shrinking, reducing already small margins.   Shrinking volumes put the bottlers at financial risk that the syrup providers cannot afford.
The issues that Coca Cola and PepsiCo faced when deciding that a century old "first-mile" only strategy no longer worked apply as well when thinking about the Postal Service and how worksharing has created a "last-mile" culture and postal observers, like Robert Cohen and others suggesting that the Postal Service pursue a "last mile" only strategy. These arguments focus on the savings that can be generated by having each part of the mail supply chain performed by the most efficient provider.   What this argument ignores is the additional transaction costs and complexity that this strategy creates for the mailing industry that may weaken the ability of mailers to get the Postal Service or any combination of suppliers to actually provide the service they require at a price that makes mail a viable communications mode.  
  • The last mile strategy separates the Postal Service from direct contact with mailers, the companies and individuals that conceive and design the communication to be sent or process the order for parcel shipping.   Rather than knowing what mailers want and the trends in demand for mail service in industry verticals, the Postal Service knows what the sender wants through their contact with intermediaries.  Given the current financial challenges, the Postal Service can ill afford anything that impedes understanding of customer needs and designing delivery products that meet those needs will impede revenue growth.  

  • The last mile strategy drives a strategy focused on high volume handling of uniform items.   The problem of uniformity is illustrated by the challenges the Postal Service is handling in trying to fit all flat shaped mail into the capabilities of large machines handling large volumes of nearly identical items.   It is not clear that focusing on uniformity and long runs make sense as mailers are looking to expand the bounds of print and shorten print runs in order to ensure that the individual mail piece appeals to the customer, and the volume of mail that fits within the uniform specifications declines.

  • The last mile strategy does not work well in transportation markets with customers requiring national distribution. When the trucking industry eliminated entry restrictions, trucking firms with limited geographic presence expanded nationwide.    This was true firms that handled truckload and less-than-truckload shipments and trucking firms that focused on long-distance and regional transportation needs of shippers for that type of service nationwide.  The Postal Service is similar in that most of the Postal Services' customers are national companies that require distribution of mail to every address in the United States or payments from households in every county of all 50 states and U.S. territories.   While many of these companies have the firms that print their mail transport it to a postal facility, sometimes involving transportation of hundreds or thousands of miles.   Mailers and printers know the coordinating transportation with entry into a postal facility is a challenging proposition. 

  • The last mile strategy ignores the transaction costs associated with negotiating what portion of the rate the first mile and last mile provider should receive, negotiating the physical transfer of the items being delivered, and negotiating the necessary transfer of information that would allow the provider of last mile service to optimize their operations.  The mergers of railroads in the last two decades primarily reflect expansion of scope of service that can be provided without contracts between service providers.

The "last-mile" strategy will remain in place as long as the Postal Service can only differentiate prices between customers on the basis of cost studies that the Postal Regulatory Commission supports and based on the economic theory that the Postal Service promoted to get these prices approved by the PRC decades ago.  It may be time for mailers and the Postal Service to develop the economic arguments for market based and cost plus pricing strategies that would allow the Postal Service to offer innovative services streamlining and coordinating the process from printing to delivery that could reduce the time and cost of taking an idea and transforming it into a delivered mail piece.

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