More than a Marginal Difference

COUNT ME AMONG the wrong-headed majority who were doubters back in the late 1990s after Red Bull had inaugurated the energy drink category, and with it, profit margins that were unheard of in soft drinks. Surveying the aisles crammed with knockoff brands at the InterBev show the following year, it was easy to predict that the competition would knock down those rich margins in no time, leaving energy drinks as just another modestly profitable segment. It wasn’t just me; lots of others drew the same conclusion. After all, it had played out that way in every other segment. Yet looking at energy drinks a decade later, their margins are still the envy of the business. The widely predicted margin collapse has yet to occur.

I wonder if we all reflect often enough on what a miracle that is. After all, we’ve seen literally hundreds of entries come and go, including quite a few from such industry giants as Coca-Cola, PepsiCo, Dr Pepper Snapple Group and Anheuser-Busch, but we have yet to see the ruinous price wars that have characterized every other sector. How durable have the premium brands been? Even private label has barely made a dent. Among other beverage categories, I can think only of beer as a segment where private label is not a factor – and in beer there is a thriving tier of subpremium brands, which is far from the case in energy.

For the most part, consumers have been content to stick with premium entries. I think much of the credit for that should go not just to the restraint shown by the manufacturers of energy drinks but to retailers who’ve worked hard to protect this important profit center. A lot of you Beverage Spectrum readers have been smart enough not to let anyone kill this golden goose.

To find another beverage segment that has protected its margins as well you have to venture outside the ready-to-drink segment to hot coffee, where Starbucks established an elevated price for good coffee and everybody else, from Caribou to Dunkin’ Donuts and McDonald’s, has been happy to ride its coattails by conjuring up premium offerings at a premium price.

True, over the past year promotional activity in energy drinks has been on the rise – two-for-$3 deals and three-for-$5 deals for the 16-oz. players – at a time that mounting economic stress has winnowed traffic at convenience stores and begun to force many Americans to cut back even on so-called affordable luxuries. Even if margins have edged back a bit from $6 or $8 per case, they’re still uncommonly lush.

So why did this segment break the trend? Looking at what’s happening in other non-alcoholic beverage segments, one has to wonder whether a key factor has been that several of the leading brands continue to operate independently. Red Bull, facing more intense competition in this country than it had experienced elsewhere, hasn’t panicked. It’s maintained its high register ring and tried to orchestrate its inevitable diversification into larger packages in a way that doesn’t seem as if it’s discounting. Hansen Natural’s Monster, while fighting its skirmishes with Rockstar and Full Throttle, has maintained its marketing commitments in alternative sports and offered line extensions – notably Java Monster coffee energy drinks – that generate an even higher register ring.

Contrast that pattern with segments like iced teas, sports drinks and bottled waters. They were all premium businesses until Coke and Pepsi entered and eventually turned them into a new front in the cola wars. In the latest segment in which they’ve chosen to do battle – enhanced waters – the transformation from premium to commodity is occurring with scary rapidity. Barely a year ago this niche was a paragon of superpremium pricing, thanks to the efforts of Glaceau, the deft marketer of vitaminwater and smartwater. Sad to say, even before that brand reaches its one-year anniversary in November of its transition to the Coke bottling system, that segment has gone the way of bottled waters, iced teas and isotonics, as Coke blows out the brand at 10 for $10, five for $5, even 10 for $8 while rivals Pepsi (with SoBe Life Water) and Dr Pepper Snapple Group (Snapple Antioxidant Water) likewise plumb the $1-per-bottle barrier. By some estimates, in doing so, Coke already has cut the value of its $4.2 billion investment by nearly half.

Against that dreary picture, energy drinks are a marvel to behold. So how long can this lucrative run continue? We can’t rule out as a concern that the foundering economy will increase the stress on margins for this most blue-collar of segments. Given the lessons of the other categories, though, I find greater concern in some of the maneuvering that was occurring as this article was going to press: Coke trying to establish a distribution alliance for Monster, Rockstar looking to negotiate a similar partnership with Pepsi or DPSG if it loses its place at Coke. In both cases, it seemed likely that an equity investment would be negotiated as part of the deals, meaning both brands would lose some of the autonomy they’ve enjoyed under their current distribution partnerships. No question, in areas from procurement to overseas expansion to procuring bigger beachheads in non-c-store channels, those alliances could be very beneficial. But seeing how quickly those giants have managed to turn enhanced waters into a commodity makes me wonder if, for energy drinks, those potential rewards will be worth the tradeoff.