In 1985, Ivan Drago (Lundgren), a muscular 6-foot-5, 261-pound Soviet boxer, arrives in the United States with his wife Ludmilla (Nielsen), and a team of trainers from the USSR and Cuba. His manager, Nicolai Koloff (Pataki), takes every opportunity to promote Drago's athleticism as a hallmark of Soviet superiority. Motivated by patriotism and an innate desire to prove himself, Apollo Creed (Weathers) challenges Drago to an exhibition bout. Rocky (Stallone) has reservations, but agrees to train Apollo despite his misgivings about the fight. He asks Apollo whether the fight is against the Russian, or "you against you".
During a press conference regarding the match, hostility is created between Apollo and Drago's respective camps. The boxing exhibition takes place at the MGM Grand Hotel in Las Vegas. Apollo enters the ring in an over-the-top patriotic entrance with James Brown performing "Living in America" complete with showgirls. The bout starts tamely with Apollo landing several punches that have no effect on the Russian. It soon turns serious though, as Drago starts to retaliate with devastating effect. By the end of the first round, Rocky and Apollo's trainer Duke (Burton) plead with him to give up, but Apollo refuses to do so, and tells Rocky not to stop the fight. Drago continues to pummel him in the second round, and despite Duke begging Rocky to throw in the towel, he reluctantly honors Apollo's wish. Eventually, Drago lands a final punch that knocks Apollo to the ground, killing him. In the immediate aftermath, Drago displays no sense of remorse commenting to the assembled media: "If he dies... he dies."
Incensed by Drago's cold indifference and feeling a deep sense of guilt, Rocky decides to avenge Apollo's death by agreeing to fight Drago in the Soviet Union on Christmas Day in an unsanctioned 15-round bout. His wife, Adrian, strenuously objects, saying that Rocky simply can't beat the bigger and stronger Russian and the fight will kill him. Rocky says it's in his nature to avenge his friend.
Rocky flies USSR without Adrian, setting up his training base in Krasnogourbinsk, a remote village in Siberia with only Duke and brother-in-law Paulie (Young) to accompany him. To prepare for the fight, Drago uses very high-tech equipment, steroid enhancement, and a team of trainers and doctors monitoring his every movement. Rocky, on the other hand, throws heavy logs, chops down trees, pulls an overloaded snow sleigh, jogs in heavy snow and treacherous icy conditions and climbs a mountain. Adrian (Shire) arrives unexpectedly to give Rocky her support after initially refusing to travel to Russia because of her doubts on his fighting chances. Her presence increases Rocky's focus and enhances his training.
Drago is introduced with an elaborate, patriotic ceremony that puts the home crowd squarely on Drago's side and against Rocky. In contrast to his fight with Apollo, Drago immediately goes on the offensive and Rocky takes a fierce pounding. Rocky comes back toward the end of the second round; a right hook inflicts a cut below Drago's left eye that silences the crowd and prompts Rocky to continue punching Drago even after the bell rings. While Duke and Paulie cheer Rocky for his heroism, they remind him that Drago is not a machine, but a man. Ironically, Drago comments that Rocky "is not human, he is like a piece of iron" with his own corner reprimanding him for being "weak" in comparison to the "small American."
The two boxers continue their battle over the next dozen rounds, with Rocky holding his ground despite Drago's powerful punches. His resilience rallies the previously hostile Soviet crowd to his side, which unsettles Drago to the point that he shoves Koloff off the ring for berating his performance. When they match before the final round, Drago appears to show a newfound respect for Rocky, saying "To the end."
Rocky finally takes down Drago in the last round, winning by knockout to the shock of the Soviet Politburo members watching the fight. A bloody and battered Rocky gives a victory speech, acknowledging how the local crowd's disdain of him turned to respect. He compares it to the animosity between Soviets and Americans, and says that seeing him and Drago fight was "better than 20 million," implying war between their two countries. The commentator translates that part of the speech incorrectly to Russian by saying that "its better than 20 million dollars". Rocky finally declares, "If I can change, and you can change, then everybody can change!" The Soviet General Secretary stands and passionately applauds Rocky, and his aides follow suit. Rocky ends his speech by wishing his son a Merry Christmas, and throws his arms into the air in victory as the crowd applauds on Christmas Day.