Coke: The Cost of Babying Bottlers
Can CEO Daft ease their plight and please Wall Street, too?
When M. Douglas Ivester was unceremoniously ousted as chief
executive of Coca-Cola Co. (KO ) three years ago, it wasn't the company's
beleaguered shareholders who forced him out. While it was the board that sealed
Ivester's fate, it was Coke's bitter and angry independent bottlers that prodded
directors to ditch him. That followed years of tense relations under Ivester,
resulting from crippling price hikes, relentless micromanaging, and
company-mandated mergers that left some bottlers swimming in debt.It's no surprise, then, that Ivester's successor, Douglas N. Daft, quickly pledged "to improve bottler economics," as he put it when he became CEO in 2000. For Daft, the biggest challenge in turning around the once-proud beverage giant may hinge on his ability to repair Coke's $100 billion global bottling network--the companies that buy syrup concentrate from Coke and actually make and distribute the soda. It's becoming increasingly important for Coke to help them out, since some have begun distributing more non-Coke brands and pushing through aggressive retail price hikes that boost their profits but reduce the amount of syrup they buy.
That explains Daft's burst of bottler-friendly activity: He bought back a majority stake in the troubled German bottling business. He has poured millions in cash into subsidizing other bottlers. He's given them considerably more freedom to operate. And he has raised concentrate prices far less aggressively than Ivester did.
But can Daft improve his bottlers' plight and still deliver the 10% to 12% profit growth he has promised Wall Street? It will be tough. The whole reason Coke spun off its bottling operations in the 1980s was to offload the low-margin business. And while Coke is on track to generate a return on equity of 38% this year, many bottlers will still post a puny return on equity of 6% or less. "The relationship between the company and bottlers is inherently unhealthy--has been and remains so," warns Bevmark LLC president Tom Pirko, a beverage consultant. "The relationship has to change, and it won't until Coke is willing to risk its own [returns]." Archrival PepsiCo Inc. (PEP ) has also spun off its bottlers. But analysts say Pepsi, by contrast, enjoys vastly better relations with them because of more equitable contracts.
Coke's bottlers say Daft and his team have made a promising start. "The relationship is like night and day from what it used to be," says Lowry F. Kline, chief executive of bottler Coca-Cola Enterprises Inc., which handles 80% of Coke's U.S. sales. CCE will pay just 1% more for concentrate in 2003 than last year, vs. the 7.6% hike in 2000. Daft is also borrowing a page from Pepsi by shifting from universal pricing of syrup, in which bottlers pay Coke a flat fee per gallon. A new formula aligns Coke's concentrate charges to the bottler's success at raising retail prices and, ultimately, bottler profits. "We got rid of the debates about how much Coke should charge us for concentrate," says Irial Finan, CEO of Coca-Cola HBC in Athens, Greece. "If we can't get pricing [at retail], they don't get any increase, either."
Coke is also continuing its subsidies, or "marketing support" payments, to bottlers. CCE is expected to net $470 million in 2002 on revenues of $16.8 billion. But without its $600 million in support payments from Coke, the bottler would be deep in the red. Daft had originally hoped to wind down those payments. He has since reversed course. On Nov. 8, Coke not only agreed to extend support payments to CCE through 2011 but is also tossing in an additional $275 million over that time.
Perhaps more important, Daft is giving his bottlers far more freedom. Coke's largest Mexican bottler, Coca-Cola Femsa, recently acquired rights to a popular apple drink, Sidral Mundet, that it now distributes alongside Coke's apple-flavored soda, Lift. "It's better that I have the brand in my hands than in my competitors'," says Femsa CEO Carlos Salazar. That would have been unthinkable a few years back. And to keep bottlers from tying up their trucks with low-volume products such as its Planet Java coffee, Coke may let U.S. bottlers transfer the distribution of these products to local food and liquor distributors while still taking a cut of the profits.
There are risks in this more laissez-faire approach. Some analysts fear that the switch in syrup pricing could hurt Coke. A weaker foreign currency could mean lower local sales and thus less concentrate bought by foreign bottlers. Coke says that won't be the case. And if bottlers no longer fear incurring Atlanta's wrath, some may be tempted to switch from some Coke products to more profitable proprietary brands--for which they don't have to pay a royalty to Coke. "Being an absentee landlord creates its own relationship and system problems that can be equally destructive," says Bear, Stearns & Co. analyst Carlos Laboy. Coke Chief Operating Officer Brian G. Dyson plays down that possibility. "There is more freedom," he says, "but we're not abdicating our leadership role."
In the past, that role has included buying back some troubled bottlers. In March, Coke said it would spend $600 million to take control of its unhappy German bottler. Now, its biggest Brazilian bottler, Miami-based Panamerican Beverages Inc., is struggling with the $1.1 billion in debt it incurred under Ivester to merge Brazilian and Venezuelan bottlers. Some analysts think Coke may yet have to take over Panamerican's Brazilian business or sell it off piecemeal to other Coke bottlers. But Panamerican has a new CEO, who Coke believes is making headway. And Coke's chief financial officer, Gary P. Fayard, says: "I think we're pretty much over the hump. Over the next couple of years, we will be a net seller [of bottling operations]." Until then, Coke's problem remains how to put the fizz in the bottlers without seeing its own profits go flat.
By Dean Foust in Atlanta, with Geri Smith in Mexico City
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