Coke was it. Not anymore.

Coke was it. Not anymore.

Coke was it. Not anymore.

Moneybox
Commentary about business and finance.
March 24 2004 5:39 PM

Coke Was It

Not anymore.

Coca-Cola is losing its fizz. Last week, the company pulled bottles of Dasani water from shelves in England, where the brand had just been launched, when it turned out the water had excessively high levels of the chemical bromate. Coca-Cola's stock trades lower than it did in December 1996. And with CEO Douglas Daft having announced his imminent retirement, the company's board is casting about for a new leader.

The Wall Street Journal noted that "to many board members, the ideal Coke chairman and CEO is a visionary who commands admiration, delegates easily, and communicates well with Coke's 50,000 or so employees and the public." That's a little like saying your ideal third baseman is a charismatic Gold Glove fielder who can hit 50 home runs and steal 40 bases.

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Coke's next CEO will also apparently need the ability to overturn some basic economic rules. Once a national or global economy is sufficiently developed, exponential growth is impossible and even incremental growth becomes more difficult. The same argument applies to certain global brands like Coca-Cola, which has enjoyed exponential growth over its 118-year history. There is a limit to how much Coke the world's population wants—or can afford—to consume. And from the looks of things, we're bumping up right against it.

Coca-Cola is perhaps the most successful American brand ever. Each day, about 1.2 billion servings of Coca-Cola products are consumed around the globe. Coca-Cola is remarkably well-established in the world's wealthiest consumer market. The company's 2002 annual report noted that the average consumer in North America "enjoys at least one serving of our products every day."

Once you have the entire population of the world's richest nation using your product at least once a day, what do you do for an encore? Especially when the stock market requires you to keep earnings growing by 10 percent annually? You resort to financial engineering and engage in actions that damage the brand. That's what Constance L. Hays concludes in the new book The Real Thing: Truth and Power at the Coca-Cola Company. The book doesn't contain the sort of juicy scandals that characterized the Enron fiasco. But it provides a careful and ultimately devastating account of how a very large corporation has coped—and coped poorly—with the limits of organic growth.

Much of Hays' book deals with the attempts of Douglas Ivester, who became CEO in 1997, to squeeze additional profits out of what had been a pretty simple business—selling the concentrate composed of sugar and a carefully-guarded mix of flavorings to bottlers. He bullied bottlers into accepting deals more favorable to Coca-Cola and relied more on Coca-Cola Enterprises—the bottler created and essentially controlled by the parent company—to make the company's balance sheet and profits look healthier.

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But Ivester couldn't make Pepsi go away. Coca-Cola may dominate the beverage market, but it doesn't own it. Every day, it is forced to engage in vicious hand-to-hand combat with giant rival Pepsi. As a result, over the past couple of years, operating margins in the United States have shrunk. Overall, the company's operating income has grown at a measly 1 percent compound rate over the past five years. In fact, last year, the company lost market share in the United States. Meanwhile, many of Ivester's efforts to lessen reliance on the flagship Coke family of products failed. The European Union quashed his effort to buy Orangina in 1998 and sharply scaled back his attempt to purchase a portion of Cadbury-Schweppes' beverage business.

A climate of slow growth, declining margins, high expectations, and tough competition proved to be a formula for encouraging financial gamesmanship. The Securities and Exchange Commission began investigating Coca-Cola after a former employee alleged that the company stuffed distribution channels and failed to comply with accounting rules. Last year, Coca-Cola conceded that some employees fiddled with a Frozen Coke promotion at Burger King in 2000—making it seem as if Frozen Coke was more of a draw than it really was.

With U.S. Coca-Cola growth leveling off, future growth must come from the portions of the world where drinking Coke isn't a daily habit. In its 2002 report, Coca-Cola noted that in Asia (population 3.3 billion), people consume about two servings of company products per month, while in Africa (population 831 million), average consumption is three servings per month. But the majority of the consumers in these untapped markets are living in relative poverty. They can't afford to buy sugar and bottled water, much less pay a premium for a fizzy combination of the two substances. As a result, growth in these developing regions has been muted, too.

The economies of India and China are growing rapidly. But GDP per capita in those countries is just $500 and $1,200, respectively. And it will be several more years before huge chunks of the Indian and Chinese population have sufficient disposable income to spend on Diet Coke or Sprite. In the meantime, the business infrastructure that allows Coca-Cola to produce and distribute its products efficiently—and hence profitably—is sorely undeveloped in these massive potential markets. In 2003, according to Coca-Cola's 10-K, sales in Africa and Asia rose 5 percent and 4 percent, respectively. For sales from these regions to make a significant contribution to Coca-Cola's overall revenues, they'd have to rise at a pace several times greater.

It's difficult to see a way out of Coca-Cola's slow-growth conundrum. The next CEO of Coca-Cola—whoever it is—will face a daunting task. It's not enough to have a Coke and a smile. Now you also need a miracle.