Coke Seeks To Regain Lost Glory
December 2 2005 by Andrew Ward
Neville Isdell forged his reputation within Coca-Colaas head of the company’s Philippine operation in the 1980s. When he arrived, Coke had 30 percent of the market and was dwarfed by PepsiCo. The Irishman turned up at a sales rally dressed in battle fatigues and hurled a bottle of Pepsi against a wall. By the time he eft the country five years later, Coke had more than doubled itsmarket share, leaving Pepsi in its wake.
It is stories such as this that persuaded Coke’s directors to call Isdell out of retirement last year to become chief executive, more than two years after his final assignment heading a European bottler. His surprise appointment came at one of the most difficult moments in the company’s 119-year history. Sales of Coke’s flagship cola are declining across much of the developed world as consumers fret about obesity, yet the company has been slower than Pepsi to diversify into healthier products.
Isdell was not the board’s first choice to replace the retiring Douglas Daft. The directors turned to him only after a series of high-profile external candidates, including Jim Kilts of Gillette and Carlos Gutierrez of Kellogg, turned down the position.
But just over a year after he swapped retirement in Barbados and France for a 25th-floor office in Coke’s North Avenue headquarters in Atlanta, there is growing confidence that Isdell was the right man for the job. The 61-year-old has been praised for restoring discipline and direction to the company. Senior management has been reshaped, investment increased, new products launched,and disruptive regulatory disputes with U.S. and European authorities settled. Four consecutive quarters of better-than-expected earnings, including a strong third quarter of 2004, have added to the cautious optimism. “If you listen to the noises coming out of North Avenue, people are starting to take pride in the Coca-Cola company again,” says Michael Bellas, chairman and CEO of Beverage Marketing, an industry consultancy.Nobody, least of all Isdell, is declaring the recovery complete. He never misses an opportunity to remind Wall Street that it will be years before Coke returns to full health.
Most observers date Coke’s problems back to the death in 1997 of Roberto Goizueta, arguably the company’s most successful chief executive.During the preceding 17 years, the charismatic Cuban immigrant delivered double-digit annual earnings growth and increased market capitalization from $4 billion to $150 billion. Since his death, the shares have lost a third of their value, and growth has shriveled to the low single digits.
Coke, and only Coke
The slump has been largely blamed on Goizueta’s two successors, Douglas Ivester and then Daft. Both men’s short and turbulent tenures were blighted by fiascos and failures. There were botched takeovers, disastrous product launches, contamination scares, regulatory disputes, a race discrimination scandal, and constant feuding between factions within the management and boardroom.
However, the real roots of Coke’s troubles arguably stretch back to Goizueta and his singleminded devotion to cola. He believed that nothing could beat the low-cost, high-margin business of producing syrupy concentrate for bottlers. While Pepsi built a powerful portfolio of noncarbonated products that would eventually boast Gatorade sports drink and Tropicana juice, Coke remained doggedly focused on cola. The company has since recognized its error and plowed resources into brands such as Powerade sports drink, Minute Maid juice and various bottled water brands. But each of those products trails its Pepsi competitor. Carbonated soft drinks still account for at least 80 percent of Coke’s sales. An array of smaller, niche beverage producers such as Red Bull, the Austrian energy drink, have further chipped away at Coke’s sales as consumers are confronted with more choices. “The magic has leaked out of the Coca-Cola brand,” says Tom Pirko, president of BevMark, a consultancy. “How do you recreate that magnetism for a whole new generation that has much less loyalty to big, monolithic brands like Coke? That’s a very hard and expensive task.
Isdell believes the company’s plight is not as bad as it is perceived. Coke remains the world’s most valuable brand at $67.5 billion, ahead of Microsoft, according to the Interbrand consultancy. Its finances are as robust as ever, with net profits of $4.8 billion and sales of $21.9 billion in 2004. Perhaps most impressive, the average human consumed 75 servings of its products last year, up from 49 in 1994. “This is not a business in crisis,” says Isdell in an interview.
One of his first steps as chief executive was to lower the company’s growth targets by a third, after years of overpromising and underachieving. “That was part of the problem I inherited-trying to meet numbers that could not be met over the near term,” he says. The revised projections called for annual income growth of 6 to 8 percent and volume growth of 3 to 4 percent.
Another of Isdell’s gripes is the failure of many U.S. observers to see beyond the company’s struggling domestic business. About 80 percent of profits and 70 percent of volume come from outside the U.S. By contrast, Pepsi conducts only a third of its business away from home. Coke’s strongest growth is in developing markets such as China, Russia, India, Brazil and Turkey. “That’s where the opportunity is,” he says. “The issue is that we are not satisfied with the growth in two large areas of the business: the U.S. and western Europe.”
One of Isdell’s first acts as CEO was to commit an additional $400 million a year to marketing and innovation, acknowledging that underinvestment in brands and product development was among the main causes of Coke’s troubles. “The company believed that all it had to do was churn out the product and people would buy it,” says BevMark’s Pirko.
Coke has pitted advertising agencies from around the globe against each other in the search for new “iconic” campaigns to revive the flagship brand. Mary Minnick, one of Coke’s most aggressive executives, was promoted from head of Asian operations to a powerful new role overseeing the marketing and innovation push. One of her priorities is to increase the exchange of ideas among the 200 countries in which the company operates.
In March, more than 100 Coke managers converged on Buenos Aires with samples of the 400 brands that Coke produces around the world, ranging from a fizzy Spanish herbal drink to canned green tea from Japan. “We held our own trade fair,” says Isdell. “We told all our regional managers, €˜You’ve got to take three ideas away from here, and we want to see them in the business plans for 2006.’”
Coke’s most innovative and profitable market is Japan, where the biggest brand is not cola but canned coffee. “If you’re looking for a total beverage business, we’ve got one in Japan [but] we have not been able to transfer that successfully to other parts of the world,” says Isdell. “For the first time, we’ve had all the key marketing folks from the U.S. actually go to Japan and look at what’s happening.”
However, Coke’s most urgent priority is stemming the decline of soft drinks in the U.S. and Europe. A recent survey by Morgan Stanley showed how the image of soft drinks was being tarnished by its association with obesity. The proportion of Americans agreeing that cola is “liked by everyone” fell from 56 percent in 2003 to 44 percent this year, while those agreeing that the drink was “too fattening” increased from 48 percent to 59 percent.
Acquisitions in the Offing?
Coke has sought to offset the slide by increasing investment in sugar-free brands such as Diet Coke and Diet Sprite Zero. Two sugar-free colas have been launched in the U.S. this year, and marketing spending behind the category has doubled. But sales of diet brands have been slowing. This could indicate that consumers are abandoning soft drinks altogether. Bill Pecoriello, an analyst at Morgan Stanley, warns that the image of diet sodas is scarcely better than their full-sugar cousins because of health worries over artificial sweeteners. Pecoriello says bottled water is the most frequent next stop for lapsed soft-drink users. But profit margins from water are much lower. Coke has sought to earn a price premium in the fiercely competitive water market with innovations such as fruitflavored Dasani. But, in general, consumers are much less brand-loyal and more pricesensitive when buying water.
Isdell accepts that the growing popularity of bottled water will put Coke’s margins under pressure. But this will be offset by growth in energy and tea drinks, which are at least as profitable as cola and in some cases more so, he says. Coke investors may ultimately have to accept a new, less cashgenerative business model as cola becomes a smaller part of the business. Moreover, the cost of developing and marketing a wider range of products will put an additional strain on earnings. “It will take lots of investment to turn this into a growth company again,” BevMark’s Pirko says. Some analysts believe Coke should follow Pepsi and expand into food. This would increase bargaining power with retailers. Pepsi has greater muscle than Coke when negotiating over price and shelf space because it supplies six of the 15 biggest-selling food and drink brands in U.S. supermarkets, compared with Coke’s two. “Dealing with Wal-Mart is much easier if you represent 10 percent of shelf space rather than five,” says Pirko.
Isdell says he feels no pressing need to enter into the food sector. He says Coke will continue to seek small acquisitions, such as the water and fruit juice companies bought in Europe. But the large deal required for an expansion into food is unlikely. “People tell me we should make an acquisition and I say, €˜Fine, but you’re telling me that we’re not running our own business very well. What makes you think we can run someone else’s business better than they can?’”
Many analysts believe Coke could be tempted to compete for Groupe Danone, the French producer of yogurt products, if rumored interest from Pepsi turned into a firm bid. More intriguing is the possibility that Coke could merge with another giant such as Kraft, NestlÃ© or Unilever. The biggest obstacle to a big deal could be Coke’s powerful directors, including Warren Buffett, whose Berkshire Hathaway owns about 8 percent of the group. The board earned notoriety five years ago by vetoing Ivester’s plan to buy Quaker Oats and its Gatorade beverage brand because it felt the $16 billion price was too high. Into the breach stepped Pepsi. Isdell is anxious to avoid similar disputes.
While analysts initially viewed Isdell as a short-term appointment, it has become clear he has no plans for a quick return to Barbados. “I want to leave in place a base that is healthy for the next 10 years,” says Isdell.