Coca-Cola union aimed at boosting sales in North America

By Jeremiah McWilliams

The Atlanta Journal-Constitution

Three years ago, Muhtar Kent, then chief operating officer of Coca-Cola Co., sat for an interview about the nagging problem of North America.

“It’s a market that is yet to be fixed,” said Kent, listing places that outperformed the United States and Canada: Mexico and Argentina. Greece, Turkey and India. “That’s why we’re addressing it with urgency.”

Now Kent is Coke’s CEO, and North America is still a problem. So last week he announced the company’s biggest step yet to attack it: buying the North American wing of Coke’s main bottler, Atlanta-based Coca-Cola Enterprises.

Beverage Digest called the deal “epochal.” Coca-Cola said taking control of the CCE operations will enable it to become more efficient and nimble in bringing drinks to market and save costs from duplicate operations.

That may not reverse a slow slide in soda sales in North America — the root of Coke’s problems on its home continent — or bring recession-weary consumers back to pricier drinks. But it should strengthen the company’s hand in coping with those challenges, executives said.

The success or failure of the move will likely become Kent ’s legacy as CEO. More important, it could go a long way toward determining whether Coke can reverse its sales erosion in North America. Though no longer Coke’s growth driver, the region remains hugely important and supplied $8.3 billion in revenue last year.

Analysts have mixed views of the $12.4 billion deal with CCE. Some call it shrewd, while others say it is risky for Coke to move so broadly into production and transportation functions it had long left mainly to bottlers.

Until now, CCE has been responsible for making and distributing more than 70 percent of Coke products in the U.S. and Canada, while Coke has focused primarily on marketing and product development, along with its fountain business.

If the CCE deal closes as planned by year’s end, Coke will directly manage virtually all of its North American business end-to-end.

Coke remains a highly profitable company with strong growth in international markets, which now account for 77 percent of its overall business. But in the past decade North America has become a drag, mainly because of slowing soda sales. Changing that will be difficult, with or without CCE’s assets.

Motivated by health and wellness, many North American consumers have migrated from soft drinks to sports drinks, teas and juices. Coke and its competitors have tried to be seen as part of the solution to health concerns, touting alternative drinks and recently announcing plans to make calorie information more prominent on soda labels.

But in the last quarter of 2009, North America was the only region in which Coca-Cola’s case sales fell. The company’s volume in North America dropped 2 percent in 2009, marking a three-year string of declines.

“Neither Coca-Cola nor PepsiCo has cracked the code” on turning around carbonated soft drinks in the United States, said John Sicher, editor and publisher of Beverage Digest. “I doubt either of them will any time soon. North America is a tremendous problem. ...Unfortunately, flat would be a victory. Growth will be very difficult.”

Absorbing CCE’s assets is aimed at strengthening Coca-Cola’s North American business in the long term, though it also could slow overall growth because much more of Coke’s revenue will come from the region, said J.P. Morgan analyst John Faucher.

Tom Pirko, a veteran adviser to Coca-Cola and PepsiCo, argues it would be wiser for Coca-Cola to keep the CCE operations off its balance sheet. The move puts Coca-Cola on the hook for “onerous” obligations to modernize the bottling system, he said.

“This is a very, very expensive and long-term proposition, with considerable risk attached,” he said. “The only way to justify the investment will be through substantially greater sales, higher volumes. But can they do this in our depressed market?”

The last 18 months have been the worst in 40 years for the nonalcoholic beverage industry in North America, said Bill Pecoriello of Consumer Edge Research. The “liquid refreshment beverage” category — including energy drinks, sports drinks, bottled coffee, bottled water and soft drinks — slipped 2.5 percent.

Said Pirko: “This juggernaut that Coke has put together is based on carbonated soft drinks. How much money and time will they put into thinking up new products? The market has different values now. Now, carbonated soft drinks are looked at like there is something wrong with them.”

Archrival PepsiCo’s volume and net revenue declined 6 percent in North America last year. Nearly a year ago it launched plans to buy its two biggest bottlers for $7.8 billion. Analysts said it could save PepsiCo perhaps $600 million a year and give it tighter links with retailers.

Coke at that time expressed satisfaction with its independent bottler set-up, which had evolved over decades and was geared toward pushing a few high-volume soda brands. Last week, however, Coke executives said they were considering the CCE deal even before PepsiCo’s move.

Coke also hopes for cost savings after it absorbs CCE’s North American operations, along with the ability to more closely control distribution and respond more quickly to demand in specific markets and sales channels.

Even with those benefits, finding the right mix of products and pricing in the new environment is a huge challenge. Gone are the days when Coke could count on steady annual growth from its core products in the U.S. and Canada.

For several years up to 1998, the soft drink business in the United States grew at an average rate of about 3 percent. In 1999 growth slipped to half a percentage point. The numbers went red in 2005, according to Beverage Digest.

Soft drink sales in North America will decline by as much as 1.5 percent for the next two years, Consumer Edge Research predicts. Carbonated soft drinks contribute 63 percent of the non-alcoholic beverage industry’s sales.

The recession complicates matters, making shoppers reluctant to spend as much on higher-priced beverages such as enhanced water, energy drinks and sports drinks.

Whatever the benefits derived from the CCE deal, Coca-Cola has a slim chance of getting back to flat volume in its North American soda business, said Morningstar analyst Phil Gorham.

“Consumer tastes are changing,” he said. “Although the recession caused some consumers to temporarily switch back to cheaper sodas, we think the long-term migration to healthier alternatives is here to stay.”

Coke insists it can generate new growth in North America. It points to surveys showing that more teenagers classify Coke as a “cool” brand, reversing a negative trend going back at least two years. It has churned out packaging innovations, such as a two-liter “contour” bottle and a “PlantBottle” made partly from sugar cane and molasses, and launched social media marketing campaigns.

The company has a spotty record of generating innovative new products, using acquisitions to add brands such as Vitaminwater and Fuze. But it has had some hits, including juice brand Simply. Perhaps the biggest success story of the past decade is Coke Zero, which has posted 15 straight quarters of double-digit growth.

Coke’s non-carbonated beverages could push the company’s sales volume in North America into positive territory once the economy improves, Pecoriello predicted. That would be easier to do if Coca-Cola could get its carbonated soft drink volume back to neutral. Coke’s goal is to do that this year.