Coca-Cola is undoubtedly a great company, hailed as the 'Dividend King' in capital markets and the undisputed market leader in the global beverage industry. Yet beneath the surface prosperity, Coca-Cola is enduring a prolonged corporate struggle.

On December 9, 2019, Coca-Cola celebrated its 100th anniversary of being listed on the stock exchange. Over the past century, it has delivered substantial returns to investors. If someone had bought one share of Coca-Cola stock for $40 in 1919, with dividends reinvested, its current market value would exceed $18 million. Over 100 years, Coca-Cola's return has reached an astonishing 460,000 times, with an annual compound return of around 15%.

In Warren Buffett's investment legend, his success with Coca-Cola is the most talked about. Since buying Coca-Cola stock in 1988, even during periods of poor performance, Buffett resolutely refused to reduce his holdings, which brought him enormous returns. Between July 2012 and 2018 alone, Buffett received $3.4 billion in dividends from Coca-Cola, while his initial investment cost was only $1.024 billion.

In capital markets, Coca-Cola is the 'Dividend King' pursued by many, and this capability is built on Coca-Cola's immense dominance in the consumer market.

As the leader in the global beverage industry, Coca-Cola's products include four of the world's top five best-selling brands (Coca-Cola, Diet Coke, Fanta, and Sprite). Through the world's largest distribution system, its products are sold in over 200 countries and regions. At its peak, Coca-Cola products were consumed 1 billion times a day, accounting for 48% of the global soft drink market.

Coca-Cola is undoubtedly a great company. Even after a century on the market, it continues to dominate and attract attention in capital markets. However, behind the surface prosperity, Coca-Cola's business numbers have not been so impressive in recent years. This century-old enterprise, after creating countless glories, is now enduring a prolonged corporate struggle.

-01- Coca-Cola's Crisis

In recent years, as global consumers have become more health-conscious, people have gradually lost interest in high-sugar carbonated drinks like cola. Carbonated soft drink sales in the U.S. have declined for 11 consecutive years, with per capita consumption falling to 153.7 liters in 2015, the lowest in 30 years. Coupled with the overall weakness of the beverage market, Coca-Cola's performance has suffered a significant impact.

In 2012, Coca-Cola's operating revenue reached $48.017 billion, but then began to decline year by year. From 2013 to 2017, its revenues were $46.854 billion, $45.998 billion, $44.294 billion, $41.863 billion, and $35.41 billion, respectively, representing year-on-year declines of 2.42%, 1.83%, 3.70%, 5.49%, and 15.41%.

Coca-Cola's 2018 financial report did not bring a turnaround, with revenue declining 10% year-on-year to $31.8 billion. As soon as the report was released, the stock price fell sharply by 8.4%, the largest drop since October 2008. On February 14 and 15 of this year, Coca-Cola's stock accumulated a decline of 9.2%, with market value evaporating by about $17 billion.

However, there seems to be a glimmer of hope in the darkness. In fiscal 2018, Coca-Cola's net revenue fell 10%, but net profit surged 405% year-on-year to $6.476 billion. But this does not mean Coca-Cola has entered a period of high growth.

The more than fourfold increase was due to the exceptionally poor net profit in 2017. In 2017, Coca-Cola's net profit was only $1.248 billion, a year-on-year decline of 81%. But analyzing the financial figures, it is not difficult to see that in 2017, due to an additional 'Tax Reform Act' compared to previous years, the company paid an extra $5.35 billion in taxes, leading to this situation.

Excluding this factor, over a longer time period, Coca-Cola's net profit has indeed been declining year by year. From 2010 to 2018, Coca-Cola's net profit fell from $11.809 billion to $6.434 billion (respectively $11.809 billion, $8.572 billion, $8.584 billion, $7.098 billion, $7.351 billion, $6.527 billion, $1.248 billion, $6.434 billion), a decrease of 45.5%.

A major reason for the profit decline is that Coca-Cola divested its low-margin bottling business. The bottling business, as a profitable segment, accounted for a large portion of Coca-Cola's revenue. Selling it would cause a decline in revenue and profit, and the short-term costs of severance and other expenses further squeezed profits.

In the new round of strategic adjustment, Coca-Cola reversed the vertical integration strategy implemented in 2010 (which involved acquiring some canning companies to integrate the upstream and downstream industry chain and ensure product quality), shifting its strategic focus to the more competitive concentrate production and distribution business.

After all, compared to selling soda directly, selling concentrate has many advantages: it is easier to standardize, transport, and distribute, and thus has higher gross margins. In November 2016, Coca-Cola sold its bottling business in China to COFCO and Swire. Although it led to a decrease in revenue, the focus strategy significantly improved the company's operational efficiency and profitability.

In 2017, with the completion of the restructuring of its U.S. bottling business, Coca-Cola's workforce was significantly reduced from 123,000 to 39,000. The company also implemented proactive layoffs and other cost-saving measures, cutting 1,200 employees in 2017 alone. The company also made major adjustments to team management and corporate structure, and updated incentive metrics and compensation principles.

After these operations, the company's net margin growth has been relatively significant. From 2014 to 2018, net margins were 15.49%, 16.63%, 15.65%, 3.62%, and 20.33%, respectively. In the first three quarters of 2019, net margins were 21.23%, 26.29%, and 27.23%.

But no matter how encouraging the profit margin figures are, the year-on-year decline in revenue and net profit is what worries Coca-Cola the most. How can Coca-Cola reverse the crisis? Is it by decarbonating and saying goodbye to the 'happy fat house water' label? Or by taming the market and making people fall in love with cola again? If Coca-Cola is no longer effective, where is the next Coca-Cola?

-02- Coca-Cola's Big Storms

The current situation is not optimistic, but Coca-Cola, having been listed for a century, has seen its fair share of storms. Crisis is nothing new to it.

In the first 30 years after its birth, Coca-Cola dominated the U.S. beverage industry with almost no real competitors. Before Coca-Cola was invented, there were almost no drinks on the U.S. market that were both tasty and 'healthy'. This drink, which could cure colds, quickly gained an unshakable position in the U.S. market due to its unique taste.

In the 1930s, the economic crisis brought a huge impact to the U.S. market, affecting Coca-Cola's sales. New entrant Pepsi-Cola seized this opportunity and switched to larger containers. Customers could buy twice the amount of cola for the same price. With this price war, Pepsi-Cola became the second-largest soft drink company in the U.S., second only to Coca-Cola.

Under Pepsi's challenge, Coca-Cola once fell into trouble. If it increased container capacity, it would have to discard 1 billion already produced original bottles, a huge loss; if it lowered prices, it would break the established consumer psychology of Coca-Cola drinkers, causing irreparable losses.

The rise of Pepsi-Cola caused a crisis for Coca-Cola, but the outbreak of World War II gave Coca-Cola a new opportunity to rise.

During World War II, Coca-Cola sponsored U.S. frontline soldiers, occupying the main political market in the U.S., and quickly laid out more than 60 production lines in Europe and the Asia-Pacific region. With the U.S. military and economic output during the war, Coca-Cola became a symbol of American culture and finally turned the tide.

In the mid-1970s, Coca-Cola encountered another unprecedented storm.

In 1975, Pepsi-Cola conducted the famous 'Pepsi Challenge' blind taste test. The conclusion was that most people preferred the taste of Pepsi. This time, Coca-Cola could not sit still and used various channels to condemn Pepsi-Cola. It even denigrated Pepsi in advertisements, calling it 'the drink of black people' and 'the pleasure of the lower class'. This move not only failed to win consumers back but also caused a brand crisis.

Coca-Cola's darkest hour came. In 1977, Coca-Cola's market share fell to 24%, losing the industry crown. Pepsi successfully overtook it. What made it worse was that President Paul's blind diversification strategy stalled the company's development, and the stock price remained depressed.

In addition, Coca-Cola faced unprecedented challenges: conflicts with bottlers, employee lawsuits, environmental groups' accusations about can pollution, illegal franchise allegations, and massive spending on advertising wars with Pepsi... For a time, Coca-Cola suffered setbacks across domestic and international markets.

In 1980, Coca-Cola's profit margin had been declining for five consecutive years, with pre-tax profit even below 12%. The continuous decline in performance once made the company doubt its product of nearly a century—Coca-Cola.

Facing the demand for 'sweeter cola', Coca-Cola decided to improve its century-old secret formula to win back the market 'stolen' by Pepsi. In April, Coca-Cola launched a new flavor—Cherry Coke—with great fanfare and stopped production of the original flavor.

Soon, hundreds of thousands of consumer complaint calls flooded into Coca-Cola headquarters in Atlanta. Angry consumers even poured cola on the streets to protest the company's actions. In just 79 days, Coca-Cola's innovation failed, and 'Classic Coca-Cola' was put back on the shelves.

This 'crisis' awakened people's nostalgia for Coca-Cola. It also made management realize their strategic mistakes and refocus on the traditional core business. After that, Coca-Cola's performance began to recover slowly. By the end of 1985, Coca-Cola's sales had overtaken Pepsi again.

From 1984 to 1988, Coca-Cola's revenue grew by 13% and net profit by 60%, and its intrinsic investment value gradually became apparent. It was during this period that Buffett keenly recognized Coca-Cola's irreplaceability and began buying Coca-Cola stock heavily in 1988, reaping substantial investment returns.

-03- Breaking the 'New Coke Syndrome': Crisis or Opportunity?

Buffett later explained his logic for buying Coca-Cola stock: because Coca-Cola's focus on cola and carbonated drinks makes its business very clear to see.

Coca-Cola's global market share is close to 50%, and at its inception, it sold only one product. Today, Coca-Cola still sells the same beverage, supplemented by a few other products.

But now, after eight years of nearly halved net profit and declining revenue, Coca-Cola no longer wants to maintain that simplicity. In 2014, nearly 75% of Coca-Cola's global beverage sales came from its carbonated beverage business. But the company is not content to stick with this shrinking business. To change the situation, Coca-Cola began to increase its layout in the non-carbonated beverage business. Coca-Cola's 'decarbonation' movement was launched with great fanfare.

In 2014, Coca-Cola acquired a 16.7% stake in functional beverage producer Monster Beverage Corp. for $2.15 billion, entering the functional beverage field with greater growth potential. In 2015, Coca-Cola acquired Xiamen Culiangwang beverage business for $400.5 million. Fruit juices, low-sugar and sugar-free drinks, beverages with added vitamins and dietary fiber, and various tea drinks enriched Coca-Cola's product line.

In 2016, Coca-Cola proposed to become a 'total beverage company'. CEO James Quincey stated before taking office, 'Coca-Cola will always be the soul of the company... but the company needs more than just the core brand.' In May 2017, Quincey officially implemented the 'total beverage strategy'. He said he would lead Coca-Cola out of its comfort zone.

To maintain its 'king status' amid rapidly changing consumer trends, Coca-Cola has shown unprecedented determination to innovate. Quincey believes that for large companies, fear of failure is usually the biggest obstacle to innovation. 'I call it the "New Coke Syndrome"—people are afraid to do new things.' To this end, Coca-Cola even introduced an innovation award to recognize failed projects.

And the 'Celebrate Failure Award' was actually given out.

In 2017, the soda director of Coca-Cola's Middle East and North Africa business unit won the award for failing to launch energy drink Sprite3G in Pakistan. According to Coca-Cola, after this failure, Akbar and his team used the lessons learned to launch 'more successful products' in Pakistan.

Of course, failure needs to be managed, i.e., 'killing zombies'. 'We analyzed about 2,000 beverage products launched in the past five years and found that 30% of the beverages accounted for only 1% of sales. In 2018, we killed more than 700 zombie products, which allowed us to redeploy resources to areas with more growth opportunities,' Quincey said.

Coca-Cola also comprehensively reformed its financial incentive structure to stimulate innovation. At the same time, to improve the 'speed of new product launches', Coca-Cola adopted a 'test-and-learn' approach. Quincey said: 'When we invest in launching a new product, we scale up quickly. Our market teams have the authority to innovate based on local preferences, and we are committed to promoting the best ideas globally according to local conditions.'

In addition, Coca-Cola is also trying to use data to help the company take smart risks, accelerate product launch speed, and ensure customers are at the center of work.

Coca-Cola has indeed made significant changes. In 2017, Coca-Cola, which had been 'teetotal' for 125 years, announced its entry into Japan's 'Chu-Hi' sparkling wine market, moving towards becoming a 'total beverage' company.

In 2018, the company continued to accelerate the pace of its total beverage strategy, continuously upgrading and expanding its product portfolio through the 'enhance-transform-scale' model, launching about 500 products globally. In China, Coca-Cola launched a number of innovative products that were welcomed and loved by Chinese consumers, such as Chunchashe sugar-free tea drinks, Sprite Fiber+, Coke Fiber+, Pure Joy Shenxian water with added dietary fiber, and Yo Tea series drinks.

On August 31, 2018, Coca-Cola also acquired Costa Limited for $5.1 billion, entering the coffee business. Global coffee brand Costa has nearly 4,000 retail stores worldwide and also operates coffee vending machine business, home coffee business, and coffee roasting business. Through this acquisition, Coca-Cola obtained a coffee business platform spanning Europe, Asia-Pacific, the Middle East, and Africa.

Coca-Cola's massive total beverage campaign has achieved some results. In the second quarter of 2019, nearly 25% of the company's revenue came from new or reformulated beverages, compared to 17% in 2018 and 13% in 2017.

But Coca-Cola needs to face the fact that carbonated drinks are its ballast, and no other beverage can compare.

Despite the industry's constant pessimism about carbonated drinks, for Coca-Cola, carbonated drinks remain the highlight of its performance. Euromonitor data shows that in 2018, Coca-Cola occupied 46% of the global carbonated soft drink market, more than double Pepsi's share; in 2018, Coca-Cola occupied 70.2% of the domestic carbonated beverage market, nearly three times that of Pepsi.

Coca-Cola is clearly aware of the stakes. While investing in more beverage categories, Coca-Cola is also finding ways to make people fall in love with carbonated drinks again.

In 2018, in the North American market, due to the success of Diet Coke and zero-sugar products, Coca-Cola's no-calorie soft drink retail sales grew by 8%. Second-quarter 2019 data showed that classic Coca-Cola carbonated drinks grew 4% year-on-year, while Zero Sugar, launched a year ago, achieved double-digit global sales growth for the seventh consecutive quarter.

From a financial perspective, Coca-Cola's performance began to recover in 2019. In the first three quarters, revenue was $8.02 billion, $9.507 billion, and $9.997 billion, up 5.17%, 6.11%, and 8.34% year-on-year; net profit was $1.678 billion, $2.607 billion, and $2.593 billion, up 22.66%, 12.56%, and 37.93% year-on-year.

The giant ship seems to have passed through the gloom and is heading towards growth. But it is still too early to say that Coca-Cola has overcome the crisis.

-04- Conclusion

In today's FMCG field, category diversification has become the only choice for enterprises. When the carbonated beverage industry faces a crisis, Coca-Cola is unwilling to stick to a shrinking market. Encouraging continuous innovation to seek the next Coca-Cola is indeed understandable.

But innovation is not a smooth road for Coca-Cola. Cola has been taming people's taste buds for over a century, with a very wide moat. Apart from Coca-Cola and Pepsi, there is almost no third cola brand. And the growth of newly deployed non-carbonated beverages is unlikely to form economies of scale in the short term to compensate for the decline in the carbonated beverage market. Moreover, product promotion requires huge amounts of capital, and it is difficult for innovative categories to bring good numbers to the company in the short term.

Moreover, Coca-Cola's monopoly position in the carbonated beverage industry is almost non-existent in other beverage segments. Although these areas are full of novelty for Coca-Cola, it is not easy to pry open the giants in each segment.

For example, Ice Dew, a purified water product that Coca-Cola once had high hopes for, has been struggling since entering the market in 2002, heavily suppressed by competitors, and only after several struggles has it reached its current fifth place in the industry.

For Coca-Cola to return to its glory days, relying solely on 'celebrating failure' and encouraging innovation is far from enough. Compared to finding the next Coca-Cola, in my opinion, a more reliable choice for Coca-Cola should be to find people who love Coca-Cola and make people fall in love with Coca-Cola again.

Coca-Cola's channel capabilities in lower-tier markets are in urgent need of improvement. In this part of the market, there is still huge untapped growth potential. For example, in emerging markets around the world, the growth of Coca-Cola's carbonated drinks is evident.

For enterprises, defending the kingdom is harder than conquering it. Stepping out of the comfort zone and innovating boldly is important, but it is equally important to defend the existing cola kingdom. For Quincey, controlling the strategic layout of 'innovation' and 'defense' and constructing a reasonable resource allocation mechanism are the only ways to prevent Coca-Cola from repeating the failed 'innovation' path of the 1970s.

Source: Lishi Business Review (ID: libusiness)

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