Is Coca-Cola Selling Off Its Baggage, or Its Future?

Coca-Cola is about to become the fabled, fashionable "asset-light" company. Is that a good thing?

Coca-Cola, a company with 130 years of history, now needs to settle one question more urgently than ever: is its most valuable asset the cola concentrate business built on that secret formula, or the vast system of bottling plants, distribution channels, and retail outlets it relies on worldwide?

Last week, word from its North American headquarters suggested the scales are tipping toward the former.

Muhtar Kent, Coca-Cola's chairman and CEO, said the company will work toward having franchise companies handle 100% of its bottling.

Barring major surprises, Coca-Cola will sell all 63 of its North American bottling plants by 2017, which means the share of the company's global beverage output made in its own plants will fall from 18% to 3%. Coca-Cola's other company-owned bottling plants around the world won't be kept much longer either.

According to The Wall Street Journal, if Coca-Cola sells the production and bottling assets it owns in North America, Germany, China, and South Africa, its revenue — $44.3 billion in 2015 — would drop to $28.5 billion, and its headcount would fall from 123,000 to 39,000. But its gross margin would rise from 23% to 34%.

Coca-Cola needs this sale to fix a profit problem that has dogged it for years.

Since 2012, Coca-Cola's sales have fallen steadily, from $48 billion to about $44.3 billion, and profit has slid from $9 billion to $7.3 billion. Soda volume in North America fell year after year from 2010 to 2014. Across Coca-Cola's whole beverage lineup, growth keeps slowing too. Worldwide in 2015, volume for classic Coca-Cola grew only 1%, while Diet Coke's volume dropped 6%.

The sluggish performance has exhausted Wall Street investors' patience — Coca-Cola could become a takeover target. Anheuser-Busch InBev, which had just bought SABMiller in 2015, is seen as a potential buyer, and Warren Buffett, Coca-Cola's largest shareholder (his Berkshire Hathaway holds 9.24% of the company's stock), might well welcome it. Carlos Laboy, an analyst at HSBC, even thinks Anheuser-Busch InBev could acquire Coca-Cola in three or four years.

For a company with 130 years behind it, Coca-Cola obviously doesn't want to be a target — or even to risk becoming one.

Yes, Coca-Cola's First Instinct Is to Shed the "Baggage"

The most effective way to fend off risk in the capital markets is to earn more. If there is no way to lift sales and profit, the most direct route is to cut costs.

Spinning off the bottling business looks like the best option.

Coca-Cola's business model, put simply, works like this: Coca-Cola sells syrup to bottling companies; the bottlers make the finished drinks and send them out through various channels to reach consumers. Coca-Cola handles marketing and brand upkeep, while the bottlers handle production and logistics, linking consumers to Coca-Cola.

Over more than 100 years, what has made all of this complicated is that these bottling companies include wholly owned Coca-Cola subsidiaries, joint ventures, and licensed manufacturers. There are now 275 bottling partners across the Coca-Cola system, 68 of them in the United States. Coca-Cola Refreshments, wholly owned by Coca-Cola, is the largest bottler in North America. The company also holds a partial stake in another North American bottler, Coca-Cola Bottling Co. Consolidated.

This is how Coca-Cola built its scale. Now that scale is seen as baggage.

Isabella Cunningham, a professor at the Stan Richards School of Advertising and Public Relations at the University of Texas at Austin, told QDaily: "When the market isn't growing, the cost of plant real estate and machinery keeps weighing on Coca-Cola." At the same time, without the debts tied to factory facilities, Coca-Cola's overall debt ratio would fall.

By that logic, what Coca-Cola thinks it is dropping now is a burden.

As for the other benefit: "As demand for carbonated drinks declines, Coca-Cola can shift part of the volume risk onto the bottlers," Cunningham said. Wall Street analysts have said much the same.

What's interesting is that over a long stretch of time, soft-drink giants like Coca-Cola and PepsiCo have bought and spun off their bottling businesses in cycles. James W. Fredrickson, chair of the management department at UT Austin's McCombs School of Business, told QDaily: "When these companies need size and business growth, they buy up the bottling plants; when they're after higher returns, they sell the bottling business off."

More important, once it sheds its bottling plants and delivery equipment, Coca-Cola can concentrate on the product.

Coca-Cola Is About to Become the Fabled "Asset-Light" Company. Is That a Good Thing?

Concentrate on the product, fine. But look back over Coca-Cola's history and one overall trend stands out: pulling the bottling companies back under Coca-Cola's control.

A Brief History of Coca-Cola's Bottling Business

1899

Asa Griggs Candler, the father of Coca-Cola, granted two Tennessee lawyers the rights to bottle Coca-Cola nationwide — the first such license.

1916

To set itself apart from imitators, and at the bottlers' urging, Coca-Cola's distinctive bottle shape was born — one of the few bottle designs of its day certified by the U.S. Patent Office.

Late 1920s

Bottled Coke outsold fountain Coke for the first time.

1920-1930

Coca-Cola began expanding abroad, setting up bottling plants in 44 countries.

1986

In 1986, Coca-Cola bought two bottling companies for $1 billion and merged them with several of its own plants to form Coca-Cola Enterprises (CCE). CCE listed separately, with Coca-Cola holding a 49% stake.

1991

CCE merged with Johnston Coca-Cola Bottling Group to run the North American bottling business.

2005

Coca-Cola set up the Bottling Investment Group to manage its bottling assets.

2010

Coca-Cola bought the North American business of its bottler CCE for $12.3 billion.

2014

South Africa's SABMiller and Coca-Cola agreed to merge their bottling businesses into Coca-Cola Beverages Africa, a soft-drink supplier that would hold 40% of Africa's cola market, sell into 12 African countries, and bring in $2.9 billion a year.

2015

Coca-Cola's three largest bottling partners in Europe — CCE, Coca-Cola Iberian Partners (CCIP), and Coca-Cola's German bottling business — announced a merger to form Coca-Cola European Partners PLC, the world's largest independent Coca-Cola bottler. Coca-Cola holds an 18% stake.

And for a beverage company, owning bottling plants means better control over quality. When Coca-Cola and PepsiCo have bought bottlers, both have cited the same goals: lower costs, more innovation across the business, and tighter control over distribution.

Coca-Cola has stumbled here too. As recently as 2015, Gansu COFCO Coca-Cola Beverages, one of its franchised bottlers, was caught falsifying wastewater monitoring data, and Coca-Cola was pulled into the backlash.

Besides, "independent bottlers don't necessarily have the ability to respond to short-term shifts in the market," Cunningham said. A company that owns its bottling business can adjust its products more nimbly as the market and consumers change. Spinning off bottling could cost Coca-Cola market share. It could also leave small and mid-sized bottlers without the leverage to bargain with big retail channels. Six years ago, when Coca-Cola bought its largest bottler, it named these very drawbacks.

So while selling the bottling plants may satisfy shareholders and investors in the short run — their returns go up — giving up bottling assets could store up problems for the long run.

For a Coca-Cola with a sprawling product line, losing control of its bottling plants could well mean it can no longer adjust quickly and flexibly as the market moves. The great advantage of owning the whole chain is that it shortens the distance to consumers and keeps a company alert to their market.

This is the road Coca-Cola has to take to become a lifestyle company rather than just a beverage company. When Buffett praised the Coca-Cola brand for its "wide moat," he clearly had this in mind. Now that link may be cut.

"Asset-light" has countless success stories behind it, and its fat margins are the envy of many. But for a Coca-Cola already losing consumers faster and faster, giving up its line to them is a dangerous move.

Muhtar Kent, pressed by profit, capital, and Wall Street, is unlikely to dwell on such worries. On last week's earnings call, he stressed that Coca-Cola will focus on the "brand business." "That's also what we do best."

The Future Rides on the Brand — But What Kind of Future Is That?

Coca-Cola really is good at managing brands. Among the dozens it still runs, 20 products had sales above $1 billion in 2014 — besides classic Coca-Cola, there are Diet Coke, Fanta, Sprite, Minute Maid Pulpy, Vitaminwater, Schweppes, Gold Peak, and Fuze Tea.

Coca-Cola of course knows how dim the future looks for its classic carbonated line, and it has indeed sped up the hunt for new products to cut its dependence on soda.

At the end of 2014, Coca-Cola launched Fairlife, a premium milk product, in the United States. In 2015, betting on the plant-protein drink market, it paid $400 million for Zhonglü Culiangwang, a Hong Kong-listed beverage company. Betting on growth in functional drinks, Coca-Cola — which already owned Glacéau, Vitaminwater's parent — spent $2.15 billion in June 2015 for a 16.7% stake in Monster Beverage, the second-largest functional drink maker in the U.S. after Red Bull.

But it is hard to say that any of them can take the place of classic-flavor Coca-Cola.

And as you may have noticed above, Diet Coke — sold on being healthier and lower in sugar — is losing volume far faster than classic Coca-Cola.

Neither Coke Zero, launched in 2008, nor Coca-Cola Life, launched in 2013, met expectations. Life was sold on low calories and the natural sweetener stevia, yet it never even matched Coke Zero's momentum.

None of this has become the new growth driver that would pull the company out of its defensive position. For years now Coca-Cola has tried hard to build a more "healthy" image, or at least to put some distance between itself and an "unhealthy" one. But hemmed in by a brand image built around Coca-Cola itself, it has little to show for the effort. Could the "brand" Muhtar Kent is counting on turn out to be another piece of baggage?

Asset-light, brand-heavy, cutting away the production arm and the sales and retail reach it controlled — in the end, the little business Coca-Cola has left is concentrated more and more on the same cola concentrate business it started with over 100 years ago.

Hmm? Isn't that exactly what a company now seen as "unhealthy" should be trying hardest to get away from?

Graphics: Lin Yuyao

Cover image from Forbes and Wikipedia