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Global Beverages 2008
SECTOR REVIEW
Global Soft Drinks...Difficult Topics
North America: right intention, wrong medicine? We like how a growing cadre of
former InBev top managers may pursue elements of a zero-based budget
(ZBB)-type model at Coca Cola Enterprises. More system synergies are likely.
On the revenue side, our old “radical” call for an incidence concentrate price
mechanism at CCE is suddenly expected. A good incidence model could be a
critical step to finally aligning KO and CCE behind price-package-channel
strategies that emphasize sustainable long-term profit growth over volume.
CCE’s stock price could rebound, but ZBB models only work where operators
know that their sacrifices will bring them wealth. So how will CCE’s chairman
insulate new wealth from being confiscated? We discuss a “nuclear option” as
the only lever available to CCE to fix its North American operations, but we
doubt it has the will to use it. Also, there are good and bad incidence models.
Which one will CCE get? What about clarity and simplification of roles? A supply
chain model, discussed in the press as a co-op of fixed assets, did not work in
Japan. Will it simply create synergies so Coke can sustain more concentrate
price increases while the industry struggles for growth? Would its structure
transfer negotiating value away to Coke from CCE? Will we get a long-term fix
for North America or just a façade that usurps the language and appearance of
successful beverage models, ignoring lessons of the past and without any of the
fundamental underpinnings that makes the good models really work elsewhere?
Australia. Amatil for sale? We ponder with our Australian, Japanese, and
European beverage analysts the implications to the Coke system of the
Kirin/Lion Nathan bid for Amatil and the web of global beer and soft drink
interests at play. What is SABMiller’s role here, and is Coke working with or
counter to SABMiller and Amatil management’s wishes?
Japan. With Coke silent on the scrapping of its once vaunted supply chain
model in Japan, we take a closer look with our new Japan beverage analyst into
Coke’s Japan evolution model and its latest problems to draw lessons for CCE.
Latin America. A functional region. We use KOF and Latin America to showcase
how good models thrive in economic downturns. We also include in this report
our recent comments on PBG’s retrenching in Mexico.
Eastern Europe. Currency devaluations and consumer retrenchment present
headwinds for bottlers heavily exposed to Eastern European markets like
Russia (one of PBG’s key growth markets), or Ukraine, a significant contributor
to PAS’s profits and influential driver of its regional growth. Key regional
currencies have plummeted since August. We have already reduced fiscal 2009
expectations for PBG on its recent impairment announcement.
North America
Beyond Mutually Assured Devaluation for Coke and
CCE
North America will always receive, fairly or not, a disproportionate share of attention from
KO shareholders. In our August downgrade of Coke we argued that the need to fix North
America was growing in urgency. The Coca-Cola Enterprises results reemphasized this
need. So what do we expect?
Let抯 briefly revisit the three options we see for fixing N.A. and their merits. Some but not
all of these elements appear to be coming through in the CCE plan to be announced in
December:
1. Fix the dual ownership model where both the concentrate supplier and the bottling
company clarify each side抯 roles, responsibilities and economic splits looking out over
the long term, borrowing elements from other functional beverage or partnership
models from around the world. Unfortunately, devolution of power to the bottlers for a
healthy balance and clarifying the obscurity of who owns what functions and which
returns in the system on a basis of mutual agreement is not something that we have
seen voluntarily happen at Coke. It only seems to happen when a bottler
demonstrates some form of exceptional power capability for establishing a healthy
balance of power. In the case of CCE, it may require CCE to be willing to say no to
cosmetic changes and to dig in its heels on demanding fundamental change.
?An incidence model and its merits. A critical step for fixing CCE is to shift the
volume-centric focus of the North American model to a profit focus for the system,
particularly now that volumes are not growing in the core category. This would
require Coke to scrap its North American concentrate price mechanism, which is
essentially a fixed dollar amount per gallon. We have argued for many years that
it would be best replaced with an incidence model (a percentage of bottling
revenues or even better, of gross profit). Fixing the percentage to be charged over
many years would help the system. This clarity would encourage bottlers to
rethink their willingness to invest behind an optimal package mix that emphasizes
profitability and to rethink their retail execution capability so that they can
optimally capture the value of the brand at every point of purchase, for every
occasion with the optimal package. With the right concentrate price mechanism
we believe that better revenue management efforts would gain traction.
?Bottlers should control fountain. We have also long argued that full retail oversight
of fountain needs to be passed on to bottlers. As we see it, a big competitor for
CCE and challenge for building and capturing the value of the core brand is
Coke抯 own cheap, low-quality volume give-away discount product, a.k.a. Coca-
Cola fountain. Fountain currently competes with bottling for many occasions that
may be more profitably serviced by bottles and cans, but at the expense of
volumes. Never mind the impact that fountain抯 free refills, Big Gulps, and
supersizing efforts have had in turning the gatekeepers of tomorrow抯 consumers
against the soft drink category. Simply put, Coke North America needs to rethink
the optimal volume base of this market.
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