Trouble bubbles for Coke

A lawsuit and a probe over the cola maker's fountain business leaves a bitter aftertaste in the wake of Vanilla Coke's success

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Coca-Cola Co. had plenty to be happy about heading into 2003. Its launch of Vanilla Coke stood as one of the company's most successful ever and Minute Maid, its key non-carbonated beverage business, was showing positive momentum against rival PepsiCo's Tropicana and others.

 

But it would require more than vanilla to put the fizz back into Coke. Facing declining consumer interest in carbonated soft drinks in developed markets, and even some developing ones, as well as an implacable and stronger foe in PepsiCo, beverage maker has its work cut out for it these days, and in more ways than one. In an effort to get leaner and more competitive in the foodservice arena, Coke cut 1,000 jobs in March. Besides the $400 million pretax charge to cover all 1,000 layoffs, one in particular may prove costlier still.

Fountain fizzle

Former Coca-Cola internal auditor Matthew Whitley claimed in a May lawsuit that he was let go not for business reasons but because he blew the whistle on accounting and ethical lapses. Among those problems, according to Whitley's suit, is that Coke executives doctored a market research test to sell Burger King, Coke's second-largest fountain customer, on Frozen Coke in what became the company's highest-profile boondoggle since New Coke.

 

Whitley's 85-page lawsuit, laden with hundreds of additional pages of Coca-Cola documents, has since spawned investigations by the U.S. Attorney's office in Atlanta and the U.S. Securities and Exchange Commission, which is investigating accounting both for Coca-Cola and Lancer, its fountain equipment supplier. A Fulton County (Georgia) Superior Court judge in September threw out most of the counts by Whitley against Coca-Cola, though his core wrongful termination action still stands.

For its part, Coca-Cola denies the allegations in Whitley's suit, terming them "frivolous" and describing him as a disgruntled employee.

But Coca-Cola also has acknowledged its 2000 market test results for frozen Coke were inflated, apologized to Burger King and its franchisees and offered to pay them $21 million. John Fisher, the fountain executive who allegedly spent $10,000 to entice youths in the Richmond, Va., area to buy meals that featured Frozen Cokes, has since left the company. Tom Moore, the head of the fountain division, who reprimanded and disciplined Fisher when he learned of the alleged test problems, himself resigned a few months after taking charge of the newly formed Foodservice and Hospitality division that prompted layoffs.

Coca-Cola, however, has rejected any efforts to pin blame higher up. In the company's response to Whitley's suit, President and COO Steve Heyer denied having seen an e-mail Whitley allegedly sent to him on the test issue while Heyer was traveling on business last February. And Coke said Whitley was fired because of the restructuring, not because he blew the whistle on the test.

Frozen Coke was only one of the problems in the fountain business. Coke's heavily touted portion-controlling iFountain dispenser never caught on with foodservice operators. And Coke withdrew Planet Java fountain dispensers from Wal-Mart Stores and elsewhere earlier this year following complaints from operators.

Taking a toll?

Industry watchers believe the scandal may take a toll on Coke, but won't seriously hamper the company long term.

 

"I don't think there's any question that the company has been tainted, and it needs to overcome that impression in the public psyche," says Tom Pirko, president of the consulting firm Bevmark, Santa Barbara, Calif. "On a more practical level, in the everyday of politics and business, things like this get submerged. This is nothing like what brought down Doug Ivester [former Coca-Cola CEO who left after criticism mounted about his slow response to safety issues that arose in Europe in 1999]. Nobody is going to stop buying Coca-Cola because of this. Heyer was able to patch things up with Burger King."

 

One reason the impact should be limited, Pirko says, is that the problems really do appear to be limited to the individuals directly involved with the businesses.

 

According to Pirko and several consumer products executives, inflating results in local test markets has become commonplace , whether by using levels of marketing support that could never be sustained nationally, or by providing special incentives to sales reps to make the test pan out, to say nothing of other "creative" means.

"It's a very subjective world," Pirko observes. "It's a little like polling, inasmuch as it all comes down to who you ask and how you word the question. Why clients would place a good deal of faith on such a marketing test is beyond me. I hate to say it, but it's naive. The results are always open to interpretation, and they're so easy to massage."

 

Coca-Cola ranked just behind Tyson Foods in a 2003 reputation ranking of foodservice suppliers by foodservice operators, conducted by Cannondale Associates before the lawsuit was filed and scandal broke. While Coke may suffer some in later surveys, Sven Risom, a partner with Cannondale, doubts the issue will have a lasting impact.

 

"My true belief is that Coke is a quality firm that delivers great products and insights," Risom says. "I truly believe [the test market and accounting issues] are very serious but relatively isolated situations. You hope they never happen again."

 

Meanwhile, Coke has been going through major changes, he said. "I think those will help them in the marketplace, because they'll be more customer sensitive and less [centered on] Coke and more like a true integrated part of their operator network."

 

The change is overdue, he adds. "Pepsi is just charging, and I think that's probably the biggest wakeup call [to Coke]. Programs that the Pepsi-Quaker-Frito-Lay organization is starting to pull together are real challenges. So to some degree Coke has to change Many companies in the past that have been perceived as arrogant, and I think Coke got that way in certain segments."

 

For his part, Heyer in a July conference call vowed the allegations wouldn't be ignored but they wouldn't distract Coke either. "We take all allegations of any inappropriate conduct very, very seriously," he said. "We feel strongly that our financial statements properly reflect the financial performance of our company, and we do not believe based on exhaustive internal analysis that there are any material misstatements in our [financial] results [Coca-Cola did identify several small items related to Whitley's allegations, resulting in a $9 million write-off] We have always prided ourselves on the quality of our people and our actions. As we go about our daily activities, we will always act with integrityAlso, let me assure you that we are very focused on running our business and we will ensure that our senior operating officers remain focused on running each of their operations around the world to continue satisfying more and more consumers every day. Our associates in food service are focused and motivated."

The fundamentals

Coke's bigger problem may be addressing fundamental challenges in the beverage business. Thomas Weisel analyst Skip Carpenter downgraded his outlook on Coke in September based on concerns about global beverage volume.

 

"We believe there is mounting evidence that Coke's objectives of 5 percent to 6 percent unit case growth and 10 to 12 percent earnings growth may be unrealistic on a sustainable basis," Carpenter recently wrote in a report. Coke benefited in the short term earlier this year from Europe's heat wave, though not from a summer that was colder and wetter than usual in much of the U.S.

 

Though Coke increasingly has focused on bottled water, fruit juices and sports and energy drinks in recent years, carbonated soft drinks still account for about 85 percent of its worldwide beverage volume. He believes that CSDs are on a "long-term secular decline" not only in established markets such as the U.S. and Germany but even emerging ones, such as Mexico and Brazil.

 

He believes that in addition to cost cutting and price increases, Coke will have to focus more on marketing and innovation , a tall order indeed.

 

For its part, Coke sees itself moving ahead in most of those areas. A 52-week analysis completed in July showed more U.S. households have tried Vanilla Coke than any other CSD brand. And they liked it when they did, with 90 percent of volume coming from repeat customers. Sprite Remix, a tropical flavored variant launched in the spring, helped boost Sprite sales 12 percent in the second quarter in retail, despite a major push by PepsiCo's Sierra Mist.

 

Sales of Powerade were up 15 percent year to date through June, Heyer said. And Coke is continuing its expansion of its Simply Orange juice brand in the second half of 2003. With the signing of high-school-to-NBA sensation LeBron James to a long-term promotional contract, Coke is hoping the athlete will do for Powerade and Sprite what Michael Jordan did for Gatorade.

 

"We have confidence in what we are doing," Heyer said. "Throughout our system, our execution is solid and it continues to improve."

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