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Wednesday, June 30, 1999

An Investment Opinion
by Louis Corrigan

Thoughts on Success and Succession

In October of 1997, Atlanta's Emory University was preparing to dedicate a new building housing its Goizueta Business School. Sadly, Coca-Cola (NYSE: KO) Chair/CEO Roberto Goizueta, the man for whom the school was named, was in a campus area hospital rapidly losing his battle with lung cancer.

In a dark mood, one might say the moral to the story is never let someone name a business school after you until you're already dead. Yet, Emory had long before claimed the Goizueta appellation. The name had simply become synonymous with business excellence. In a real sense, the man was already an institution.

The Cuban-born Goizueta became Coke's president in May of 1980. After just six weeks on the job, he had a strategy for revitalizing the company's creaky bottling companies. A month later he was elected chairman and CEO. In his book, I'd Like to Buy the World a Coke: The Life and Leadership of Roberto Goizueta, reporter David Greising describes just how decisively Goizueta took charge and instituted new performance criteria. Having seriously schooled himself in financial management only during his first weeks on the job as president, Goizueta was nonetheless "shocked to learn how little Coke's managers knew about the financial end of the business," Greising writes. Many operating execs couldn't read a balance sheet.

Goizueta became one of the first executives of a major U.S. corporation to manage a business with a strict focus on "economic profit," or returns in excess of the cost of capital. Reluctant to take on debt under legendary Chairman Robert Woodruff, Coke had instead issued stock to fund acquisitions even while keeping its dividend payments high. That combination left the company with a pristine balance sheet but an annual cost of capital running at 16%. That wasn't just more expensive than short-term bank debt; it was also well above the 10% annual return generated by many of Coke's non-cola businesses.

Enough, Goizueta said. Future projects had to return more than their cost of capital, or they wouldn't get funded. Long-term strategic decisions would be focused on maximizing economic profit. Such moves sparked a revolution and a renaissance. During Goizueta's tenure, Coca-Cola's sales soared from $4 billion to $18 billion. Its stock did even better, exploding in value from just $4.3 billion to $180 billion as Coke's revenues became much more profitable and its global brand and reach exemplary.

But this is not a column about the firm's success under Goizueta. Rather, it's more about the company's failures over the 21 months since his death and what they might tell us about leadership in general. In the weeks prior to Goizueta's death, Coca-Cola's stock traded around $62 a share -- exactly where it closed today.

Despite recently underperforming the market, Coke clearly remains a great company. One could even argue that years of its future greatness had already been factored into its share price in October of 1997 since the radical transformation of its business had long ago occurred under Goizueta. Though now 30% below its all-time high of $89 hit last summer, the stock still trades at 44 times projected FY99 earnings, still pricey by conventional metrics.

Yet, there's no denying that the company has confronted challenging times of late. Today it announced that its second quarter case volume would drop 1% to 2%, the third straight down quarter. Its plan to acquire Pernod's Orangina brands has been slowed by regulatory headaches in France. Its purchase of Cadbury Schweppes' brands outside the U.S has also antagonized various European governments. Worse, it faces an ugly racial discrimination suit filed by a group of African-American employees who claim that whites get the plum jobs at Coke. Then there's the recent debacle in Europe, where lax quality controls led Coca-Cola to sell contaminated beverages that caused dozens of customers in Belgium and France to get sick. Just when this brand-sullying PR nightmare seemed over, Coke announced it's recalling bottled water sold in Poland because it contains mold.

The global financial crisis has pummeled many of Coca-Cola's important developing markets, where the company derives most of its profits. There's not much any manager can do to prop up short-term results in the face of such macro pressure. The goal is simply to continue to build for the long term. And Coke is likely doing just that. But quality control problems? Racial bias suits? Unacceptable.

Such troubles are surprising given that new Chair/CEO Douglas Ivester was handpicked and groomed by Goizueta, who made him CFO in 1984 and then promoted him to president and COO in 1994. Though Coke's board readily granted Goizueta sweet pay packages to keep him on the job beyond his planned retirement date, no one had serious doubts that Ivester was ready for the job when tragedy struck. Indeed, the financial media hailed Wall Street's lack of anxiety over succession at Coke as the keystone to Goizueta's stunning career. The ultimate mark of managerial greatness, it would seem, is the ability to cultivate such a richly talented and cooperative executive team -- and such a clear heir apparent -- that your legacy lives on even if you are ripped untimely from this world.

I don't dispute that judgment. Moreover, Goizueta himself stumbled plenty as CEO, "diworsifying" into the movie business with Columbia Pictures and then giving us the famous New Coke disaster. Even the smartest CEOs have their miscues, but they also exhibit a talent for deftly extricating themselves from trouble. Still, if a legend's protege can't guarantee smooth sailing, what happens to enterprises where the leader's vision and reputation seems singularly crucial to continued success and no talented understudy is waiting in the wings?

What would happen if, God forbid, Fed Chairman Alan Greenspan dropped dead tomorrow? Frankly, it wouldn't surprise me to see U.S. stock markets plunge 10% or more in one day. That might prove an excessive reaction. But given his masterfully pragmatic handling of increasingly complex economic data and his stature among other Fed members, Greenspan today is irreplaceable. The Fed is a less doctrinaire, better institution today because its members have had a chance to watch an artist at work. Yet, that's not the same as being able to forge his paintings. A Wall Street Journal editorial on Monday even pleaded with Greenspan to try to codify his thinking, which has come to look merely like highly informed intuition. That would be a start, but just a start.

Examples are everywhere. Although Jeff Vinik is arguably a great stock picker, he's a nervous trader better suited to run his own hedge fund than the nation's largest mutual fund. Vinik could not begin to replace Fidelity Magellan's Peter Lynch, and that led to several years of serious troubles at Fidelity. More recently, portfolio manager Ryan Jacob left the Internet Fund, which had delivered a stellar one-year return of 272%, due to a dispute over control. Jacob surely can't yet be compared to a Lynch. But his fund has outperformed others focused on the Web, so his departure has rightly led investors to ask whether it's really the same fund without him.

What about America Online (NYSE: AOL) without Steve Case. Yes, Bob Pittman could step in, but isn't the company much stronger with both of them? Or how about without Jeff Bezos? Yes, Wall Street loves current CFO and future chief strategy officer Joy Covey, but Bezos is the man with the ever-evolving vision and infectious laugh. Commentators talk about Berskshire Hathaway (NYSE: BRK.A) carrying an alleged premium thanks to the fact that all-world investor Warren Buffett runs the show. But what's the Bezos premium on Amazon? The Steve Jobs premium on Apple (Nasdaq: AAPL)? The Bill Gates premium on Microsoft (NYSE: MSFT)?

In its Buffett cover story this week, Business Week raises the important question of succession. The article says he's picked two tentative successors, one to manage Berkshire's stock portfolio and another to manage its operating business. "I hope whoever follows me would behave pretty much as I would if I were to live forever," Buffett says. The article also includes an instructive memo from Buffett in which he asks the folks who run his companies to send him a letter "updating your recommendations as to who should take over tomorrow if you become incapacitated tonight."

That's a typically smart move on Buffett's part. Indeed, it should lead us all to think about who's ready to take over our responsibilities, personal and professional, and whether we're doing enough to prepare them for the challenge. Still, the unpleasant reality is that even the best organizations suffer from what I'd call the Michael Jordan syndrome. They may have a truly great, multi-talented Scottie Pippen available to lead the show when Da Man is gone. But to no one's surprise, Pippen couldn't replace Jordan. Indeed, he's probably less of a player now that he can't riff off of his royal Airness. When the great ones leave the league, it's inevitable that their old teams confront some major pitfalls. Often, the once great organizations even wind up in last place where they're stuck rebuilding, looking for new talent.

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