Coca-Cola Makes Strides to Ensure a Bright Future

Coca-Cola’s focus on innovation and increasing its marketing investment makes for an ideal business strategy

Jul 12, 2014 at 9:00AM

The beverage industry has been facing challenges in the carbonated soft drink (CSD) category, mainly in developed markets, because of obesity concerns as consumers become more health conscious. To address these challenges, especially the ones faced in the CSD category, beverage companies, including The Coca-Cola Company (NYSE:KO) and PepsiCo (NYSE:PEP), have been reinvesting in their businesses, focusing on innovation, and increasing marketing investments to strengthen their brand portfolios and increase sales volume. Also, the companies are undertaking cost reduction initiatives to support reinvestments and bottom-line growth. 

Consistent global performer
Coca-Cola is the world's leading beverage company, with large international exposure. The company generates more than 50% of its total revenues from outside the U.S. The company has delivered consistent growth across the globe over the years; however, recently it has been experiencing weakness in revenues and volume growth in developed markets. Developing markets remain strong, though, and are the main long-term growth driver.

In the recent first quarter, the company experienced 2% year-over-year volume growth, which was below its long-term volume growth target of 3%-4%. A 4% year-over-year volume decline in Europe pressurized total volume growth. However, 7% volume growth in Asia Pacific in the quarter, primarily driven by 12%, 6%, and 3% volume growths in China, India, and Japan, respectively, and 2% volume growth in Eurasia and Africa supported the company's overall volume growth. Developing markets remain an important growth driver in the long term, as population and per capita income in those regions is on the rise.

Trimming the cost structure
Furthermore, Coca-Cola is working to make its cost structure leaner and increase productivity in an attempt to improve its bottom-line results and support reinvestments in the business. The company is working on a four-year productivity plan, under which it hopes to generate annual savings of $550-$650 million by 2015, mainly through supply chain optimization and the integration of bottling operations. In the first quarter of 2014, to further enhance productivity, Coca-Cola introduced a plan to drive an additional $1 billion in productivity in the next three years.

Under Coca-Cola's ongoing productivity improvement initiatives, the company has completed operational excellence diagnostics for about 50% of its plants in North America, and the process is expected to be completed by 2015. Once the operational excellence diagnostics is completed, each location will be able to generate savings of $1 million. The cost saving measures undertaken seem to be delivering results, as the company was successful in expanding its gross margin by 60 bps year over year in 2013, and by 50 bps year over year in the first quarter of 2014.

PepsiCo, Coca-Cola's rival, is also working on cost control initiatives to support reinvestments and support earnings growth. The company's cost-saving initiatives seem to be on track, as it enjoyed gross margin expansion of almost 90 bps year-over-year in 2013. PepsiCo's cost-control efforts are mainly directed toward increasing automation, increasing shared services and optimizing manufacturing facilities. PepsiCo is expecting to generate annual cost savings of $1 billion in 2014. The company recently announced another cost saving program for the next five years, starting in 2015, which is expected to generate cost savings of $5 billion.

Major marketing investments
Coca-Cola is also ramping up its marketing activities and has planned to increase marketing investments by $1 billion by 2016 to support volume and innovation. The company will increase its marketing investments by $400 million in 2014. Only 5% of the planned marketing investments increased in the first quarter of 2014, which means marketing investments will accelerate in the remaining year and will bode well for volume.

Moreover, Coca-Cola has been focusing on innovation and portfolio diversification, which remain critical for the company's long-term success. Consistent with its innovation and diversification efforts, Coca-Cola recently increased its stake in Keurig Green Mountain (NASDAQ:GMCR) from 10% to 16%. Coca-Cola initially acquired a 10% stake in Keurig Green for $1.25 billion. Keurig Green and Coca-Cola are developing a machine that will make both non-carbonated and carbonated drinks. Moreover, Green Mountain will be Coca-Cola's exclusive partner for the manufacturing and sale of pod-based cold beverages. Green Mountain will also benefit from the transaction, as it will be able to use Coca-Cola's supply chain and consumer base to expand its presence in international markets.

Final take
Coca-Cola has a large developing market footprint, which will offset the volumes weakness in developed markets and provide growth in the long term. Also, the company has been taking the right initiatives by reinvesting in businesses by focusing on innovation and growing its marketing investment. Also, Coca-Cola's initiative of improving productivity will augur well for its performance in the future.

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Furqan Asad Suhail has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola, Keurig Green Mountain, and PepsiCo. The Motley Fool owns shares of PepsiCo and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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