Coke's problems in Japan mount - Concern grows in what has been a strong market

www.accessatlanta.com [ The Atlanta Journal-Constitution: 3/4/03 ] By SCOTT LEITH Atlanta Journal-Constitution Staff Writer

Sales are sluggish, prices in stores are falling, and bottlers are making less and less money.

That's the current business landscape for Coca-Cola in Japan, for years held high as one of the company's star markets.

While Japan remains a model of innovation for Coke and the source of more profits for the company than anywhere but North America, Japan also has become what many observers see as Coke's single-biggest trouble spot worldwide.

Coke's challenges in Japan can get overlooked, given the noisier problems elsewhere: boycotts in the Middle East, for example, and sales disruptions in volatile Venezuela.

But those are little markets in comparison. Japan accounts for about $1 out of every $5 that Coca-Cola makes in profits. Even though Coke's Japanese business is stable, several analysts are concerned about future growth.

"It's important for Coke to have a better-than-stable outlook for Japan," said Andrew Conway of Credit Suisse First Boston.

Coke's Japanese situation has been getting an increasing amount of buzz from analysts and even the media. A Japanese business publication, Toyo Keizai, recently detailed what it called the "melancholy" in Coke's Japanese bottling network.

"If Coca-Cola continues this way, its entire system will sink," the publication said, as translated from Japanese.

That judgment might be over the top, but the article was noteworthy in merely highlighting the worries of Coke bottlers. In Japan's business culture, such public airings can be unusual.

Bottlers are critical because they actually make and distribute most products. Coke itself earns much of its money by selling syrup to bottlers.

Coke has recently talked of improving bottler profitability in general as a way to ultimately help the company itself. Coke and its biggest bottler, Atlanta-based Coca-Cola Enterprises, have both noted a much-improved relationship in recent times.

In Japan, however, bottlers have experienced "significant declines" in profits, said J.P. Morgan analyst John Faucher, while Coke is "posting impressive profit growth."

"The deterioration in the Japanese bottling system's operating profit situation is not a short-term trend, either," Faucher said in a report. "Over the past few years, we have seen precipitous declines."

While Coke Japan's profits have grown, statistics compiled from five publicly traded Japanese Coca-Cola bottlers show a collective decline of about 15 percent in operating profit in 2002, according to J.P. Morgan. On the bright side, the bottlers have remained profitable.

To be sure, the hurdles in Japan are complex. Coke and its bottlers are dealing with a wobbly economy, including prices that are on a deflationary slide. Political reforms are slow in coming.

The Japanese marketplace is changing too, and not to the advantage of the Coca-Cola system. In Japan, about 42 percent of Coke's sales volume comes from vending machines. Coke has 1 million of them, and they yield hefty profit margins.

Increasingly, however, Japanese consumers are buying more beverages in supermarkets. These stores provide good sales volume but slimmer profit margins.

Mary Minnick, who runs Coke's Asia division, is a former president of Coca-Cola Japan. She knows the region well.

In an interview, Minnick said plans are percolating to improve sales in Japan, and she downplayed the problems.

"None of this is really new," she said, adding that there are many reasons for the declines. Coke bottlers, she said, are "very profitable" by average Japanese standards.

But Coke's sales growth has been slim in Japan. In 2002, volume increased 2 percent for the whole year, while it dropped 1 percent in the fourth quarter.

Soft sales are a big issue for Coke, even though the company remains a powerful force in the Japanese beverage market. The company's top-selling products are Coca-Cola and Georgia Coffee.

According to Credit Suisse First Boston, Japan accounts for about 22 percent of Coke's worldwide profits, even though it generates just 5 percent of Coke's sales volume. That makes each case sold more profitable than anywhere else, including the United States, where volume is far greater.

In Japan, however, Coke finds itself "at a crossroads" with its bottlers, said Bill Pecoriello of Morgan Stanley. "The bottlers are trying to focus on their profits," he said, while Coke believes bottlers can cut costs as one way to improve results.

That tactic is being pursued through joint buying of many goods needed to produce soft drinks, Minnick said. Coke itself has cut costs, too, including a 40 percent staff reduction in 2000.

There are other changes in the works. Japan has 15 different Coke bottlers. They produce most, but not all, of the beverages they sell. In one move that could appease them, Coke is negotiating to give bottlers part ownership in a Coke-owned unit that makes tea drinks.

At the moment, bottlers handle distribution of the popular products but don't make as much money because they aren't the manufacturers.

On the other hand, Minnick said, she'd also like to increase joint manufacturing as a way to cut costs. "It involves some hard choices," she said. Cuts would be likely. Even with those kinds of changes in mind, Coke is "perfectly comfortable" with having so many bottlers, Minnick said, so forced consolidation is not on the table.

Hisashi Nakai, an analyst who follows the beverage industry in Japan, said he believes Coke and its bottlers can solve their problems but "only when Japan's national economic problems will be solved."

As for other changes in the marketplace, the reality is that Japan always has been an evolving place. Consumers there are well-known for constantly shifting to new products.

What Coke faces is a "Herculean task," Faucher said, that doesn't offer easy solutions. "We think that over the next several years, system profitability will continue to come under significant pressure."