Coca-Cola and Procter & Gamble's Aborted Effort to Create a Global

question 30

Essay

Coca-Cola and Procter & Gamble's Aborted Effort to Create a Global Joint Venture Company
Coca-Cola (Coke), arguably the world's best-known brand, manufactures and distributes Coca-Cola as well as 230 other products in 200 countries through the world's largest distribution system. Procter & Gamble (P&G) sells 300 brands to nearly 5 billion consumers in 140 countries and holds more food patents than the three largest U.S. food companies combined. Moreover, P&G has a substantial number of new food and beverage products under development. Both firms have been competing in the health and wellness segment of the food market for years. P&G spends about 5 percent of its annual sales, about $1.9 billion, on R&D and holds more than 27,000 patents. The firm employs about 6,000 scientists, including about 1,200 people with PhDs.
Both firms have extensive distribution systems. P&G uses a centralized selling and warehouse distribution system for servicing high-volume outlets, such as grocery store chains. With a warehouse distribution system, the retailer is responsible for in-store presentations of the brands, including shelving, display, and merchandising. The primary disadvantage of this type of distribution system is that it does not reach many smaller outlets cost effectively, resulting in many lost opportunities. In contrast, Coke uses three distinct systems. Direct store delivery consists of a network of independently operated bottlers, which bottle and deliver the product directly to the outlet. The bottler also is responsible for in-store merchandising. Coke's warehouse distribution is similar to P&G's and is used primarily to distribute Minute Maid products. Coke also sells beverage concentrates to distributors and food service outlets.
On February 21, 2001, Coca-Cola and Procter & Gamble announced, amid great fanfare, plans to create a stand-alone joint venture corporation focused on developing and marketing new juice and juice-based beverages as well as snacks on a global basis. The new company expected to benefit from Coca-Cola's worldwide distribution, merchandising, and customer marketing skills and P&G's R&D capabilities and wide range of popular brands. The new company would focus on the health and wellness segment of the food market. Less than nine months later, Coke and P&G released a one-sentence joint statement on September 21, 2001, that they could achieve better returns for their respective shareholders if they pursued this opportunity independently. Although it is unclear what may have derailed what initially had seemed to the potential partners like such a good idea, it is instructive to examine the initial rationale for the proposed joint effort.
Each parent would own 50 percent of the new company. Because of the businesses each partner was to contribute to the JV, the firm would have annual sales of $4 billion. The new firm would be an LLC, having its own board of directors consisting of two directors each from Coke and P&G. Moreover, the new firm would have its own management and dedicated staff providing administrative and R&D services. Coke was contributing a number of well-known brands including Minute Maid, Hi-C, Five Alive, Cappy, Kapo, Sonfil, and Qoo; P&G contributed Pringles, Sunny Delight, and Punica beverages. The new company would have had 15 manufacturing facilities and about 6,000 employees.
Although the new firm was to have access to all distribution systems of the parents, it would have been free to choose the best route to market for each product. Although Minute Maid was to continue to use Coke's distribution channels, it also was to take advantage of existing refrigerated distribution systems built for Sunny Delight. Pringles was to use a variety of distribution systems, including the existing warehouse system. The Pringles brand was expected to take full advantage of Coke's global distribution and merchandising capabilities. Minute Maid was to gain access to new outlets through Coke's fountain and direct store distribution system.
The new company's sales were expected to grow from $4 billion during the first 12 months of operation to more than $5 billion within two years. The combination of increasing revenue and cost savings was expected to contribute about $200 million in pretax earnings annually by 2005. Specifically, Pringles's revenue growth as a result of enhanced distribution was expected to contribute about $120 million of this projected improvement in pretax earnings. The importance of improved distribution is illustrated by noting that Coke has access to 16 million outlets globally. In the United States alone, that represents a 10-fold increase for Pringles, from its current 150,000 points of outlet. Similarly, improved merchandising and distribution of Sunny Delight was expected to contribute an additional $30 million in pretax income. The remaining $50 million in pretax earnings was to come from lower manufacturing, distribution, and administrative expenses and through discounts received on bulk purchases of foodstuffs and ingredients. P&G and Coke were hoping to stimulate innovation by combining global brands and distribution with talent from both firms in what was hoped would be a highly entrepreneurial corporate culture. The parents also hoped that the stand-alone firm would be able to achieve focus and economies of scale that could not have been achieved by either firm separately.
The results of the LLC were not to be consolidated with those of the parents but rather shown using the equity method of accounting. Under this method of accounting, each parent's proportionate share of earnings (or losses) is shown on its income statement, and its equity interest in the LLC is displayed on its balance sheets. The new company was expected to be nondilutive of the earnings of the parents during its first full year of operations and contribute to earnings per share in subsequent years. The incremental earnings were expected to improve the market value of the parents by at least $1.5-2.0 billion (Bachman, 2001).
Some observers suggested that P&G would stand to benefit the most from the JV. It would have gained substantially by obtaining access to the growing vending machine market. Historically, P&G's penetration in this market had been miniscule. This perceived disproportionate benefit accruing to P&G may have contributed to the eventual demise of the joint venture effort. Coke may have sought additional benefits from the JV that P&G was simply not willing to cede. Once again, we see that, no matter how attractive the concept may seem to be on the surface, the devil is indeed in the details when comes to making it happen.
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-Why do you think the parents selected a limited liability company structure for the new company? What are the advantages and disadvantages of this structure over alternative legal structures?

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