Is Coke’s Franchising Business Model Obsolete?

Lynne Kiesling

There is a fascinating article in today’s Wall Street Journal (sub. req.) about a lawsuit that Coca-Cola bottlers have brought against Coca-Cola. The issue is Wal-Mart’s request to the company for direct shipment of Powerade to Wal-Mart warehouses. One large bottler, Coca-Cola Enterprises (which is responsible for 77% of C-C sales in the US), has agreed, and the second-largest bottler is entering the lawsuit on their side. While Powerade is only a small portion of Coca-Cola’s beverage portfolio, C-C bottlers are concerned that Powerade direct shipment to Wal-Mart is the camel’s nose in the tent that will end the C-C bottler’s business model.

Smaller bottlers wouldn’t be affected immediately. Yet they fear this is an opening wedge, a shift that ultimately could threaten their survival. Their concern is that straight-to-warehouse delivery will prove pleasing to Wal-Mart, that other chains will demand it, and that it would inexorably spread to other drinks and bottlers. The small bottlers then would see their close relationships with grocers diminished, and local marketing would suffer. Those relationships are the main way the bottlers feel they can drive sales in their territories — and thus their own business success.

Agreements dating to 1899 give Coke bottlers exclusive rights to handle sales and distribution within their territories, all the way down to building displays in grocers’ aisles. Coke must rely on the bottlers, as well, to manage a growing assortment of new drinks and to execute marketing promotions. As a result, Coke’s growth has always been built on a symbiotic relationship with local bottlers.

In 1899, the holder of the Coca-Cola formula did not foresee any valuable business proposition in bottling and distributing the drink; he was entirely focused on fountain distribution around Atlanta. He didn’t think there was enough demand to justify the equipment investment that would be required. So he agreed to a franchise contract with two entrepreneurs who agreed to bottle and distribute Coca-Cola in return for a payment of $1/gallon of syrup. They advertised the daylights out of the new drink, and it became enormously popular. Notice how this early development illustrates the Coasian “nature of the firm” make-or-buy decision: the owner did not see the value of doing bottling and distribution within the firm, so he contracted out that right to franchisees, who made a bundle.

Thus the past century of Coca-Cola’s growth has been based on bottling and distribution franchisees with exclusive service territories, and with functions that go all the way from bottling to shelf-stocking at retailers. Note here the similarities with the wine and beer tiered distribution system; in this case, though, the distributors are franchisees instead of fully independent middlemen.

As Coke tries to reverse the slippage and boost new noncarbonated drinks, some Coke executives and analysts believe the fragmented bottling network is a relic that must change. They depict the lawsuit plaintiffs as family-run businesses clinging to the past. Meanwhile, giant grocery retailers are aggressively pushing for ever-tighter efficiency in their supply chains. If Coke is to turn itself around, some maintain, it must gain better command of all the tentacles of its business.

“Coke is going back to control, control, control,” complains Mr. Browne, chairman and chief executive of Great Plains Coca-Cola Bottling Co. “Their goal is getting rid of us munchkins.”

The head of Coke’s North American business, Donald Knauss, says Coke isn’t trying to get rid of bottlers but can’t ignore shortcomings in its business model. “It’s about having one system that operates in concert,” he says. “We can’t keep having internal debates where 20 bottlers want to do it this way and another 35 bottlers want to do it that way. I don’t think we can grow unless we adapt to how the customer landscape has changed.”

The real issue here is the shelving function and the relationship with the retailer, which have always been extremely valuable to the bottler (as well as to C-C more broadly). In its focus on its supply chain logistics, for which Wal-Mart is justifiably famous, Wal-Mart wants to take on the shelving function. C-C bottlers, though, have invested in both the technology and the personnel to perform that function with increasing efficiency, so they are not going to relinquish that function readily.

For Wal-Mart, traditional store delivery frees up labor and offers other benefits, says a spokesman, Kevin Thornton. But the giant retailer has developed an elaborate distribution system that allows it to “know in real time how much product we have left and when we need to order new product,” Mr. Thornton says. The warehouse-delivery plan “will allow us to apply that inventory management to Powerade. Doing this with Gatorade proves this business model works.”

…

Mr. Browne [a regional bottler] acknowledges that if Wal-Mart gives Powerade more shelf space, sales of Powerade are likely to increase. But he says any problems of distribution or half-empty shelves can be solved within the existing system, noting that his own Powerade sales at Wal-Mart leapt 45% last year. Accusing Coke of caving in too easily to a retailer request, he says, “If someone calls up and says put more sugar in the Coke, are you going to do that, too? Coke is giving everything away.”

It’s interesting that Gatorade, owned by Pepsi, is warehouse-shipped. So here’s the interesting question: is the shelf-stocking function obsolete? It allows C-C to monitor whether the retailer is indeed giving C-C the shelf space agreed to in their contract. But have the other benefits of that function been overrun by the benefits of supply chain control to the retailer? Are there other ways that the C-C bottler could monitor the shelf space allocation? Why not write it in to the contract with Wal-Mart that the C-C bottler has to have access to the real-time inventory data and the shelf configuration in the stores? That sounds like a beneficial adaptation to me.