Expansión Magazine February 05, 2003

C O V E R rmoran@expansion.com.mx

Coca-Cola’s New Bosses FEMSA becomes the largest bottler in the world outside of the United States, and is sure it will be able to deal with the territories that caused problems for others. By Roberto Morán Photos: Gilberto Contreras Translated by Marianne Morgan Every half an hour, a truck with two trailers, with 64 pallets stacked with beverage cases, leaves from the new Coca-Cola bottling plant in Toluca. This is more than twice what a normal truck carries, and just one example of the production capacity of the large companies that manufacture these beverages. The Toluca plant, owned by Coca-Cola FEMSA, can produce 600,000 cases daily, or 14 million drinks a day, enough to quench the appetite that the entire country of Mexico has for this brand. And that is

just for the moment, because the plan is to increase capacity from 8 to 12 production lines, to make it the largest flagship bottler on the planet, surpassing a factory in Sao Paulo. With installations of this caliber, the large beverage bottlers have fewer costs than their smaller colleagues. It is logical then, says José Antonio Fernández, president of Fomento Económico Mexicano (FEMSA) – the company that owns Coca-Cola FEMSA – that the companies servicing smaller

Expansión Magazine February 05, 2003

Expansión Magazine February 05, 2003

territories will end up forming an alliance amongst them or being absorbed by those larger than them. The latest move by his company is the best example of what is occurring in the beverage production industry: consolidation. As was announced last December, the organization is ready to buy Panamco, the second-largest company in the world in this niche, and the largest outside of the U.S., which will involve a disbursement of 3.6 billion USD in cash and stock. Once consolidated, the two companies will produce one out of three Coca-Colas consumed in Latin America and half of those consumed in Mexico. If everything goes according to what Fernández and his team plan, the operation will become definite in April 2003. Coca-Cola FEMSA, a subsidiary of Monterrey’s FEMSA, the firm that started out as Cervecería Cuauhtémoc, is moving into somewhat murky waters with this acquisition. Panamco, which was born as Grupo Azteca in 1941, has been the second largest bottler in the world since 1997, when it acquired the Venezuelan Coca-Cola Hit for 1.1 billion USD. In those days, the directors told Expansión that it would take them five years to consolidate and to become established in the market. They ended up being absorbed, overwhelmed by more than 800 million USD in debt, and were hit hard by the economic instability in several of their markets. Why is this company from Nuevo León so sure that it will be able to take this on? Federico Reyes, the CFO, explains that we are dealing with two very different scenarios.

Three years ago, Coca-Cola FEMSA made the decision not to pay out dividends to its stockholders. “[FEMSA did so] despite the large cash flow it was generating,” says Reyes, “because it knew that there may be a possibility of an acquisition of this size. They prepared with a very large cash piggy bank and huge annual profit-generating power. This permitted them to make a transaction of this magnitude and still conserve their rating [of some international credit rating agencies].” On the other hand, adds the executive, “Panamco was coming in very differently. “With high leverage, low cash flow, they were trying to reduce their debt,

but their operations could not convince the markets that they were on the right track.” The reaction of the financial markets was almost like a textbook case: the day of the announcement, the stock of the buying company went down and that of the acquired company went up. “That happened to us, but it happens to everyone. We were expecting the decrease, but I believe that it was moderate, signaling that it was taken well by the market,” assures Reyes. “Generally, they recognize the strategic value that this operation represents.” According to the rating agencies Standard & Poor’s and Moody’s, the transaction only meant a change from positive to stable for Coca Cola FEMSA’s outlook. In other words, they both consider that the financial impact on the company – that took out a loan for 2 billion USD– is

Expansión Magazine February 05, 2003

temporary, and that furthermore, the acquisition makes sense for the consolidation of the consortium. Marco Vera, an analyst at Deutsche Bank, says the organization would have to get rid of Panamco’s operations in Venezuela, Brazil, and Colombia, countries “infested with structural problems.” According to him, these markets, instead of diversifying the risk for the company, make it larger. “They are distractions that are not worth it,” he said. However, Carlos Salazar, CEO of Coca-Cola FEMSA, considers that all the new markets acquired by his company have great possibilities. No one disputes the logic of buying new territories in Mexico and Central America. FEMSA already operated in the Mexico Valley and in the Southeast of the country. Panamco has activity in the bordering territories, in the middle of Mexico, and in Central America, which allows them to increase coverage, take advantage of their

installed capacity, and in some cases, save costs that were duplicated. “[Outside of this zone] the priority is Brazil, says Salazar. “It is the second largest consumer of drinks in the area, after Mexico, and the plant in Sao Paulo (property of Panamco), represents no less than 30% of that nation’s consumption.” Fernandez concedes that it is very difficult to work in Colombia yet even so, bottling companies are generating profits. At any rate, the executive reminds us that three-fourths of the group’s combined cash flow will come from Mexico. Carlos Laboy, an analyst at Bear Stearns & Co., does not agree with Vera’s opinion. He asserts that at 100 million each, the markets in Brazil and Venezuela ended up costing almost nothing to Coca Cola FEMSA, especially if you compare them with the 1.1 billion that Panamco paid for the latter country in 1997. FEMSA’s Trials Fernandez estimates that within

five years, they’ll know if buying Panamco was a good move and “whether we manage it well.” But he is confident that the corporation’s first international experience, when it acquired the bottler in Buenos Aires in the mid-1990s, will be a guide of sorts for their actions. In Argentina, FEMSA found a very different market than the Mexican one. “Coca- Cola in Mexico is a product that serves the customer by giving energy and refreshment, providing inexpensive calories with clean water, fast. In a way, a Mexican ‘eats’ Coca-Cola and takes refreshments from it. In Argentina, when we first got there, the beverage was a luxury product,” says Fernandez. Although this comment runs the risk of causing a stir, similar to the one caused some time ago by a certain Secretary of Commerce, who said that sodas were an important part of the nutrition of the Mexican people, it does illustrate the difference between Mexico and the rest of the Latin American markets. “Coca-

Expansión Magazine February 05, 2003

Cola has been encroaching into the Argentinean homes,” continues Fernández. “The new generation is getting used to living with it, and little by little we will have the per capita consumption that we have in Mexico, in that country.” Here, the average consumption per resident is 462 eight-ounce bottles per year (the highest in the world), while in Buenos Aires it is 271. Salazar explains that his company has been able to advance in Southern lands because it has applied the way of doing business that it uses at its headquarters in Mexico. Since Fernández arrived at the helm of FEMSA in 1995, the firm has adopted a series of practices that clearly define the responsiblities of each one of its employees. In large part, the way

the company works emerged from the theories of Riaz Khadem, co-author of the book, One Page Management, who was invited as a consultant to initiate the transformation of the corporation. When FEMSA arrived in Argentina, the price of the beverage was double that of Mexico, due to the effect of the Argentinean Peso – US Dollar parity. In addition, the South American bottler had little ability to produce different presentations of the beverage; that prevented

them from offering distinct products for the diverse markets. As if that were not enough, retailing in South America is very different than in Mexico. There, it is concentrated in a few points of sale, mostly supermarkets; here, it is distributed among tiny grocery stores, so that large companies with a good logistics strategy, like FEMSA or Bimbo, have the means to win. With this structure, it is easier for smaller bottlers of many brands to compete with the giant beverage makers as well. “Cheap brands came out, cheap colas or other flavors, at a much lower cost than ours. Maybe they don’t pay taxes or don’t meet the sanitary conditions,” explains Fernández. According to Fernandez, the Mexican conglomerate diversified its presentations, improved its price strategy, and even came out with a “cheap brand, to directly hit and compete with the others.” Salazar remembers that the plant in Argentina was utilizing less than 50% of the available machinery running time, due to maintenance problems and lack of efficiency in changing the line – to change requirements was taking too much time. In a few months, the efficiency of that plant rose to 90% and what was learned was also transferred to Mexico. Each improvement that the organization achieves is documented and transferred to all its plants. “In Oaxaca you will find the same working practices that are used in Tabasco or in Alcorta [Argentina]. We have put that down in Coca Cola’s Red Book and we already have 206 operative practices listed.

Expansión Magazine February 05, 2003

When we arrive in a new territory, we already have the ‘key competencies,’” Salazar said. In Buenos Aires, the company also introduced a more diverse line, price differentials, and in some cases, brought back glass bottles, which are less expensive in that South American country. Fernández insists that the obsession of clearly defining the job goals of each employee of the firm has helped make Coca-Cola FEMSA the most profitable bottler in the world, at least among those traded in the stock market. In 2002, FEMSA’s profit margin before taxes and other deductions (EBIDTA) over sales was over 25%. In Argentina, with everything plus the difficulty of the market, it was over 17%, in

contrast to the losses incurred in the mid-’90s. Of course, this pleases The Coca-Cola Company, stockholder of both the acquiring and the acquired firms. “I don’t know if Coca-Cola FEMSA will be able to do better than Panamco,” diplomatically states Rodrigo Calderón, Director of External Relations of Coca-Cola Mexico, in charge of bottler liaisons. “But without a doubt, they will have to leverage less. That lends viability to FEMSA’s businesses in those countries.” And now Latin America According to the teachings of Riaz Khadem, each employee, in consultation with his or her boss, must come up with his or her “critical success factors,” that is, which goals he or she will reach to show that they’re fulfilling their

commitment within the company. Salazar already has his own critical success factor, which is, in short, to turn around Panamco’s operation within 18 months. “Our interest lies in presenting our way of doing business, and adding their way to it, not to go in as conquistadors” Salazar clarifies. In any case, Panamco’s more than 67,000 workers will have to adopt many of the practices of Coca-Cola FEMSA’s 14,000 workers, and according to Laboy of Bear Stearns & Co., they will have much to learn: “FEMSA excels at two things: its excellent supply chain management and its performance at the points of sale. Panamco was deficient in both areas.” The analyst refers to the way of doing things implemented in the Mexican consortium since the mid-’90s, thanks to which “it operates with less than half the number of

Expansión Magazine February 05, 2003

warehouses than Panamco, and their average delivery at a point of sale is three times as large. Coca-Cola FEMSA’s salesmen are doing a better job per point of sale, thus enabling them to sell more beverages and more products, and they probably work with a better pricing structure as well.” Salazar reveals some of the secrets of his system. The company was one of the first to implement a practice called presale. Instead of the delivery truck driver selling at each store and delivering the same day, a salesman takes the orders and sends the merchandise the next day. This way, they are sure that the stores receive exactly what they want (with more than 90% accuracy, explains the executive), instead of just getting what the delivery truck has available at the moment, plus the freight “touring miles” become much less. Reduction of “touring miles” means that the delivery truck carries only exactly what is necessary to stock each retailer and doesn’t take the beverages on “tour” the whole day. “From around 300 cases per day per truck, we now moved to nearly 500”, says the executive of the beverage maker. These types of improvements in productivity have extended far and wide throughout the firm. And that has allowed productivity to increase by 30%, with a smaller number of bottling plants and practically the same number of delivery trucks and employees. In 1995, it had 15 factories in Mexico, and now it only has nine. “We could have never executed such a big risk [like Panamco’s acquisition] had it not been for these practices, these levels of productivity and

for such an orderly working culture,” declares Salazar. What’s next? Laboy foresees that FEMSA will take advantage of Coca-Cola FEMSA’s installations to introduce other products as well, such as its beers, although the Mexican company explains that this is not one of its priorities. Fernández and Salazar want to take the practices that have made them profitable in Mexico and Argentina to all the new territories. To their way of working, they say, they will add the philosophy of FEMSA which, since its founding in 1890, has offered their workers a sort of welfare plan, inspired by the Christian social doctrines of the late 19th century. According to the executives, the most important issue for the organization was not the acquisition of Panamco, but rather to prove that it knows how to do things. “The purchase,” says Fernández,“doesn’t have as much merit as what occurred between 1995 and 2002, when we demonstrated teamwork. The Coca-Cola Company would never have had the confidence in us had we not shown them, with facts, what we can do [Coca-Cola has veto rights], and nobody would have loaned us 2 billion USD if we didn’t have the ability, if they didn’t say, ‘These guys really know how to operate.’” With the collaboration of Zacarías Ramírez