CFO Studio Magazine - Curt Allen, CFO, Subaru

46 WWW.CFOSTUDIO.COM 1st QUARTER 2015 CFO Studio Advisory Board & Technical Review Committee Tim Anglim YesCFO > Founder and President Andrew Savadelis Angion Biomedica > Chief Financial Officer Michael Eldredge American Sensor Technologies, Inc. > Chief Financial Officer VIEW PROFILES AT www.cfostudio.com Bert Marchio Edge Therapeutics > Chief Accounting & Operations Officer Gerald Najarian The Remington Group, LLC > Partner Howard Reba Marlin Equity Partners > Finance Director Although management communicated this strategy change, an analysis of Coca-Cola’s financial statements provides corroborating evidence of their changed strategy. Financial Transformation Financial statements communicate strategy and changes in strategy. For Coca-Cola the evidence is in a comparison of recent years’ financial data. The charts on the previous page present selected financial information trends. The charts show the impact of Coca- Cola’s acquisition of its former bottling operations in October 2010. Because the transaction occurred late in the year, 2011 is the representative year showing the impact of strategy on financial returns. Due to the bottling strategy change, total assets increased by 64 percent, from $48.7 billion in 2009 to $80.0 billion in 2011. As a result of this, return on assets decreased from 15 percent to 11 percent over the same period of time. The strategy change also impacted profitability. Even with a sales increase from $30.0 billion to $46.5 billion from consolidating the bottling operations sales, an expected profitability boost from operating leverage did not materialize. Operating income as a percent of sales fell from 27 percent in 2009 to 22 percent in 2011 because bottling operations are about half as profitable as beverage concentrate and syrup sales. This lower profitability level continued into future years, indicating the drop in 2011 was not due to acquisition integration costs. New Vertical Integration Strategy Coca-Cola segments beverages into the categories of sparkling (soda) and still (waters, juices, teas, coffees, sports drinks, and energy drinks). Consumer consumption of still beverages is growing at a fast rate, and sparkling beverage consumption has been flat or declining. For example, in 2000, still beverages totaled only 11 percent of Coca-Cola’s volume. By 2009, this figure more than doubled to 23 percent. The changing beverage market from growth in still beverages and increased numbers of product offerings resulted in greater cost and complexity in manufacturing, packaging, and distribution. In response to changing market dynamics in 2009, Coca-Cola and its bottling partners developed and communicated their 2020 Vision, a strategy two years in the making. This vision included bringing new beverage innovations to the marketplace and increasing profit margins. In October 2010, Coca-Cola executed its vertical integration strategy by acquiring the entire North American bottling operations. Implementing this strategy gave Coca-Cola control of manufacturing and distribution of an increasingly complex and diverse product offering to the consumer beverage market. In addition to gaining operating control, the move significantly increased Coca- Cola’s assets and dollar profits through cost synergies and through consolidating 100 percent of the bottler profit. Gross margins, however, decreased due to including lower profits from asset-intensive operations. Vertical integration extends a company’s operating control of the value chain within the same industry. It expands the company’s management activities backward into supply sources and forward to the ultimate customer. Vertical integration is a viable strategy if it creates a competitive advantage that results in increased volume and profits.This could occur from: • Achieving greater scale economies. • Realizing more production efficiencies without reducing product quality. • Developing a better customer experience. • Strengthening core competencies and minimizing strategic weaknesses. Conclusion Management’s strategy communication can occur both directly in written documents and indirectly through an analysis of financial statements. Coca-Cola’s vertical integration strategy enhanced its performance of critical strategic activities in the value chain by improving the customer experience through gaining control of distribution and direct customer contact. The financial tradeoff, however, became increased business risk from greater asset investment financed by higher debt and from reduced asset efficiency and lower profitability. C 2 CFO CFO