The Coca-Cola Company is experimenting with new recipes at a research facility in Beijing. By tapping into knowledge of Chinese herbal remedies and ingredients, researchers hope to create a drink to ensure the brand’s long-term success in China.
The researchers are not the only ones dabbling with new combinations. Coca-Cola executives are betting that their proposed US$2.4 billion purchase of Huiyuan Juice Group, China’s largest juice manufacturer, will be a tonic for their strength in the local soft drink market.
The prospect of Coca-Cola and Huiyuan joining together has come under scrutiny as competitors and consumers worry about a US company monopolizing a market that includes all non-dairy and non-alcoholic drinks. The bid is seen as a key test case for the country’s new Anti-Monopoly Law, introduced on August 1.
Some say that Coca-Cola need not worry: The law and market are both on its side. But the law is ambiguous enough to make the outcome of what is expected to be a lengthy vetting process uncertain.
"The Anti-Monopoly Law is going to be very important here … I would be shocked if the process is not a very detailed and painstaking investigation," said Peter Wang, a partner at law firm Jones Day in Shanghai.
Beyond soft drinks
The thinking behind the deal is easy to follow. Carbonated beverages are the core of Coca-Cola’s business, but compound annual sales growth of these products in China is expected to fall to 5.3% between 2007 and 2012, down from 8.3% in 2002-2007, according to market research firm Euromonitor International.
Coca-Cola has also been slow to invest in more effervescent categories such as bottled water, ready-to-drink tea and juice. The latter is the largest and fastest-growing segment, making up 66% of soft drinks by volume, and growing 23% annually between 2002 and 2007.
That has put Coke in a weak position as public sentiment grows against its carbonated drinks, argues Matthew Crabbe, managing director of market research firm Access Asia. "Perceptually, [it’s] a bad position to be in, to be viewed simply as a carbonated soft drinks manufacturer," said Crabbe. "There’s mounting public dissatisfaction … with high-sugar, high-fat content foods. Carbonated soft drinks are bundled together with those, rightly or wrongly."
Buying Huiyuan would allow Coke to address that dissatisfaction while establishing itself in two juice segments it has been unable to crack. While the company’s Minute Maid brand leads the juice drink category – fruit-flavored drinks with less than 25% juice content – it has no presence in nectars (25%-99% juice) or the small but fast-growing – at about 13% per year – 100% juice segment.
Huiyuan, in contrast, is the market leader in those two categories, commanding market shares of 44% and 42% in 100% juice and nectars, respectively.
"Huiyuan is highly complementary to Coca-Cola’s China business," said Coca-Cola Pacific Group Communications Director Kenth Karhoeg.
Although critics of the deal suggest Coca-Cola and Huiyuan might be too complementary, Euromonitor analyst Michelle Huang notes that the overlap between the two companies isn’t enough to dominate the market in any one area.
But the Anti-Monopoly Law leaves much room for interpretation.
Wang of Jones Day describes the implementation rules for the law as no more than "bare bones." There are gaps where earlier drafts made clear definitions of terms such as "control," useful in deciding whether a deal should be reviewed.
Instead, the rules merely set monetary thresholds. In an internationally linked merger or acquisition, such as the Coke-Huiyuan deal, the government must be notified in advance if the total business volumes of the participants is over RMB10 billion (US$1.4 billion) globally, and if at least two partners have business volumes of over RMB400 million (US$58.6 million) in China. The rules are unclear about notification procedures.
"You have to make a filing. But the government can decide what to do with your filing, so there’s plenty of discretion," said Wang.
Fortunately for Coca-Cola, that discretion may work in its favor. Unlike earlier high-profile foreign M&A attempts, such as the failed takeover of heavy machinery firm Xugong by Carlyle, a private equity group, Coca-Cola’s bid is not in an industry of notable strategic value.
On the contrary, said Kevin Luo, an analyst with Guotai Junan Securities, the government is encouraging foreign investment in the soft drink sector. He believes there is a "high possibility" that the deal will ultimately be approved.
Huiyuan’s competitors might not welcome that statement, but a successful deal could prove to be beneficial.
China’s soft drink business is highly fragmented: In 2007, Huiyuan and Coke had only a 20% combined share of the total juice market, and 17.9% of the soft drink market, according to Euromonitor. Danone, which has the largest share of the soft drink market through its stake in Wahaha, took only 16.3%.
In fruit and vegetable juices, Huiyuan and Coke are followed by Uni-President with a 7.2% market share, Tingyi, with 6.6% and Danone, with 5.1%.
By encouraging further consolidation, a successful Coca-Cola bid could improve quality and efficiency across the market, noted Access Asia’s Crabbe.
The unification of Coke and Huiyuan alone would not be enough to force the industry down a new path, however. Even together, the two firms will not monopolize upstream and downstream channels, where companies like Tianyi Fruit Holdings maintain strong positions, said Guotai Junan’s Luo. Furthermore, Coke and Huiyuan remain uncompetitive in a number of soft drink segments.
"The Chinese beverage market is highly competitive, and it will stay highly competitive following our potential acquisition," said Coca-Cola’s Karhoeg.
Just as much as the drink being researched in Beijing, that competition could be Coke’s secret recipe for success.