(FORTUNE Magazine) – Behind the new CEO's elimination of 6,000 jobs and the declarations about righting the ship lies a simple truth: Coca-Cola is more broken than practically anyone had realized. It's a startling discovery, even though we already knew that the man who quit as chief executive in December, Doug Ivester, left a mess in his wake. Now it's coming to light that Coke's glorified leader before Ivester, Roberto Goizueta, made mistakes too--by setting unrealistic growth targets and by offloading Coke's problems onto its bottler network, which is its lifeline to consumers. That lifeline isn't healthy. The man now in charge, Doug Daft, faces a huge challenge in putting Coke back on course.

Daft's overhaul suggests, in fact, that this amazing growth machine wasn't quite the real thing. Consider Coke's disclosure that it plans to reduce bottlers' supplies of concentrate--the secret concoction that provides the bulk of Coke's earnings. As Daft explains it, this reduction is a natural response to various forces such as the consolidation of its vast bottling network and advanced information systems. But there's more to it than this. Morgan Stanley's Andrew Conway, the top-ranked beverage analyst, notes that to put inventories in line, Coke is forgoing $600 million in expected revenues and $400 million in pretax earnings in the first half of this year. Why surprise the Street? Why didn't the company instead slow its shipments to reduce inventories gradually? "We have reduced them gradually over the last several years," says Daft, but he admits that in three big markets--Japan, Germany, the Baltics--Coke didn't slow shipments enough.

Daft insists that Coke has not been "stuffing the channel." Indeed, Coke hasn't been channel-stuffing the way the cigarette companies were a decade ago--that is, shipping more and more product, amidst declining consumer demand, to pump up revenues and profits. Coke hasn't built an ever-increasing bloat, but obviously it's been shipping more concentrate than some bottlers need--hence the reduction in one big swoop. "Coke reduced inventories in 1996 too, and said it was a 'one-time, non-recurring' event," says analyst Conway, who worries that this latest "one-time" reduction may not be the last. Counters Daft: "Yes, it is."

Coke's problems--and prospects--hinge on the bottler relationship, which is symbiotic and too often dysfunctional. Except for the brand, the bottling network is Coke's most valuable asset. It's the part of the system that does the heavy lifting--makes the drinks, buys the trucks, delivers the cases, does the local marketing--all with Coke's help. Today's model of ten "anchor" bottlers--big operators that are partly owned by Coke and have executives from Atlanta on their boards--originated in 1986 when Coke, wanting its balance sheet pristine, spun off a collection of U.S. bottlers called Coca-Cola Enterprises. For a decade Coke reorganized the network, picking up weak bottlers and selling them to stronger ones. The company not only built a powerful distribution arm, it also lifted its own profits with one-time gains from the asset sales. This was a brilliant strategy. It turned stupid in the execution.

Over the years, Coke has sapped its bottlers' profits in order to boost its own. Under Ivester, who relished the art of the deal, Coke charged its bottlers top dollar to acquire franchises in certain territories--Venezuela, South Korea, Italy--"as if Coke expected no economic crises for the next 20 years," says one company veteran. The bottlers, eager to expand, paid up. Particularly as economies in Asia and Latin America cratered, volumes and returns went down. "Coke got what it wanted, but the bottlers' profits eroded," says Merrill Lynch's Emanuel Goldman.

It wouldn't be so bad if Coke hadn't also been squeezing many bottlers on the cost of concentrate. Analysts say that Coke has increased concentrate prices 3% to 4% annually during the past decade; U.S. bottlers, hooked on discounting, generally haven't been able to raise prices to their customers. The upshot: Only one of Coke's ten anchor bottlers around the world, Coca-Cola Femsa in Mexico, is believed to earn a return above its cost of capital. Says Deutsche Bank's Scott Wilkins: "Coke can't be successful long-term unless its anchor bottlers earn positive returns."

There's such irony in this! Roberto Goizueta beat the drum on the topic of returns: If a company earns a return below its cost of capital, it is "essentially liquidating the business," he said. Did he, in his passion to enhance Coke's own profits, not foresee the implications of a stressed system? We wish we could ask him. Since Goizueta died in the fall of 1997, the bottlers' poor performance has directly hurt Coke's earnings: Coke's equity income from its bottling investments, $155 million in 1997, was a negative $184 million last year. Plus, the bottlers' high debt has left Coke a bit hamstrung. Moody's and S&P analyze Coca-Cola according to the debt of the Coke system, including some bottlers. Fearful of losing its A rating, Coke, which bought back stock voraciously under Goizueta, stopped doing so last year.

Daft is on the spot. The Coke board gave the new CEO the title of chairman in mid-February, two months ahead of plan--so Ivester is gone. Now Daft is considering writing down impaired assets in India. And he has directed Coke's lawyers to "seek a reasonable settlement" of Coke's racial-discrimination suit. An Australian who spent most of his 31-year career at Coke in Asia, Daft, 56, has "a zero-bureaucracy mentality," says Coke director Herbert Allen. True to form, Daft is moving quickly to repair relations with various constituents--most important, Coke's bottlers.

The bottlers want a bigger cut, they say, of the Coke system's "profit pie." Daft responds: "The way to benefit both Coke and our bottlers is to get the pie growing--and right now it's a pretty deflated pie." Daft faces a particularly difficult challenge because Ivester last fall hiked concentrate prices in the U.S. beyond the normal increase, infuriating bottlers. Daft says he won't withdraw the increase this year (he needs the revenue), but he's vowing to spend more on marketing. He also intends to "act local"--move power to the field and sell more regional drinks--which is smart, but analysts warn that such moves may pressure Coke's margins.

With the stock down to $52 from a high of $85, Daft needs to appease Wall Street too. He'll soon do something that Ivester refused to do: give more realistic growth targets. Conway expects Coke's long-term goal of 15% to 20% earnings increases to drop to 13% to 16%. "It won't fall below the mid-teens," Daft says.

This is all about getting back investors' trust. Four years ago, Roberto Goizueta told me, "Doug Daft is very easy to underestimate." Maybe, but Goizueta never imagined Daft would be tested like this.

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