Coke Losing the Pepsi Challenge

Christmas came early to PepsiCo’s NY headquarters last year. Through diversification into healthier products, PepsiCo is leaving Coca-Cola feeling rather flat, says Fiona Rintoul

Christmas came early to PepsiCo’s NY headquarters last year. On December 12 the second best known name in soft drinks overtook arch rival Coca-Cola by market value for the first time ever in 100 plus years of stock market sparring. Quite a turnaround when you consider that just six years ago Coca-Cola’s market value (US$144m) was nearly triple that of Pepsi’s (US$51m).

Two lines crossing on a graph is, of course, largely symbolic, and it was certainly no surprise to the markets. But still. This was one of those how-the-mighty-are-fallen moments that sends a shiver down the spine.

Is that it then? Has brand of brands Coca-Cola finally been knocked off its perch by the garish blue-toned upstart? Will snake-hipped Lotharios henceforth order a rum and Pepsi on Copacabana beach?

Things certainly don’t look too rosy for the drink in the red can. Many analysts left a pre-Christmas investor meeting at which Coca-Cola unveiled a new product and marketing campaign unconvinced that the company was ready to turn the corner. And in the new year, the likes of Goldman Sachs beverage analyst Judy Hong downgraded Coke, reversing an earlier view that 2006 would be a breakthrough year.

2005 was always going to be a transitional period for Coca-Cola. At a November 2004 investor meeting chief executive Neville Isdell, hauled out of retirement to steer the global fizzy drinks maker back into port, acknowledged mistakes had been made and presented an 18- to 24-month Manifesto for Change.

“Long-term growth rates were lowered and we knew we would see a lot of change,” Lauren Torres, senior beverage analyst at HSBC Securities told the drinks business. The problem now is that halfway into the transitional period analysts have received a progress report that doesn’t “provide enough to make us more positive.”

Consensus earnings estimates for Coca-Cola in 2006 from analysts polled by Thomson First Call are US$2.27, 66 cents lower than PepsiCo’s US$2.93. This discrepancy in favour of the blue can persists into 2007 when analysts predict earnings of US$3.29 per share for PepsiCo and US$2.49 for Coca-Cola.

Reversal of fortunes
The reversal in the companies’ fortunes can be traced back to 1998, the year Coca-Cola’s share price peaked at US$89, more than twice its current level. It was around this time that PepsiCo realised the writing was on the wall for carbonated soft drinks.

The seemingly unassailable Coca-Cola failed to grasp this salient fact. While PepsiCo set about diversifying its business away from passé sugary pop, Coca-Cola was busy flogging sweet brown fizz to new markets worldwide.

In 1998, PepsiCo acquired the fruit juice maker Tropicana. This healthy option was followed by others, such as Quaker Oats, which put the company into snacks and brought the sports drink Gatorade into its portfolio.

Today, Coca-Cola and PepsiCo have an 80:20 rule all of their own: more than 80% of Coke’s profits derive from carbonated soft drinks, while PepsiCo looks to fizz for just slightly over 20% of its profits. Last year, sales of carbonated soft drinks grew by about 1%. This year analysts expect sales to be flat to down. As they say in the big country, go figure.

“Diversification is one of the big themes,” says Torres. “Pepsi has been ahead of the game in rolling out non-carbonated soft drinks. It was the same with water. Coke was way behind.”

Through Gatorade, PepsiCo has a much larger share of the sports drink market than does Coca-Cola, which introduced its sport drink Powerade later. And PepsiCo’s Aquina brand is the market leader in bottled water in the US. Not only was Coca-Cola late to the party with its bottled water Dasani, the UK launch turned into a PR fiasco when Dasani was shown to be fiddled-with Kent tap water. A health scare compounded the damage and left Coke looking seriously stupid.

By contrast, analysts are impressed by the intelligence of PepsiCo’s acquisition strategy. “They do bull-time acquisitions that fit well with their current distribution,” says Torres. An example is the recent purchase of Star Foods in Poland, where PepsiCo has been distributing its Lay potato chips since 1991.

Coca-Cola remains the more international company, however, and analysts believe this is one area where it does look stronger than PepsiCo. Sales of carbonated soft drinks have been flat in the developed world, but in markets such as Russia and China there is potential for per-capita consumption growth.

JP Morgan beverage analyst John Faucher bases his “overweight” Coke rating partly on overseas potential. “We think results in Japan and Latin America will remain strong next year given solid macro trends, which should offset lingering weakness in certain European markets,” he says. Faucher also notes that the impact of a US$400m marketing spend by Coke in 2005 will largely be felt in 2006.

Other analysts point to the company’s improved relationship with its bottler as
a reason to be cheerful. And although some were underwhelmed by the marketing initiatives outlined at the December investor meeting, not everyone’s a cynic. “We believe Coca-Cola has enough innovation (packaging and brands) and creative marketing to drive at least 3-4% volume growth in 2006,” says Caroline Levy, beverage analyst at UBS.

So there’s some cautious optimism in the market about the world’s greatest brand. But there are nagging doubts too. Crucially, for a company that turned something as prosaic as sugary brown carbonated water into an icon, there’s a feeling in the market that Coca-Cola has failed to capture the Zeitgeist. “Ask people the last Coke advert they remember and it can be from 20 years ago,” says Torres.

PepsiCo, by contrast, has plugged into contemporary health and wellness trends. “They’ve angled themselves as the better-for-you company,” Torres says. In response, Coca-Cola has said it wants to get into health and wellness too. But to the market that sounds a bit like playing catch-up. Again.

Another and possibly more interesting prong to Coke’s new marketing strategy is to get back to traditional advertising in a bid to revive its iconic status. But its proposed new slogan, Welcome to the Coke Side of Life, failed to excite investors, even if they could see past the fact that drinks of the sugary tooth-rot variety are yesterday’s news.

Those who live by the sword, die by the sword. The main problem for Coke is one that’s potentially insoluble: it was cool and now it’s not. db February 2006