Coke Vs. Pepsi: It’s The Real Thing

The functional beverage category fizzes with the entry of mainstream players.

By Adam Ismail

Pepsi, Purchase, NY, has made quite a bit of acquisition news lately with its purchases of Quaker Oats, Chicago, IL, and SoBe, Norwalk, CT, but there are broader market implications. In the age of technology anything with less than 10% growth has become unattractive to the market. The management at many food companies recognized this and it made the functional foods and beverage spaces very hot for acquisitions. It would be hard for Pepsi management to turn down the opportunity to enter the space.
Functional beverages have been defined as everything from orange juice with added calcium to beverages infused with herbal remedies to yogurt drinks with probiotic bacteria. Mostly the argument about what a functional beverage is has centered on how purist the people in the argument are. For a company that knows how to market beverages, like a Coke or a Pepsi, all that matters is that consumer perceives the drink as having a healthy function, because that means they will buy it.

When it acquired SoBe, Pepsi got more than just a beverage upstart, it acquired a $166 million brand with intensely loyal Generation X consumers. Isn’t Pepsi’s slogan for its core cola brand “The Choice of Generation Next?” Seems like a perfect fit. It has also grown much faster than 10% per year.
With Quaker Oats, it of course bought Gatorade, which dominates the rapidly growing sports beverage sector. The highly coveted prize has nearly 85% marketshare in the segment, beating out Pepsi’s own All Sport brand and Coke’s Powerade.

What makes it more radical is what it means for Coke, Atlanta, GA, which for the most part has been absent from the functional beverage space. The acquisitions take two companies, which dominate two separate segments with commanding marketshare, off the market and out of Coke’s reach. With the exception of AriZona Iced Teas, Lake Success, NY, Beverage Marketing USA’s core brand, there is nothing left to acquire that can compete head to head with Pepsi and AriZona has already said it will remain independent.

Conventional wisdom says that at the end of any industry shakeout there will be two or three players left standing, but for Coke to be the second it really needs to pick up the pace. In the sports beverage segment they have been trying for years to be a significant number one or two, but they just could never match Gatorade. In the herbal beverage category, which some analysts estimate to have about $300 million dollars in retail sales, SoBe controls well over half. Again, the intensely loyal Generation X consumers are not likely to switch.

The International Angle

Of course Coke could always try looking beyond the U.S. borders for acquisitions. Red Bull, which is a privately held Austrian company located in Salzburg, has been rumored to be a hot property because it has a lead in the very high growth energy drink category in both the U.S. and European markets. By the way, coffee does not qualify as an energy drink. The pharmaceutical giant SmithKline Beecham, Philadelphia, PA, has three functional beverage brands, Ribena, Horlicks and Lucozade, which itself controls over 80% of the U.K. energy beverage segment. Even though it is packaged into the company’s consumer healthcare division, beverages don’t usually mix well with pharmaceutical company core competencies, so a suitor may be welcome.

What hurts Coke even more is that it had wanted to buy both Gatorade and SoBe, but Pepsi essentially beat them each time. So how is it going to respond? Coke has already said it will begin developing new alternative beverage brands at breakneck speeds. Its first product, KMX, is currently being rolled out into a few select markets and took only a few months to develop. The energy drink is going after Red Bull, but will still have to fend off SoBe’s new energy drink, Anheuser Busch’s 180 Degrees brand and about 20 other upstart brands that have little chance of surviving on their own.

Another sign that Coke is not going to sit on its laurels came with the announcement that it had formed a broad new age beverage joint venture with Nestle, Vevey, Switzerland. The two collaborated in the past to bring Nestea to the masses, but this time they are expanding that joint venture to focus specifically on new markets like healthy beverages. The two companies have al­ready thrown their Chinese tea businesses into the new venture, but are going to begin development immediately on new waterbased healthy beverages (for more information on the Coke/Nestle venture, see Top of the News, p. 8).

A Future Of Fierce Competition

A lot of analysts wonder if Coke can really compete in this new and innovative category, but the first clue that it is changing its conservative paradigm is that KMX took a mere three months to develop and launch. That has not been done since Coca-Cola was invented at the fountain in a soda shop drugstore. Given the amount of capital Pepsi invested in the space through acquisition, you can bet Coke is going to be coming out with a number of other products and brands, putting a nearly equal amount of capital to work. It should be said, however, that even after the Pepsi acquisitions, Coke is still the largest beverage company in the world and it is not in danger of losing that position. Perhaps its deal with the world’s largest food company will bode well for the ongoing battle for marketshare. However, Wall Street wants growth and if Pepsi can compete in a growth world, Coke better be able to do so as well.

NW

Adam Ismail is senior consultant with Health Business Partners (HBP), Providence, RI, a boutique investment bank that works exclusively with companies in the natural products and complementary health services industries. HBP also provides capital to businesses in these industries as well as tracking financial data in the natural products industry and providing M&A and strategic advice, in addition to direct investments. HBP can be reached at One Park Row, Providence, RI 02903; 401-272-1333 x168; Fax: 401-272-1331; E-mail: [email protected]; Website: www.healthbusiness.com.