Pepsi Ups the Ante on the Bottle Front

As PepsiCo announced a 1% drop in first-quarter profits, the beverage and snack giant bid $6 billion for its largest bottlers. A warning shot to Coke?

By Burt Helm

Coca-Cola (KO) may soon have to face off against a leaner, meaner Pepsi.

On Apr. 20, PepsiCo (PEP) announced it made two bids totaling some $6 billion for its two largest bottlers, Pepsi Bottling Group (PBG), based in Somers, N.Y., and Minneapolis-based PepsiAmericas (PAS). The deal, if successful, will give PepsiCo control of 80% of its North American beverage distribution network, help it cut more than $200 million in pretax costs annually, and improve margins. Pepsi Bottling Group and PepsiAmericas declined to comment beyond a statement from each saying the company had received the offer and was considering it.

PepsiCo also announced its first-quarter earnings on Apr. 20. In the quarter ending Mar. 30, PepsiCo profit slid 1%, to $1.14 billion, or 72¢ per share, topping analysts' estimates. Revenue fell to $8.26 billion in the first quarter from $8.33 billion a year ago. Adjusted for currency changes, the company said earnings rose 8% and revenues rose 6%. PepsiCo said it expected both profits and revenue to rise by mid- to high-single-digit percentages for the full year.

Consumers Down on Colas

The acquisition bids come as the beverage industry, and PepsiCo in particular, faces a slowdown in sales. Consumers are turning away from carbonated drinks in favor of juices, teas, and water, and opting for private-label brands and tap water. To combat the slowdown, Pepsi's beverage division has embarked on an ambitious overhaul, consolidating Pepsi with the businesses of Tropicana and Gatorade, which operated largely as separate entities, into one operating division, and reinventing seven of its largest brands.

PepsiCo hopes the bottler acquisitions will give it more freedom to market newer, less established products, and experiment with different bottle and can sizes. As separate entities, bottling companies tend to focus on efficiency, and prefer to carry a few high-volume products, such as two-liter bottles of Pepsi. That made it tougher in the past to get traction for a niche brand, like sparkling fruit juice Izze, because it required convincing the separate bottling companies that it would be successful, to get in front of consumers. In particular, Pepsi plans to move toward more of the popular health and wellness products, says Pepsi Americas Beverages CEO Massimo d'Amore. "This gives Pepsi unprecedented control and flexibility over how it moves its products to market," says John Sicher, editor of industry newsletter Beverage Digest.

The deals could also give PepsiCo a new edge against Coke in the high-volume restaurant channel. That is a business Coke has long dominated, thanks in part to a subtle difference in the way the two companies are set up. While both Coca-Cola and PepsiCo spun off their bottling businesses in the mid-1990s to remove the assets from their balance sheets, Coca-Cola retained the rights to sell to restaurants; Pepsi-Co handed over some of those duties to bottlers. The upshot was that while Pepsi had the cumbersome task of working with all its regional bottlers to agree to the price and a split of the profits, Coke could offer a single price to national restaurant chains.

Eyeing More Sales to Restaurants

Today, Coca-Cola dominates that business in the U.S., with a 75% market share, according to analyst Bill Pecoriello of ConsumerEdge Research. All told, restaurant sales constitute 22% of the total volume of soda sold in the U.S.

Now PepsiCo is licking its chops at the prospect of securing new sales in restaurants. "It's a very large market, it's also a very competitive one, and becoming vertically integrated in that market is certainly a big plus for us," says d'Amore. If the deal goes through, PepsiCo could put itself on more equal footing with Coke in the food-service business, and even get an edge by bundling soda fountain service with Frito-Lay and Quaker Oats snacks, two of PepsiCo's brands.

Meanwhile, the proposed deals put added pressure on Coca-Cola to acquire its main bottler, Coca-Cola Enterprises (CCE). Atlanta-based CCE declined to comment, as did Coca-Cola, citing the quiet period before its Apr. 21 earnings release. "The ante has gone up," says Michael Bellas, a consultant at Beverage Marketing. Coke must examine whether it can compete with a more nimble Pepsi, without owning its bottling network, too, Bellas says. Following the news of Pepsi's plans, shares of CCE spiked, closing up 2.6%, at 15.27.

Helm is marketing editor for BusinessWeek in New York .

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