New CEO E. Neville Isdell made clear from the start that he sees little wrong at Coca-Cola Co (KO). "The system isn't broken. There's still opportunity for both Coca-Cola and the other [soft drink] brands," said the affable Irish citizen upon his May 4 appointment. But as he digs into the strategic questions about how to reignite growth at Coke, he might want to take a closer look at its first-quarter earnings report.
The sharp 35% rise in profits owed little to the company's four core brands: Coke, Diet Coke, Sprite, and Fanta. Instead, Coke got a jolt from the noncarbonated brands that were once treated as orphans by its cola-centric management. Sales of its Dasani water brand rose 23% globally despite being pulled from shelves in Europe in late March because initial shipments contained the carcinogen bromate. And Coke's Powerade sports drink saw volume surge 28% worldwide on the back of a new ad campaign featuring NBA prodigy LeBron James, as well as four extra selling days in the quarter.
It's the first good news Coke has had for some time in its battle to make up precious ground against PepsiCo Inc. in the beverage industry's most competitive rivalry. While Coke retains an iron grip on the $64 billion U.S. carbonated soft-drink market, it remains a distant second or worse in the up-and-coming "noncarb" category. Sales of beverages such as water, juice, tea, and sports drinks are growing as much as eight times faster than U.S. soda sales. Yet Coke's commanding 44%-to-32% lead over PepsiCo in U.S. soda sales compares with a 16%-to-24% deficit against its rival in the $27 billion noncarb market, says consultant Beverage Marketing Corp.
Getting the noncarb business right will be a top priority for Isdell, 60, a former Coke exec who will return in the early summer to take over from current CEO Douglas N. Daft. Given the one-two punch of economic turmoil in key overseas markets and lack of growth in the U.S. soda business, Coke's operating profits have risen an average of only 1% since 1997, to $5.2 billion in 2003. While the noncarbonated market is going gangbusters -- growing 8% last year alone -- U.S. soda consumption has grown by less than 1% in each of the past five years. Add mounting concerns about childhood obesity and the possibility that consumers are simply suffering from cola fatigue, and the soda market is likely to remain under pressure.
STUCK IN THE PAST. You have to give PepsiCo credit for its savvy in seeing the opportunity before Coke, which was long reluctant to diversify into any beverages that it feared couldn't match the lucrative margins of soft drinks. Daft's predecessor, M. Douglas Ivester, had to be dragged kicking and screaming into the water business: Coke made most of its money selling syrup concentrate to bottlers, and he didn't see how the company could justify its cut of profits on water. (Today bottlers pay Coke for "mineral packets" that give Dasani its taste, in addition to marketing fees.) He also passed on a chance in the 1990s to buy Quaker Oats Co. -- which at the time owned Snapple (CSG) as well as Gatorade (PEP).
Daft's efforts to convert Coke into a "total beverage company" also met with periodic resistance from Coke's board. He lost a bidding war for the SoBe line of New Age drinks to Pepsi in 2000 and the Gatorade line after Coke director Warren E. Buffett vetoed Daft's all-stock deal for Quaker by saying it wasn't worth 10.5% of Coca-Cola.
Bottlers, meanwhile, refused to embrace Daft's acquisitions of Planet Java, a bottled coffee intended to compete against the Frappuccino brand carried by PepsiCo bottlers, and the Mad River line of New Age teas. The independent bottlers have long preferred products with the high volumes and simple plastic packaging that allow them to run their production lines at full tilt -- and products such as Planet Java and Mad River offered neither. "We just didn't see the opportunity," says Ron Wilson, president of the Philadelphia Coca-Cola Bottling Co. Given the apathy, Coke execs shelved both Planet Java and Mad River last year. They plan to distribute such niche products via food brokers; bottlers will get a cut of profits for coordinating sales and merchandising efforts with merchants. "We know what we need to do now," says Chief Financial Officer Gary P. Fayard.
CREATIVITY NEEDED. Coke execs believe they're starting to pick up momentum on the noncarb front. In the U.S., the new Minute Maid Lemonade line has sold briskly, and Coke boasts that in chilled juices, its Minute Maid team outsmarted PepsiCo's Tropicana by being the first to include a blend designed to lower cholesterol.
Analysts think Coke may have to scrap Dasani in Europe and return under a different name, perhaps as a spring water rather than a purified one. But Coke says its water business is gaining traction elsewhere. Its three-year-old Turkuaz brand is the best-seller in Turkey, and its NaturAqua line has become the second-best-selling water in Hungary after just nine months. While Coke remains a distant second in U.S. sports drinks, it says it is enjoying heady growth in the many international markets where Gatorade isn't sold. Keith D. Pardy, vice-president for emerging global brands, says Powerade sales rose 23% worldwide last year.
The recent growth in some areas is coming off a small base of sales. And some analysts think Coke will have to be a lot more creative on the product and marketing fronts to make up lost ground. David M. Podeschi, senior vice-president of merchandising for 7-Eleven Inc. (SE), commends Coke for the "great strides" it has made with soda extensions such as Vanilla Coke and Diet Coke with Lemon, "but they could do more innovation on the noncarb side." Coke's new CEO will have to figure out how to generate as much fizz out of juice and water as he does from soda. By Dean Foust in Atlanta