The cold warriors

By Ranvir Nayar DUBAI

Until the early 1990s, Pepsi, the world's second largest cola company, was in an incredible position in the Middle East. Due to a boycott of its rival, the company had nearly the entire market to itself. Barely a decade later, however, Pepsi is struggling to maintain its lead over Coke, which has staged a comeback as dramatic as its ouster four decades earlier. The reasons for Pepsi's failure are various, but they can all be traced to the company's attitude: We're number one, went the thinking, and we don't have to do anything to stay there.

Pepsi may still be number one in the Middle East, but Coke is satisfied with the outcome of the battle so far. After having been pushed out of the market by the three-decade-old boycott of a range of American products in parts of the Middle East, Coke has been re-entering key markets in the region since the early 1990s. Within a decade, Coke has reclaimed a third of the entire market from Pepsi.

What is surprising is not the fact that Coke won significant market share, but how quickly - and to what extent - Pepsi lost its own share of the market. Coke officials openly admit that they have been surprised by their performance. "If you take the largest markets, like Saudi Arabia where we came back in 1993 and we had an entrenched competitor there," says Bashar al-Kadhi, public affairs director for Coca-Cola Middle East in Bahrain, "that is one of the markets where we have really made inroads. We now have 30 percent of the market and if five years ago we told people that we would have 30 percent of the market, I don't think people would have believed us. We have done it and we are very happy about it." (Independent industry analysts put Coke's share in the kingdom at a more modest 22 percent.)

The Middle East and North African markets currently account for only a small percentage of global sales for both Pepsi and Coke. Coca-Cola sold 3 billion liters in the region last year - barely three percent of its global sales. Overall, the carbonated soft drink market is worth about $7 billion at the retail end.

But what makes the market irresistible for the two giants is its potential. The region's hot weather naturally creates demand for cold drinks. The public consumption of alcohol is extremely limited, if not totally forbidden, in most countries in the region. Thus, on all social occasions, the choice is between fruit juice and carbonated drinks. Another positive factor is the region's youthful population. Twenty-five percent of Saudi Arabia's population is under 20. And it is this segment of the population that accounts for the largest chunk of sales, although Saudi Arabia's current per capita consumption is less than 20 gallons per year, compared with 55 gallons in the United States.

Comeback. It certainly has not been an easy comeback for Coke. The red giant has had to fight Pepsi tooth and nail for a share of the highly competitive Middle East market. Planning regional market strategies has kept the Coke management and sales team - as well as bottlers and partners - on their toes for the better part of the last decade. Coke began by looking at the investment required to re-enter the market and to rebuild its entire infrastructure - bottling plants, distribution network, refrigerated trucks, warehouses and sales teams.

Coke says it has invested nearly $500 million in the region in the last five years; the latest big-ticket item was the $20 million plant opened in Saudi Arabia last year. Coke's al-Kadhi says that putting this infrastructure into place was the priority in Coke's strategy. "First you need the infrastructure in place," he says, "so we have invested heavily in infrastructure. We have built plants, trucks, hired lots of people. That is the main thing: we are willing to invest, and we are willing to put our money where our mouth is."

But you don't gain a share in such a competitive market simply by throwing money at it. Coke has benefited tremendously from strategic mistakes made by Pepsi, both in the over 30 years of monopoly and, more recently, since Coke's comeback. Pepsi had nearly three decades in which it had the entire market to itself, and it could have developed extremely strong bonds with all the players in the market - the bottlers, wholesalers, dealers and restaurants - in order to ensure that when Coke came back into the market, it would have had trouble finding suitable partners for its relaunch.

Pepsi's big mistake was adopting a take-it-or-leave-it approach to clients, dictating tough terms to the entire supply chain and giving them little reason to love the company or stick with it. And Pepsi failed to innovate when it was a monopoly. It focused on one thing: volume. As long as consumers were buying and drinking Pepsi, the management appeared to be satisfied. It was left to Coke to introduce novel concepts like installing coolers at retail outlets.

"We have introduced a lot of innovations in the market," says al-Kadhi. "When you went out in this market a few years ago, you could not get cold soft drinks, so we introduced coolers, and the industry has listened. Now everyone is doing it, but we were the first ones to introduce this feature so that you could get a nice cold Coke at your grocer or retailer. Earlier, it was a single-serve market and through the PET bottles, we introduced a whole new segment, which is the family size." Of course, Pepsi was quick to imitate Coke and aggressively launched its own coolers and PET bottles in the market which have become very popular in the Middle East.

But it was not just the end users that benefited from Coke's innovations. Coke's direct clients - fast-food outlets, grocers, dealers and restaurants - benefited most according to the company. These clients are important links in the supply chain and need to be handled with kid gloves since they can have an enormous influence on sales. However, in its monopoly days, Pepsi again chose to adopt a tough stance with them, refusing even basic facilities like credit for their purchases - a standard industry practice.

When Coke came in, it focused on building these relationships. "Our other focus has been customer service and here we are talking about restaurants and fast-food chains," says al-Kadhi. "We have been very successful with them. We have really come in and talked to them to find out what they wanted and we are trying to implement what the industry wants."
Pepsi, however, denies that it ignored the clients. "These claims are totally unfounded," states one Pepsi official. "We have always recognized the importance of partnerships with QSRs [quick serve restaurants] and have always striven to provide them with the best service. The channel is growing at around 20 percent per annum, and Pepsi-Cola has nearly a 70 percent share of the QSR market."

Yet another problem for Pepsi in some key markets is its organizational structure, which often leads to a conflict of interest between bottlers. In Saudi Arabia, five bottlers are run by five separate influential trading companies. While having five big families on your side can be an advantage, it can also turn out to be a major stumbling block, as Pepsi is believed to be discovering now.

Although these five families may all be Pepsi partners, they are competing in several other business sectors, resulting in a lack of trust and team spirit. This divisiveness is hurting Pepsi's interests just as the battle with Coke is heating up. It also means that any Pepsi decision about the Saudi Arabian market involving its bottlers becomes very complicated - Pepsi has to convince all five families before it can move ahead.

Investment. Learning from Pepsi's mistakes, Coke has adopted the formula of dealing with only one bottler in each country. And to further strengthen its relationship, Coke has often invested in the bottling plants by taking a stake in the bottling company. "In the United States and Europe," says al-Kadhi, "we mostly have independent bottlers. Since some of the bottlers did not have experience with soft drinks, we told them we will invest with you as a company. And so we invested in these bottlers to show our commitment and to give our expertise. We invest where it is strategically correct for us to invest."
Pepsi is trying to address its bottling system by encouraging mergers of its various bottlers or by buying them out. It has taken over plants in Egypt and Jordan, and has encouraged the merger of its franchisees in Kuwait and Bahrain. But it still has to tackle the problem in Saudi Arabia and the UAE, where it has three bottlers.

Bottlers in the Middle East are finding their margins squeezed by the cola price wars. In recent months, retail prices in the UAE have been slashed by as much as 10-15 percent in order to prod sales. The two companies are also worried about sales growth, which was in double digits for the last decade but is now beginning to slow down.

Volume. While both Coke and Pepsi seem bent on playing the volume game, unmindful of margins, their bottlers are growing increasingly restless. "The price wars that the two brands are having right through the year have thrown all our forecasts out of joint. It's not one for the weak willed," remarks the chief financial officer at a leading Gulf bottler. "Nearly all bottlers in these markets, irrespective of which side they are on, have made huge investments in adding new capacity, lines and logistics. But the return on investment is taking a much longer duration, which has strained results," the official says.

Coke and Pepsi are plugging on regardless, hoping that their investments pay off in the longer run. Coke has plans to invest another $400-$500 million in the region over the next five years while Pepsi also says it will also invest heavily. "This is a strategy the company intends to pursue as recently demonstrated by a multi-million dollar investment in the business interests, operations and assets of the company's exclusive bottler in Lebanon - Société Moderne Libanaise Pour Le Commerce," says a Pepsi official. "The resultant joint venture is designed to further strengthen and build Pepsi-Cola business in the country and at enhancing and expanding production capacity and sales and distribution capability across the country."

Despite its problems and Coke's rapid comeback, Pepsi still has the edge in the market. Until recently, Coke - which boasts of being the most recognized brand in the world - was, humiliatingly, called "Red Pepsi" in Saudi Arabia. Coke also needs to build its brand and distribution in the markets where Pepsi is entrenched.

Pepsi has another, crucial advantage over Coke: its global strategy. Over the last few years, Pepsi has been moving from being a mere carbonated drinks manufacturer to becoming a foods company, though it is trying to extricate itself from the messy business of running restaurants. Pepsi has been buying snack companies all over the world, including the Middle East. "Pepsi has bought Chipsy Snacks in Egypt," says Martin Jerrett, a Middle East specialist at the British beverage research firm Canadean. "They will be doing the same in Saudi Arabia. They are not investing too much money in fighting the invasion by Coke, but focusing more on developing their business."

Coke, by contrast, is still struggling with its own diversification strategy. Its attempt to buy Orangina, a European soft drink company, was terminated by market regulators, and its merger with Cadbury Schweppes is yet to be consummated. But Coke says its strategy is clear. "We are well on the way to becoming a total beverage company," says al-Kadhi. "You can wake up in the morning and drink a Coca-Cola brand and then at lunchtime have a Coca-Cola product and then in the evening have some of the adult drinks. With the Schweppes brands coming in our portfolio, you can have that as well. We are coming in with innovations there and not just with carbonated drinks. Over the next two to three years, you will see some innovative products in the juice market and the water market. Basically, anywhere there is a non-alcoholic soft drink, we hope to be there."

The next few years will prove crucial for both Coke and Pepsi in the Middle East. Coke has the disadvantage of having to struggle just to gain parity. But while Pepsi has rested on its laurels, Coke appears to relish the fight with its rival. Accustomed to being number one, Coke finds itself positioned as the region's scrappy underdog. And, at least for now, that's just fine with them.