Management External Analysis

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SOFT DRINKS AND BOTTLED WATER

Producers in this industry supply the world's sodas, bottled waters, and other prepared nonalcoholic beverages.

Industry snapshot

The global soft drinks industry is almost exclusively a marketing phenomenon. The

actual product is a comparatively simple blend of water, sweeteners, flavors, and other

additives. The industry's genius lies in convincing billions of consumers to drink soft drinks

instead of plain water or other beverages. Through its vast annual investments in

advertising and marketing, the industry has garnered some of the highest brand

recognition in the world along with spectacular sales. However, in the 2010s carbonated

soft drinks have faced increased competition as bottled water (often flavored or with special

ingredients added) and noncarbonated drinks continued to gain market share. In addition,

amid concern about sugary drinks and weight gain, the consumption of soda has lessened.

The two big industry leaders, Coca-Cola and Pepsi, showed a slight loss of market share in

2013. The United States boasted the highest world consumption of soft drinks.

Increased prices and increasing consumer interest in noncarbonated choices were

expected to offset declining carbonated drink sales to push industry revenues to more than

US$511 billion by 2014, according to Research and Markets. Global volume sales were

expected to reach 465.4 billion liters by 2014. Carbonated beverages were the largest single

segment, making up 42.5 percent of the market in terms of value. North America and Latin

America accounted for nearly 44 percent of worldwide sales of soft drink sales.

While soft drinks are enjoyed in virtually every nation on earth, most of the major

markets, including North America, Europe, and Japan, were considered mature, meaning

that per capita consumption was expected to rise slowly, if at all.

By the early 2010s, the traditional concept of equating soft drinks primarily with

carbonated beverages, particularly colas, had begun to include a much broader array of

choices that reflected the growing popularity of other ready-to-drink (RTD) beverages, such

as teas, coffees, herbal beverages, juices, and sports, and energy drinks. For example,

between 2007 and 2012 both Brisk and Starbucks RTD choices had become billion-dollar

brands for PepsiCo. In the second quarter of 2012 alone, Coca-Cola increased its RTD sales

13 percent, focusing on such brands as Gold Peak and Honest Tea, which it sold in North

America; Ayataka green tea, marketed in Japan; and Fuze Tea, which was launched in

Latin America during the quarter.

Organization and Structure

Soft drink manufacturing is remarkably similar worldwide. Soft drink companies

manufacture and sell beverage syrups and bases to bottling operations, a growing

proportion of which are owned by the soft drink manufacturers themselves. The bottling

operations add sweeteners and carbonated water to produce the final product and

distribute it, usually in specific territories assigned by the soft drink manufacturers.

Global soft drink manufacturers usually develop local bottling operations in the

countries in which they operate. They license bottlers to sell their products or buy local

bottlers outright. While they might import ingredients, bottling is done locally. By the early

2010s, PepsiCo and Coca-Cola had company-owned franchised bottling plants that

produced their respective brands in more than 120 countries. Some soft drinks, including

mineral waters like Perrier, have distinct qualities that cannot be reproduced in local

markets and are exported in bottled form to foreign markets.

In the bottling operation, incoming water is cleaned and clarified. Carbon dioxide

gas, which provides effervescence, is supplied to bottlers either in solid form (dry ice) or

under pressure in liquid form. To create a finished product, the flavoring syrup is diluted

with water and then cooled, carbonated, and bottled. The bottling process is highly

automated, as is the washing of returnable bottles.

Soft drink consumption varies widely by region and by culture. As a result,

consumption does not necessarily coincide closely with population or economic development.

For example, combined sales of Coca-Cola Co. products in Germany, Great Britain, Spain,

Italy, France, and the Benelux countries (Belgium, the Netherlands, and Luxembourg),

which are some of the most highly developed economies in the world, were matched by sales

in Mexico and Brazil, despite their developing economies.

Soft drinks are available around the world in two forms: packaged and fountain

service. In the latter, soft drinks are dispensed into cups. Fountain drinks had become a

major push in many convenience stores where low cost and variety attracted customers. In

2009 Coca-Cola introduced its "Freestyle" self-serve fountain beverage dispenser that

boasted more than 100 different flavor choices. The machines offered consumers the

opportunity to create customized flavors, such as Coke Zero with raspberry flavoring or

Barq's vanilla with the touch of a button on the machine's touch pad. In September 2011,

the machines were placed in all company-owned U.S. Five Guys locations, and Burger King

followed suit two months later, according to information from the Coca-Cola website. By

2012 there were 1,500 machines in U.S. Burger King locations.

Background and Development

The term soft drink was coined to distinguish flavored drinks from hard liquor. Soft

drinks are nonalcoholic beverages, carbonated or uncarbonated, containing a natural or

artificial sweetening agent, natural or artificial flavors, and other ingredients. Coffee, tea,

milk, cocoa, and undiluted fruit and vegetable juices are not usually classified as soft

drinks. Soft drinks were originally designed to substitute for liquor in an effort to reduce

alcohol consumption.

Soft drinks first appeared in seventeenth-century Europe as a mixture of water and

lemon juice sweetened with honey. In 1676 Paris-based Compagnie de Limonadiers was

founded and granted a monopoly by the French monarchy. Company vendors dispensed

cups of lemonade from tank packs on their backs. The first carbonated beverages, which

also debuted in Europe, were inspired by the popularity of effervescent water from natural

springs, which were widely thought to have medicinal value.

Joseph Priestley, called the father of the soft drinks industry by some, experimented

with carbon dioxide gas from brewery fermenting vats. In 1772 he invented a small

carbonating apparatus in London that pumped carbon dioxide into water. Mineral salts and

flavors were later added as the appeal of soft drinks spread.

In 1886 John Pemberton, an Atlanta, Georgia, pharmacist, invented Coca-Cola, the

first cola drink. In the nineteenth century, soft drinks were only sold in outlets that could

provide fountain service, but when bottling machinery was invented in the 1890s in the

United States, soft drinks could be distributed to other retail outlets. By the beginning of

the twentieth century, sales of Coca-Cola were booming throughout the United States as a

network of bottlers developed. This type of distribution system then began to be used by

other manufacturers and in other countries.

The consumption of soft drinks continued to expand worldwide throughout the

twentieth century, as rising disposable incomes in industrialized countries allowed more

consumers the luxury of drinking beverages other than water. During the 1960s, low-

calorie soft drinks using artificial sweeteners became popular with consumers concerned

about the excess calories in sugar. These diet soft drinks were first sweetened with

cyclamates (later banned after being deemed carcinogenic), then saccharine, and then

aspartame (NutraSweet), a more natural-tasting artificial sweetener. During this time,

Gatorade, a sports soft drink designed to replace fluids lost during exercise, was developed

at the University of Florida. It quickly gained popularity and attracted competitors in the

late 1980s and early 1990s. In the early 1990s, so-called New Age beverages, such as ready-

to-drink teas and coffees, trendy fruit juice combinations, and flavored waters, became

popular in the United States and soon were gaining ground in other countries.

While markets with high per capita consumption of soft drinks like those in the

United States, Mexico, and Canada produced the highest sales volume for soft drink

manufacturers, in the late 1990s manufacturers were working to develop franchises in low

per capita consumption markets. Many of these markets, such as Eastern Europe, Russia,

and China, had been closed to competition for decades but invited expansion from soft drink

manufacturers as their economies became liberalized. India and Vietnam were liberalizing

their economies in the mid- to late 1990s as well, and soft drink makers moved quickly to

take advantage of the situation. South Africa, long closed to Western investment during the

apartheid era, was reopened in the mid-1990s and attracted high-profile soft drink

investors. With growing international trade and falling trade barriers, very few countries

remained closed to the largest multinational beverage companies in the mid-1990s. By the

early years of the first decade of the twenty-first century, Coca-Cola was doing business in

almost every country in the world.

Moving Away from Traditional Colas.

Consumers in the first decade of the twenty-first century sought to increase health

awareness, and this led to a declining demand for traditional colas. Although Coca-Cola and

Pepsi-Cola remained the top carbonated sodas in 2004, each dropped in popularity between

1998 and the early years of the first decade of the twenty-first century, when consumers

began demanding healthier beverages, or those perceived as healthier, such as diet colas,

fortified fruit juices, bottled waters, sports-related formulations, energy drinks, and iced

teas.

By the early years of the first decade of the twenty-first century, physicians had

begun to recognize obesity as a significant public health threat throughout both the

developed world and developing countries. Although many factors are involved in the

development of obesity, one significant contributor is the consumption of high-calorie foods

and drinks. In addition to the consumption of sugar-sweetened soft drinks being closely

associated with obesity, studies have shown a connection between type 2 diabetes, dental

cavities, and low nutrient levels. Regular sodas use high-fructose corn syrup (HFCS), which

has come under attack from the health industry as a leading cause of childhood obesity.

Artificial sweeteners continued to be controversial. Other ingredients of concern in sodas

are caffeine, which is linked to anxiety and insomnia, and sodium benzoate, which has a

potential link to DNA damage and hyperactivity.

Current industry conditions

Although no one was ready to call for the total elimination of carbonated soft drinks,

in the 2010s consumption trends were definitely shifting in major markets like the United

States and the United Kingdom. As Americans became more health conscious, sales of

carbonated soft drinks waned and sales of bottled water, juice, and other liquid refreshment

beverages increased. The consumption rate of carbonated soft drinks (CSD) continued its

decline in 2013, which had been the trend since 2005. The entire liquid refreshment

beverage (LRB) market grew 1.0 percent in the United States in 2012, which showed

growth for the third year in a row after two years of decline. Energy drinks and RTD coffee

were the biggest winners in 2012, increasing volume sales 14.3 percent and 9.5 percent in

2012, respectively.

In the United States, bottled water sales amounted to US$11.8 billion in 2012, with

Americans drinking 30.8 gallons a year, on average, according to an April 25, 2013, report

by the International Bottled Water Association. The same article also quoted Gary

Hemphill, managing director, information services with the Beverage Marketing

Corporation, who noted that "All signs point to U.S. consumers' already displayed thirst for

bottled water continuing in the years ahead. Changes in per capita consumption indicate

persistent interest in a product that consumers embrace as a healthful alternative to other

beverages."

Nestlé Waters America had a 22 percent share of the U.S. bottled water market,

which included Pure Life and Poland Spring. PepsiCo's Aquafina brand and Coca-Cola's

Dasani, along with Poland Spring, were among the top 10 trademarks for the LRB sector of

the U.S. beverage industry.

Sports drinks had a good showing in 2012 with a 2.3 percent increase in volume over

the previous year. Gatorade led the way with 46 percent of the global market for sports

drinks in 2012 and posted sales of US$3.3 billion. In 2012 the sector was valued at US$12.5

billion, according to information in a February 10, 2013, PRWeb report. According to a July

26, 2013, report in MediaPost News, sports drinks had sales of US$6.94 billion in the

United States. The sports drink market grew by 25 percent over the previous five years.

Sales of energy drinks and shots were expected to have grown by 60 percent from 2008 to

2012 and were forecasted to reach US$21.5 billion by 2017.

Energy drink industry giant Monster energy drink showed US$519.4 million in net

sales and had a market share of 37.5 percent as of Q3 2013, ahead of Red Bull with 29

percent. Rockstar, another energy drink company, trailed both at 10.1 percent, according to

a January 16, 2014, article by Ben Boukley at Beveragedaily.com.

In November 2013, PepsiCo announced that it would discontinue its line of "natural"

Gatorade, selling under the names of Gatorade Naturals and G2 Naturals. This brand had

limited distribution through the U.S. grocery retailers Whole Foods and Kroger's, but the

core market of athletes failed to embrace the products, according to a January 16, 2014,

article by Candace Choi in Bloomberg Businessweek.

Coke, Pepsi, Mt. Dew, and Dr Pepper ranked as the leading liquid beverage brands

in 2012 with carbonated soft drink (CSD) market shares of 42 percent, 28.1 percent, 6.8

percent, and 6.5 percent, respectively. These soft drinks were followed by fifth-place

Gatorade and sixth-place Sprite with 4.1 percent and 3.7 percent, respectively. Beverages

Nestlé Pure Life, Dasani, and Aquafina took the seven through nine slots, and tea maker

AriZona rounded out the top 10 megabrands in the liquid beverage category. In the more

limited carbonated beverage category, Coke again took top place in 2012 with a 17 percent

share. In 2012 Diet Coke moved into second place with 9.4 percent, followed by Pepsi with

8.9 percent of the CSD share. Mt. Dew, Dr Pepper, and Sprite followed with market shares

of 6.8 percent, 6.5 percent, and 5.7 percent, respectively. Diet Pepsi, Diet Mt. Dew, Fanta,

and Diet Dr Pepper completed the top 10.

Industry research and technology

Facing lagging sales due to health concerns, soda manufacturers began

experimenting with natural sweeteners such as honey and stevia. In 2014 Coke engaged

Pure Circle to produce a stevia-based sweetener called Reb-X. Meanwhile, Pepsi was

formulating a sweetener called X617, which would reduce the calories in its products as

well as the amount of high-fructose corn syrup used, according to a January 29, 2014,

article posted on the Euromonitor blog.

One of the most notable trends in 2013 was the rise in popularity of appliances that

allowed consumers to create soda at home using tap water, carbon dioxide cartridges, and

flavorings. In 2012 Americans bought more than 1.2 million home carbonators, such as

SodaSparkle and SodaStream, and one of the appealing attributes of these machines is the

fact that they do not contribute to the proliferation of disposable plastic bottles, which end

up in landfills, according to a New York Times article by Julia Moskin on February 26,

2013.

Industry leaders

The Coca-Cola Company.

The Coca-Cola Company has been a virtually unstoppable marketing machine for

decades. In the 2010s, Coca-Cola was the number-one nonalcoholic beverage company in

the world. Coca-Cola's dominance of the international market has its roots in World War II,

when the company underwent a vast expansion to supply U.S. soldiers in Europe and Asia

with soft drinks.

Coca-Cola owned four of the top five branded colas: Coke, Diet Coke, Sprite, and

Fanta. As of 2013, Coca-Cola had over 500 brands, which saw sales of US$48.02

billion. Forbes ranked the company as the world's third most valuable brand.

PepsiCo Inc.

Pepsi-Cola was created in 1898 in New Bern, North Carolina, by druggist Caleb D.

Bradham, who claimed it cured dyspepsia (indigestion). The Pepsi-Cola Co. grew

throughout the twentieth century and in 1963 acquired Frito-Lay, the largest U.S. snack

foods company. The company changed its name to PepsiCo Inc.

PepsiCo is the second-largest global food and beverage company and in 2013 it saw

US$65 billion in revenue, of which 50 percent came from foreign markets. PepsiCo has 22

brands, which produce revenue in excess of US$1 billion. Those brands include Pepsi,

Gatorade, Tropicana, Aquafina, Quaker Oats, and Frito Lay. The increase in the middle

class in emerging and developing markets accounted for 35 percent of sales, according to a

June 14, 2013, article in Forbes by Andrew Goodman.

Dr Pepper Snapple Group.

The Dr Pepper Snapple group was the number-three company with 16 percent of the

U.S. soft drink market share, behind Coca-Cola with 40 percent and PepsiCo with 30

percent. The group owns over 50 brands that include Sunkist, A&W, 7-Up, Snapple, Dr

Pepper, Nantucket Nectars, Country Time, Mott's, and Déjà Blue. "In addition, about 75

percent of the company's volume was generated from brands that were either number one

or number two in their category, with 6 of the top 10 non-cola soft drinks under its

corporate umbrella," according to an October 25, 2013, article by Chuck Carnevale

in Forbes.

As of 2013, the company had an 11 percent share in the U.S. LRB market. In 2014

the company'Mott' brand launched a new line of juices, called Fruit Punch Rush, Wild

Grape Surge, and Strawberry Boom, which had no artificial sweeteners, 40 percent less

sugar than traditional fruit juices, and 100 percent of the recommended daily allowance of

vitamin C. They were being marketed as a healthier option for children.

Cott Corp.

The Canadian-based Cott Corp. produced a wide variety of private-label beverages

for brand owners, distributors, and retailers. In addition to CSDs, the company produced

most types of LRBs, including teas and juices as well as sports and energy drinks along

with an assortment of water products. Cott supplied or marketed more than 500 brands.

According to information on the Cott website, the Q3 2013 results showed revenue of

US$543 million, which reflected a 7 percent decline from the previous year. Total volume

sales decreased from 225 million cases to 208 million cases amid a market decline in overall

CSD sales in North America. The U.K./European markets, however, reported a 14 percent

increase in revenue with volume rising from 51 million cases to 56 million cases. Mexico's

revenue fell by 23 percent and volume decreased from 6 million cases to 5 million cases.

AriZona Tea Company.

Introduced in 1992, AriZona Tea Company reported remarkable success competing

against RTD teas from established brands like Lipton and Nestea. A small, family-owned

company founded in 1971, Ferolito, Vultaggio & Sons established itself as a distributor of

beer products in New York City. By 1986 the company had introduced its first product,

Midnight Dragon Malt Liquor. This was followed by Crazy Horse Malt Liquor, which in

1992 sold more than 1 million cases. In 1992 the company entered the RTD iced tea market

with AriZona Iced Tea. As with Crazy Horse, the product was distinguished by innovative

and award-winning packaging, using 24-ounce single-serve containers with the bright hues

and graphics of the U.S. Southwest culture.

As of 2013, AriZona Tea was the number-one RTD tea. The company also sold

products other than tea, which included new offerings such as Skinnygirl, a sparkling water

flavored with fruit juice, and SODA SHAQ, a vanilla-flavored CSD named after basketball

star Shaquille O'Neal. There were two drinks named after professional golfers: the Arnold

Palmer Drive was a combination of coconut water and three types of teas, and Golden Bear

Pink Lemonade was named for Jack Nicklaus.

Major countries in the industry

The United States.

The U.S. soft drink industry was the largest in the world both in terms of sales and

consumption. In 2012 the U.S. comprised 46.4 percent of the market with US$152.9 billion

in revenue and was projected to have a market value of US$180.3 billion in 2016, according

to a November 12, 2013, article published by PRWeb. In 2013 Americans consumed a yearly

average of 44 gallons of soda. Health concerns also drove the industry into new avenues.

"For the United States, Euromonitor identified coconut water, tea pods, Fiji Water's

packaging, half-tea half-lemonade drinks, and SodaStream's national attention as trends,"

of 2013, according to a January 15, 2014, article by Jessica Jacobsen inBeverage

Industry. The same article noted that while coconut water had been popular in Southeast

Asia and Brazil for some time, the novel product caught U.S. consumers' interest due to its

more healthful nature and "being a good source of electrolytes and potassium and its low

number of calories." Tea pods, while still a tiny portion of the market, were expected to see

the most growth among the hot drinks sector, and some were even made specifically for

making iced tea.

Diet soft drinks saw a 7 percent decline in sales in 2013 as consumers became

concerned that the low- or no-calorie options could actually lead to weight gain and the

possible link to Type 2 diabetes and stroke. The market was forecast to contract by 20

percent through 2020. The backlash against artificial sweeteners such as aspartame led to

experimental marketing of more natural sweeteners such as stevia and monkfruit.

As of 2013, Coca-Cola had 45 products that included stevia as an ingredient, which

were sold in 15 countries, and the company also produced a low-calorie product called Coke

Life that was marketed in Argentina and Chile. PepsiCo also had a stevia-sweetened

product called PepsiNEXT that was sold in France and Australia. Zevia, a California-based

premium-brand company, launched a calorie-free soda that was sweetened with both stevia

and monkfruit, which tasted fruitier than stevia alone, according to a December 22, 2013,

Reuters article by Marina Lopes.

The fastest-growing category in terms of volume in the United States was energy

drinks. In 2011 the market grew by 12 percent and by 11 percent in 2012 to reach revenue

of roughly US$16 billion. Monster Beverage Company, Red Bull, and Rockstar accounted

for over 90 percent of the market share of energy drinks. The sports drinks market was led

by Gatorade and G2, both owned by PepsiCo, and had a combined share of 75 percent.

Powerade, owned by Coca-Cola, had 20 percent of the market. The combined energy and

sports drink market was forecast to grow by 17 percent from 2012 to 2017, with

expectations that it would hit 8.5 billion liters and create US$20 billion in annual sales,

according to a December 13, 2013, article in Forbes.

Although energy drinks grew in popularity, bottled water was the second-leading

beverage among U.S. consumers behind carbonated soft drinks. In 2012 the bottled water

market was worth US$11.8 billion, which reflected a 6.7 percent increase. From 2007 to

2012, bottled water consumption per capita was up by 10 percent to 30.64 gallons. Leading

market brands included Nestea's Pure Life, Coca-Cola's Dasani, and PepsiCo's Aquafina.

Mexico.

In the early 2010s, Mexico was the world's number-two soft drink market by volume

but the world's leading market by per capita consumption. Mexico's more than 90 million

people annually consumed 163 liters (43 gallons) of carbonated soft drinks per year,

compared to 118 liters (31 gallons) per capita in the United States. As with other North

American markets, Mexico began to see significant growth in sales of juices and bottled

water through the first decade of the twenty-first century. Bottled water accounted for

about 45 percent of nonalcoholic beverage sales in Mexico.

With obesity rates in Mexico surpassing those in America, with nearly 70 percent

being considered overweight and roughly a third considered obese, lawmakers in 2013

levied a 12 percent, or 1 peso per liter, tax on sugary drinks and an 8 percent tax on junk

food. Such taxes had already been imposed by other Latin American and European

countries. Other nations were expected to follow suit, according to an October 31, 2013,

Reuters article by Elinor Comlay.

Coca-Cola dominated the market in Mexico, accounting for roughly three-fourths of

it, followed by PepsiCo. The company reported US$48 billion in revenue for 2012. Coca-Cola

Fomento Económico Mexicano, S.A.B. de C.V. (FEMSA) was the largest franchised bottler,

producing over 4 billion cases annually. FEMSA distributed Coca-Cola products in Mexico,

Central America, South America and the Philippines.

The Middle East.

Coca-Cola has had a presence in Egypt, its largest in the Arab world, since 1942 and

was the headquarters for the North and West Africa Business Unit as of 2013. The

beverage giant had nine bottling operations in that country and employed 12,000 people.

The company opened a Moroccan concern in 1947. Although Coca-Cola was boycotted by the

Arab League from 1968 to 1991, that did not put a damper on the demand by consumers for

the product, according to an April 29, 2013, article by Kristin Wagner on

Yourmiddleeast.com. The expanding middle class and increased urbanization were key to

their continued growth.

PespsiCo was also involved in emerging markets. According to a September 4, 2013,

article by Nat Rudarakanchana in International Business Times, PepsiCo saw a 14 percent

increase in revenue from the Middle East, Africa, and Asia in Q2 2013.