Coke Falls Short in New Pepsi Challenge

ATLANTA (TheStreet) -- Coca-Cola(KO), following Pepsi's(PEP) lead, said recently it will buy the North American operations of its biggest bottler, Coca-Cola Enterprises(CCE).

The move may produce as much as $350 million in savings and enable the world's biggest seller of soft drinks to respond more nimbly to changing tastes. Pepsi and Coke have felt weaker demand for carbonated beverages. Expanding beyond sugary offerings will be key to both in coming years.

Coke is the reigning champion in the carbonated-beverage battle, but the war is shifting. As in snack foods, consumers are hungry for healthier fare. While Coke and Pepsi sell alternatives to carbonated beverages, the advantage goes to Pepsi, which has enlarged its product line through innovation and acquisitions. Pepsi offers Gatorade, a favorite of professional sports players and weekend warriors; SoBe teas, marketed toward the Whole Foods(WFMI) and Starbucks(SBUX) set; and Aquafina water, which sponsors film festivals.

Coke has similar products, ranging from Vitamin Water to Minute Maid juices, but the breadth is less impressive. In addition to Pepsi's beverages, the company also owns the Quaker and Frito-Lay brands, adding diversification to food items as well.

Besides Pepsi's food operations, the companies are similar in most respects. Each offers a good deal of international diversification, with nearly half of revenue coming from foreign countries, tapping into faster economic growth in emerging markets. Coke and Pepsi hedge against currency risks.

Both companies also employ similar levels of borrowing, with debt-to-equity ratios of about 0.47. As Coke and Pepsi buy their main bottlers, debt levels will rise, though they have more than enough capacity as they remained profitable through the recession.

The purchase of the bottling plants is a way to "vertically" integrate operations, or own companies along the supply chain, including suppliers and buyers. As consumers shun soft drinks, a company can alter supply more quickly and exploit savings to reduce prices, thus stimulating demand. All that can be done with a negligible effect on profit margins.

The response to changing market conditions signals that both companies are forward-looking, but because Coke is following Pepsi, the once-mighty Coke appears to be at a disadvantage.