Coke, Pepsi battle over bottled water

Pressed by recession, consumers opting for cheaper private labels

Not long ago, Coca-Cola Co. and PepsiCo pulled off a remarkable feat: converting the world’s most plentiful liquid — water — into a product wrapped in brand images, aspirations and marketing hooks.

It was easy to get excited about bottled water three years ago, as sales were rising smartly. The mergers and acquisitions reflected it. In 2007, Coca-Cola Co. plunked down a cool $4.1 billion to buy Glaceau, the maker of Vitaminwater. It was Coca-Cola’s largest purchase ever.

Things are much less exciting now for Coca-Cola and PepsiCo. The old rivals are now locked in a similar predicament. As a recession and economic uncertainty have caused shoppers to cut their spending, big bottled water brands have suffered.

Sales of Coca-Cola’s mainstay Dasani brand were down by 22 percent in the first nine months of 2009; PepsiCo’s Aquafina fell 9 percent, according to Beverage Digest.

Meanwhile, the big winner is private label bottled water, up 12 percent. Those waters are cheaper than the offerings from Coca-Cola and Pepsi, and appeal to America’s new sense of frugality.

The appeal of affordability won’t soon go away. Sales of private label water will rise another 10 percent this year, according to Beverage Marketing Corp. As shoppers look to save money, the price gap between branded water and nondescript private labels is proving troublesome for Coca-Cola and PepsiCo, despite their marketing prowess, sales muscle and powerful distribution networks. Analysts speculate that Coca-Cola and PepsiCo will have to change their tactics.

“Big Blue and Big Red are masters of one thing,” said consultant Tom Pirko, using the industry shorthand for Pepsi and Coke. “That is, marketing soft drinks.”

Water presents different challenges. “Here they are with a product that is really anonymous; it’s all image,” Pirko said. “They can no longer provide the ‘oomph’ in consumer demand.”

Coca-Cola, which sells a range of waters, including cheaper Aquarius Spring and more expensive Smartwater and Vitaminwater, doesn’t seem overly worried. CEO Muhtar Kent last month expressed confidence in Vitaminwater despite a sales decline. Except for the fact that the recession has pressured premium brands, “there’s no problem at all” with Vitaminwater, he said.

The bottled-water category in general shrank less dramatically last year than carbonated soft drinks. That is slim consolation for Coke and Pepsi, which have seen bottled water become a drag on their results after a decade of contributing growth.

The question that divides beverage industry insiders is whether bottled water will be a commodity business marked by cutthroat prices, or a category where brands can command premium treatment and shopper loyalty.

Have water brands like Dasani and Aquafina created enough loyalty so that consumers will return to them when the recession recedes? Or will consumers stick with their frugal ways? Shoppers tend to be less loyal to water brands than to their preferred beers or sodas.

“People may have a preferred [water] brand,” said Gary Hemphill, senior vice president of information services at Beverage Marketing Corp. “But if their brand isn’t on the shelves at the supermarket, there aren’t too many consumers who will walk around the block to get their preferred brand.”

Both Dasani and Aquafina are strong brands, said John Sicher, editor of Beverage Digest, yet there’s been a migration to cheaper waters and tap water. To grow Dasani and Aquafina again, Sicher said Coke and Pepsi have to shrink the price gap between their brands and private label water.

To do that, the companies might have to change how to they get their water to stores. Coke’s model of using bottlers to truck 24-packs of water directly to stores is an expensive proposition and makes it hard for the company’s prices to compete with Nestle and private label waters. Changing that distribution model by shipping cases of water to warehouses instead of individual big-box stores might keep Dasani’s prices within striking distance of private label waters.

The new trucking arrangement would have to be worked out between Coke and its bottlers. The company declined to discuss the specifics of potential changes.

“Coke and Pepsi cannot compete with their current business model,” said Bill Pecoriello of Consumer Edge Research, who argued that water is becoming a commodity business.

As retail prices for water continue to drop, the 24-packs of Dasani and Aquafina waters aren’t making money for their parent companies. Coca-Cola and Pepsi will have to decide if they want to get out of that business altogether, Pecoriello said, referring to case-packs of water.

Atlanta-based Coca-Cola Enterprises, the world’s largest bottler of Coca-Cola drinks, put less emphasis on selling case-packs of water last year. It didn’t want to lose money by handling cheap water. “We don’t have a particular interest in driving unprofitable case-pack water,” said CCE chief executive John Brock.

Coca-Cola seems to agree. “We want to make money for our share owners, not just drive volume,” spokesman Ray Crockett said.

Meanwhile, market leader Nestle is armed with a powerhouse national brand, Nestle Pure Life, and a stable of older brands. Connecticut-based Nestle Waters North America saw its sales volume rise 4.5 percent in the first nine months of 2009.

Coca-Cola and Pepsi stumbled when they tried to steal Nestle’s market share by lowering prices, said Gerry Khermouch, editor of Beverage Business Insights. It didn’t work, because Nestle kept pace.

“They’ve got the lowest production costs,” Khermouch said of Nestle Waters. “I think Coke and Pepsi were both shocked that as they went lower on price, Nestle was up to the fight.”

With consumers expected to gravitate towards private label brands in 2010, some industry analysts say it will be a tough year for water brands at Coke and Pepsi. Many buyers, satisfied with store-brand bottled water, may not return to more expensive brands even when the economy improves.

Nearly one in five households are now buying private label bottled water, according to Consumer Edge Research. Among those consumers, more than 60 percent were very satisfied with their purchases. Only private label cereal had a higher rating. Private label water gained 6.8 percentage points of market share since 2007.

There will be a very slow recovery for the brands, said Michael Bellas, chairman of Beverage Marketing Corp. “The consumer is still looking for value.”