Coca-Cola and PepsiCo Go

For thirty years, until the late 1970s, the cola segment of the soft drink industry went through a golden age in which the main players, Coca-Cola and PepsiCo, were very profitable. These two companies competed against each other by advertising their respective products, Coke and Pepsi, based on abstract lifestyle product attributes. PepsiCo would introduce advertisements showing that it was cool to drink Pepsi, and Coca-Cola would produce advertisements with catchy jingles such as “things go better with Coke.” Neither company competed on price. Coke led the market throughout the period, although by the mid-1970s, Pepsi was closing in. At this point, Pepsi launched a new and innovative strategy: the Pepsi challenge. The Pepsi challenge was a taste test in which customers were blindfolded and asked which drink they preferred, Pepsi or Coke. In the test, about 55% of customers consistently said they preferred Pepsi, a significant result given that Pepsi trailed Coke in market share. Pepsi test-marketed the Pepsi challenge in Dallas, and it was so successful that in the late 1970s, Pepsi rolled out the challenge nationally, a situation that presented a real dilemma for Coke. It could not respond with its own blind taste test because in the tests, the majority of people preferred Pepsi. Moreover, the Pepsi challenge had changed the nature of competition in the industry. After thirty years of competition through product differentiation based on lifestyle product attributes with no direct (and aggressive) product comparisons, Pepsi had shifted to a direct product comparison based on a real attribute of the product: taste. PepsiCo had altered its business model and changed how it chose to differentiate its product from Coke. As Pepsi was now gaining market share, Coca-Cola’s managers decided to make an aggressive response: deep price discounts for Coke in local markets where they controlled the Coke bottler and the local Pepsi bottler was weak. This was a successful move; in markets where price discounting was used, Coke started to gain its share back. PepsiCo then decided to respond in kind and cut prices too. Before long, price discounting was widespread in the industry. Customers were coming to expect price discounting, brand loyalty had been eroded, and the value associated with differentiation had been reduced. Both Coke and Pepsi experienced declining profitability.