A New Formula For Success

Muhammad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Most business experts generally regard Coca-Cola's introduction of the so-called "New Coke" in 1985 as one of the biggest disasters in marketing history.  The Coca-Cola Company (NYSE: KO) decided to change its formula for its flagship carbonated soft drink "Coke" in 1985 because it felt that it needed to do something to stay competitive with its archrival Pepsi, which had a somewhat sweeter flavor.  The company pressed ahead with the change when double-blind pre-market testing showed that consumers preferred the sweeter taste of "New Coke" over both Pepsi and what later came to be known as "Classic Coke."

But when The Coca-Cola Company rolled out the New Coke for consumers, the product was immediately and overwhelmingly rejected.  American consumers brought their wrath upon the Coca-Cola Company, flooding the corporation with complaints and outright expressions of hatred toward New Coke and the company's management. It was an unrelenting national tidal wave against the company for weeks until they backed down just 79 days after announcing the new product.  Coca-Cola slashed production of 'New Coke" and re-introduced the old formula as "Classic Coke". The company called off a plan to stop production of "Classic Coke" throughout the world and replace it with the New Coke.  The Coca-Cola Company had failed to take into account that their product was an American icon—a symbol of national prosperity and way of life that connected them with generations of previous American Coke drinkers—and that consumers regarded any changes to Coke as an attack on the American way of life, even if they hadn't tried the New Coke. 

The company learned an important lesson that served well to warn many other businesses throughout the world:  if you produce an iconic product, beware of alienating consumers with any changes or you may be regarded as an enemy of your own product or worse.  American consumers essentially said to them, "The Coca-Cola Company betrayed Coke.  The Coca-Cola Company betrayed America."

So did Pepsi really just announce that it was changing the formula of Diet Pepsi?  Have they learned nothing from their chief rival's monumental blunder over 25 years ago?

On Monday, August 27th, two unidentified bottlers of Pepsi-Cola beverages leaked to the press that PepsiCo (NYSE: PEP), the maker of the beverage, had informed all bottlers that the company would be making a change to the basic formula of Diet Pepsi.  The company has prohibited the bottlers and all employees and other people associated with the brand from discussing the proposed change.  Everyone would agree that Diet Pepsi is now an American iconic product—the go-to drink for anyone who wants to watch their weight but doesn't want to give up cola-flavored products.  The questions for PEP on the lips of everyone is now, "Why?  Given Coca-Cola's experience with New Coke, are you people nuts?" 

The beverage maker initially denied that it was making any changes to its formula, but admitted later in the week that it was, indeed, making some changes that, it claimed, would not affect the taste of Diet Pepsi.  Beverage industry insiders said that the changes Pepsi is considering involve using sweeteners other than the current aspartame.  Apparently, the company has found that the chemical breaks down quickly both in heat and when the liquid is significantly disturbed during transportation.  PEP is looking at replacing the aspartame with acesulfame-potassium (also known as "ace-K")—a Food and Drug Administration-approved sweetener used in a wide variety of foods—or a combination of ace-K with other sweeteners as that sweetener is more chemically stable than aspartame. 

Although PEP claims that the change will have no effect on Diet Pepsi's familiar taste, beverage market analysts seem to be in agreement that it is almost impossible to make such a radical change in the drink without having at least some effect on its taste.  They point out that PEP is failing to take into consideration a major factor that Coca-Cola admittedly ignored when it introduced New Coke and walked into its marketing disaster:  Do consumers actually prefer the old "inferior" product, degraded aspartame and all, over some new "improved" version with a different sweetener that lasts longer?  PEP is betting that there will be no change in taste—or that consumers won't care if there is.

But, again, why?  Diet Pepsi is, after all, an iconic product associated with living the good life while trying to make sure you preserve your health, good looks and youth.  In other words, it's a "you-really-can-have-it-all" product.  Why mess around with what's already working?  Consumers apparently have not been contacting the company to find out why the aspartame has degraded in the can or bottle; in fact, they probably never even noticed this problem.

PEP's problem with Diet Pepsi is that the brand has fallen to become only the seventh leading soda in the United States and PEP's soda division is probably the most important unit in the company, with over $20 billion in worldwide sales for the most recently ended quarter.  But that figure was down 5% from the same period last year.  PEP felt that it had to do something.

A healthy PEP is crucial for many other companies, especially those in the restaurant and beverage industries.  This spring, for example, PEP signed agreements with the Applebee’s and IHOP restaurant chains by which those chains will exclusively sell PEP beverage products in all of their restaurants.  Applebee’s Neighborhood Grill and Bars have almost 1,900 locations throughout the U.S., while IHOP (International House of Pancakes) operates a little over 1,500 locations in the United States and three other countries.  Both the IHOP and Applebee’s chains are owned and operated by DineEquity, Inc.  (NYSE:  DIN).

For the PEP investor, the implications of this change will probably not pan out until, at the earliest, the start of 2013.  The company has announced that it will not make any changes in its formula until the New Year.  As can be noted in the chart below, PEP's stock price has shown steady progress upward during the past 120 days, with a slight glitch downward in recent days after the possible changes to the Diet Pepsi formula came to light. 

<img src="/media/images/user_13010/pep_large.jpg" />

Barring any unforeseen news on Diet Pepsi or any other of PEP's brands, I don't expect any changes, beyond minor adjustments, to the PEP stock price remaining in the $72 to $75 range.  However, when PEP makes a change to its formula—if it makes a change to its formula—then expect a major adjustment to both the value of PEP stock and its expected earnings.  We just don't know what that change will be, whether up or down, and that determination is probably beyond determination by any market analyst. 

Instead, the typical investor in PEP should be able to make that determination on their own.  When you hear that the new Diet Pepsi has been released, run down to the nearest store, buy a can of the new stuff, and drink it.  If it tastes like the old Diet Pepsi, you may want to consider increasing your position in the stock. 

If it tastes different, however, you'll want to get out of the stock as soon as possible—you'll probably have to move fast to beat out everybody else in the rush to sell.  And before you leave the store, buy a bottle of Coke to take home with you.  You may need it to calm your nerves. 


muhammadbazil has no positions in the stocks mentioned above. The Motley Fool owns shares of The Coca-Cola Company and PepsiCo. Motley Fool newsletter services recommend PepsiCo and The Coca-Cola Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

blog comments powered by Disqus