In 2006, for the first time in 108 years of head-to-head competition, PepsiCo was worth more (in market cap terms) than The Coca-Cola Company, even though Coke still outsells Pepsi almost 2-to-1.

In 1998, Coca-Cola’s market cap was $US220 billion and the company’s stock price was trading in the high-$80s. Fast forward to 2006, and Coca-Cola’s stock price had plummeted to near the $40 mark. Worse yet, in December 2005, Coke’s market cap for the first time in history fell below that of PepsiCo’s (see note below).

Where did Coke go wrong?

Coke failed to recognise that consumers’ emerging preference for other soft beverages – water, teas, and sports drinks – would fracture demand. Instead, they ridiculed initiatives by rivals to expand into non-carbonated drinks.

As a result, Pepsi’s Aquafina became the No. 1 water brand, with Coke’s Dasani trailing; in sports drinks, Pepsi’s Gatorade owns 80 percent of the market while Coke’s Powerade has 15 percent.

Importantly, Pepsi took an even broader view than other competitors of its core market, expanding into non-beverage markets through the acquisition of Frito-Lay Snacks and Quaker Foods; the former now controls 60 percent of the U.S. snack-food market.

In short, Pepsi didn’t out-compete Coke. It changed the game.

At some point, the Boards of both Coke and Pepsi faced the same question: How much money and attention should be focused on a new, but growing, operation that is far less profitable than the core business?

Both Coke and Pepsi’s business systems were geared to selling soda, which generated enviable margins for more than a century. The profit margins on selling other drinks paled in comparison. Pepsi made the move in response to obvious shifts in consumer demand, and reaped the rewards.

In this case, it wasn’t a technological innovation (i.e. better, fizzier soft drinks) that broad-sided Coke. It was a business model innovation (becoming a “total beverage company”).

There are some important lessons here from which any company can learn. Specifically, established companies are at risk of falling into

the same “competency trap” that Coke did – continuing to invest in their traditional core competency to such a degree that they become unresponsive to the wider market play.

(Note: As at the time of writing, the market cap imbalance appears to have been rectified – PepsiCo’s M/C was $US107.87B compared to Coca-Cola’s $US121.50B. However, this is a little misleading. PepsiCo’s shares closed at $US66.22, compared to Coke’s $US52.60, and PepsiCo had a P/E of 19.50 and Earnings Per Share of $3.40, which is much healthier than Coca-Cola’s, at 23.51 P/E and EPS of $US2.24)