The decision by the Pepsi Bottling Group to drop Cadbury-Schweppes' products from its portfolio was the latest confirmation to Cadbury boss John Sunderland that the company's US distribution set-up needed a radical overhaul. He spoke to David Robertson about the challenge ahead. 

Pepsi and Coca-Cola have been working for years to consolidate their complex and incestuous distribution networks in North America and now Cadbury Schweppes is fighting to do the same.

For Pepsi and Coke, improving North American distribution has been a necessecity, and occasionally an obsession, over the past 20 years, but for Cadbury Schweppes - the third-placed producer with brands such as Dr Pepper, 7UP and A&W root beer - it could be a matter of survival.

As the Coke and then Pepsi brands grew in the early days, they encouraged local franchisees to set up bottling factories to service particular locations. These franchisees were given the freedom to control local marketing, sales and distribution. But as the brands became bigger the disparate strategies being followed by dozens of bottlers across the country became a problem.

For the bottlers the relationship with their suppliers was also tense. They were often prevented from bottling for other companies, were not given enough support in their local marketing or, conversely, there was too much interference from the marketing departments of the suppliers. And the price of the syrup used to make the end product kept rising, unfairly many claimed.

The disputes were bad for everybody, particularly Coke, which seemed to suffer most. As a result there has been substantial reorganisation of the red (Coke) and blue (Pepsi) distribution systems starting with Coke in 1986. Coke began merging its bottlers to form Coca-Cola Enterprises in which it owned 51%, although that has since dropped to 38%.

The disputes continued until last year when both parties signed an agreement to produce joint business development plans. Chief operating officer Brian Dyson admitted last year that the problems had "not been our finest hour. We had become so arrogant as a system."

PepsiCo divested its major bottler, the Pepsi Bottling Group, in 1999 but still maintains a 40% stake. Pespi and Coke both now have coherent, certainly in a historical context, distribution systems.

But Cadbury Schweppes is only just starting down this consolidation path. It currently puts 20% of its business through the red stream, 30% through blue and 50% through independents, called the white stream. Not surprisingly Cadbury Schweppes is uncomfortable with this arrangement as it effectively allows competitors to manage its distribution.

As an example 7UP, the Cadbury Schweppes brand, will leave the Pepsi Bottling Group in the US at the end of this year because Pepsi is increasing promotion of its own lemonade, Sierra Mist and does not want to be working with a rival.

Cadbury Schweppes is also suing Pepsi, alleging that the US company tried to prevent it distributing products through Tricon restaurants (KFC, Pizza Hut and Taco Bell). Tricon is a former Pepsico subsidiary.

Conversely the red stream is more than happy to have Dr Pepper in its stable as it does not clash with any of Coke's existing brands. But allowing a successful product to be sold by a company 38% owned by your main competitor is effectively putting money in his pocket.

Cadbury Schweppes chief executive John Sunderland has decided that he has to do something about the situation. North American beverages are vitally important to the group, producing 58% of total profits and Sunderland has decided that the only viable thing to do is to develop the third way - the white stream.

The company bought into a series of bottlers and encouraged them to merge creating the Dr Pepper/7UP Bottling Group through which it puts half of its white stream business. When 7UP leaves PBG it will join this company, which is 40% owned by Cadbury Schweppes, and brands are likely to join in the future.

"A number or our brands are in the other systems and are being distributed through what is effectively a competitor," Sunderland told just-drinks. "We have had to protect our distribution and that decision [to sue Pepsi] was not taken lightly.

"We will take business out of Pepsi and it will come into the independent channel."

Sunderland added that he wanted to push as much distribution as possible through white to build a realistic alternative to red and blue which could mean angering Coke by pulling Dr Pepper out of the red stream.

But until white consolidates further, a process Cadburys will continue to drive, it will be exposed to one off hits like the bankruptcy of Portland Bottling earlier this year. For a couple of months residents of the north west USA were left without Cadbury Schweppes' brands until Columbia, another independent, came to the rescue.

There is also a financial cost and in the first half of this year the problems with Pepsi reduced volumes by 1%. Like for like sales were down 0.6% although overall sales rose by 6% to £852m.

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Analysts on Wall Street spoke to just-drinks about how the importance of North America to Cadbury Schweppes makes it the defining issue for the company.

While developing the white channel makes obvious sense for Cadbury Schweppes it also has its dangers. The cross-distribution system gave Cadbury Schweppes' brands a degree of protection within the red or blue organisations - on their own they will be fair game for the two biggest soft-drinks groups in the world.

Cadbury Schweppes will not only take some pain in the short term shifting into the white stream but it will also face a huge long-term battle to survive as the third-placed producer in a savage market.