Coke's current tribulations would be worrying enough, seeing its bitter rival, PepsiCo, enjoying rather better times adds insult to injury. Chris Brook-Carter reports.

Coke versus Pepsi. Red versus blue. It's a battle that has historically seen Pepsi come off second best. In terms of consumer preference the choice should be black and white, merely a matter of taste. And yet new research suggests the mind has as much of a role to play as the tongue in determining which drink you are going to like the best.

Scientists believe people react differently to brands when they know what they are tasting as opposed to when they taste "blind". And, according to the tests, Coke holds a psychological advantage over Pepsi. The study found a characteristic pattern of brain activity in volunteers who knew they were drinking Coke, but nothing comparable for those who knew their fizzy drink was Pepsi. Pepsi, it appears, has been playing second fiddle to Coke even in our subconscious.

But the perception of Pepsi as the underdog has been undergoing something of a transformation of late, on the stock exchange at least, if not yet in the minds of average cola drinker.

Coca-Cola, beset by problems from the boardroom to the factory floor, has been struggling to convince the market it is anything but a stagnant investment vehicle. Pepsi by comparison has been moving from strength to strength, boosted by a diversified business model that has allowed it to weather downturns in the traditional domestic carbonate market - opportunities the larger and more conservative Coke has been unable to grab.

Around the time Coke released a profit warning earlier this month, Pepsi reported third-quarter results that came in ahead of analysts' estimates. It reported healthy top-line growth of 6% for the quarter, while achieving operating margin expansion - all done despite the tough consumer and cost environment.

Analysts refer to the youth culture which pervades the PepsiCo business and this seems to have driven a successful run of acquisitions and brand development that have expanded PepsiCo's portfolio and given the business the platform for this growth.

While Coca-Cola has struggled to generate growth from a business that heavily relies on the flagship cola, PepsiCo has steadily increased sales of its non-carbonate brands and snack foods, which now account for a large proportion of overall revenues.

Certainly Pepsi has been hit too by the downturn in sales of carbonated soft drinks, a trend driven by an increasingly health conscious public, but in North America, sales of PepsiCo's non-carbonated brands - including Tropicana juice, Aquafina water and Gatorade sports drinks - rose by over 5%.

This growth partially offset a decline in the carbonated category. Overall drinks volumes were still down by 1%, but the higher margins gained from the non-carbonates helped push operating profits from the division up by 8%.

But perhaps the real success story has been Pepsi's international operations, which have offset further the difficult trading in the US beverage market. As one analyst put it: "When you look at Pepsi's performance versus Coke, it is just night and day. Pepsi is getting great growth from international sales, which is a huge opportunity. Coke has already expanded throughout the world.''

It certainly has a growth advantage over Coke on the international scene at present. PepsiCo's international volumes were up by 11%. Pepsi was driven in particular by a strong performance in Asia, where snack sales jumped 14% and beverage revenues by 16%, led by Japan, China and India.

The company said that in Latin America, the launch of the redesigned PET bottle in Mexico and Venezuela contributed to high single-digit regional growth. However, even in the tougher European environment beverage sales were up by 10%.

Overall, volume and favourable mix primarily drove international revenue growth of 11% in the quarter, with positive foreign exchange contributing approximately two percentage points. And year to date, the figures are even better, with revenue growth of 14%, with favourable foreign exchange contributing almost four percentage points of growth.

Most analysts expect the US market to continue to get tougher, as new Coke CEO Neville Isdell ups the temperature of the cola wars by increasing Coke's spending behind its core brands.

But encouragingly for PepsiCo, it still only generates about a third of its revenues outside the US, compared with about 80% at Coke, so there is still plenty of opportunity for continued expansion abroad.

After Isdell's downbeat tone following Coke's results, it must have been refreshing for industry watchers to hear Pepsi CEO Steve Reindmund speak with such optimism when he said: "International is delivering sustained high growth, Frito-Lay stepped up performance versus the second quarter, and, although North America beverage volume growth slowed in the quarter, we expect improved volume performance in the balance of the year. Our momentum remains strong as we enter the last quarter. Overall, we are stronger than ever and 2004 will be another good year for PepsiCo."

As if Isdell doesn't currently have enough to worry about, the sight of his company's most ardent rival in such bullish mood adds a further unwelcome dimension to Coke's current predicament.