Pepsi is making strides towards addressing some of the major challenges presented by the industry's external environment. The company's dual strategy towards increasing innovation has provided it with more and better innovation opportunities than its main rival, albeit less than smaller, younger firms. Pepsi's culture is more conducive to innovation and the company takes greater risks with business acquisitions in order to improve its product portfolio. In addition, Pepsi also has focused energy on growth in international markets rather than on bolstering its core products in the domestic market. Over time, this will provide Pepsi with strong diversification of income streams. Pepsi's demonstrated ability to operate outside of its core beverage industry also implies that the company will be better able to manage the threats faced by that business. If a sugar tax on soft drinks does through in the U.S., Pepsi will lose a lower percentage of its revenue than will Coke. That said, with its secondary revenue streams being in fatty, salty snacks, Pepsi remains heavily exposed to the prospect of so-called health taxes.

Pepsi's responses to the external challenges have been reasonably successful. The company has seen the same stagnating revenues and profits that Coke has (MSN Moneycentral, 2010), but the company has been more actively engaged in driving innovation and therefore is expected to outperform its rival in the future. The success may not have emerged yet, but the antecedents for success are present.

Overall, the soft drink business remains challenging...

They remain profitable to the extent that factor inputs are reasonably priced on world markets, and as a function of the brand power that they have built over the years. Given that the business is entering maturity, neither Pepsi nor Coke is expected to be strong growth stories. However, Pepsi's approach to its challenges is more proactive where Coke's responses have been largely reactive. Pepsi's moves, therefore, have put the company in a better position to respond to the challenges in the external environment than is its main rival. Pepsi has fewer weaknesses and appears to have a more motivated, dynamic organizational culture. While the company may be dependent on certain brands and markets, it is in a better position to supplement those brands with new ones either created in house or acquired from outside.
Works Cited:

Khermouch, G. & Howard, T. (1999). Does beverage innovation mean Pepsi One, SoBe or RC Edge? Brandweek. Retrieved June 24, 2010 from http://findarticles.com/p/articles/mi_m0BDW/is_20_40/ai_54726973/

Venkataraman, S. (2008). PepsiCo: The challenge of growth through innovation. University of Virginia. Retrieved June 24, 2010 from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=909036

2009 PepsiCo Annual Report. Retrieved June 24, 2010 from http://www.pepsico.com/Investors/Annual-Reports.html

MSN Moneycentral: PepsiCo. (2010). Retrieved June 24, 2010 from http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=PEP&lstStatement=Income&stmtView=Ann