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China's Soda Wars

Imagine this scenario. Coca-Cola is sued for bribery and trademark infringement. It loses in arbitration and beginning the next day it is banned from selling soda under its iconic brand across the US. It immediately switches to a new name, keeping the original packaging design and colors. Meantime, the victor in the lawsuit starts selling a soda under the name Coca-Cola using the same script lettering, same can design as the original, and tasting pretty much exactly like Coke.

Sounds far-fetched, doesn't it? But, this is precisely what's going on now in China. After a arbitration hearing filled with lurid tales of bribery and corruption, the country's most popular and most famous soft drink changed hands overnight. The brand is called Wang Lao Ji, (王老吉). Everyone in China is familiar with it. It's a soft drink made from Chinese medical herbs. It outsells Coke by a significant margin in China. Like Coca-Cola, Wang Lao Ji's recipe was first dreamed up by a pharmacist during the 19th century, and the exact formula remains a secret. In 1949, the Chinese government nationalized the private pharmacy that owned the Wang Lao Ji recipe.

Twelve years ago, a Hong Kong company called Hong Dao Group licensed the Wang Lao Ji brand name from a state-owned medical products company based in Guangzhou. Hong Dao is owned by the descendants of Wang Zebang, the original inventor of Wang Lao Ji back in 1828. Hong Dao invested heavily to create China's first home-grown soft drink megabrand, borrowing many of the same techniques that Coca-Cola pioneered, including saturation advertising and efficient nationwide distribution.

Last year, Hong Dao sold about three billion (yes, billion) cans of its Wang Lao Ji. The price, at around Rmb 4 (US 75 cents) per can, is higher by about 40% than the price Coke charges in China. At that price, gross margins must be about the highest of any legal product sold in China, probably +80%.

Since May, when it lost the arbitration case, Hong Dao has been forbidden to sell Wang Lao Ji in China under that name. So, overnight, the company switched to a new name, Jia Duo Bao (加多宝)but kept the original colors and packaging intact. Just as quickly, the Guangzhou SOE, called Guangzhou Wanglaoji Pharmaceutical Co., Ltd. (广州王老吉药业有限公司), a subsidiary of the state-owned Guangzhou Pharmaceutical Holdings Limited (广州医药集团有限公司), began selling its own version of Wang Lao Ji in a can almost identical to the one used up to then by Hong Dao.

So now there are two drinks, with two different brand names, owned by two different companies, with similar if not identical taste, being sold in almost identical cans. The famed Coke-Pepsi rivalry in the US looks very anemic by comparison.

Who benefits most? At the moment, it's the ad agencies and television stations. Both companies are now pouring in tens of millions of dollars into tv advertising to influence Chinese customers. The ads ran during almost every prime-time commercial break during coverage of the Olympics. Hong Dao's ads look identical to their previous ads for Wang Lao Ji, but now they promote this new Jia Duo Bao brand name. The ads hint that the new drink is same as its Wang Lao Ji, but without actually mentioning that name. Guangzhou Pharmaceutical Holdings' tv ads are very similar to the old Hong Dao Wang Lao Ji ads, as well as the new Jia Duo Bao ones, with lots of smiling and zesty young people drinking and partying.

During the arbitration, detailed were revealed about the way Hong Dao originally secured the license in 2000 to the Wang Lao Ji name. It turns out a manager at Guangzhou Pharmaceutical Holdings agreed to take a bribe of about $500,000 in return for giving Hong Bao a sweetheart deal. Hong Bao paid less than $1 million a year for the rights to use the Wang Lao Ji brand name in China, even as annual sales of Hong Dao's product reached Rmb 16 billion, ($2.5 billion.)

The manager who took the bribes was given a long prison term for misappropriating state property.Perhaps anticipating it might lose the arbitration case, Hong Dao began last year putting the name Jia Duo Bao, in small letters, on its Wang Lao Ji cans. When the arbitration decision was announced, both companies reacted with breathtaking speed and efficiency. Hong Dao pulled all its Wang Lao Ji cans and almost immediately had its new Jia Duo Bao aluminum cans in stores. The SOE too clearly had everything geared up, awaiting the court decision. Its version of Wang Lao Ji was quickly on shelves across China. The SOE says the red can's sales in July grew ten-fold compared to the previous month.

At this point, neither company is competing on price. Nor is there any sign that the overall market for this drink is growing much. So, the likely effect will be to split the 2011 Rmb16 billion of annual sales revenues by around 50-50. Guangzhou Pharmaceutical Holdings' stock price has shot up, anticipating a flood of profits from selling its Wang Lao Ji in the familiar red cans. Guangzhou Pharmaceutical Holdings are clearly the winners in all this. They surrendered the tiny annual licensing fee from Hong Dao, and now own outright what is arguably among China's ten most famous brands.

Watching from the sidelines, I remain somewhat amazed that the two companies did not reach some kind of settlement rather than going through the arbitration process. I find Chinese generally to be very practical in business, and loathe to settle disputes in court. Given Hong Dao's revenues and likely profits from selling Wang Lao Ji, it seems it could have put much more money on the table and persuaded Guangzhou Pharmaceutical Holdings to continue to license the brand. Switching to Jia Duo Bao has imposed heavy marketing and re-branding costs at a time when its previous monopoly market share is under serious attack.

Not that long ago, of course, China was mainly a market for all kinds of knockoff products - or to use the Chinese phrase, "shanzhai" 山寨. There was little interest in or defense of trademarks and copyright. Go back 30 years to when I first came to China, and there were few, if any, brands at all. That has all changed very markedly, particularly within the last two years.

China's consumer market, within a decade, will likely overtake the US to become the world's largest. With consumers shifting en masse to buying brand-name products, all brands active in China, both domestic and global, across just about every product category, are scrambling for every nano-unit of market share.

In the case of Wang Lao Ji and Jia Duo Bao, never in such a short time has such a large consumer market, the one for Chinese soft drinks, been so completely ruptured and so completely remade.