Cola Wars Case Analysis

The average level of profitability in the global soft drink industry has historically remained quite high. Why is that? Coke and Pepsi can leverage their market control to make contracts that favor the concentrate producers Coke and Pepsi can set their prices above the CPI, bottlers cannot because of customer expectation Bargaining power of buyers is limited to low switching costs and management of about 10-20% of product distribution through regional accounts Use the “Five Forces” framework to compare the economics of the concentrate business to the bottling business: why is the profitability so different? [60 points] Threat of Entry

Threat of entry for an industry is defined as the difficulty or the ease by which a new player can enter the an industry. In the case of the concentrate and bottling businesses associated with producing carbonated soft drinks (CSDs), tThe threat of entry can be measured in a number of ways. and we will compare the concentrate business to the bottling business with respect to those points. Economies of scale:

If the supply of the product is less than the demand of the product, then the suppliers can increase profit margins easily. But if the supply is equal to the product or greater than the product, thean the consumers will have the upper hand and the suppliers will have only minimal profit margins. Therefore, iIf a new entrant party wants to enter the industry citing after observing the higher profit margins of previous players already in the industry, the supply may become greater than the demand and the profit margins of the whole industry decline it may be the case that after the new supplier enters the market, the supply is greater than the demand and the profit margins of the whole industry decline.

If we considerWhen considering the concentrate business with respect to the above phenomenona, the demand is not quantifiable. As a result, So in the concentrate business, a new entrant is not deterred by thisis phenomenon in the concentrate businessa. If we look atAs for the bottling business, a new supplier will have to check the supply and demand statistics. According to Exhibit 3b of the case study, the sales of both Coca-Cola’s and PepsiCo’s largest bottlers have declined from the year 2008 to 2009. This points out, which shows that the bottling market is saturated and the bottling industry is not a very attractive industry. If a new player enters the market, the profit margins will further decrease further.1 Product Differentiation:

A new entrant can differentiate its product from existing products in the market and thereby create a new, separate market for itself. It is possible for a concentrate manufacturer to use this phenomena phenomenon and enter the concentrate market. In the case of the bottling business, the product differentiation phenomenona will not work as the product design is suggested by the concentrate manufacturersconcentrate manufacturers suggest the product design and the bottling company doesn’t have much say in itcannot influence it. Cost aAdvantages independent of scale:

Cost advantages include the technical knowhow of an existing player, favorable access to raw materials and, favorable geographical location of an existing player. For the concentrate business, this factor does no’t play a very important role, as the concentrate manufacturebusiness relatively involves relatively little capital investment in machinery, overhead or labor. The only thing that matters most important factor withinfor the concentrate business is the knowledge and understanding of the market and the industry.

A new entrant in this business will have to take into account that the established players already know a lot about the industry and the market and the new entrants would be at a disadvantage compared to them. In the bottling business, the cost of advantage matters a lot. The established players would have chosen a favorable geographical location and they would know about the source of the raw materials, they would know the labor. So new entrants would be at a huge disadvantage in this business. Contrived Deterrence:

Consumers have a loyalty toward theare loyal to already established brands. The case study clearly states that the Coca-Cola bottle is recognized as an American symbol and people have a loyalty towards the brandconsumers are fiercely loyal to the brand. Some people also have loyalty towards Pepsiyet another large group is very loyal to Pepsi. Thus,So a new entrant will not be taken as seriously by the consumers the consumers will not take a new entrant as seriously. This phenomenona is not applicable to the bottling business, as consumers have no loyalty to the companies which that make produce bottles forof soft drinks. Bargaining power of suppliers

In the cola wars, the concentrate producers are the highest levelhighest-level suppliers and have the greatest bargaining power. With Coke and Pepsi owning a majority of the cola market share, they are able to set prices and terms of their concentrate sales. Both firms have held pricing contracts with bottlers (the primary buyer) that exemplify the bargaining power Coke and Pepsi maintain over bottlers. Modifications to pricing contracts over the past few decades favored the concentrate producer. Coke’s 1987 Master Bottler Contract changed the pricing model from fixed-price (as established in a 1899 contract) to one that allows prices to be adjusted based on changes in ingredient cost.

This model gave a bit of flexibility to bottlers as they had the option to purchase sweeteners in the open market. Pepsi, conversely, designed their contract so bottlers had to purchase everything from Pepsi “at prices and on terms and conditions determined by Pepsi” (page 3). In both cases, the agreements allowed concentrate prices to increase more than inflation: since these pricing contracts had been set, the cost of CSD concentrate increased about 3.6% from 1988 to 2009, while the consumer price index increased 2.9% in the same time span (exhibit 5). Because of market share control, Coke and Pepsi were able to increase their prices in line with one another, as Pepsi did in the early 1970s.

While bottlers could theoretically pass the additional cost onto retailers, customers had price expectations and little price elasticity. Even with the cost of concentrate increasing at a greater rate than the CPI, the retail price (adjusted for inflation) decreased 1.4% from 1988 to 2008 (exhibit 5). Ultimately, the bottling industry was not unique in any way. This led to the concentrate producers to consolidate the bottling industry. Because the bottling industry allowed for this vertical integration, independent bottlers had very limited bargaining power –. tThey could easily be squeezed out (and ultimately were) by the concentrate producers. Bargaining power of buyers

Before Coke and Pepsi began to vertically integrate the bottlers, each bottler (buyer) was independently owned and franchised. Franchising agreements granted regional exclusivity so concentrate producers depended on regional franchises to meet the demands and orders placed. Additionally, franchises maintained smaller regional accounts, including convenience stores, gas stations, small grocery stores, and drug stores. While these accounts made up about 10-20% of total distribution (page 4), the variable profit was up to two times greater than that in other distribution channels, such as mass retailers or supercenters (exhibit 6). Since the additional profit is retained by the bottlersbottlers retain the additional profit, they may be more motivated to increase regional accounts and ultimately increase distribution for the concentrate producer.

Bottlers also held bargaining power in their ability to modify processes to change what products they bottle. Costs to switch CSD production—within certain container restrictions and product type—was low (page 2). However, this element of bargaining power was limited. Coke and Pepsi had similar operating agreements with bottlers, so switching between the two would not necessarily improve profit margin. Switching to regional or smaller brands incurred additional costs—such as delivery (occasionally on split pallets) and warehouse storage—that could make the change less lucrative. Threat of subsitutes

Threat of substitutes is another major risk to consider in a market entry for the global soft drink market. In the Coke/Pepsi case, substitutes are different types of drinks described as non-CSDs such as milk, coffee, bottled water, tea, sports drinks, etc. that can directly compete with sales of CSDs. However, the concentrate and bottling economics of substitute drinks are different from one another. When discussing non-CSD drinks the concentrate component is naturally eliminated. The manufacturing process of these drinks lacks the concentrate components of Coke or Pepsi, therefore reducing a major barrier to entry for a competitor. We can safely say that there is a greater threat of substitution for CSDs by substitute drinks (non-CSDs) since barriers to entry for substitutes are shortened by eliminating the concentrate requirementeliminating the concentrate requirement shortens barriers to entry for substitutes.

The threat of substitution for the bottling side of the business, however, is different however with a small caveat. For the most part, bottling businesses can diversify their output and reliability on the concentrate providers by bottling non-direct competitor products. The article provided an example of a plant bottling 7 Up as long as it was not carrying a direct competitor such as Sprite. In addition, the capital intensiveness of the bottling business is another factor that deters competition in nearby territories.

 One of the biggest threats to the bottling industry is perhaps customized bottling technology in the long run. Companies like SodaStream provide the same experience but only at the comfort, customized and convenience of any household through a technology that allows the customer to carbonize drinks at home. A direct agreement between major concentrate producers and new technologies such as SodaSteam could potentially circumvent the entire bottling industry and provide concentrate directly to end-users. Threat of Rivalry

Threat of rivalry is indicated by the number of rivals or competitors in the industryThe number of rivals or competitors in the industry indicates threat of rivalry. If there are too many firms producing the same product or giving the same service, market share will be limited and the profit margin of every firm will be low as they will all have a limited market share. However, if there is one firm’sa monopoly or a very few firms produce a product, then each firm’s market share will increase. So Aa new entrant should must keep this in mind before making enteringry into an industry. In this case, If we study the concentrate business with this respect, according to Exhibit 2 of the case study, about 66 % of the U.S. Soft Drink Market is shared by three firms namely Coca-Cola Company, PepsiCo Inc. and Dr. Pepper Snapple Groupthree firms, namely Coca-Cola Company, PepsiCo Inc. and Dr. Pepper Snapple Group, share about 66 % of the U.S. Soft Drink Market while.

The rest of the market is shared by a lot of many small companies. 2 The So the concentrate business is therefore not an attractive business. according to this phenomena as the market is dominated by three firms and there are a lot of small firms sharing the market. If we consider the bottling business with this respect, the above mentioned phenomena threat of rivalry will not have much effect as the product is the same and it will only depend on the demand and supply. How can Coke and Pepsi be so profitable in the middle of a “war?” (Hint: How do Coke and Pepsi compete?) Among the players in the industry, Coke and Pepsi are the largest players in the industry, with market share of 43.1% and 31.4% in 2005, respectively3. These two giants haves competed for over 100 years. Yet, in the fierce market competition, both giants are profitable, which. The reason why they are so profitable could be explained by the way how they compete.can be explained by how the two giants compete.

There Coke and Pepsi’s competition could can be divided into three levels of’ competition. The first level’s competition is that simply between Coke and Pepsi. As Roger Enrico, former CEO of Pepsi, said: “…Without Coke, Pepsi would have a tough time being an original and lively competitor. The more success they are, the sharper we have to be….” (Enciro 1988) .4. Their competition has resulted in constantly improving and expanding because of each other. Besides, they also have adopted relatively differentiated strategies in the previous wars. For example, Pepsi strengthened its relations with some restaurant chains through mergers and acquisitions.  Rather than resulting Their wars did not result anin absolute erosion for one side overall, Coke and Pepsi’s war has but strengthened their own market and even expanded new markets and product lines in most cases.

The second level of’s competition is that between the two giants and other players. Since the two giantsCoke and Pepsi haves obtained obsoletely absolute market leadership in terms of market share, they can monopolize marketing, distribution channels, and bottlers. Their monopoly dominant status in the industry leaves limited space for other competitors to challenge their market position and pricing power. Finally, tThe third level of’s competition is can be attributed to between the CSD production giants and bottlers. As we can see from the supplier’s and buyers’s bargaining power analyses, Coke and Pepsi have a strong bargaining power over bottlers. This is evident when taking, as we can see from the concentrate price per case into account, which has increased by an annual growth rate of 3% from 1988-20095. The keep-climbingcontinually climbing concentrate price also helps the two giants to maintain a strong profitability.

What’s moreFurthermore, even though Coke and Pepsi have never cooled their competition, they seldom introduce price wars which may expand market but hurt profit, except Pepsi once lowed price in 1960s but it resumed it price to the same as Coke soon in early 1970s. Why would concentrate producers want to vertically integrate into bottling? [5 points] Recently, Coke and Pepsi both have invested a lot in bottling, even havehaving obtained strong market position and bargaining power over bottlers. There are three main intentions reasons that for Coke and Pepsi to integrate into bottling, including: (list the three here quickly).

Above all, they the concentrate producers want to engage their relationsdirectly with local clientsconsumers. Traditionally, bottlers are have been responsible for distribution and sales with local and independent buyers6. After the key account market (such as Wal-Mart, Mcdonald, and KFC) has become saturated for Coke and Pepsi, to ensure and expand local and independent buyers’ market, Coke and Pepsi integratestrengthened the relations with local and independent buyers through integratinge bottlers to ensure and expand the local and independent buyers market. Secondly, theyCoke and Pepsi also seek want to reduce the cost throughout the bottling process by integratinge bottlers to create scale of economyeconomies of scale. Both Coke and Pepsi used to have hundreds of bottlers. The redundant and scattered bottlers could not collaborate align resources (logistics, labor, and bottling capacities etc.) togetherwith each other.

After Through integration, however, they could share these resources and reach scale of economyan economy of scale. What’s more Integrating the bottlersthe integrated bottlers also could strengthened their Coke and Pepsi’s bargain powers against over can makers. Overall, Coke and Pepsi could reduce more costs and create more profit through vertical integration than independent bottlers could in the past. Thirdly, Coke and Pepsi could also update bottlers’ technology and make bottling more environmentally friendly to counter the complex environment disputes. Analyze the general environment of the global soft drink industry (see also the WSJ articles posted on Blackboard). What are potential future opportunities and threats for the global soft drink industry?

Today’s global soft drink industry is still characterized by fierce competition between the two dominating players in the industry, Coke and Pepsi, as it has been since the beginning of the 20th century. Yet the industry has changed immensely since Pepsi was sold for a nickel and Coke could only be bought in a glass bottle. Currently, the global soft drink industry is grappling with sustaining growth and profitability in the face of ever evolving sociocultural, political and legal as well as economic factors. In 1970, Americans were consuming an average of 23 gallons of carbonated soft drinks (CSDs) per year.7 Although consumption continued to grow over the next three decades, the beginning of the 2000s marked a stark change of course in this trend as consumers became increasingly aware of the health risks associated with consuming the large amounts of sugar inherent to most CSDs.

This has resulted in two major changes: CSD consumption has decreased significantly in the US (down from 53 gallons per year in 2000 to 46 gallons per year in 2009), and regulators across the world have increasingly scrutinized soft drinks. In fact, lawmakers in France instated a tax on soda and regulators in Hungary leveled a tax against products high in sugar, salt or fat.8 But such legislation is not only limited to Europe. In Mexico, for example, where citizens drink more Coca-Cola per capita than in any other country, the government recommended banning sugary sodas in schools and considered a 20% soda tax in 2013.9 It is therefore clear that such health-centered legislation will continue to pose a threat to the global soft drink industry as more countries consider instating laws to regulate sugary beverages.

Responding to this marked change in consumer demand, soft drink companies have diversified their product offerings beyond the traditional soda to include lines of purified water, juices, sports drinks, energy drinks and ready-to-drink teas. Zero and no-calorie drinks have also become more popular. In 2013, Coke reported that zero to no-calorie CSDs yielded one-third of its sales volume in North America.10 Such diversification marks a distinct opportunity for soft drink companies as the demand for traditional CSDs continues to decrease. Pepsi has also capitalized on this opportunity and even taken it one step further by diversifying its product offering beyond beverages to include snack foods as part of its Frito-Lay business, a move that increased the company’s value by $43 billion between 1998 and 2006.

Yet continually diversifying product offerings and expanding these across the globe not only provides opportunities for increased growth and profitability, but also invites new threats to growth and profitability – antitrust regulation, foreign exchange controls, advertising restrictions and local competition are all elements that may impede a soft drink company’s business abroad.12 In 2008, for example, Coke sought to expand its business in China but was denied the purchase of the Chinese mainland’s most profitable juice company, China Huiyan, after officials voted the purchase would violate antitrust law. This decision came as Pepsi opened new bottling plants and invested about $1 billion in the mainland, a clear threat to Coke’s profit margin in this huge market.13 The uncertainties soft drink companies face in new global markets, therefore, will continue to pose a threat.

Beyond this, soft drink companies’ growth and profit will be hindered by factors arising due to environmental and social concerns. This became evident in 2007, when Coke was heavily criticized in India for contributing to water shortages. Although Coke was unsure these efforts would reduce costs, the risk of losing the license to operate in India was too high and the company therefore instated expansive water-saving efforts to combat the issue.14 Just how much could be lost if pressure from civil society on environmental issues was ignored could be observed in the early 2000s, when environmentalists voiced severe criticisms against the plastic bottles used for bottled water, known as PET. 

Coupled with the economic downturn of the time, consumers sought cheaper, more environmentally friendly products, which led to negative operating profit margins in the bottled water business for both Coke and Pepsi – Coke’s market share decreased from 22% to 15% between 2004 and 2009 while Pepsi’s fell from 14% to 11%.15 As climate change takes root across the globe, environmental concerns will continue to drive civil society to take action against large corporations perceived to exacerbate environmental issues, severely threatening their growth and profitability. If approached cleverly, however, soft drink companies could turn these threats into an opportunity to stand out as a leader in combating climate change, as Coke attempted in partnering with the World Wildlife Fund to monitor its water-saving efforts in India.16 Whether or not these efforts will be enough to combat threats arising from environmental and social issues as society’s attitudes and values continue to evolve, however, remains to be seen.