The competition between Coca Cola and Pepsi

An industry analysis by Porters Five Forces reveals that the soft drink industry has historically been favorable for positive profitability, as exemplified by Pepsi and Cokes financial outcomes. Soft drink industry is very profitable, more so for the concentrate producers than the bottler’s. This is surprising considering the fact that product sold is a commodity which can even be produced easily. There are several reasons for this, using the five forces analysis we can clearly demonstrate how each force contributes the profitability of the industry.

Threat of new entrants

Entering bottling, meanwhile, would require substantial capital investment, which would deter entry.

although the CP industry is not very capital intensive, other barriers would prevent entry. Through their DSD practices, these companies had intimate relationships with their retail channels and would be able to defend their positions effectively through discounting or other tactics.

It would be nearly impossible for either a new CP or a new bottler to enter the industry. New CPs would need to overcome the tremendous marketing muscle and market presence of Coke, Pepsi, and a few others, who had established brand names that were as much as a century old.

Companies that have a door to door distribution channel in place like snack companies could choose to diversify into soda industry

Switching costs are low for consumers who risk very little by trying new brands or

Beverages

Barriers to entry are relatively high, though, with large advertising budgets and competitive brand loyalty to big players like Coca-Cola and Pepsi

The drinks with high growth and high hype are non-carbonated beverages such as juice drinks, sports drinks, tea-based drinks, dairy-based drinks, and especially bottled water

Bargaining power of buyers

through five principal channels: food stores, convenience and gas, fountain, vending, and mass merchandisers (primary part of “Other” in “Cola Wars…” case)

Bottlers own a manufacturing and sales operation in an exclusive geographic territory, with rights granted in perpetuity by the franchiser, subject to termination only in the event of default by the bottler

1980 Soft Drink Interbrand Competition Act preserved the right of CPs to grant exclusive territories to their bottlers, giving less bargaining power to Bottler’s buyers because there is no alternative supplier

Bottlers are locked into contracts that grant CPs the right to set prices and other terms of sale

Bottlers are allowed to handle the non-cola brands of other Cps at their discretion

Bottlers are also given freedom in choosing whether or not to carry new beverages introduced by the CPs but cannot carry directly competitive brands

Competition for brand shelf space in retail channels gives some bargaining power back to buyers

Threat of substitute products

Through the early 1960s, soft drinks were synonymous with “colas” in the mind of consumers.

In the 1980s and 1990s Coffee, tea, water, juices, sports drinks, distilled spirits became more popular

Efforts to reduce threat:

Bottlers: Increased capital investment and development of management skills

Concentrate: diversification

Proliferation in the number of brands did threaten the profitability of bottlers through 1986, as they more frequent line set-ups, increased capital investment, and development of special management skills for more complex manufacturing operations and distribution. Bottlers were able to overcome these operational challenges through consolidation to achieve economies of scale. Overall, because of the CPs efforts in diversification, however, substitutes became less of a threat.

Bargaining power of suppliers

Sugar and water are main ingredients. Corn syrup became cheaper in 1980’s.

With an abundant supply of inexpensive aluminum in the early 1990s and several can companies competing for contracts with bottlers, can suppliers had very little supplier power.

Coke and Pepsi effectively further reduced the supplier of aluminum can makers by negotiating on behalf of their bottlers, thereby reducing the number of major contracts available to two. With more than two companies vying for these contracts, Coke and Pepsi were able to negotiate extremely favorable agreements. In the plastic bottle business, again there were more suppliers than major contracts, so direct negotiation by the CPs was again effective at reducing supplier power.

Concentrate producers (CPs) negotiate directly with bottlers’ major suppliers -particularly sweetener and packaging suppliers – to encourage reliable supply, faster delivery, and lower prices

Coca-Cola and Pepsi are among the metal can industry’s largest customers and maintain relationships with more than one supplier, giving these suppliers less bargaining power due to the availability of alternative suppliers

Metal cans make up the majority of the bottlers’ packaged product (60%), followed by plastic bottles (38%) and glass bottles (2%)

Rivalry among existing competitors

Duopoloy

Attacking hinders profitability

Price wars resulted in weak brand loyalty and eroded margins for both companies in the 1980s. The Pepsi Challenge affected market share without hampering per case profitability, as Pepsi was able to compete on attributes other than price.

Industry is largely consolidated with two major players and a few smaller competitors like Cadbury Schweppes, making the companies interdependent

International demand for carbonated soft drinks is growing, but domestic demand is slowing down substantially

Exit barriers are high for bottlers with expensive equipment, moderate for concentrate producers

Advertising budgets are high, customers are influenced by brand perceptions

1: Why, historically, has the soft drink industry been so profitable?

a. Since 1970 consumption grew by an average of 3%

b. From 1975 to 1995 both Coke and Pepsi achieve average annual growth of

around 10%

c. American’s drank more soda than any other beverage

d. Head-to-Head Competition between both Coke and Pepsi reinforced brand

recognition of each other. This assumes that marketing added to profits

rather than eating them up.

e. Very large market share. 53% in year 2000.

f. Average 10.65% net profit in sales for both Pepsi and Coke.

2: Compare the economics of the concentrate business to that of the bottling business. Why is the profitability so different?

The fundamental difference between CPs and bottlers is added value. The biggest source of added value for CPs is their proprietary, branded products.

Coca-Cola and Pepsi have both decided to operate primarily in the production of soft drink syrup while leaving independent bottlers with a more competitive segment of the industry

a. Concentrate business: Concentrate producers were dependent on the Pepsi and Coke bottling network to distribute their products. Starting and maintaining a concentrate manufacturing plant involved little capital investment in machinery, overhead, and labor. Significant costs were for advertising, promotion, market research, and bottler relations. Producers negotiated with bottlers’ major suppliers. One factory could serve the entire United states

b. Bottlers: Purchased concentrate, added carbonated water, added corn syrup, bottled it, and delivered it to customer accounts. Gross Profits were high but operating margins were razor thing. Bottlers handled merchandising. Bottler’s could also work with other non-cola brands.

From Exhibit 5, a typical concentrate producer’s gross profit is 83% compared to 35% for a typical bottler. Similarly, pretax profit for a concentrate producer is 35% and it is 9% for a bottler. The COGS for a concentrate producer is significantly lower than of a bottler (65% of Net Sales). Packaging is half and concentrate is one-third of bottler’s COGS. In addition to higher COGS, bottlers are responsible fo redelivering the product to the customers, which involve delivery personnel placing and managing the CSD in the store. The associated costs are typically around 21%. On the other hand, the significant cost for a concentrate producer comes from advertising and marketing expenses (39%). So the profitability of the concentrate business is evidently higher, almost four times, than that of bottlers, even though concentrate producers have pretty high advertising and marketing expense.

Compared to concentrate production, soft drink bottling is not very profitable. The concentrate business is successful because of the Coke and Pepsi duopoly and their subsequent power over buyers and suppliers. The companies are able to maintain profitable pricing for their concentrate products. The bottling businesses suffer because they have no bargaining power with their suppliers and diminishing power with their buyers. Additionally, bottlers have high fixed costs related to operations, which the concentrate business avoids. It is important to understand the structural capital conditions of this sector. The returns have been used wisely: one important strategy has been to enforce a reduction in numbers of manufactures to further grow market share and bargaining powers. The bottlers have a significantly different starting position.

3: How has the competition between Coke and Pepsi affected the industry’s profits?

For over a century, intense rivalry between duopoly Coke and Pepsi shaped the soft drink industry (combined they are 73% of the market share). The most intense battles of the cola wars were fought over the $60 billion industry in the USA, where the average American consumes 53 gallons of carbonated soft drinks per year. in a carefully waged competitive struggle, from 1975 to 1995 both Coke and Pepsi had achieved average annual growth of around 10% as both US and worldwide carbonated soft drink consumption consistently raised. This cozy situation was threatened in the late 1990s, when US consumption dropped for two consecutive years and worldwide shipments slowed for both Coke and Pepsi.

Globalization provides Coke and Pepsi with both unique challenges as well as opportunities at the same time. To certain extent globalization has changed the industry structure because of the following factors.

Rivalry Intensity: Coke has been more dominant (53% of market share in 1999).  in the international market compared to Pepsi (21% of market share in 1999) This can be attributed to the fact that it took advantage of Pepsi entering the markets late and has set up its bottler’s and distribution networks especially in developed markets. This has put Pepsi at a significant disadvantage compared to the US Market.

Pepsi is however trying to counter this by competing more aggressively in the emerging economies where the dominance of Coke is not as pronounced, With the growth in emerging markets significantly expected to exceed the developed markets the rivalry internationally is going to be more pronounced.

Barriers to Entry: Barriers to entry are not as strong in emerging markets and it will be more challenging to Coke and Pepsi, where they would have to deal with regulatory challenges, cultural and any existing competition who have their distribution networks already setup. The will lack the clout that have with the bottler’s in the US.

Suppliers: Since the raw material’s are commodities there should be no problems on this front this is not any different

Customers: Internationally retailers and fountain sales are going to be weaker as they are not consolidated, like in the US Market. This will provide Coke and Pepsi more clout and pricing power with the buyers

Substitutes:   Since many of the markets are culturally very different and vast numbers of substitutes are available, added to the fact that carbonated products are not the first choices to quench thirst in these cultures present additional significant challenges.

4: Can Coke and Pepsi sustain their profits in the wake of flattening demand and the growing popularity of non carbonated beverages?

a. It should not be a problem to sustain their profits through the next decade. The more important question is whether they can sustain their historical rate of growth. To do so they need to seek out new markets and increase consumption in currently developing markets such as China and India

b. I would recommend Coke to focus on its emerging international market. I would also encourage Coke to expand their offerings. I think Coke made a serious mistake when they failed to purchase Quaker Oats and with it the Gatorade Sports Drink line. If Coke focuses on several beverage offerings they can leverage their internal bottling and distribution infrastructure. Different types of beverages can keep Coke’s overall profit intact when there is a shift in consumer preference, such as a shift from soft drinks to healthier alternatives (Think of the effect Atkins had on the food industry)

c. For Pepsi I would basically recommend the same thing as Coke. I would encourage Pepsi to focus on its line of soft drink alternatives, which seem to have a much stronger market share than Coke’s line. I would encourage Pepsi to only compete with Coke when it is profitable to do so.

The industry structure for several decades has been kept intact with no new threats from new competition and no major changes appear on the radar line

This industry does not have a great deal of threat from disruptive forces in technology.

Coke and Pepsi have been in the business long enough to accumulate great amount of brand equity which can sustain them for a long time and allow them to use the brand equity when they diversify their business more easily by leveraging the brand.

Globalization has provided a boost to the people from the emerging economies to move up the economic ladder. This opens up huge opportunity for these firms

Per capita consumption in the emerging economies is very small compared to the US market so there is huge potential for growth.

Coke and Pepsi can diversify into non-carbonated drinks to counter the flattening demand in the carbonated drinks. This will provide diversification options and provide an opportunity to grow.

Industry should be proactive about growing health concerns in US Market

1. Should continue to lobby FDA to prevent caffeine-warning labels

2. Should promote exercise through sponsoring competitive sports tournaments

B. Companies need to refocus energies on advertising to rejuvenate industry and to fuel

product demand both domestically and abroad (See Exhibit 3)

C. Cola industry leaders, Coca-Cola and Pepsi, should practice game theory to better

understand their competitive market environment