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Cola Wars Continue: Coke and Pepsi in 2010

Cola Wars Continue: Coke and Pepsi in 2010 A case discussion note January 17, 2012 1. Historically, why has the soft drink industry been so profitable? Historically, the soft carbonated soft drink (CSD) industry has been valued at $74 billion in the United States. In order to understand the reasons why the industry has been hugely profitable despite the ‘Cola Wars’, an examination of the CSD industry with Porter’s five forces analysis will be conducted.

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As market leaders, the analysis will be centred on both Coke and Pepsi (hereafter “C&P”).

Threat of new competition: Barriers to entry in the CSD industry are extremely high and there are various factors to support this. Firstly, both C&P spend gargantuan amounts of funding of advertisement. According to Exhibit 8, in 2009 alone, both C&P spent $234 million and $145 million respectively in advertising expenditure. Therefore, while the actual initial capital investment needed to start up a CSD company is relatively economic, the amount required by new entrants to continually push their brand and gain visibility is extremely high.

Due to these extreme levels of expenditure on marketing and brand awareness, the two cola companies have accrued exceedingly high levels of brand equity and consumer loyalty worldwide. As such, even with sufficient funds for start-up and subsequent advertising, new entrants are unlikely to sway persisting consumer tastes. Because of the sheer scale of both CSD companies, both C&P have pre-existing contracts with their bottlers, thus limiting their bottlers’ ability to produce similar products with rival brands.

Additionally, through the use of extensive consolidation through the use of acquisitions and re-franchising of their bottlers, both C&P have made it essentially impossible for new entrants to find bottlers for the distribution of their drinks. In the event that the new entrants decide to build their own bottling plants (which is quoted to potentially cost hundreds of millions in the case), they would only find themselves facing insurmountable fixed start-up costs in addition to the ridiculous amount they have to spend on marketing.

Even if new entrants somehow found a way to produce and market their drinks, the incumbents’ (C&P) far-reaching networks would make it impossible for them to secure any form of distribution channels. Shelf spaces in supermarkets were dominated by C&P because supermarkets were given a cut of the profit generated from the sales of their products. These cuts accumulate to a significant amount of profit-generation for the retailers. Additionally, combined, C&P owned 89% of national pouring rights.

The fact that the incumbents had exclusivity in both supermarkets, fountain outlets, and other forms of retail channels would make it almost impossible for new entrants to distribute their products. Bargaining power of consumers: Historically, the two main customers of soft drink producers were supermarkets (29. 1% of distribution) and fountain outlets (23. 1%). In general, retail outlets have been unsuccessful in asserting much bargaining power over the industry.

In part due to the level of fragmentation as well as their reliance on C&P as drivers of customer traffic. Longstanding contracts and acquisition of fountain outlets also serve to weaken consumer’s bargaining power. Bargaining power of suppliers: Major suppliers for C&P provided commodities in the form of cans, sugar, bottles, etc. These products were highly homogenous and could be substituted easily. The aluminium can industry, in particular, depended on firms like C&P because they were majority buyers.

Due to such dependence, suppliers asserted little or no bargaining power over the industry. Intensity of competitive rivalry: Even though C&P are essentially a duopoly in the CSD industry, competition between the two have traditionally centred on marketing efforts like advertising, new products, and promotions rather than pricing. Their rivalry, historically, was also in a market with consistent growth. As such, profits were not adversely affected even though their rivalry was highly documented and publicised.

Threat of substitutes: There are a number of alternative substitutes for soft drinks and these include beer, bottled water, tap water, juices, tea, coffee, wine, powdered drinks, milk, and distilled spirits. Yet, according to Exhibit 1, Americans, historically, consistently drank more CSDs than any other beverage. As such, the threat of substitutes affecting C&P’s profitability was limited. To further nullify the effects of substitutes, they also produced and promoted their own range of substitutes to reduce potential losses. 2. Compare the conomics of the concentrate business with that of the bottling business. Why is the profitability so different? Using data from Exhibit 4, we are able to see that the operating income of a concentrate producer is 32% of its net sales while that of a bottler is only 8%. The reason the bottling business earns significantly lesser than its concentrate counterpart can be attributed to two main factors – significantly higher cost of goods sold (COGS) and the existence of selling and delivery expense. We see that the COGS of a bottler are at 58%, much higher than the concentrate producer’s 22%.

The reason for this difference is predominantly due to Master Bottler Contracts established to allow for a certain level of “price fixing” on the concentrate producers’ part. Additionally, as mentioned previously, raw materials for concentrate producers are abundant and homogenous; hence COGS for them will be significantly lower. Also, the bottler is in charge of selling and delivery, and hence incurs an 18% selling and delivery expense while there is no such expense on the concentrate producer’s part. These reasons explain why the concentrate business has a more profitable business model than the bottling business. . How has the growing popularity of non-carbonated soft drinks influenced the industry? Non-carbonated soft drinks have been gaining popularity in the past decade, increasing from 13% in 2000 to 17% in 2009. This growing popularity has resulted in the generation of both local and global strategies by CSD firms unwilling to lose out on the budding market. In order to capitalize on the opportunity, both C&P greatly expanded their lines of beverages to include sports drinks like Gatorade and tea-based drinks like Lipton. Majority of drinks introduced during this time were non-CSDs.

Besides creating new products, Coke also aggressively gained market share through acquisitions and extending their fountain services to include coffee and tea. The non-CSD opportunities globally were also aggressively pursued by companies like C&P. To gain localized expertise, however, the soft drink companies did not merely think to introduce new products into foreign markets. Instead, they resorted to acquiring the respective market leading, non-CSD companies in the countries they chose to invest in. The companies of choice were usually major fruit juice producers.

Beyond takeovers, C&P also tried their hands at innovation and localization of beverages. These mainly came in the form of integration of local drinks (e. g. blended green tea with Sprite) or utilization of local ingredients in the production of new drinks (e. g. beverages with Chinese herbs). The emergence and rapidly growing popularity of the non-CSD has garnered much retaliation from major players in the CSD industry. In order to get their share of the pie, they have formulated expansion strategies both locally and globally which seem to center around acquisition.