Economic Analysis Of An Oligopoly Market Structure

NEW YORK – Feeling bad about the economy? Indulge a little, have a soda. Marketers at Coca-Cola Co. and PepsiCo Inc. are counting on that sentiment to appeal to consumers overwhelmed with a drumbeat of bad economic news. “What people want to do is pause and refresh,” said Coca-Cola chief marketing officer Joe Tripodi. Pepsi, the world’s second-largest soft drink maker, launched a new marketing campaign at the beginning of the year, while No. 1 Coke launched its campaign three weeks later.

Soda makers, who have seen their highest-profile products lose ground to energy drinks and pricey bottled water in recent years, are turning away from the lifestyle marketing that has dominated the soda wars. Now, they hope to draw customers back to the old favorites with a simple lure: they’re cheaper — or at least a better value. Coke’s campaign includes 16-ounce plastic bottles of Coke, Coke Zero, Diet Coke, Sprite and Fanta for 99 cents. The new size could draw people looking for a bargain, in that a 20-ounce bottle costs $1. 25 to $1. 50.

An ad campaign called “Open Happiness” and tied to the “Coke Side of Life” ads launched on “American Idol” last week. One spot features two students sitting across from each other in a library and flirting by drawing competing images of Coke bottles and on their arms. “A lot of people have left the category,” Beverage Digest editor John Sicher said last week. “Also, a lot of young people have not entered the category, so these ads may help Coke both recruit new young consumers and re-recruit some lapsed ones. ” Coke plans to run three ads during Sunday’s broadcast of the Super Bowl football championship on NBC.

PepsiCo spokeswoman Nicole Bradley said PepsiCo would air five to six minutes of commercials for bottled drinks during the Super Bowl, making it the biggest advertiser for the game. The ads will feature Pepsi, Gatorade, PepsiMax and SoBe Life Water. With the launch of its new logo, the company also has increased its number of drink ads on billboards and in other public places such as subway stations, bus stops and on tops of taxis. In recent years, as U. S. soda sales fell steadily — including 2. 5 percent in the third quarter last year at PepsiCo, while Coke doesn’t break out soft drink performance — the two turned to other bottled drinks for growth. PepsiCo refocused its drinks portfolio around bottled Lipton teas and Starbucks coffees, its Aquafina bottled water, Izze sparkling juice drinks and others.

Coke made the biggest drinks acquisition in industry history in June 2007 when it bought Glaceau’s VitaminWater for $4. 1 billion. Though its products contain plenty of sugar, the brand had attracted health-conscious consumers with drink names such as Power-C, Defense, Endurance, Rescue and Multi-V.

But CEO Muhtar Kent said last fall that soft drinks are the “oxygen of our industry. ” The chief executives of both soda makers indicated they were refocusing on soft drinks last fall as consumers felt the weight of a recession but it had not yet been officially declared. PepsiCo’s push is “complementary” with the trend of shoppers trading down, the company’s North American beverages chief Massimo D’Amore said Tuesday. He declined to say the company was appealing to consumers’ pocketbooks. “We will not communicate on price,” he said in an interview. “Value to consumers is much broader than price.

It’s not the primary focus of our marketing. “D’Amore told reporters gathered Tuesday to hear details of the company’s Super Bowl plans that Pepsi’s

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drink portfolio is the “exact ammunition” it needs to win in the current climate. Chief Executive Indra Nooyi has said the company — which also owns the Frito-Lay, Tropicana, Gatorade and Quaker brands — aims to slow the decline of U. S. soda sales. Both companies are grappling with how to hold on to consumers that have grown wary of the high-fructose corn syrup that is used in a wide variety of bottled drinks, from soft drinks to bottled teas and energy drinks.

David Schardt, senior nutritionist at the nonprofit Center for Science in the Public Interest, said “the companies’ latest campaigns are not going to improve public health if sales of sugar-based sodas do rebound”. “We already drink too many of our calories” he said. ECONOMIC ANALYSIS OF AN OLIGOPOLY MARKET STRUCTURE 1. INTRODUCTION 1a. ARTICLE SUMMARY Not many corporations can boast of a 100 Year rivalry. The beverages industry witnessed such intense competition between Coca-Cola and PepsiCo.

One can say that the competition between the corporations was and still is so intense that it could be likened to sibling rivalry. The product offerings of both companies are so similar, if Pepsi were to offer a new product it wouldn’t be surprising to see Coca-Cola follow suit. Pepsi has always taken the lead in developing new products, but Coke soon learned their lesson and started to do the same. The companies not only compete in soft drinks, but also have branched out to other beverages including coffee, juice drinks and even water. As the companies lose their market share in energy drinks and pricy bottled water in recent years; now they refocus on soda pop to draw customers back.

PepsiCo is innovative with launching a marketing campaign of new logos while Coke’s campaign is price strategy with a range of cheaper products. The fact is each company is coming up with new products and ideas in order to increase their market share. The creativity and effectiveness of each company’s marketing strategy will ultimately determine the winner with respect to sales, profits, and customer loyalty. 1b. JUSTIFICATION OF THE TOPIC Pepsi and coke control over 75. 3% of market (as shown in the figure 1).

These two companies have significant control over the direction of the market in terms of price, quality and taste. This clearly indicates that the industry has a duopolistic structure. It is not easy to enter into the market as it needs a large investment and can expect the big players to crush into the competition. The presence of barriers to entry protects the present players from competition from new firms. The companies compete on product differentiation either through product itself or through heavy advertising to reduce the elastic of demand for their product.

Clearly the industry is oligopolistic with the market shared between these two firms, and the oligopoly characteristics of high concentration ratio, fewness, high barriers entry, product differentiation and mutual interdependence apply. Figure 1 Source: Beverage Marketing Corporation, New York. Retrieved from www. beverageworld. com > “data and statistics” on 4/10/2008 2. ECONOMIC ANALYSIS A firm under oligopoly faces a kinked demand curve (see figure 2). The point of the kink is the point of the established market price.

The kink of the demand curve suggests that a competitor would react asymmetrically to price increases and price decreases by the firm. Suppose the price is established at $1. 99 for a six-pack of either Pepsi or Coke. Let’s consider the demand curve for Pepsi. If Pepsi increases its price to $2. 49 per six-pack, it will lose some of its market to Coke along the AB component of the demand curve. Pepsi will be able to sell 500 six-packs a day instead of the original sales level of 1000.

Coke is likely to stay at $1.99 and enjoy the additional sale, as some people who were originally buying Pepsi will be switching to Coke. If Pepsi lowers its price to $1. 49 to gain an advantage over Coke and increase it sales to 1500 six-packs, it may not succeed. The increase in sales by Pepsi to 1500 can only happen if Coke did not react to Pepsi’s price cut. However, Coke is likely to match the price reduction by Pepsi to protect itself against loss of market share. As the result of price cuts by both Pepsi and Coke, there will be an increase in sales by both — at least partially at the expense of smaller competitors.

The sales of Pepsi increase to 1300 six-packs per day from the original 1000. This is along the BC segment of the demand curve. Therefore, there are two demand curves facing Pepsi—AB relatively elastic for price increases and no reaction by Coke, and BC relatively inelastic for price decreases and price matching reaction by Coke. This explains the kinked demand curve for Pepsi and similarly for Coke. Notice that the kink in the demand curve is at the established market price. It is also important to realize that the established price tends to be maintained.

Neither Pepsi nor Coke will be inclined to raise their price since it would cause loss of sales and market share to the rival. Also neither of them is particularly interested in lowering the price and starting a price war since the outcome is loss of profit for both in favor of consumers. The profit maximization level of output can be determined by adding to the demand-MR model the cost curves for a firm under oligopoly. The profit maximizing level of output is 1000 six-packs of Pepsi, where MC = MR. Pepsi can sell this quantity at $1. 99 according to the demand curve.

The average total cost of production at 1000 level of output is $0. 99 per six-pack. Therefore the company is making $1000 a day of economic (or excess) profit as illustrated in Figure 3. An interesting observation is that the profit maximization of oligopolies, generally, occurs at the kink of the demand curve, which in-turn represents the established market price and market shares of the oligopolies. Another observation is that moderate changes in the cost conditions of oligopolies do not cause a change in their profit maximization quantity and price as long as they are in the vertical range of the MR curve.

This implies that technological improvements that lower the cost of production or change in the price of inputs encountered by an oligopoly would not lead to a quantity or price change. We therefore suggest that under an oligopoly market prices are rigid. Firms especially avoid lowering their price from fear of igniting a price war. Instead oligopolies resort to non-price competition such as advertising. Price wars can and occasionally do occur when one of the dominant firms in the oligopoly market experiences a significant decrease in its production cost and attempt to increase its market share.

Coke and Pepsi know that they are spending millions of dollars on advertising just to counter each other’s ads. Advertising game will provide us with a modeling framework within which to show the choice that the managers of oligopolistic firms face. ( see figure 4) Although it would increase both firms’ payoffs if both play “Less Advertising”, this cannot be easily achieved. According to the above payoff matrix, playing “Intensive Advertising” yields a higher payoff for Coke no matter what Pepsi does. In other words, “Intensive Advertising” is Coke’s dominant strategy.

Similarly, “Intensive Advertising” is also Pepsi’s dominant strategy. Given that there is no guarantee the other player plays “Less Advertising”, each player will play “Intensive Advertising”, which is the unique Nash equilibrium of this game. 3. CONCLUSION Sales of carbonated soft drinks have been declining in US for several years, as consumers turn to a growing number of new beverages like enhanced waters, sports drinks and energy drinks. But the problems have accelerated in a volatile economy, with consumers eating at restaurants less and buying fewer grab-and-go beverages.

In addition, consumers are increasingly choosing tap water over other beverages at restaurants and at home to help save money and the environment. Both companies have also relied on finding new markets, especially in foreign countries. Although the goal of both companies are exactly the same, the two companies rely on somewhat different marketing strategies. The companies must be willing to accommodate their “target markets”. They have to always be creating and updating their marketing plans and products. Gaining market share occurs when a company stays one-step ahead of the competition by knowing what the consumer wants.

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