Strategic Management 12 PB

Prof. ZHENG Xin

Prof. ZHANG Haiyan


Cola Wars Continue:
Coke and Pepsi in the Twenty-First Century

By
Eugen Martens (Student ID: 14900098)
Gabriel de Rauglaudre (Student ID: 13946412)






March 8, 2014
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Introduction
The soft drink industry has been a profitable one in spite of the cola wars between the two
largest players. Several factors contribute to this profitability, and these factors also help to
show why the profitability of the concentrate production site of the industry has been so
much greater than the bottling side. Over the years the concentrate producers have
experimented with different levels of vertical integration, and although it has not necessarily
been clear which have been more successful historically, some decision criteria can be
developed to help determine if and when complete vertical integration is necessary.

Profitability in the soft drink market
As analysis using Porters five forces shows why the soft drink industry has been so
profitable. Suppliers and buyers have not had more power over the industry than it has had
over them. Internal rivalry, while seeming intense, has not eroded the profitability of the
industry because of its concentration and the fact that the two major players have primarily
competed on the basis of advertising and promotion and not price. Entry is difficult both for
reasons of scale and the strong brand identity of the current major players. Substitutes have
not been close enough to take away significant market share, although the emergence of
new substitutes may pose the largest threat to the industrys profitability.

Suppliers and Buyers
Suppliers to the soft drink industry are, for the most part, providing commodity products
and thus have little power over the industry. Sugar, bottles and cans are homogenous goods
that can be obtained from many sources, and the aluminum can industry has been plagued
by excess supply. The one necessary ingredient which is unique is the artificial sweetener;
aspartame is clearly preferred by consumers of diet beverages and for a time was under
patent protection and therefore only available from one supplier. However the patent
expired and another producer entered, reducing the market power of NutraSweet.
Buyers can be considered at the customer or the retail level. For consumers, taste will be an
important part of the preference for a particular soft drink; thus although there is no
monetary switching cost, there may be a loss of enjoyment associated with a less-preferred
brand. Because of this, consumers have historically been brand-loyal and not based
purchase decision on price.
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Retail outlets have not been able to exhibit much buyer power over the industry, although
they can do more easily than consumers. Traditionally these outlets have been fragmented
and have been reliant on the major soft drink brands to increase store traffic. However, at
the time of the case there has already been evidence of some buyer power on the part of
grocery stores, as they successfully resisted an attempt to price the varieties with more
costly inputs higher. As grocery chains increasingly consolidate and as discount outlets
continue to grow, buyer power on the part of retailers is likely to increase.

Substitutes
While the U.S. soft drink market was growing, substitutes did little to interfere. Soft drinks
are sufficiently unique that when a consumer wants a soft drink another product is not likely
to satisfy. Other cold drinks such as water, juices and ice tea offer similar refreshing
qualities, yet they do not have the same taste properties. Hot beverages and alcoholic
beverages are not desirable or appropriate for many of the occasions when one would want
a soft drink. The one category that threatens soft drink producers is the new age product,
which offers more natural ingredients and/or health benefits. The soft drink industrys initial
answers to these beverages, in the form of Tab Clear and Crystal Pepsi, are not going to
compete effectively.

Entry
Significant barriers exist to entering the soft drink industry. Bottling operations have a fairly
high minimum efficient scale and require fixed assets that are specific not only to the
process of bottling but also to a specific type of packaging. Exit costs are thus also high.
Bottling operations do exist which in theory could be contracted out, but they are tied up in
a long-term contracts with the major players and thus can only contract with other
producers in a limited way. Perhaps the most significant barrier to entry is the strong brand
identity associated with the best-selling soft drinks. Placing another cola on the market is not
an attractive value proposition.




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Internal rivalry
The concentration in the industry (Coke and Pepsi have 73% market share in 1994) would
suggest that internal rivalry is somewhat less than if there were many players of equal size.
Although the competition between Coke and Pepsi has become fiercer over time, they
traditionally competed primarily on advertising, promotion and new products rather than
price. The products are similar but not homogenous and buyers are fairly brand loyal. Retail
buyers have significant costs for switching from the major brands since those are responsible
for bringing people into the store. Flattening and potentially declining U.S. demand may be a
factor, which increases internal rivalry and encourages more price competition and thus
erosion of profits.

The greater profitability of concentrate producers over bottlers
The concentrate producers are in the most advantageous positions relative to Porters Five
Forces. Their suppliers are the commodity producers mentioned earlier and have little
power. They enjoy protection from the barriers to entry, which result from high fixed costs
and MES associated with bottling, yet their own fixed asset base is quite low and so they are
removed from the resulting asset specificity and exit costs. Concentrate is the substance,
which makes the resulting soft drink what it is, so there is no good substitute for the bottlers
who purchase the concentrate. The bottlers could switch to another brand, but because of
territorial limits the major concentrate producers have been allowed to impose, the bottler
could not easily switch to an analogous product of the competitor, as there is probably
already another bottler in the region producing it. Smaller concentrate producers with less
brand identity will not be able to supply concentrate for a product that can generate the
same sales volume, so these are no good substitutes. Bottlers can exert some buyer power,
since they provide an asset that is specific to a given geographic area. It would be costly for
the concentrate producer to reproduce this and is the reason the bottler exist as an
independent entity in the first place. There are many bottlers and few concentrate
producers, and the function of the bottler can be easily imitated, while Coke and Pepsi are
unique. Thus the concentrate producers have monopoly power over their brand, while the
bottlers are providing a commodity service and this difference results in the different profits
each player is able to generate.

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Is vertical integration a promising way?
The structure of the current contracts, particularly the feature of territorial exclusivity,
makes the relationship between concentrate producers and bottlers fairly vertical already.
Because bottlers do not compete with one another, they are free to cooperate as if they
were part of the company. Evidence of this is found by the example of bottlers, which can
afford to adopt packaging innovations providing the product to nearby bottlers that cannot.
On the other hand, under current contracts bottlers are allowed to choose production of a
competitors non-cola product over the analogous franchise product, complete vertical
integration would ensure that bottlers produced only the products of the owner. The answer
to whether the ownership of bottlers is necessary is not obvious and this is evidenced by the
fact that concentrate producers went through several cycles of buying and selling their
bottlers.

Conclusion
Higher level of geographical expansion, with special focus on fast growing markets in Asia
could be a viable strategy. Consumption of CSD in China is 22, India 6 and USA 874 (8 oz per
capita). These figures tell us that there is a lot of potential in these markets. To achieve that
Coke/Pepsi would have to invest more on marketing activities and increase production in
these countries. Especially Pepsi should penetrate to markets where Coca Cola is weak in
sales by using domestic marketing campaign with local celebrities.
The world is becoming much healthier conscious and consumers are tending to get away
from carbonated drinks. Therefore non-carbonated with cola taste could be developed.
Nobody would deny an energy drink such as Gatorade with cola taste. Proofs for that
recommendation are Haribo sweets that have cola flavor in cola bottle form.
To engage in a new cola war is actually beneficial for both companies because cola wars
have been successful for Pepsi and Coca-Cola in the past, because they draw attention to the
products and they will likely do so again.