Q1: 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.

Q2: 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.
Q3: 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.

Q4: 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.