Coca-Cola Vs. Pepsi

Introduction

The carbonated soft drinks' (CSD's) sector is dominated by three major players: Coke is dominant company of the soft drink industry and boasts a global market share of around 44%, followed by PepsiCo at about 31%, and Cadbury Schweppes at 14.7% (Exhibit 3). Separately from these major players, smaller companies such as Cott Corporation and Royal Crown form the remaining market share.

Coke and Pepsi are the main pieces of this market. They struggle for over a century to conquer the number one position in the market, competing fiercely in last few years, following each one's strategic decisions.

Nevertheless, something seems to threaten the profitability of these two giants. The increasing share of non-carbonated soft drinks seems to be able to decrease the high margins that once ruled in the CSD's industry. In this sense, what will the future of Coke and Pepsi be? How will Concentrate Producers (CP's) and bottlers face this new challenge?

In this assignment it's our intent to discuss the economics behind this situation. We will start by analysing the profitability within the soft drink industry; the differences between CP's and bottlers' profitability and, in the end we will explain the main consequences of competition between this two giants over the industries profitability. To conclude this work, we will also discuss the future of Pepsi and Coke regarding the non-carbonated soft drink industry.

The facts behind the soft drink industry profitability

In order to understand the levels of profitability in the soft drink industry we need to determine what main forces are affecting the industry's structure. These forces allow to determine the intensity of competition and hence the profitability and attractiveness of an industry.

The U.S. Carbonated Soft Drink Industry

The industry of CSD's is composed by concentrate producers (CP's), bottlers, retail channels and suppliers. Nevertheless, the main players in such industry regarding production and pricing are the first two. Both CP's and bottlers are profitable. While CP's are responsible for mixing raw materials, bottlers purchase the concentrate from CP's and add carbonated water and high fructose corn syrup, bottling or canning the CSD after. Therefore, both have an interdependent form of operating, sharing costs in procurement, production, marketing and distribution. In this case, the industry is similar to a vertically integrated one. In fact, bottlers are obliged to buy the concentrate from CP's if they want to produce. They also deal with similar suppliers and buyers. As shown in Exhibit 5, in 2000, a typical U.S. CP earned 35% pretax profits on their sales, while a typical bottler earned only 9% profits, which meant that the industry is able to generate positive economic profits.

Threat of Potential Entrants

Although there are only three major players in this industry (Coca -Cola Company, PepsiCo and Cadbury Schweppes), the easiness of entry and exit does not constitute any threat for them.

Barriers to entry: It would be very difficult for a new company to enter this industry because they would not be able to compete with the established brand names, distribution channels, and high capital investment. Through their Direct Store Door (DSD) practices, these companies have close relationships with their retail channels and are able to defend their positions effectively through discounting or other tactics. So, although the CP's industry does not require a vastly investment, entering in the bottler sector would require substantial investment dissuading, therefore, the entry. The regulatory approval of intrabrand exclusive territories, via the Soft Drink Interbrand Competition Act of 1980, ratified these exclusive territories of distribution, making it impossible for new bottlers to get started in any region where an existing bottler operated.

Barriers to Exit: Leaving this industry would be difficult due to the significant loss of money from the fixed costs, requiring contracts with distribution channels, and advertisements used to create the strong brand images. This industry is well established already, and it would be difficult for any company to enter or exit successfully.

Threat of Substitute Products

The substitutes for "colas" are those that are not in the carbonated soft drink industry. Such substitutes are bottled water, sports drinks, coffee, and tea. Over time such beverages are becoming more popular. It is also very cheap for consumers to switch to these substitutes making the threat of substitute products very strong. Coke and Pepsi responded to these pressure by diversifying their portfolios, through partnerships (e.g. Coke and Nestea), acquisitions (e.g. Coke and Minute Maid), and internal product innovation (e.g. Pepsi creating Orange Slice), capturing the value of popular substitutes internally. Rise in the number of brands did threaten the profitability of bottlers. But in the last few years, they were able to increase investment in innovation and R&D in order to improve the efficiency of a more complex production and distribution. Bottlers were also able to surmount these operational challenges by achieving economies of scale. Overall, diversification processes reduced the threat of substitutes.

Bargaining Power of Suppliers

In CSD's industry's suppliers do not have much competitive pressure. The inputs for Coke and Pepsi's products are primarily sugar and packaging. Sugar can be purchased from many suppliers, and the companies can easily switch to corn syrup if it becomes too expensive (e.g. 1980's to lower de bottling costs). Therefore, Coke and Pepsi and their bottlers have highly bargaining power. Given the importance of cans in cost structure, bottlers and CP's often maintained relationships with more than one supplier reducing their power. The excess of input suppliers in the market led, sometimes, to intense competition to obtain a single contract.

Bargaining power of Buyers

The soft drink industry sells to consumers through five channels: food stores (34.8%), convenience and gas stations (8.5%), fountain (23.1%), vending (13.5%) and mass merchandisers (20.1%).

Supermarkets were a highly fragmented industry. These stores counted on soft drinks to generate consumer traffic, so they needed Coke and Pepsi products. Therefore, there were important negotiations in order to determine the best shelf space needed to every product. Nevertheless,