Cola Wars

Principles of Strategy

Case Study 1 - Cola Wars

16.11.2004

1. Why is the soft drink industry so profitable?

The US soft drinks (including but not limited to wine, tea, coffee, milk & beer) annual consumption of gallons per capita grew from a sum of 114.5 in the year 1970 to a sum of 153.6 in the year 2000. Out of this, the annual consumption of gallons per capita of CSDs grew from a sum of 22.7 in the year 1970 to a sum of 53 in the year 2000 which reflects a growth of 230% of the consumption of these drinks. The production and distribution of CSDs involves four major participants: 1) Concentrate producers that the process of their job involves little capital investment where only one plant is enough to serve the entire US. 2) Bottlers that in spite the fact that their operating margins were razor thin their profits often exceeded 40% 3)Retail channels 4) Suppliers. The US soft drink market share of Coca Cola Company (hereto "Coke") and PepsiCo Inc. (hereto "Pepsi") grew from 53.8 % in the year 1970 to 75.5% in the year 2000. From this fact we can learn that the soft drink industry structure is a structure of two dominant firms holding the market power and a competitive fringe with many smaller firms acting as price takers. The above mentioned data regarding the soft drink market & industry in the US could explain why this industry is so profitable. However, we can understand better the reason for the industry being so profitable by analyzing the industry with Porter's five forces model.

1) Customers - as shown above, the consumption of soft drinks has a tendency of rising through the years. Due to the character of the soft drink as a product and the basic need it fulfills, the customers of this market are fragmented, meaning there are a lot of them and no buyer has any particular influence on the product's price. Another factor regarding the customers in the market is the distribution channels of the product that include supermarkets, discount retailers, warehouse clubs, drugstores, vending machines and fountains in restaurants, hotels or any other public place that sells soft drinks such as theme parks. Coke & Pepsi used their advantage as dominant firms in the industry to "take over" the distribution channels or at least get better terms then the other producers in the industry and by that they gained power over the customer in determining the prices of the products. Coke & Pepsi fought for shelf space in supermarkets to ensure visibility and accessibility for their products and created new locations such as placing coolers at checkout counters to increase impulse purchases. In the fountain area, the companies invested in the development of fountain equipment, such as service dispensers, cups and other point of sale material for advertising and promotion. This "take over" also got to a point where Pepsi purchased Pizza Hut, Taco Bell and KFC and naturally became their sole supplier of soft drinks. These purchases led of course to agreements between Coke and McDonald's, Burger King and Wendy's. Another example is in the vending machine channel where Coke & Pepsi paid sales commission to owners of property on which vending machines were located.

2) Suppliers -The suppliers of the inputs for the production of the soft drinks are divided into two: 1) The suppliers for the concentrate producers - they supply caramel coloring, phosphoric and/or citric acid, natural flavors, and caffeine. 2) The suppliers for the bottlers - they supply two major inputs. The first input is sweeteners that include sugar, high fructose corn syrup and artificial sweetener. The inputs supplied for the concentrate producers and the different sweeteners are very basic and have many competitive suppliers, a fact that gives the producers power in bargaining for the purchase terms of these products. The second input for the bottlers are packages, which include aluminum cans (60%), plastic bottles (38%) and glass bottles (2%). As specified in the case, Coke and Pepsi negotiated on behalf of their bottling networks and were among the metal can industry's largest customers. This fact along with the fact that there were usually two or three can manufacturers competing for a single contract gave the power in the industry to Coke and Pepsi over their suppliers.

3) Established Rivals - As mentioned above, the soft drink industry is an industry with high concentration with two dominant firms (Coke & Pepsi) holding a large market share. This kind of industry structure could also be defined as a duopoly due to the two rivals being very competitive with each other in a way that every rival acts in a way that elicits a counter response by the other rival. One example is the transition from a single product strategy to a strategy that involved new cola, non cola flavors and a variety of packaging options in the 1960's. A similar transition occurred also in the 1980s when both Coke and Pepsi offered more then ten major brands, using at least seventeen containers and numerous packaging options. Another example and a more specific one was the launch of Pepsi's "Pepsi Challenge" campaign. Coke reacted to this campaign by rival claims, retail price cuts and a series of advertisements questioning the tests involved in the campaign. Although these actions of the two rivals consisted of a lot of money, it can be seen that along the years these rivalry actions not only didn't hurt any of the two companies but also enlarged both companies share in the soft drinks market on the expense of other producers.

4) Substitutes - Porter's model refers to substitute products only in other industries such as the non carbonated drinks in our case. The shift in trends from carbonated drinks to non carbonated drinks did not hurt the two companies that vigorously expanded their brand portfolios. This expansion was made by the acquisition of different brands, alliances with different brands and the launching of new products. By the end of this expand both companies had in their portfolio the leading brands in sports drinks (Gatorade by Pepsi, PowerAde by Coke), Ice Tea Drinks (Lipton by Pepsi, Nestea by Coke), bottled water (Aquafina by Pepsi, Dasani by Coke) and orange juices (Tropicana by Pepsi, Minute Maid by Coke). This expantion prevented the companies from losing due to the shift in trends and even improved their market share of the soft drinks.

5) Potential Entrants - Due to the fact that the soft drink industry is controlled by the two very dominant companies Coke and Pepsi, every company would find it very hard to enter the soft drink