Mr.

Pepsi Case

Comm 491 Section 105

PepsiCo, Inc.: USA Division - Case

PepsiCo, Inc. is one of the leading soft drink manufacturing companies in the world with market share of 30.8% in 1987, second only to the Coca-Cola Company who captured 39.9% of the market in that same year. PepsiCo Worldwide Beverages is separated into three functional business lines: Pepsi USA, Pepsi Bottling Group (PBG) and Fountain Bottling Group (FBG). Each company performs a separate, yet important role for the Pepsi Company. However, due to culture clashes and misaligned goals between the three companies, a reorganization of the company's business lines is required to ensure continued strong performance into the future.

Pepsi-USA, considered the flagship branch of PepsiCo, has an elitist attitude in regards to the other divisions of PepsiCo, which leads to an inefficient competitive environment and results in ineffective cost decisions. The overall company objectives have become secondary to the goals of the individual divisions. This competitive environment, however, also leads to increased efficiency and innovation which offsets some of the inefficiencies. The separation of PBG and bottlers at the local level also means that decisions must go up through the entire organizational chain of command, which leads to slow and unproductive decision-making.

We believe we need to find a good solution to the internal organizational structure, yet also be mindful of prevailing market conditions. Therefore, we will first analyze the present market conditions by using Porter's Five Forces Model. Next, we will look at vertical integration possibilities for concentrate producers and bottlers and why bottlers are given certain perpetual rights. After this comprehensive market analysis, we will compare the possible solutions for the present Pepsi situation and suggest the optimal strategy for PepsiCo.

1. Five Forces Analysis

1.1 Internal Rivalry

PepsiCo is situated in an oligopolistic market, dominated by itself and Coca-Cola. Together they represent over 70% of the US soft drink market. Due to this market structure, it should theoretically be easier to maintain price coordination between the two main firms. Nonetheless, intense non-price differentiation exists in this market, mainly through large-scale advertising campaigns.

Pepsi and Coke control big proportions of the market due to the strength of their brand images. Many consumers are loyal to one brand or another for various reasons. Coke's sense of nostalgia and Pepsi's drive to link itself to "being young" are campaigns that carry a lot of brand equity, creating immense barriers to entry for potential entrants. Furthermore, the soft drink market has already matured, leaving little room for new entrants to produce enough soft drinks to attain economies of scale and learning curve efficiencies.

1.2 Barriers to Entry

The soft drink industry is very capital intensive. A company that wants to enter the soft drink market will need to start plants and acquire machinery so that they can produce the soft drink concentrate. They will also need to either bottle and distribute their own drinks or find bottlers to distribute the drinks to buyers. Such a large and extensive network is hard to develop and it would be costly for entrants to build a network to enter the market. Considering all these facts, it is obvious that PepsiCo has very large economies of scale. An incoming firm will not be able to achieve such economies of scale at least in the short-medium run. Other than fixed capital, PepsiCo also has high brand recognition in the market. Such brand equity prevents new entrants from capturing market share. Even though PepsiCo has made it difficult to enter the market, specialty soft drink producers that target regional niche markets may have some success because they could know the market better than PepsiCo and provide these niche markets with better value for their money. The best example of such a company is Jones Soda.

1.3 Substitutes

There are many substitutes to soft drinks such as bottled water, specialty sodas (ex. Dad's Root Beer, Jones Soda), sports drinks and energy drinks, and juices. Because of this fact, the prices of Pepsi and other soft drinks are affected.

1.4 Buyer/Supplier Power

The main purchasers of bottled Pepsi are supermarkets, who have reduced in number and increased in size (increased concentration of buyers) in recent years because of mergers and acquisitions. This has caused bottled beverage prices to consistently decline. The buyer market for fountain drinks is relatively powerful. Despite the fact that individual fast food stores are plentiful, they are owned and operated by a small number of national firms (i.e. Pizza Hut, Burger King, Taco Bell, etc.) who coordinate the purchasing for individual stores.

The suppliers (i.e.: water, coloring, sugar) of soft drink producers are relatively powerless due to high degree of competition within their own industry (lower concentration than PepsiCo's market). This would result in lower cost inputs for PepsiCo and its rivals within its industry.

Vertical Integration Strategies

Concentrate producers have an incentive to buy bottlers for several reasons. Distribution of the soft drink concentrate through the market would be made efficient, as different bottlers would distribute the product to their respective territories. Concentrate producers would also save the time spent looking for different bottlers while saving transaction costs as well. They would also have full control of the bottling operations and therefore could control the quality and efficiency of production. Since there is most likely a learning curve involved for the bottling employees, concentrate producers would only have to train their in-house bottling staff once instead of employees of different bottlers each time. Most importantly, purchasing upstream firms such as bottlers could ensure coordination in the vertical chain. All of these advantages could ultimately lead to achievement of economies of scale.

Bottlers are given the right to distribute Coca-cola or PepsiCo in perpetuity mainly because both parties will be able to save on transaction costs. Neither