Barriers to Entry and Bargaining Power

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Chapter 2
Chapter 2

Strategy Analysis

2. What are the critical drivers of industry profitability?

Rivalry Among Existing Firms. The greater the degree of competition among firms in an industry, the lower average profitability is likely to be. The factors that influence existing firm rivalry are industry growth rate, concentration and balance of competitors, degree of differentiation and switching costs, scale/learning economies and the ratio of fixed to variable costs, and excess capacity and exit barriers.

Threat of New Entrants. The threat of new entry can force firms to set prices to keep industry profits low. The threat of new entry can be mitigated by economies of scale, first mover advantages to incumbents, greater access to channels of distribution and existing customer relationships, and legal barriers to entry.

Threat of Substitute Products. The threat of substitute products can force firms to set lower prices, reducing industry profitability. The importance of substitutes will depend on the price sensitivity of buyers and the degree of substitutability among the products.

Bargaining Power of Buyers. The greater the bargaining power of buyers, the lower the industry’s profitability. Bargaining power of buyers will be determined by the buyers’ price sensitivity and their importance to the individual firm. As the volume of purchases of a single buyer increases, its bargaining power with the supplier increases.

Bargaining Power of Suppliers. The greater the bargaining power of suppliers, the lower the industry’s profitability. Suppliers’ bargaining ability increases as the number of suppliers declines when there are few substitutes available.

6.  Coca-Cola and Pepsi are both very profitable soft drinks. Inputs for these products include corn syrup, bottles/cans, and soft drink syrup. Coca-Cola and Pepsi produce the syrup themselves and purchase the other inputs. They then enter into exclusive contracts with independent bottlers to produce their products. Use the five forces framework and your knowledge of the soft drink industry to explain how Coca-Cola and Pepsi are able to retain most of the profits in this industry.

While consumers perceive an intensely competitive relationship between Coke and Pepsi, these major players in the soft drink industry have structured their businesses to retain most of the profits in the industry by concentrating operations in its least competitive segments. Coke and Pepsi have segmented the soft drink industry into two industries—production of soft drink syrup and manufacturing/distribution of the soft drinks at the retail level. Moreover, they have chosen to operate primarily in the production of soft drink syrup, while leaving the independent bottlers with the more competitive segment of the industry.

Coca-Cola and Pepsi compete primarily on brand image rather than on price. They sell their syrup to independent bottlers who have exclusive contracts to distribute soft drinks and other company products within a specific geographic area. (While other syrup producers exist, they are typically regional and have very small shares of the market.) Given the large number of competing forms of containers for soft drinks (glass bottles, plastic bottles, aluminum cans, etc.), it is difficult for bottlers to earn any more than a normal return on their investment. Consequently, Coke and Pepsi can write exclusive contracts with bottlers prohibiting them from simultaneously bottling for a competitor. It is also difficult for independent bottlers to switch from Coke to Pepsi products, since there is likely to be an existing Pepsi bottler in the same geographic area. Consequently, independent bottlers have little bargaining power and Coke and Pepsi are able to charge them relatively high prices for syrup.

The threat of new entrants at the syrup level is restricted by limited access to adequate distribution channels and by the valuable brand names that have been...
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