Cola Wars Continued – Coke vs. Pepsi in 2006

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Cola Wars Continued – Coke vs. Pepsi in 2006

Reading the case, special attention should be paid to the underlying economics of the soft drink industry and its relationship to average profits, the relationship between the different stages of the value chain in the industry, the relationship between competitive interaction and industry profits, and the impact of globalization on industry structure.

While preparing the case, you should start by carefully characterizing the carbonated soft drink industry. To do this, clearly specify Coke and Pepsi’s market in the value chain of the industry, their main suppliers and main buyers.

Both concentrate producers (CP) and bottlers are profitable. These two parts of the industry are extremely interdependent, sharing costs in procurement, production, marketing and distribution. Many of their functions overlap; for instance, CPs do some bottling, and bottlers conduct many promotional activities. The industry is already vertically integrated to some extent. They also deal with similar suppliers and buyers. Entry into the industry would involve developing operations in either or both disciplines. Beverage substitutes would threaten both CPs and their associated bottlers. Because of operational overlap and similarities in their market environment, we can include both CPs and bottlers in our definition of the soft drink industry. In 1993, CPs earned 29% pretax profits on their sales, while bottlers earned 9% profits on their sales, for a total industry profitability of 14% (Exhibit 1). This industry as a whole generates positive economic profits.

Then answer the following questions.

1.Why is the soft drink industry so profitable?

Answer: Answer lies in viewing industry through the lens of competitive forces at play. While competition in the industry is fierce, there are relatively few players and other competitive forces are weak or have been reshaped by dominate industry players.

(i) Established Rivals: Low – Industry dominated by two companies and handful of niche players (i.e. Cadbury Schwepps / Doctor Pepper).
(ii) Customer Power: Low – Although there is choice, the customer base outside of fountain drinks is dispersed and therefore have limited to no clout in negotiating lower prices.

(iii) New Entrants: Low – New entrants are deterred by high capital investments in bottling, distribution and enormous marketing budgets of existing players.

(iv) Substitute Offerings: High but actively reshaped to Low – However, Soft drink vendors reshape this force by improving availability and convenience of acquiring their products through vending machines, fountain sales and convenience channels. In recent years, soft drink vendors have diversified into new products that threaten to take share away from traditional sugar sodas, (diet soda, fruit juices, bottled water).

The soft drink industry sold to consumers through five principal channels: food stores, convenience and gas, fountain, vending, and mass merchandisers (primary part of “Other” in “Cola Wars…”case). Supermarkets, the principal customer for soft drink makers, were a highly fragmented industry. The stores counted on soft drinks to generate consumer traffic, so they needed Coke and Pepsi products. But due to their tremendous degree of fragmentation (the biggest chain made up 6% of food retail sales, and the largest chains controlled up to 25% of a region), these stores did not have much bargaining power. Their only power was control over premium shelf space, which could be allocated to Coke or Pepsi products. This power did give them some control over soft drink profitability. Furthermore, consumers expected to pay less through this channel, so prices were lower, resulting in somewhat lower profitability. National mass merchandising chains such as Wal-Mart, on the other hand, had much more bargaining power. While these stores did carry both Coke and Pepsi products, they could negotiate more...
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