Cola Wars: External Environment Analysis

Cola Wars: External Environment Analysis

Overview

After a long history of battling each other for soft drink industry supremacy in the so-called "cola wars" that have raged for decades, Coca-Cola (Coke) formulated in 1886, and Pepsi-Cola (Pepsi) formulated in 1893, have evolved into a consolidated industry. As buyers have become more sophisticated , basing their purchases more on brand loyalty rather than flavor or price, profit margins have become an important objective as these two firms struggle to differentiate their products from each other in the carbonated soft drink (CSD) business (Wheelen & Hunger, 2010, p. 114). Both companies continue to fight for increasingly larger shares of the world's CSD market and have both enjoyed steady year after year growth in average annual revenues followed by challenges resulting in flagging sales, operational setbacks, and changes in the consumer market place. Declining prices, a flood of new non-CSDs beverages, health concerns and new federal nutrition guidelines, demographic and lifestyle changes, bottling plant consolidations, efficiencies and technological improvements have all affected the economics of the CSD industry. Throughout this evolution however, both Coke and Pepsi have implemented similar competitive strategies, often mirroring each other, but aimed at increasing worldwide shares and increasing profits. "Consequently, they are strong rivals and are organized to operate similarly" (Wheelen & Hunger, 2010, p. 116).

Economics of Soft Drink Industry and Bottling Businesses

Historically the soft drink industry has been very profitable. "The most intense battles in the so-called cola wars were fought over the $66 billion carbonated soft drink (CSD) industry in the United States" (Yoffie & Slind, 2009, p. 1). In fact, from 1975 through the mid-1990s, Coke and Pepsi both enjoyed an average annual growth rate of 3% and revenues of around 10% (p. 1). Fueling the growth were the availability of CSDs through various retail channels, introduction of new beverages, and declining prices. U.S. beverage consumption rates from 1970 through 2004 show CSDs increasing from 22.7 gallons per capita to 52.3, respectively with beer being the next closest beverage consumed at a distant 21.6 gallons (Yoffie & Slind, 2009, Exhibit 1, p. 16). However, the economics of the concentrate and bottling businesses are vastly different. Indeed, according to the Financial Data for Coca-Cola, Pepsi-Cola, and Their Largest Bottlers provided in Exhibit 3 ( p. 18) of Yoffie and Slind's case study, a significant profit differentiation exists between concentrate producers (CPs) and the bottling businesses. Coke and Pepsi's net profits/sales are 22.1% and 14.4% respectively, whereas their bottlers, CCE and PBG, are 3.3% and 4.2% respectively. Likewise, per Exhibit 4's Comparative Costs of a Typical U.S. Concentrate Producer and Bottler, 2004 (p. 19), the CPs pretax profits are 30% per case as a percent of sales, whereas the Bottler's profits are 9%.

But why is the bottling business so much less profitable than the concentrates? According to Michael Porter, the level of competitive intensity in any given industry can be measured by basic competitive forces, where the stronger the force, the more limited the company is to raise prices and increase their profits (Wheelen & Hunger, 2010, p. 110). Thus, to better understand the economics between these two businesses, this paper will analyze the CSDs as compared to the Bottlers using Porter's Five Forces to reveal why the CSD industry has experienced such favorable profitability while the bottling business is so much less (Wheelen & Hunger, 2010, p. 110).

Threat of New Entrants

CSDs: A substantial factor leading to profitability in the soft drink industry, are the significant barriers that exist to entering the industry. Although the CP's costs are very low due to simplicity in the process and readily available raw materials, it would be nearly impossible for a new CP to enter the industry for several reasons. New CPs would need to overcome the tremendous marketing muscle and market presence of Coke and Pepsi. They have established brand names that are among the most recognized in the world. In 2004, Coke and Pepsi's combined share of the market was 66.8% with advertising expenditures nearing $1 million annually (p. 13 and Exhibit 8, p. 21). In fact, Coke's trademark and their 6.5 oz bottle "skirt" design are an American icon (p. 6). These companies also have mature distribution and sales practices, and intimate relationships with their retail channels. Retailers would experience significant costs for switching from the major brands since they are responsible for bringing customers into the store. Thus retailers would easily be able to defend their positions effectively through use of dominant shelf space, discounting and other tactics thereby dissuading them from carrying and selling new or substitute products.

Bottlers: Bottlers hold franchise contracts with CPs for exclusive territories to distribute their products in perpetuity. These contracts forbid bottlers from serving competitor's brands for similar products within their distribution and network channels, thus the markets are saturated for those territories. Indeed, regulatory approval of intrabrand exclusive territories, via the Soft Drink Interbrand Competition Act of 1980 (p. 4), ratified this strategy, making it impossible for new bottlers to get started in any region where an existing bottler operated.

Additionally, the bottling business requires substantial capital investment. Interchangeable high speed production lines with large capacity automated warehousing could cost as much as $75 million (p. 3). They also invest in trucks and distribution networks, preferring larger drop sizes to minimize delivery costs. They provide direct store delivery, secure shelf space, stack products, position trademark labels, set up point of purchase displays and hold cooperative agreements where retailers agree to promotions and discounts in exchange for payment or rebate.

Rivalry Among Competitors

CSDs: Ironically, the rivalry between Coke and Pepsi is relatively low. In 2004, Coke and Pepsi had a combined market share of 74.8% (Exhibit 2, p. 17) suggesting that internal rivalry is somewhat less than if there were many producers of equal size in the industry. Historically, Coke and Pepsi have competed in a way to benefit each other. According to Roger Enrico, former CEO of Pepsi: "I'm sure the folks at Coke would say that nothing contributes as much to the present-day