Cola Wars

1. Why historically, has the soft drink industry been so profitable?

An industry analysis through Five Forces Model reveals that the market forces are favorable for the profitability:

a. Bargaining Power of Suppliers: Since the primary inputs for CSD industry are sugar, sweeteners, color and packaging (bottles and cans), the suppliers of these raw materials have less bargaining power against the concentrate producers (CPs) and bottlers.

i. Sugar: Sugar can be obtained from various sources on an open market and if price of sugar increases, the cola companies can easily switch to low price artificial sweeteners or high-fructose corn syrup. Though aspartame, used in diet beverages, gained the bargaining power for time-being while it was under patent protection

ii. Cans: With abundant supply of inexpensive aluminum in early 1990s, several can companies competed for the contracts. These can suppliers had the little bargaining power in controlling the prices. Concentrate Producers (CPs) further negotiated on behalf of bottlers, reducing the number of suppliers. By 2009, only Ball, Rexam, Crown Cork & Steal were major can suppliers.

iii. Plastic Bottles: Again there were more plastic bottle suppliers than the contracts, so direct negotiation by CPs reduced their bargaining power.

b. Bargaining Power of Buyers: The distribution of CSDs took place through five principal channels: Supermarkets (29.1%), fountain outlets (23.1%), vending machines (12.5%), mass merchandisers (16.7%) and convenience stores (10.8%). Overall the industry enjoyed profitability due to lower buyer bargaining power.

i. Supermarkets: End consumers have developed their loyalty to particular cola brands. Thus, to generate the store traffic, supermarkets needed Pepsi and Coke products. However, these supermarkets were highly fragmented and so didn't have high bargaining power except to charge premiums for providing the shelf space.

ii. Fountain Outlets: This was the least profitable channel for the CSD industry as buyers at the fast food chains could stock products of only 1 buyer giving them the power to negotiate the pricing. Further, these were the important channels for cola companies to develop brand equity and loyalty.

iii. Vending machines: This was the most profitable channel for the CSD industry ad there were no buyers to bargain at these locations. The companies can directly sell to consumers though the machines owned by the bottlers. The property owners were paid their sales commission based on the total sales at their property.

iv. Mass Merchandisers: Included discount retailers such as Walmart and Target, have more bargaining power as these stores can sell their own private label CSD or generic labels. Thus they could negotiate for prices and were less profitable for the CSDs.

c. Threats of New Entrants: With high competition it was nearly impossible for a new CP or new bottler to enter the market. Also, retailers enjoy high margins from these major players that new entrants have to pay significant high price to negotiate for the shelf space.

a. CPs: Pepsi and Coke have gained the strong brand recognition and loyalty through huge spending on advertising. They have developed strong relations with suppliers and the retailers and could easily defend themselves against potential new entrant.

b. Bottlers: Bottlers were tied in long term contracts with established brands and have exclusive defined territories for distribution. Over time they have grown so much that it would require substantial capital investment for the new bottlers to enter.

d. Threats of Substitutes: The major players in the CSD industry have sufficiently developed their brand loyalty and preferences through unique tastes, colors to consumers. However, other beverages such as bottled water, juices, beer, wines, milk, coffee, etc. tried to cause the threat to CSD. But Coke and Pepsi responded by expanding their offering through acquisitions of Minute Maid (Coke), Duncan Foods (Coke), Frito Lays (Pepsi), thus capturing the market for the substitutes. This reduced the threats from the substitutes.

e. Degree of Rivalry: With acquiring the US soft drink market share of 72%, Pepsi and Coke were the only major players and thus the revenues were extremely concentrated. These companies primarily competed on the advertising promotions and the new products rather than the price. There was enough competition to hamper the profitability of the industry.

2. Compare the concentrate business to that of the bottling business: Why is the profitability so different?

The concentrate business has always been more profitable than bottling business in CSD industry even though both address to the same end consumers and their actions are dependent on one another. The net profit as percentage of sales in 2009 for Pepsi and Coke concentrate business is 13.8% & 22% respectively whereas for the bottling business it is only 4.6% and 3.4% respectively. The reasons for the differences in profitability are:

a. Low Bargaining Power: The concentrate business enjoys the value of being branded and unique that is hard to replicate by other CPs. Thus, there are less CPs in the market. On the other hand, bottlers don't have any unique formulas and branded products. So the value provided by the bottlers is quite less. Because it is easy to replicate, bottling business has lot of competitors. Thus, the bargaining power of these bottlers is low against the CPs that reduces their margins.

b. Contractual Agreements: Because of the contractual liabilities, it is hard for the bottlers to switch to new territories as there may be other competitors in that region. These agreements also