Coke vs Pepsi, 2001

  • View
    3.754

  • Download
    23

Embed Size (px)

Text of Coke vs Pepsi, 2001

Alaa Mehsen

1

The carbonated soft drinks' (CSD's) sector is dominated by

three major players: Coke is dominant company of the soft drink industry and boasts a global market share of around 44%, followed by PepsiCo at about 31%, and Cadbury Schweppes at 14.7%. Separately from these major players, smaller companies such as Cott Corporation and Royal Crown form the remaining market share. Coke and Pepsi are the main pieces of this market. They struggle for over a century to conquer the number one position in the market, competing fiercely in last few years, following each one's strategic decisions.2

The industry of CSD's is composed by concentrate

producers (CP's), bottlers, retail channels and suppliers. Nevertheless, the main players in such industry regarding production and pricing are the first two. Both CP's and bottlers are profitable. While CP's are responsible for mixing raw materials, bottlers purchase the concentrate from CP's and add carbonated water and high fructose corn syrup, bottling or canning the CSD after. Therefore, both have an interdependent form of operating, sharing costs in procurement, production, marketing and distribution. In this case, the industry is similar to a vertically integrated one. In fact, bottlers are obliged to buy the concentrate from CP's if they want to produce. They also deal with similar suppliers and buyers.3

Although there are only three major players in this industry (Coca ola Company, C PepsiCo and Cadbury Schweppes), the easiness of entry and exit does not constitute any threat for them. Barriers to entry: It would be very difficult for a new company to enter this industry because they would not be able to compete with the established brand names, distribution channels, and high capital investment. Through their Direct Store Door (DSD) practices, these companies have close relationships with their retail channels and are able to defend their positions effectively through discounting or other tactics. So, although the CP's industry does not require a vastly investment, entering in the bottler sector would require substantial investment dissuading, therefore, the entry. The regulatory approval of intrabrand exclusive territories, via the Soft Drink Interbrand Competition Act of 1980, ratified these exclusive territories of distribution, making it impossible for new bottlers to get started in any region where an existing bottler operated. Barriers to Exit: Leaving this industry would be difficult due to the significant loss of money from the fixed costs, requiring contracts with distribution channels, and advertisements used to create the strong brand images. This industry is well established already, and it would be difficult for any company to enter or exit successfully.

4

The substitutes for "colas" are those that are not in the carbonated soft

drink industry. Such substitutes are bottled water, sports drinks, coffee, and tea. Over time such beverages are becoming more popular. It is also very cheap for consumers to switch to these substitutes making the threat of substitute products very strong. Coke and Pepsi responded to these pressure by diversifying their portfolios, through partnerships (e.g. Coke and Nestea), acquisitions (e.g. Coke and Minute Maid), and internal product innovation (e.g. Pepsi creating Orange Slice), capturing the value of popular substitutes internally. Rise in the number of brands did threaten the profitability of bottlers. But in the last few years, they were able to increase investment in innovation and R&D in order to improve the efficiency of a more complex production and distribution. Bottlers were also able to surmount these operational challenges by achieving economies of scale. Overall, diversification processes reduced the threat of substitutes.

5

In CSD's industry's suppliers do not have much competitive

pressure. The inputs for Coke and Pepsi's products are primarily sugar and packaging. Sugar can be purchased from many suppliers, and the companies can easily switch to corn syrup if it becomes too expensive (e.g. 1980's to lower de bottling costs). Therefore, Coke and Pepsi and their bottlers have highly bargaining power. Given the importance of cans in cost structure, bottlers and CP's often maintained relationships with more than one supplier reducing their power. The excess of input suppliers in the market led, sometimes, to intense competition to obtain a single contract.6

The soft drink industry sells to consumers through five channels: food stores (34.8%), convenience and gas stations (8.5%), fountain (23.1%), vending (13.5%) and mass merchandisers (20.1%). Supermarkets were a highly fragmented industry. These stores counted on soft drinks to generate consumer traffic, so they needed Coke and Pepsi products. Therefore, there were important negotiations in order to determine the best shelf space needed to every product. Nevertheless, due to the high number of supermarket chains, these stores did not have much bargaining power, except the power over shelf space. In this case, Pepsi and Coke would start competing for the best space in the shelf. Both of them wanted their products to be visible for the consumer in order to generate higher sales volume. Furthermore, consumers expected to pay less through this channel, so prices were lower, resulting to some extent in lower profitability. National mass merchandising chains (e.g. Wal-Mart) and discount stores had more bargaining power because they bought large volumes of the soft drinks, allowing them to buy at lower prices. Restaurants had less bargaining power because they do not order a large volume. However, this channel was relatively less profitable for soft drink producers. The least profitable channel for CSD's was fountain sales. In fact, buyers at major fast food chains only needed to stock the products of one manufacturer, establishing an exclusivity contract with one of the brands (Pepsi vs. Coke) and thus negotiating for an optimal price. Coke and Pepsi found these channels important, however, as a way to build brand recognition and loyalty, so they invested in the fountain equipment and tableware that was used to serve their products at these outlets. Nevertheless, Coke and Pepsi gained only 2% margins. Vending was far beyond, the most profitable channel for the soft drink industry. Coke and Pepsi were able to sell directly to consumers through machines owned by the bottlers, setting high prices. Finally, in convenience stores and gas stations bottlers also had many profits (about $0.69 per case in 2000) due to the establishment of high sales price. It is important to mention that the only buyers with more significant power were fast food outlets. Therefore, industry enjoyed substantial profitability because of limited buyer power. However, with the number of people are drinking less soft drinks, the bargaining power of buyers could start increasing due to decreasing buyer demand.

7

This industry is highly concentrated. Therefore, profits are

also extremely concentrated in this industry. Together Coke and Pepsi present a concentration ratio of 75.5%. By the same assumption the top three drink companies controlled about 90.2 % of the market,. In other perspective, by the Herfindahl index the degree of concentration was about 0.315. In fact, one could characterize the soft drink market as an oligopoly since this ratio is between 0.2 and 0.6, or even a duopoly between Coke and Pepsi, resulting in positive economic profits. There was tough competition between Coke and Pepsi for market share, and this occasionally weighed down profitability. In the last few years, due to the reduction of CSD's consumption, the competition between companies has gone fiercely.8

9

Given the information that we were able to gather by analysing

the five forces of Porter's model regarding the CSD's industry, we can now state that this is, in fact, an industry with stable profits. Despite of its intense pressure, mainly, between Coke and Pepsi, the industry is not affected by the buyers, suppliers, substitutes or even by potential entrants. They do not represent a threat to the already established companies. As we mentioned before, buyers and suppliers have few bargaining power, and with the diversification process undertaken by Pepsi and Coke diminished the pressure from substitutes. Also, new entrants are not willing to enter this industry given the intense competition and initial costs required. The existent companies have been operating in the market for more than one century, which represents an advantage over the knowledge of the new entrants.10

When we give a closer look to the CSD's industry, it's easy to define who the major companies in the market are. The consumer very well knows Coke and Pepsi. Not only are they responsible for producing very similar products but also for competing fiercely in a range of diversified markets. The structure of the CSD's market is anchored in these two companies due to its high level of concentration. When combined, Pepsi and Coke hold about 75.5% of market share. There are other CP's in this industry but their limited influence in the market has no strategic effects over the industry. The rivalry between these two giants started for more than a century ago and it is here to last. This as been a period of continuous struggle where every step of one of the companies was carefully waged by its opponent. Nevertheless, competition between Coke and Pepsi was seen as a way to sharply improve the procedures in which each one of them operated. Putting in other words, the existence of a direct competitor led these companies to fight every day for being the best in the market. Therefore, and associated to the arising consumption of CSD's in the U.S and worldwide in 1975-1995, both Peps