Cola Wars Continue: Coke and Pepsi in 2010

Historically, the soft drink industry has been profitable due to continuous expansion
of the total pie. Coke and Pepsi kept each other on the edge in spite of fierce
competition each achieved about ten percent annual revenue growth as the
worldwide consumption of Carbonated Soft Drink increased. There was a generally
rising demand which can be attributed to an increase in the number of flavors &
variety and declining real prices (due to economies of scale being achieved) and
partly to heavy promotions, marketing and advertising by concentrate producers
and bottlers. Also the soft drink industry has established an unmatched distribution
network, making their product readily available anywhere, hence increasing the
topline, which leads to increasing the profits.
Further, there wasnt much bargaining power of suppliers. For packaging they made
up the largest consumers in metal can industry, threatened with integration and as
metal cans are a commodity and various manufacturers competed for the similar
contract, they had low switching costs. Though substitutes were available,
Americans drank a lot of soda. The main competition was between just these two
players as they made up most of the market share. Threat of new entrants was low
due to Capital intensive, advertising, promotion, market research cost, brand loyalty
to the existing brands and court barring Concentrate Business:
-

Concentrate manufacturing process involved relatively little capital

investment in machinery, overhead or labor.
A typical concentrate manufacturing plant, which could cover a
geographic area as large as the US , costs between $50 million to $100
million to build.
Significant costs were for advertising, promotion, market research and
bottler support.

a. Bottling Business:
- This business was capital intensive and involved high speed production
lines.
- Bottling and production lines cost from $4 million to $10 million each,
depending on volume and packaging type (cost of facility with capacity 40
million cases was $120 million)
- Main cost components were concentrate and syrup. Other significant
expenses included packaging, labor, and overhead.
- Gross Profits were high (only absolute terms on per case basis) but
operating margins were thin due to expenses such as selling and
distribution.
The concentrate producers and the bottling plants had a symbiotic relationship
since the concentrate producers depended on the bottlers for the end product to
reach the customers, also the bottlers revenues depended on how much the
concentrate producers were spending on average on advertising. Overall, the
concentrate producers had much more power than the bottlers in this relationship
as is evident from the size of these players, and the Bottler Contracts

What is remarkable to see here is that even though there was price cutting in some
cases, i.e. Pepsi launching at half the price of Coke during the 70s, the profitability
in not only absolute terms but %terms has increased for both Pepsi as well as
Coke(ref exhibit 3a). This is mainly because healthy competition developed the
market for both these CSD majors driving their sales up, helping them build
economies of scale, and even while lowering prices, making better profits.
Coke and Pepsi infact created a duopoly kind of situation by the 80s driving away
small players, by securing tie ups with bottling plants and other key stakeholders
like fountain outlets.

To answer this question, it is imperative to understand why the demand is falling. It

is mainly because of rising health concerns among the consumers of the products.
Also, the demand is falling for CSDs in general, and not particularly for these 2
giants.
Both Coke and Pepsi have infact taken some steps in this direction going
aggressive in new geographies (Coke going bullish on India and China), investing in
complementary businesses where economies of scope could be leveraged like
packed foods, and experimenting with new localized beverage flavors (Coke coming
out with diet coke and Pepsi buying/distributing Gatorade and Lipton).
Also, we see there has been a recent consolidation of the bottling plants. Coke and
Pepsi should realize that though their core business at this point in time lies in
CSDs, they have built unique networks over the years with bottlers giving them
access to an amazing distribution network. (Cokes distribution network in India
reaches the remotest hilly areas and villages where even electricity, or municipal
facilities havent yet reached.) They can then perhaps perceive themselves to not
strictly be in the CSD business but in an FMCG business with a focus on beverages.
The drop in CSDs market share has been captured by categories such as bottled
water and non-carbs. Both these giants should focus on diversifying in these
categories.
Infact, they have already taken steps in this direction by investing in bottled water
category (Aquafina Pepsi, Dasani - Coke) and energy drinks (Pepsi - Gatorade), and
Juices (Minute Maid Coke).
Also, we believe that in the kind of situation right now, Coke and Pepsi should cooperate which is also one of the aspects of strategic behavior through which a firm
can improve its competitive outcomes (according to game theory) to probably fund
campaigns to suggest/lobby against higher taxes on sugary carbonated drinks etc.