Business Analysis of the Bottled Water Industry in the UK

Environmental

Sea levels rise up to a third of an inch every year, with estimations of 1 to 2 feet over a century. Temperature is expected to rise by 3.6°C by 2100. Concerns about global warming and climate change are constantly increasing and the bottled water industry has to take this into consideration. The impact that the production of bottled water have on the environment does not help the industry in this regard. For one million bottled water consumed each year, 1.5 million barrels of oil are required to produce the plastic bottles, 100,000 megajoules is the energy required for manufacturing, and £187,000 is the cost of CO2e to manufacture plastic bottles. Needless to say that bottled water companies need to do something to reduce their impact on the environment. Some of the measures taken so far include: making lighter bottles, using PLA bottles -also said to do not pose recycling problems-, minimizing the carbon footprint of the packaging and reducing carbon emissions when producing the resin needed for the bottle. Also, using commercial composting to reduce organic waste and informing customers about the amount of greenhouse gases produced during the lifetime of the product are becoming more common. The switch from PVC to PET bottles already marked a step further for the industry for the protection of the environment, but other measures are now needed. Recycling is indeed still a major issue, as of the 13 billion plastic bottles bought in England in 2007, not even 3 billion were recycled.  

Legal

Until the 1970s, no specific regulation applied to the bottled water market. The general population started then to raise doubts about the health benefits of bottled water, the safety of the source and the labelling procedure used by bottled water companies. This lead the European Union to launch the EC Mineral Waters Directive (80/777/EEC), which only applied to natural mineral water, still nowadays the most regulated water of the market as well as the most drunk (78% of the respondents drink bottled water according to Mintel report). Such regulation is very strict in terms of labelling procedures, safety and protection of the source and limits for potentially toxic elements. Indeed, water must be bottled only at source to avoid contamination, only filtration and carbonation are permitted and must be reported on the labelling. No restrictions exist however on mineral content for these waters, as personal taste has been found to be a criterion for buying water. The EC Drinking Water Directive (98/83/EEC) regulates instead all other types of bottled water which must conform to all standards prescribed by the Food Standards Agency as well as to restriction on mineral content. Nevertheless, it is in the companies’ responsibilities to ensure that their bottled water is free from microbiological contaminants (once a week) and from physical, chemical, radiological contaminants (at least once a year). In the UK, water is classed as ‘food’ and is consequently subject to the Food Safety Act 1990.

The industry must however also comply with other regulation regarding the environment. The Control of Pollution Act 1974, the Environmental Protection Act 1990 and Environment Act 1995 which set up the Environmental Agency in charge of protecting the environment from flood and pollution have shown the commitment of the Government in protecting the environment for the own benefit of its citizens.

PORTER’S FIVE FORCES FRAMEWORK

Porter’s five forces framework is used to assess the attractiveness of industries by looking at the five forces of competition in a market or sector: the threat of entry, competitive rivalry, the power of buyers, of suppliers and, finally, the threat of substitutes. Such forces, however, should not be seen as independent, but influencing each other: indeed, if a significant shift occurs in any of the forces, organisations may need to take appropriate measures to counteract it in the marketplace. Porter argues that, once a business has identified the power of each of these forces, it may need to re-design its corporate strategy. Different solutions are provided to make it possible: set lower prices, innovate and differentiate the products or services, enhance product’s or service performance, strengthen the brand’s image, provide financing at lower interest rates, offer a better customer service, make the product customisable, etc. Cost leadership, differentiation and focus are the strategies identified by Porter that could help a firm to achieve a competitive advantage over its competitors.

The charts that follow were drawn to get an understanding of the strength (or relative weakness) of each force of the competitive arena. However, a high factor does not necessarily mean that the force is strong or weak, but rather that it favours new entrants, strengthens the rivalry, the power of suppliers and buyers and of substitute products. An overall score will finally reveal whether the bottled water industry is seen as a profitable market to enter or an idle sector which would lead to more losses than gains.  

Threat of new entry

The threat of new entry is the first force to be examined (see Figure 5). Is the market easy to enter for new firms?

Figure 5: Threat of New Entrants

Entry barriers in the bottled UK market are moderately unfavourable when considering capital requirements. Indeed, initial costs are generally quite significant. An approximate investment of about £196,000 is needed if considering costs deriving from source certification, pumping, road grading, fencing, tanks holding, disinfecting equipment and maintenance. Moreover, practising economies of scale will initially be difficult, as new entrants do not have either the experience or the necessary knowledge to cut costs as efficiently as big players can do. Economies of scale also constitute a barrier to entry as new firms are forced by existing firms to enter the market at large scale, at their own risk of meeting the strong retaliation of incumbents, which would be highly possible in a concentrated market like the one of bottled water. The access to distribution channels is also difficult, considering that major brands make the access challenging and that supermarkets and hypermarkets, which hold nearly 50% of the market volume, are more likely to feature well-known brands. Individual retailers hold, on their side, 18% of the market volume. Besides, brand switching is particularly high, which constitutes an opportunity for new entrants that could easily attract customers. The bottled water market does not even require much human intervention. Scientists as well as quality control people are obviously needed to make sure the water complies with the regulation, but the majority of processes involved in manufacturing water are by now automated. No particular know-how is therefore needed, although scrupulous attention to hygiene practises is required. A positive factor for potential entrants is also found by Mintel in the low amount of responses at the question considering the influences when buying bottled water, where only 16% of the respondents replied that they choose it on the base of the brand, demonstrating the fact that brand loyalty in the sector is fairly low, probably due to the low level of differentiation offered by the existing brands. This last point should be taken into consideration from companies that either want to enter the market or want to redesign their strategies in order to better compete in the sector and gain market share. On the other side, subsidies from the Government, always more committed in protecting the environment, are not easy to obtain, although there are no regulations that limit the access to the market for new entrants.

The average score derived from the analysis of these forces is 3,1/5, indicating that potential entrants should carefully evaluate whether they have the resources to enter and to compete successfully with existing brands. On the other side, they could be successful if they focus on meeting customer expectations, thus developing new healthy products that could make them gain a competitive advantage over the other firms.

Competitive rivalry

Competitive rivalry is the second force examined and factors affecting it are shown in Figure 7. How competitive is the industry in which bottled water firms operate?

Figure 6: Competitive Rivalry

The competitive arena of the UK bottled water industry accounts few large firms and a high number of small companies with specific geographic niches. Besides, the market is characterized by the presence of 2 dominant strategic groups, Groupe Danone and Nestlé, the former holding the French brands Evian and Volvic, whereas the latter the English brand Buxton. The biggest players are the own-label brands, Volvic and Evian, with respectively 25%, 19% and 16% share of the market. Highland Spring (8%) and Buxton (6%) follows (Figure 8 shows the 2006 estimated brand shares).

Figure 7: estimated brand shares in the bottled water off-trade, by value, 2006

Source: MINTEL Bottled Water - UK - June 2007

As Figure 7 shows, the industry is highly concentrated, with big players owing a big chunk of the market. The own-label brands has particularly suffered from price discounting, which only contributed to decrease the perception of quality of their water in the minds of consumers. The ‘others’ category includes key niche players like Thirsty Planet and We Are One and Blue that are however struggling to get access to distribution channels due to the presence of major brands. With their focus on alleviating the plight of 1 billion people in the world that do not have access to drinkable water, they are however succeeding in gaining reputation and market share. As to the industry growth rate, this has been quite affected over the last 2 years by the economic downturn (-5,5% in volume in 2008 according to Mintel), despite the positive growth experienced over the last 8 years. However, forecasts seem to agree that the category is on-track to recover in 2010 and may grow by 5% annually by 2012. Besides, the industry does not seem to suffer from surplus capacity, as it did not yet experienced a very high fall in demand that was not able to cope with. As to the nature of competitors, the fact that some of them are located in foreign countries strengthens rivalry, as they have different objectives and strategies. Evian, for example, particularly mainly targets the group 15-34 years old, and particularly women. With its “Detox with Evian” campaign run at the beginning of 2007, the company hoped to boost sales by stressing on the importance of recovering from the excesses of Christmas and the New Year. In 2004 it also launched a new range of skincare products containing Evian water. Volvic, instead, targets a wider range of people, including sportsmen, and mainly focuses on the “volcanic concept” to highlight the purity of its water. In 2005, the company also targeted children, with the launch of its flavoured water Volvic Splash and makes use of the character SpongeBob SquarePants for its packaging. Highland Spring, the UK leader in the production of mineral water focuses on the hydration benefit and on the provenance of its water, of Scottish origins, reason for which it decided to change its logo in 2004. The brand is also the official water supplier for several sports events and benefited from the sponsorship of the number one British tennis player Andy Murray in 2006. There is opportunity for regional brands however, as the focus on maintaining a sustainable environment increases and consumers begin to question the worthiness of buying imported water. Exit barriers are fairly low, as there are no specialized assets or government policy, although strategic interrelationships are present, due to the existence of mergers and acquisitions. Also, fixed costs and the cost per unit are fairly low for established industries and companies with high scale operations represent a fair portion of the market. As bottled water is weakly differentiated and buyer switching costs are quite high, companies have to rely on marketing tools. With regard to this point, it is sufficient to mention that eight key players of the market accounted for approximately 93% of the total advertising expenditure in 2006, with Evian and Volvic accounting 50% of it, highlighting the importance of branding in the sector. The overall score is 3,3/5, which reveals that the competitive rivalry situation does not seem to be very much aggressive, especially due to the fact that the market is suffering at the moment from the recession.

Power of suppliers

This section analyses the bargaining power of suppliers in the bottled water industry. It should however be specified that, as bottled water companies either supply, manufacture or deliver their products, the key players in this industry are the same as the ones identified in the section “Competitive rivalry”, apart from own-label brands that buy their water from the UK leader producer of own-label brands, Greencore Mineral Water. Thus, a high supplier’s bargaining power should not be seen as an obstacle for existing firms, but rather as an advantage for them. In the case of own-label brand water, however, it may constitute a threat.

Figure 8: Power of Suppliers

The threat of forward integration is thus limited, as bottled water companies would not find profitable to open their own retail outlets. The product they sell is indeed quite susceptible to demand and trends and a very high investment would be needed. Also, the likelihood that water bottlers can find alternative customers is fairly high, if one considers the strong distribution power of multinationals like Nestlé or Groupe Danone. However, for the several small firms this becomes quite difficult. The degree of differentiation is instead fairly low, as bottled water companies may only differentiate in the type of water they produce and, more recently, on adding minerals or flavourings. A common example is offered by the brand Volvic and its ‘Touch of Fruit’. Suppliers’ bargaining power regarding the availability of substitutes is high, as in the industry there are no good substitute inputs yet, apart from recent developments in the packaging, as using PLA bottles rather than PET bottles, which could influence the final consumer, always more pressured to focus on improving its green credentials. Considering the fact that bottled water companies rely heavily on economies of scale and that half of their product volume is hold by supermarkets and hypermarkets as mentioned earlier, the importance of the buyer industry is high for them, which weakens their bargaining power. However, their profit margins are considerably high, bearing in mind the market growth experienced in the last years and the fact that production costs can be 25% to 30% lower than actual selling prices. Consumers are in fact charged not for the water itself, but mainly for costs derived from bottling, packaging, marketing, retailing, etc. The supplier’s bargaining power average is 3/5, meaning that their power is not either low or high, but it could increase drastically if the industry could find better ways to differentiate its products, thus attracting more customers and have higher profits.

Power of buyers

The next force is aimed at analysing the bargaining power relative to customers, considering both retailers and end consumers. What is the influence they have on the industry?

Figure 9: Buyers’ bargaining power

End consumers’ bargaining power relative to suppliers is low, due to their highly fragmented nature. On the other side, big retailers hold half of the market volume and are highly concentrated. In the UK, the market leader is Tesco, with 28% of the market share, followed by Asda (15,1%), Sainsbury (14,8%), Morrison (10,3%) and Co-op (6,1%). Therefore, the quantities purchased by the biggest retailers represent a significant fraction of the supplier’s production, which makes the buyers more powerful (e.g., dictate on prices) as suppliers heavily rely on their purchases. The pretty important gap that separates Tesco for its competitors may also be taken into consideration by suppliers, as it is an indicator of where consumers prefer to shop. The other retailers, however, are not just standing there but taking action to increase their market share. And for the moment they are succeeding by beating the leader, which saw a negative 3,7% growth. There are also some little companies that only sell bottled water, but they also are highly fragmented in nature. Besides, buyers’ bargaining leverage is relatively high, especially due to the presence of the Internet and the fact that they now have access to full information on market prices, making it easier for them to make comparisons and arrive to more carefully thought choices. However, this seems to apply more to the buyer industry rather than to individuals, as there is still lack of awareness about the different kinds of bottled water on the market and their relative benefits. The differentiation of the product and the risks associated with changing the bottled water that final end users buy are both very low (which in turn increases competition that engages in a fight to attract more customers), which leads consumers to opt for the cheapest product. According to Mintel, 32% of the respondents replied that when buying bottled water “they buy any, they are not selective”, 29% of them reported that “the flavour” also influence their choice and 26% go for the cheapest price. The package and the format has interestingly been found to be the most important factor when choosing bottled water, again highlighting the importance of characteristics such as image and convenience in the market. Also, for 61% of people bottled water is overpriced, indicating the high price sensitivity of buyers, which strengthens their power (and again, makes rivalry fiercer). This probably explains the high market share of own-label brands, partly supported by the low differentiation of the market. However, when it is the retailers that switch to other suppliers, this may lead to losses in both image and profits, especially if well-known brands are the ones to be replaced. Also, the possibility that buyers could backward integrate exist, as in the case of multinationals acquiring smaller firms, but it does not constitute a threat as, like argued before, the acquired firm could then profit from their distribution power. Also, bottled water does not affect the quality of any buyer industry products, as it is only an on-shelf product. Therefore, buyers are more price sensitive and have more power over their suppliers. The average score for this force is 4,4/5, showing that the industry is highly driven by its customers needs and wants. The lack of differentiation, together with the questioned superior quality of bottled water, does not in fact help the industry in attracting customers, which prefer to find other means for quenching their thirst, analysed in the next section.

Threat of substitutes

The threat represented by substitute products of bottled water is the last force analysed. How much is the industry affected by the presence of such products?

Figure 10: Threat of substitutes

In 2007, 42% of people were found to only drink tap water, while 55% to drink bottled water. Such results show that tap water constitutes a very high threat for water bottlers, as it takes them out a significant proportion of consumers, thus revenues. Increasing environmental concerns and pressures also have a significant influence on consumers, who are influenced by environmental pressures. However, by focussing on people’s sensitivity, companies like Thirsty Planet succeeded in increasing their sales, even though the hard times the bottled water market is going through. Tradition of drinking bottled water does not help either in this regard, as in the UK this is not as much as eradicated as in other European countries. On a less threatening side, soft drinks as coffee, tea, fruit juices, flavoured water also represent substitutes to bottled water, although their power is limited as they cannot be considered as fully substitutes to drinking water (it would be very rare to find someone living of coffee or tea…). Indeed, water is more perceived as a need rather than a urge. However, when it comes to price things get more complicated for water bottled companies. They have to face the fact that tap water is available to customers in their houses for moderately low prices compared to bottled water. Tap water is in fact found to cost 150 times less than bottled water, compared with the average price of Evian water (the figure goes up to thousands in the case of expensive imported bottled water), and consumers are reluctant to pay for something they can already have for much cheaper and that does not either provide them with added value. The average score for the threat of substitutes is, once again, pretty high, being it 4/5. The bottled water industry should really find other ways to increase their profits rather than trying to influence its customers by using ads that depict a pure and pristine area, or making claims about the excellence of their water to influence customers’ choices. This may in fact not last very long and customers may end up feeling being teased and leaving the market.

CONCLUSIONS AND SUGGESTIONS

Making an average of all the scores for each force, the overall industry profitability score is 3,6/5. The industry should therefore be considered as attractive, even if attention should be particularly taken at the buyers and substitutes level, the main influential forces in this case.

The research carried out has enabled to identify the key drivers of the industry, being differentiation and marketing of the bottled water. New companies and existing companies should take this into consideration if they want to compete successfully in the market. Developing strategies to increase costumer’s awareness of the quality of bottled water could be a solution. However, in a market like the UK where tap water is highly regulated and safe, I believe that this would not be the most profitable solution. Turning environmental concerns to their advantage could instead be the best choice, something that the Australian company One Water is trying to achieve by donating all its profits from the sell of bottled water to the installation of clean water supplies in developing countries. The idea is based on the willingness of 82% of Australians to buy bottled water if they knew that all the profits were donated to providing people with access to clean drinking water. If we think about it, there are two billion deaths each year caused by contaminated water and I think this to be a more than sound reason for buying it. On top of which, we would also contribute to our own health and well-being.

The future of imported water may however being at risk, due to the high transportation costs foreign companies have to face and their consequent high impact on the environment. A shift towards national or even regional brands may be predicted.

Furthermore, in order to provide customers with the certainties they need, the industry could also consider to develop a water tester, which is to say a tool able to inform you whether the water you drink is safe or not for your health.

Finally, starting to focus on profitable segments left aside, like the elderly, could also open new opportunities to businesses in the market. Functional water could, for example, provide a solution here.

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APPENDIX

Academic debate on the techniques

Porter’s five forces model is an analytical tool that definitely changed the way business leaders thinks. However, it is not what was defined a “panacea”, as it may fail in identifying all the problems an organization faces. In fact, according to O’Shaugnessy, the exhaustion and exclusivity of the list that Porter provides for evaluating the power of each force is questionable and appears arbitrary. No direction on how to evaluate the strength or the weakness of such forces is either provided. Nevertheless, the model provides the management with insights for taking action and it is not only based on subjective judgement. Additionally, the author does not make any distinction between segmentors and nichers. This distinction does not apply for the market of bottled water, being characterised by costumers with similar needs. However, the car industry, for example, is a very broad market characterized by different customers with different needs, either looking for status (e.g. Jaguar) or fuel economy (e.g. Peugeot). In this case, evaluating for example the buyer sensitivity factor could be misleading. Speed also questions on the choice of cost leadership as a strategy: he argues that it is applicable to only one company that is either able to differentiate its products or services or focus on specific segments. Thus, it has no value if operated alone. Besides, it is important to take into consideration that the framework developed by Porter dates back to the eighties, characterized by a stable market structure, different from today’s dynamic competitive environment. Therefore, the ability of the model to predict industry’s rapid changes is debatable; this is the main reason why it should always be used after having identified the factors that affect the remote environment in which the industry operates (for example, by using the PESTEL analysis). Another limitation of the model is that it was designed to only analyse individual business strategies and does not consider the interrelationships within the portfolio of large corporations. The model is in fact best suitable for analysing simple market structures, companies offering a moderate product or service range and not a very dissimilar target audience. Moreover, being based on competition, it does not consider strategic alliances as a strategy for achieving competitive advantage.

Critique of analysis tools

The PESTLE framework, otherwise called STEPE, is a useful analytical tool to get an understanding of the factors in the macro environment that affect the way an industry works. It becomes very helpful to make a business aware of the opportunities and threats that it may have to deal with in the near future. However, to profit the most from its benefits, a sound and comprehensive research should be carried out. In addition, it may be difficult to understand the implications that have their causes in some factors, like the political ones, if the researcher’s knowledge is little in that domain.

On the other side, Porter’s five forces framework is very important to provide a company with an understanding of the environment where it is operating: is it possible for new businesses to enter the market and take our customers away? Is it the market highly competitive? How much the power of our suppliers and buyers affect the way we operate? And finally, are there any threats in the form of similar products that limit or could limit the industry’s profitability? What measures should we take to avoid all these factors?

However, the fact that Porter does not give any indication on how to calculate the power of the forces made me come up with the idea of using charts and calculating average scores.

Some factors are sometimes not considered to be as important because of the nature of different competitors in the industry, either in size and profits. For example, the advertising expenditure is very high for big companies such as Evian, but it becomes relatively small when small players are considered. Taking into consideration the high concentration of the market, however, the level of advertising expenditure becomes quite high. The power of each factor is therefore attributed on the base of my judgement and knowledge, thus it is highly subjective and may be lower or higher. It is useful, however, to get a quantitative understanding of the power of each forces and address action particularly to the ones either identified as weak or neutral. The likelihood that these forces could change in the near future is also high, due to the constantly changing environment and marketplace.

The choice of which factors affect the force is also arbitrary, but I tried to keep as close as possible to Porter’s model and evaluate also the factors that could have a weaker impact on the force in order to be able to calculate an average score. Nevertheless, few specifications should be made. Forward integration for suppliers was considered as neutral: however, I believe that it should not be seen as a factor limiting their power, as they already sell water to the customer. Backward integration should not either be seen as a threat: in the case of the bottled water industry, for example, the fact of multinationals acquiring brands should be more seen as an opportunity for the brand to increase its image in the eyes of customers rather than a threat for the business. Strategic interrelationships, mergers and acquisitions are not in fact taken into consideration by Porter as other strategies to adopt to gain competitive advantage. Also, the access to distribution channels for new entrants may be higher if the new firms that enter the market deliver added value products, like highly innovating for the market. Considering that what consumers are demanding is particularly a higher differentiation to make them not switch to the tap, big retailers would also be more willing to buy and shelf them. The access to distribution channels should however be also considered when evaluating the competitive rivalry, as it constitutes one of the major factors for which niche players like Thirsty Planet are struggling to gain market share. Furthermore, it would also enhance the score for competitive rivalry, and give a better picture of the competitive situation.

Limitations

The major limitation of this paper is that it considers bottled water as a unique product, while revenues and profits come from different types of bottled water. For instance, natural mineral water is the most regulated type of bottled water; the Five Forces analysis takes this into consideration for this kind of water, but what about other firms that, for example, only sell spring water? They have less strict laws to follow, thus the market could be easier to penetrate. Annual reports of the main players are not either available nor there is most updated information about the industry for the UK market. Thus, further research would be needed to understand where profits really lie, for example by analyzing the portfolio of a bottled water company and its products’ life cycles. This would help new entrants to gain an understanding about which are the most profitable products, where major opportunities lie and what are the major challenges that they will have to deal with. It would also be interesting to discover how much likely are fortified, enriched or functional water to become a part of our lives in the future and whether taste will have the upper hand over the ‘original’ spring or natural mineral water. Is the future of these last waters menaced by a better and safer tap water?

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REFERENCES

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