These histories of the two companies lead them to the new infant market of Shanghai. Coca Cola originally entered the Chinese market in 1927 but left in 1949 due to the new Chinese government regulations. In 1948, Shanghai became the first market after the U.S to post annual sales of more than one million unit cases. In 1979 it came back into the Chinese market, following the introduction of China’s open- door policy, with a shipment of 30,000 cases from Hong Kong due to the fact that they couldn’t open their own Coca Cola factories in China. Most of the Coca Coal investments in China since 1979 have focused on upgrading existing Coca Cola bottling plants and building new production facilities. By now Coca Cola has more than 24 bottling plants.
Pepsi Cola only entered the Chinese market in 1982 after having several problems finding the proper joint venture that would suit them. After battling for it for 3years while watching Coca Cola’s success in China they were finally ready for another war. Pepsi Cola has 14 plants around China. The plant in Shanghai was opened between the years of 1990-92. Although Pepsi Cola wasn’t the first in the market, its aim is to be number one as they keep on growing from day to day.
After understanding the history of both companies now it will be easier to understand their market structure, oligopoly, and the theory behind it.
The oligopoly theory:
An oligopoly is characterized by a few firms, the market is likely to be dominated by a small number of large sellers. In general, entry of new firms into an oligopolistic industry is difficult but possible. The theory presents how firms should act in an oligopolistic market.
Studies of oligopolistic markets have shown that individuals firms can use various different kinds of behavior patterns. However, there are some features which are common to most oligopolistic markets, it is these features which economic models of oligopoly must be able to incorporate. Non-price competition, in a perfect competitive market the main competition is on the price, although in an imperfect competitive market, which is oligopoly, price is often not the most important in the competition process. Each firm usually forms its own strategy according to the market. Firms produce the product, which depends on the consumers; the product can either differentiate or be homogeneous to its competing product. A price is usually set by the price leader and the firms do not compete on it and therefore it hardly varies. Promotion is the key in oligopoly because this is the thing that in the end actually draws in the costumers. The last factor is where and how the firm distributes its products, also where are the factories, plants and the transportation of the product as this is a main part of the total costs.
One model of oligopoly was developed in the late 1930sby Paul Sweezy in the USA and R Hall and C Hitch in the UK. Any theory on oligopoly must make the comparison between one firm and another, meaning the reaction of one firm to the other. The kinked demand curve model assumes that there will be asymmetrical reaction to a change in price by one firm; therefore the kinked demand curve actually shows why oligopolistics do not change their price. Oligopolistic firms usually compete because of the fact that the products made by them are substitutes, and this is one of the main reasons why firms will not tend to change their prices. This is called the substitution effect: part of the change in quantity demanded of one good when price changes which is caused by the consequent change in relative prices.
Figure 1:
If a firm increases its price, the other firms' price will not change because then the firm that increased the price will lose market share. On the other hand, if a firm reduces its price, the other firms' price will not change because then they gain market share. Therefore the firm will gain a little more demand curve as a result. Therefore, the demand curve facing a firm is more elastic for a price rise than for a price fall. However the main theory of why prices in oligopoly are so stable is because changes in costs, which shift the marginal cost curve, will not change either the profit maximizing level of output nor the profit-maximizing price.
:2Figure
In Figure 2 it is shown that with a demand curve kinked around the existing 0P, a rise or fall in marginal costs will not affect the profit maximizing level of output or price because of the big gap between the different MCs. Hence figure 2 can be used to explain relative price stability in oligopolistic markets.
The firm assumed to be a short run profit maximiser. Therefore if the price is 0Pand the firm is producing 0Q, the marginal cost curve must cut the marginal revenue at out put 0Q, somewhere between price 0V and 0W. This means that there are number of possible marginal cost curves which would produce a price of 0P. The oligopolist would absorb the whole of the cost by reducing its profit.
Collusion in the price leadership is what sometimes oligopolistic industries have to use. This means that they need to come to an agreement between the dominant firms to not undersell one another. However, in the real business this process is illegal and therefore outright collusion is not used.
Since in an oligopoly there are big firms, the firm normally has many plants and therefore tends to enjoy economies of scale, which is when in a fall in the long run average costs of production as output rises and therefore long run units cost curves that are horizontal rather than upward- climbing. Thus there is no cost impediment to growth at least not for a long time this is shown in figure 3.
Figure 3:
Figure 3 represents the area where oligopolistic firms act. Productive efficiency is said to exit when production takes place at lowest cost. If the long run average cost curve (LRAC) is U shaped, then this will occur at the bottom of the curve when constant return to scale exists. The output range over which average costs are at a minimum is said to be optimal level of production. In figure 3, the optimal level of production occurs in the shaded area between the point A and B. There range between the economies of scale and constant return to scale is where oligopolies exist.
This figure also explains that if output rises more than proportionally to inputs the average cost of producing that output will fall. The firm’s costs will rise less than the output of goods. There are said to be ‘economies of scale’ and this is shown as section (a). If inputs and outputs change proportionally it is said to be constant return to scale, as the average costs will remain constant, this is shown as (b). If outputs are producing less and less output proportionally as they are increased there are diseconomies of scale. This is shown in section (c).
Adding to the information on oligopoly, a newer theory was presented in 1944 by mathematician John von Neumann and economist Oskar Morgenstern, The Game- Theory. The game theory gives a more imaginative approach than an oligopoly. It reveals the issue of interdependence directly by assuming that each firm’s managers proceed on the assumption that their rivals are extremely ingenious decision makers.
The most commonly feature of oligopoly is the price stability (Anderton, Alain). The Game theory explains this. Considering a two firms market (duopoly). Each firm can either raise the price of its product or leave it unchanged. We further assume that each firm has its own expectation concerning its profit change as result from each strategy. The game is a zero sum game, meaning that any gain by one player is exactly related to a loss in the second player. Therefore one firm will decide to leave its price unchanged because that if it raises its price it will gain a profit only if the second firm will raise its price too. If the second firm would have changed the price then it would have losses, although if it does not react to the price change, it will lose but still not as much as before. Hence both firms will leave the price unchanged, and the firms will have to use other objects to compete with on another.
Interdependence limits the ability of oligopolistic firms to exploit markets to their own benefits. Although oligopoly has more than one firm in the market, in order to dominant in the market the firm has to have strong brands. A strong brand has major advantages for a producer. A strong brand has few substitutes as far as the costumer concern. Thus, the firm can increase the price for the good, and by that have a monopoly and the demand for it will not fall greatly (Anderton, Alain). In order to appreciate oligopoly better, Pepsi Cola and Coca Cola are the best examples, because they are two known, big firms that act in an oligopolisitc market.
The Cola War
“Everyone knows that Pepsi Cola and Coca Cola will always be different but the price is not an issue”, said Maurice Tan the marketing manager of Pepsi Cola in Shanghai, China (personal interview). He claims this because of the fact that both of the companies are big and has established themselves already in China. Therefore there is no use to competing on price, “price competition just causes problems” as Tan says. “Being first in China, we have become what is called a ‘price leader’, and therefore there is no competition from our side of the game” says Summata, marketing manager of Coca Cola in Shanghai, China (personal interview). He claims that competing on price will not give yield to any of the companies. That is why we can see that the price of both Coca Cola and Pepsi Cola in Shanghai is approximately $0.23. The price does changes from place to place in China but in most of the cases the price is the same for the two rivals, and if it’s not then the difference is really slight.
As said above in both the oligopoly theory and in the game theory a major as aspect of oligopoly is that the firms do not compete on price. This is because there is no use of doing it for both companies whether by raising or by lowering the price. The game theory explains this issue best.
Yet before even concerning the price of the product, there has to be a product, and Coca Cola and Pepsi Cola produce lot of new products that fit to the Chinese needs. Both Coca Cola and Pepsi Cola developed the non- carbonated drinks for the Chinese people, which do compete, but not between themselves but between them and the other Chinese drinks. However the main products that compete are the Coca Cola and Pepsi Cola, although it is a different product with different tastes. For some people it is still considered as a substitute. In Shanghai for example, people has a sweet tooth and therefore they prefer Pepsi Cola for it is sweeter than Coca Cola, “ It is very important to make the buyers of our product a constant buyer, meaning that no matter what they will buy it will always be our product. That is why our coke will always everywhere remain the same. The Chinese costumers like international products and will buy them, but we have to prove that our product is the best,” says Summata (personal interview).
In Shanghai, Pepsi Cola is winning the war, and it’s not hard to understand why. Pepsi Cola distributes its product not only to the international fast food restaurants such as, Pizza Hut, but it also distributes its product to local chain restaurants where young people eat. On the other hand, Coca Cola’s major places of distributing their product not including super markets and etc. are only MacDonald’s and KFC, which are also big for the local people but still, Pepsi adds more influence by distributing their cola in local restaurants. However Pepsi Cola only wins the war in Shanghai because Coca Cola has more plants around China than Pepsi Cola, Coca Cola having 24 plants, and Pepsi having 14. It makes it easier for Coca Cola to control even the small villages around China without having to add too much transportation costs. Having said this, the points made are still not the real war; the real war is the promotion.
“Coca Cola doesn’t specify their promotion, Coca Cola is talking to everyone everywhere, “ says Summata (personal interview). That is why Coca Cola’s campaign might be easier, not having to think about what will attract who, nevertheless that is not what Summata says, he says that because of the fact that they do not specify, and talk to everyone in one promotion act they have to think about all the people and make it fit. On the other hand, Pepsi Cola do specify their audience as teenagers, although this is hard, says Maurice Tan “because we always have to be ‘cool’ we always have to be up to ‘their’ expectations, and these always change.” (personal interview). Coca Cola has 26.1 million U.S dollars each year for promotion in China although Pepsi has only 23.4 million and it does cause the difference. They both do the same promotions, one starts with one and the other starts it few months later. For example, the soccer league that they both have, started by Coca Cola and Pepsi did the same, although Pepsi succeeds more because more teenagers drink it. Commercializing wise Pepsi Cola uses a bigger portion of their budget for TV commercials, banners and etc. This is because of the young generation that they sell their product to. It seems as if Pepsi allocates its budget more efficiently in China because according to a survey (see appendix A), many of the youngsters claim that one of the main reasons that they drink Pepsi Cola more than Coca Cola (See figure 4) is because of the taste mainly but also commercials and banners in the streets.
Figure 4:
- What is your favorite soft drink?
- Coca Cola
- Pepsi Cola
- Xurisheng
- Wahaha
- Jianlibao
- Robust
Using the budget that is given for promotion wisely is very important in oligopoly because this is the main competition strategy and this is what makes one of the firms a price leader, and a leader in the market in general. Percentage wise Coca Cola has more sales than Pepsi Cola around China. Nevertheless in Shanghai it seems as if Pepsi Cola has become the dominating firm in the battle. Due to the fact that Shanghai is very different from other cities in China, being more westernized and welcomes western products in a different way to other cities. Therefore, the battle in Shanghai is the hardest one because Shanghai is like a leader for the products, if one firm is strong in Shanghai it is more likely that is will be strong in other places in China.
Conclusion
Oligopoly is a very interesting market structure because of the fact that its main competition is not price. Pepsi Cola and Coca Cola represent oligopoly in a way that it almost seems as if they written the theory themselves. It is very hard to understand the way these companies really work because neither company will really say their main strategy against their rivals. Therefore the only conclusion that could be drawn concerns only the information that was read and heard from the firms’ representatives and from the consumers.
After researching Pepsi Cola and Coca Cola in Shanghai, it was found that their main competition is promotion since they have no- price competition. According to a survey (see appendix A) comparing Coca Cola and Pepsi Cola, one of the results was that the commercials done by Coca Cola actually influenced the consumers more than Pepsi Cola’s commercials, figure 5.
Figure 5:
- Did commercials influence you to try the drink?
On the other hand, another result was that Pepsi Cola is bought more than Coca Cola in Shanghai. Hence, there had to be another question that will answer the gap between these two,” Do you have any preference on the cola’s brands, or they are the same to you?” the answer to this question helped concluding that because Shanghai is an infant market, it still doesn’t have a clear concept of branding. Likewise Pepsi Cola and Coca Cola are both colas and therefore their commercials in Shanghai do not necessarily manipulate the costumers to buy Coca Cola or Pepsi Cola, they actually influence to buy cola. Hence commercials in the end don’t really matter for the Chinese people because eventually they try both brands and based on the fact that Pepsi Cola is sweeter it is in most cases the chosen one.
Shanghai is different from any other westernized places in the world because it is still a developing city, it is important to note that it does not reflect upon the Chinese market all around China. Additionally the Chinese government still controls even the international business, hence both Pepsi Cola and Coca Cola have to be in joint ventures according to the law, which means that every promotion act, or any other acts, has to go through the Chinese part in the joint venture. In addition, although Coca Cola and Pepsi Cola are the ones that entered the market and put out the product, the Chinese shares in these joint ventures are bigger and therefore stronger. This is interesting because that now, with WTO coming into China, everything will change and the war between these companies might even get bigger and more intense due to the fact that they might have some more freedom to act in the way they act in other places around the world.
