Moreover, the basis of their competitive advantage is extremely different and is reflected in their unequal ability to generate profit. While the CPs producers exhibit an advantage based on strong and nearly inimitable assets (the brand of their proprietary products and their consolidated image), bottlers can reach operational efficiency by optimizing the use of their resources and creating economies of scale. While the function of bottlers can be easily imitated, Coke and Pepsi are unique: bottlers provide a commodity service, while concentrate producers have monopoly power over their brand. That’s why when the demand of CSDs declined and producers raised concentrate prices in conformity with the CPI, or when new products which requested more expensive bottling process were launched, bottlers had no choice and still had to accept the producers’ decisions with dramatic effects on their margins.
During the 80s, the contracts which characterized the relationship between producers and bottlers were replaced by a new vertical integrated structure, as both Cola and Pepsi became directly involved in bottling and acquired some bottling companies. The strongest argument for vertical integration is to align incentives of all parties involved in the entire production process: being separate companies, the concentrate producers and the bottlers would each employ different strategies to maximize their own return (for example they have contrasting interests about the new healthy products), whereas integrated they can be fully focused on customers. Moreover, it gets even more difficult for potential rivals to enter the soft drink industry, as they would have to invest huge capital in bottling plants to replicate Cola’s and Pepsi’s strategy and to benefit from the reduction of transactions costs.
From my point of view, vertical integration brings its own set of issues: the concentrate producers lose substantial flexibility in varying the production because they would be constrained by the switching costs, while by outsourcing the bottling function, they would have the ability to add or reduce capacity quickly by signing or terminating contracts. Another related drawback is that they have to bear the bulk of the capital costs, as they own the bottling processes. So, as nowadays consumers’ demand of soft drinks is much more diversified and fluctuating and as the margins of CSD producers are less safe then before, they may come back to quasi-integration strategies, such as franchising, taking an equity stake or outsourcing completely. This would allow them not to be affected by the lowest revenues of bottlers and to adapt their offer to the customers’ need quickly and with less switching costs.
Either way, as in 2004 concentrate producers earned 30% pretax profits on their sales and bottlers earned 9%, the soft drinks business is still profitable, even though it involves commoditized products. Its attractiveness can be explained by analyzing the external environment using Porter’s Five Forces Model: both Coca Cola and Pepsi benefit from a market which is protected from existent and potential competitors and where they show a stronger bargaining power then their suppliers and buyers.
Rivals - The hard competition between these two giants has strongly affected the structure of the soft drink industry: the smaller, familiar firms, which could not invest in competitive marketing campaigns and could not benefit from economies of scale, were quickly chased away from the market or acquired by Cola (Minute Maid), Pepsi (Tropicana) or Cadbury (Dr Pepper). Therefore, Coke and Pepsi, together with their associated bottlers, in 2004 commanded 74% of the soft drink market and if we also consider Cadbury Schweppes, the top three companies controlled the 89%. In fact, we could characterize the soft drink market as an oligopoly or even a duopoly between Coke and Pepsi, resulting in positive economic profits for the two giants. They traditionally competed primarily on advertising, promotion and new products rather than price, but potentially declining U.S. demand may now encourage more price competition and thus erosion of profits.
Substitutes - Especially during the 21st century, the concern about healthy life and low-fat diet became more and more widespread among the Americans. In 2005, the American Beverages Association limited the CSD sales in schools as it identified fizzy drinks as one of the main causes of obesity. So non-carbs companies could finally represent a threat for the established CSD companies as Pepsi and Coca Cola. But these, and Pepsi even more, seized the opportunity to increase their profits matching the evolving consumers’ demand through alliances (Coke and Nestea) acquisitions (Coke and Minute Maid) and internal product innovation (introduction of purified-water products). As they got to a wider horizontal integration, they enjoyed the benefits of economies of scope, using their existing brand, distribution network and contracts with bottlers. In conclusion, because of the CPs efforts in diversification, substitutes became less of a threat.
New Entrants - Barriers to entry are really high for potential competitors: they would have to face relevant marketing and advertising costs, they would have to build strong relationships with bottlers or they would have to invest in capital intensive plants if they chose to have their own bottling process. What’s more, brand loyalty is a relevant fact that leads consumers to opt for well-known brands with long history, such as Coca Cola and Pepsi. So, even though the presence of new competitors would be threatening, as consumer-switching costs are negligible, new entrants are usually deterred by the need of heavy capital investments..
Bargaining power of suppliers: The inputs for Coke’s and Pepsi’s products are primarily sugar and packaging, which are both commoditized products and do not demand a specific know-how. Sugar could be purchased from many sources on the open market, and if sugar becomes too expensive, the firms can easily switch to corn syrup, as they did in the early 1980s. Moreover, Coca Cola and Pepsi are among the metal can industry’s largest customers and they maintain relationships with several suppliers who have little bargaining power, due to the availability of alternative suppliers.
Bargaining power of buyers - In the 80s both Coca Cola and Pepsi decided to get directly involved in bottling, so the final buyers for these companies are now the retail channels. Among these, supermarkets and gas stations have a low bargaining power as they belong to a really fragmented industry. On the other hand, mass merchandisers (such as Wal-Mart) have a stronger influence on drink prices as they carry both Coke and Pepsi products and can negotiate more effectively thanks to their. To add on it, another yet less profitable channel is that of fountain sales: they deal only with a single brand and they can negotiate for very convenient prices, but they still represent an important way for CSD companies to build customers’ brand loyalty: that’s why both Cola and Pepsi signed long term contracts with fast food chains (Cola with Burger King) and made acquisitions (Pepsi with KFC). This strategy of vertical integration allowed them to get closer to the final customer and to negotiate reasonable prices with fountain sellers, limiting their bargaining power.
The positive external conditions can therefore explain the profitability of the soft drink business. Furthermore, we must consider the peculiar internal competencies that have allowed both Pepsi and Cola to reach a dominant position. First of all, their ability to create a brand that is easily recognizable and it has become a sort of guarantee of good quality, as well as a symbol of the American culture (especially in case of Coca Cola). It becomes easy to explain why these two giants both adopted a strategy that mostly involves marketing and advertising operations, rather than a price competition. Their competitive advantage is actually based not on low prices or merely on a good operational efficiency (that can still be imitated), but above all on the uniqueness of their brands, which they have reached following similar strategies and adapting their offerings to the external changes (marketing; vertical, horizontal, international integration; product innovation).
Pepsi and Cola should now keep their brand unique by adapting their strategy to the changes in the external environment and highlighting their new offers through attentive marketing campaigns. From a technological point of view, they should make their plants more efficient and keep inventing innovative formulas for their products. Considering the social aspect, they should match the customers’ care for health (by introducing new non-carb products, sports drinks etc) and the growing concern about ecology (by using recyclable packaging). Finally, as regards the demographic evolution and as American soft drinks market is now in the matured stage of the life cycle, they may stress their international integration, consolidating their presence in the emerging countries, which still present great unexploited business opportunities.
APPENDIX
Data from
- Wikipedia
- www.thecoca-colacompany.com
- www.pepsi.com
Martina Pagani 13/09/2011 Page
