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Cola Wars Continue: Coke vs. Pepsi in the 1990s Essay

Question 1

The concentration producing industry has one buyer and through its value chain. Instead, costs for advertising, promotion, market research, and bottler relations were significant. On the other hand, bottling industry is the mid-way player in the soft drink industry. There are two suppliers and one buyer involved in its value chain (Exhibit 1).

Whether two industries are profitable depends on soft drink consumption, which had increased for more than 20 years and plateaued in the 1990s.

The economics of the CP and bottling is very different from each other in terms of number and size of rivals, and the scope of competitive rivalry. There are two giants competing head to head on the CP industry, smaller national producers, such as Seven-Up and Dr Pepper, are relatively trivial. There are a lot of players of same size in the bottling industry. Unlike the furious competition between Pepsi and Coke, no sense of competition can be felt in bottling industry. Reasons are that, first, Pepsi and Coke control the majority of bottlers in 1990s; second, intrabrand competition is restricted by the franchise agreement, which is protected by ‘Soft Drink Interbrand Competition Act’.

From the view of capital requirement, it is easier for others to enter the CP industry than to enter the bottling industry, since comparing to $30-$50 million dollars requirement to establish a bottling plant covering only one 80th of ability to serve the entire US market, the requirement for one CP plant with a nation-wide capacity is only $5-$10 million dollars. In addition, brand loyalty is low in the CP industry since consumers are sensitive to price and there is little switching cost. There are many substitutes for soft drinks, such as tea, beer, and milk. There is no substitutes existing in the bottling industry, and no customer loyalty and switching costs for bottlers since they could only use packages authorized by the franchiser, which means no distributors can tell the difference of the same brand provided by two bottlers, and easily switch among different bottlers.

Cost and financial structures of a CP and a bottler illustrate that high cost of sales is one of the major reasons behind the relative low profitability of the bottling industry. The ratio of cost of sales over net sales is 40% higher than that of CP. One possible reason is that bottlers heavily depend on CPs, and thus, CPs use bottlers to diversify expenses. Another reason is that bottlers hold much more inventory than CPs do since bottlers receive soft drink concentrates according to its processing capacity, while they sell products based on selling capability. Also, bottlers have plant and equipment that are ten times more than that of CPs, and a good will that is roughly 45 times more, which means that bottlers have to deduct more depreciation from gross profit than CPs do.

One of the reasons why bottlers are backward integrated by CPs is that, as the Cola-war heating up, small bottlers were no longer able to handle CPs’ goals and thus they would not be chosen as Pepsi and Coke’s partners. Most of them were merged or driven out of the market by larger ones adopting the DSD method, which is the only delivery category that provides a positive net profit per unit. Other driving forces for Pepsi and Coke to integrate bottlers are that, by doing this, they can narrow down the number of packagers they deal with, lower costs of negotiation with bottlers, and set up barriers to find buyers for other smaller national CPs.

Question 2

Bargaining power of buyers is the weakest competitive force for CPs. On the other hand, the strongest competitive force for the bottling industry is bargaining power of suppliers because of the interactional relationship between the two industries in question.

Both of the two industries would like to weak each other’s bargaining power, however, CPs take the initiative in the negotiation. First, it is CPs who build franchise networks. CPs understand how the bottling process works, while the bottlers don’t know how to run a soft drink brand. Second, CPs negotiate with bottlers’ other suppliers to secure reliable supply, faster┬ádelivery, and low price. Also, franchise agreement between CPs and bottlers has been becoming more favorable to CPs. So it is safe to say that bottlers have been affiliated to CPs to a deeper degree than CPs to bottlers. Finally, the bottling industry does not have giants who are able to penetrate into the CP industry. On the other hand, the CP industry has Pepsi and Coke to integrate bottlers.

Threat of new entrants is the second weakest force for the CP industry. One of the major reasons is that it is difficult to access a bottler since like Pepsi and Coke are taking control of most of the packagers. Another reason is, although capital required to establish a soft drink concentrate plant with the capacity of serving the entire US market is low, costs for advertising, promotion, market research and bottler relations are a heavy burden and specialized know-how, such as brand management, is a natural barrier to penetrators. However, the fact that customers’ loyalty is becoming weaker makes the force not as weak as bargaining power of buyers.

The bargaining power of suppliers to CPs also seems weak in the case since, as the advent of diet soft drinks, the expiration of the patent to aspartame, and oversupply of aluminum on the world market, suppliers to CPs are losing bargaining power. However, there is no detail of suppliers industry given to provide us with confidence to say that it is the weakest force.

Threat of substitutes, and competitive rivalry among the incumbents are relatively weak for the CP industry. Comparing to its substitutes, such as beer, milk, and bottled water, soft drink is and will continue to be performing outstandingly (Exhibit 2). Type of competition in the CP industry is duopoly, two giants, Pepsi and Coke are competing with each other head to head. Other CPs are confined to a market share that is lower than 30%. The unsystematic competition makes competitive rivalry less intense when consider the industry as a whole.

Threat to new entrants for bottling industry is weak since, unlike the CP industry, bottling industry has a high capital requirement, from $30 to $50 million, to build a plant of five lines with one 85th to one 80th of the national volume. There is even no profit margin for small bottlers because they are not big enough to be engaged in the DSD to make a positive profit.

Bargaining power of buyers is the third weakest force for the bottling industry. To bottlers, they receive volumes of concentrates at the level of their processing capacity; while at the other end of value chain, number of cases they can sell depends on bottlers’ marketing capability. To retailers, they don’t have switch costs since Pepsi Cola from bottler ‘A’ is the same as that from bottler ‘B’. However, continual brand availability and maintenance is crucial to CPs, they don’t want to see that too much inventory held by packagers erode relationship with each other. So, CPs have to help bottlers work on marketing and how to deal with retailers.

Threat of substitutes, and competitive rivalry among the incumbents are the weakest. First, there are no substitutes for packages. Second, there is no competition among bottlers in that not only is intrabrand competition restricted, but also competition among brands are concerned by CPs since the bottlers are heavily controlled by concentrate suppliers nowadays.

Question 3

The reason why the Cola-War does not escalate out of control is that both of Pepsi and Coke understand the importance of keeping its rival alive. Strategically, they are vital to each other’s maintenance.

There are three possible results of the Cola-war, monopoly, duopoly, and near prefect competition. All players in this industry are dreaming to be the king of monopoly. However, under current situation, it is difficult to defeat each other without harming themselves for both of Pepsi and Coke. Launching plans and actions aiming at eliminating its competitor will probably result in the third result, near prefect competition, in which the industry would only have players bearing the same size as nowadays Seven-Up and Dr Pepper.

Obviously, duopoly is the best and easiest choice for the big two. First, as risk avoiders, they can maintain current size and dominant position in the market, keep small national brands at an inferior level. Second, they can keep business environment nearly unchanged. The duopoly situation has been lasting for more than two decades. It is the one they are familiar to. No matter whoever is driven out of business or both of them lose the dominant position, they have to re-evaluate the industry and re-plan their strategic plan. Third, they can lower the possibility of making mistakes by observing what each other are doing.

Based on above reasons, Pepsi and Coke choose not to wage a war that is out of control.

Methods Coke and Pepsi adopt to keep the war within ‘bounds’ are focusing on key success factors, following each other’s actions selectively, and realizing gap in international market.

There are three KSFs in this industry, brand differentiation, relationship with packagers, and developing new beverages. Focusing on KSFs enable both of Pepsi and Coke stay in the right track leading to higher level competition of duopoly.

Following each other’s actions selectively prevents them from distracting to dangerous actions. They both followed closely each other’s actions based on KSFs, such as launching marketing plans, vertical integrating bottlers, and develop new products. They also distinguish bad actions from good ones. For instance, Pepsi gave its employees one-day brake when it received the information that Coke decided to change its Coca-Cola’s formula.

Pepsi has admitted that Coke is much stronger on international market. It is very important that it uses ‘guerilla warfare’ in selected international market instead a frontal attack with Coke everywhere, which would entrap Pepsi in the quicksands of international market.

Question 4

Over the last century, firms specialized in tobacco, food, and restaurant, such as Philip Morris, Hicks & Haas, Triarc, R.J. Reynolds, and Cadbury Schweppes, tried to penetrate into the soft drink industry through purchasing small national CPs like Dr Pepper, Seven-Up, and Royal Crown Cola, however, few of them survived. Reasons for this fact fell with the faulty strategic planning process. Those who entered but do not end up with success failed to recognize three key success factors in this industry in the beginning, building brand recognition, developing packaging networks, and changing distribution channels.

First, Pepsi successfully competed with Coke through adopting brand differentiation. In responding to Pepsi’s attack, Coke spent even more money on advertising, which gained two companies world wide fame, heated up the war between them, and shaped their capacity to remain as top players. However, other CPs did not cash in on the brand differentiation strategy, which can be illustrated by a compare of dollar amount spending on advertising by brand in the US. (Exhibit 3)

Second, there was no evidence that small national CPs tried to secure packagers to build their bottling network. Instead, they had to resort to bottlers owned by Pepsi and Coke, while small bottlers do not have the capacity to handle national distribution. Costs for new entrants to maintain bottler relations or organize small bottlers are so high that may eat up gross profit.

Finally, as discount retailers such as Wal-Mart and K mart prospered during the 1990s, CPs are facing pressures on lowering their wholesale price. Besides, it seems only Pepsi and Coke were involved in Door-Store Delivery method, CPs that sell products to private label and warehouse would be facing less distributors due to negative net profit/unit.

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