Soft drink market is really profitable, more so for the concentrate manufacturers than the bottler’s. This is surprising considering the reality that product sold is a commodity which can even be produced easily. There are a number of factors for this, using the five forces analysis we can clearly demonstrate how each force contributes the success of the industry. Barriers to Entry: The several aspects that make it extremely hard for the competitors to go into the soda market include: Bottling Network: Both Coke and PepsiCo have franchisee arrangements with their existing bottler’s who have rights in a specific geographic area in perpetuity.
These contracts forbid bottler’s from handling brand-new completing brand names for comparable products. Likewise with the recent consolidation among the bottler’s and the backwards integration with both Coke and Pepsi purchasing considerable percent of bottling business, it is really challenging for a firm going into to find bottler’s happy to disperse their product.
The other approach to try and develop their bottling plants would be extremely capital-intensive effort with brand-new efficient plant capital requirements in 1998 being $75 million.
Advertising Spend: The advertising and marketing invest (Case Exhibit 5 & & 6) in the industry remains in 2000 was around $ 2. 6 billion (0. 40 per case * 6. 6 billion cases) primarily by Coke, Pepsi and their bottler’s. The average ad spending per point of market share in 2000 was 8. 3 million (Exhibition 2). This makes it incredibly hard for an entrant to compete with the incumbents and gain any presence. Brand Name Image/ Loyalty: Coke and Pepsi have a long history of heavy marketing and this has earned them substantial amount of brand name equity and faithful consumer’s all over the world.
This makes it virtually impossible for a new entrant to match this scale in this market place. Retailer Shelf Space (Retail Distribution): Retailers enjoy significant margins of 15-20% on these soft drinks for the shelf space they offer. These margins are quite significant for their bottom-line. This makes it tough for the new entrants to convince retailers to carry/substitute their new products for Coke and Pepsi. Fear of Retaliation: To enter into a market with entrenched rival behemoths like Pepsi and Coke is not easy as it could lead to price wars which affect the new comer. Suppliers:
Commodity Ingredients: Most of the raw materials needed to produce concentrate are basic commodities like Color, flavor, caffeine or additives, sugar, packaging. Essentially these are basic commodities. The producers of these products have no power over the pricing hence the suppliers in this industry are weak. Buyers: The major channels for the Soft Drink industry (Exhibit 6) are food stores, Fast food fountain, vending, convenience stores and others in the order of market share. The profitability in each of these segments clearly illustrate the buyer power and how different buyers pay different prices based on their power to negotiate.
Food Stores: These buyers in this segment are some what consolidated with several chain stores and few local supermarkets, since they offer premium shelf space they command lower prices, the net operating profit before tax (NOPBT) for concentrate producer’s in this segment is $0. 23/case Convenience Stores: This segment of buyer’s is extremely fragmented and hence have to pay higher prices, NOPBT here is $0. 69 /case. Fountain: This segment of buyer’s are the least profitable because of their large amount of purchases hey make, It allows them to have freedom to negotiate.
Coke and Pepsi primarily consider this segment “Paid Sampling” with low margins. NOPBT in this segment is $0. 09 /case. Vending: This channel serves the customer’s directly with absolutely no power with the buyer, hence NOPBT of $0. 97/case. Substitutes: Large numbers of substitutes like water, beer, coffee, juices etc are available to the end consumers but this countered by concentrate providers by huge advertising, brand equity, and making their product easily available for consumers, which most substitutes cannot match. Also soft drink companies diversify business by offering substitutes themselves to shield themselves from competition.
Rivalry: The Concentrate Producer industry can be classified as a Duopoly with Pepsi and Coke as the firms competing. The market share of the rest of the competition is too small to cause any upheaval of pricing or industry structure. Pepsi and Coke mainly over the years competed on differentiation and advertising rather than on pricing except for a period in the 1990’s. This prevented a huge dent in profits. Pricing wars are however a feature in their international expansion strategies. 2. Economics of Bottling vs Concentrate Business Factor Bottling Business Concentrate Business.
(Data from Exhibit 5) As the above table indicates concentrate business is highly profitable compared to the bottling business. The reasons for this are: Higher number of bottler’s when compared to the concentrate producer’s which fosters competition and reduces margins in the bottling business Huge capital costs to set up an efficient plant for the bottlers while the capital costs in concentrate business are minimal Costs for distribution and production account for around 65% of sales for bottler’s while in the concentrate business its around.
17% Most of the brand equity created in the business remains with concentrate producer’s Possible Reasons for Vertical Integration: With the decrease in the number of bottler’s from 2000 in 1970 to less than 300 in 2000, the concentrate producers were concerned about the bottler’s clout and started acquiring stakes in the bottling business. They could offer attractive packaging to the end consumer. To preempt new competition from entering business if they control the bottling. 3. Effect of competition between Coke and Pepsi on industry profits:
During the 1960’s and 70’s Coke and Pepsi concentrated on a differentiation and advertising strategy. The “Pepsi Challenge” in 1974 was a prime example of this strategy where blind taste tests were hosted by Pepsi in order to differentiate itself as a better tasting product from Coke. However during the early 1990’s bottler’s of Coke and Pepsi employed low priced strategies in the supermarket channel in order to compete with store brands, This had a negative effect on the profitability of the bottlers.
Net profit as a percentage of sales for bottlers during this period was in the low single digits (-2. 1-2. 9% Exhibit 4) Pepsi and Coke were however able to maintain the profitability through sustained growth in Frito Lay and International sales respectively. The bottling companies however in the late 90’s decided to abandon the price war, which was not doing industry any good by raising the prices. Coke was more successful internationally compared to Pepsi due to its early lead as Pepsi had failed to concentrate on its international business after the world war and prior to the 70’s.
Pepsi however sought to correct this mistake by entering emerging markets where it was not at a competitive disadvantage with respect to Coke as it failed to make any heady way in the European market. 4. Can Coke and Pepsi sustain their profits in the wake of flattening demand and growing popularity of non-carbonated drinks? Yes Coke can Pepsi can sustain their profits in the industry because of the following reasons:
The industry structure for several decades has been kept intact with no new threats from new competition and no major changes appear on the radar line This industry does not have a great deal of threat from disruptive forces in technology. Coke and Pepsi have been in the business long enough to accumulate great amount of brand equity which can sustain them for a long time and allow them to use the brand equity when they diversify their business more easily by leveraging the brand.
Globalization has provided a boost to the people from the emerging economies to move up the economic ladder. This opens up huge opportunity for these firms Per capita consumption in the emerging economies is very small compared to the US market so there is huge potential for growth. Coke and Pepsi can diversify into non–carbonated drinks to counter the flattening demand in the carbonated drinks. This will provide diversification options and provide an opportunity to grow. 5. Impact of globalization on Industry structure:
Globalization provides Coke and Pepsi with both unique challenges as well as opportunities at the same time. To certain extent globalization has changed the industry structure because of the following factors. Rivalry Intensity: Coke has been more dominant (53% of market share in 1999). in the international market compared to Pepsi (21% of market share in 1999) This can be attributed to the fact that it took advantage of Pepsi entering the markets late and has set up its bottler’s and distribution networks especially in developed markets.
This has put Pepsi at a significant disadvantage compared to the US Market. Pepsi is however trying to counter this by competing more aggressively in the emerging economies where the dominance of Coke is not as pronounced, With the growth in emerging markets significantly expected to exceed the developed markets the rivalry internationally is going to be more pronounced.
Barriers to Entry: Barriers to entry are not as strong in emerging markets and it will be more challenging to Coke and Pepsi, where they would have to deal with regulatory challenges, cultural and any existing competition who have their distribution networks already setup. The will lack the clout that have with the bottler’s in the US. Suppliers: Since the raw material’s are commodities there should be no problems on this front this is not any different Customers: Internationally retailers and fountain sales are going to be weaker as they are not consolidated, like in the US Market.
This will provide Coke and Pepsi more clout and pricing power with the buyers Substitutes: Since many of the markets are culturally very different and vast numbers of substitutes are available, added to the fact that carbonated products are not the first choices to quench thirst in these cultures present additional significant challenges. The consumption is very low in the emerging markets is miniscule compared to the US market. A lot more money would have to be spent on advertising to get people used the carbonated drinks.