Briefly describe the basic structure of the CSD industry and how it has evolved. The CSD industry is very much concentrated. According to Exhibit 2 of the case, the market concentration of the two firms was over 75% in 2000 (44% for Coca Cola and 31% for Pepsi) and almost 72% in 2009 (almost 42% for Coca Cola and almost 30% for Pepsi). The barriers to enter the CSD market are very high mainly because of the economies of scale enjoyed by Pepsi and Coca Cola.
These two firms produce a very large portion of the total output of the market and they reach their MES (minimum efficient scale) when they cover for over 70% of the market. Another important barrier to enter this industry is the well-known reputations that Coca Cola and Pepsi have. It would take many years and many millions of dollars invested for somebody else to be able to build such reputation in the CSD industry. On May of 1886, pharmacist Dr. John Pemberton had created a drinkable medicinal formula which he termed “Coca-Cola”.
Pemberton’s original Coca-Cola recipe called for coca leaves and kola nuts. After mixing his concoction with sparkling mineral water, Pemberton began to market the beverage as a fountain drink, and as an alternative to beer and ginger ale. In the next year pharmacist Dr. Asa Candler, bought the formula from Dr. Pemberton. Due to his penchant for aggressive marketing and advertising, Dr. Candler’s Coca-Cola business became quite successful, and Coca-Cola became one of America’s most popular fountain drinks. After 1905, coca leaves were no longer used as one of the main ingredients in Coca-Cola.
In time, fructose syrup replaced the crystal sugar used in the soda, allowing for cheaper and faster manufacture of the syrup. The bottling industry also allowed for a wider distribution of the soda, further increasing its sales and its popularity. During 1960’s Coke launched Fanta, Sprite and Tab. Today, Coca-Cola products are consumed at a rate of more than one billion drinks per day globally . In 1893, another pharmacist, Dr. Caleb Bradham, also concocted a tonic drink. This drink was carbonated and contained sugar, vanilla, rare oils, pepsin, and cola nuts.
Dr. Bradham sold his drink at his pharmacy’s soda fountain, much like Dr. Pemberton did with his Coca-Cola. By 1898, “Brad’s drink” had been renamed to Pepsi Cola. After successfully marketing the product and even issuing shares of stock for the Pepsi Cola Company, Caleb lost the company through bankruptcy in 1923. Pepsi-Cola’s luck finally changed in 1940, through the success of an advertising jingle called “Nickel Nickel”. In 1964, diet Pepsi Cola was introduced, further increasing sales for the company.
In 1965, Pepsi-Cola changed its official corporate name to PepsiCo and acquired the product line Mountain Dew and Lipton’s Iced Tea, as well as Frito Lay’s. It also negotiated business deals with companies like Taco Bell, Kentucky Fried Chicken, and Pizza Hut. Today, PepsiCo sales total over $29 billion employs more than 150,000 people speaking over 40 languages around the world.  The basic structure of the CSD industry was built around competitors Coke and Pepsi. During their CSDs inception there wasn’t any competition for alternative beverages other then one another.
The materials, production, and suppliers were easy, accessible and demanding of both products. They were perfectly competitive which drove profits towards advertising to hike sales. – SWOT ANALYSIS Strengths Large scale of operations Weaknesses Negative publicity in regard of health issues Opportunities Acquisitions and intense competition Threats Dependence in bottling partners 2. How would you characterize the CSD market? Is it hyper competitive, monopoly, monopolistic competition or oligopoly? Describe how the market characteristics apply in terms of specific examples.
The CSD market is an oligopoly. In such market, Pepsi tends to react quickly to any move made by Coca Cola and viceverza. Every decision made by one of the industry leaders affects directly the other main competitors. Two companies control over 70% of the market, and the barriers to enter the industry are very high. The main advantage that both Coca Cola and Pepsi have over other market players is their brand recognition. The CSD industry is very profitable, more so for the concentrate producers than the bottler’s.
This is surprising considering the fact that product sold is a commodity which can even be produced easily. The CSD market is an oligopoly because it is dominated by a small number of strategically interacting firms. There are high barriers to entry and exit to the market. The actions taken by Coca-Cola highly impact Pepsi-Cola and vice versa. Each force contributes the profitability of the industry, for example: Bottling Network: Both Coke and PepsiCo have franchisee agreements with their existing bottlers who have rights in a certain geographic area in perpetuity.
These agreements prohibit bottler’s from taking on new competing brands for similar products. Also with the recent consolidation among the bottler’s and the backward integration with both Coke and Pepsi buying significant percent of bottling companies, it is very difficult for a firm entering to find bottler’s willing to distribute their product. Retailer Shelf Space (Retail Distribution): Retailers enjoy significant margins of 30% on these soft drinks for the shelf space they offer as seen in Exhibit 10. 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. 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 Bargaining Power: The major channels for the Soft Drink industry are: Supermarkets, Convenience stores, Drug stores, Fast food fountain, 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. [Exhibit 6] Substitutes: Large numbers of substitutes like water, beer, coffee, juices, etc, are available to consumers but this is 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.
The CSD market is a simple oligopoly, and a duopoly at that considering that there truly are only two competitors, Pepsi and Coca cola. A perfect example of this is during the “Pepsi challenge” in 1974. Shortly after the success of the challenge Coca-Cola offered rebates, retail price cuts, and a series of advertisements that questioned the tests’ validity. 4. Assess the outcome of the Cola Wars. How did the two giants engage in their competitive battles? How did competition play out between them? Use specific examples.
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.
Gross profit as a percentage of net sales for bottlers during 2010 was 42% (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. Pepsi and Coca Cola have faced each other to “play” the game theory for several decades and the outcomes have varied. According to Adam Smith, oligopolistic companies tend to cooperate to increase their profits at the expense of consumers. I believe that Coca Cola and Pepsi have cooperated without explicit agreements for the benefit of both companies.
Their collusions were tacit. They followed “tit-for-tat” and “price leadership” strategies Competition has continued to ensue between the two CSD giants and will continue as long as the decline of cola sales, emergence of noncarbonated drinks continues and the continuation of both companies adapting to CSD alternatives in order to promote consumers healthy life style changes. It is difficult to say that the future of CSD and Pepsi/Coke will be cooperative; so far we’ve seen that when one firm raises its prices and the other follows, and often encountering collusion.
Bibliography 1. http://www. worldofcoca-cola. com/coca-colahistory. htm 2. http://cr. pepsi. com/usen/pepsiusen. cfm? date=20120718 Exhibits Soft drink consumption by country Rank | Countries | Amount | # 1 | United States:| 216 litres | | # 2 | Ireland:| 126 litres | | = 3 | Norway:| 119. 8 litres | | = 3 | Canada:| 119. 8 litres | | # 5 | Belgium:| 102. 9 litres | | # 6 | Australia:| 100. 1 litres | | # 7 | United Kingdom:| 96. 5 litres | | # 8 | Netherlands:| 96. 1 litres | | # 9 | New Zealand:| 84. litres | | # 10 | Sweden:| 82. 4 litres | | # 11 | Switzerland:| 81. 4 litres | | # 12 | Denmark:| 80 litres | | # 13 | Austria:| 78. 8 litres | | # 14 | Germany:| 72 litres | | # 15 | Finland:| 52 litres | | # 16 | Italy:| 50. 2 litres | | # 17 | France:| 37. 2 litres | | # 18 | Japan:| 21. 6 litres | | | Weighted average:| 89. 8 litres | | DEFINITION: Consumption of carbonated soft drinks. Litres per person per year, 2002. SOURCE: Global Market Information Database, published by Euromonitor via NationMaster