The competition within the $74 billion carbonated soft drink (CSD) industry has been remarkable ever since Coca-Cola was formulated in 1886, and further intensified when Pepsi was introduced in 1893. Ever since then, the CSD industry has been dominated by these two companies, with Coke taking the lead in the early stage, followed by Pepsi doubled its market share between 1950 and 1970 by offering its concentrate at a lower price than its competitor. The CSD industry has been profitable historically due to numerous reasons.
Firstly, in the world’s largest market for CSD products, consumption had been growing at a steady rate of 3% annually from 1970 to 2000 in the U. S. , marking a high growth stage in the industry life cycle (Appendix B). This allowed both Coke and Pepsi (C&P) to achieve annual sales growth of around 10%, while competing head-to-head against each other and other smaller CSD producers. Competition between C&P reinforced their brand image, as the increase in marketing efforts could be transferred into profit and sales growth when the overall demand was increasing in a growing industry.
However, the increasing industry volume was largely obtained by C&P, leaving other smaller firms vulnerable with stagnated growth opportunity. Secondly, according to Porter’s Five Forces analysis in Appendix A, high barrier for new entrants, low bargaining power of suppliers of both concentrate producers and bottlers, moderate buyer’s bargaining power and low degree of threats of substitutes prior to 2000, have been favorable to the high profitability and growth of the CSD industry. In terms of concentrate producers, the manufacture process involves little fixed costs and capital investments.
This ensures high level of gross margin for them and frees up funds for marketing related expenditures. As the industry became more consolidated, large firms such as C&P gained pricing power over bottlers through master price contracts. For bottlers, even though heavy capital investments and fixed costs limit their profitability, they often receive financial assistance and incentives from concentrate producers, and are awarded exclusive territory distribution rights that limit intra-brand competition.
The profitable aspect of the CSD industry came to a slow corner in late 1990s, as consumers became more health-sensitive, while nutrition organizations claimed that CSD products was the main cause of the American diet. Demand for CSD beverages started to diminish, although it still remained the most consumed beverage type in America. From the industry life cycle perspective, the CSD industry has entered post-mature/early-decline stage.
In the wake of flattened demand and gradual change in consumer preference, the most challenging question faced by C&P is how to ensure continued growth and profitability. From the resource based-view perspective, the most valuable resources of C&P are their brand equity, as well as their economies of scale. These two valuable resources awarded C&P the ability to utilize both differentiation and cost-leadership strategies, which give C&P the competitive advantage in pricing power and cost efficiency relative to other firms in the industry.
By combining these two generic strategies, a general guidance could be followed when addressing some of the key issues in the following discussion and arrival of recommendations. Demand for CSD as measured by gallons per capita and shares of total beverage consumption peaked in 2000 in the U. S. market. Since then, consumption for CSD had slowly fallen due to previously mentioned reasons. In the mean time, the rise in popularity of non-CSD drinks has caught much attention by C&P.
Sports and energy drink, as well as ready-to-drink tea in particular, was among the rising stars of non-CSD segment. They have possessed steady increase in market share of the segment, as measured in terms of annual unit case volume, as well as contributed exceptional high gross margin of 65%, 70% and 60%, respectively. The question arises for C&P as how they should allocate investments in capital expenditures and marketing efforts between CSD and non-CSD products. Capital expenditures for CSD products are minimized for both concentrate producers and bottlers given mass-production scale.
However, handling non-CSD products is problematic for bottlers, as production volume remains relatively small comparing to CSDs, which increases handling and warehouse costs. This issue could be addressed by providing financial assistance and assigning specific bottlers with the exclusive national distribution right of certain non-CSD beverages, which shift non-CSD into mass-production products and better leverage their economies of scale, therefore lowers handling costs for bottlers.
In terms of marketing, C&P has been emphasizing on their flagship cola brands by allocating most of their marketing budget onto promoting the duo market share leaders. However, as demand for non-CSDs such as sports and energy drinks growing rapidly, it’s crucial for both firms to capture solid market shares and promote their brand image in order to differentiate their products and establish footholds in this growing segment. Although CSDs demand in the U. S. market has flattened, it remains popular internationally.
Emerging markets like China and India with growing middle class population in particular, display higher growth potential than the domestic market. Coke has successfully established its footholds internationally through early expansion, and is recognized as a symbol of the American culture. Its operating margin from international markets has been superior, which suggests more profitability generated from overseas. Meanwhile, Pepsi is urged to expand globally by improving its brand equity through effective marketing and strategic alliances with influential local organizations.
Both firms will need to study the culture and trend in each market comprehensively in order to capture the most profitable beverage segments. Both firms will face various degrees of protectionism in certain markets, which could be overcome by offering foreign governments incentives such as charitable donations and community involvement. A thorough understanding of brand portfolio helps firms better allocate resources and make decisions to spin-off under-performing segments.
As illustrated by Appendix C, brands fall in the “Star” quadrant need to receive the highest attention level and most fund allocation; “Cash Cows” need continued support, while their established market presence allows C&P to allocate more resources into promoting the “Star” brands; “Question Marks” need to be closely monitored for growth opportunity. Lastly, C&P may consider exit strategies on under-performing brands to free up company resources. C&P have a history of consolidating and spinning off their bottler networks.
While keeping bottlers as separate entities creates financial flexibility, the upside of consolidation weighs out the downsides. By consolidating their bottler network, conflicts of interests are eliminated as decision-making process is centralized; cost synergies throughout the value chain could be achieved by eliminating financial incentives and combining administrative and sales forces, which corresponds to the overall cost-leadership strategy; unified production also improves the effectiveness of quality control, which could be translated into improved brand image.
In sum, C&P can achieve growth and profitability by leveraging their size and brand equity, and applying a combined differentiation and cost leadership strategy. A transition from traditional carbonated beverage producers to well-rounded beverage companies is much needed in today’s rapidly changing industry environment. Both firms need to bolster CSD demand in the emerging market while developing and acquiring remarkably profitable non-CSD brands, as well as popular diet beverage products tailored to consumer preferences domestically.