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Why soft drink industry is so profitable ?

Why soft drink industry is so profitable ?
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Cola wars between Cocacola and Pepsi Cola wars between Cocacola and Pepsi Document Transcript

  • 2013 10/20/2013 THE COLA WARS COMPILED BY: Akash Deep Kamal Atri Roy Nilesh Saha Prachi Khemani Swati Bhutoria Neha Singh
  • 1. Why is the soft drink industry so profitable? There has always been demand for soft drinks since early ages when the substitutes for them were only water. But gradually people started demanding something more, which means quenching the thirst with freshness. Thus the need for soft drinks came in. we will analyze this with the help of Porter’s Five Forces. Porter’s Five Force analysis reveals that market forces are favorable for profitability in this industry. The cost to produce soft drinks is extremely low and they make a profit at any price. Porter's Five Forces Analysis – Soft Drink Industry Bargaining Power of Buyers  The soft drink market is the largest group in the larger beverage industry. The soft drink industry is worth $60 billion dollars. Three firms control 89% of the United States soft drink sales. To say the least there is plenty of the pie to go around but it is hard to gain market share.  There are a large number of customers with the average American consuming over 56 gallons of soda a year. The average soft drink costs under $2 which makes each individual purchase relatively insignificant.  Because the soft drink industry is very competitive, switching suppliers is relatively easy and the price difference is rather small. Difference can occur based on geographic location and how far the products need to travel.  There is no need for information on how to use the product it is a simple task.  The buyer is not aware of the need for additional information because all the information that is needed is provided. There are no steps to using the product and all nutrition facts and ingredients are listed on the label.
  • Bargaining Power of Suppliers  The distribution of CSDs took place through Supermarkets, fountain outlets, vending machines, mass merchandisers, convenience stores, drug chains and gas stations and other outlets.  The main distribution channel is the Supermarket where bottlers fight for shelf space to ensure visibility for their products. In this ever-expanding array of products offered by existing players, there would be intense competition for the new entrant.  The mass merchandisers include warehouse clubs and discount retailers like Wal-Mart. These companies sell popular and leading products like Coke and Pepsi, so for a new entrant to find itself, a merchandiser is difficult task.  Competition for fountain accounts is very intense and often CSD companies sacrificed profitability in order to land and keep those accounts. Coke and Cadbury Schweppes have long retained control over fountain sales. Ex: Coke supplies for Subway, McDonald’s and Burger King whereas Pepsi took over Pizza Hut, Taco Bell, and KFC. In this case, new entrant has huge competition to face.  In vending channel, Coke and Pepsi have their dominance by giving financial incentives to encourage investment in machines. It would very challenging for a new entrant to compete. Threat of New Entrants The existing players in the soft drink industry have much advantage relative to new entrants. First, supply-side economy discourages new entrants by forcing them to enter the market in large scale. CSD’s demand side benefits of scale also make it difficult for new entrants to be accepted by the public. In 2002, a survey found that 37% of respondents chose a CSD because it is their favorite brand, while only 10% said so about bottled water. This demonstrates CSD customers’ high brand loyalty and their lack of desire to buy from new entrants. In terms of capital requirement, concentrate manufacturers only requires $25~$50 million to set up a plant that can serve the entire United States of America. Yet, new entrants may have difficulties competing with major players’ well-established brands and their large scale unrecoverable (therefore, hard to finance) spending on advertising. There is also unequal access to bottlers and retail channels for newcomers. Most bottlers are in long-term contracts with major CSD brands; also, the largest distribution channel, supermarkets, consider CSD a “big traffic draw”, thus provide little to no shelf space for newcomers. In addition, strong fear of retaliation from major players also makes newcomers hesitate to enter.
  • Threat of substitutes: A substitute performs the same or a similar function as an industry’s product by a different means. The threat of substitution is downstream or indirect, when a substitute replaces an industry’s product. 1. This industry has large numbers of substitutes like water, beer, wine; coffee, milk, tea, juices etc are available to the end consumers. 2. The soft drink companies diversify business by offering substitutes themselves to shield themselves from competition. Ex: Pepsi produces Mug Root Beer (1.4% market share), Slice fruit juice (0.3%) and Tropicana fresh juices. Coke produces Barq’s and Diet Barq’s (0.4%), Minute Maid brands producing fresh fruit juices (1.5 %). By diversifying the business, the market share of the company raises to greater high. Coke recorded a high of 43%, after diversifying from 33.4%, when it was restricted to only Coca-cola. And Pepsi rose from 20% to 31%. And Cadbury rose from 4.7% to 14.5%. 3. Threat of substitute product is countered by soft drink industry by huge advertising, brand equity, and making their product easily available for consumers, which most substitutes cannot match. . Rivalry among Existing Players;  Coca-cola was started way back in 1890s and after a period of nearly 40 years, in 1939 Pepsi was launched. When Pepsi was launched, it was called the ‘imitator’ by the coke group, but soon it became a dominant force in the of decline of coke’s market share. Pepsi mainly aimed on packaging. When it was launched, it came out with a campaign of--- “Twelve full ounces, that’s a lot. Twice as much for a nickel, too”, which forced Coke to launch three new packages: King-sized ten-ounce, the twelve ounces, and the twenty-six ounces Family size.  In 1985, Coke announced that it has changed the 99-year old Cola formula. Pepsi claimed that the new coke mimicked Pepsi in taste, which promoted an outcry from loyal customers to bottlers. And, this forced the Coke to bring back its original formula.  Pepsi mainly concentrated on advertising and marketing with film-stars to sports celebrities for promoting their products, which became very successful. Many other new players followed this later.  In terms of marketing, the rivalry between Coke and Pepsi heated up with “Pepsi Challenge” in Dallas. This was responded (by Coke) with an ad campaign questing the validity of the test. It also introduced rebates and retail price cuts.
  •  In terms of Retail channels, Coke and Pepsi fought over fountain sales to acquire more national accounts. Competition remained vigorous: In 2004, Coke won the Subway account away from Pepsi, while Pepsi grabbed the Quiznos account from Coke. Coke however continued to dominate the channel with 68% share of national pouring rights, against Pepsi’s 22% and 10% for Cadbury.  In 1966, Coke had market share of 33.4%, Pepsi with 20.4% (Cadbury was not launched then) and in 2004, Coke has 43.1%, Pepsi has 31.7%, Cadbury with 14.5% and other companies with 5.2%. The Intra-rivalry has had an impact on the sales figures of industry players. The discounts given to the retailers reduced the overall profit margins. This forced the companies to search for alternative supplies (like corn syrup instead of sugar). 2. Compare the economics of the concentrate business to the bottling business. Why is the profitability so different? We can compare the business from the exhibits provided in the case- FACTORS CONCENTRATE BOTTLER DOLLARS PER CASE* %OF SALES DOLLARS PER CASE* % OF SALES NET SALES COST OF SALES 0.71 0.12 100 17 5.80 3.77 100 65 GROSS PROFIT 0.59 83 2.03 35 SELLING AND DELIVERY 0.01 2 1.22 21 ADVERTISING AND MARKETING 0.28 39 0.12 2 GENERAL AND ADMINISTRATION 0.06 8 0.23 4 PRE TAX PROFIT 0.25 35 0.52 9
  • 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 it’s around 17%  Most of the brand equity created in the business remains with concentrate producer’s The profitability were so different because-  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 pre-empt new competition from entering business if they control the bottling. 3. How has the competition between Coke and Pepsi affected the industry's profit? The competition between Coke and Pepsi affected the industry's profits because they have branched out to other markets. By making high quality products and branching out to the food industry the profits have greatly increased. 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.
  • Another way of looking at the industry profit is-  Since 1970 consumption grew by an average of 3%  From 1975 to 1995 both Coke and Pepsi achieve average annual growth of around 10%.  American’s drank more soda than any other beverage  Head-to-Head Competition between both Coke and Pepsi reinforced brand recognition of each other. This assumes that marketing added to profits rather than eating them up.  Very large market share. 53% in year 2000.  Average 10.65% net profit in sales for both Pepsi and Coke. The Market Share- 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. 4. Can Coke and Pepsi sustain their profits in the wake of flattening demand and the growing popularity of non-carbonated drinks? Yes Coke can Pepsi can sustain their profits in the industry because of the following reasons:  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.  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  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.
  • CONCENTRATE PRODUCERS 1. Is it profitable? Yes it can be regarded as profitable since the process in this case which involved blending of raw materials ingredients packaged in plastic containers required little capital investment in machinery, overhead or labour. . A typical concentrate manufacturing plant cost approximately $25million to $50 million, and one plant can serve the entire US. According to the data provided in case the Pre-tax profit is 35% of total sales. We can better explain it with the help of PORTERS FIVE FORCES ANALYSIS: a. Threats from new entrants– In the case of concentrate producers, threat of new entrants is limited because they have patented the formula and have copyrights and trademarks to protect their other intellectual property rights. The concentrate producers invested heavily in their trademarks over time with innovative and sophisticated marketing campaigns. b. Bargaining power of buyers - From the concentrate manufacturer's perspective, the bargaining power of buyers is low. Buyers are bottlers. Bottlers are usually franchisees and the bottler typically does not want to do anything that would make the concentrate producer reconsider their current arrangement. c. Threat of substitute products- There is little or no threat of substitute products because the formula used to create the concentrate is proprietary as patented. d. Bargaining power of the suppliers-The bargaining power of the suppliers to the concentrate manufacturers is relatively low because the raw materials needed to produce the concentrate are basic commodities that the producers can find from a number of alternative sources. e. Threat from competitors- The fifth force in the five forces model is competitive rivalry and while it is certainly true that the cola wars involve competitors trying to take market share from one another, these wars have not become sustained price wars in which on producer's concentrate is reduced in cost in an effort to help that company.
  • f. Threat from competitive Rivalry- Threats from new entrants are limited because they have patented their formula and did copyrights and trademarks on their own property to protect their other intellectual property rights. We found that the bargaining power of buyers is low. There is little or no threat of substitute products because they have patented their formula that was used to create the concentrate. The bargaining power of the suppliers to the concentrate manufacturers is relatively low because the raw materials needed to produce the concentrate are basic commodities that the producers can find from a number of alternative sources. The fifth force is competitive rivalry which coke was in a very high position. It is so because the cola wars involve competitors trying to take market share from one another. 2. If this is a profitable industry, why have so few firms successfully entered this business over the last century? What are the barriers to entry? What have other marketing companies, e.g. P&G, not been successful in launching competitive products? We cannot neglect the fact that firms like Coca – Cola and Pepsi definitely had the advantage of being the first movers in this industry since it was Coca- Cola who came up with this innovation and this is reason that Coca – Cola is far ahead of Pepsi. When Coca – Cola and Pepsi entered the market, they developed a market base which they had developed through extensive advertising, promotion, market research and the marketing campaigns. The marketing base as well as the promotional strategies of coke was on a very high point and hence it was nearly impossible for any new CP to overcome the tremendous marketing strategies and market presence of Coke, Pepsi and a few others who had established brand names that were as mucg as a century old. As such the only way through which a new firm could penetrate in the market could be through their DSD practices, these companies had intimate relationships with their retail channels and would be able to defend their positions effectively through discounting or other tactics. The Barrier to Entry here would not be the CP industry since it is not very capital intensive but the, bottling, meanwhile, would require substantial capital investment, which would deter entry. The main entry barrier here is an absolute control over bottling franchises and intensive retail channel like supermarket, restaurant, fountain outlets etc. Existing bottlers had exclusive territories in which to distribute their products. Regulatory approval of intrabrand exclusive territories, via the Soft Drink Inter-brand Competition Act of 1980, ratified this strategy, making it impossible for new bottlers to get started in any region where an existing bottler operated, which included every significant market.
  • Other marketing companies had not been successful in launching competitive products because of the most common reason that Cola has been invested huge in their promotional strategies and had already created a huge marketing base. So, even if they think of entering into the bottling sector, first thing would crackle in their mind is to get enter into the bottling will surely lead to a huge capital investment. So many other companies thought that it would a very risky positioning to invest into such a huge capital at the present situation. 3. If it is so hard to enter, have their historically been substitutes available? What did they cost? Why didn’t they have much of an effect on price? Yes there historically have been substitute drinks available like tea, coffee, soda, juice, beer, milk, wine, powdered drink, and bottled water. Flavored soft drinks such as citrus, lemon-lime, pepper and root beer were also popular. Most of them were free or much less costly per ounce or were preferred more. The cost of those substitutes were much available at very affordable rates But the main problem was the availability. Research has been done and have found out that many substitutes are not always available everywhere conveniently. They have not much effect on price because many a times soft drinks are an impulse buy. More often it is about lifestyle choices as they were positioned. Drinking Coke or Pepsi was a status symbol for many. 4. How do the soft drink companies get away with charging $1.00 for a product when the “healthy” substitute (tap water?) is free? Tap water undoubtedly is a healthy substitute since both tap water and Soft drink companies solve the purpose of quenching thirst. However, tap water is a habitual product in which consumer involvement and differentiation is low. The general behavioural theory of consumers is that they move from a product of low involvement, differentiate to high involvement, differentiate product. Pepsi Vice-President said that “If Americans want to drink tap water, we want it to be Pepsi tap water” for his new business which depicted his new strategy. According to the survey done, Americans consumed 23 gallons of Carbonate Soft Drink (CSD) annually in 1970 and consumption grew by an average of 3% per year over the next 30 years Even though CSD available in market is more or less the same in taste but it differentiates itself from tap water. Also the integrated marketing communication undertaken by the CSD generates an image which helps to develop high involvement from the side of consumer and also gives them a status symbol.
  • CSD always focused on quenching thirst and people always want something new and attractive. So even if water was available for free, soft drinks brought in the concept of quenching thirst with freshness. As years passed by, the consumption of CSD has also started increasing. At 60% - 70% market share, the cola segment of the CSD industry maintained its dominance throughout the 1990s, followed by lemon/lime, citrus, pepper, and root beer, orange and other flavors. 5. Do buyers have any real power relative to the concentrate manufacturer? Who are they? The buyers are the BOTTLERS and they have much power relative to the concentrate manufacturer. Because concentrate manufacturer produce most generic product and in case of bottlers they are franchised by big company like Coca-Cola, Pepsi. Being a major market share holder these companies has absolute control over most bottler’s manufacturers. Buyers are the bottlers and they had very little power in the last 25 years even when they were independent due to high switching costs. Franchise agreements locked bottlers into exclusive deals. Concentrate is 40-45% of COGS to the bottler. But CPs offer significant benefits like buying power for cans, brand development, etc. Buyers are also final consumers who are price sensitive and susceptible to advertising. In the plastic bottle business, again there were more suppliers than major contracts, so direct negotiation by the CPs was again effective at reducing supplier power. 6. How can companies make so much money in the middle of a “war”? Who have won the cola wars? Who have lost? Why? What have been the “weapons of war? According to the case, we have found the market share of Coke and Pepsi- 1950: Coke 47%, Pepsi 10% 1970: Coke 35%, Pepsi 20% 1980: Coke 36%, Pepsi 28% 1990: Coke 41%, Pepsi 32% 2000: Coke 44%, Pepsi 31.4, Cadbury Schweppes 14.7% Initially Coke was the winner (through 1960s).
  • Coke was the winner mainly due to the following reasons: 1. Extensive bottling franchise 2. Brand name. 3. Creating a good brand image 4. A good market base as well as customer base Smaller brands have lost the war as these two brands had gained almost 70% of the market share. Historically they could piggy-back on Pepsi and Coke’s bottler systems. But the big brands pushing for shelf-space pushed out the smaller brands out of the market. We can say that the above reasons were mainly the “War of Weapons” that has mainly focused on maintaining good relations with the customers. It also includes shelf-space, advertising largely based on lifestyle and brand name, selective discounts on downstream products, not on upstream products. 7. Why does the war not escalate out of control? How do they keep the war within “bounds”? The war does not escalate out of control because opportunity for gaining advantage for both Coke and Pepsi is very short-term. Coke and Pepsi are equally competitive and capable of quickly imitating each other on all probable dimensions. Any escalation or price cuts would simply be met by imitation. Both the players Coke and Pepsi Kept their the War within Bounds by following ways- a. Both Pepsi and Coke targeted the place where the rival players were not operating For example- Coca Cola sale through fountain outlets which has differentiated them from other players, Pepsi more focussed to sale through supermarkets, Coca Cola not allowed for Russia but Pepsi took it as an opportunity to grow and targeted Russia. b. A strategic move or we can say a positivity made their war in boundary as when both the player reply to the competitor in a positive manner such as develop the market overall through franchisee contract, bottling, campaign, introducing new product. c. Both Coke and Pepsi gave more concentrate on backward integration by maintain long relationship with their new as well as existing customers. They set up a strategic support to the operating process members which include bottlers, concentrate producers.
  • BOTTLERS:- 1) How do the economics of bottlers differ from Concentrate Producers? Ans) A CP’s most significant costs were for advertising, promotion, and market research and bottler relations. They usually took the lead in developing the programs particularly in product planning, market research and advertising. They invested heavily in their trademarks over time with innovative and sophisticated marketing campaigns. Bottlers assume a larger role in developing trade and paid an agreed percentage typically 50% or more of promotional and advertising costs. They employed extensive sales and marketing support staff to work with and help improve the performance of the bottles setting standards and operating procedures. Among national concentrate producers COCA COLA and PEPSI COLA, the soft drink unit of Pepsi co claimed a combined 76 % of the US CSD market in sales volume in 2000. The Bottling process was capital intensive and involved specialized, high speed lines. Lines were interchangeable only for packages of similar size and construction .Bottling and canning lines cost from $ 4 million to $ 10 million each depending on volume and package type. The minimum cost to build a small bottling plan with ware house and office space was $ 25 to $ 35.Roughly 80-85 plants were required across the United States. Among top bottlers in 1998 packaging account for approximately half of the bottler’s cost of goods sold; concentrate for one third and sweeteners for one tenth .Labour accounted for most of the remaining variable costs .Bottlers also invested in trucks and distribution network. 2) What was the logic of the franchise system? Why did Coke and Pepsi use (exclusive vs. non-exclusive) franchise agreements in the past? Ans) Coca-Cola and Pepsi franchise agreements allowed bottlers to handle the non cola brands of other concentrate producers .Franchisee agreements also allowed bottlers to choose whether or not to market new beverages introduced by the concentrate producer. Some restrictions applied however as bottlers could not carry directly competitive brands. For example a coca cola bottler could not sell royal crown cola but it can distribute seven ups, if it decided not to carry sprite. Franchised bottlers had the freedom to participate in or reject new package introductions, local advertising campaigns and promotions and test marketing. Historically, Coca-Cola was the first concentrate producer to build nationwide franchised bottling networks .The typical franchised bottler owned a manufacturing and sales operation in an exclusive geographic territory, with rights granted in perpetuity by the franchiser. In the case of coca cola territorial rights did not extend to fountain accounts directly not through its bottlers. The rights granted to bottlers were subject to termination only in the event of default by the bottler .The original coca cola franchise contract did not provide for contract renegotiation even if ingredients costs changed.
  • 3) If you could be a bottler for Coke or Pepsi, would you rather choose New York City or Oklahoma City? Ans) Oklahoma City is a much more profitable business. The main reason comes back to the economics of distribution: the critical issue for bottlers to make money is large drop sizes. 28% of total bottler costs are selling and delivery. In NYC, it is probably much higher. A truck has to deal with traffic, parking and has to deliver to thousands of small stores in small quantities. In Oklahoma City, by comparison, the typical drop size is likely to be very large: the bottler delivers primarily to supermarkets, which are off major roads with less traffic and delivers large volumes at one time. 4) Who are the buyers? Ans) Convenience Stores, Small Grocery stores and Drug chains: This segment is extremely fragmented and hence has to pay higher prices.  Fountain: This segment of buyers is the least profitable. They attain power of negotiation depending on the amount of purchases they make. When the amount is large, company allows them to have freedom to negotiate. Coke and Pepsi primarily consider this segment “Paid Sampling” with low margins. Coke and Pepsi have entered fast-food restaurants, Pepsi supplying to Pizza Hut, KFC etc and Coke supplying to McDonalds, Burger King, and Subway etc.  Vending: This channel serves the customers directly. Bottlers took charge of buying, installing, and servicing machines, and for negotiating contracts with property owners, who typically received sales commissions in exchange for accommodating those machines. This segment of buyers has absolutely no power with the buyer.  Supermarkets, the principal customer for soft drink makers, were a highly fragmented industry. The stores counted on soft drinks to generate consumer traffic, so they needed Coke and Pepsi products. But due to their tremendous degree of fragmentation (the biggest chain made up 6% of food retail sales, and the largest chains controlled up to 25% of a region), these stores did not have much bargaining power. Their only power was control over premium shelf space, which could be allocated to Coke or Pepsi products. This power did give them some control over soft drink profitability. Furthermore, consumers expected to pay less through this channel, so prices were lower, resulting in somewhat lower profitability.  Buyers can credibly threaten to backward integrate and produce the industry’s product themselves if vendors are too profitable. This category includes Mass Merchandisers such as warehouse clubs and discount retailers like Wal-Mart. These companies form an increasingly important channel. These retailers often have their own private-label CSD, or they sold a generic label.
  • 5) What about the suppliers? Do they have power? Ans) Concentrate Producers have significant power. Other suppliers were can manufacturers like American National Can, Crown Cork & Seal and Reynolds Metals. There was chronic excess supply of metals in the industry. Two or three can producers often competed for a single contract. Coke and Pepsi negotiated the contracts on behalf of the bottlers. 6) Substitutes? Ans) There were no substitutes for the bottlers (except direct delivery to the fountain by the CP). 7) Rivalry? Ans) While other brands shared the rivalry problems with Coke and Pepsi, these two (Pepsi & Coke) were the biggest rivals of each other. They have competed on various strategies like price discounts, extensive marketing, and automation of the bottling plants etc. i) Coca-cola was started way back in 1890s and after a period of nearly 40 years, in 1939 Pepsi was launched. When Pepsi was launched, it was called the ‘imitator’ by the coke group, but soon it became a dominant force with the decline of coke’s market share. Pepsi mainly aimed on packaging. ii) Pepsi concentrated on advertising and marketing with film-stars to sports celebrities for promoting their products, which became very successful. Many other new players followed this later. iii) In terms of Retail channels, Coke and Pepsi fought over fountain sales to acquire more national accounts. Competition remained vigorous.
  • THE COLA WARS CONTINUE IN 2013……… THANK YOU