Session 5:

Cola Wars

MGCR 423 Strategic Management

Mitali Banerjee
Sept. 18, 2023
Returns Across Industries 1995-2015

ROCE – WACC (%)

Cosmetics 36.1
Tobacco 26.7
Soft drinks 19.1
Pharmaceuticals 18.1
Medical supplies 14.5
Computer software 12.7
Printing and publishing 8.5
Financial services 7.6
Petroleum products 4.8
Retailing 4.1
Aerospace / defense 3.7
Computers & peripherals 3.2
Auto parts 3.1
Building materials 3.1
Automobiles & trucks 1.6
Telecom services 0.5
Airlines - 2.4
Textiles - 2.9
Iron and steel - 3.7
Paper products - 4.2
Telecom equipment - 6.1

Strat Mgmt
2
Profitability of Soft Drinks vs Other Industries

ROA ROE

Merck 8% 17%

US Steel 0% -2%

Coca Cola 16% 30%

* Based on 2011 Financial Statements

Strat Mgmt
3
You taste its quality ?

Strat Mgmt
4
“It Tastes Good Because It's My Favorite Brand”

People who were asked to blind-test Coca-Cola and two store brands of
cola split their preferences almost evenly among the three: 31% for Coke
and 33% and 35% for the others.

But when the samples were identified, 65% of the participants in the
experiment said they preferred Coke, according to Jennifer E. Breneiser
and Sarah N. Allen of Valdosta State University.

The findings suggest that a person's preference is affected by knowledge

of a soda's brand name, and the research supports past studies indicating
that colas don't differ much in flavor, the authors say.

Strat Mgmt
5
Industry Analysis – 5 Forces

Strat Mgmt
6
Main Players in the Soft Drink Industry Value Chain

Concentrate
Suppliers Bottlers Retailers Consumers
Producers

Strat Mgmt
7
If given a choice which player would you want to be?

• Concentrate Producer?
• Bottler?

Strat Mgmt
8
Concentrate Producers (CPs) and Bottlers

• What is the nature of this relationship?

Concentrate Bottlers
Producers (CPs)

Strat Mgmt
9
How do the five forces affect CPs?

Strat 10
Mgmt
Threat of new entrants to CPs

• Economies of Scale?
• Differentiation?
• Fixed Costs?
• Switching Costs of Buyers?
• Access to Distribution Channels?
• Value of Experience?

Strat 11
Mgmt
Threat of New Entrants to Concentrate Production

• Economies of Scale:
– Coke and Pepsi have higher economies of scale on adverstising
Ex. 8 Coke Dr. Pepper Gatorade
Ad spent per $15million $19million $38 million
market share
point

• Differentiation: Advertising Leads to high perceived differentiation

• Fixed costs: Moderate by brand image built on long history of
advertising (which are not entirely fixed costs)
• Switching costs of buyers: High-bottlers cannot contractually switch
• Access to distribution channels: High-Bottlers are locked up in
contracts
• Value of Experience: Low

Strat 12
Mgmt
CPs: Intensity of Competition?

Strat 13
Mgmt
Factors that Affect Intensity of Competition Among
Incumbents

• Number of competitors & concentration

• Industry growth
• Fixed costs
• Switching costs
• Competitors with high strategic stakes
• High exit barriers
• Capacity increased in large increments
• Level of Differentiation

Strat 14
Mgmt
CPs Intensity of Competition

• Concentration in the Industry:

– Coke and Pepsi control 71% of market share
– Long history of interaction so little uncertainty about competitors’ behavior
– Each can imitate the other very quickly and hence opportunity to gaining
market share from another is short-lived
• Historically reasonable growth rates
• Fixed costs: High historical ad spend brand image.
• Switching costs: Bottlers locked in
• Strategic Stakes of Competitors: High
• Exit Barriers: Moderate
• Capacity increments: low
• Level of Differentiation: Level of ”perceived differentiation” hight

Strat 15
Mgmt
Profitability of CPs
Profitability of Concentrate Producers vs. Bottlers

CPs

• Sales 100 %
22 %
• COGS

• Gross Margin 78 %

• Selling and delivery 0%

• Advertising and marketing 21 %
• General and administration 25 %

• Return on Sales 32 %
Source: exhibit 4

Strat 16
Mgmt
Competition among CPs

• Competition on
– Shelf space
– Advertising on brand image to increase “perceived differentiation”
– Selective discounting on downstream products not upstream products

• No competition of concentrate prices

Strat 17
Mgmt
Bargaining Power of Suppliers to CPs

Strat 18
Mgmt
Coca-Cola’s Secret Recipe

Strat 19
Mgmt
Supplier Bargaining Power

• Supplies are commodities

• Concentration among suppliers: Low to moderate
• Suppliers total product costs as a fraction of industry product costs
• Importance of supplier to CP’s products: Low
• Standardization within the industry: High
• Suppliers profit level: Low
• Buyer’s ability of integrate backward: High
• Buyer’s knowledge of industry profits: High

Strat 20
Mgmt
CPs’ Buyers: Bottlers

• CPs are concentrated:Only two (or three) major concentrate producers

with sufficient demand
• Franchise agreement (exclusive territory but non-compete clause)
• No credible threat of backward integration: Bottlers cannot bottle their
own concentrate and that of Coke or Pepsi
• Price Negotiations limited by contract terms
• CP’s buyers have low bargaining power

Strat 21
Mgmt
Substitutes to CPs

• Water which is free!

• Juice
• Tea

Strat 22
Mgmt
 Summary: Attractiveness of CP

• Highly attractive
– High barriers to entry given ad spend needed to build brand image
– Structural features limits intensity of price competition among incumbents
– Supplier bargaining power low
– Buyer bargaining power low
– Substitutes: Many but ease of access, brand and addictive nature of
product has historically limited substitutes.

Strat 23
Mgmt
Five Forces for the Bottlers

Strat 24
Mgmt
Bottlers: Supplier Bargaining Power

• Carbonated water, sugar, & packaging are commodities. So low

bargaining power

• As discussed earlier, CPs have considerable power over bottlers

• Bottlers have little to no bargaining power over CPs

Strat 27
Mgmt
Bottlers: Buyer Bargaining Power

- Supermarkets – Yes
- Chain restaurants – Yes
- Fountains – Yes
- Vending Machines – Yes

Strat 28
Mgmt
Bottler Profitability
Profitability of Concentrate Producers vs. Bottlers

Bottlers

• Sales 100 %
58 %
• COGS

• Gross Margin 42 %

• Selling and delivery 18 %

• Advertising and marketing 10 %
• General and administration 6%

• Return on Sales 8%
Source: exhibit 4

Strat 29
Mgmt
Bottlers: Threat of New Entrants

• High capital investment in bottling and canning lines ($40m-$100m

per plant)
• Often, specialized resources required (i.e., specific to the needs of
Pepsi and no one else)
• High capital investment for delivery and logistics
• Geographical exclusivity in the franchise agreement

Strat 30
Mgmt
Bottlers: Intensity of Competition

• Why do CPs keep a system of geographical exclusivity?

– For bottlers, the key is to find profitable sales.
– Geographic exclusivity prevents bottlers focusing on easy, profitable sales
outside territory.
• Bottler must saturate territory to grow
• Builds ubiquity and brand awareness for CPs

• Geographic exclusivity limits rivalry across territories but can intensify

rivalry within a territory

• Within a territory what do bottlers compete on? (Hint: Capital intensive

business with the only sales options are geographically limited)

Strat 31
Mgmt
Substitute to Bottlers

• None except for delivery to fountains by CPs.

Strat 32
Mgmt
 Summary: Attractiveness of Bottling

• Not nearly as much as concentrate production!

- High barriers to entry
- Limited substitutes
- Rivalry can be fierce in certain geographic markets where Coke
& Pepsi are fighting
- Buyer power significant
- Concentrate suppliers have substantial power and
appropriate most of the vertical industry returns

Strat 33
Mgmt
CSD Industry Structure

Concentrate
Suppliers Bottlers Retailers Consumers
Producers

Supermarkets
Mass Retailers
Water/Packagi Convenience Stores
ng/Sweetener Drug Stores
Fountains
Vending Machines

Strat 34
Mgmt
Profitability of Concentrate Producers vs. Bottlers

CPs Bottlers

• Sales 100 % 100 %

22 % 58 %
• COGS

• Gross Margin 78 % 42 %

• Selling and delivery 0% 18 %

• Advertising and marketing 21 % 10 %
• General and administration 25 % 6%

• Return on Sales 32 % 8%
Source: exhibit 4

Strat 35
Mgmt
 Who is Losing the Colar Wars?

Appendix #2: US soft drink market shares (1975-2015)

1975 1985 1995 2005 2015

Coca Cola Company 35% 40% 42% 43% 41%

Coca Cola 27% 22% 21% 18% 17%
- Diet Coke / Coke Light - 7% 9% 10% 10%
Caffeine free Coke - 2% 3% 2% 1%
Sprite / Diet Sprite 2% 5% 6% 6% 6%
Fanta 1% 1% 1% 2% 2%
Others 5% 3% 2% 5% 5%

Pepsi Co 24% 30% 31% 31% 30%

Pepsi Cola 19% 19% 15% 11% 10%
Diet Pepsi / Pepsi Max 2% 4% 6% 6% 6%
Caffeine free Pepsi - 3% 2% 2% 1%
Others 3% 4% 8% 12% 13%

Dr Pepper Snapple Group (DPS) 11% 12% 15% 15% 16%

Dr Pepper 4% 4% 7% 8% 8%
7 Up 7% 6% 3% 2% 2%
Schweppes - 1% 1% 1% 1%
Canada Dry - 1% 1% 1% 1%
Others - - 3% 3% 4%

Other Concentrate Producers 30% 18% 12% 11% 13%

Strat 38
Mgmt
Evolution of CP/Bottler relationshio

• Price negotiations
• Vertical integration and spin-offs
• Historically bottling profitable but less so over time

Strat 39
Mgmt
What can we learn from the case?

• Occupying particular parts of the industry value chain shapes a firm’s

ability to appropriate the value they create.
– CPs appropriate much of the value
– Bottlers get squeezed
• Industry structure evolves and is not a given.
– Players like CPs acquire and divest bottlers to compete profitably
• Excessive value appropriation has long-term effects on quality of
buyers/suppliers
– As bottlers’ margins suffer, their quality suffers.

Strat 40
Mgmt
Next Class: Business Level Strategy

Strat 41
Mgmt