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Cola Wars Continue: Coke and Pepsi in 2006

Spenser Garrison Strategic Management 3/17/10 Case 1: Cola Wars Continue: Coke and Pepsi in 2006 The soft drink industry is very competitive for all companies involved. Recently the competition between established firms has only increased with the market nearing its saturation point. All companies in the industry, especially those thinking about entering, have to think about Porter’s 5-Forces model and the pressures it outlines; rivalry among establish firms, risk of entry by potential competitors, substitute products, suppliers, and buyers.

When talking about market share, PepsiCo and Coca-Cola have the lions share. They have dominated the industry over the past 40 years with Coca-Cola leading in the category in 2004 (C256). With little resistance from Cadbury Schweppes, the distant third largest company in the industry, the two companies’ main focus was to increase market demand by outdoing each other in promotions, advertisements, and corporate acquisitions. Rivalry and power struggle have defined the existence of PepsiCo and Coca-Cola, looking for a competitive advantage to gain an edge on the competition.

This rivalry has been to the benefit to the companies, the industry, and its consumers as a whole. Both have learned to not only stay afloat, but flourish in an industry that has constantly grown since Coca-Cola began advertising in 1891 (C258). They did this by increasing the demand in their products, and gaining brand loyalty by their consumers. In some instances, they were selling cases of Dasani (Coca-Cola) and Aquafina (PepsiCo) for less than the cost of bottling it (C267). The risk of entry by potential competitors isn’t a strong competitive pressure in the industry.

PepsiCo and Coca-Cola dominate the industry with their brand name and distribution channels, which makes it difficult for new entrants to compete with these existing firms. High fixed costs of production facilities, logistics, and economies of scale also deter entry. It’s difficult for a new firm with a small production capacity, and a high cost structure to compete when, as soon as their product is introduced to the market, the two leading firms drop prices below your cost structure.

Pepsi and Coke’s economies of scale allows them to do this since it costs so much less for them to produce their products than it would a new company. Substitute products come from competitors outside of the soft drink industry. These include: coffee, sports drinks, bottled water, tea, and juices. This is an increasingly growing force since consumers are becoming more health conscious in society. Most people are thinking about what carbonated soft drinks do to their bodies and replace them with sports drinks which appear to be healthier.

These drinks also allow for a larger variety of flavors the appeal to different consumers (C263). Coffee and tea may also be substitutes for the consumer who drinks soda for the caffeine they contain. Consumers can switch to coffee to decrease the amount of sugar and carbonation. These also come in a larger variety of flavors provided companies, such as Starbucks, that have become extremely popular over the past 20 years. These substitutes are a large and powerful force in the industry, especially since the switching costs (the cost to switch from one product to the next) are essentially zero.

Supplies to the industry don’t hold much competitive pressure. Bottling and packaging of the product don’t hold much of a bargaining position in the industry. Coca-Cola’s CEO Roberto Goizueta looked to consolidate a large number of bottlers in 1986, creating an independent bottling subsidiary called Coca-Cola Enterprises (CCE), went public and sold 51% of its shares while retaining the remaining which enables Coke to have separate financial statements from CCE (C261). This vertical integration essentially made Coke its own bottler, which almost cut out suppliers entirely.

PepsiCo soon followed suit in the late 1980s with the Pepsi Bottling Group (PBG) and went public in 1999, retaining 35% of its shares (C261). By 2004 Coca-Cola had CCE bottling 80% of its North American bottle and can volume, while PepsiCo had PBG bottling 57% of their beverages in the region (C261). These consolidations took away much of suppliers’ bargaining power. The buyers of soft drinks range from Supermarkets, to mass retailers and supercenters, to gas stations. Soft drinks are sold to these stores which are, in turn, resold to customers.

Buyer power in the industry is very strong. Larger stores purchase soft drink in large volumes allowing them to buy at low prices. Gas stations have less bargaining power since they buy smaller quantities. Although soft drink demand is beginning to plateau which could cause a shift in bargaining power to the buyer because of decreasing demands in both Pepsi and Coke. Porter’s 5-Forces model completely encompasses all factors of the soft drink industry. It has shown that industry has been very profitable in earlier years, especially to Pepsi and Coke.

Demand for soft drinks is beginning to level off because of a new health conscious trend by the consumer which will inevitably affect profits. The industry has also been defined by intense rivalry by the two largest firms which leave little room for new entrants. The soft drink industry has reached its peak in society and will soon begin to decline soon because of the consumers decrease in demand for the product and increased demand in other healthier products. For both companies to stay profitable, they will have to curtail their products to the new health conscious trend of the consumer.

The value created by the soft drink industry is apparent and distributed across the industry in a variety of ways. Pepsi and Coke at first only produced their cola products, two companies each with one product line. The success of both companies led them to diversify their production capabilities and produce different flavors of soda; Fanta, Sprite, and Tab (1960-63) from Coke, and Teem, Mountain Dew, and Diet Pepsi (1960-64) from Pepsi (C259). These expanded product lines proved to be highly profitable and were continued and expanded on in the years to come.

By the late 1980s Coke and Pepsi each offered more than 10 major brands of soda in 17 or more sizes (C261). This product proliferationincreased profitability, rivalry, and barriers to entry. Soon both companies would break into markets other than carbonated soft drinks. Sports drinks such as Gatorade and Powerade, juices and juice drinks, energy drinks, tea based drinks, and bottled water. These new product lines all had substitute products from the other company to battle with. Pepsi and Coke had a vast understanding on game theory and demonstrated it with their sequential and simultaneous move games.

This led to an enormous selection for the consumer, whose only problem was choosing a flavor. Both Pepsi and Coke both have secret recipes to their flagship cola. Coke was the first to be imitated in its early years. The company constantly fought trademark infringements in court. There were as many as 153 barred imitation of Coca-Cola in 1916 alone (C259). When Pepsi proved to be a viable competitor to Coke, the company filed a suit against Pepsi claiming it was an infringement on the Coca-Cola Trademark.

From that point on the two companies engaged in competitive marketing campaigns to gain market share. In 1950, Coke controlled 47% of the US market, while Pepsi’s was only 10%. Coke and Pepsi are two gigantic companies that have flourished throughout their existence. They can be described as the definition of rivalry and competition in the modern business world. They are exact substitutes of each other and have battled to control the carbonated soft drink industry for over a century.

From the 1950s-present, the carbonated soft drink industry has steadily increased in terms of consumption by person in the US (C251). Both companies have spent billions in marketing, research, acquisitions, and promotions to meticulously exchange percentage points in the $66 billion a year industry that they have created (C250). Unfortunately times are changing, and the superiority that the carbonated soft drink industry once held among beverages is slowly fading. Schools are banning sodas from being sold in them, claiming they are unhealthy for children (C263).

People in today’s society are more health conscious than they were in prior years. This is why you see a health clubs left and right, and “0g Trans Fat” labeled on snack foods. A majority of the US population is very health conscious, which leaves little room for the sugary carbonated soft drinks that used to dominated beverage consumption. The stability of the Soft drink Industry as a whole is in jeopardy. Coke and Pepsi will have to find alternatives to increase market share, or break into new markets, if they want sales to keep increasing like they have in the past.

Non-carbonated beverages, such as juices, sports drinks, and energy drinks, are beginning to grow more rapidly than when they first were introduced, while carbonated beverages are leveling off. This health conscious shift will lead Coca-Cola and Pepsi executives to focus in these once thought auxiliary components of their business to pick up the slack that the carbonated industry is leaving behind. Coke and Pepsi will not be able to repeat their success with carbonated beverages in the water segment. Water can’t differ like soft drinks can.

There are simply too many similar substitutes for customers to turn to, and the brand loyalty diminishes. A mere 10% of consumers say they choose a brand of water because “it’s my favorite brand” when compared to the 37% of carbonated beverage consumers (C267). To compete in this new market, Coke and Pepsi will need a new competitive dynamic to stay profitable, one that won’t end in price wars. Fortunately for the market it is much cheaper to bottle and sell water than it is carbonated soft drinks, so competitive advantage will need to inevitably be realized in other parts of the business.

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