Search by keyword:

Go
Sort By:

• Home
• Search Essays
• FAQ
• Guarantees
• Privacy
• Lost Essay?
• Contact

Essay Color Key

Free Essays
Unrated Essays
Better Essays
Stronger Essays
Powerful Essays
Term Papers
Research Papers

• Popular Essays
• Excellent Essays
• Discount
• Free Essays A-F
• Free Essays G-L
• Free Essays M-Q
• Free Essays R-Z
• Essay Topics
• Plagiarism
 • Donate a Paper

Report Plagiarism

Case Study of the Soft Drink Industry:

Length: 4504 words (12.9 double-spaced pages)

Rating: Red (FREE)
----------------------------------

Case Study of the Soft Drink Industry

Incomplete Essay

Table of Contents

Introduction 3
Description 3
Segments 3
Caveats 4
Socio-Economic 4
Relevant Governmental or Environmental Factors, etc. 4
Economic Indicators Relevant for this Industry 4
Threat of New Entrants 5
Economies of Scale 5
Capital Requirements 6
Proprietary Product Differences 7
Absolute Cost Advantage 8
Learning Curve 8
Access to Inputs 8
Proprietary Low Cost Production 8
Brand Identity 9
Access to Distribution 9
Expected Retaliation 9
Conclusion 10
Suppliers 10
Supplier concentration 10
Presence of Substitute Inputs 11
Differentiation of Inputs 12
Importance of Volume to Supplier 13
Impact of Input on Cost or Differentiation 13
Threat of Backward or Forward Integration 13
Access to Capital 14
Access to Labor 14
Summary of Suppliers 14
Buyers 15
Buyer Concentration versus Industry Concentration 15
Buyer Volume 15
Buyer Switching Cost 15
Buyer Information 16
Threat of Backward Integration 16
Pull Through 16
Brand Identity of Buyers 17
Price Sensitivity 17
Impact on Quality and Performance 17
Substitute Products 18
Relative price/performance relationship of Substitutes 18
Buyer Propensity to Substitute 18
Rivalry 18
Industry Growth Rate 20
Fixed Costs 21
Product Differentiation 21
Brand Identity 21
Informational Complexity 22
Corporate Stakes 22
Conclusion 23
Critical Success Factors 23
Prognosis 24
Bibliography 26
Appendix 27
Key Industry Ratios 27

Introduction

Description
The soft drink industry is concentrated with the three major players,
Coca-Cola Co., PepsiCo Inc., and Cadbury Schweppes Plc., making up 90 percent of
the $52 billion dollar a year domestic soft drink market (Santa, 1996). The
soft drink market is a relatively mature market with annual growth of 4-5%
causing intense rivalry among brands for market share and growth (Crouch, Steve).
This paper will explore Porter's Five Forces to determine whether or not this
is an attractive industry and what barriers to entry (if any) exist. In
addition, we will discuss several critical success factors and the future of the
industry.

Segments
The soft drink industry has two major segments, the flavor segment and
the distribution segment. The flavor segment is divided into 6 categories and
is listed in table 1 by market share. The distribution segment is divided in to
7 segments: Supermarkets 31.9%, fountain operators 26.8%, vending machines
11.5%, convenience stores 11.4%, delis and drug stores 7.9%, club stores 7.3%,
and restaurants 3.2%.

Table 1: Market Share

1990 1991 1992 1993 1994

Cola 69.9 69.7 68.3 67 65.9

Lemon-Lime 11.7 11.8 12 12.1 12.3

Pepper 5.6 6.2 6.9 7.3 7.6

Root 2.7 2.8 2.3 2.7 2.7

Orange 2.3 2.3 2.6 2.3 2.3

Other 7.8 7.2 7.9 8.6 9.2

Source: Industry Surveys, 1995

The only limitations on access to information were: 1. Financial information has

not yet been made available for 1996. 2. The majority of the information targets
the end consumer and not the sales volume from the major soft drink producers to
local distributors. 3. There was no data available to determine over capacity.

Socio-Economic

Relevant Governmental or Environmental Factors, etc.

The Federal Government regulates the soft drink industry, like any industry
where the public ingests the products. The regulations vary from ensuring clean,
safe products to regulating what those products can contain. For example, the
government has only approved four sweeteners that can be used in the making of a
soft drink (Crouch, Steve). The soft drink industry currently has had very
little impact on the environment. One environmental issue of concern is that
the use of plastics adversely affects the environment due to the unusually long
time it takes for it to degrade. To combat this, the major competitors have
lead in the recycling effort which starting with aluminum and now plastics. The
only other adverse environmental impact is the plastic straps that hold the cans
together in 6-packs. These straps have been blamed for the deaths of fish and
mammals in both fresh and salt water.

Economic Indicators Relevant for this Industry

The general growth of the economy has had a slight positive influence on the
growth of the industry. The general growth in volume for the industry, 4-5
percent, has been barely keeping up with inflation and growths on margins have
been even less, only 2-3 percent (Crouch, Steve).

Threat of New Entrants

Economies of Scale

Size is a crucial factor in reducing operating expenses and being able to make
strategic capital outlays. By consolidating the fragmented bottling side of the
industry, operating expenses may be spread over a larger sales base, which
reduces the per case cost of production. In addition, larger corporate coffers
allow for capital investment in automated high speed bottling lines that
increase efficiency (Industry Surveys, 1995). This trend is supported by the
decline in the number of production workers employed by the industry at higher
wages and fewer hours. This in conjunction with the increased value of
shipments over the period shows the increase in efficiency and the economies
gained by consolidation (See table 2).

Table 2 General Statistics: Year

Companies Workers Hours Wages Value of Shipments
1982 1626 42.4 85.2 7.84
16807.5 1983 41.5 85.1 8.24 17320.8 1984 39.8
81.7 8.51 18052 1985 1414 37.2 77.8 9.1 19358.2 1986
1335 35.5 73.5 9.77 20686.8 1987 1190 35.4 71.5 10.45
22006 1988 1135 35.2 71.8 10.78 23310.3 1989 1027 33.4
67.7 10.98 23002.1 1990 941 32 65.7 11.48 23847.5 1991
31.9 66.8 11.85 25191.1 1992 29.8 61.6 12.46
26260.4 1993 28.6 59.3 12.93 27224.4 1994 27.4
56.9 13.39 28188.5 1995 26.2 54.5 13.86 29152.5 1996
25 52.1 14.32 30116.5 Source: Manufacturing USA, 4th Ed.

Further evidence of economies is supported by the increased return on assets

from 1992-1995, as shown in table 3. Coke and Pepsi clearly show increased
return on assets as the asset base increases. However, Cadbury/Schweppes does
not show conclusive evidence from 95 to 96.

Table 3

CADBURY/SCHWEPPES 93 94 95 96 ASSETS 2963100

3266900 3501500 4595000 SALES 3372400 3724800
4029600 4776000

NET INCOME 195600 236800 261900 300000

Sales/Income 5.80% 6.36%
6.50% 6.28% Income/Assets 6.60% 7.25% 7.48% 6.53%

COKE ASSETS 11051934 12021000 13873000 15041000 SALES

13073860 13963000 16181000 18018000

NET INCOME 1664382 2176000 2554000 2986000

Sales/Income 12.73% 15.58% 15.78% 16.57%
Income/Assets 15.06% 18.10%
18.41% 19.85%

PEPSI ASSETS 20951200 23705800 24792000 25432000 SALES

21970000 25021000 28472400 30421000

NET INCOME 374300 1588000 1752000 1606000 Sales/Income

1.70% 6.35% 6.15% 5.28%
Income/Assets 1.79% 6.70% 7.07% 6.31%

Source: Compact Disclosure

Capital Requirements

The requirements within this industry are very high. Production and
distribution systems are extensive and necessary to compete with the industry
leaders. Table 4 shows the average capital expenditures by the three industry
leaders.

Table 4
Dec-95 Dec-94 Jan-94 Jan-93 Receivables 1624333
1385767 1226633 1077912 Inventories 867666.7
803666.7 777366.7 716673.7 Plant & Equip 5986333
5795367 5246600 4642058 Total Assets 15022667
14055500 12997900 11655411 Source: Compact Disclosure

The magnitude of these expenditures causes this to be a high barrier to entry.

Proprietary Product Differences

Each firm has brands that are unique in packaging and image, however any of the
product differences that may develop are easily duplicated. However, secret
formulas do create a difference or good will that cannot be duplicated. The
best example of this is the "New Coke" fiasco of 1985. Coke reformulated its
product due to test marketing results that showed New Coke beat Pepsi 47% to 43%
and New Coke was preferred over old Coke by a 10% margin. However, Coke
executives did not take into account the good will created by the old Coke name
and formula. The introduction of New Coke as a replacement of Coke was met by
outrage and unrelenting protest by the public. Three months from the initial
launch of New Coke, management apologized to the public and reissued the old
Coke formula. Test marking shows that there is only a small difference in
actual product taste (52% Pepsi, 48% Coke), but the good will created by a brand
can have significant proprietary differences (Dess, 1993). This is a high
barrier to entry.

Absolute Cost Advantage

Brands do have secret formulas, which makes them unique and new entry into the
industry difficult. New products must remain outside of patented zones but
these differences can be slight. This leads to the conclusion that the absolute
cost advantage is a low barrier within this industry.

Learning Curve

The shift in the manufacturing of soft drinks is gravitating toward automation

due to speed and cost. However, industry technology is low and the
manufacturing process is not difficult, therefore the learning curve will be
short and will have a low barrier to entry.

Access to Inputs

All the inputs within the soft drink industry are commodity items. These
include cane, beet, corn syrup, honey, concentrated fruit juice, plastic, glass,
and aluminum. Access to these inputs is not a barrier to enter the industry.

Proprietary Low Cost Production

The process of manufacturing soft drinks is not a proprietary process. The

methods used in the process are relatively standard within the industry and the
knowledge needed to begin production can easily be acquired. This is not a
barrier to entry.

Brand Identity

This is a very strong force within the industry. It takes a long time to
develop a brand that has recognition and customer loyalty. "Brand loyalty is
indeed the HOLY GRAIL to American consumer product companies." (Industry
Surveys,
1995) A well recognized brand will foster customer loyalty and creates the
opportunity for real market share growth, price flexibility, and above average
profitability (Industry Surveys, 1995). Therefore this is a high barrier to
entry.

Access to Distribution

Distribution is a critical success factor within the industry. Without the

network, the product cannot get to the final consumer. The most successful soft
drink producers are aggressively expanding their distribution channels and
consolidating the independent bottling and distribution centers. From 1978 to
the present, the number of Coca-Cola bottlers decreased from 370 to 120
(Industry Surveys, 1995). In addition, 31.9% of the soft drink business is in
supermarkets, where acquiring shelf space is very difficult (Santa, 1996). This
is a high barrier to entry.

Expected Retaliation

Market share within the industry is critical; therefore any attempt to take
market share from the leaders will result in significant retaliation. The soft
drink industry is a moderately mature market with slow single digit growth
(Industry Surveys, 1995). Projected growth rates are 4-5% in sales volume and 2-
3% in margin (Crouch, Steve). Therefore, growth in market share is obtained by
stealing share from rivals causing retaliation to be high in defense of current
market position. This is a high barrier to entry.

Conclusion

To be successful on a large scale, the high capital requirements for

manufacturing, distribution, and marketing are high barriers to entry.
Therefore the threat of new entrants is low making this an attractive industry.

Suppliers

Supplier concentration

Supplier concentration is low due to the fact that the main ingredients are
sugar (cane and beet), water, various chemicals, and aluminum cans, plastic and
glass bottles. There are many places to get sugar and ingredients for soft
drinks because they are commodity items. The containers (aluminum cans, bottles
etc.) make up 36 percent of all the inputs that the industry uses. Other
supplies like sugars, syrups and extracts account for 23 percent of the inputs
(Manufacturing USA). There are five major suppliers of glass bottles. Altrista
Corp., Anchor Glass Container, Glassware of Chile, Owens Illinois, and Vistro Sa
are the major makers of glass bottles (Compact Disclosure). This is a fair
amount of suppliers considering that only five percent of soft drink sales are
in glass bottles. There are even more suppliers of plastic bottles. This is
good because 43% of all sales are from plastic bottles (Prince, 1996). All this
makes the concentration for glass and plastic suppliers moderate. The aluminum
can industry is even older and more established than the plastic industry.
Reynolds Metal Products, American National Can Company and Metal Container
Corp.
are the main suppliers of aluminum cans. 50.6% of total soft drink sales are
packaged in aluminum cans (Prince, 1996). Since the aluminum industry is older
and more established, these are likely to be the only manufacturers for a while.
Even though the concentration of aluminum producers are low there are only three
major players in the industry, Coke, Pepsi, and Cadbury. These three account
for nearly 90% of domestic soft drink sales (Dawson, 1996). This makes the
balance of power slightly favor the suppliers of aluminum cans, even though the
number of producers and buyers are equal (3). Syrups and extracts account for
16.7% of input costs to the soft drink industry (Manufacturing USA, Fourth Ed.).
Even though these are a small percentage of inputs, all the major soft drink
companies own companies that produce flavoring extracts and syrups (Industry
Surveys, 1995). This is probably due to the fact that they all have "secret
formulas" and this is how they protect the secret. Coke, Pepsi, and Dr. Pepper
all have "secret formulas". This makes the concentration of suppliers for
extracts very low but they are owned by the soft drink industry. This backward
integration by the major players makes the power question moot. Suppliers do
have limited power over the soft drink industry. The concentration of suppliers
remains relatively low, which would seem to give the supplier power. The shear
mass and volume that the industry buys negates that effect and balances, if not
tips it back toward the soft drink industry.

Presence of Substitute Inputs

There is not a lot of variety in inputs. The biggest substitute input was when
the industry switched from aluminum cans to plastic bottles. This made the
glass industry almost shake out completely. The next big substitute input was
for sugar. Since people were demanding more and more ways to lose weight and
consume fewer calories, the diet soft drink exploded in sales. This demand made
the soft drink industry find an alternative to sugar to sweeten their product.
This substitute turned out to be Nutrasweet non-sugar sweetener. This was
found to reduce the calories and retain the taste of their respective products.
Other sweeteners, like molasses, do not work because they change the flavor of
the product. Most of these substitute inputs had already taken place so they
become less relevant to the industry as time marched on. Substitute inputs
usually do not become important until the customer or market changes
dramatically. This happens when new studies come out from the government about
how harmful something is. This was the case when scientists came out with the
study that stated that saccharin was harmful to rats. The industry had to
respond by reducing its use of saccharin and look for a substitute. At this
time, the industry found Nutrasweet to be a reasonable substitute for saccharin,
which was used more heavily in diet drinks. All in all, there are a lot of
substitutes for packaging but not for sweeteners because these sweeteners must
have government approval (Crouch, Steve). This makes suppliers have power over
the industry as seen in the almost overnight empire of Nutrasweet. This will
most likely change drastically when Aspirtain (Nutrasweet) loses its patent in a
few years.

Differentiation of Inputs

Sugar is commonly available while Nutrasweet is patented. There is no

differentiation for sugar and only one choice in Nutrasweet. As far as the
other chemicals and inputs, they are commodity items, and it does not matter who
supplies them. This makes suppliers have little power over the soft drink
industry.

Importance of Volume to Supplier

The soft drink industry buys a large portion of the Nutrasweet market but their
percentage of purchases are falling as other products begin to use it. Sugar is
bought but not in the volume that the grocery store or other industries do. The
aluminum can, plastic bottles and glass bottles (less now) are all pretty much
dependent on the soft drink industry for their livelihood. This makes the
supplier have pretty much no power over the industry.

Impact of Input on Cost or Differentiation

Since the inputs are basic elements there is no differentiation and therefore no
impact on the final product for using different inputs. If the price of the
input changed, it would dramatically change the price of the product as the
aluminum cartel did in 1994. Since the major inputs are commodity items, the
prices can change dramatically due to environmental forces. If the sugar
industry suffers a loss due to weather or because of political unrest (like in
Cuba), then the prices go up and the soft drink industry is usually left
absorbing them. The soft drink industry can not, in all cases, simply pass
along the price increase. Customers and distributors are more price sensitive
than ever. This makes the supplier have a fair amount of bargaining power over
the industry.

Threat of Backward or Forward Integration

With the current climate of "sticking to the core of the company," there is
little threat of backward integration into the supplier's industry. This is
after the fact that they already have integrated into the extracts to protect
their secrets. The integration into the extract-producing segment of the
suppliers will be the extent of the backward integration. The suppliers do not
have the capital required to forward integrate into the soft drink industry.
This makes the industry attractive for investment.

Access to Capital

The soft drink industry is very profitable and therefore looked upon favorably
by financial institutions. This includes the stock market, direct investors
(bondholders), and banks. Currently the operating margins for the industry have
grown from 17.9% in 1992 to 19.5% in 1996. The projected operating margins are
projected to grow to 20.5% from 1997 to 2001 (Value Line 1996). The profit
margins and demand are increasing for the soft drink industry (Industry Surveys,
1995). What this means is that capital is available for expansion or upgrading,
if additional capital is required. This is favorable to the industry.

Access to Labor

The industry is not highly technical except for chemical engineering. This
means that the demands for skilled labor are not very high. Which means that
the soft drink industry will not have trouble finding labor. There are no
established labor unions. The average labor cost is no more than in any other
industry. The average hourly wage is $11.85 per hour, which just about the same
as all manufacturing firms of $11.49 (Manufacturing USA).
Summary of Suppliers

When you sum up the different aspects of the suppliers you come to the quick
conclusion that the power is definitely in the hands of the soft drink industry.
This makes the industry very attractive for investment and for the companies
already in the industry from the supply aspect. This means that it is
attractive to new entrants as well.

Buyers

Buyer Concentration versus Industry Concentration

The buyers for the soft drink industry are members of a large network of
bottlers and distributors that represent the major soft drink companies at the
local level. Distributors purchase the finished, packaged product from the soft
drink companies while bottlers purchase the major ingredients. With the
consolidation that has occurred within the industry, there is little difference
between the two. Distributors are assigned to represent a specific geographic
area, for example a town or a county. In turn, these distributors are
responsible for distributing the product to the retailers who sell the products
to the end consumer. In recent years, the national companies have been
purchasing independent bottlers in an effort to consolidate the business and
gain some distribution economies of scale (Thompson and Strickland, 1993).

Buyer Volume

The contractual agreements, which are present in this industry, dictate that the
major soft drink companies will sell their products to the distributors.
Therefore, buyer volume is not a factor for this industry. Buyer Switching Cost

Independent bottlers have contractual agreements to represent that company

within a certain area. Switching costs would include establishing new
relationships with other companies to represent and the legal costs associated
with distributors being released from the contract.

Buyer Information

Distributors are very informed about the product that they are distributing.
Information flows freely between the soft drink Companies and the local
distributors and down to the retailers. There are many co-operative promotions
where distributors and soft drink companies collaborate on price and advertising
campaigns (Crouch, Steve). For example, major soft drink firms will send a
regular report out to its distributors describing upcoming promotional events
where the cost will be shared between the two companies. For promotions that
fall outside of this report, the distributors will have to coordinate that
sponsorship with the soft drink company.

Threat of Backward Integration

It is doubtful that local distributors will move into the actual production
process of soft drinks. Distributors specialize in the transportation and
promotion of the product that they rely on the carbonated beverage companies
produce. However, major retailers; for example Wal-Mart and Harris Teeter have
begun distributing their own private label brands of soft drinks. Wal-Mart now
offers Sam's Choice and Harris Teeter offers President's Choice at a
significantly lower price. These private label competitors will not provide the
variety of packaging alternatives, which make the national leaders so successful
(PepsiCo 1995 Annual Report). For example, Pepsi offers 12-ounce cans, 20 ounce
bottles, 1 liter bottles, six packs, twelve packs, cases and "The Cube" 24 can
boxes.

Pull Through

Pull through is not a factor from the independent bottler's perspective. These
bottlers have a franchise agreement to represent a major carbonated beverage
company on the local level. These distributors are legally bound to represent
these companies and therefore cannot choose not to promote certain types of
beverages.

Brand Identity of Buyers

Brand identity of buyers is not relevant to the distributors because of the

contractual relationship that exists where distributors represent the soft drink
companies. The distributors have an exclusive contractual agreement to
represent that soft drink brand.

Price Sensitivity

Distributors are not highly price sensitive buyers. Independent bottlers are on
a national contract so all distributors pay the same price for the same products.

Price to Total Purchases

Soft drinks are the single product that the distributors are concerned with so
price is very important to them. Soft drink companies rely on these distributors
to represent them on the local level, so it is important to maintain a healthy
relationship.

Impact on Quality and Performance

All three of the leading carbonated beverage producers, Coca-Cola, PepsiCo, and
Cadbury Schweppes believe that their buyers (distributors) are an important step
in taking their products to the end consumer. The service, which their
distributors provide to the retailers, makes a difference to the retailers who
sell the product to the end consumer. The actions of that distributor reflect on
the soft drink company so if the distributor does not provide the level of
service that retailer or restaurant desires, it may harm the company's image.
Substitute Products

Relative price/performance relationship of Substitutes

The carbonated beverage industry provides a non-alcoholic means of satisfying an

individuals desire to quench their thirst. Traditionally, coffee and tea would
be considered substitute products. In recent years, carbonated beverages have
seen the emergence of many new substitute products that wish to reduce soft
drink's market share. The soft drink market has been traditionally competitive,
without the added friction from "ready to drink tea, shelf stable juice, sports
drinks and still-water" competitors also. (Gleason, 1996) Leaders in these
emerging segments include Quaker Oats, with their Snapple and Gatorade products,
Perrier, and Arizona Iced Teas. "In other words, Pepsi isn't Coke's biggest
competition, Tap water is." (Gleason, 1996). Generally speaking, soft drinks
are less expensive to the consumer than these substitute products.

Buyer Propensity to Substitute

Buyer propensity to substitute is low due to the contractual relationships

between the soft drink companies and the distributors.

Rivalry

Degree of Concentration and Balance among Competitors

Three main competitors: Pepsico, Coca-Cola, and Dr. Pepper/Cadbury

control the Soft Drink industry. Their combined total sales revenues account
for 90 percent of the entire domestic market. This market dominance makes the
industry a fiercely competitive and dynamic business environment to operate in.
The single market leader is Coca-Cola with a 42 percent market share and over
$18 billion in sales worldwide. PepsiCo maintains a 31 percent market share
with $10.5 billion in sales worldwide. The smallest of the three leaders is Dr.
Pepper/Cadbury, which holds roughly 16 percent of the market. Coke's consistent
dominance of both Pepsi and Dr. Pepper/Cadbury has caused Coke to become a
household name when referring to soft drinks.
As far as balance among competitors is concerned, PepsiCo is a much
larger company than Coke and Dr. Pepper/Cadbury combined. The reason being that
PepsiCo also owns companies in the snack and food industries (Frito-Lay, Pizza
Hut, Taco Bell, and KFC). With a work force of 480,000 people, PepsiCo is the
world's third largest employer behind General Motors and Wal-Mart. This has not
lead to a more profitable soft drink business, nor has it helped PepsiCo use its
size to steal market share from Coke or Dr. Pepper/Cadbury.

Diversity among Competitors

Though Coca-Cola dominates the industry in sales volume and market share,
it does not dominate when it comes to innovative marketing and business strategy
efforts. For instance, PepsiCo generates 71 percent of its revenues from the
U.S., while Coca-Cola derives 71 percent of its from international markets.
Similarly, PepsiCo only gets 41 percent of its total revenues from soft drinks.
The remaining 59 percent come from its snack and food business. Coke on the
other hand gets all of its revenues from its soft drinks. Clearly both of the
industry leaders have different strategies as far as revenue generation is
concerned. However, as far as their product lines are concerned they are very
similar and operate parallel to one another. Pepsi and Coca-Cola both have
lemon-lime, citrus, root beer, and cola flavors. Dr. Pepper/Cadbury does not
have as similar a product line to that of Pepsico and Coca-Cola. It
manufactures Dr. Pepper (a unique spicy cola drink), ginger ale, tonic water,
and carbonated water under its Schweppes and Canada Dry brands. Coke does have
an answer to Dr. Pepper in its Mr. Pibb, but only holds a .4 percent market
share compared to Dr. Peppers 6 percent market share. The relatively low level
of diversity makes the soft drink industry unattractive for investment.

Industry Growth Rate

Although new product lines have come into the beverage industry over the
past two to three years, the soft drink segment has held and grown its share
steadily. The onslaught of the sport drink and bottled tea have proven to be a
passing fad that has gained little if no long term market share from soft drinks.
Growth figures for the soft drink industry have been very steady since 1993,
and are projected to continue to be so into the last part of the twentieth
century. As can be seen in Figure 1, volatility was somewhat prevalent in the
1980's but has since lessened and leveled off (Valueline, 1996). Figure 1

Year '87-'88 '88-'89 '89-'90 '90-'91 '91-

'92 '92-'93 '93-'94 '94-'95 Growth 5.7% 5.2% 2%
3% 2.9% 4% 4.4% 4%

Over the past ten years soft drinks have gained 5 percent of total
beverage sales, putting them over the 25 percent share level for all
beverage sales. As for new and emerging markets, both Coke and Pepsi are
attacking the international environment. Coca-Cola generates 80 percent
of its revenues abroad, and Pepsi is attempting but failing to put more
emphasis there as well. "Pepsi is losing customers to Coke in every major
foreign territory. The company has always struggled overseas, but in the past
few months it has lost key strongholds in Russia and Venezuela to Coke" (Sellers,
1996). Because of the consistent growth of both the domestic and foreign
markets, the soft drink industry is attractive for investment.

Fixed Costs

The S&P Industry Survey has shown the soft drink industry profit margin
to be on a steady incline over the past fifteen years. Levels in 1980 were near
14%, while as of year-end 1995 were over 20% and expected to flatten a bit.
This flattening effect may be an indication that fixed costs are on the rise due
to expansion

How to Cite this Page

 MLA Citation:
"Case Study of the Soft Drink Industry." 123HelpMe.com. 04 Apr 2010
<http://www.123HelpMe.com/view.asp?id=86540>.

Enter up to 5 keywords in the search box below and select 'Go'.

(Example: Nick Great Gatsby)

Go
Sort By:

Spanish Verb Chart PRIVATE Online Tutor Web Design Spanish Vowels
Spanish verbs, conjugations, Learn Spanish FAST Website development Spanish Vowels
tenses, and more

Search for:
[Same Sex Marriage] [America]

Important Note: If you'd like to save a copy of the paper on your computer, you can COPY and PASTE it into
your word processor. Please, follow these steps to do that in Windows:

1. Select the text of the paper with the mouse and press Ctrl+C.
2. Open your word processor and press Ctrl+V.

Company's Liability

123HelpMe.com (the "Web Site") is produced by the "Company". The contents of this Web Site, such as text,
graphics, images, audio, video and all other material ("Material"), are protected by copyright under both United
States and foreign laws. The Company makes no representations about the accuracy, reliability, completeness,
or timeliness of the Material or about the results to be obtained from using the Material. You expressly agree
that any use of the Material is entirely at your own risk. Most of the Material on the Web Site is provided and
maintained by third parties. This third party Material may not be screened by the Company prior to its inclusion
on the Web Site. You expressly agree that the Company is not liable or responsible for any defamatory,
offensive, or illegal conduct of other subscribers or third parties.

The Materials are provided on an as-is basis without warranty express or implied. The Company and its
suppliers and affiliates disclaim all warranties, including the warranty of non-infringement of proprietary or
third party rights, and the warranty of fitness for a particular purpose. The Company and its suppliers make no
warranties as to the accuracy, reliability, completeness, or timeliness of the material, services, text, graphics and
links.

For a complete statement of the Terms of Service, please see our website. By obtaining these materials you
agree to abide by the terms herein, by our Terms of Service as posted on the website and any and all alterations,
revisions and amendments thereto.

Back to Search Results

Return to 123HelpMe.com

Copyright © 2000-2010 123HelpMe.com. All rights reserved. Terms of Service

DEFINITION

Firms in this industry acquire ingredients such as liquid beverage bases, syrup,
sweeteners and other ingredients like caffeine, potassium and sodium from their
various manufacturers and blend these ingredients into soft drink beverages. Along
with water acquired from natural springs, and other sources, these beverages are
bottled in glass or plastic or otherwise canned in aluminum for sale to grocery product
wholesalers, retailers.

1. Why is the soft drink industry so profitable?

An industry analysis through Porter’s Five Forces reveals that market forces are favorable for
profitability.
Defining the industry: Both concentrate producers (CP) and bottlers are profitable. These two parts of
the
industry are extremely interdependent, sharing costs in procurement, production, marketing and
distribution.
Many of their functions overlap; for instance, CPs do some bottling, and bottlers conduct many
promotional
activities. The industry is already vertically integrated to some extent. They also deal with similar
suppliers
and buyers. Entry into the industry would involve developing operations in either or both disciplines.
Beverage substitutes would threaten both CPs and their associated bottlers. Because of operational
overlap
and similarities in their market environment, we can include both CPs and bottlers in our definition of
the soft
drink industry. In 1993, CPs earned 29% pretax profits on their sales, while bottlers earned 9% profits
on their
sales, for a total industry profitability of 14% (Exhibit 1). This industry as a whole generates positive
economic profits.
Rivalry: Revenues are extremely concentrated in this industry, with Coke and Pepsi, together with their
associated bottlers, commanding 73% of the case market in 1994. Adding in the next tier of soft drink
companies, the top six controlled 89% of the market. In fact, one could characterize the soft drink
market as an
oligopoly, or even a duopoly between Coke and Pepsi, resulting in positive economic profits. To be
sure, there
was tough competition between Coke and Pepsi for market share, and this occasionally hampered
profitability.
For example, price wars resulted in weak brand loyalty and eroded margins for both companies in the
1980s.
The Pepsi Challenge, meanwhile, affected market share without hampering per case profitability, as
Pepsi was
able to compete on attributes other than price.
Substitutes: Through the early 1960s, soft drinks were synonymous with “colas” in the mind of
consumers.
Over time, however, other beverages, from bottled water to teas, became more popular, especially in
the 1980s
and 1990s. Coke and Pepsi responded by expanding their offerings, through alliances (e.g. Coke and
Nestea),
acquisitions (e.g. Coke and Minute Maid), and internal product innovation (e.g. Pepsi creating Orange
Slice),
capturing the value of increasingly popular substitutes internally. Proliferation in the number of brands
did
threaten the profitability of bottlers through 1986, as they more frequent line set-ups, increased capital
investment, and development of special management skills for more complex manufacturing operations
and
distribution. Bottlers were able to overcome these operational challenges through consolidation to
achieve
economies of scale. Overall, because of the CPs efforts in diversification, however, substitutes became
less of
a threat.
Power of Suppliers: The inputs for Coke and Pepsi’s products were primarily sugar and packaging.
Sugar
could be purchased from many sources on the open market, and if sugar became too expensive, the
firms could
easily switch to corn syrup, as they did in the early 1980s. So suppliers of nutritive sweeteners did not
have
much bargaining power against Coke, Pepsi, or their bottlers. NutraSweet, meanwhile, had recently
come off
patent in 1992, and the soft drink industry gained another supplier, Holland Sweetener, which reduced
Searle’s
bargaining power and lowering the price of aspartame.
2
With an abundant supply of inexpensive aluminum in the early 1990s and several can companies
competing for contracts with bottlers, can suppliers had very little supplier power. Furthermore, Coke
and
Pepsi effectively further reduced the supplier of can makers by negotiating on behalf of their bottlers,
thereby
reducing the number of major contracts available to two. With more than two companies vying for
these
contracts, Coke and Pepsi were able to negotiate extremely favorable agreements. 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.
Power of buyers: The soft drink industry sold to consumers through five principal channels: food
stores,
convenience and gas, fountain, vending, and mass merchandisers (primary part of “Other” in “Cola
Wars…”
case).
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.
National mass merchandising chains such as Wal-Mart, on the other hand, had much more bargaining
power. While these stores did carry both Coke and Pepsi products, they could negotiate more
effectively due
to their scale and the magnitude of their contracts. For this reason, the mass merchandiser channel was
relatively less profitable for soft drink makers.
The least profitable channel for soft drinks, however, was fountain sales. Profitability at these
locations was so abysmal for Coke and Pepsi that they considered this channel “paid sampling.” This
was
because buyers at major fast food chains only needed to stock the products of one manufacturer, so
they could
negotiate for optimal pricing. Coke and Pepsi found these channels important, however, as an avenue
to build
brand recognition and loyalty, so they invested in the fountain equipment and cups that were used to
serve their
products at these outlets. As a result, while Coke and Pepsi gained only 5% margins, fast food chains
made
75% gross margin on fountain drinks.
Vending, meanwhile, was the most profitable channel for the soft drink industry. Essentially there
were no buyers to bargain with at these locations, where Coke and Pepsi bottlers could sell directly to
consumers through machines owned by bottlers. Property owners were paid a sales commission on
Coke and
Pepsi products sold through machines on their property, so their incentives were properly aligned with
those of
the soft drink makers, and prices remained high. The customer in this case was the consumer, who was
generally limited on thirst quenching alternatives.
The final channel to consider is convenience stores and gas stations. If Mobil or Seven-Eleven were
to negotiate on behalf of its stations, it would be able to exert significant buyer power in transactions
with
3
Coke and Pepsi. Apparently, though, this was not the nature of the relationship between soft drink
producers
and this channel, where bottlers’ profits were relatively high, at $0.40 per case, in 1993. With this high
profitability, it seems likely that Coke and Pepsi bottlers negotiated directly with convenience store and
gas
station owners.
So the only buyers with dominant power were fast food outlets. Although these outlets captured most
of the soft drink profitability in their channel, they accounted for less than 20% of total soft drink sales.
Through other markets, however, the industry enjoyed substantial profitability because of limited buyer
power.
Barriers to Entry: It would be nearly impossible for either a new CP or a new bottler to enter the
industry.
New CPs would need to overcome the tremendous marketing muscle and market presence of Coke,
Pepsi, and
a few others, who had established brand names that were as much as a century old. 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. So, although the CP industry is not very
capital
intensive, other barriers would prevent entry. Entering bottling, meanwhile, would require substantial
capital
investment, which would deter entry. Further complicating entry into this market, existing bottlers had
exclusive territories in which to distribute their products. Regulatory approval of intrabrand exclusive
territories, via the Soft Drink Interbrand 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 in the US.
In conclusion, an industry analysis by Porter’s Five Forces reveals that the soft drink industry in 1994
was favorable for positive economic profitability, as evidenced in companies’ financial outcomes.
2. Compare the economics of the concentrate business to the bottling business. Why is the profitability
so
different?
In some ways, the economics of the concentrate business and the bottling business should be
inextricably linked. The CPs negotiate on behalf of their suppliers, and they are ultimately dependent
on the
same customers. Even in the case of materials, such as aspartame, that are incorporated directly into
concentrates, CPs pass along any negotiated savings directly to their bottlers. Yet the industries are
quite
different in terms of profitability.
The fundamental difference between CPs and bottlers is added value. The biggest source of added
value for CPs is their proprietary, branded products. Coke has protected its recipe for over a hundred
years as
a trade secret, and has gone to great lengths to prevent others from learning its cola formula. The
company
even left a billion-person market (India) to avoid revealing this information. As a result of extended
histories
and successful advertising efforts, Coke and Pepsi are respected household names, giving their
products an
aura of value that cannot be easily replicated. Also hard to replicate are Coke and Pepsi’s sophisticated
strategic and operational management practices, another source of added value.
Bottlers have significantly less added value. Unlike their CP counterparts, they do not have branded
products or unique formulas. Their added value stems from their relationships with CPs and with their
4
customers. They have repeatedly negotiated contracts with their customers, with whom they work on
an
ongoing basis, and whose idiosyncratic needs are familiar to them. Through long-term, in depth
relationships
with their customers, they are able to serve customers effectively. Through DSD programs, they lower
their
customers’ costs, making it possible for their customers to purchase and sell more product. In this way,
bottlers are able to grow the pie of the soft drink market. Their other source of profitability is their
contract
relationships with CPs, which grant them exclusive territories and share some cost savings. Exclusive
territories prevent intrabrand competition, creating oligopolies at the bottler level, which reduce rivalry
and
allow profits. To further build “glass houses,” as described by Nalebuff and Brandenberger (Co-
opetition, p.
88), for their bottlers, CPs pass along some of their negotiated supply savings to their bottlers. Coke
gives 2/3
of negotiated aspartame savings to its bottlers by contract, and Pepsi does this in practice. This practice
keeps
bottlers comfortable enough, so that they are unlikely to challenge their contracts. Bottlers’ principal
ability is
to use their capital resources effectively. Such operational effectiveness is not a driver of added value,
however, as operational effectiveness is easily replicated.
Between 1986 and 1993, the differences in added value between CPs and bottlers resulted in a major
shift in profitability within the industry. Exhibit 1 demonstrates these dramatic changes. While industry
profitability increased by 11%, CP profits rose by 130% on a per case basis, from $0.10 to $0.23.
During this
period, bottler profits actually dropped on a per case basis by 23%, from $0.35 to 0.27.
One possibility is that product line expansion in defense against new age beverages helped CPs but
hurt bottlers. This would be expected if bottler’s per case costs increased due to the operational
challenges and
capital costs of producing and distributing broader product lines. This, however, was not the case; cost
of sales
per case decreased for both CPs and bottlers by 27% during this period, mostly due to economies of
scale
developed through consolidation. The real difference between the fortunes of CPs and bottlers through
this
period, then, is in top line revenues. While CPs were able to charge more for their products, bottlers
faced
price pressure, resulting in lower revenues per case.
These per case revenue changes occurred during a period of slowing growth in the industry, as shown
in Exhibit 2. Growth in per capita consumption of soft drinks slowed to a 1.2% CAGR in the period
1989 to
1993, while case volume growth tapered to 2.3%. In an struggle to secure limited shelf space with more
products and slower overall growth, bottlers were probably forced to give up more margin on their
products.
CPs, meanwhile, could continue increasing the prices for their concentrates with the consumer price
index.
Coke had negotiated this flexibility into its Master Bottling Contact in 1986, and Pepsi had worked
price
increases based on the CPI into its bottling contracts. So, while the bottlers faced increasing price
pressure in a
slowing market, CPs could continue raising their prices. Despite improvements in per case costs,
bottlers
could not improve their profitability as a percent of total sales. As a result, through the period of 1986
to 1993,
bottlers did not gain any of the profitability gains enjoyed by CPs.
3. Why have contracts between CPs and bottlers taken the form they have in the soft drink industry?
5
Contracts between CPs and bottlers were strategically constructed by the CPs. Although beneficial to
bottlers on the surface, the contracts favored the CPs’ long-term strategies in important ways.
First, territorial exclusivity is beneficial to bottlers, as it prevents intrabrand competition, ensures
bargaining power over buyers and establishes barriers to entry. But it is also beneficial to CPs, who are
also
not subject to price wars within their own brand. The contracts also excluded bottlers from producing
the
flagship products of competitors. This created monopoly status for the CPs, from the bottler
perspective. Each
bottler could only negotiate with one supplier for its premium product. Violation of this stipulation
would
result in termination of the contract, which would leave the bottler in a difficult position.
Historically, contracts were designed hold syrup prices constant into perpetuity, only influenced by
rising prices of sugar. This changed in 1978 and 1986, as contracts were renegotiated, first to
accommodate
for rises in the CPI, and then to give general flexibility to the CP (Coke) in setting prices. Coke could
negotiate this more flexible pricing because its bottlers were dependent on it for business. It further
ensured
that its bottlers would be captive to its monopoly status by buying major bottlers and then selling them
into the
CCE holding company, which would only produce Coke products. Coke would capture 49% of the
dividends
from CCE, without the complications of vertical integration.
4. Should concentrate producers vertically integrate into bottling?
Given the data in Exhibit 1, indicating the CP business has grown more profitable over the last seven
years, while the bottling industry has struggled to retain any profitability, it would not be advisable to
vertically
integrate.
Stuckey and White (p. 78) indicate that a firm should “Integrate into those stages of the industry chain
where the most economic surplus is available, irrespective of closeness to the customer or the absolute
size of
the value added.” In the soft drink industry, CPs generally miss out on the profits earned through
fountain
sales. Pepsi, realizing that fast food chains were capturing most of the value of fountain sales, entered
the fast
food business by purchasing Taco Bell, Pizza Hut, and KFC. These mergers allowed the firm to capture
more
value from its soft drink sales, but these mergers could also be problematic. For example, PepsiCo
might not
have a core competency in food sales or a strong position in the industry. Because it might not be able
to
effectively transfer skills or share activities with its fast food businesses, the mergers might not be
successful in
the long run. Stuckey and White also point out that “high-surplus stages must, by definition, be
protected by
barriers to entry.” So it could be difficult for Coke to enter the fast food business. It could be
prohibitively
expensive to purchase McDonalds or Burger King, and developing a chain of its own against such
formidable
competition would be extremely risky. So integration into this phase of the value chain would be
difficult or
impossible for Coke.
As Stuckey and White say, “don’t vertically integrate unless it is absolutely necessary to create or
protect value.” We shall address each of these individually to formally refute the plausibility of vertical
integration of CPs into bottling. (1) “The market is too risky and unreliable.” On the contrary, the
concentrate
market is highly stable and will be for a long time to come. (2) “Companies in adjacent stages of the
industry
6
chain have more market power than companies in your stage.” The opposite is true, CPs already have
more
market power than bottlers, so they should not vertically integrate. (3) “Integration would create or
exploit
market power by raising barriers to entry or allowing price discrimination across customer segments.”
In fact,
CPs already have market power through efficient barriers to entry, and effectively price discriminate
through
various retail channels. (4) “The market is young and the company must forward integrate to develop a
market, or the market is declining and independents are pulling out of adjacent stages.” The market is
neither
young nor declining.
Having determined that a vertical integration strategy fails all four of Stuckey and White’s tests, CPs
should not pursue vertical integration into bottling.