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Abstract

This essay introduces the carbonated soft drinks in the world beverage market, and
Coca-Cola and Pepsi Co, the two companies that have been competing and fighting
to control profits and market share in this segment. First, this essay explains the
reasons that the carbonated soft drink industry is so profitable and lucrative.
Second, this essay compares the economics of the concentrate business to the
bottling business, and explains the reasons that the profitability metrics are
different. Third, this essay explains how the competition between Coke and Pepsi
have affected the world beverage markets profits with carbonated soft drinks.
Fourth, this essay forecasts the feasibility of Coke and Pepsi being able to sustain
their profits as a result of demand decreasing and the emergence of non-
carbonated drinks.

Context:

A free market is conceived and maintained as multiple firms decide to bring a


product to the market with the express purpose of satisfying the needs and wants of
consumers and with making a profit for the company. The context of this essay is
the interaction between Coca-Cola and Pepsi Co as they compete in the beverage
market in the US with carbonated soft drinks for the biggest market share and profit
margins in the $60 billion dollar industry. Through and through this essay is
concerned primarily with the actions of Coca-Cola & Pepsi Co and their
corresponding implications for the micro-cosm of the profits of these firms and the
profits in the macro-cosm of the beverage segment with sales of carbonated soft
drinks. The first section of this essay examines the macro-cosm of the beverage
market with respect to the profitability of carbonated soft drink.

Why is the soft drink industry so profitable?

First, this essay explains the reasons that the carbonated soft drink industry is so
profitable and lucrative. In the carbonated soft drink industry, there are a few major
players that produce majority of the carbonated beverages, namely Coca-Cola, and
Pepsi Co. The reasons for the soft drink industry being so profitable is that they are:
1) cheap to produce concentrate for bottling and fountain sales; 2) companies have
direct distributors; 3)companies often bottle, package, and produce concentrate
through their own subsidiaries; 4) companies have pouring rights with certain
restaurants, and gas station chains through contracts guaranteeing exclusive rights
to provide only their carbonated beverages, which guarantees profit; 5) the soft
drink industry is also profitable due to their strategic brand partnerships, and
through partnerships to promote mixed consumer participation in the consumption
of a beverage and for example to use the can to buy a ticket to an amusement park
at a discount. Sixth, the soft drink industry is profitable because consumers demand
and consume millions of gallons of soft drinks each year, therefore there is a
dependence among consumers for carbonated soft drinks from the big three
producers aforementioned above.

First, the soft drink industry is profitable because carbonated beverages are cheap
to produce for bottling and fountain sales, with high profit margins. Second, the soft
drink industry is profitable because companies distribute directly to gas stations,
restaurants and supermarkets. Third, the soft drink industry is profitable because
companies keep bottling and packaging in house reducing their break even, and
increasing their profit margins. Fourth, the soft drink industry is profitable because
Coca-Cola and Pepsi Co have pouring rights contracts with specific restaurants,
supermarkets, and gas stations enabling them to eliminate competition in this
setting and maximize profit margins by guaranteeing that of the carbonated
beverages purchased by consumers one of their products will be the only one
purchased. Profit margins are protected and enhanced in this scenario providing a
consistent stream of constant renewed business. The first four reasons that the soft
drink industry is profitable will be examined using an example of how Coca-Cola,
Pepsi and a gas station receive profit from their partnership and consumption of
carbonated beverages by means of fountain drinks.

The profitability of the soft drink industry will be examined in the following example
using a $50 five gallon bag of Coca-Cola (or Pepsi) in a gas station partnership in a
fountain drink environment. Coca-Cola and Pepsi offer incentives for fountain sales
when purchasing five gallon bags of their concentrate continually; and argue that as
a result of implementing their concentrate in fountain sales that their gross margin
will increase by $34,766 in one year and will see an ROI in 7 months with CSA's
pricing on fountain syrup.[1] In order for firms to qualify they have to own their
own fountain machine and generate at least $6,800 in sales annually for this to be
feasible for them.[2] Coca-Cola and Pepsi make $50 per five gallon bag of
concentrate sold for each beverage. Say for instance that one gas station purchases
ten five gallon bags of Coca-Cola and Pepsi concentrate three times a week that
means that Coca-Cola or Pepsi make $1500 in sales each week from one gas station
less the cost to produce.

Then think big picture, lets take the relationship between the number of gas
stations in the US by population and the 30 gallons sold of CSDs in each gas station
each week of Coca-Cola and Pepsi. In Millis (2012), the author argues that there is a
gas station for about every three thousand people, and if there are 300 million
people in the US, that there are about 100,000 gas stations in the US.[3] Based on
there being 100, 000 gas stations in the US, if each gas station purchases 30 gallons
of CSDs at $50 for five gallons then Coca-Cola or Pepsi, make $150,000,000 each
week if they were to hypothetically sell the aforementioned amount of fountain
CSDs. Other factors would come into play, however this simulates profits received
by these companies if the above were true.
It is also important to analyze the profits of CSDs of gas stations, down to the
individual drink and brand, because this will enable Coca-Cola and Pepsi to hone in
their supply of each CSD to each demographic area based on consumer demand. In
Marburger, the author argues that they purchase five gallons of CSD for $50, and
then with a 5 to 1 water to syrup ratio serve about 3,782.4 ounces of CSD per five
gallons of product (weekly quota numbers mentioned above). Breaking the cost
down into a 20 oz. fountain drink filled with CSDs, it costs the store $22 cents give
or take for each of these drinks. Further, ice plays a part in pricing and profit. Since
there is a five to one ratio of water, and when consumers fill their cup with ice, they
only really receive about 9 ounces of CSD, so the gas station is able to turn about a
$1.00 profit on $1.25 sales of a 20 oz. fountain CSD.[4] The point is that in store
fountain beverages are profitable for Coca-Cola and Pepsi because there is a
demand from consumers, the companies are often able to achieve pouring rights,
partnerships, and offer products at a price point where both parties receive extreme
profits in the 100,000 gas stations in America.

Fifth, the soft drink industry is profitable because Coca-Cola and Pepsi Co
strategically partner with other firms to associate and inter-link brands. The reason
that this is profitable for Coca-Cola for example is that they strategically partner
with Six Flags in Dallas, Texas by offering a $15 discount on two tickets to the
amusement park. Why is this profitable someone might ask? The reason that this
brand association between Coca-Cola and Six Flags is popular is two-fold,
consumers drink a coke to get discount tickets to the amusement park which brings
both parties revenue, bringing traffic from Coca-Cola consumers. From another
perspective, Six Flags does not allow outside drinks in the park, and offers $10
plastic Six Flags bottles to be filled with Coca-Cola fountain drinks in the park. The
relationship is profitable because Coca-Cola offers advertising on their drinks for Six
Flags which brings Six Flags revenue, and Six Flags in turn offers to sell Coca-Cola
products in the park. In fact, in 2003 Coca-Cola ( the world`s biggest brand, and
Six Flags ( the number one brand among teens) signed a contract for Coca-Cola to
be the exclusive supplier of soft drinks in all 28 Six Flags locations.[5]

The implications for this partnership are that the new agreement will move Coca-
Cola availability in the Six Flags system from 65% to 100%, making Coca-Cola the
official soft drink supplier of Six Flags parks worldwide, which has over 50 million
consumers in the parks each year,[6] and when they decide to consumer a cold
soft drink it will always be a Coca-Cola product. The point is that the partnership
resulted in Coca-Cola obtaining a 100% market share in 28 Six Flags locations
internationally with 50 million consumers possibly purchasing only a Coca-Cola
product. In short, both parties benefit from the partnership in terms of the profit.

Sixth, the soft drink industry is profitable because consumers demand soft drinks,
and therefore demand the continued existence of Coca-Cola, and Pepsi. The reasons
for continued profits of the major suppliers of concentrate in bottles or fountains to
the market is because of the aforementioned reasons and that consumers
associate consumption with certain activities. For example, CSD producers continue
making profits because consumers associate going to Taco Bell with tacos and
getting a Pepsi drink with dinner, or going to the movies and getting a large Coca-
Cola to see their movie.

In other words, it is impossible for consumers to conceive of going to the movies


without a Coca-Cola or to Taco Bell without a Pepsi product. Furthermore, there have
been studies that in the 50s there were subliminal messages embedded in the
commercials at the movies that prompted consumers to "Eat Popcorn" and "Drink
Coca-Cola."[7] Although studies have emerged apparently discounting the efficacy
of said messages, and highlighting ethical implications of such messages inducing
consumers to buy certain products. However, it is still plausible to assert that
consumers cannot conceive of the movies without their Coca-Cola or Pepsi product
regardless of the means used in order to induce consumers to purchase these
products.

Also, the profit margins on fountain sales at the movies are exponential versus the
above example at gas stations. For example, the sale of a large Coca-Cola at the
movies in McKinney, Texas is the same price as a matinee adult ticket, which is
$4.00. This brand association leads to continued revenue for the movies, Pepsi,
Coca-Cola, and an increase in brand equity due to the simple association between
the soft drink and the activity of consumption. The aforementioned is the reason for
profit.

Compare the economics of the concentrate business to the bottling


business: Why is the profitability so different?

Second, this essay compares the economics of the concentrate business to the
bottling business, and explains the reasons that the profitability metrics are
different.

The economics of the bottling business

The bottling business uses concentrate, and places in bottles for Coca-Cola and
Pepsi. Among the bottled CSDs for Coca-Cola and Pepsi, most are packaged in
metal cans (60%), plastic bottles (38%), and glass bottles (2%).[8] The bottling
business is capital intensive,[9] and requires high overhead labor, and production
costs. The economics of bottling industries consist of around $10 million dollars to
produce each product line of Coca-Cola or Pepsi product, with about $40 million of
capital required to allocate for a plant, and the need for about 90 plants to handle
the domestic distribution of CSDs.[10] The good news is that the bottling industry
receives nearly 40% of their capital investment in gross profits, however they have
no room for error in their budget.[11] One of the ways that Coca-Cola and Pepsi
have controlled the costs associated with the bottling aspect of the distribution of
their CSDs is through acquiring bottling companies and doing bottling in house in
order to reduce variable costs, reducing their breakeven point and increasing their
profits. Further, the companies have adjusted the sizes and types of packaging of
their CSDs through segmenting the size and type of CSD to their target market
thereby honing in demand and controlling profit. Another reason that bottling is
more expensive is that it requires Coca-Cola and Pepsi to use more concentrate. In a
bottled CSD consumers want more of the Coke or Pepsi taste, and therefore this
requires more concentrate which also costs more.

The economics of the concentrate business compare to the economics of the


bottling industry. One of the reasons that the concentrate business is more effective
economically is the ratio of concentrate to water, and ice per 20 oz. drink.
Concentrate is often produced in five gallon bags, and sold directly to restaurants,
and gas stations. Coca-Cola and Pepsi usually make about $50 per five gallon bag of
concentrate sold to each gas station. If there are 100,000 gas stations in America,
with orders of thirty five gallon bags of CSD each week of Coke and Pepsi products,
then Coke and Pepsi would theoretically receive $150,000,000 each week if
consumption demand matched the supply. The point is that concentrate is cheaper
to produce, concentrate is mixed with a five to one ratio with water and then with
ice, so when a consumer orders a 20 oz. CSD, they are really only receiving about 9
ounces of CSD. In other words, the profit margin is high, the consumption demand is
high, and all parties win due to consumer demand.

The real time economics between the concentrate and bottling industry for Coca-
Cola and Pepsi are captured in in Yoffie & Slind (2009).[12] In Yoffie & Slind (2009),
the authors argue that the concentrate sells per case for $.71 cents, that it costs
$.12 cents per case for sales, that a net profit of $.59 before other costs; and after
selling marketing and administration costs, that Coca-Cola and Pepsi make about
$.25 profit per case of concentrate.[13] In Yoffie & Slind (2009), the authors argue
that the bottling business captures the following metrics per case, $5.88, cost of
sales of $3.77, gross profit of $2.03, and after administrative fees that bottlers
receive $.52 per case sold. [14] The point is that relative to the costs, the
concentrate is a more lucrative business in terms of the profit margin and
contribution margin per unit, whereas the bottling industry has a lower profit margin
and contribution margin per unit due to the high amount of selling, delivery and
administrative costs. In fact, the difference in economics is captured in the $1.20
difference per unit cost of bottling, and the $.01 cost for sales and delivery and the
$.17 cent cost for administration per unit, which leads to the concentration portion
having a higher contribution per unit, and thus a higher profit margin per unit.

How has the competition between Coke and Pepsi affected the industry's
profits?

Third, this essay explains how the competition between Coke and Pepsi have
affected the world beverage markets profits with carbonated soft drinks. The
competition between Pepsi and Coke have affected the profits of the soft drink
industry in a positive manner. The competition of Coke and Pepsi has a push-pull
effect on the market and in effect the profits of the industry, because as one
company has an innovation or enters a new market with a new CSD, this inspires
the other company to rise to the new level of competition and make a decision to
act in solidarity in order to gain new market share in step with the other company.
Specifically, Pepsi usually dominates the retail stores, due to partnerships with
places such as Taco Bell with exclusive pouring rights, whereas Coke has
traditionally leveraged power in the fountain sales. In the fountain industry Coke
has about 70% of the market share while Pepsi maintains around a 30% market
share, needless to say competition is strenuous to tip the scales. Based on the
above example of CSDs in gas stations. Say that Coke provides 70% and Pepsi
provides 30% of the sales for 30 gallons at $50 each to each of the 100,000 gas
stations each week (for $1500 profit per gas station each week), the implications of
their competition can be seen. The below illustrates the profit and competition for
Coke and Pepsi:

In the above, example a hypothetical example was used that has been maintained
throughout the Case by the author to illustrate the profits received by Pepsi and
Coca-Cola based on sales of CSDs in 100,000 gas stations in America each week.
The profits that Coca-Cola and Pepsi receive take into consideration $8 of the $50
that five gallons of CSDs are sold for which include, selling and delivery cost,
advertising and marketing cost per gallon, and administrative costs. The purpose of
this example is to simulate how sales would be captured in a live environment and
the implications that this would have for the competition between Coca-Cola and
Pepsi.

Can Coke and Pepsi sustain their profits in the wake of flattening demand
and the growing popularity of non-carbonated drinks?

Fourth, this essay forecasts the feasibility of Coke and Pepsi being able to sustain
their profits as a result of demand decreasing and the emergence of non-
carbonated drinks. In Yoffie & Slind (2009), the authors posit that Coca-Cola and
Pepsi achieved a 10 % annual growth between 1975 and 1995,[15] despite
strenuous competition. There has been a shift in demand from consumers as
consumption of traditional CSDs has subsided to more nutritious beverages. In the
wake of a change in demand Pepsi and Coca-Cola must align their product lines
(CSDs & Non-CSDs) to mirror consumer demand in order to sustain their profits in
the soft drink segment. Pepsi diversified their product line offering in order to align
themselves with consumer demand in the Non-CSD markets. For example, Pepsi led
the sports drink segment with 76% of the market share with Gatorade, while
Powerade only had 19%.[16] Pepsi also led the tea based drink segment with 38%
market share with Lipton, while Nestea trailed with 27%.[17] Last, in the bottled
water segment Pepsi led market share with 13% market share with Aquafina, while
Dasani fell behind at 8% market share.[18] In short, it is possible for Coke and Pepsi
to sustain their market share in the wake of the rise in demand for Non-CSDs, if they
align their product line offerings of CSDs and Non-CSDs with consumer demand, and
continue to diversify their product lines, and find ways to reduce their costs so that
they can continue to maintain excellent profit margins.

In an effort to summarize the salient points of this essay, take into consideration the
following re-capitulation. First, the soft drink industry is profitable for six reasons, 1)
they are cheap to produce concentrate; 2) companies have direct distribution; 3)
companies keep production in house, therefore stores are dependent on main
companies to satisfy quotas in stores to fulfill consumer demand; 4) companies
have pouring rights, partnerships with companies that enable Coke or Pepsi to
operate exclusively without competition (Six Flags and Taco Bell); 5) the soft drink
industry is profitable due to consumer demand of the CSDs and Non-CSDs that Coke
and Pepsi offer. The metrics of the concentrate and bottling business are
comparative, however the contribution margin per unit of concentrate supersedes
that of bottling due to selling, delivery, and administrative costs. Competition
between Coke and Pepsi displays a positive correlation, because as each company
comes out with innovative CSDs and Non-CSDs each company is inspired to do
something new to grow their brand, sales and profits in order to keep up. The only
way for Coke and Pepsi to sustain their profits in the wake of Non-CSD demand is to
align their product lines with consumer demand.

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