If you order your custom term paper from our custom writing service you will receive a perfectly written assignment on Cola Wars. What we need from you is to provide us with your detailed paper instructions for our experienced writers to follow all of your specific writing requirements. Specify your order details, state the exact number of pages required and our custom writing professionals will deliver the best quality Cola Wars paper right on time.
Out staff of freelance writers includes over 120 experts proficient in Cola Wars, therefore you can rest assured that your assignment will be handled by only top rated specialists. Order your Cola Wars paper at affordable prices with Live Paper Help!
Soft Drinks� Case Analysis
In the years between 175 and 1, the Coca Cola Company posted an average return
on equity of 0.5%. Similarly, PepsiCo Inc. recorded an average return on equity of
1.%. Although these figures likely include the return form non-soft drink operations
(it’s difficult to tell from the available information in the Yoffee and Foley case), it is
clear that the soft drink industry is extremely profitable�profitable, that is, for
concentrate producers such as Coke and Pepsi.
For other members of the soft drink supply chain, the soft drink industry is not nearly as
attractive. Pretax profit for a typical bottler, by way of example, is less than one-third of
that of a standard concentrate producer. This discrepancy between the profitability of
concentrate producers and that of bottling companies results from the competitive
structure of the two separate industries.
Concentrate Providers A Structural Analysis
Using a basic structural analysis of the market for soft-drink concentrate, it is easy to see
why the industry is so profitable. First, there are few direct competitors within this
market Coke and Pepsi make up 7% of the entire market, with only a handful of
additional providers making up the remaining 8%. Furthermore, competition among
these companies is limited by strong brand recognition, especially for Coke and Pepsi.
Because the major players can rely on their strong, differentiated brands, they are able to
price their products substantially above long-term average costs1.
Secondly, the basic cost structure of the industry � low fixed costs relative to high
variable costs � helps concentrate producers avoid descending into stiff price
competition. The tendency for competing on price is further limited by Coke and
Pepsi’s near-century of competition � a history that has allowed them to learn how to
avoid destroying profits in mutually damaging price wars.
Third, concentrate providers have a strong strategic advantage vis-à-vis their suppliers.
Because the concentrate producers purchase undifferentiated raw materials from a large
host of supplier firms, they are able to avoid losing a significant portion of the value they
create in upstream market transactions. The upshot of this strategic advantage is that the
average concentrate provider spends only about 17% on direct costs of producing
concentrate. This allows Coke and Pepsi to invest in other aspects of the business �
brand recognition, retailer relations, and market research � that will help perpetuate these
strategic asymmetries and allow concentrate providers to continue capturing the lion’s
share of the value created by the entire soft drink industry.
1 Smaller brands charge substantially less than do Coke and Pepsi. Indeed, profitability for each producer
is in direct proportion to the strength of their relative brands. A comparison of net profitability for Dr.
Pepper, Seven-Up, and Royal Crown in Exhibit shows that profitability for Royal Crown � a company
with substantially less brand recognition than Dr. Pepper or Seven-Up � has historically lagged behind that
of Dr. Pepper and Seven-Up.
The typical concentrate production plant costs $5-$10 million and could supply the entire country. This
compares to $. billion capital investment required for bottlers to serve a commensurate demand.
Likewise, concentrate providers have a strong strategic advantage vis-à-vis their
customers. The large number of undifferentiated bottling companies allows concentrate
providers to shop around for the highest prices for concentrate, locking in the most
favorable returns in long-term contracts. This allows concentrate providers to avoid
losing a significant proportion of the value they create in their downstream market
transactions.
Finally, although producing the physical soft drink concentrate is a trivial industrial
exercise, the importance of brand recognition has created high barriers to entry. In fact,
Saloner, Shepard, and Podolny specifically cite Coke and Pepsi as having a “promotional
advantage of incumbency from cumulative investment.” This brand recognition helps
Coke and Pepsi perpetuate all of these strategic advantages by increasing the long-term
barriers to entry in the concentrate market, thus preserving Coke and Pepsi’s ability to
expropriate the vast majority of the value created along the entire value chain.
It is interesting to note that the concentrate providers have managed to isolate the one
aspect of the soft drink market that can provide ongoing positive returns. Although we
are used to thinking of soft drink production as being composed of several industries
along a multi-step value chain, the only reason it appears this way is because Coke and
Pepsi have been very adept at outsourcing virtually all aspects of the business that do not
provide long-term positive returns. In fact, it is likely that the only reason why Coke and
Pepsi continue to manufacture soft drink concentrate is that it is easier to promote the
brand if they can lay claim to producing the “essence of the product.” In pure economic
terms, however, the concentrate is simply yet another commodity input, whereas the
brand is the essence of the product.
Bottlers A Structural Analysis
By contrast, the soft-drink bottling industry exhibits all the signs of long-term unprofitability.
Bottlers face stiff competition in a highly fragmented competitive
landscape in 14, there were between 80 and 85 bottlers nationwide, each of which
produced an undifferentiated commodity. Moreover, as of 14, there are few � if any �
barriers to entry.
In direct contrast to Coke and Pepsi’s strategic advantage vis-à-vis their upstream
providers, bottlers face a far less hospitable environment in their market for raw
materials. Not only are there only a handful of concentrate providers, but two producers
� Coke and Pepsi � together make up almost 60% of the market for soft drink
concentrate.
This is aggravated by the extent to which the bottling company’s customers have
acquired an increasing amount of market power. WalMart’s huge size relative to other
retailers and its effective use of its own soft drink brand has put increasing pressure on
the prices that bottlers can charge to their retail customers.
This pressure is compounded by the basic cost structure of the bottling industry in which
high fixed costs relative to variable costs increase the incentives for short-term pricing
below average total costs. The upshot of all of these factors is an industry that earns zero
long-term economic profits.
Historical Relationship Between Bottlers and Concentrate Producers
Coke and Pepsi have long relied on exclusive bottling franchises as the primary method
of bottling and distributing their products. As of as of the early 180s, Coke and Pepsi
owned only 0%-0% of their bottling companies; the rest were either privately- or
publicly-owned franchises.
The historical relationships between concentrate providers and bottlers evolved as a result
of the underlying economics of the soft drink business. Using the analysis of Stuckey
and White, the industry displays the characteristics of one beset by vertical market
failure. In this case, however, the advantages of these market dynamics accrue to the
concentrate providers. Because there are many buyers (bottlers) and few sellers
(concentrate providers), sellers dominate the market. (This is illustrated in the diagram
below.)
Given that the majority of the value within the value chain resides in brand recognition
associated with concentrate production, Coke and Pepsi clearly benefit from outsourcing
bottling and distribution. Nonetheless, concentrate providers clearly need to assure that
their brands are not compromised by the manner in which bottlers and distributors market
and sell their products. Franchise arrangements have allowed concentrate prducers to
control their brands without diluting their own capital and management resources.
The specific terms of these franchise agreements demonstrate the extent to which
concentrate providers have managed to take advantage of the market dynamics and assert
control over the entire soft drink value chain. Concentrate producers used their own sales
and marketing organizations to promote soft drink sales. They also set production
standards to control soft drink quality. They also have gone so far as to mandate the DSD
(direct store door) delivery, effectively redistributing value within the supply chain from
the bottlers to the retailers.
The nature of this relationship, however, is not entirely expropriatory. Coke and Pepsi
clearly recognized the extent to which the strategic asymmetries surrounding the bottling
industry could very well lead to negative long-term economic profits and sup-par bottling
and distribution of soft drink products. In order to promote long-term health of the
bottling industry, Coke and Pepsi lobbied extensively for the 180 Soft Drink Interbrand
Competition Act�federal regulation that preserved the right of concentrate producers to
grant exclusive territories. In essence, this legislation, promoted the strategic advantage
of the bottlers vis-à-vis retail stores, transferring value from retail stores back to bottlers.
Vertical Integration Reasons and Rhetoric
Given the benefits provided by the franchise system, it is difficult to see why Coke and
Pepsi would want to vertically integrate into bottling. Yet this is exactly what they began
to do, starting in the mid-180s. According to Yoffie and Foley, Coke and Pepsi almost
doubled their reliance on company-owned bottlers between 180 and 1. The
“analyst’s reasons” for such expansion, however, make little economic sense.
Few Number of Buyers Many
Number
of Sellers
Sellers
Dominate
Buyers
Dominate
No One
Dominates
High
Trading
Risk
Few
Many
Weakened bottlers needed capital infusion and thus sought buyers. While it is perhaps
correct that the profitability of the bottling industry was declining through the late
seventies and early eighties, this can only be seen as an effect of the franchise agreements
� agreements put in place and enforced by the concentrate providers. Indeed, if
concentrate providers were really concerned about the long-term viability of the bottling
industry, they could have simply improved the terms of the franchise agreements. In
essence, then, this purported cause simply begs the question why did the concentrate
providers allow the bottling companies to reach such a weakened state that they had no
choice but to look for buyers?
Many bottlers were small and unable to handle the corporate goals in a particular
market. Once again, this does not address the question of why the concentrate providers
would need to purchase these bottling companies to address this issue. Indeed, if the
franchise arrangements were working well at the time � and all evidence seems to point
to their dramatic success � it would have been a better strategy to encourage the larger
bottling franchises to take over the small franchises. Given the financial resources of the
major concentrate providers, this seems like a fairly simple task, at least relative to
pursuing a policy of vertical integration.
Many bottlers were located near a company-owned bottler. It is difficult to see exactly
why this would help encourage a change in strategy of the major concentrate providers.
Presumably, there had been franchises located near company-owned bottlers in the
140s, 150s, 160s, and 170s, but it wasn’t until the 180s that Coke and Pepsi began
buying up independent franchises in earnest.
Many bottlers were under-investing. The major concentrate providers had long
encouraged bottling companies to increase their investment in various areas of the
business. For example, Coke and Pepsi’s push to have bottlers implement DSD is an
investment in their relationship with the various retailers. If the major concentrate
providers really wanted to encourage investment on the part of the bottlers, they could
have easily done so through modified franchise agreements. This would have achieved
the same ends, while keeping the balance sheet as trim as possible.
Understanding the Push for Vertical Integration
According to Stuckey and White, there are only four ways a company can benefit from
vertical integration
• Capturing market power of those in adjacent stages in the industry chain
• Increasing entry barriers and obtaining the opportunity to price discriminate
• Promoting the formation of a “mature market”
• Addressing vertical market failure
Unfortunately, none of these rationales provides a very satisfactory explanation of why
Coke and Pepsi began buying up their bottling franchises in the 80s and 0s. Indeed, the
first three reasons to vertically integrate have little to do with the reality of the soft drink
industry.
If Coke and Pepsi indeed pursued a rational policy, the only possible explanation is that
the two companies saw a potential change in the nature of the vertical market failure they
were facing. As the economies of scale in the bottling industry grew and the minimum
Ironically, this is the exact market dynamic that had long benefited the major concentrate providers and
provided an incentive for disaggregating concentrate manufacturing and bottling.
efficient scale of bottling increased, more and more bottling companies were destined to
go out of business. For example, between 160 and 18, the average bottling plant
volume increased from approximately 400,000 cases to .5 million cases.
It is possible that Coke and Pepsi foresaw a time when there would be only a handful of
bottling companies � a situation in which their market power would be seriously
compromised. In essence, then, perhaps Coke and Pepsi feared a transformation from
one in which there were few sellers and many buyers to one in which there were few
sellers and few buyers.
Perhaps both companies were attempting to promote their long-term strategic advantage
by locking in a set of relationships before the bottling industry began to consolidate in
earnest. This would accomplish two objectives. First, both companies would assure
themselves bottling capacity long into the future. Second, they would do so before they
had to pay for the long-term benefit of this strategic advantage. In other words, the price
of these acquisitions would rise disproportionately if Coke and Pepsi waited for
significant consolidation to occur within the industry.
If this were indeed the reasoning behind Coke and Pepsi’s rationale, pursuing a policy of
vertical integration would be justified in economic terms.
Perhaps, however, it is more likely that concentrate producers were merely working to
meet a set of irrational expectations of the investor community. If Wall Street analysts
sincerely believe the purported explanations set forth by Yoffie and Foley, it could make
sense from a short-term shareholder value perspective to vertically integrate into bottling.
Regardless of which explanation better fits the circumstances, it is clear that Coke and
Pepsi would only obtain true long-term value from these acquisitions if the bottling
industry were to further consolidate to the point that concentrate producers would no
longer be able to profit from the strategic asymmetries of the market. As of the date of
the HBS case study, this had not yet occurred and it was difficult to foresee whether or
not vertical integration would ever provide long-term value to the major players within
the soft drink industry.
Few Number of Buyers Many
Number
of Sellers
Sellers
Dominate
Buyers
Dominate
No One
Dominates
High
Trading
Risk
Few
Many
Please note that this sample paper on Cola Wars is for your review only. In order to eliminate any of the plagiarism issues, it is highly recommended that you do not use it for you own writing purposes. In case you experience difficulties with writing a well structured and accurately composed paper on Cola Wars, we are here to assist you. Your cheap custom college paper on Cola Wars will be written from scratch, so you do not have to worry about its originality.
Order your authentic assignment from Live Paper Help and you will be amazed at how easy it is to complete a quality custom paper within the shortest time possible!