Running head: PRODUCTION AND PRICE WARS 1
Production and Price Wars
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PRODUCTION AND PRICE WARS 2
Production and Price Wars: A Case Study of Coke and Pepsi
Introduction
The manifestation of price wars is often characterized by a short-lived and yet intense
period when competing firms reduce their prices in the hope of winning extra markets. In
addition, price wars are also staged in a bid to generate cash flow through increased revenues.
Consequently, price wars are not static and may recur over long periods pitting brands against
each other. Particularly, oligopolistic market structures are characterized by increased prospects
of price wars as the few leading companies make aggressive price cuts to edge out competitors.
The classical case of Coke and Pepsis provides a perfect example of oligopolistic price wars
based on the need for continued domination and control of emerging and existing markets. In
turn, the price wars between the two companies are based on a similar interest in dominating the
soft drink market. While these price wars' main purpose is to secure new markets, it also serves
as a collusion to keep off other competitors.
Table 1: Coca Cola and Pepsi
Both Coca-Cola and Pepsi have significant levels of dominance in the global soft drink
markets. Based in the US, each company has carved a niche in the soft drink market and
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endeared them as global beverage leaders. The continued competition between the two
companies has contributed to greater product variety and lower prices for consumers. According
to Stofova and Kopcakova (2020), Coca-Cola and Pepsi have overarching similarities in terms of
their flagship products and ideal consumers, thereby contributing to increased prospects for
heightened competition. Besides their similarities, the companies have a significantly high
concentration rate in the soft drink market, making them perfect oligopolies (See table 1).
Although both companies portray a similar business model at face value, Pepsi has a more
diversified business model based on its venture in the consumer packaged goods industry.
Ultimately, the price wars between Pepsi and Coca-Cola are based on the need to maintain
inherent control of the market while limiting the potential of other competitors.
Market structure
The competition between Pepsi and Coca-Cola is best illustrated as both colluding and
non-colluding oligopolies, which is based on price leadership. According to Mazzeo (2012), an
oligopoly represents an imperfect market structure characterized by the domination and control
of a market by a few large firms. In essence, oligopoly market structures may have many other
players exerting little influence in the market, as in the case of Pepsi and Coca-Cola. Even
though there are multiple other players in the global soft drink market, Coca-Cola and Pepsi have
taken global leadership through their control of a significantly large share of the market. Besides,
the existence of few large firms in the form of Pepsi and Coca-Cola qualifies their market
structure as a non-colluding oligopoly. Similarly, the two companies dictate the price of products
in the market, making it difficult for other competitors and new entrants. The companies’
efficient mass production technologies give them a competitive edge that also acts as a deterrent
for new entrants.
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Still, the price leadership attained by the two dominant companies in the soft drink
market makes it a feasible oligopoly. In particular, any price reduction by one of the two
companies attracts a similar and almost uniform price drop by the other company. However, an
increase in the price of a product by one company does not attract a similar increase. It is not
surprising, therefore, that the companies have largely maintained their prevalent pricing
structures to avoid losing out their markets to the oligopolistic competitor. Besides, a key feature
of the soft drink market is that both Pepsi and Coca-Cola are interdependent on each other as
portrayed in their pricing strategies. As noted in Han and Ryan (2017), the interdependence of
dominant firms is a positive indicator of an oligopolistic market structure. Similarly, the two
companies have a concentration rate of 69.0%, which is a significantly high market share of the
global soft drink market (See Figure 1).
Figure 1: Market Share
Kinked Demand Theory
The pricing strategy for both Coca-Cola and Pepsi is based on slight marginal profits over
the production costs. Inherently, the competition between the two companies restricts their price
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adjustments because of the potential loss of market share. According to Mazzeo (2012),
oligopolistic market structures impart significantly huge implications on slight changes in
pricing. This relationship is best illustrated through the kinked demand theory, which is based on
a more elastic demand curve when the price is increased compared to a less elastic demand curve
during price drops. Indeed, any increase in the price of products of one company would easily
result in reduced demand as consumers prefer alternative products. The similarity of products
between the two companies means that consumers have a greater chance of finding substitute
products across the two companies. Ultimately, price change decisions across both Pepsi and
Coca-Cola are based on the specific direction of the price change.
In the kinked demand theory, companies in an oligopolistic market structure do not match
the price increases of their competitors. Instead, a price increase is more likely to be ignored by
the competitor as the latter seeks to capitalize on the new demand for its products as substitutes
for the first company. In this case, Coca-Cola would not match a price increment by Pepsi even
when the production costs have risen. Instead, the company would sustain its prevailing prices in
the short term in the hope of eating up into Pepsi’s market share. In contrast, a price reduction by
one company is almost certainly met with a similar reduction in the price of the other company’s
products. This behavior is based on the need to protect existing markets from predatory pricing
strategies of the competing company. This part of the demand curve is represented through an
inelastic curve because both firms act in similar ways. In turn, the ability of these companies to
match their competitor’s price strategies results in a kink in the demand curve (see figure 2).
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Figure 2: Kink Demand Curve
Still, the marginal revenue curve in both companies is dependent on the price of their
products. In turn, any price drop in products results in a kink in the marginal revenue curves as it
drops downward to create a gap. Based on the kink in the marginal revenue curve, the marginal
cost curve of the new price intersects at the same quantity as the initial price before the reduction
of the price (Chan, 2016). As such, companies in an oligopoly do not experience changes in the
quantity of production based on changes in pricing. This behavior is based on the fact that a price
reduction in one company is matched by a similar price reduction in the other competing
company, thereby maintaining prevailing demand levels. The kink demand theory accurately
depicts the pricing strategies in Coca-Cola and Pepsi, which resists the idea of altering their
prices. Even when price adjustments are made, they are always made in concert with the other
competing firms.
Similarly, the kinked demand theory is consistent with the actions of the two companies
in terms of their price wars over the years. Indeed, any reduction in the price of one product has
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always been met by a similar reduction of price in the competing brand. Indeed, the adoption of
similar changes in the pricing of products in both companies would not provide motivation for
consumers to switch from one product to the other. In turn, the companies have consistently
maintained their prices with little drive to make price reduction strategies as that would reduce
their profitability in the long run. Indeed, reduced prices for products would attract a similar
strategy from the competing brand, thereby reducing the overall profits because of an unchanged
demand for products. In a bid to avoid such a situation, the companies seek to absorb all changes
in the cost of production by adopting mass production to sustain their revenue.
Cartel Model
The price wars between Coca-Cola and Pepsi can also be represented through the cartel
model of oligopoly, which identifies competing firms as colluders in price setting. The fact that
these companies have limited other competitive threats means that they are highly competitive
against each other. However, the companies are unlikely to compete across price because of the
substitutive nature of their products. According to Miller, Sheu, and Weinberg (2020), the main
characteristic of a cartel model in an oligopoly is the aspect of collusion between few firms. In
this case, Coca-Cola and Pepsi collude to keep away new entrants and other competitors from
their markets. However, the collusion between the two companies is involuntary because they do
not dictate the prices through fixing costs. Instead, the fear of losing out on market shares results
in the form of collusion that results in the maintenance of prevailing prices for long durations.
Besides, the unwillingness to lose out on profitability through price reduction forces the
companies to agree on the need for maintaining prevailing prices.
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The emergence of price wars between Pepsi and Coca-Cola is often done over short
periods of time. For instance, the adoption of new technologies in one company could result in
reduced costs of production, thereby necessitating a price drop to earn a bigger share of the
competitor’s market. However, these companies often replicate technological advancements and
other cost-reducing interventions, thereby resulting in almost similar prices for substitute
products. Essentially, matching prices for substitute products between the two companies may
lead to a maximization of profit in ways that are similar to monopolistic market structures. It is
not surprising that these companies often peg their production on the matching of marginal
revenue and marginal costs because this is the point where profits are maximized. Although the
relationship between Coca-Cola and Pepsi is generally considered non-colluding, they collude
involuntarily in setting prices of substitute products.
The existence of collusion between oligopolistic companies is difficult to detect because
of the secrecy of agreements between multinational companies. However, the fact that both Pepsi
and Coca-Cola offer similar products that have almost similar production costs means that they
cannot compete on price. Consequently, the costs of production do not always inform pricing
strategies, as does the desire to attain a bigger market share. Price reductions in one company can
almost certainly be traced to efforts to eat up into a competitor’s market share. In turn, competing
brands often replicate such price drops with similar strategies, thereby resulting in price wars.
However, these price wars may then result in diminished profitability as competing firms
struggle to sustain their production processes at the least margins. That notwithstanding, both
companies adopt low price strategies to maximize their market share in the short term and attain
profitability in the long term.
Game Theory
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The game theory is also indicative of the price wars and strategies adopted by Pepsi and
Coca-Cola in their oligopolistic market structure. According to Osborne (2004), game theory is
the science of strategy that portrays the behavior of competing players in strategic situations.
Although both companies have the choice of setting higher or lower prices to attain profitability,
they both adopt unique strategies based on internal and external factors, including production. As
portrayed below, the numbers indicated in the right represent values for Coca Cola while those in
blue are figures for Pepsi (See Figure 3). Despite the guaranteed payoffs of collusion, the two
companies engage in a non-colluding oligopolistic market structure where prices are determined
in competition and not through collaborations. In the end, the two companies adopt price
reduction strategies that guarantee access to a sizeable portion of the market while sustaining
reasonable profitability.
Figure 3: Game Theory in Coca Cola and Pepsi
Both companies adopt a lower price as the dominant strategy based on the inherent
benefits of a bigger market share. If Pepsi increases its price, Coca-Cola is most certainly likely
to go lower to attain profitability of $2500, which is greater than the profitability of $2000 if it
were to go higher in pricing. Even when Pepsi adopts a price reduction for its products, Coca-
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Cola is most likely to lower its prices as it would accrue a profit of $1000 relative to $950 if it
were to increase its prices. Similarly, a price increase in Coca-Cola is likely to attract a reduction
in Pepsi, which would make a $2500 profit (See Figure 3). In contrast, imposing a high price for
its products would only guarantee $2000 in profitability for Pepsi. Still, a reduction of price by
Coca-Cola would also compel Pepsi to reduce its price in the hopes of making a profit of $1000
compared to the profit of $900 if it were to go higher.
Conclusion
The prevalence of price wars between Pepsi and Coca-Cola over the last few decades is
based on their competition within an oligopolistic market structure. Indeed, the need for
continued domination and control of emerging and existing markets contributes to similar pricing
strategies that eventually culminate to price wars. It is not surprising that any price reduction by
one of the two companies attracts a similar and almost uniform price drop by the other company.
The competition between the two companies further restricts their price adjustments because of
the potential loss of market share. In the kinked demand theory, companies in an oligopolistic
market structure do not match the price increases of their competitors. The game theory is also
indicative of the price wars and strategies adopted by Pepsi and Coca-Cola in their oligopolistic
market structure.
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References
Chan, T. (2016). Demand for Soft Drinks: Characteristics, Corners, and Continuous Choice.
RAND Journal of Economics, 37, 466-482.
Han, Y., & Ryan, M. (2017). Teaching Strategic Thinking on Oligopoly: Classroom Activity and
Theoretic Analysis. e-Journal of Business Education and Scholarship of Teaching, 11(1),
127-139.
Mazzeo, M. J. (2012). Product choice and oligopoly market structure. RAND Journal of
Economics, 221-242.
Miller, N., Sheu, G., & Weinberg, M. (2020). Oligopolistic price leadership and mergers: The
united states beer industry. Available at SSRN 3239248.
Osborne, M. J. (2004). An introduction to game theory (Vol. 3, No. 3). New York: Oxford
university press.
Štofová, L., & Kopčáková, J. (2020). The Competition Strategy between Coca-Cola vs. Pepsi
Company. Calitatea, 21(179), 40-46.
