Business case write-up

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1. Historically, the soft drink industry has been very profitable, especially for concentrate

producers (CPs). Exhibit 4 of the case shows that the average operating profit margins of CPs is

about 30%. This can be understood by analyzing the five competitive forces of this industry. Coca-

Cola and Pepsi have established significant barriers to entry. While it would be possible for new

entrants to produce a comparable product, it would be very difficult to overcome the brand

advantages of established firms due to economies of scale. For example, Exhibit 8 shows that Coke

only spent about $15 million per market share while Gatorade had to spend $38m per share in

marketing and advertising. It appears that a large market share allowed established firms to spread

the fixed cost of advertising better. The capital requirement for developing a national bottling

network is also very high. For example, both Coke and Pepsi had over 100 bottlers, and each

bottling plant would cost $40m-$100m. In addition, new entrants would face limited access to

distribution channels. Established firms controlled major bottlers and had developed long-term

relationships with major distributors. Other forces will be discussed below.

2. Exhibit 4 shows that the operating income of bottlers is only 8% (vs. 32% for CPs). This large

difference can be explained by the power of their buyers and suppliers. For CPs, their major

suppliers are not very powerful. Exhibit 4 shows that CPs only spent 22% of their revenue on

inputs (vs. bottlers’ 58%). This suggests that CPs’ suppliers are less important to them than the

suppliers of bottlers. In particular, CPs’ suppliers include providers of corn syrup, acid, coloring,

and caffeine. Because the commodity nature of these inputs, CPs should have multiple alternative

suppliers to choose from and negotiate reasonable prices with suppliers. In contrast, bottlers spent

a large portion of their revenue on concentrates alone, and they only had two major suppliers to

choose from, reflecting a high power of their suppliers. For CPs, their major buyers are not very

powerful, either. Bottlers are allowed to only buy concentrates that do not directly compete with

Coke and Pepsi’s products, leaving them with only one major supplier. In addition, a given bottler

can only serve a specific geographic territory. Because Coke and Pepsi’s bottling network covered

most regions, it’s almost impossible for a bottler to switch between the two CPs. Although fountain

account holders like McDonald’s have relatively larger power than bottlers, Exhibit 4 shows that

they only account for about 30% of cola sales. This suggests that CP’s buyers have low power

overall. In contrast, 5/7 of bottlers’ major buyers (see Exhibit 4) are powerful and large distributors.

Although cola is a major draw of traffic for these distributors, bottlers’ major buyers typically

carry both Coke and Pepsi products and enjoy relatively high power as buyers.

3. Coke and Pepsi competed by focusing on promoting brand names, introducing new products,

and developing their bottlers’ networks. Because they can largely imitate each other’s new actions,

they seemed to have restrained price competition. Specifically, Exhibit 5 shows that the price of

concentrates has increased significantly over time. In addition, Exhibit 2 shows that both Coke and

Pepsi enlarged their market share over time. Thus, the competition between them seems to have

benefited both firms, pushing other competitors out of their businesses.

4. In response to the increased threat for substitutes (i.e., non-CSDs), both Coke and Pepsi have

taken decisive steps. Both firms have become major players in the markets of substitutable

products. They have increased their control over their bottlers, which will allow them to distribute

non-CSDs with greater flexibility. In addition, both firms have developed world-class marketing

capabilities. Their significant advantages in distribution and brand equity are not easily imitable

by other firms. Their dominate positions in the CSD market would also allow them to invest

heavily in R&D and consumer research. Exhibit 10 shows that branded non-CSDs would allow a

high profit margins comparable to CSDs. Thus, I am confident that Coke and Pepsi will sustain

their high profitability.