Cola Wars Continue Coke and Pepsi in 2006 Case Solution

1. Why is the soft drink industry so profitable?

Between 1996 and 2004, the soft drink industry has increased rapidly with an average of 3 percent per year. The major reason for the profitability of this industry is the greater per capita consumption of carbonated soft drinks. The two major contributors to the industry were Coca-Cola and Pepsi and both the companies continued to offer great varieties such as new flavors, diet coke, and brand extensions and so on. It increased the profitability of the industry.

Moreover, the soft drink industry is full of diversity and variety in which Pepsi and Coca Cola own more than 3/4th of the entire market. Hence, Porter's five forces can be used to explain profitability in such a market environment. There is less market competition and the barriers to entry are stronger. Similarly, in a market where both these cola giants have maintained a strong position, the customers cannot quit easily nor can they shift to substitute products. Hence, both these companies enjoy a distinctive advantage over other soft drink companies because of their brand reputation, diversified portfolio and variety of products. It helps in maintaining better market positioning and higher profitability in the soft drink industry. Another reason for the large profits in this industry is the increasing customer demand for carbonated drinks, snacks, and other beverage products being offered by the cola companies.

2. Why historically has the soft drink industry been so profitable?

Historically, the soft drink industry has been quite profitable because of increased customer demand as well as the availability of a greater variety of products. More flavors and varieties increase the number of sales thus increasing the profits of coal companies. Furthermore, new methods of advertising and marketing were introduced such as better fast-food chains, vending machines and so on.

The case study also indicated that historically, the revenues of the soft drink industry have remained concentrated mainly between the two major cola giants i.e. Pepsi and Coke. Due to this reason, it has always been difficult for new companies to emerge and take up better market positions. Customers have developed brand loyalties and thus they do not easily accept the products of other similar companies. Hence, the profits of these two companies have formed a major portion of industry revenues.

The two companies have also used the strategy of low pricing throughout the world. It has helped in increasing profitability. Even though the profit margins have remained low but due to the expansion of business to large geographical and demographic segments, the cola giants have maintained their superiority and market positioning. Due to this strong positioning, they have acquired hold over retail channels and other store locations. Since these channels are associated with eighty percent of the sales, therefore Pepsi and Coke have established their hold over the market sales leading to greater revenues and profits.

3. Compare the economics of the concentrated business to that of bottling business? Why is profitability so different?

Concentrate Producers’ Business

This business is less capital intensive as compared to bottling. Through small amounts of investments in machinery, maintenance, and labor, this business can be run. Secondly, the costs of concentrated business is confined mainly to four areas i.e. research and development, advertisement and marketing, promotion and support but this business continues to employ a large number of people to manage the bottling business.

Pepsi decides its concentrated prices after negotiating with the bottlers and these prices are based on CPI whereas Coke determines its prices according to the Master Bottling Contract. However, the prices continue to increase at a rapid pace that makes the concentrated business more successful than the bottlers.

Bottling

On the other hand, the bottling business requires heavy investments and is thus more capital intensive. Investment is needed for maintaining large bottling lines. However, the bottling business cannot operate independently because, for key inputs, it depends on the concentrated business. All these factors collectively lead to fewer revenues in the bottling business.

The returns gained by bottlers are fewer than revenues gained by concentrate producers because of the risk levels too. The concentrate business producers are liable for brand advertising and invest profoundly in trademarks to fuel profits, this leads to high returns.