Cola Wars Continue: Coke and Pepsi in 2010

Cola Wars Continue: Coke and Pepsi in 2010 (HBS 711462)

1)  Why, historically, has the soft drink industry been so profitable?  

Firstly, the soft drink industry has consisted of few major competitors, and there has not been fragmented competition within the industry. For example, Coca-cola’s imitators were barred from producing their versions of cola, which meant that there were few cola product substitutes that consumers could choose from. Hence, since consumers have few alternatives for specific types of soft drinks, players in the soft drink industry were able to profit from the lack of choices of consumers, resulting in the industry on the whole being profitable.

Next, there has been heavy advertising for soft drinks. For instance, In the 1920s, Coca-cola initiated “lifestyle” advertising which emphasized the role that Coke played in consumers’ lives. During the Great Depression, Pepsi sold bottles that were two times bigger for the same price as Coca-cola. In the 1980s, both Coca-cola and Pepsi doubled their advertising expenditures. In the 2000s, Coca-cola spent hundreds of millions on sponsorships and global marketing, while Pepsi spent over $1 billion to rejuvenate its image. These measures taken by the players in the soft drink industry has enticed consumers to choose soft drinks over other beverages. (In 2000, soft drinks accounted for 81% of non-alcoholic beverage volume.) Hence, the emphasis on advertising has led to the soft drink industry being profitable.

2)  Compare the economics of the concentrate business to that of the bottling business: Why is the profitability so different?  

One reason that the concentrate business is more profitable than the bottling business is the lower cost incurred by the concentrate business. The concentrate business requires few inputs which are less costly, such as colorings and flavorings. It requires little capital investment in machinery, overhead and labor. On the other hand, the bottling business has higher cost of inputs, such as the cost of concentrate, syrup and packaging. It requires heavy capital investment, with significant expenses in labor and overhead.

Next, the marketing programs that concentrate businesses implement are typically financed jointly with bottling businesses. However, bottling businesses have to spend even more on advertising their products, product and packaging proliferation, and widespread retail price discounting. Bottlers also have to pay for more than half of advertising costs in exchange for the shelf space of retailers. These lead to higher capital requirements and lower profitability.

Another key reason is that the concentrate business’ profits are linked to quantity sold, whereas the bottling business’ profits are due to the package types and the location where the drinks are sold. For instance, Coke charges the same price for concentrates sold to bottlers in Africa and the United States, but the bottler in Africa might earn a much lower price for their product as compared to the bottler in the United States, leading to lower profits.

Additionally, an advantage of concentrate businesses over bottling businesses is that they are able to adjust their prices to increase or maintain profits, in the event of inflation or changes in the costs of their inputs. For instance, the 1987 Master Bottler Contract enabled Coke to determine concentrate price and other terms of sale. Similarly, Pepsi’s Master Bottling Agreement enabled it to sell raw materials to its bottlers at prices set by Pepsi.

3)  How has the competition between Coke and Pepsi affected the industry’s profits?