Why, Historically, Has the Soft Drink Industry Been So Profitable

Case assignment/preparation questions:

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

Application of Porter’s five forces helps us in the analysis of the soft drink industry.

 Industry Structure Analysis: The soft drink industry has two major manufacturing verticals – the concentrate producers (CP) and the bottlers, both of which are profitable even though the profit margins might vary.

 Bargaining power of Suppliers: With respect to CP, Raw materials required to make a CSD (Carbonated soft drink) is mainly Sugar which has alternatives like High fructose Corn Syrup and stevia based sweeteners. Hence there is no dependency on one supplier and the CSD makers can negotiate better prices. Packaging is another area where this industry needs suppliers. Plastic bottle manufacturing companies are many and hence supplier’s power is reduced. Again due to the vast availability of aluminum, there are several can making competitors available to the bottlers and the bottlers could determine and make favorable agreements. Overall the Bargaining power of the supplier is limited.

 Bargaining power of Buyers: Buyers mainly constitute the retail channel entities - Supermarkets (29.1%), fountain outlets (23.1%), vending machines (12.5%), mass merchandisers (16.7%), convenience stores and gas stations (10.8%), and other outlets (7.8%).

o Supermarkets have limited bargaining power as they are fragmented and do not constitute any major share of consumption. Control over shelf space allocation gave them some limited power.

o Mass merchandisers had more power than supermarkets as they had considerable percentage of consumption. Hence these chains proved less profitable than supermarkets for the CSD makers.

o Fountain outlets were placed at major food chains and these food chain outlets had considerable power and retained majority of the profits and there was very less profit margins for the CSD makers.

o Vending machines were the most profitable as there was no buyer involved.

o Gas stations: Since Pepsi and Coke negotiated agreements with individual gas stations and not a chain like seven-eleven or Mobil, the bargaining power of the buyer was limited and the profitability was high.

Other than Fountain outlets, all the other avenues of retail channels have less bargaining power and are more profitable for CSD makers.

 Threat of new entrants: Threat of new entrants is limited as any new entrant would have to overcome huge advertising and marketing costs in order to make any inroads in to the market share of Pepsi, Coke etc. Established brands like Pepsi and Coke have a huge distribution network which can be leveraged to prevent competition.

 Threat of substitutes: There are many substitutes like tea, energy drinks, bottled water etc. which have lowered the CSD consumption. In response, Pepsi and Coke diversified their operations by acquisition of many companies manufacturing substitute products. Substitute products haven’t dominated CSDs as it may take many more years and it is difficult to compete with lower prices of CSDs and existing brand loyalty amongst consumers.

 Rivalry amongst competitors: Pepsi and Coke together control 75% of the market share. Both companies have tried to better each other for the past few decades which included price wars as well. There is very less possibility for a new entrant in this business who can create new rivalry. Declining cola sales and emergence of non-CSDs can only increase the rivalry amongst these two cola giants.

The industry analysis using Porter’s five forces proves that the soft drink industry has been a profitable business based on the financial results of all the factors discussed above.

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

Even though Concentration Producers (CPs) and bottlers have individual