Cola Wars Continue: Coke and Pepsi in 2010

Group 1

Carlie Freeman

Matt Milligan

Zach Chuey

Hannah Adams

Dr. Ramesh Dangol

April 15th, 2019

Cola Wars Continue: Coke and Pepsi in 2010

Executive Summary

        For over a hundred years, Coca-Cola and Pepsi have been engaging an intense “cola war,” fighting over the most significant market share in the carbonated soft drink industry. They have faced a variety of different threats, including but not limited to, the threat of substitutes, the threat of the bargaining power of suppliers and buyers, and the threat of new entry. However, the biggest challenge they face is the threat of substitutes. Since 2005, the carbonated soft drink industry has been declining due to the increase in popularity of non-carbonated soft drinks such as bottled water. This is caused to consumers being more health conscious and desiring a zero calorie drink option. Through it all, though, Coke and Pepsi still hold a combined 72% of the market share. Although, sales for Coca-Cola have been flucationing over the past decade, Coke has still remained more profitable than Pepsi. In 2009, it was 13.1% more profitable than Pepsi. But, as the face of the industry is changing in terms of the relationship between buyers and suppliers and in terms of the changing landscape of consumer wants and desires, both companies have the opportunity to become more profitable if they respond to the new threats. As the threat of substitutes is increasing, both Coke and Pepsi are looking for alternatives to stay ahead of the competition and compete with the new upcoming health kick in America.

Competitive Rivalry

        The beginning of the cola wars was quite simple in a sense. The first event that stirred this rivalry was in 1950 when Alfred Steel, a former Coke marketing executive, became the CEO of Pepsi. He was the one who initiated the direction this rivalry will take, by making Pepsi’s motto “Beat Coke.” This motto seemed to hold true in the mid 1900’s. Pepsi successfully narrowed Cokes lead by a 2 to 1 margin with the help of their “young at heart” marketing campaign in 1963. At the same time, Pepsi worked on modernizing their plants and improving their delivery services. In doing so, they were able to sell concentrate to its bottlers at a price that was about 20% lower than what Coke charged. This was around the time that both Coke and Pepsi started experimenting with new flavors and options. Coke was the leader in doing so and launched Sprite, Fanta, and a low calorie tab. Pepsi went ahead and countered this action by launching Teem, Mountain Dew, and Diet Pepsi.    

 Despite the events that occurred over the years, Coke and Pepsi participated in a carefully waged competition from early 1975 to the mid-1990’s. What is meant by carefully waged is that both Coke and Pepsi could not continue to be their own independent firms without the other. Without Coke, Pepsi would have a very difficult time with being an original soft drink company - the more successful the competition would be, the better other company would have to perform. With that being said, they both followed in each others footsteps with various strategies such as economies of scale and product differentiation. They both had to consistently find new ways to be original which would foster the same actions for the competitor. An example of product differentiation would both companies deciding to take control of their customized can production. This would make their products have a more branded approach and hopefully differentiate them within the CSD industry. Soon after, metal cans were essentially a commodity, and often two or three can manufacturers competed for a single contract.    

Threat of Substitutes

When discussing threat of substitutes, it can be defined as the availability of a product that consumers can purchase instead of the industries product. A substitute product is a product from another industry that offers similar benefits to the consumer as the product produced by the firms within the industry. With that being said, there is a high threat of substitutes in the beverage industry, being that there are many similar products that offer the same benefits as Coca-Cola and Pepsi. With high threat of substitutes, comes high competition and low barriers to entry. In 1970, roughly 23 gallons of CSD’s were consumed annually, and a 3% growth throughout the preceding years. What made this growth so rapid, was the increasing availability and convenience for people to consume CSD’s, as well as the introduction to diet and flavored varieties. On top of that, with the increasing number of substitutes, firms started competing on price, making CSD’s more affordable for consumers. What is interesting is that consumers have a vast amount of substitutes to choose from to satisfy the basic need of quenching thirst in an enjoyable way. These substitutes consist of beer, milk, coffee, water, juice, tea, power drinks, and so on. However, Cola segment still managed to maintain its dominance with a market share of 71% in 1970 and a market share of 55% in 2009.  

Both in the United States and abroad, the increasing popularity of alternative beverages stirred up complications for CSD makers in terms of their traditional production and distribution methods. The smaller and specialized products made it challenging for bottlers to make with their existing infrastructure. WIth that being said, bottlers grew frustrated with not being fully involved with the new growth. Coke and Pepsi sold their finished goods to bottlers who distributed them alongside their own bottled products at a percentage markup. Whereas energy sports drinks offered larger margins than CSD’s because they were focused on premium prices and were usually chosen for immediate, single serve consumption. In places like convenience stores, energy drinks had an average case price of $34.32, compared to CSD’s who case price was $8.99 on average. Yes, power drinks were promising higher margins, but the volume for such products remain small compared to CSD’s volume, even while growing fast. All CSD companies were faced with the challenge of achieving pricing power, especially in the take-home segments. Particularly, the rapid growth of mass-merchandising led by Wal-Mart and various club stores, created a new threat to profitability for Coke, Pepsi, and their bottlers.

The threat of substitutes in the beverage industry have affected the overall industry profit in a positive way, but no alternative has come close to Coke and Pepsi. In 2004, Coke sold 3.2 Million cases and Pepsi sold 2.1 Million cases. Whereas substitutes such as Gatorade, 7UP, Dasani, and Lipton were only selling between 176,000 and 546,000 cases. These numbers may be much lower than Coke and Pepsi’s numbers, but substitutes have still created a positive return for the beverage industry. Between 2004 and 2009, Aquafina and Dasani had a change in market share of 3.5% and 4.1% and Coke and Pepsi had a change of -3.5% and -5.5%. This shows the power of substitutes, especially those that are more health conscious than CSD’s.

When considering comparable quality between Coke, Pepsi, and their substitutes within the beverage industry, it is ultimately up to the end user to decide. However, there are many steps and factors in places before these products are in the hands of the end user. These include the concentrate producers and bottlers. In order to produce high quality beverages, Coke and Pepsi rely largely on concentrate producers. Their primary role is to take the raw material ingredients, package the mixture in plastic containers, and ship these containers to bottlers. This is a vital customer of Coke and Pepsi, because they ensure the bottlers are receiving the products they are intending on selling. As for bottlers, they receive these containers and add high-fructose corn syrup and carbonated water, bottle them, and deliver them to each customer account. Both Coke and Pepsi arranged agreements with their botters to do “direct store door” delivery, where they go directly to the secured shelf space, stacked in stores, positioning their trademark label, and setting up point-of-purchase or end-of-aisle displays. Whereas other substitutes such as Shasta and Faygo distribute through food store warehouses which is an extra step to the end consumer.    

Threat of the Bargaining Power of Suppliers

According to Porter’s Five Forces Model, the threat of the bargaining power of suppliers exists when suppliers threaten a firm’s performance by increasing the prices of their supplies or decreasing the quality of the product they are supplying. A supplier is a high threat to a firm when the following indicators are present; first, when there is a small number of suppliers for firms to choose from in an industry, suppliers have more power because it is less likely a firm will find a better option when there are so few present to begin with. Next, suppliers have increased power over firms when the supplier is selling a highly differentiated product. Suppliers are also a threat to firms when suppliers are not threatened by substitutes. Furthermore, firms face increased threats from suppliers’ power when suppliers threaten with forward vertical integration. Lastly, suppliers threaten firms when firms are not recognized as important customers for suppliers.

In the case, Coca-Cola and Pepsi operated as suppliers in the carbonated soft drink (CSD) industry by selling their concentrate to bottlers who would then sell the finished CSD product to retailers. In the beginning of the cola wars, Coca-Cola faced varying amounts of pressure from the buyers in their industry, aka their bottlers, because they were originally bound under the 1899 contract that was a fixed-price contract and offered no opportunity for price renegotiation as the costs of ingredients changed throughout the years. Through a series of amendments, Coke was able to increase their power as suppliers and establish the 1987 Master Bottler Contract. This new contract used a formula that established a cap price and adjusted prices quarterly according to changes in ingredients. However, Pepsi was able to maintain a higher amount of supplier bargaining power in it’s contract with its top bottler. Their contract allowed the bottler to distribute Pepsi’s CSD products perpetually, but it required the bottlers to purchase the concentrate at prices and terms and conditions that were determined by Pepsi itself. The bargaining power of suppliers remained high because buyers were dependent on the differentiated product the concentrate producers were supplying.