Semester 1; Coca Cola Case Analysis

Question 1
Introduction

In my analysis of the bottling and concentrate business’, I aim to investigate why the profit
margins of these two business’, despite being in the same industry, are so different.

The case which I looked at is that of Coca-Cola and Pepsico in the carbonated soft drinks
(CSD) market. In the CSD market the concentrate producers make concentrate from the raw
materials and send it onto the bottlers who package and distribute the finished good to
retailers. The bottlers are meant to market the good as well but as their profit margins are
already so small and to continue to be competitive, Pepsi and Coca-cola tend to subsidise
many of the marketing and advertising costs themselves. Despite this, in 2004 the concentrate
producers pre-tax profit was 30% of sales whereas the bottlers pre-tax profit was 9%.1 This
huge gulf in profit shows that not just one factor but many have a part to play in the
difference between the concentrate and bottling business’ profit.
Supplier and buyer power
As the concentrate producer and the bottler are next to each other in the production line they
must interact with each other efficiently.
Coca-cola went about this by having a long term contract with their bottlers. The main
contract they use is the 1987 Master Bottler Contract, which gives Coke the right to set the
price of the concentrate but didn’t oblige them to input marketing or advertising costs.2
Pepsi’s contract with its main bottler however, stated that they have the right to distribute
Pepsi’s products but that they must purchase raw materials on the terms and conditions which
Pepsi set. 3
Coca-Cola and Pepsi both were meant to set their prices in line with the Consumer Price
Index (CPI) and the rise in price of the raw materials used to make the concentrate.

Both contracts meant that bottlers were price takers and in no position of power due to the
fact that the CSD market was an oligopoly dominated by these two multinational companies
so if they were to refuse a contract the likely-hood is that they wouldn’t receive a better
contract from elsewhere.

This relates to the profitability of concentrate producers and bottlers as when the market
began to plateau and the retail price of Coca-cola or Pepsi remained the same, the concentrate
producers continued to increase their prices. Between 2002 and 2004 the change of retail
price remained at 1.6% since 1988 and the change in the concentrate price increased from
2.3% to 3.6%. In addition in the same time period the CPI increased from 2% to 2.6%. 4 This
shows that the concentrate producers were overly inflating their prices to gain a higher profit
margin. As the change in retail price remained the same, their revenue remained the same in
real monetary value and the bottlers costs were increasing with the rise in concentrate prices
which meant that bottlers profit margins were steadily decreasing in 2004.
 Barriers to entry

Initially starting up as a bottler is incredibly capital intensive as it costs from around $40
million to $70 million to build a bottling plant.5 And although a few large plants would be
more efficient, cost saving and be able to supply enough to meet the demand of the entire
united states, in order for effective distribution to take place.

On the hand although you need very little capital to start up a concentrate business, in order
to compete with the CSD giants of Coca-cola and Pepsi you need a huge capital injection to
be set aside for marketing purposes alone. Without this it’s unlikely that your product will be
given shelf space in supermarkets or in vending machines which are the main distribution
channels for CSD’s.

Another issue for concentrate producers is brand equity in that market brand loyalty is very
high so breaking into Coca-Cola and Pepsi’s stranglehold on the market is incredibly
difficult.

Lastly the main barrier to entry of a bottler also involves Coca-Cola and PepsiCo’s
domination of the market as they already have established links with their bottlers so it’s very
hard to draw them away from their contracts with them and there are very few other
concentrate producers that will need a bottler in the same area, so gaining a contract with
enough business for an entire plant to make the project will be incredibly difficult.

Substitutes

Due to the high barriers to entry there are very few substitutes in the bottling industry, which
means that as long as the demand remains similar to its current level and that bottlers keep
their contracts, the bottlers should remain profitable. Also the fact that bottlers can produce
bottles and cans of not only CSD’s but alternatives such as water, fruit juices and other
healthier options, means that bottlers are more flexible to changes in the market and don’t
have to invest heavily in order to respond rapidly to these changes.

Concentrate producers profits are particularly affected by substitutes such as water, tea,
energy drinks and fruits juice as in recent times, societies trends have changed to more
healthier options than CSD’s. This is making larger concentrate producers such as Coca-Cola
and in particular PepsiCo, diverse into other drink markets. In 1998 PepsiCo spotted that
substitutes for their original soda drinks were growing in popularity and moved swiftly to
acquire Tropicana, a fruit juice business. 6

Rivalry
Concentrate producers rivalry between each other is very strong with the main rivalry being
between Coca-Cola and Pepsi. This rivalry has impacted upon profit in that market share has
to be split between the two rivals which means that revenue is lower and in order to compete
with each other Coca-Cola and Pepsi are spending increasing amounts of money on
marketing which increases costs.

In some regions bottlers have similar direct competition however this very rarely occurs. The
bottlers main rivalry that can impact upon their profitability is the other channels of
distribution that can be used such as fountains/vending machines, which makes up 34% of the
share of the industry volume distributed. 7 This affects profitability as the bottlers get
bypassed in the production chain and the concentrate producer sells directly to the retailer.

Conclusion

The difference in profitability between concentrate producers and bottlers is due to many
factors. Concentrate producers costs are lower, particularly set up costs and in order to
maintain crucial large contracts from the likes of PepsiCo or Coca Cola the bottlers must
continue to inject large amounts of capital in order to keep their machinery up to date and
working as efficiently as possible.

Another key factor in the difference in profitability is the control over concentrate prices that
the concentrate producers have. Increasingly over the past few years the concentrate producer
has been increasing the price over the rate that the Consumer Price Index has shown. This
means that bottlers are buying the concentrate at an overly inflated price and their costs
increase leading to profit margins decreasing.

Bibliography
1. David B. Yoffie, Coca Cola Wars Continue: Coke and Pepsi in 2006, April 2, 2007,
page 169, Introduction to Organisation and Management.
2. David B. Yoffie, Coca Cola Wars Continue: Coke and Pepsi in 2006, April 2, 2007,
page 153, Introduction to Organisation and Management.
3. David B. Yoffie, Coca Cola Wars Continue: Coke and Pepsi in 2006, April 2, 2007,
page 153, Introduction to Organisation and Management.
4. David B. Yoffie, Coca Cola Wars Continue: Coke and Pepsi in 2006, April 2, 2007,
page 169, Introduction to Organisation and Management.
5. David B. Yoffie, Coca Cola Wars Continue: Coke and Pepsi in 2006, April 2, 2007,
page 153, Introduction to Organisation and Management.
6. http://www.nytimes.com/1998/07/21/business/pepsico-to-pay-3.3-billion-for-
tropicana.html
7. David B. Yoffie, Coca Cola Wars Continue: Coke and Pepsi in 2006, April 2, 2007,
page 170, Introduction to Organisation and Management.