Cola Wars – Case Study Solution

Questions

 Why has the concentrate business been so profitable historically? What are the challenges now
facing the business?
 How do the economics of the concentrate business compare to that of the bottling business?
 Should Coke and Pepsi own bottlers?
 How can Coke and Pepsi sustain their profits in the wake of flattening demand and the growing
popularity of non-CSDs?

Answers are explained from the second page.

Total: 7 pages

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 1. Why has the concentrate business been so profitable historically? What are the challenges now
facing the business?

Let us start with a Porter’s five force analysis to understand why the concentrate business has been
profitable so historically.

Barriers to entry – Very High – There are widespread economies of scale, the concentrate producers
have humongous promotion expense, which is very hard to copy. The companies have been
established players in the industry for a 100 years, and have thus an impeccable brand image.
Concentrate business has global Presence, it is a mature market.

Bargaining power of suppliers – Very Low – The supplies required by the concentrate producers –
water, sugar, plastic canisters etc. are very easily available and there are a large number of suppliers
providing these, thus the bargaining power of supplier is very low. Advertisement given to suppliers.

Bargaining power of buyers – Low to Medium – Bottler are the first buyers, which gives them an
advantage. They are provided with advertisements as well but there are high switching costs for the
bottler. To summarize, There are some buyers like Walmart that have bargaining powers but drug
stores, clubs etc. don’t. The bargaining power of buyers is certainly more than the bargaining power
of suppliers but still limited.

Threat of substitutes – Medium – Many substitutes are available for CSDs but there are few close
substitutes. There is little customer loyalty among CSDs. But the concentrate producers have come
with line extensions, cannibalizing their own products but also preventing competition. Thus, overall
rating deserved is medium.

Inter-industry rivalry – Low to Medium – HHI index is 1625.26, which suggests that it is an oligopoly,
making the inter industry rivalry low for the concentrate producers. Why still a low to medium rating
has been given is because the competition is very stiff among the limited number of competition.
Competition is on terms of brand, not on price.

BRAND 2009 SHARE (%) Square of Mkt. Share

COKE 19.6 384.16
PEPSI 11.3 127.69
MOUNTAIN DEW 6.1 37.21
DR. PEPPER 5.3 28.09
SPRITE 3.9 15.21
GATORADE 3.7 13.69
AQUAFINA 2.2 4.84
DASANI 1.9 3.61
POLAND SPRING 1.9 3.61
7 UP 1 1
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MINUTE MAID 0.6 0.36
SIERRA MIST 1 1
LIPTON 1.6 2.56
CRYSTAL GEYSER 1.5 2.25
ARROWHEAD 1.1 1.21
POWER ADE 1.2 1.44
NESTLE PURE LOFE 3.2 10.24
BARQ'S 0.7 0.49
SUNKIST 0.8 0.64
Others 31.4 985.96
HHI Index 1625.26
Note: Data has been drawn from Exhibit 7.

Other than Porter’s 5 forces, we can also apply a simple thinking as to why the concentrate producers
have been so historically profitable. It is because their return on investment (ROI) is quite high, which is
because of low capital investment.

Industry Value Chain:

Challenges now faced by the concentrate business:

Pestle framework

 Political, Legal, Environmental - Venturing into new markets – With venturing into new markets,
the concentrate producers would have to deal with local (political, legal, customer preferences)
differences.

 Economical - Flattening demand curve – Because of price cuts and heavy discounts, the
customers have become insensitive towards changing in price. The concentrate producers’
strategies had been on increasing margin by increasing price more than inflation. That is not
likely to work for long-term.

 Social - Changing customer behavior – The customer demand trend was shifting towards
healthier options.

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  Technological factors are not really relevant in this particular case. Pestle analysis does not
cover the financial part. There are two challenges faced in that regards as well:

 Financial situation – With acquisitions of bottlers, there is a huge debt incurred and the debt to
assets ratio has gone up, which could be dangerous if increased further.

 Fall in CSD sales – The CSDs sales were declining in North America, the primary market for the
concentrate producers.

2. How do the economics of the concentrate business compare to that of the bottling business?

 Bottling was capital intensive wherein manufacturing plants were costing about
hundreds of millions and needed high speed production lines which were interchange
only for products of similar packing and sizes.
 From Exhibit 4 we can say that concentrate business is far more profitable compared to
bottlers. Operating income for concentrate business is 32% whereas for bottlers it is 8%.
COGS is a vital element for bottler’s expenses comprising of 58%. General and admin
expenses are a major portion for concentrate business which attributes to 25%.
 Concentrate producers need few inputs compared to bottlers. They basically needed
caramel coloring, phosphoric acid or critic acid, natural flavors and caffeine. Bottlers on
the other hand had two major input. Firstly, cans, plastic bottles and glass bottles for
packaging. Secondly, artificial sweeteners and high fructose corn syrup for sweetening
purposes.
 Bottlers delivered CSD directly to store instead of warehouses and hence they saved on
incurring additional costs of storage, transportation, merchandising and stocking by
retailers. Concentrate manufacturing process involved less capital in machinery, labor or
overhead.
 Concentrate producers negotiated on the behalf of bottling network with can
manufactures and they built supplier relationships as concentrate were the largest
customers. During 1960 -70s both the concentrate companies tried to own a major part
of can business but by 1990 they exited this business and started developing long term
relationship with suppliers.
 For vending channel, initially bottlers had right to sell fountain syrup which were taken
over by concentrate. Bottlers took charge of installing, purchasing and selling machines
and negotiating contracts with property owners. Concentrate producers offered
financial incentives to encourage investment and they played a major role in
development of vending technology.
 Concentrate producers regularly increased the concentrate pries and the increase was
more than the increase in inflation.
 The major portion of concentrate costs were activities such as advertising, promotion,
market research and bottler support. Concentrate producers financed marketing
program jointly with bottlers but they usually took a lead in developing the programs
when it came to product development and advertising. They also employed a major
portion of sales people to support the function of sales, operational improvements for
bottlers.

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  Although the number of bottlers reduced by still they were nearly 300 and there was
more competition amongst them than that of concentrate producers giving the
bargaining edge to concentrate producers.
 Even from the point of view of brand equity bottlers had nothing of their own – no
branding or trademarks hence they were less known and this gives them less bargaining
power.
 Now if we launch a new ‘size’ in existing product line we can see that the concentrate
process won’t change significantly but there will changes for bottler’s process. But if we
launch new ‘product’ line we can see that both will face significant changes in their
process.

3. Should Coke and Pepsi own bottlers?

Pros of owning Bottlers:

 There was a fall in number of bottlers from 2000 to 300. If they fall further, they will
gain unnecessary power and can start exploiting.

 It is more efficient to produce product in fewer places.

 Owing bottlers will increase barriers of entry and also reduce threat of competition by
inculcating exclusivity.

 Owning bottlers will allow the concentrate producers to negotiate alone with retailers,
instead of investing in bottlers to do so.

Cons of owning bottlers:

 Increase debt (in 1986, when Coke owned bottlers, it costed them a debt of over 1
billion Dollars. In 2009-10, that figure would be a whole lot more.)

 Bottling is not the core capability of these concentrate producers. Shift of focus can be
detrimental to the main business.

4. How can Coke and Pepsi sustain their profits in the wake of flattening demand and the growing
popularity of non-CSDs?

Strategic options available:

1. Packaging – In the case it mentions that before when the concentrate producers changed
their packaging (introduced pet bottles and can), their growth spewed. One option is to
think of a new packaging design.
2. Repositioning – Coke and Pepsi could try to reposition the unhealthy image of their CSDs by
showing athletes or soldiers consuming them.
3. Readjusting Stock Offerings – Coke and Pepsi might need to re-think which products to
keep, which to discard and which to promote from its existing stock portfolio. Some
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 products have more margin than others, some products are in line with changing customer
demands. All this needs to be taken in account.
4. New drinks – Launch new drinks in line with the changing customer values. Draw on the
health and nutrition trend.
5. Channel Pricing – Different channels have different prices, different variable profit and
different share of industry volume. The relation among these can be redesigned for
different channels for increasing profitability.
6. Value Branding – Focus on complementary products – Coke and Pepsi could rebrand
themselves around their inevitability with different kinds of alcohol, and fast food like Pizza.
7. Expanding internationally – As the North American market is near saturation.
8. Acquiring – Coke or Pepsi could acquire Dr. Pepper or other small companies to increase
market share and maintain profitability.
9. Letting Bottlers operate as a separate entity – This would let the concentrate producers
focus on their core capability and reduce expense on staff and advertising.
10. Venturing into snacks – This would be brand extension. This could be profitable but could
turn out to be a disaster as well.

Evaluation of Alternatives

Alternatives have been evaluated on the basis of four Ss i.e. the above 10 options – how do they affect
the Stock, Space, Staff and Selling Price. This 4S model is useful for retail and thus has been used here.

Stock – 45% – Stock means what all product lines does these company carry. Coke and Pepsi offer its
customers CSDs as well as non-CSDs. The customer demand trend is shifting towards healthy and
nutritious drinks. Thus, the effect on stock carries the most weightage.

Space – 35% – Space refers to resources. Efficient utilization of resources is critical for the concentrate
business. Some of the above options may involve a large change in the resources requirement and that
could be beneficial as well as detrimental.

Staff – 2% – There is really not much data given in the case regarding staff. It has been assumed that
change in Stock or Space would not have much impact on staff efficiency. Staff has thus been given the
least weightage.

Selling Price – 18% – Selling price determines margin. If these concentrate producers are able to tap into
the customers’ demand, they can charge a higher price. Or if they are able to add value to the customers
in any way, their ability to charge a premium increases. Since flattening demand is one of the problems
that the concentrate producers are facing. This ability to charge premium matters.

Criteria Weightage O 1 O2 O3 O4 O5 O6 O7 O8 O 9 O 10
Stock 0.45 3 3 5 5 3 3 4 4 3 3
Space 0.35 2 3 2 2 5 3 3 3 4 3
Staff 0.02 3 3 3 2 3 3 3 3 4 3
Selling Price 0.18 4 2 4 4 4 2 4 3 3 3
Ranking 2.83 2.82 3.73 3.71 3.88 2.82 3.63 3.45 3.37 3
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Notes: O1-O10 means Options 1-10.
Grading scale – 1 to 5, 5 being the highest. 3 means moderate change. 3 also means that the outcome of
the option could go either favorably or unfavorably, it is hard to judge. Below 3 means unfavorable
change, above 3 means favorable change.

Recommendation:

We have decided to choose four options out of 10, which according to our calculations will the most
critical impact on the 4 Ss. The option numbers we have chosen are 3, 4, 5 and 7 i.e. readjusting stock
offering, launching new drinks in line with customer demands, indulge in reforming the channel pricing
and expanding internationally. The reason for choosing these four is not only because they are the top
four alternatives but also that they are related to each other.

Implementations:

Option 3 – Readjusting Stock Offerings

If we compare Exhibit 9 and 10, we can see that margin for Energy drinks is the highest but it has the
lowest volume sold. Juice is the second highest volume sold but has the least margin. Probably, the
concentrate producers should shift focus from juice to energy drinks.

Option 4 – New Drinks

New Drinks such as Yoga Cola can be launched in line with the changing customer trends.

Option 5 – Reforming Channel Pricing

In Exhibit 6, if we can notice that drug stores have the highest variable profit but the lowest industry
volume and supermarkets have the lowest variable profit but the highest industry volume. Price can be
increased in supermarkets and decreased in drug stores to reach at a better equilibrium.

Option 7 – Expand internationally

We would say expand into developing markets like Africa, where health is less of a concern. Good old
CSDs can do wonder there.

This case study solution is an original work of Six Hats Consulting Organization. It is illegal to reproduce
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