MAKE VERSUS BUY: PEPSI-COLA AND ITS BOTTLERS

When the cola industry began, the two major suppliers were Coca-Cola and Pepsi-Cola. Coke
and Pepsi were primarily syrup manufacturers. They obtained raw materials, such as caramel
and sugar, from independent suppliers and relied on independent bottlers to distribute and
market their products. This allowed Coke and Pepsi to protect the source of their advantage in
the markettheir syrup formulaswhile using independent firms to perform all other tasks.
This division of labor made sense. Upstream inputs like caramel and sugar can be obtained from
competitive markets at prices at or near minimum average cost. Downstream bottlers knew their
local consumers better than did the Pepsi and Coke corporate offices, and could better judge the
need for price discounts and other marketing ploys.

As the market for cola has grown, Coke and Pepsi have continued to obtain raw inputs from the
market. However, both of them, especially Pepsi, have increasingly consolidated distribution and
marketing. Whereas Pepsi at one time relied exclusively on independent bottlers, it began to
substantially consolidate bottling and distribution operations in the 1970s and 1980s. The
company-owned Pepsi Bottling Group controlled over 60 percent of worldwide bottling
operations by 1990. In 1999, Pepsi spun off the Pepsi Bottling Group, but retained a 40 percent
ownership stake, thereby retaining de facto control.

Timothy Muris, David Scheffman, and Pablo Spiller have identified several important reasons
for the consolidation of ownership of cola bottlers. Changes in the technology of bottling have
created economies of scale that have reduced the number of bottling plants by nearly 90 percent.
Small bottling plants continue to close, their output taken up by expanding existing facilities.
The remaining independent bottlers are larger and more strongly committed to their own
marketing philosophies. This became a large problem for cola makers, who found that in the
1980s they needed to substantially increase the coordination of their retailing activities across
the different regions served by bottlers.

The need for increased coordination of retailing activities can be traced to several changes in
marketing. First, the 1970s and 1980s saw the emergence of regional and national purchasers of
cola products, including major grocery chains, discount retailers, and fast-food outlets. Retailers,
such as Wal-Mart, purchase soft drinks through a national office and use sophisticated sales
information to design their own marketing plans. Coke and Pepsi need to be equally centralized
and sophisticated to service these customers. Second, Coke and Pepsi increasingly use
sophisticated advertising and promotionsthe Pepsi Challenge is a good exampleas a major
competitive weapon. These require a strong national marketing campaign and the cooperation of
bottlers in implementing the promotions across different territories.
Coke and Pepsi must determine how to coordinate the marketing and distribution functions
when there are important national and local components. Pepsi found that its national marketing
themes and campaigns often conflicted with those of local bottlers. In one instance, Pepsi
distributors promoted a real fruit display for Pepsi Slice while Pepsis national marketing
division was pushing an end-of-aisle display by offering VCRs to store managers. Neither
promotion was fully implemented, and Pepsi was left with a surplus of VCRs. The solution to
the coordination problem was simplePepsi bought out many of its bottlers and centralized its
marketing activities.

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