Ezinne Onyearugha MGMT 574

Will Coke sustain its profits through the next decade? The Coca-Cola Company has built the most successful brand ever. In 2005, the world consumed approximately 115 billion litres of Cokes products. The Coca-Cola brands account for 55% of the companys sales. Both concentrate producers (CP) and bottlers are profitable. These two parts of the industry are extremely interdependent, sharing costs in procurement, production, marketing and distribution. Many of their functions overlap; for instance, CPs do the bottling, and bottlers conduct many promotional activities. The industry is already vertically integrated to some extent. They also deal with similar suppliers and buyers. Entry into the industry would involve developing operations in either or both disciplines. Beverage substitutes would threaten both CPs and their associated bottlers. Because of operational overlap and similarities in their market environment, we can include both CPs and bottlers in our definition of the soft drink industry. Rivalry: Revenues are extremely concentrated in this industry, with Coke and Pepsi, together with their associated bottlers, commanding 73% of the case market. In fact, one could characterize the soft drink market as an oligopoly, or even a duopoly between Coke and Pepsi, resulting in positive economic profits. To be sure, there was tough competition between Coke and Pepsi for market share, and this occasionally hampered profitability. Substitutes: Through the early 1960s, soft drinks were synonymous with colas in the mind of consumers. Over time, however, other beverages, from bottled water to teas, became more popular, especially in the 1980s and 1990s. Coke and Pepsi responded by expanding their offerings, through alliances (e.g. Coke and Nestea), acquisitions (e.g. Coke and Minute Maid), and internal product innovation (e.g. Pepsi creating Orange Slice), capturing the value of

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increasingly popular substitutes internally. Proliferation in the number of brands did threaten the profitability of bottlers through 1986, as they more frequent line set-ups, increased capital investment, and development of special management skills for more complex manufacturing operations and distribution. Bottlers were able to overcome these operational challenges through consolidation to achieve economies of scale. Overall, because of the CPs efforts in diversification, however, substitutes became less of a threat. Power of Suppliers: The inputs for Coke and Pepsis products were primarily sugar and packaging. Sugar could be purchased from many sources on the open market, and if sugar became too expensive, the firms could easily switch to corn syrup, as they did in the early 1980s. Therefore, suppliers of nutritive sweeteners did not have much bargaining power against Coke, Pepsi, or their bottlers. Power of Buyers: The soft drink industry sold to consumers through five principal channels: food stores, convenience and gas, fountain, vending, and mass merchandisers. Supermarkets, the principal customer for soft drink makers, were a highly fragmented industry. The stores counted on soft drinks to generate consumer traffic, so they needed Coke and Pepsi products. But due to their tremendous degree of fragmentation (the biggest chain made up 6% of food retail sales, and the largest chains controlled up to 25% of a region), these stores did not have much bargaining power. Their only power was control over premium shelf space, which could be allocated to Coke or Pepsi products. This power did give them some control over soft drink profitability. Furthermore, consumers expected to pay less through this channel, so prices were lower, resulting in somewhat lower profitability. National mass merchandising chains such as WalMart, on the other hand, had much more bargaining power. While these stores did carry both Coke and Pepsi products, they could negotiate more effectively due to their scale and the

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magnitude of their contracts. For this reason, the mass merchandiser channel was relatively less profitable for soft drink makers. Through other markets, however, the industry enjoyed substantial profitability because of limited buyer power. Barriers of Entry: It would be nearly impossible for either a new CP or a new bottler to enter the industry. New CPs would need to overcome the tremendous marketing muscle and market presence of Coke, Pepsi, and a few others, who had established brand names that were as much as a century old. Through their DSD practices, these companies had intimate relationships with their retail channels and would be able to defend their positions effectively through discounting or other tactics. So, although the CP industry is not very capital intensive, other barriers would prevent entry. Entering bottling, meanwhile, would require substantial capital investment, which would deter entry. Further complicating entry into this market, existing bottlers had exclusive territories in which to distribute their products. An industry analysis by Porters Five Forces reveals that the soft drink industry was favorable for positive economic profitability, as evidenced in companies financial outcomes. Brand building is Coca-Cola's core competency. Coca-Cola is known throughout the world. Their image is respectable and dependable, which took them years to build. From generation to generation, Coca-Cola has been one of the most popular soft drinks available. Not only is it a favorite among many individuals, but it has become a household name. Their brand and logo are never mistaken, which is why consumers feel comfortable in purchasing Coca-Cola products. This core competency is certainly hard to imitate. In recent years, however, growth has slowed. Historically, Coke has been accustomed to growth rates of 10% per year, but in 2004 and 2005 volume growth has averaged only 3% per year.

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There are three main reasons that Cokes growth has slowed down. First of all, in North America, Cokes penetration in the soft drink market is so high that there is little room for growth; secondly, increasing concerns over obesity have caused some people to switch to noncarbonated drinks and finally the demand for carbonated drinks elasticity which leads to lower price variation. The question is what Coke can do to sustain its profits over the next decade. The Coca-Cola Company can restore its growth rate to previous levels with three main thrusts which are expansion in the non-carbonated drinks markets, practicing game theory to better understand their competitive market environment and expanding its sales in international markets. The Coca-Cola Company itself doesnt carry out the bottling function. Rather, Coke sells its flavored concentrate mixture to bottlers, who then combine the concentrate with water and sweetener, before bottling or canning it. Each bottler has the exclusive distribution rights to a particular territory. The Coca-Cola Company partially owns most of its bottlers, but in most cases holds less that 50% of the voting shares on the bottler companies. The Coca-Cola Company itself focuses its efforts primarily on brand development, market research, promotion and bottler relations. The bottlers pay a portion of those costs, but benefit enormously from Cokes branding as well as from Cokes assistance in local promotions and advice on marketing methods. Coke regards China as a market that provides much potential for growth. China has a population of 1.2 billion people, and is growing increasingly affluent, though its average income per capita is still $6,800. The average Chinese person consumes only 22 eight ounce cans of soft drinks per

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year since they lean towards juices instead. In contrast, the average American consumes the equivalent of 874 cans. The other big source of growth potential is in the area of non-carbonated drinks. Coke lags behind Pepsi in all the key non-carbonated drink markets. Tropicana (owned by Pepsi) leads Minute Made (owned by Coke) in the juice market, Lipton (Pepsi) leads Nestea (Coke) in the iced tea market, Gatorade (Pepsi) leads PowerAde (Coke) in the sports drink market, and Aquafina (Pepsi) leads Dasani (Coke) in the bottled water market. The bottled water market has grown especially quickly in recent years. But in the last few decades some drink types have seen sales surge and then recede. The bottling of non-carbonated drinks has typically been done by The Coca-Cola Company itself or by independent companies, not by Cokes soft-drink bottlers.

Potential Competitors: Companies that have a door to door distribution channel in place like snack companies could choose to diversify into soda industry. Switching costs are low for consumers who risk very little by trying new brands or beverages. Barriers to entry are relatively high, though, with large advertising budgets and competitive brand loyalty to big players like Coca-Cola and Pepsi. The drinks with high growth and high hype are non-carbonated beverages such as juice drinks, sports drinks, tea-based drinks, dairy-based drinks, and especially bottled water The Bargaining Power of Suppliers: Concentrate producers (CPs) negotiate directly with bottlers major suppliers ,particularly sweetener and packaging suppliers, to encourage reliable supply, faster delivery, and lower prices. Coca-Cola and Pepsi are among the metal can industrys largest customers and maintain relationships with more than one supplier, giving these suppliers less bargaining power due to the availability of alternative suppliers. Metal cans make up the majority of the bottlers packaged product (60%), followed by plastic bottles (38%) and glass bottles (2%) The Bargaining Power of Buyers: Bottlers own a manufacturing and sales operation in an exclusive geographic territory, with rights granted in perpetuity by the franchiser, subject to termination only in the event of default by the

Ezinne Onyearugha MGMT 574 bottler. 1980 Soft Drink Interbrand Competition Act preserved the right of CPs to grant exclusive territories to their bottlers, giving less bargaining power to Bottlers buyers because there is no alternative supplier. Bottlers are locked into contracts that grant CPs the right to set prices and other terms of sale. Bottlers are allowed to handle the non-cola brands of other Cps at their discretion. Bottlers are also given freedom in choosing whether or not to carry new beverages introduced by the CPs but cannot carry directly competitive brands. Competition for brand shelf space in retail channels gives some bargaining power back to buyers Threat of Substitute Products: Threat from substitute products are probably second in importance to the cola industry only to the rivalry among established firms: coffee cafes, tap water, milkshakes, fruit juice, hot tea, hot chocolate, chocolate milk and so on Rivalry Among Established Companies: Industry is largely consolidated with two major players and a few smaller competitors like Cadbury Schweppes, making the companies interdependent. International demand for carbonated soft drinks is growing, but domestic demand is slowing down substantially. Exit barriers are high for bottlers with expensive equipment, moderate for concentrate producers. Advertising budgets are high, customers are influenced by brand perceptions