1.

     Why, historically, has the soft drink industry been so profitable?

2.     Compare the economics of the concentrate business to that of the bottling
business: Why is the profitability so different?
3.     How has the competition between Coke and Pepsi affected the industry profits?
4.     How can Coke and Pepsi sustain their profits in the wake of flattening demand
and the growing popularity of non-CSDs?

Participants:

1. Concentrate Producers
2. Bottlers
3. Retailers
4. Suppliers

Important Timeline

1886:

Concentrate Business vs Bottling Business

Operating margins of Bottlers were about one-third of concentrate producers. (exhibit 4)

Insights:
1. Bottlers earn $0.06 per case more than the concentrate producer. However, operating
margin of bottler (8%) is one-fourth of the concentrate producers (32%).
2. Selling and Delivery is entirely the responsibility of Bottlers, taking away 18% of the revenue.

Concentrate Bottling
Capital Relatively little capital investment in Capital intensive, high speed production
Investment machinery, overhead or labour – $50 lines that are interchangeable only for
to $100 million to cover area as large products of similar type and packages of
as US similar size
Each line cost $4 to $10 million.
Each plant could cost hundreds of million of
dollars.
While handful of such plants could provide
enough capacity, both Coke and Pepsi had
around 100 plants for nationwide
distribution
Cost Drivers Advertising, promotion, market Concentrate, syrup, packaging, labour, OH
research, bottler support
Pricing Coke’s 1987 Master Bottler Contract: Coke
contracts had the right to determine concentrate
price and other terms of sale. Adjusted
prices according to changes in sweetener
prices.
Pepsi’s Master Bottling Agreement:
Granted bottlers perpetual rights to
distribute Pepsi’s CSD products but
required it to purchase raw materials from
Pepsi at prices, and on Terms and
conditions determined by Pepsi. Normally
 increased based on CPI. Concentrate
makers raised concentrate prices, often by
more than increase in inflation (graph)
Dependenc
y
1 )Why, historically, has the soft drink industry been so profitable?
Soft drink plays an important role in the people’s daily life. There is no doubt that this
industry is profitable. The soft drink can be found in everywhere in the world, and the
reasons of its high profit have several aspects.
The first aspect is a little capital investment and material cost. They include that
machinery, overhead, labor, and materials. The machinery, overhead, and labor are
the basic requirements and for soft drink industry, the levels of these conditions are
not very high. So the cost of those is low and reasonable. On the other hand, the
manufacturers add the concentrate flavors to the drink and improve people’s desire
for the soft drink. Of course, the concentrate flavors are not expensive, just like
caramel coloring, phosphoric or citric acid, natural flavors and caffeine.
What’s more, the marketing channels are increased in a way. People can buy the
soft drink in different channels, and they can enjoy the drink everywhere. For
example, they can buy them throughvending machines, in fast food chains, in
supermarkets or other restaurants. It is convenient for people to solve the thirsty
problem so that the soft drink manufacturer can get profits from it.
The last reason is that high consumption needs in the market. The manufacturers
increased the advertising budgets for a soft drink. It is easy for people to know that
what the soft drink is and the characters of soft drink. The soft drink became a
household word in people’s life, and everyone knows that they can try the drink with
low cost.  The increased sales volume makes the soft drink manufacturers get more
benefits from the marketing.
2) Compare the economics of the concentrate business to that of the bottling
business: Why is the profitability so different?
The reasons for the differences can be explained in these aspects: a barrier to entry;
substitutes; suppliers, buyers, rivals, etc. This question can be explained more
clearly through giving a metaphor between cola war and real war. In the army, some
troops’ position is at front-line, like sales in cola business. And other troops’ position
is at base or logistic line, like the concentrate business or bottling business in cola-
biz. The barrier to entry means quantity advantages and business secret in a way.
The barrier to entry is the key to deal with this problem. Another important reason is
business secret, the cola formula. Substitutes and rivals are the financial leverage.
So it is the second reason why the concentrate industry has higher profitability than
the bottling industry because of the interest expense which is from financial leverage.
Suppliers and buyers are duopoly and competition market. In conclusion, duopoly
even pure monopoly is a real dream for every firm or industry, just on profit margin
section. But for consumers, it is a real nightmare.
On the other hand, this question can be explained like this. Concentrate
manufacturers had supplier power: they could decide the price of sweeteners.
However, bottling manufacturers had the buyers’ poweron bargaining leverage.
Concentrate manufacturers still want bottling manufacturers to buy and carry their
product. Therefore, although concentrate manufacturers can decide some prices
about sweetener costs, they still had to make attractive prices for the bottling
manufacturers buy their product.
3) How has the competition between Coke and Pepsi affected the industry’s profits?
The war between the Coke and Pepsi adjusted operations or branding properly to
increase theefficiency of deliveries to markets. Advertising budgets increased
obviously. Initially, the budget was usedto sales and made Pepsi and Coke knew by
consumers, but now after the two giants established, the budgetallocation has
shifted to the branding and marketing. It affects sales directly because it influences
people tobuy the products.
Therefore, the effects can be summarized in three points. The first key point is
vertical integration. Concentrate producer to build a nationwide franchise bottling
network, Coke was the first mover and Pepsi followed it. New franchise agreements
allowed bottlers to handle the non-cola brands of other concentrate producers.
Bottlers could not carry directly competing for brands. The second point is the details
of effects on industry’s profits. Throughout the 1980s, the growth of Coke and Pepsi
put a squeeze on smaller concentrate producers. Shelf space for small brands
declined and shuffled from one owner to another. The third point is acquisition during
the Cola Wars. For example, in a five years period, Dr. Pepper was sold several
times, Canada Dry twice, Sunkist once, Shasta one, and A&W once. Phillip Morris
acquired Seven-UP in 1978 for a big premium, but racked up huge losses in the
early 1980s, and then left the CSD business in 1985.
4. Can Coke and Pepsi sustain their profits in the wake of flattening demand
and the growing popularity of on-CSDs?
There is no doubt that Coke and Pepsi can sustain their profits in the wake of
flattening demand and the growing popularity of on-CSDs. At first, they focus their
strength on the local market. They can improve recognition and brand awareness of
their products, pay attention to substantial managerial influence in bottling and the
distribution network by anchor bottling model and deepen their traditional products
as well as introduce a variety of new products. Secondly, the overseas expansion
also has an important position. Global soft drink sales growth slowed in the 2000s,
but emerging markets such as China, India were still growing rapidly. Therefore, the
Giants make a large investment overseas to develop new bottling plants,
constructing more distribution channels, sales and marketing efforts as well as
product research and development.
Please answer the question by using the above informations.
1) Why, historically, has the soft drink industry been so profitable?
2) Compare the economics of the concentrate business to that of the bottling
business: Why is the profitability so different?
3) How has the competition between Coke and Pepsi affected the industry’s profits?
4) Can Coke and Pepsi sustain their profits in the wake of flattening demand and the
growing popularity of non-CSDs?