Foundations of

Strategic Analysis
MGMT 420: Business Strategy | Week 2 | Cola Wars
Professor Jana Gallus

1
Tips for Wal-Mart memo
• Look at our Coors Quantitative Analysis
- Uploaded slides and a short memo on CCLE
- Remember lesson on how to scale

• Disaggregate cost drivers (what goes into COGS, etc.)

• Identify what is key; clearly and succinctly explain why and

how much it matters

• Clearly state assumptions; make your logic clear; avoid high-

level unsupported statements

• Grading criteria distributed via CCLE Announcement

2
 Course structure
2. Competitive
advantage

1. Foundations

3. Competitive 4. Corporate
dynamics strategy

3
“If you find yourself confronted with a
hard trade-off, you must have taken
some serious strategic missteps.”

True False

4
Sources of PPDs
Industry Analysis: understand why average profits are high in
some industries and low in others

Industry

Unexplained variation

Within industry
Year-to-year variation (“positioning”)

5
The CSD industry
• The average American consumes 

46 gallons (~174 liters) of carbonated
soft drinks a year (2009)
- 25% of their beverage consumption
(by volume)!

• Tap water?
- 32 gallons

• Next highest?
- Milk & beer: ~21 gallons each

• CP’s gross margin: 78%

- Operating margin: 32%

Beverage Marketing
6
Corporation
But problems loom…
“Several times a year a weighty and serious investor
looks with profound respect at Coca-Cola’s record,
but comes regretfully to the conclusion that he is too
late. The specter of saturation and competition rise
before him.”
– Fortune magazine
Nov, 1938

7
 Why has no other company
succeeded in the U.S. CSD market?

8
What do you think of when you
think of Coca-Cola?

9
10
11
Last entrants?

12
Here comes Richard again

13
Brand

Combines Richard Branson’s Leverages Red Bull’s brand

marketing savvy and Cott’s image, product capabilities and
distribution expertise supplier relationships

14
Recipes are closely guarded
• Coca Cola kept recipe in a SunTrust Bank Vault
until 2011, and then moved it into a vault at its
corporate headquarters in Atlanta.

• Coca Cola employee tried to sell a formula for a

new drink to Pepsi for $1.5 m, and became subject
to an FBI sting. Sentenced to 8 years in jail.

15
Recipes are closely guarded

16
The Pepsi Challenge

17
Blind tasting challenge

36% identify as
Coke

35% identify as 39% identify as

Coke Coke
18
Learning goals

1. Understand industry Value Chain

• Who are the important players?
• What activities do we want to engage in?

2. Learn about and conduct an industry analysis

• Who captures value in the CSD industry?
• What are some of the main lessons from industry
analysis?

19
 CSD Industry Value Chain [10’]
Raw materials Manufacturing Packaging Distribution Marketing/Sales

20
 Industry Value Chain

Raw materials Manufacturing Packaging Distribution Marketing/Sales

Aluminum, Supermarkets
Plastic
Cans,

Bottles Conv. stores
Sugar, 

Corn syrup
Restaurants
Bottler End consumer
Water
Warehouse
Concentrate
Aspartame clubs
production
Cinnamon, Vending
Lemon oil, etc. machines

Media/non-
point of sale
21
CP vs. bottler economics

CP Bo%ler
$/case % of sales $/case % of sales
Net sales $0.98 100% $4.63 100%
COGS $0.22 22% $2.67 58%
Gross profit $0.76 78% $1.97 42%
Direct markeBng $0.21 21% $0.45 10%
Selling & delivery $0.00 0% $0.85 18%
G&A $0.24 25% $0.31 6%
OperaBng income $0.30 32% $0.36 8%

22
CP vs. bottler economics
• Bottlers do the hard work
- Capital intensive bottling
- Costly logistics and distribution

• But….
- CPs negotiate with some suppliers
- CPs advertise heavily, and don’t pass on the entire
cost to bottlers
- CPs financially helped and eventually bailed out
struggling bottlers
- Bottlers are given an exclusive territory

23
Which territory do you prefer?

Manhattan

Oklahoma

24
Do CPs act nice to bottlers?
• CPs negotiate with artificial sweetener companies
- Aspartame was under patent until 1992
- Searle could greatly increase product costs if it priced like a monopoly

• CPs advertise heavily, and don’t pass on the entire cost to bottlers
- Why are they passing on any of the cost?
- Bottlers have little say over the ads

• CPs financially helped and eventually bailed out struggling bottlers

- Coca-Cola bought its bottlers for $2.4 billion; CCE later worth $12 billion
- 70% higher return than investing in DJIA

• Bottlers are given an exclusive territory

- To force them to saturate their territory

25
Any questions so far?

26
Learning goals

1. Understand industry Value Chain

• Who are the important players?
• What activities do we want to engage in?

2. Learn about and conduct an industry analysis

• Who captures value in the CSD industry?
• What are some of the main lessons from industry
analysis?

27
Forces driving industry competition
Threat of
new entrants

BARRIERS TO
ENTRY

MARKET
COMPETITORS

SUPPLIERS BUYERS

Bargaining power
 Rivalry among Bargaining power


of suppliers existing firms of customers

SUBSTITUTES

Threat of substitute

products/services Source: Porter (1980) 28
Forces driving industry competition
Threat of
new entrants

BARRIERS TO
ENTRY

MARKET
COMPETITORS

SUPPLIERS BUYERS

Bargaining power
 Rivalry among Bargaining power


of suppliers existing firms of customers

SUBSTITUTES

Threat of substitute

products/services Source: Porter (1980) 29
Industry analysis
Helps us understand how value created by an industry is
distributed among players within the industry

Profits are the function of:

• The amount of value created, PIE
- Consumers’ WTP minus suppliers’ WTS
• The proportion of the value created that is captured by
- Competitors (i.e., rivals)
- Potential competitors (i.e., entrants)
- Other players in supply chain (suppliers & buyers)
- Substitutes

30
Value creation and the PIE
Willingness to pay The max. amount of money that you can extract
from your customers before they walk away

Total value created by company

Potential Industry Earnings (PIE) = ∑ of total

value created across all industry competitors

The min. you can pay your suppliers before

Willingness to supply they walk away
31
PIE splitting
• Rivals
- Will competition between rivals ↓P & hence value capture?

• Entry
- Will new entrants rush into the market?

• Substitutes
- Will consumers switch to substitutes that offer more value?
How do consumers think about value?
- Consumer surplus, WTP-P

• Suppliers and Buyers

- Will powerful suppliers or buyers extract value?
- Suppliers try to ↑C; buyers try to ↓P
32
 Where we see the 5 forces
Willingness to pay

Consumer
surplus
Substitutes
Price Rivalry, Entry, Buyer power
Firm profit

Total Cost
Organizational
cost
Input Cost Supplier power
Supplier
surplus

Willingness to supply
33
“Industry Analysis is a core
strategic framework, helping us
analyze value creation.”

True
False

34
Any questions so far?

35
CSD Industry Analysis [10’]

• Who are the relevant players?

• How powerful is each “force”? WHY?

Feel free to use your workspace again; just add a slide

36
Which force is most threatening?

Suppliers Entrants
Rivals Substitutes
Buyers The Dark Side

37
Rivalry

38
Rivalry: 

Coke & Pepsi compete fiercely!

• Suits & countersuits

• “Beat Coke” (Steele)

• Pepsi Challenge

39
Pepsi Challenge … gone global

Vice President Nixon with Soviet Premier Khrushchev (left)

40
 Rivalry: 

Coke & Pepsi compete fiercely!

• Competition for national fountain accounts

- Pepsi acquires Pizza Hut (1978), Taco Bell (1986), KFC (1986)
– later spun off, but retained pouring rights
- Coke gets Wendy’s & Burger King to switch; also has
McDonald’s (the largest account i.t.o. sales)
- 2004: Coke wins over Subway (largest i.t.o. outlets); Pepsi
grabs Quiznos

41
Arms race
Coke
• Fanta, Sprite & Tab by 1963
• 11 new products in ‘80s
• Launches Powerade in 1988
• Allows bottlers to add
sweeteners in 1979
• Moves from sugar to corn
syrup in 1980
• Hires Bill Cosby, Aretha
Franklin & Kobe Bryant
• Consolidates bottlers in ‘80s
Pepsi
• Teem, Mountain Dew & Diet
Pepsi by 1964
• 13 new products in ‘80s
• Buys Gatorade in 1990
• Allows bottlers to add
sweeteners in ‘70s
• Moves from sugar to corn
syrup in 1983
• Hires Michael Jackson, Ray
Charles & Drew Brees
• Consolidates bottlers in 1980
42
Rivalry: 

Coke & Pepsi compete fiercely!
• Brand proliferation and advertising
• Taste
• Bottler network
• Shelf space and national fountain accounts

What is missing?
• They don’t compete on price! “Soft rivalry”
- Concentrate P increased by 3.6% p.a., CPI: 2.9%
(1988-2009)

43
The bloodless cola wars
• Despite the appearance
of fierce rivalry between
Coke and Pepsi, the
truth is that concentrate
prices have grown
faster than the CPI for
decades

• The competition that

does occur is largely
NOT about price, which
allows for sustained
profits for both firms

44
 Bain study for Pepsi (mid 1990's)

Market share

• Pepsi hired Bain and asked: 


How can we overtake Coke?

• Bain: cut price, become #1, and

raise prices again later

• Roger Enrico: “We don’t

compete on price. Period.”

45
 “Without Coke, Pepsi would have a hard
time being an original and lively competitor. The
more successful they are, the sharper we have
to be. If the Coca-Cola company didn’t exist,
we’d pray for someone to invent them. On the
other side of the fence…. Nothing contributes
as much to the present-day success of the
Coca-Cola company than Pepsi.”
–– Roger Enrico, former CEO of Pepsi

46
To this day, a content #2
U.S. CSD companies, by volume share

Nov 26, 2020, Statista 47

Take-away

Coke and Pepsi have found a way to

compete on value created (through
changes in WTP-C), and not on value
captured (through Price).

48
Structural factors increasing rivalry
• Market characteristics
- Greater number of competitors
- Slow industry growth
• Customer and product attributes
- Low taste heterogeneity
- Little ability to differentiate products
- Perishable products
• Production economics
- Low capacity utilization
- High fixed costs, low variable costs
49
Fixed Costs and Variable Costs
• FC: costs you must incur
regardless of production quantity
Average price for Lamictal generics
• VC: costs that you incur as you
produce additional units
• When FC are high, there is an
incentive to sell a lot to spread
those costs over a larger base
• When VC are low, incremental
sales are profitable even at very
low prices
Example: generic prescription drugs. Large
➡ Both tend to push firms to FC to set up the production line, each
compete strongly on price additional pill costs pennies. (+ No
differentiation & many firms)

50
• Prices dropped from $1.50 to $0.75

51
Break
[15 min.]

52
Coca-Cola and Pepsi mostly
compete on

Price
WTP–Cost

53
Forces driving industry competition
Threat of
new entrants

BARRIERS TO
ENTRY

MARKET
COMPETITORS

SUPPLIERS BUYERS

Bargaining power
 Rivalry among Bargaining power


of suppliers existing firms of customers

SUBSTITUTES

Threat of substitute

products/services Source: Porter (1980) 54
Barriers to Entry (BTE)

55
 Industry Value Chain

Raw materials Manufacturing Packaging Distribution Marketing/Sales

Aluminum, Supermarkets
Plastic
Cans,

Bottles Conv. stores
Sugar, 

Corn syrup
Restaurants
Bottler End consumer
Water
Warehouse
Concentrate
Aspartame clubs
production
Cinnamon, Vending
Lemon oil, etc. machines

Media/non-
point of sale
56
 Barriers to Entry

Raw materials Manufacturing Packaging Distribution Marketing/Sales

Aluminum, Supermarkets
Plastic
Cans,

Bottles Conv. stores
Sugar, 

Corn syrup
Restaurants
Bottler End consumer
Water
Warehouse
Concentrate
Aspartame clubs
production
Cinnamon, Vending
Lemon oil, etc. machines

Media/non-
point of sale
57
Advertising effectiveness
• Millions of advertising per point of market share
- Coke: $15.3 ($234m for 15.3% market share)
- Pepsi: $15.5
- Dr. Pepper: $18.5
- RedBull Cola: $145
- Virgin Cola: $578

• Cumulative investment in brand equity over long

period of time

58
EOS in advertising

Source: Grant (2010). Contemporary Strategy Analysis 59

Importance of MES and AC
Cost p. unit of output (AC)

MES
 MES with

without advertising
advertising

Units of output per period

60
Advertising effectiveness
• Millions of advertising per point of market share
- Coke: $15.3 ($234m for 15.3% market share)
- Pepsi: $15.5
- Dr. Pepper: $18.5; RedBull Cola: $145; Virgin Cola: $578

• Cumulative investment in brand equity over long-term

• Advertising is a barrier to entry

- Note: it also reduces rivalry! Increases differentiation

• Those Pepsi ads making fun of Coke…

… are GOOD for Coke
61
Brand investments…

• Increase costs
• Raise barriers to entry
• Increase differentiation
• All of the above

62
Barriers to entry (BTE)
BTE ensure competitors cannot enter and lower P; they include:
• Economics
- Economies of Scale, MES
- Network effects
- Capital requirements
- Learning/experience curve in production
• Product differences
- Brand
• Legal/contractual
- Patents or trade secrets

63
 

The secret formula of Coca-Cola
“The most famous trade secret in history”


64
65
The Coca Cola recipe!

66
DIY

67
Barriers to entry (BTE)
BTE ensure competitors cannot enter and lower P; they include:
• Economics
- Economies of Scale, MES
- Network effects
- Capital requirements
- Learning/experience curve in production
• Product differences
- Brand
• Legal/contractual
- Patents or trade secrets
- Supplier or distributor agreements
68
How feasible is entry?

69
Vending machines (UCLA)

70
 “If you gave me $100 billion and said, 

‘Start a company that could take over
leadership in soft drinks from Coke,’ I’d give it
back to you and say, ‘It can’t be done.’”

“I’ve never sold a share of my Coca-Cola stock.

And I likely never will.”
–Warren Buffett
(Caveat: Buffett is a major investor in Coke, and therefore has a vested
interest in people thinking that the barriers to entry are insurmountable)

71
72
 “The biggest threat to Coke’s existence during
my entire tenure as CEO has been…
… McDonald’s informing me that they planned
to launch their own cola and sell it in their
restaurants.”

–– Roberto Goizueta in 1995, CEO of The Coca-Cola Company (1980-1997)

73
 Barriers to Entry

Raw materials Manufacturing Packaging Distribution Marketing/Sales

Aluminum, Supermarkets
Plastic
Cans,

Bottles Conv. stores
Sugar, 

Corn syrup
Restaurants
Bottler End consumer
Water
Warehouse
Concentrate
Aspartame clubs
production
Cinnamon, Vending
Lemon oil, etc. machines

Media/non-
point of sale
74
Questions?

75
Other Buyers?
Which ones?
How powerful?

76
Buyer power: Bottlers
Share of value captured by buyers is influenced by:
• Number and concentration of buyers
• Ease of switching (incl. brand loyalty)
• Buyers’ ability to backward integrate
• Relative price of good compared to buyer’s total
spending

✦ Coke and Pepsi make their bottlers sign exclusive

contracts, and do not allow them to advertise or
otherwise differentiate

77
Pricing and volume changes
1988-2009
Raw change CAGR
Retail price per
-$2.8 -1.40%
case (infl. adj.)
Concentrate price
$0.86 3.60%
per case
Volume 

2.02 1.20%
(billion cases)
Consumption
5.7 0.60%
(gallons/capita)
CPI 2.90%

78
Buyer power: Consumers
Amount of value captured by consumers is influenced by:
• Number and concentration of buyers
- Very fragmented! (In the billions, worldwide)
• Ease of switching (incl. degree of brand loyalty)
- High degree of loyalty
• Buyers’ ability to backward integrate
- Zero chance
• Relative price of good compared to a buyer’s total
spending
- Very small part of spending; low price sensitivity

✦ Coke & Pepsi give almost no power to buyers

79
Suppliers

80
Supplier power
Mirror image of buyer power

Share of value captured by suppliers:

• Number and concentration of suppliers
• Degree to which suppliers provide commodity 

vs. custom inputs (differentiation)
• Availability of substitute inputs
• Ease of switching
• Suppliers’ ability to forward integrate

81
Supplier power
Mirror image of buyer power

Share of value captured by suppliers:

• Number and concentration of suppliers
• Degree to which suppliers provide commodity
vs. custom inputs (differentiation)
• Availability of substitute inputs
• Ease of switching
• Suppliers’ ability to forward integrate

82
Substitutes

83
Source: Statista, Nov 25, 2020 84
Threat of substitutes
Leakage of demand to substitutes is more likely when:
• Price elasticity of demand is greater
• Products are more similar (characteristics, availability, etc.)
• Higher velocity industries
- Higher rate of technological change, allowing previously
“different” products to converge in capabilities
- Higher rate of change in consumer tastes

✦ Substitutes usually attack “from below”

85
Availability & product proliferation

86
Concentration of profits
• In B2B settings, 80% of profits typically come from
20% of customers
- Not as true in consumer markets

• But half of Coke’s & Pepsi’s sales come from 2% of

consumers
- … who drink 8 cans a day or more
- Addictive product → reduces threat of substitutes

• Note: advertising also helps reduce substitution

threat, as does availability (“impulse” buying)
87
In sum

88
 Porter’s Five Forces summary slide
Threat of new entrants
• Economies of scale • Capital requirements
• Proprietary product differences • Access to distribution
Bargaining power • Brand identity • Network effects
Bargaining power
of suppliers • Switching costs • Government policy of customers
• Input differentiation • Absolute cost advantages • Expected retaliation • Buyer
• Switching costs concentration
• Absence of • Buyer volume
substitute inputs Rivalry among existing competitors • Switching costs
• Supplier • Switching costs • Industry growth • Buyer information
concentration • Concentration & balance • FC / value added • Ability to integrate
• Importance of • Informational complexity • Overcapacity backward
volume to supplier • Diversity of competitors • Product differences • Substitute products
• Cost relative to • Corporate stakes • Brand identity • P / total purchases
total purchases • Exit barriers • Perishable product • Undifferentiated
• Impact of inputs on product
cost or • Brand identity
differentiation • Low impact on
• Threat of forward Threat of substitutes quality / perform.
integration • Relative price performance of substitutes • Low buyer profits
• Switching costs
• Buyer propensity to substitute

Source: Porter (1985). Competitive Advantage. New York: Free Press. 89

Questions?

90
Industry analysis: In practice
1. Be clear about industry definition
- Industry boundaries are often fuzzy
- Rule of thumb: Include “close” substitutes to a product,
exclude more distant substitutes
- There is no “right” definition
- Adopt the definition that is most useful for clarifying
the strategic question at hand
- A more expansive industry definition simply turns
producers of substitutes into rivals, and vice versa
- Don’t confuse companies w/ industries (many firms
compete in multiple industries; a single firm can also
play multiple roles) 91
Industry analysis: In practice
2. Distinguish between structure and conduct
- The structure of an industry determines likely
outcomes, but different behaviors are possible
- Consider rivalry:
- Usually, more rivals implies there is a higher
likelihood of strong competition
- But a lot hinges on how intensely rivals compete,
and along which dimensions (e.g., price vs. R&D)
- Even a duopoly can be unattractive
- An attractive industry can be destroyed quickly
if rivalry heats up
92
Industry analysis: In practice
3. Beware pitfalls of causal interpretation
- E.g.: “There isn’t any entry, so BTE must be high”
- Lack of entry into an industry could mean
- BTE are high
- Low PIE, high supplier power, and/or high
rivalry make the industry unattractive
➡ Just because firms do not enter does not mean
they cannot enter!

93
Industry analysis: In practice
4. Overall assessment of industry attractiveness
- Requires that one synthesize the lessons
regarding value creation and value capture
- No ready formula
- One strong force can destroy profitability
- Comfort with ambiguity

94
 Five Forces in CSD industry
Threat of new entrants
• Brand identity & lack of shelf space present
Bargaining power Bargaining power
major BTE
of suppliers of buyers

• Perception of • Fragmented
“secret • Exclusive
product” Rivalry among existing competitors territories
• Commoditized • Perceived differentiation
inputs • Heavy competition on advertising,
brand positioning, sub-brands, etc.
• BUT little price competition

Threat of substitutes
• CSDs highly accessible • Govt regulation
• CSDs “addictive”

Source: Porter (1985). Competitive Advantage. New York: Free Press. 95

Coca Cola’s Strategy
Coca Cola has the leading global brand for
carbonated soft drinks, which it uses to differentiate
itself both from competitors (to avoid price
competition) and potential entrants (to forestall entry),
and outsources the difficult, low value-added parts of
the Value Chain to third-parties.

96
97
Learning outcomes
• Industry Value Chain shows who are the important
players and which are the high-value-added activities

• Industry analysis is the starting point for

understanding a firm’s current position
- Explains the PIE split between customers, rivals
and suppliers (value capture)
- Useful to predict leakage of value

• Lesson: Focus on value adding activities and never

cut price if you can avoid it!

98
Your levers as a strategist?

WTP

Price
Cutting Price is not strategic!
It does not create value
Cost

WTS

99
Dec. 27, 2019 100
Sources of PPDs
Industry Analysis: understand why average profits are high in
some industries and low in others
Industry

Unexplained variation

Within industry
Year-to-year variation (“positioning”)

Competitive Advantage (next 2 weeks): understand

differences in profitability across companies within an industry 101
What is strategy?
Internal choices
Job 2: configure all of a firm’s
internal choices for alignment

A strategy is an integrated set of choices that

positions a firm in its industry so as to generate
superior financial returns over the long run.

External environment Competitive dynamics

Job 1: position the firm in Job 3: manage interactions with
the external environment for other players to sustain
success advantage over time

102
Discussion

103
Which “force” is the most threatening?

Substitutes

104
How often do you drink CSDs?

Never
Once a month
Once a week
Daily

105
How often do you usually* buy
bottled water?
Never
Once a month
Once a week
Daily

* think pre-pandemic 106

 “The drop in soda consumption represents the single largest
change in the American diet in the last decade.”
–The Upshot (2015)

Ruth Fremson/The New York Times

107
One response 

(in this case to UK sugar tax, 2018)

“We have no plans to change

the recipe of Coca-Cola
Classic …”

“People love the taste ... and

have told us not to change.”

108
Response
• Bought biggest bottlers –> control over Value Chain
- Coke announced refranchising & 10-year contracts
• Increased marketing efforts of CSDs
• Global markets (status symbol)
- But bottlers in other markets fight back (Indian
bottlers form cooperative, 3 largest Kenyan bottlers
merge, Mexican bottlers switch allegiance)
• Innovation (e.g., custom beverages, alternative
sweeteners, new/smaller packaging)
• Cost cutting, efficiency gains

109
 Can Pepsi and Coke
repeat their success w/
CSDs in non-CSDs?

How do the industries

compare?

Indra Nooyi, CEO of PepsiCo 110

Non-CSD industry
Similar to CSDs
• BTE
• EOS in advertising
• Distribution network
• Shelf space
• Rivalry
• Perceived differentiation
among premium brands?
• Suppliers
• Commoditized inputs
• Buyers (bottlers)
• Even weaker
Less attractive industry structure
• Lower BTE
• Lower switching costs/loyalty
• Lower volume and capital requirements
• Rivalry
• Highly fragmented, competitive structure
• Private-labeled, cheaper bottled water/juices
• Buyer power (consumers)
• Hard to create brand loyalty (e.g., Dasani) or
differentiation (try packaging, marketing)
• Higher price-sensitivity
• Substitute products (e.g., tap water)
• Not addictive (it’s bottled water, after all)
111
Total beverage companies
Different business model
• Supply chain & bottling requirements add complexity
• Non-CSDs sell in lower volumes
• Bottlers struggle even more
- Lose out on manufacturing profit (non-CSDs are
produced by Coke/Pepsi)
- Higher operating costs (e.g., due to larger # of stock-
keeping units and lower volume)
- Retailers (now even more consolidated –> higher
pricing power) want to negotiate directly with CPs

112