Case Cola Wars Continue

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Cola Wars Continue (Prof. David Yofffie, HBS):

Cola Wars Continue (Prof. David Yofffie, HBS) Case Discussion: July 20, 2011

Major Themes:

Major Themes Underlying economics of an industry: Relationship to profits Different stages of the value chain in an industry: Incentives for vertical integration How globalization can impact industry structure 7/20/2011 2 Session led by Prof. J.K.Mitra, FMS, Delhi

Opening Questions:

Opening Questions In such a profitable industry (see Exhibit 4) , why have so few firms successfully entered this business over the last century? Why haven’t other great marketing companies, such as P&G ( see Exhibit 9 ), been successful in launching competitive products? 7/20/2011 3 Session led by Prof. J.K.Mitra, FMS, Delhi

Slide 4:

What are the barriers to entry? 7/20/2011 4 Session led by Prof. J.K.Mitra, FMS, Delhi

First-mover Advantages :

First-mover Advantages • Brand equity : Cumulative spend on Ad. Brand identity over a long period. Part of American “culture” / World culture. • Limited shelf space , vending slots, and fountains: Much more costly than moving into open channels. • The franchise system : Bottling is very capital intensive, and bottlers have exclusive arrangements for colas ( 60% of CSD demand). It cost roughly $4 billion to $7.5 billion [100 plants X $40m-$75m per plant] to build national distribution ( p. 3 ). • Scale economies in advertising : Coke and Pepsi get much more “bang for the buck” for their core brands than smaller brands do. (From Exhibit 8 ) 7/20/2011 5 Session led by Prof. J.K.Mitra, FMS, Delhi

Question:

Question Weren’t there substitutes available? What did they cost? Why didn’t they have much of an effect on the price? 7/20/2011 6 Session led by Prof. J.K.Mitra, FMS, Delhi

Substitution:

Substitution Many substitutes: Water Coffee Fruit juice, etc Most of the substitutes are free, or much less costly per ml than CSDs. How do the soft drink companies get away with charging $1.00 for a product when the “healthy” substitute (tap water) is free? 7/20/2011 7 Session led by Prof. J.K.Mitra, FMS, Delhi

Substitutes:

Substitutes Not always conveniently available. In many cases, soft drinks are an impulse buy. Lifestyle choices: Coke and Pepsi have made their drinks represent a choice about how you live, not just how you quench your thirst. “Addiction” (especially to Coke): Half the consumption of Coke is reportedly consumed by people that drink an average of 8 cans per day! Americans drink more soft drinks than any other beverage by a huge margin ( Exhibit 1 ); and in some foreign countries, drinking Coke or Pepsi is a status symbol 7/20/2011 8 Session led by Prof. J.K.Mitra, FMS, Delhi

Suppliers:

Suppliers Do suppliers have any real power vis-à-vis the concentrate manufacturer? Who are they? What really goes into regular concentrate for Coca-Cola? • Not sugar (added by the bottler) • Not water (added by the bottler) • IT’S A SECRET! • NO ONE KNOWS? • How much do you think the ingredients cost? 7/20/2011 9 Session led by Prof. J.K.Mitra, FMS, Delhi

Buyers: Bottlers:

Buyers: Bottlers Bottlers have had very little power in the last 25 years, even when they were independent. Why? • High switching costs • Franchise agreements locked bottlers into exclusive deals Concentrate is 40% to 45% (p. 3) of COGS to the bottler, but CPs offer significant benefits: . buying power for cans, sugar, etc. .marketing, brand development, and product development Competitors are very concentrated and large, relative to the bottling network: Historically, Coke had 800 bottlers. 7/20/2011 10 Session led by Prof. J.K.Mitra, FMS, Delhi

Buyers: Final Customers:

Buyers: Final Customers Fragmented: Customers number in the billions! Price-sensitive, but susceptible to advertising No switching costs, but substitutes not always available 7/20/2011 11 Session led by Prof. J.K.Mitra, FMS, Delhi

Rivalry:

Rivalry How can companies make so much money in the middle of a “war”? Who has won the cola wars? Who has lost? Why? What have been the “weapons of war”? 7/20/2011 12 Session led by Prof. J.K.Mitra, FMS, Delhi

Rivalry: Structural Characteristics:

Rivalry: Structural Characteristics Two players, with a long history of interaction, dominate almost 75% of the market. The terms are clear and well defined; both have carefully avoided downward spiral seen in other competitive contexts. High degree of perceived differentiation 7/20/2011 13 Session led by Prof. J.K.Mitra, FMS, Delhi

Rivalry: Tools of War:

Rivalry: Tools of War “War” is measured one from the beginning: Prices on concentrate have not been affected since the early 1970s (Exhibit 5). Competition is focused largely on: Shelf space Lifestyle-based advertising and brand name Selective discounting on the downstream products (not on the upstream product) DSD BUT… NOT ON CONCENTRATE PRICES 7/20/2011 14 Session led by Prof. J.K.Mitra, FMS, Delhi

Rivalry:

Rivalry Why doesn’t the war escalate out of control? How do Coke and Pepsi keep the war “within bounds”? Opportunity for gaining advantage is very short-term Both are capable of quickly imitating each other on almost every dimension Efforts to escalate are simply met by imitation (Michael Jackson & Bill Cosby, FridgePack & FridgeMate; Kinley & Aquafina) ‘War’ is just to keep fizz and froth alive rather than to fight it out 7/20/2011 15 Session led by Prof. J.K.Mitra, FMS, Delhi

Who has been winning the war?:

Who has been winning the war? (Exhibit 2) 1950: Coke 47%, Pepsi 10% 1970: Coke 35%, Pepsi 20% 1980: Coke 36%, Pepsi 28% 1990: Coke 41%, Pepsi 32% 2000: Coke 44%, Pepsi 31.4, Cadbury Schweppes 14.7% 2006: Coke 43.1%, Pepsi 31.7%, Cadbury Schweppes 14.5% Initially (through the 1960s), Coke was the winner: • Extensive bottling franchise • Brand name Then Pepsi gained significant share 7/20/2011 16 Session led by Prof. J.K.Mitra, FMS, Delhi

Pepsi Strategy:

Pepsi Strategy Selective discounts in distribution outlets Targeted growing take-home market (i.e., contestable locations—supermarkets) Targeted younger consumers (“Pepsi Generation”) Motivated its bottlers (bottler size; concentrate pricing) Competed on package size and advertising, not price. Coke was focused on overseas markets, while Pepsi focused on the US grocery channel 7/20/2011 17 Session led by Prof. J.K.Mitra, FMS, Delhi

Who wins since Pepsi Challenge?:

Who wins since Pepsi Challenge? Both Coke and Pepsi! Increased share of total CSD market [ Although Coke’s cola share has actually declined; see Exhibit 2 ] Expanded primary demand for CSDs [ In the last five years, cola share declined, but CSD VOLUME has soared ]. Rising tide has lifted both boats! 7/20/2011 18 Session led by Prof. J.K.Mitra, FMS, Delhi

Who has been losing?:

Who has been losing? Smaller Brands Historically, they could piggyback on Coke and Pepsi’s bottler systems Historically, little head-to-head competition (classic niche/focus strategies) 1990s and after: Coke and Pepsi proliferate product Force head-to-head competition Coke and Pepsi fill shelf space, push small brands off the shelf Industry is consolidating; smaller brands sell to Cadbury 7/20/2011 19 Session led by Prof. J.K.Mitra, FMS, Delhi

Summary, so far:

Summary, so far Constrained competition High BTE Locked-in buyers Secret ingredients (low cost, hard to imitate) Lots of substitutes, but advertising and widespread distribution limit their impact In sum, a great business! 7/20/2011 20 Session led by Prof. J.K.Mitra, FMS, Delhi

BOTTLERS:

BOTTLERS How do the Economics of Bottlers differ from the economics of CPs? What was the logic of the franchise system? Why did Coke and Pepsi use exclusive (vs. non-exclusive) franchise agreements in the past? 7/20/2011 21 Session led by Prof. J.K.Mitra, FMS, Delhi

Bottling: Barriers to Entry:

Bottling: Barriers to Entry Exclusive franchises High capital investment in bottling and canning lines High investment in trucks, distribution centers Shelf space limited 7/20/2011 22 Session led by Prof. J.K.Mitra, FMS, Delhi

Open Question:

Open Question If you could be a bottler for Coke or Pepsi, would you rather have NYC or Oklahoma City as your territory? 7/20/2011 23 Session led by Prof. J.K.Mitra, FMS, Delhi

Buyers: Fountain:

Buyers: Fountain Large fountain accounts, such as McDonalds, have significant power: Fountains usually carry only one brand, so they can easily play dominant players off against each other Coke and Pepsi are strongly motivated to get fountain accounts, in order to build brand awareness. They don’t lower the price of concentrate; they simply “give back” money to the fountain in the form of promotions. 7/20/2011 24 Session led by Prof. J.K.Mitra, FMS, Delhi

Buyers: Vending:

Buyers: Vending Highly profitable for the bottler—why? ( Data in Exhibit 6 combine vending--the most profitable channel-- with fountain, the least profitable ). Machines are in hard-to-reach places, allowing for high retail prices. In general, single-serve channels are always more profitable, explains why the growing convenience/gas channel is very profitable for bottlers BTE/capital costs are high for vending machine The bottler shares the profit with the owner of the real estate 7/20/2011 25 Session led by Prof. J.K.Mitra, FMS, Delhi

Buyers: Supermarkets:

Buyers: Supermarkets For the supermarket, it is a high turn product—it draws in customer traffic. Not necessarily as price-sensitive as they are in other product categories Coke and Pepsi try to minimize supermarket power by offering more efficiency—i.e., product is delivered to the door, stocked for them. Compared with convenience stores, mass retailers, drug stores, etc supermarkets get some of the lowest prices ( Exhibit 6 ) and bottler margins are generally lower because of the supermarkets’ buying power and the competition for shelf space. 7/20/2011 26 Session led by Prof. J.K.Mitra, FMS, Delhi

Suppliers:

Suppliers Do they have power? CPs have significant power, But … Suppliers, such as can makers, are intrinsically weak (commodities), and Coke and Pepsi negotiate the contracts on bottlers’ behalf Even for suppliers with potentially strong bargaining positions, like Searle (maker of NutraSweet), CPs negotiate on bottlers’ behalf 7/20/2011 27 Session led by Prof. J.K.Mitra, FMS, Delhi

Substitutes for Bottlers:

Substitutes for Bottlers NONE ( except direct delivery to the fountain by the CP ) Warehouse delivery reduces some of the function of the bottler 7/20/2011 28 Session led by Prof. J.K.Mitra, FMS, Delhi

Rivalry:

Rivalry Other brands share the rivalry problems with Coke and Pepsi But … Geographic exclusivity limits the competition among bottlers. For CP producer, every sale (no matter how much it costs to deliver) is a profitable sale; for bottlers, the key is to find profitable sales (i.e., where sales and delivery do not eat all of their margin). If bottlers had non-exclusive territories, the tendency would be to expand geographically and go after the easy sales (vending, warehouses, etc.). But the CP wants exclusive franchises to force the bottler to saturate their territory : A bottler can only grow in this system if it increases saturation. 7/20/2011 29 Session led by Prof. J.K.Mitra, FMS, Delhi

Summary, so far:

Summary, so far Bottling is clearly much less profitable; most bottlers lost money in the 1990s. The keys are rivalry and suppliers: BTE—high Substitution—limited Rivalry—can be fierce in certain markets where Coke and Pepsi are fighting Suppliers—Coke and Pepsi appropriate most of the returns Buyers—vary with the distribution channel 7/20/2011 30 Session led by Prof. J.K.Mitra, FMS, Delhi

Transition:

Transition Coke and Pepsi have created a very profitable industry that has lasted more than a century. What are the likely challenges to the stability of the industry structure in the coming decade? What are the potential drivers of structural change? Globalization Demographics/flattening demand Non-CSD beverages 7/20/2011 31 Session led by Prof. J.K.Mitra, FMS, Delhi

Non-CSD beverage:

Non-CSD beverage Coke and Pepsi are attacking these categories themselves, each trying to become a “total beverage company.” Will this approach lead to brand dilution? Do CPs risk becoming a less profitable business if they do not extend the brand? No good answers yet to these questions: Pepsi, so far, has had more success and has been more aggressive with non-CSDs. 7/20/2011 32 Session led by Prof. J.K.Mitra, FMS, Delhi

Non-CSD beverage:

Non-CSD beverage The business model for non-CSDs is somewhat different from the classic CSD model (pp. 11-14) The supply chain and bottling requirements add complexity to the value chain, compared with the relatively simple CSD model. 7/20/2011 33 Session led by Prof. J.K.Mitra, FMS, Delhi

Non-CSD beverage:

Non-CSD beverage The basic principles of the business remain the same: Coke and Pepsi own the brand and control product development; Dedicated bottlers leverage economies of scope in distribution (selling to same outlet, same trucks). There are exceptions—e.g., Gatorade is delivery through food wholesalers. As niche products, non-CSDs carried prices and margins that are higher for everyone in the value chain. 7/20/2011 34 Session led by Prof. J.K.Mitra, FMS, Delhi

The Implications of Bottled Water:

The Implications of Bottled Water Will Coke and Pepsi be able to repeat their success with CSD in the water segment, or will a new competitive dynamic emerge? (page 14) 7/20/2011 35 Session led by Prof. J.K.Mitra, FMS, Delhi

Bottled Water:

Bottled Water Repeat of CSD New (less attractive) Industry Structure Economies of scale in advertising Hard to create brand loyalty Barriers to entry in distribution Highly fragmented, competitive structure Similar economics of concentrate firm High price sensitivity Little differentiation (e.g., taste) 7/20/2011 36 Session led by Prof. J.K.Mitra, FMS, Delhi

Bottled Water:

Bottled Water Unless Coke and Pepsi can generate brand loyalty and establish their brands, water is more likely to become a commodity-like product, where despite the scale and barriers in distribution, most of the profits will be extracted by the distribution channel (retailers) rather than by the concentrate companies or (especially) the bottlers. 7/20/2011 37 Session led by Prof. J.K.Mitra, FMS, Delhi

Summary of the Case:

Summary of the Case 1. One of the clearest examples on how firms can create and exercise market power. 2. To really understand the opportunities for strategy, we have to look at the underlying economics of the firm and the industry, and its related (upstream and downstream) parts. Without understanding the economics of the CP and bottler, we cannot understand the motivations and the likely success of moves like vertical integration. 7/20/2011 38 Session led by Prof. J.K.Mitra, FMS, Delhi

Summary:

Summary 3. Coke and Pepsi did not just inherit this business; they created it. Part of their on-going success will be a function of their ability to structure not only their businesses, but the industry as a whole ( In other words, industry structure is not always exogenous, it can be endogenous). 4. Coke and Pepsi are the classic case (no pun intended) of “smart” competitors: When they go to war, they kill the bystanders— not themselves. 7/20/2011 39 Session led by Prof. J.K.Mitra, FMS, Delhi

Thank You:

Thank You