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[Profitability for Soft Drinks]

Five forces model Analysis

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Table of Contents

Profitability of the Soft Drink Industry .......................................................................................................... 3

Economics of the Concentrate Business VS Bottling Business ..................................................................... 4

Impact of Coke & Pepsi on Industry Profits .................................................................................................. 5

Profit Sustainability ....................................................................................................................................... 6

Distinctive Competence ................................................................................................................................ 6

Conclusion ..................................................................................................................................................... 7

References .................................................................................................................................................... 8

Appendix 1 .................................................................................................................................................... 9

Appendix 2 (Exhibit 4; Case) ....................................................................................................................... 10



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Profitability of the Soft Drink Industry

Michael Porter’s Five Forces Model (Appendix 1) defines and analyzes an industry in terms of

five main factors. These, according to him determine the attractiveness of an industry for an

outsider.

In the soft drinks industry, the competitive rivalry between the firms is extremely fierce. The

most explicit evidence to this fact has been witness by the industry when both Pepsi and Coca

Cola launched aggressive responses to each other’s marketing and sales efforts not letting

smaller brands survive either. However, because the ultimate leading powers were Pepsi and

Coke only, the profits in the industry became and still are highly concentrated making the

industry a perfect example of a duopoly. Due to the same reason, while there aren’t any barriers

to entry as such, the dominance of these two brands through their high brand equity makes it an

extremely risky industry to enter unless the entrant can offer and prove to be the provider of an

innovative, better product that can sustain profits in their presence. As a result, not many

initiators can stand the competition they may anticipate and the threat of new entrants is

therefore very low. The attractiveness, however, is still questionable for any entrant considering

this factor additionally because the most major bottling and distribution networks operate in

collaboration with these two giants.

The threat of substitutes essentially does exist in the soft drinks industry primarily due to the

increasing introduction of juices, energy drinks, tea and coffee drinks. This is in addition to the

rising inclination of the consumer towards ‘safe’ drinks in response to concern for increasing

obesity amongst the consumers. However, the introduction of such products by both Pepsi and

Coke reduced this threat for them but majorly posed it against the profits of the bottlers which

had to increase capital investment for their production. The issue however, was overcome by

way of consolidation of the independent bottlers resulting in economies of scale advantage.

Both Coke & Pepsi have been a source of drawing clientele for the retail outlets. Consequently,

even in the wake of competition for shelf space, the brands are an essential for the retailers. This

only reduces the bargaining power of the customers before the CPs. The bargaining power of the

suppliers in this industry is low too mainly because for the CPs the major source of cost is sugar

and packaging the former of which may be replaced with high quality corn syrup. The



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availability of the latter through various suppliers trying to get the contract reduces the supplier

power even further.

Economics of the Concentrate Business VS Bottling Business

Globally, in the beverage industry, both the concentrate producers (CPs) and the bottlers have

been linked together; most importantly because the bottlers are the major source of producing

and distributing the end product of the CP. Apart from this, because the bottling business is

largely dependent on the CP for the major ingredient of the product, its profitability dependent

on the product’s sales has a reciprocal impact on the profitability of the concentrate business.

Alternatively, it must be noted that because of being a more capital intensive a business, bottlers

are likely to be negatively impacted by the slightest change in the concentrate prices.

While the CPs have to incur a lower direct material cost and an even lesser relative plant costs,

the bottling business is more capital intensive, requires investment in the maintenance of the

installed machinery and more direct raw material cost. Besides this, the major sources of cost for

the CPs are in terms of the advertising expense, promotions, market research for the brand and

on gaining bottler support. Comparatively, the bottlers’ additional expense on selling and

delivery of the final product adds to its cost. So essentially, the cost was 60% of the net sales for

the bottlers, comparative to mere 17% for the CPs as shown in the (Exhibit 4) of the case study

(Appendix 2).

However, the employment of larger work force that assists the bottlers in selling products and

negotiating with the key suppliers places a greater pressure on the bottom line of the CPs. Yet, at

the end of the day, the pre-tax profit of the CPs outruns that for the bottlers. Thus, it would not

be incorrect to contend that profitability of both the businesses varies primarily due to the extent

of cost that both have to incur. Otherwise, due to interdependence, both the CPs and bottlers are

likely to experience reciprocal gains or losses. Additionally, because the CPs, at least the leading



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ones, are more of diversified businesses, they are much able to cover their costs from other

unrelated or semi-related products. Besides, the CPs have high value brands such as Coca Cola

and Pepsi virtually irreplaceable as a household consumer beverage brand. Resultantly, when the

bottlers are unable to leverage any such value addition which the CPs effectively do, the relative

profitability tends to differ to a large degree.

Impact of Coke & Pepsi on Industry Profits

Coca Cola and Pepsi are the two leading brands especially in the cola soft drink industry. Even

when it comes to beverages as a whole (apart from Nestle’s mineral water brand), both the

brands dominate the industry. On an overall basis, the profits of the entire industry are largely

concentrated with both these brands only. Thus on an overall basis, one may propound that both

Coke and Pepsi are positive contributors to the industry wide profitability. However, the incident

oligopolistic or rather the duopolistic nature of the industry may suggest otherwise if the

profitability is to be considered in terms of the industry’s attractiveness.

Furthermore, because both the brands have years of brand equity to back their ongoing sales and

profits, it is rather difficult to break the aura that surrounds the soft drink maestros. Over time

however, the industry has had to witness lowest possible profits especially during the price wars

of 1980s –early 1990s in response to the efforts of both brands to capture greater market share.

However, because by 2005, the carbonated soft drinks (CSD) made 80% of Coke’s and two

thirds of Pepsi’s global beverage business, the industry wide profitability as sapped down by the

pressures brought on by the increasing health concerns and litigations against the leading brands

especially in countries such as India. As a result, the beverage industry faced fairly static

earnings with reference to the CSDs.

Later, after strategic alliances with various fast food chains such as Subway, Mcdonalds, KFC

etc has enabled both the brands and thus the industry to experience significant improvements.

Yet, CSD growth of less than 1% and inclination towards non-carbs balances out the net effect

on the industry at large.



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Profit Sustainability

Over years, the profitability of the beverage industry has deteriorated especially with regards to

the CSDs. Yet, Coke and Pepsi can sustain their long term profitability even in the times of

flattened demand. Firstly, both the brands have developed a strong association with its

consumers and the resultant brand equity may not be giving it growing profits currently but

would be extremely fruitful in the long run success of the two companies. Furthermore, even

with the growing preference for non-CSDs, the profits might become static for some time, but

their expansion into more markets, introduction of more brands in both related and semi-related

product categories and accompanying marketing efforts would reap benefits in the long term.

The major hampering factor may be certain law suits and issues such as those related to

product’s contamination. However, if both the companies are able to effectively invest in CSR

initiatives and build on their existent brand equity, the problem may be alleviated. Additionally,

both the industry leaders may improve upon their CSD sales by promoting colas as a product

useable as more than just a refresher. For instance, if coke is associated with everyday food, it

would become a brand usable by everyone in the family thereby increasing the per capita

consumption. However, Pepsi must indulge in market development since its strongest rival Coke

has better operations going on globally. In any case, with strong relations with bottlers and well

established brand equity, the sapped down profits may be a temporary set-back which may

improve with improved efforts in terms of CSR, trade promotions, and market development.

Distinctive Competence

The main factor that has contributed to the financial success of Coca Cola and Pepsi is their

dominant position in the industry with respect to the CP-Bottler relationship, distribution

network and marketing efforts especially comparative to brands such as RC cola, Cadbury

Schweppes and the like. However, what determines their dominant position is their long

standing position and the resultant brand loyalty worldwide. Thereby, even when the sales for

colas go down, the existing ones largely are concentrated with both these leading brands.



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In addition, these brands have held the place for pioneers especially when it comes to colas.

‘Pepsi Generation’ promotion and the brand’s consequent association with the youth and being

young at heart makes it an evergreen brand. Similarly, Coca Cola’s distinctive taste and its years

old secret patented recipe give it an edge over the other brands along with its association with a

certain lifestyle that the brand took off to associate it with.

It is important to note however, that for both these companies, the major cause for such success

is also the duopolistic nature of the industry that obviously has come into being as a result of

aggressive competition over many years. The threat that this poses to any possible new entrant,

consequently adds to the advantage of these brands of many others. To sum up, the brand name

and equity are the sole distinctive competence factors for both Coke and Pepsi followed by their

sophisticated integration of the bottling operations with the company through consolidation of

the independent bottlers.

Conclusion

The soft industry is highly attractive when understood from the point of view some of the forces

of Porter’s model. However, the fierce completion that exists in the industry is a threat for any

new entrant considering entrance into this industry unless it has something different, innovative

and better to offer. Still, it would be difficult to match the equity that Pepsi and Coca Cola have

developed over time. Both these however have come to the current stage of success through their

continuous marketing and sales efforts even in the wake of flattening demand which is likely to

be recovered after some time because of the long standing association of the consumer with these

brands being the ultimate refreshers.



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References

Campbell, D., Stonehouse, G., Housten, B., Business Strategy-An Introduction, 2002

Costello, T., Arch Rivals Coca Cola VS Pepsi, CNBC on MSN, 2003

[Available at http://www.msnbc.msn.com/id/3718141/, Accessed 7th

Feb,2010]

Kithung’A, N., Brand Associations & Consumer Perceptions of Value of Product

Keller, K. Strategic Brand Management, Pearson Education Inc, 2008

Strickland, A. , Strategy; Winning the Marketplace: Core Concepts, Analytical Tools,

Cases, 2004



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Appendix 1

Porters Five Forces Model

Source: http://www.themanager.org/pdf/p5f.pdf



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Appendix 2 (Exhibit 4; Case)



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