Bottling business

1. Compare the economics of the concentrate business to the bottling business: why is the profitability so different? (50%)

Pepsi-Cola and Coca-Cola were both established at the very end of 19th century. Their history is more than a hundred years old and the size of these two companies is huge. Both of them work in the consumer goods industry providing beverages and other drinks to the customers (http://www.thecoca-colacompany.com/ourcompany/historybottling.html) . Pepsi and Coke dominate the market in this sector and form oligopoly in the US and even in the world market: “Among national concentrate producers, Coca-Cola and Pepsi-Cola claimed a combined 74.8% of the U.S. CSD market in sales volume in 2004, followed by Cadbury Schweppes and Cott Corporation.” (Financial data for Coca-Cola, Pepsi-Cola, and Their Major Bottlers.) Their businesses are structured in the same way. They are the biggest concentrate producers. They sell ready concentrate to the bottlers which after convert it into the ready product which is brought to the shop shelves. Bottlers are situated all over the world as the principle of franchising is used. That greatly helps in the spread of CSDs across the globe. However, the returns received by concentrate producers differ from those received by bottlers for several reasons (Yoffie, 2007).

Concentrate producers:

• Capital investment. Concentrate production business is less capital intensive than bottling. It requires less funds to be invested in machinery, labor and modernization. “A typical concentrate manufacturing plant cost about $25 million to $50 million to build, and one plant could serve the entire United States” (Yoffie, 2007).
• The number of significant costs is small. The major ones are: advertising, Market Research and product development. However, concentrate producers tended to employ large number of people to work with bottlers and their suppliers to ensure quality control and efficiency of production as well as reliable supply of raw materials (e.g. cans) and low prices (Yoffie, 2007).
• Franchising. The concentrate producers work using the principle of franchising. It means that bottlers pay them in order to become part of the bottling network and are granted “the sales operation in an exclusive geographic territory…(Yoffie, 2007)”
• Concentrate price. Coca-Cola was able to determine its concentrate prices since 1987 when the Master Bottling Contract was established. Pepsi’s Master Bottling contract was a bit different to Coke’s as it obliged bottlers “to purchase raw materials from Pepsi at prices, and on terms and conditions, determined by Pepsi”. They based the price of the concentrate on CPI and negotiated it with bottlers. “From the 1980s to the early 2000s, concentrate makers regularly raised concentrate prices, even as inflation-adjusted retail prices for CSD products trended downward”, – another reason for greater returns in concentrate production business. As brand promotion was very strong and formula was always kept a secret the whole thing with concentrate was kind of exclusive, so it greatly added towards the price of the concentrate itself and, as the result, towards the returns of concentrate producers (Yoffie, 2007).
• Raw materials. Concentrate producers required fewer raw materials and their major spending were on caramel coloring, citric acid, caffeine and natural flavorings. Bottlers, vice versa, required large number of production materials. Their major inputs purchased were: packaging (e.g. cans, glass bottles etc.), as well as sweeteners (e.g. aspartame). This process helped concentrate makers to reduce the outflow of the money which increased their profitability (Yoffie, 2007).

Bottlers:

• Dependency. Bottlers were always very dependent on concentrate producers as they were obliged to buy raw materials from them (Pepsi Master Bottling Agreement). They were also very dependent on suppliers of packaging, flavors and sweeteners (Yoffie, 2007). As the price of the concentrate rose, bottlers could not react in the same way and increase price of the final product as they were squeezed by other suppliers of different fruit drinks and other beverages. All of these factors contributed to lower returns in bottling business (Porter, 1997)).
• Bottling is much more capital intensive industry than concentrate production. It requires huge fund investments and on-going improvement and modernization of bottling lines. Large bottling plant with “a capacity of 40 million cases, could range as high as $75 million” (Yoffie, 2007).
• High competition. The number of bottlers is much greater than the number of concentrate producers, so the competition took place between them. There was approximately 2000 bottlers in 1970s and the figure dropped to less than 300 by 2004. Ongoing modernization and increasing capacity was required from bottlers (which were often small and family-owned) and not all of them could meet those requirements, so their number dropped. High competition ensures that returns are really low, only enough to survive (Yoffie, 2007).
• Investments. Besides investments in modernization, bottlers bought trucks for transporting and established the distribution channels. It all required some investments as well (Yoffie, 2007). “Bottlers’ gross profits routinely exceeded 40%, but operating margins were usually in the 7% to 9% range (Comparative Costs of a Typical U.S. Concentrate Bottler and Producer) .
• Stability. The returns received by bottlers are less than returns received by concentrate producers due to the risk levels as well. The concentrate producers are responsible for brand promotion and invest heavily in trademark to stimulate sales. High returns is what they get as the result. However, bottlers have little risk in their operations as they are given the famous name well-known all over the world. This development provides them with stable returns, and low risk.

Can Coke and Pepsi sustain their profits into the future in the wake of flattening demand and the growing popularity of non-carbonated drinks? Justify your answer.

In order to answer this question, it is necessary to look at the history of the two companies, as they fought for every customer and had to cope with flattening demand in the past already.

Coca-Cola and Pepsi-Cola are the world’s leading concentrate producers in their industry. These two are U.S. original Multinational Companies which sell their concentrate to the bottlers around all around the world (http://www.thecoca-colacompany.com/ourcompany/historybottling.html). Both of these companies have a lot of experience gained during the years of “Cola Wars” and enough funds to keep going and compete for the customers. Coke and Pepsi have innumerous techniques and ideas on how to keep and increase their sales. For example, the introduction of Diet Coke in 1982 was a huge success, ant it was said, that it was the “most successful consumer product launch of the Eighties” (Yoffie, 2007).

The Eighties were very important for both companies as a lot of things, which helped sales, happened and new products were introduced. New types of packaging were introduced by the companies and there was a huge rivalry over the shelf space in the shops. Besides, Pepsi and Coke , both had around ten well-known brands, which helped them to enter the other markets (Yoffie, 2007) .

In my opinion, both of these firms will be able to sustain their future profits. At the very beginning of the 21st century, Coke had some problems with execution, whereas Pepsi did quite well and acquired some other companies (e.g. Quaker Oats, South Beach Beverage). These actions increased Pepsi’s success and helped it to gain more diversified portfolio. The future of Pepsi and Coke possibly lies in diversification into other non-CSD products (Yoffie, 2007).

Due to the health issues (“regular CSDs as the largest source of obesity-causing sugars…”), the consumption of ordinary CSDs dropped. However, brands like Coke Zero and Pepsi Diet helped to keep total sales stable as there was a decrease in the consumption of regular soda, but an increase of these substitutes (Yoffie, 2007).

Pepsi realized that in order to be successful it needs to diversify and diversify aggressively, so it did: “Pepsi developed a portfolio of non-CSD products that outsold Coke’s rival product in each category…” As the result of that development Pepsi was sharing 47.3% of the non-CSD market comparing to Coke’s 27%. Both, Pepsi and Coke, diversified into non-CSDs (e.g. Nestea, Gatorade) (Yoffie, 2007).

Introduction of new brands and diversification is not enough to sustain profits, and both companies understand that. The U.S. market is very close to satisfaction as an average American consumes approximately 52 gallons of CSDs a year. As the result Coke and Pepsi looked abroad for the future profits. Coke has a big advantage over Pepsi, at it secured its place as the largest soft drink producer just at the very end of the Second World War. During the period after the war Coke expanded its international distribution channels and became a synonym of the American culture. Later Pepsi could move into Middle East and Soviet bloc (Yoffie, 2007).

Another reason for Pepsi and Coke remain in business and sustain all the profits is that the barriers to entry exist. Product differentiation exists on the market and CSD is a very specific type of product. It means that if a person wants a can of cola there is not many substitutes he/she can get instead of it (Pepsi, Coke or Schweppes). As the result of huge investments in advertising, customer service and trademark itself there is a strong brand identification and “It is perhaps the most important entry barrier in soft drinks…” This fact ensures stable consumption levels and profit sustainability in future (Porter, 1997).

In order to plan for the future SWOT analyses can be done for the firms to see what they have and what challenges they will possibly face.

Strengths:

• Brand identification (Porter, 1997)
• Well established distribution channels (Yoffie, 2007)
• Retained earnings and past experience
• Economies of Scale (Porter, 1997)

Weaknesses:

• Conflicts with Bottlers (Yoffie, 2007)
• Execution (Yoffie, 2007)

Opportunities:

• Further diversification into other non-CSDs (Yoffie, 2007)
• Further internationalization

Threats:

• Competition (Porter, 1997)
• Substitution (Porter, 1997)
• Suppliers (Porter, 1997)
• Buyers (Porter, 1997)

Brand identification.

As the result of the heavy investments of the concentrate producers, the brand is well-known all over the world, and a consumer will choose rather choose something he/she has already tried before. (e.g. between Pepsi-Cola and Pepsi-Kola the consumer would rather pick the first one). This gives Pepsi and Coke the advantage over their rivals.

Well-established distribution channels.

Both companies have worked with their bottlers, literally, for ages. They have worked with other buyers like Wal-Mart as well, so the system of supply works really well and is very efficient. New competitors will have to shift these international giants from the shelves to enter the market.

Retained earnings and past experience.

For more than a hundred years Coke and Pepsi were and still are the leading concentrate producers and gained enough funds and experience during the “Cola Wars” to keep going and increase their profits and market share.

Economies of Scale.

These market leaders (Pepsi and Coke) are very big players who have gained very big economies of scale and can undercut many of their competitors.

Conflicts with bottlers.

Pepsi and Coke were increasing the concentrate prices squeezing their bottlers and their profits for too long. CCE had to increase its retail price between 6% and 7% as it was in debts already, so did PBG, this resulted in decrease in concentrate makers’ profit. These conflicts could be very dangerous, as the competitors can always act fast.

Execution.

There was a big problem with execution within Coke in 2001, when it missed few big steps of Pepsi (e.g. SoBe acquisition). Another miss was that Pepsi purchased Quaker Oats.

Further diversification into other non-CSDs.

As the consumption of non-CSDs is increasing it can be a good opportunity for Coke and Pepsi to further integrate their businesses into production of other soft drinks excluding Pepsi and Coke themselves (e.g. bottled tea). This will help both companies to increase their share of the market.

Further internationalization.

As American market is very close to the point of saturation the concentrate producers need to further expand in international markets in Europe and especially Middle and Far East. New consumers will help both companies to sustain their profits.

Competition.

As the industry grows new competitors enter the market, so competition rises and profits can be decreased, so the weaker players will be pushed out of the market. This case can decrease the profits of both companies, so they might suffer.

Substitution.

New firms enter the market, so they develop new products which become substitutes for the existing products, this can as well decrease the companies’ profit and decrease their share on the market.

Suppliers.

As number of competitors rises, suppliers can manipulate them and alter the prices, as the concentrate producer market will look more like imperfect competition, so in order to sell more you need to drop the price.

Buyers.

Very big buyers, like Wal-Mart, can put pressure on the industry as it may ask to lower the prices and as a result profit will drop.

Both of these companies are very mature players and well-established businesses. They have been fighting for the consumers for several decades and faced a lot of challenges. Of course, challenges like globalization, increased demand for non-CSDs and competition can result in decreased profits and market shares, but these obstacles make the firms more efficient and consumers benefit because of that.