Cola Wars: Porters 5 Forces
Michael Porter developed five different forces in a framework he felt influenced industries. This framework was designed to help companies find ways to off-set a rival company and to help develop a more solid business plan. It has been known over the years a rivalry has existed been two of the biggest soda companies, Coca Cola and Pepsi. Three of Porter’s forces that are exemplified in this “coke war” are buyer power, barriers to entry, and rivalry which will be explained and elaborated on in the following essay. Buyer Power
The retailers have a low to moderate buyer power over the consumer soft drink industry, due to the producer’s ability to forward integrate, the sheer number of buyers, and the buyer’s ability to forward integrate. Buyer power is the degree of influence customers have on the producing agent. Soft drink companies such as Coca Cola and Pepsi have used forward integration to take over their channels of distribution. They created contracts that gave them the ability to set concentrate prices for their bottlers; in turn bottlers would respond to price fulgurations by adjusting retail pricing.
In 2000, when Coca Cola raised concentrate prices by 7. 6%, bottlers raised the retail prices by 6 to 7%. This demonstrates that buyers have limited control over the price changes. Coca Cola has also made great efforts to take over the bottling of their product, by establishing the independent subsidiary Coca Cola Enterprises. They began by acquiring bottlers to produce one third of their volume during 1986 which increased to 80% in 2004. This gave Coca Cola more control over retail pricing, and distribution of their products to retail stores.
Since there are so many retail stores that carry products that consumer soft drink, CSD, companies make, it is hard for buyers to create a collaborative effort to resist price increases. Buyer power also suffers if retailers are fragmented and are not concentrated to a single type. Almost any type of store will carry a CSD product, which makes sales very spread out across the board. The different kinds of intermediaries involved in retail sales are Fountain and Vending machines, Super-markets, Convenience and Gas, Super Centers, Mass Retailers, and Club and Drug Stores.
To put things in perspective 34 % of sales comes from Fountain and Vending, while 31% are from supermarkets. Fountain and Vending machines are mostly controlled by the CSD bottlers. Even though supermarkets may sell the second largest volume, CSD companies make up 5. 5% of their sales and also bring customers to their door. Not enough to convince you? Consider this: CSD companies such as Coca Cola produce a wide variety of products ranging from sports drinks to water, all the way to energy drinks. Coca Cola most likely will not sell a product to a supermarket unless they carry their full line of products.
If the retail prices increase on the Coca Cola product they may have little control over resistance, because they rely on the other products they provide. Lastly, Coca Cola is considered the most valuable brand in the world, with 10 major successful brands and substantial power in the realm of business. Although Coca Cola may have a significant amount of power over their buyers, companies with much smaller market share, and product lines are taken advantage of by larger retailers. For example, mass merchandisers make up 14% of Pepsi’s total revenue, making that intermediary crucial to the company’s profitability.
In some cases retailers do have power to resist price increases because they purchase a large number of outputs. Typically there are far more buyers than concentrate producers, which can give them leverage over smaller brands that rely on the sales they generate. Barriers to Entry When entering a market there are certain barriers that prevent a firm from becoming established, or gaining market share. In the consumer soft drink industry there are high capital requirements, unequal access to distribution channels, and brand loyalty which translates to high barriers to entry.
In the text it states the price of a concentrate manufacturing plant is fairly reasonable. Manufacturing facilities cost around $25 million, and $50 million including machinery, overhead, and labor. For established companies with separate revenue streams, generating this kind of money could be fairly reasonable, especially since one of these plants can serve the entire country. Coca Cola and Pepsi operate around 100 plants each for adequate distribution of their product. New entrants would have a hard time investing enough capital that would be required to keep up with Coke and Pepsi’s istribution. Advertising and promotion costs are also high in 2004; Coca Cola spent $246,243 just on advertising their cola product. This shows that in order to compete in this industry, entrants are forced to spend large sums of money on advertising, packaging, proliferation, and widespread retail price discounting. The high capital investment also translates to lowers profit margins, which makes entry even more unappealing. Another factor that creates a barrier to entry is the unequal access to distribution channels.
Coke and Pepsi created agreements with their franchised bottlers that prevent them from handling competing brands of other concentrate producers. This prevents companies from entering an industry and using a Coca Cola bottler to get their product on the market. Also as Coca Cola and Pepsi grow in size so does the shelf space they require. As stated previously Coca Cola and Pepsi produce around 10 brands each, this constricts the amount of shelf space an entry producer will have access to. The top two cola companies have also made a significant amount of acquisitions, to boost the distribution of their products relative to their competitors.
Coca Cola won 68% pouring rights against Pepsi’s 22% and Cadbury Schweppes 10%, across the United States. The reason Coca Cola has a majority of the pouring rights is because their agreements with Burger King and McDonalds, as well as their exclusive pouring rights and contracts around the world; whereas entry producers do not have the capital to invest, in buying out pouring rights. The ability to use vending machine technology requires a high capital investment from incumbent firms. Coca Cola and Pepsi offer their bottlers incentives to develop vending machine technology which accounts for 34% of the industry sales volume.
Entry companies would have to invest in this technology to compete with the volume sales figures. One of the marketing goals of a company is to establish brand loyalty. When brand loyalty is achieved, customers will most likely not switch to a competitors brand. As a barrier to entry, brand loyalty is affected by many factors, such as presence in the market, or advertising and promotion efforts, to name a few. Both Coca Cola and Pepsi were created in the 80’s, as pioneers of the cola industry. Coca Cola was the first to invent the original cola recipe, and patent the 6. -oz bottle. Coca Cola also used strong promotional efforts in World War II, which contributed to brand identity. The case does not supply information regarding the sales across different age groups, but I believe figures would suggest higher sales levels across the ages compared to newer brands. It is apparent that the companies with the longest presence in the industry have the highest market share, which also directly correlates with the amount of advertising each company has expended over time.
Another perfect example of this trend in the CSD industry is energy drink company Red Bull, having the largest market share while also spending the most on advertising. This goes to show by having consistently strong promotional efforts and advertising both Coca Cola and Red Bull have excelled in their markets. It is difficult for new entrants of soft drink market to match the brand loyalty Coca Cola has established through aggressive advertising over the course of the company’s existence. Rivalry In the beverage industry rivalry is at best a mechanism that drives profits and keeps the industry in motion.
Coca Cola explains that they are in the position they are in today because of their rivalry with Pepsi. Rivalry is high because of the competition between top brands, low product differentiation and slow industry growth. It is clear that there is a substantial rivalry between Coca Cola and Pepsi that alone claim 74. 8 % of the U. S. CSD market as of 2004. Not only does this information tell us that there is a small amount of major competitors in the industry, but it also says that there is a fight for market share with the top two brands. This is most exemplified in the advertising expenditure of the two companies.
During 2003 Pepsi spend a total of $236,396 on advertising while Coca Cola spent $167,675; the year after Coke responded by raising their advertising expenditure to $246,243. This trend also happened in 1981 to 1984, when coke doubled its advertising spending; as a result Pepsi did as well. The next variable that contributes to the high degree of rivalry is the low product differentiation. Although there are many efforts made by beverage companies to differentiate their product from others, there are no truly unique attributes about a single CSD brand. Each cola company provides a elatively similar option in packaging, container size and ounces per container. It is typical for companies such as Coca Cola and Pepsi offer 10 different brands, 17 container types and provide many discounts and promotions. For example Coke make Sprite and Pepsi has Sierra Mist and Dr Pepper owns 7UP; this creates a rivalry over who has the best lemon lime soft drink product. To show my point, Pepsi launched “The Pepsi Challenge”, which gave customers the ability to try out the different brands and see how they compare. Pepsi knew they needed to find a way to show consumers the difference between their brand and the competitors.
This approach fueled the rivalry among other CSD companies especially Coca Cola. Slow industry growth spurs rivalry because it calls for companies to develop new competitive advantages and core competencies to keep sales alive. The market share for cola products has dropped from 71% in 1990, to 60% in 2004. Other products such as energy drinks and bottled water are increasing in market share, as consumers switch their focus to more functional and healthy alternatives. Goizueta said, “The product and the brand, had a declining share in a shrinking segment of the market. Signifying the need for soft drink manufacturers to find new ways to boost sales and increase rivalry. To put a number on these increasing trends, bottled water volume sales grew by 18. 8% in 2004, compared to 7. 6% non-carb CSDs and1% CSD growth. Top companies now have to find ways to proliferate their CSD products in relation to their rivals. It is also a definite possibility with the slow sales volume growth of 10 billion cases in 2001 to 10. 2 in 2004 that companies will invest in new beverage arenas such as the functional category, thus creating new rivalries.
