Cola Wars
Soft Drinks– Case Analysis
In the years between 1975 and 1993, the Coca Cola Company posted an average return
on equity of 30.5%. Similarly, PepsiCo Inc. recorded an average return on equity of
21.2%. Although these figures likely include the return form non-soft drink operations
(it’s difficult to tell from the available information in the Yoffee and Foley case), it is
clear that the soft drink industry is extremely profitable—profitable, that is, for
concentrate producers such as Coke and Pepsi.
For other members of the soft drink supply chain, the soft drink industry is not nearly as
attractive. Pretax profit for a typical bottler, by way of example, is less than one-third of
that of a standard concentrate producer. This discrepancy between the profitability of
concentrate producers and that of bottling companies results from the competitive
structure of the two separate industries.
Concentrate Providers: A Structural Analysis
Using a basic structural analysis of the market for soft-drink concentrate, it is easy to see
why the industry is so profitable. First, there are few direct competitors within this
market: Coke and Pepsi make up 72% of the entire market, with only a handful of
additional providers making up the remaining 28%. Furthermore, competition among
these companies is limited by strong brand recognition, especially for Coke and Pepsi.
Because the major players can rely on their strong, differentiated brands, they are able to
price their products substantially above long-term average costs1.
Secondly, the basic cost structure of the industry – low fixed costs relative to high
variable costs – helps concentrate producers avoid descending into stiff price
competition2. The tendency for competing on price is further limited by Coke and
Pepsi’s near-century of competition – a history that has allowed them to learn how to
avoid destroying profits in mutually damaging price wars.
Third, concentrate providers have a strong strategic advantage vis-à-vis their suppliers.
Because the concentrate producers purchase undifferentiated raw materials from a large
host of supplier firms, they are able to avoid losing a significant portion of the value they
create in upstream market transactions. The upshot of this strategic advantage is that the
average concentrate provider spends only about 17% on direct costs of producing
concentrate. This allows Coke and Pepsi to invest in other aspects of the business –
brand recognition, retailer relations, and market research – that will help perpetuate these
strategic asymmetries and allow concentrate providers to continue capturing the lion’s
share of the value created by the entire soft drink industry.
1 Smaller brands charge substantially less than do Coke and Pepsi. Indeed, profitability for each producer
is in direct proportion to the strength of their relative brands. A comparison of net profitability for Dr.
Pepper, Seven-Up, and Royal Crown in Exhibit 2 shows that profitability for Royal Crown – a company
with substantially less brand recognition than Dr. Pepper or Seven-Up – has historically lagged behind that
of Dr. Pepper and Seven-Up.
2 The typical concentrate production plant costs $5-$10 million and could supply the entire country. This
compares to $3.2 billion capital investment required for bottlers to serve a commensurate demand.
Likewise, concentrate providers have a strong strategic advantage vis-à-vis their
customers. The large number of undifferentiated bottling companies allows concentrate
providers to shop around for the [next page]