Cola Wars
the highest prices for concentrate, locking in the most
favorable returns in long-term contracts. This allows concentrate providers to avoid
losing a significant proportion of the value they create in their downstream market
transactions.
Finally, although producing the physical soft drink concentrate is a trivial industrial
exercise, the importance of brand recognition has created high barriers to entry. In fact,
Saloner, Shepard, and Podolny specifically cite Coke and Pepsi as having a “promotional
advantage of incumbency from cumulative investment.” This brand recognition helps
Coke and Pepsi perpetuate all of these strategic advantages by increasing the long-term
barriers to entry in the concentrate market, thus preserving Coke and Pepsi’s ability to
expropriate the vast majority of the value created along the entire value chain.
It is interesting to note that the concentrate providers have managed to isolate the one
aspect of the soft drink market that can provide ongoing positive returns. Although we
are used to thinking of soft drink production as being composed of several industries
along a multi-step value chain, the only reason it appears this way is because Coke and
Pepsi have been very adept at outsourcing virtually all aspects of the business that do not
provide long-term positive returns. In fact, it is likely that the only reason why Coke and
Pepsi continue to manufacture soft drink concentrate is that it is easier to promote the
brand if they can lay claim to producing the “essence of the product.” In pure economic
terms, however, the concentrate is simply yet another commodity input, whereas the
brand is the essence of the product.
Bottlers: A Structural Analysis
By contrast, the soft-drink bottling industry exhibits all the signs of long-term unprofitability.
Bottlers face stiff competition in a highly fragmented competitive
landscape: in 1994, there were between 80 and 85 bottlers nationwide, each of which
produced an undifferentiated commodity. Moreover, as of 1994, there are few – if any –
barriers to entry.
In direct contrast to Coke and Pepsi’s strategic advantage vis-à-vis their upstream
providers, bottlers face a far less hospitable environment in their market for raw
materials. Not only are there only a handful of concentrate providers, but two producers
– Coke and Pepsi – together make up almost 60% of the market for soft drink
concentrate.
This is aggravated by the extent to which the bottling company’s customers have
acquired an increasing amount of market power. WalMart’s huge size relative to other
retailers and its effective use of its own soft drink brand has put increasing pressure on
the prices that bottlers can charge to their retail customers.
This pressure is compounded by the basic cost structure of the bottling industry in which
high fixed costs relative to variable costs increase the incentives for short-term pricing
below average total costs. The upshot of all of these factors is an industry that earns zero
long-term economic profits.
Historical Relationship Between Bottlers and Concentrate Producers
Coke and Pepsi have long relied on exclusive bottling franchises as the primary method
of bottling and distributing their products. As of as of the early 1980s, Coke and Pepsi
owned only 20%-30% of their bottling companies; the rest were either privately- or
publicly-owned franchises.
The historical relationships between concentrate providers and bottlers evolved as a result
of the underlying economics of [next page]