Cola Wars
of the soft drink business. Using the analysis of Stuckey
and White, the industry displays the characteristics of one beset by vertical market
failure. In this case, however, the advantages of these market dynamics accrue to the
concentrate providers. Because there are many buyers (bottlers) and few sellers
(concentrate providers), sellers dominate the market. (This is illustrated in the diagram
below.)
Given that the majority of the value within the value chain resides in brand recognition
associated with concentrate production, Coke and Pepsi clearly benefit from outsourcing
bottling and distribution. Nonetheless, concentrate providers clearly need to assure that
their brands are not compromised by the manner in which bottlers and distributors market
and sell their products. Franchise arrangements have allowed concentrate prducers to
control their brands without diluting their own capital and management resources.
The specific terms of these franchise agreements demonstrate the extent to which
concentrate providers have managed to take advantage of the market dynamics and assert
control over the entire soft drink value chain. Concentrate producers used their own sales
and marketing organizations to promote soft drink sales. They also set production
standards to control soft drink quality. They also have gone so far as to mandate the DSD
(direct store door) delivery, effectively redistributing value within the supply chain from
the bottlers to the retailers.
The nature of this relationship, however, is not entirely expropriatory. Coke and Pepsi
clearly recognized the extent to which the strategic asymmetries surrounding the bottling
industry could very well lead to negative long-term economic profits and sup-par bottling
and distribution of soft drink products. In order to promote long-term health of the
bottling industry, Coke and Pepsi lobbied extensively for the 1980 Soft Drink Interbrand
Competition Act—federal regulation that preserved the right of concentrate producers to
grant exclusive territories. In essence, this legislation, promoted the strategic advantage
of the bottlers vis-à-vis retail stores, transferring value from retail stores back to bottlers.
Vertical Integration: Reasons and Rhetoric
Given the benefits provided by the franchise system, it is difficult to see why Coke and
Pepsi would want to vertically integrate into bottling. Yet this is exactly what they began
to do, starting in the mid-1980s. According to Yoffie and Foley, Coke and Pepsi almost
doubled their reliance on company-owned bottlers between 1980 and 1993. The
“analyst’s reasons” for such expansion, however, make little economic sense.
Few Number of Buyers Many
Number
of Sellers
Sellers
Dominate
Buyers
Dominate
No One
Dominates
High
Trading
Risk
Few
Many
Weakened bottlers needed capital infusion and thus sought buyers. While it is perhaps
correct that the profitability of the bottling industry was declining through the late
seventies and early eighties, this can only be seen as an effect of the franchise agreements
– agreements put in place and enforced by the concentrate providers. Indeed, if
concentrate providers were really concerned about the long-term viability of the bottling
industry, they could have simply improved the terms of the franchise agreements. In
essence, then, this purported cause simply begs the question: why did the concentrate
providers allow the bottling companies to reach such a weakened state that they had no
choice but to look for buyers?
Many bottlers were small and unable to handle the corporate goals in a particular
market. Once again, this does not address the question of why the concentrate providers
would need to purchase these [next page]