1. Why is the soft drink industry so profitable?

Compare the economics of the concentrate business to

the bottling business. Why is the profitability so different? Why do concentrate producers want to
vertically integrate into bottling?

The soft drink industry is profitable for a number of reasons. Firstly, the soft drink industry saw a growth
in consumption starting from the 1970s, between 3%-10%. Secondly, the soft drink industry had a few major
players, Coca-Cola and Pepsi-Cola. Both companies, helped by their brand awareness, didnt have much
competition in the market and were able to maintain a high market share and didnt have to compete on
prices with the smaller companies thereby giving them good profits. Lastly, Coca-Cola and Pepsi-Cola
were concentrate producers, franchisers of bottlers, as well as owners of bottlers. This helped the companies
keep more of their profits not having to share it with other companies in the production chain.
Economics of the concentrate business to the bottling business The relationship between the
Concentrate producers (CPs) and the bottlers is important to profitability in the industry as the CPs provide
the important ingredients and the bottlers determine the final price of the product. While Coke and Pepsi
produce their own concentrate, they have also faired into bottling by own a number of bottlers. We can see
from the case that the major difference in profitability between the CPs and the bottlers is added value.
For the concentrate business, starting a concentrate manufacturing plant involved little capital
investment in machinery, overhead and labor - $25 million to build a plant that could serve the US.
Significant costs for the CPs were for advertising, promotion, market research, and bottler relations with
the marketing programs cost shared with bottlers.
The bottler business, on the hand, required much more capital investment; costing between $30 million
to $50 million to build a large plant, with 85 plants needed to serve the US. The bottling business also
offered other services such as: delivery to customers; bottling and canning, and merchandising which
further reduced their margins.
The concentrate business/manufactures were typically owned the soda companies, for example Coke or
Pepsi, and their companies could only manufacture their concentrates. However, the bottlers were allowed
to handle the non-cola brands of other CPs giving them an opportunity to increase their sales.
These economics of CP v Bottlers can also bee seen from Exhibit 2 in the case: Gross profit (83% v 43%);
Pretax profit (29% v 9%); COGS (17% v 57%); and PPE per case (0.07 v .82).

Table 1: Porters Five Forces for the Concentrate and Bottling Businesses
Porters Five
Forces

Concentrate Business

Bottling Business

Bargaining Power of
Buyers

Level: Low
Two main buyers of concentrate:
fountain and bottlers
Little negotiation necessary as bottlers
determine the final price of product
Concentrate producers, while they sell
to some bottlers, also own other
bottlers so they control both channels
Industry products are standardized
Limited differentiation among buyers

Level: High
Five main channels (food stores, gas
stations, fountain, vending, other)
Strive for the best shelf space in retail
stores
Low switching cost
Little product differentiation, except in
taste

Bargaining Power of
Suppliers

Level: Low
Many suppliers are available for the
inputs packaging, sweetener, natural
flavors, etc.
Low product differentiation
Low switching cost

Level: Medium
Raw materials are easily available in
the market (packaging, high fructose
corn syrup, carbonate water etc.)
However, CPs hold greater power as
their materials are essential to the final
product
Popular CP brands also help increase
sales for bottlers.
CPs are also dependent on bottlers as
their strategies affect sales and
competition in the market.

Threat of New
Entrants

Level: Low
While there is little capital investment
needed, the Coke and Pepsi have
advantages such as high market share,
economies of scale and brand
recognition.

Level: Low
Bottlers have maintained a good
relationship with retailers and
suppliers benefits include economies
of scale
High cost of capital investment
required to enter
Exclusive territories granted to the
bottler by the CPs

Threat of Substitutes

Level: Medium
Extensive substitute products (water,
juice, coffee, tea, beers, wine, milk,
energy drinks)
However Coke and Pepsi have
introduced similar products under
different brand names

Level: Low
CPs will always need bottlers
Marketing channels such as fountain,
cannot easily replace bottlers, as
bottlers provide a big portion of CPs
revenue

Rivalry Among
Competitors

Level: High
Concentrated industry by two main
competitors Coke and Pepsi
Aggressive growth strategies
High barriers to exit with major fixed
costs
Low product differentiation

Level: High
The number of bottlers have decreased
in the market, increasing competition

From our analysis we notice that the bottling business is not as profitable as the concentrate business.
Coke and Pepsis high market power in the industry provides for the higher profitability of the concentrate
business. The lower profitability in the bottling business can be attributed to the high fixed coats which
reduces its margin, as well as the high bargaining power of its buyers and as well as the power its suppliers
have over them.
Concentrate producers want to vertically integrate into bottling mainly to capture the profits from the
bottlers, as well as consolidate the market. The concentrate producers consolidated to reduce the bargaining
power of the buyer i.e. the bottlers thereby maintaining their market power. Finally, due to the low profits
in the bottling business, bottlers werent encouraged to invest.

2. How are the economics different for China?

The tables below, Table 2 and Table 3, discuss the economics of the concentrate and bottling
businesses in China using Michael Porters five forces analysis.
Table 2: Porters Five Forces for the Concentrate Businesses in China
Porters Five Forces
Bargaining Power of
Buyers

Concentrate Business
Level: High
Service outlets were known to switch products to either Coke or Pepsi when
enticed by the producers. To combat this, concentrate producers had to
establish strong relationships with their buyers.

Bargaining Power of
Suppliers

Level: Low
The elements that were require to produce concentrate: sweeteners, caffeine,
citric or phosphoric acid, and coloring are commodities that can be sourced
easily, giving suppliers little power.

Threat of New Entrants

Level: Low Mid

The Chinese government imposed restrictions on the building of new plants, the
size of plants, and the number of tons of concentrate that each plant could
produce, bottle, and sell. This made it difficult for incumbent concentrate
producers to expand, but also served as a barrier to new entrants. However, the
government also served as a potential new competitor, as it could enter the
market as a buyer or seller at any time.

Rivalry Among
Competitors

Level: High
Competition between Coke and Pepsi was high as they fought for market share.
They even established factories on the same street, which only intensified the
rivalry.
Tactics such as the Pepsi Challenge and price wars later initiated by Coke also
serve to illustrate the high incumbent rivalry.
The Chinese government made attempts to keep Coke and Pepsi from
competing in the same cities, except for major cities like Beijing, Shanghai, and
Guangzhou, however, they played the competing companies against each other

in other cities like Chongqing.

Threat of Substitutes

Level: Mid High

In China, there were a number of substitute products that consumers could
access and these were products consumers were more accustomed to.
Water-based drinks, yogurt-based drinks, orange flavored carbonated
beverages, and other beverages produced by the 3,000 local soft drink brands
were all alternatives to cola.

Table 3: Porters Five Forces for the Bottling Businesses in China

Porters Five Forces
Bargaining Power of
Buyers

Bottling Business
Level: Mid High
In China, soda was being increasingly sold through fast food restaurants and
convenience and department stores and the primary mode of dispensation for
these outlets were through fountains. This left less room for bottled beverages.
However, inconsistencies in the ratio of concentrate to water or poor water
quality would result in differences in beverage taste in these fountain drinks.
The consistency of taste in bottled drinks and growing at-home consumption
posed significant potential for bottling.

Bargaining Power of
Suppliers

Level: High
Coke and Pepsi were able to license their concentrates to bottlers and mandate
which competing brands bottlers could work with. This created significant
control for concentrate producers.

Threat of New Entrants

Level: Low
Bottling manufacturing infrastructure was very expensive and it was hard to
enter the market without significant capital investments. A typical bottling plant
in China run about $20M - $25M and only consisted of two lines.

Rivalry Among
Competitors

Level: High
The government negotiated bottling franchise rights with Coke and Pepsi in
many geographic areas. However, in unlicensed areas bottlers competed
fiercely.

Threat of Substitutes

Level: Low
Despite the alternative modes of dispensation through fountain drinks,
concentrate producers were always in need of bottlers in order to deliver its
products to other distributors for at-home and other use.

3. What are different types of multinational company (MNC) strategies for Coke and Pepsi.
What are their modes of entry for various international markets? What are the
advantages/disadvantages of the MNC strategies and the different modes of entry for Coke
and Pepsi?
Coke and Pepsi adopted multinational company strategies that had characteristics of both multidomestic and global strategies. These strategies could be termed to be a transnational strategy. Coke and
Pepsis strategy both focused on achieving global efficiency and local responsiveness. Coke and Pepsi
employed similar modes of entry. However, Coke preferred a joint venture mode of entry while Pepsis
preference was for newly owned subsidiaries.
Coke entered into china as far back as the 1920s through a Greenfield venture. After the closure of
Cokes facility in China, the company returned to China through an alliance with Ceroilfood. Overtime, Coke
expanded into China through partnerships with the Chinese government and Key bottlers, most of which
operated as joint-ventures. 62% of Cokes first 13 bottling plants were joint ventures while 38% were state
owned. Coke in partnership with the Ministry of light also planned to build 10 soft drink plants in keyland
cities which were contracted as equity joint ventures. Coke had planned to turn state owned bottling plants
into joint ventures eventually in order to improve efficiency.
Pepsi entered into China in the 1980s, Pepsis main mode of entry was through wholly owned
subsidiaries. However, by the 1990s Pepsi bottled soft drinks in joint-venture plants. Pepsi planned to build
10 new bottling plants which were to be joint-ventures with local government agencies. Unlike Coke, Pepsi
had majority holding in its joint-venture partnership, this signified long term commitment to Pepsi.
The advantages and disadvantages of Coke and Pepsis modes of entry, are listed in Table 4 below.
Table 4: Advantages and Disadvantages of of the MNC strategies and the different modes of

entry for Coke and Pepsi?

Mode of Entry

Strategic alliances / Joint

ventures

New Wholly owned

Subsidiary

Advantages
Share of risk and resources
Development of new core
competencies
Increased knowledge from
various partners
Access to new market
Allows maximum control of
the firm
Potential above-average
returns

Disadvantages
Challenge of integration

Capital Intensive
High risk

4. Discuss Porters model of competitive advantage of nations as it relates to the soft drink
industry.
These are the attributes of a national economy that contribute to a national advantage. It is helps a firm
decide which business level strategy to use internationally. They include:
a. Factors of production/Inputs
Depending of the type of participant, firms within the soft drink industry required large capital
investments. The most significant costs, requiring a minimum of $20m -$30m were incurred by bottlers to
establish a plant. In developed economies, like U.S and Europe, there were well-established credit systems
that supported transactions between bottlers and their clients. Emerging economies like China, were
generally cash societies and credit systems were less developed. As a result, only the major players such as
Coca-Cola (Coke) and Pepsi operated as both concentrate producers and bottler owners or franchisers,
whereas the smaller international industry players such as Dr. Pepper/Seven-Up, Cadbury Schweppes and
RC Cola only produced concentrate and sold to independent bottlers.
On the other hand, compulsory education and the size of the Chinese labor market better supported the
distribution and sales processes, which were rather labor intensive by offering firms the opportunity to
obtain skilled labor at lower costs of $2,000 compared to $30,000 per sales person in the U.S. This enabled
them to earn 60% more in operating margins than they would have in the U.S.
b. Demand conditions
The industry faced shifting demand in both developed and emerging markets in the 1980s and 90s.
There was the emergence of healthy, new-age drinks and tea-based beverages, of which consumption grew
by over 17% in gallons per year. The industry responded by offering a variety of fruit, diet, no-sugar
beverages and bottled water. Also, demand increased in Eastern Europe, China and India for the major
players when the markets were opened up to their products. For instance, in China alone, in the 1990s, the
1.2 b people drank less than 3 coke products per year compared to the 250 m in the U.S that drank 296 per
year. A boost in consumption to a little over 200 was estimated to result in a 60% growth per year within 15
years pioneered by international brands. In addition, demographic trends, preference for western products
and rising per capita income levels in emerging markets were expected to boost demand. The firms were also
able to earn more through geographic pricing discrimination by pricing products at 3 RMB in Beijing
compared to 2.3-2.7 RMB in Shanghai. The challenge however for the industry in markets like China was
that, demand favored beverages with lime/lemon base whereas cola products were rumored to be unhealthy
for pregnancy.
c. Related and supporting industries
Companies in the packaging, sweetener, retail and distribution business provided support for the soft
drink industry. The U.S market was the most developed. In emerging markets like China, however, there
were some challenges. Although can packaging was a growing preference, it was limited in supply.
Distribution was also highly fragmented in China with a high degree of government intervention. Foreign

companies were allowed to participate in retail distribution but wholesale was reserved for domestic
companies, with about 85% of wholesale going through the government system. Foreign firms however
expanded their businesses in the Chinese market through joint ventures that were also highly regulated in
terms of partnership recommendations, determining locations for establishment, and advertisements,
amongst others.
Cokes key partners included Swire Pacific Trading Company, with which it established packaging and
distribution partnerships in China and other Asian countries; CITIC a state company, which provided the
importation of advanced technology and management expertise and trading infrastructure; and the Kerry
Group, which partnered with coke in Asia in the beverage business and owned other businesses including a
sugar plantation.
Pepsi on the other hand used links with corporations rather than Asian powerhouses for expansion and
included famous people in its adverts.
d. Firm strategy, structure & rivalry
The soft drinks industry was highly competitive with the major players, Coke and Pepsi, employing many
similar strategies. Coke had taken the lead in expanding internationally before Pepsi decided to follow suit
using a niche strategy to compete with Cokes in its high volume and high profit regions. Coke however
emerged as an industry leader, mainly due to the companys franchising strategy versus Pepsis direct
ownership strategy. Other competitors in China included the eight local Chinese companies, especially
Tianfu, a company that produced an imitation cola drink and had government support. In North America
and Europe, Cott Corporation competed fiercely by introducing private-label and discounted sodas. This
resulted in the loss of profits for Coke and Pepsi in the 1990s. The intensity of rivalry in China was however
less intense than in other parts of the world, since the government had determined the locations in which
the companies may operate. Generally, the combination of changing tastes and high rivalry, resulted in the
introduction of more beverage varieties.

5. International environment and culture as it relates to Coke and Pepsi.

The way that business was conducted by companies within the software industry, was affected
by the differences in cultural beliefs and practices in various countries. For instance, whilst western
cultures permitted the use of unconventional marketing practices to compete, resulting in Pepsis
success in stealing Cokes market share in Mexico, Asian cultures disallowed the practice. Also the
success or failure of ones business in China depended on whether or not the company had guanxi-a
personal connection with someone of influence. Pepsi was able to win a distribution business by
funding the diagnosis and treatment of a C.E.O with cancer. Apart from that, compared to western
cultures, where accepting of huge entertainment favors clearly constituted fraud or corruption, in
China, foreign firms were at times required to provide entertainment for clients and their relatives.

Lastly the companies had to be conscious of the meaning of names provided for products in
promotions in foreign countries in order not to lose business.