Liverpool John Moores University

Micro Analysis of
Soft-Drink Industry - 2008

Submitted By

Tom Jacob

Course Name: Master of Business Administration

Module Name: International Business And Trade
Submission Date: October 2008
Submitted to: Dr. Tim Harris
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 Micro Analysis of Soft-Drink Industry - 2008

1)Threat of New Entrants

Soft-drink industry is fully saturated and growth is small. This makes it very difficult
for new, unknown entrants to start competing against the existing firms. The new
company have to overcome tremendous marketing muscle and market presence of
Coke, Pepsi, and a few others, who had established brand names that were as much
as a century old. Through their DSD practices, these companies had intimate
relationships with their retail channels and would be able to defend their positions
effectively through discounting or other tactics. Another barrier to entry is the high
fixed costs for warehouses, trucks, and labour, and economies of scale. New
entrants cannot compete in price without economies of scale. These high capital
requirements and market saturation make it extremely difficult for companies to
enter the soft drink industry.

Currently, the biggest threat of entry is from private label manufacturers such as
Cott Corporation. Private labels now hold as much as 12.1% share in the CSD
market, the majority of which is held by Cott. The challenge to existing brands is to
further build brand loyalty in their core cola products so that consumers will not be
swayed by the cheaper, private label imitations products. More importantly,
retailers, finding far more attractive margins with private labels, may choose to push
these products instead of the majors.

For all CSD companies the end product is, despite extensive advertising campaigns
that promote the contrary, almost identical. The product differentiation comes from
established marketing campaigns that have created brand identification and
loyalties. For a new entrant to compete effectively, they would have to be willing to
spend the time and resources necessary to first convince the consumer to try the
new product, and after trial, switch their loyalties. Otherwise the new company
have to bring in a differentiating factor which will make it stand out in the market.
The threat of new entrants is partially increased by the low switching costs for
consumers.

Thus, the overall threat of new entrants is considered little to moderate with a
special note made of the increasing presence of private labels.

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 2)Threat of Substitutes
Bottled water, sports drinks, smoothies, juices, tea & coffee and energy drinks are
becoming increasingly popular with the trend to the more health conscious
consumer. There are progressively more varieties in the water and sports drinks that
appeal to different consumers’ tastes, but also appear healthier than soft drinks. In
addition, coffee and tea are competitive substitutes because they provide caffeine.
The consumers who purchase a lot of soft drinks may substitute coffee if they want
to keep the caffeine and lose the sugar and carbonation. Specialty blend coffees are
also becoming more popular. The new culture of coffee drinking among the youth,
with the increasing number of trendy coffee stores that offer many different
flavours to appeal to all consumer markets is a substantial threat to the industry. It
is also very cheap for consumers to switch to these substitutes making the threat of
substitute products very strong.

Cola companies responded by expanding their offerings, through alliances (e.g.

Coke and Nestea), acquisitions (e.g. Coke and Minute Maid), and internal product
innovation (e.g. Pepsi creating Orange Slice), capturing the value of increasingly
popular substitutes internally. This increased the capital investment (more complex
manufacturing operations and distribution) affecting the profitability overall.
Because of the efforts in diversification, however, substitutes became less of a
threat. But the challenge lies in increasing brand loyalty within these substitute
markets

Thus, the overall threat of new substitutes is considered moderate, although the
opposing trends are increasingly becoming strong.

3)Rivalry in the Industry

In a maturing market such as the CSD, the only way to gain market share is to steal
from one’s rivals. Revenues are extremely concentrated in this industry, with Coke
and Pepsi & Cadbury, commanding 73% of the market in 1994. As of 2006, that
grew to 78% with Coca-Cola, the king of the soft drink-empire boasting a global
market share of around 50%, followed by PepsiCo at about 21%, and Cadbury
Schweppes at 7%. Adding in the next tier of soft drink companies, the top six
controlled 89% of the market.

Tough competition for market share, have occasionally hampered profitability. For
example, price wars resulted in weak brand loyalty and eroded margins for Coke and
Pepsi in the 1980s. All the major players have significant investments in advertising
in an attempt to build and maintain brand loyalty.
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Considering everything, the threat of rivalry is very strong and a big deterrent to
entering the market.

4)Bargaining Power of Suppliers

The inputs for CSD products are primarily sugar and packaging. Sugar could be
purchased from many sources in the open (globalized) market, and if sugar became
too expensive, the firms could easily switch to corn syrup, as they did in the early
1980s. With an abundant supply of inexpensive aluminium in the early 1990s & the
naughties and several can companies competing for contracts with bottlers, can
suppliers had very little supplier power. Big cola companies effectively further
reduced the supplier of can-makers by negotiating on behalf of their bottlers,
thereby reducing the number of major contracts available to two. With more than
two companies vying for these contracts, they were able to negotiate extremely
favourable agreements. In the plastic bottle business, again there were more
suppliers than major contracts. The importance of the large cola companies to the
suppliers also serves to contain whatever bargaining power they may have.

5)Bargaining Power of Buyers

The soft drink industry sells its goods to the end consumers through five principal
channels: food stores, convenience chains (e.g. cost cutter) & Petrol stations,
fountain, vending, and mass merchandiser.

Food stores, the principal customer for soft drink makers, are a highly fragmented.
Due to their tremendous degree of fragmentation, these stores do not have much
bargaining power. Their only power is control over premium shelf space. This power
does give them some control over soft drink profitability. Furthermore, consumers
expected to pay less through this channel, so prices were lower, resulting in
somewhat lower profitability.

National mass merchandising chains such as Asda & Tesco, on the other hand, had
much more bargaining power. They could negotiate more effectively due to their
scale and the magnitude of their contracts. For this reason, the mass merchandiser
channel was relatively less profitable for soft drink makers.

The least profitable channel for soft drinks, however, is fountain sales. Profitability
at these locations was so abysmal for Coke and Pepsi that they considered this
channel “paid sampling.” This was because buyers at major fast food chains like KFC
only needed to stock the products of one manufacturer, so they could negotiate for
optimal pricing. Coke and Pepsi found these channels important, however, as an
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avenue to build brand recognition and loyalty, so they invested in the fountain
equipment and cups that were used to serve their products at these outlets. As a
result, while Coke and Pepsi gained only 5% margins, fast food chains made 75%
gross margin on fountain drinks.

Vending, meanwhile, was the most profitable channel for the soft drink industry.
Essentially there were no buyers to bargain with at these locations, where CSDM
could sell directly to end consumers through machines owned by bottlers. Property
owners were paid a sales commission on products sold through machines on their
property, so their incentives were properly aligned with those of the soft drink
makers, and prices remained high. The customer in this case was the consumer, who
was generally limited on thirst quenching alternatives.

The final channel to consider is convenience stores and gas stations. If BP or Shell
were to negotiate on behalf of its stations, it would be able to exert significant buyer
power in transactions.

The bargaining power of the end consumers is very low. They are a fragmented
group and no one individual’s purchases account for a significant portion of the
manufacturer’s profits. Although the presence of substitutes does serve to increase
buyer power for the consumers, the high degree of brand loyalty mitigates this
power.

So the only buyers with dominant power are fast food outlets and national mass
merchandising chains.

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