Coke vs. Pepsi Case Discussion

1. Coke vs. PepsiCase Discussion James Oldroyd Kellogg Graduate School of Management Northwestern University J-oldroyd@northwestern.edu

2. Sample Exam Question • In this class we have discussed the “experience curve” as a strategy concept. • A) Please describe and define what the experience curve is (identify what information you would need to calculate an experience curve (for a company or an industry). • B) Identify at least two ways that the experience curve is used by companies to help them in making business decisions. • Please describe Porter’s diamond model and discuss how it helps identify which countries are likely to produce companies that will succeed in international competition.

3. Growth • How did the companies get us to double our consumption of soda?

4. Entry Costs Bottler Concentrate Producer Why are there more Bottlers than Concentrate Producers?

5. What are the other costs? http://www.pepsi.com/current/music/britney/video/pepx4296_nownthen_hi.asx http://www.coca-cola.com/tvads/

6. Why buy the bottlers? Concentrate 40% margin Bottlers 10% margin Vs.

7. Coke & Pepsi Summary • This case provides an understanding of the underlying economics of an industry and its relationship to average industry profits. The concentrate industry is, on average, more attractive than bottling. • The reason there is not more entry into the concentrate industry (even though only $5-10 million plant investment to serve the U.S) is largely due to barriers to entry: • Brand equity: cost to keep up with Coke & Pepsi ad spending is roughly $20-25 billion over 10 years (Coke brand valued at $75 billion in 1999). • Bottling/franchise system: cost of national distribution (80-85 plants) is $1.6-4.3 billion. May keep niche players out. • Limited shelf space, fountains, vending slots: cost of slotting allowances could be $500 or more per store; fountains may be impossible due to long term contracts/vertical integration. • Relative to bottling, the concentrate industry also has fewer substitutes, greater bargaining power over suppliers (the raw materials for concentrate) and buyers (buyers are fragmented). This all adds up to a more attractive industry structure for concentrate.

8. Total Barrier to Entry Brand equity $20-25 billion over 10 years Bottling/franchise system 4.3 billion shelf space 28 million + (56,000 Stores X $500 per store) $30 Billion + Total

9. Coke and Pepsi today

10. Three Levels of Business Strategy Industry Firm Business Unit • Which Business Units? • Business Unit Boundaries • Managing Cross Business Synergies • Choose Your Sandbox • Business Definition • Firm Resources Strategic Advantage

11. Industry Analysis Porter’s Five Forces Model Threat of New Entrants Bargaining Power of Suppliers Rivalry among Existing Competitors Bargaining Power of Buyers Threat of Substitutes

12. Industry A D B C Barriers to EntryWhat factors keep potential competitors out? Threat of New Entrants Bargaining Power of Suppliers Rivalry among Existing Competitors Bargaining Power of Buyers Threat of Substitutes • Scale economies • e.g., aerospace industry • Scope economies • e.g., retailing • Capital requirements • e.g., aerospace industry • Switching costs • e.g., MSDOS operating system • Access to distribution • e.g., Campbell soup • Entry deterring regulations • e.g., Tobacco

13. A C B Nature and Focus of RivalryWhy industries are more or less “competitive”? Threat of New Entrants Bargaining Power of Suppliers Rivalry among Existing Competitors Bargaining Power of Buyers Threat of Substitutes • Factors • Industry growth rates • Where to secure growth • Exit barriers • e.g., specialized assets, emotional barriers • Fixed costs • e.g. capacity increments • Lack of product differentiation • e.g. differences in functionality, performance • Switching costs Industry Competitive rivalry can focus on many factors, including price, quality, technology, features, service, etc.

14. A C D B Customers Threat of SubstitutesWhat alternatives are available to customers Threat of New Entrants Bargaining Power of Suppliers Rivalry among Existing Competitors Bargaining Power of Buyers Threat of Substitutes • Direct substitution with the same functionality • diesel vs gas engines • DirecTV vs cable • Eliminating need for product • water meters vs flat rate Industry

15. Willingness to Pay Value Captured by Customer Price Value Captured by Firm Cost Value Captured by Supplier Supplier opportunity cost Value Division Customer Firm Supplier Added Value is the total value created with the firm in the game – total value created without the firm in the game or the value that would be lost to the world if the firm disappeared. A firm cannot capture more than its added value.

16. Buyer Power Supplier Power Supplier or Buyer PowerHow can my suppliers or customers extract value Threat of New Entrants Bargaining Power of Suppliers Rivalry among Existing Competitors Bargaining Power of Buyers Threat of Substitutes • Supplier concentration • Few vs many suppliers • Supplier volume • Large vs small purchase decisions • Product differences • Dependence on unique features • Threat of forward integration • Ability to become competitor • Switching costs • Limitations on ability to change suppliers • Buyer concentration • Few vs many customers • Volume of purchases • Large vs small purchase decisions • Available alternative products • Competitive products • Threat of backward integration • Ability to become a competitor • Switching costs • Threat of switching suppliers

17. How Industry Structure Influences Profitability 120 100 Others (>10) (20%) 80 Green Giant (4%) Percent of Market Others (>1000) (90%) Others (>10,000) Campbell (17%) 60 Swanson (25%) 40 20 ConAgra (1%) Stouffer (34%) American (2%) Kroger(3%) Safeway (4%) 0 Farmers Frozen Entree Makers Food 5-10% ROE 20-25% ROE Retailers 8-12% ROE

18. Threat of New Entrants Bargaining Power of Suppliers Rivalry among Existing Competitors Bargaining Power of Buyers Threat of Substitutes Successful Strategies Should: • Avoid excessive rivalry • (e.g., attack emerging vs entrenched segments) • Raise barriers to entry • (e.g., make preemptive investments) • Reduce the threat of substitution • (e.g., incorporate their benefits) • Minimize buyer power • (e.g., build customer loyalty) • Offset supplier power • (e.g., alternative source(s))

19. Additional Industry Analysis Tools • SWOT Analysis: Numerous Environmental Opportunities Overcome Weaknesses Grow Substantial Internal Strengths Critical Internal Weaknesses Restructure Diversify Major Environmental Threats