A1) Porter’s five forces analysis of why this industry has been profitable:
Threat of new entry – Extremely low
There are many different barriers to new entry in the CSD industry. Some of them mentioned in the case are:
Bottlers – Pepsi and Coke have exclusive franchisee agreements with a lot of bottlers since they are a crucial step in the chain.
The exclusivity of these restricts the bottlers from working with anyone else so newcomers would be at an extreme disadvantage having to do this in-house.
Bottling is the most expensive part of the chain so this would increase the cost to entry since the firms would need a very large capital investment to start off with. New plants with a 40 million-case bottling capacity costs $75 million in 2005.
The acquisition, consolidation and tight integration of the bottlers with the concentrate producers, results in very few bottlers who would want to work with any newcomer to provide distribution.
The geographic area rights in perpetuity, provided in the negotiated agreements, incentivize the bottlers to stick with their current clients.
Brand Loyalty: Coke and Pepsi have a large amount of Brand equity, which seems insurmountable to the competition, especially if just entering the market.
Expenditure on Advertising and Marketing: The new entrants cannot even begin to compete based on the high costs of advertising and marketing, which are borne primarily by the concentrate producers. In 2004 these would have been almost $3.46 billion (0.51 per case * 6.8 billion cases).
Price undercutting, a strategy frequently employed by Pepsi and Coke, would drive out new entrants as they would be squeezed on their margins constantly and would not have the advantage of economies of scale in the beginning.
Retail Channel: Entrenched relationships with Coke, Pepsi and Cadbury Schweppes are hard to compete against as a new entrant.
The channel members are heavily incentivized at the cost of profitability of the concentrate producers in some cases (Coke and Burger king, Page 4); a move that a new entrant can just not afford.
Together the big players have taken control of buying, installing and servicing vending machines as well as developing vending technology.
Buyers – Can exert power and discriminate but managed through partnerships
The buyers are the channel members and include Supermarkets, fountain outlets, vending machines, mass merchandisers (Super centers, mass retailers, club stores), convenience stores, gas stations and other outlets. Their power to exert downward pressure on prices depends on their share of industry volume (relative to other buyers) and their cost of switching to another brand.
Coke and Pepsi have been able to consistently maintain profitability by testing price sensitivities with expanding products, innovating to drive impulse purchases and target different segments using separate retail channels. A big reason behind this profitability is also the partnerships and ongoing investments concentrate producers and bottlers have maintained with the retail channel to distribute CSDs.
Supermarkets: CSDs are a big draw to the supermarkets and annual sales reached $12.4 billion in 2004. Since they result in the highest volume of distribution, the existing duopoly fights very hard for shelf space, which is at a premium. Impulse purchases and expanding product lines keep profitability consistent.
Fountain outlets: Many existing producers are already incentivizing fountain outlets to carry their product (like Coke to burger king) despite a hit on their profitability. The expectation is that over time this may lead to high profits due to consistent recurring sales.
Vending machines: The bottlers have taken over the buying, installing and servicing of machines while incentivizing store owners with negotiated contracts. Concentrate producers encourage this investment and also play a role in the development of vending technologies.
Mass merchandisers: An