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Soft Drink Industry Case Study Essay, Research Paper

Soft Drink Industry Case Study

Table of Contents

Introduction 3

Description 3

Segments 3

Caveats 4

Socio-Economic 4

Relevant Governmental or Environmental Factors, etc. 4

Economic Indicators Relevant for this Industry 4

Threat of New Entrants 5

Economies of Scale 5

Capital Requirements 6

Proprietary Product Differences 7

Absolute Cost Advantage 8

Learning Curve 8

Access to Inputs 8

Proprietary Low Cost Production 8

Brand Identity 9

Access to Distribution 9

Expected Retaliation 9

Conclusion 10

Suppliers 10

Supplier concentration 10

Presence of Substitute Inputs 11

Differentiation of Inputs 12

Importance of Volume to Supplier 13

Impact of Input on Cost or Differentiation 13

Threat of Backward or Forward Integration 13

Access to Capital 14

Access to Labor 14

Summary of Suppliers 14

Buyers 15

Buyer Concentration versus Industry Concentration 15

Buyer Volume 15

Buyer Switching Cost 15

Buyer Information 16

Threat of Backward Integration 16

Pull Through 16

Brand Identity of Buyers 17

Price Sensitivity 17

Impact on Quality and Performance 17

Substitute Products 18

Relative price/performance relationship of Substitutes 18

Buyer Propensity to Substitute 18

Rivalry 18

Industry Growth Rate 20

Fixed Costs 21

Product Differentiation 21

Brand Identity 21

Informational Complexity 22

Corporate Stakes 22

Conclusion 23

Critical Success Factors 23

Prognosis 24

Bibliography 26

Appendix 27

Key Industry Ratios 27



The soft drink industry is concentrated with the three major players,

Coca-Cola Co., PepsiCo Inc., and Cadbury Schweppes Plc., making up 90 percent of

the $52 billion dollar a year domestic soft drink market (Santa, 1996). The

soft drink market is a relatively mature market with annual growth of 4-5%

causing intense rivalry among brands for market share and growth (Crouch, Steve).

This paper will explore Porter’s Five Forces to determine whether or not this

is an attractive industry and what barriers to entry (if any) exist. In

addition, we will discuss several critical success factors and the future of the

industry. Segments

The soft drink industry has two major segments, the flavor segment and

the distribution segment. The flavor segment is divided into 6 categories and

is listed in table 1 by market share. The distribution segment is divided in to

7 segments: Supermarkets 31.9%, fountain operators 26.8%, vending machines

11.5%, convenience stores 11.4%, delis and drug stores 7.9%, club stores 7.3%,

and restaurants 3.2%.

Table 1: Market Share

19901991199219931994 Cola69.9

69.768.36765.9 Lemon-Lime11.711.812

12.112.3 Pepper5. Root Orange2.32.3 Other7.

Source: Industry Surveys, 1995


The only limitations on access to information were: 1. Financial information has

not yet been made available for 1996. 2. The majority of the information targets

the end consumer and not the sales volume from the major soft drink producers to

local distributors. 3. There was no data available to determine over capacity.


Relevant Governmental or Environmental Factors, etc.

The Federal Government regulates the soft drink industry, like any industry

where the public ingests the products. The regulations vary from ensuring clean,

safe products to regulating what those products can contain. For example, the

government has only approved four sweeteners that can be used in the making of a

soft drink (Crouch, Steve). The soft drink industry currently has had very

little impact on the environment. One environmental issue of concern is that

the use of plastics adversely affects the environment due to the unusually long

time it takes for it to degrade. To combat this, the major competitors have

lead in the recycling effort which starting with aluminum and now plastics. The

only other adverse environmental impact is the plastic straps that hold the cans

together in 6-packs. These straps have been blamed for the deaths of fish and

mammals in both fresh and salt water.

Economic Indicators Relevant for this Industry

The general growth of the economy has had a slight positive influence on the

growth of the industry. The general growth in volume for the industry, 4-5

percent, has been barely keeping up with inflation and growths on margins have

been even less, only 2-3 percent (Crouch, Steve).

Threat of New Entrants

Economies of Scale

Size is a crucial factor in reducing operating expenses and being able to make

strategic capital outlays. By consolidating the fragmented bottling side of the

industry, operating expenses may be spread over a larger sales base, which

reduces the per case cost of production. In addition, larger corporate coffers

allow for capital investment in automated high speed bottling lines that

increase efficiency (Industry Surveys, 1995). This trend is supported by the

decline in the number of production workers employed by the industry at higher

wages and fewer hours. This in conjunction with the increased value of

shipments over the period shows the increase in efficiency and the economies

gained by consolidation (See table 2).

Table 2 General Statistics: Year

CompaniesWorkersHoursWagesValue of Shipments


16807.5 198341.585.18.2417320.8 198439.8

81.78.5118052 1985141437.277.89.119358.2 1986

133535.573.59.7720686.8 1987119035.471.510.45

22006 1988113535.271.810.7823310.3 1989102733.4

67.710.9823002.1 19909413265.711.4823847.5 1991

31.966.811.8525191.1 199229.861.612.46

26260.4 199328.659.312.9327224.4 199427.4

56.913.3928188.5 199526.254.513.8629152.5 1996

2552.114.3230116.5 Source: Manufacturing USA, 4th Ed.

Further evidence of economies is supported by the increased return on assets

from 1992-1995, as shown in table 3. Coke and Pepsi clearly show increased

return on assets as the asset base increases. However, Cadbury/Schweppes does

not show conclusive evidence from 95 to 96.

Table 3


326690035015004595000 SALES33724003724800


NET INCOME195600236800261900300000 Sales/Income5.80%6.36%

6.50%6.28% Income/Assets6.60%7.25%7.48%6.53%

COKE ASSETS11051934120210001387300015041000 SALES


NET INCOME1664382217600025540002986000

Sales/Income12.73%15.58%15.78%16.57% Income/Assets15.06%18.10%


PEPSI ASSETS20951200237058002479200025432000 SALES


NET INCOME374300158800017520001606000 Sales/Income

1.70%6.35%6.15%5.28% Income/Assets1.79%6.70%7.07%6.31%

Source: Compact Disclosure

Capital Requirements

The requirements within this industry are very high. Production and

distribution systems are extensive and necessary to compete with the industry

leaders. Table 4 shows the average capital expenditures by the three industry


Table 4

Dec-95Dec-94Jan-94Jan-93 Receivables1624333

138576712266331077912 Inventories867666.7

803666.7777366.7716673.7 Plant & Equip5986333

579536752466004642058 Total Assets15022667

140555001299790011655411 Source: Compact Disclosure

The magnitude of these expenditures causes this to be a high barrier to entry.

Proprietary Product Differences

Each firm has brands that are unique in packaging and image, however any of the

product differences that may develop are easily duplicated. However, secret

formulas do create a difference or good will that cannot be duplicated. The

best example of this is the “New Coke” fiasco of 1985. Coke reformulated its

product due to test marketing results that showed New Coke beat Pepsi 47% to 43%

and New Coke was preferred over old Coke by a 10% margin. However, Coke

executives did not take into account the good will created by the old Coke name

and formula. The introduction of New Coke as a replacement of Coke was met by

outrage and unrelenting protest by the public. Three months from the initial

launch of New Coke, management apologized to the public and reissued the old

Coke formula. Test marking shows that there is only a small difference in

actual product taste (52% Pepsi, 48% Coke), but the good will created by a brand

can have significant proprietary differences (Dess, 1993). This is a high

barrier to entry.

Absolute Cost Advantage

Brands do have secret formulas, which makes them unique and new entry into the

industry difficult. New products must remain outside of patented zones but

these differences can be slight. This leads to the conclusion that the absolute

cost advantage is a low barrier within this industry.

Learning Curve

The shift in the manufacturing of soft drinks is gravitating toward automation

due to speed and cost. However, industry technology is low and the

manufacturing process is not difficult, therefore the learning curve will be

short and will have a low barrier to entry.

Access to Inputs

All the inputs within the soft drink industry are commodity items. These

include cane, beet, corn syrup, honey, concentrated fruit juice, plastic, glass,

and aluminum. Access to these inputs is not a barrier to enter the industry.

Proprietary Low Cost Production

The process of manufacturing soft drinks is not a proprietary process. The

methods used in the process are relatively standard within the industry and the

knowledge needed to begin production can easily be acquired. This is not a

barrier to entry.

Brand Identity

This is a very strong force within the industry. It takes a long time to

develop a brand that has recognition and customer loyalty. “Brand loyalty is

indeed the HOLY GRAIL to American consumer product companies.” (Industry Surveys,

1995) A well recognized brand will foster customer loyalty and creates the

opportunity for real market share growth, price flexibility, and above average

profitability (Industry Surveys, 1995). Therefore this is a high barrier to


Access to Distribution

Distribution is a critical success factor within the industry. Without the

network, the product cannot get to the final consumer. The most successful soft

drink producers are aggressively expanding their distribution channels and

consolidating the independent bottling and distribution centers. From 1978 to

the present, the number of Coca-Cola bottlers decreased from 370 to 120

(Industry Surveys, 1995). In addition, 31.9% of the soft drink business is in

supermarkets, where acquiring shelf space is very difficult (Santa, 1996). This

is a high barrier to entry.

Expected Retaliation

Market share within the industry is critical; therefore any attempt to take

market share from the leaders will result in significant retaliation. The soft

drink industry is a moderately mature market with slow single digit growth

(Industry Surveys, 1995). Projected growth rates are 4-5% in sales volume and 2-

3% in margin (Crouch, Steve). Therefore, growth in market share is obtained by

stealing share from rivals causing retaliation to be high in defense of current

market position. This is a high barrier to entry.


To be successful on a large scale, the high capital requirements for

manufacturing, distribution, and marketing are high barriers to entry.

Therefore the threat of new entrants is low making this an attractive industry.


Supplier concentration

Supplier concentration is low due to the fact that the main ingredients are

sugar (cane and beet), water, various chemicals, and aluminum cans, plastic and

glass bottles. There are many places to get sugar and ingredients for soft

drinks because they are commodity items. The containers (aluminum cans, bottles

etc.) make up 36 percent of all the inputs that the industry uses. Other

supplies like sugars, syrups and extracts account for 23 percent of the inputs

(Manufacturing USA). There are five major suppliers of glass bottles. Altrista

Corp., Anchor Glass Container, Glassware of Chile, Owens Illinois, and Vistro Sa

are the major makers of glass bottles (Compact Disclosure). This is a fair

amount of suppliers considering that only five percent of soft drink sales are

in glass bottles. There are even more suppliers of plastic bottles. This is

good because 43% of all sales are from plastic bottles (Prince, 1996). All this

makes the concentration for glass and plastic suppliers moderate. The aluminum

can industry is even older and more established than the plastic industry.

Reynolds Metal Products, American National Can Company and Metal Container Corp.

are the main suppliers of aluminum cans. 50.6% of total soft drink sales are

packaged in aluminum cans (Prince, 1996). Since the aluminum industry is older

and more established, these are likely to be the only manufacturers for a while.

Even though the concentration of aluminum producers are low there are only three

major players in the industry, Coke, Pepsi, and Cadbury. These three account

for nearly 90% of domestic soft drink sales (Dawson, 1996). This makes the

balance of power slightly favor the suppliers of aluminum cans, even though the

number of producers and buyers are equal (3). Syrups and extracts account for

16.7% of input costs to the soft drink industry (Manufacturing USA, Fourth Ed.).

Even though these are a small percentage of inputs, all the major soft drink

companies own companies that produce flavoring extracts and syrups (Industry

Surveys, 1995). This is probably due to the fact that they all have “secret

formulas” and this is how they protect the secret. Coke, Pepsi, and Dr. Pepper

all have “secret formulas”. This makes the concentration of suppliers for

extracts very low but they are owned by the soft drink industry. This backward

integration by the major players makes the power question moot. Suppliers do

have limited power over the soft drink industry. The concentration of suppliers

remains relatively low, which would seem to give the supplier power. The shear

mass and volume that the industry buys negates that effect and balances, if not

tips it back toward the soft drink industry.

Presence of Substitute Inputs

There is not a lot of variety in inputs. The biggest substitute input was when

the industry switched from aluminum cans to plastic bottles. This made the

glass industry almost shake out completely. The next big substitute input was

for sugar. Since people were demanding more and more ways to lose weight and

consume fewer calories, the diet soft drink exploded in sales. This demand made

the soft drink industry find an alternative to sugar to sweeten their product.

This substitute turned out to be Nutrasweet non-sugar sweetener. This was

found to reduce the calories and retain the taste of their respective products.

Other sweeteners, like molasses, do not work because they change the flavor of

the product. Most of these substitute inputs had already taken place so they

become less relevant to the industry as time marched on. Substitute inputs

usually do not become important until the customer or market changes

dramatically. This happens when new studies come out from the government about

how harmful something is. This was the case when scientists came out with the

study that stated that saccharin was harmful to rats. The industry had to

respond by reducing its use of saccharin and look for a substitute. At this

time, the industry found Nutrasweet to be a reasonable substitute for saccharin,

which was used more heavily in diet drinks. All in all, there are a lot of

substitutes for packaging but not for sweeteners because these sweeteners must

have government approval (Crouch, Steve). This makes suppliers have power over

the industry as seen in the almost overnight empire of Nutrasweet. This will

most likely change drastically when Aspirtain (Nutrasweet) loses its patent in a

few years.

Differentiation of Inputs

Sugar is commonly available while Nutrasweet is patented. There is no

differentiation for sugar and only one choice in Nutrasweet. As far as the

other chemicals and inputs, they are commodity items, and it does not matter who

supplies them. This makes suppliers have little power over the soft drink


Importance of Volume to Supplier

The soft drink industry buys a large portion of the Nutrasweet market but their

percentage of purchases are falling as other products begin to use it. Sugar is

bought but not in the volume that the grocery store or other industries do. The

aluminum can, plastic bottles and glass bottles (less now) are all pretty much

dependent on the soft drink industry for their livelihood. This makes the

supplier have pretty much no power over the industry.

Impact of Input on Cost or Differentiation

Since the inputs are basic elements there is no differentiation and therefore no

impact on the final product for using different inputs. If the price of the

input changed, it would dramatically change the price of the product as the

aluminum cartel did in 1994. Since the major inputs are commodity items, the

prices can change dramatically due to environmental forces. If the sugar

industry suffers a loss due to weather or because of political unrest (like in

Cuba), then the prices go up and the soft drink industry is usually left

absorbing them. The soft drink industry can not, in all cases, simply pass

along the price increase. Customers and distributors are more price sensitive

than ever. This makes the supplier have a fair amount of bargaining power over

the industry.

Threat of Backward or Forward Integration

With the current climate of “sticking to the core of the company,” there is

little threat of backward integration into the supplier’s industry. This is

after the fact that they already have integrated into the extracts to protect

their secrets. The integration into the extract-producing segment of the

suppliers will be the extent of the backward integration. The suppliers do not

have the capital required to forward integrate into the soft drink industry.

This makes the industry attractive for investment.

Access to Capital

The soft drink industry is very profitable and therefore looked upon favorably

by financial institutions. This includes the stock market, direct investors

(bondholders), and banks. Currently the operating margins for the industry have

grown from 17.9% in 1992 to 19.5% in 1996. The projected operating margins are

projected to grow to 20.5% from 1997 to 2001 (Value Line 1996). The profit

margins and demand are increasing for the soft drink industry (Industry Surveys,

1995). What this means is that capital is available for expansion or upgrading,

if additional capital is required. This is favorable to the industry.

Access to Labor

The industry is not highly technical except for chemical engineering. This

means that the demands for skilled labor are not very high. Which means that

the soft drink industry will not have trouble finding labor. There are no

established labor unions. The average labor cost is no more than in any other

industry. The average hourly wage is $11.85 per hour, which just about the same

as all manufacturing firms of $11.49 (Manufacturing USA).

Summary of Suppliers

When you sum up the different aspects of the suppliers you come to the quick

conclusion that the power is definitely in the hands of the soft drink industry.

This makes the industry very attractive for investment and for the companies

already in the industry from the supply aspect. This means that it is

attractive to new entrants as well.


Buyer Concentration versus Industry Concentration

The buyers for the soft drink industry are members of a large network of

bottlers and distributors that represent the major soft drink companies at the

local level. Distributors purchase the finished, packaged product from the soft

drink companies while bottlers purchase the major ingredients. With the

consolidation that has occurred within the industry, there is little difference

between the two. Distributors are assigned to represent a specific geographic

area, for example a town or a county. In turn, these distributors are

responsible for distributing the product to the retailers who sell the products

to the end consumer. In recent years, the national companies have been

purchasing independent bottlers in an effort to consolidate the business and

gain some distribution economies of scale (Thompson and Strickland, 1993).

Buyer Volume

The contractual agreements, which are present in this industry, dictate that the

major soft drink companies will sell their products to the distributors.

Therefore, buyer volume is not a factor for this industry. Buyer Switching Cost

Independent bottlers have contractual agreements to represent that company

within a certain area. Switching costs would include establishing new

relationships with other companies to represent and the legal costs associated

with distributors being released from the contract.

Buyer Information

Distributors are very informed about the product that they are distributing.

Information flows freely between the soft drink Companies and the local

distributors and down to the retailers. There are many co-operative promotions

where distributors and soft drink companies collaborate on price and advertising

campaigns (Crouch, Steve). For example, major soft drink firms will send a

regular report out to its distributors describing upcoming promotional events

where the cost will be shared between the two companies. For promotions that

fall outside of this report, the distributors will have to coordinate that

sponsorship with the soft drink company.

Threat of Backward Integration

It is doubtful that local distributors will move into the actual production

process of soft drinks. Distributors specialize in the transportation and

promotion of the product that they rely on the carbonated beverage companies

produce. However, major retailers; for example Wal-Mart and Harris Teeter have

begun distributing their own private label brands of soft drinks. Wal-Mart now

offers Sam’s Choice and Harris Teeter offers President’s Choice at a

significantly lower price. These private label competitors will not provide the

variety of packaging alternatives, which make the national leaders so successful

(PepsiCo 1995 Annual Report). For example, Pepsi offers 12-ounce cans, 20 ounce

bottles, 1 liter bottles, six packs, twelve packs, cases and “The Cube” 24 can


Pull Through

Pull through is not a factor from the independent bottler’s perspective. These

bottlers have a franchise agreement to represent a major carbonated beverage

company on the local level. These distributors are legally bound to represent

these companies and therefore cannot choose not to promote certain types of


Brand Identity of Buyers

Brand identity of buyers is not relevant to the distributors because of the

contractual relationship that exists where distributors represent the soft drink

companies. The distributors have an exclusive contractual agreement to

represent that soft drink brand.

Price Sensitivity

Distributors are not highly price sensitive buyers. Independent bottlers are on

a national contract so all distributors pay the same price for the same products.

Price to Total Purchases

Soft drinks are the single product that the distributors are concerned with so

price is very important to them. Soft drink companies rely on these distributors

to represent them on the local level, so it is important to maintain a healthy


Impact on Quality and Performance

All three of the leading carbonated beverage producers, Coca-Cola, PepsiCo, and

Cadbury Schweppes believe that their buyers (distributors) are an important step

in taking their products to the end consumer. The service, which their

distributors provide to the retailers, makes a difference to the retailers who

sell the product to the end consumer. The actions of that distributor reflect on

the soft drink company so if the distributor does not provide the level of

service that retailer or restaurant desires, it may harm the company’s image.

Substitute Products

Relative price/performance relationship of Substitutes

The carbonated beverage industry provides a non-alcoholic means of satisfying an

individuals desire to quench their thirst. Traditionally, coffee and tea would

be considered substitute products. In recent years, carbonated beverages have

seen the emergence of many new substitute products that wish to reduce soft

drink’s market share. The soft drink market has been traditionally competitive,

without the added friction from “ready to drink tea, shelf stable juice, sports

drinks and still-water” competitors also. (Gleason, 1996) Leaders in these

emerging segments include Quaker Oats, with their Snapple and Gatorade products,

Perrier, and Arizona Iced Teas. “In other words, Pepsi isn’t Coke’s biggest

competition, Tap water is.” (Gleason, 1996). Generally speaking, soft drinks

are less expensive to the consumer than these substitute products.

Buyer Propensity to Substitute

Buyer propensity to substitute is low due to the contractual relationships

between the soft drink companies and the distributors.


Degree of Concentration and Balance among Competitors

Three main competitors: Pepsico, Coca-Cola, and Dr. Pepper/Cadbury

control the Soft Drink industry. Their combined total sales revenues account

for 90 percent of the entire domestic market. This market dominance makes the

industry a fiercely competitive and dynamic business environment to operate in.

The single market leader is Coca-Cola with a 42 percent market share and over

$18 billion in sales worldwide. PepsiCo maintains a 31 percent market share

with $10.5 billion in sales worldwide. The smallest of the three leaders is Dr.

Pepper/Cadbury, which holds roughly 16 percent of the market. Coke’s consistent

dominance of both Pepsi and Dr. Pepper/Cadbury has caused Coke to become a

household name when referring to soft drinks.

As far as balance among competitors is concerned, PepsiCo is a much

larger company than Coke and Dr. Pepper/Cadbury combined. The reason being that

PepsiCo also owns companies in the snack and food industries (Frito-Lay, Pizza

Hut, Taco Bell, and KFC). With a work force of 480,000 people, PepsiCo is the

world’s third largest employer behind General Motors and Wal-Mart. This has not

lead to a more profitable soft drink business, nor has it helped PepsiCo use its

size to steal market share from Coke or Dr. Pepper/Cadbury.

Diversity among Competitors

Though Coca-Cola dominates the industry in sales volume and market share,

it does not dominate when it comes to innovative marketing and business strategy

efforts. For instance, PepsiCo generates 71 percent of its revenues from the

U.S., while Coca-Cola derives 71 percent of its from international markets.

Similarly, PepsiCo only gets 41 percent of its total revenues from soft drinks.

The remaining 59 percent come from its snack and food business. Coke on the

other hand gets all of its revenues from its soft drinks. Clearly both of the

industry leaders have different strategies as far as revenue generation is

concerned. However, as far as their product lines are concerned they are very

similar and operate parallel to one another. Pepsi and Coca-Cola both have

lemon-lime, citrus, root beer, and cola flavors. Dr. Pepper/Cadbury does not

have as similar a product line to that of Pepsico and Coca-Cola. It

manufactures Dr. Pepper (a unique spicy cola drink), ginger ale, tonic water,

and carbonated water under its Schweppes and Canada Dry brands. Coke does have

an answer to Dr. Pepper in its Mr. Pibb, but only holds a .4 percent market

share compared to Dr. Peppers 6 percent market share. The relatively low level

of diversity makes the soft drink industry unattractive for investment.

Industry Growth Rate

Although new product lines have come into the beverage industry over the

past two to three years, the soft drink segment has held and grown its share

steadily. The onslaught of the sport drink and bottled tea have proven to be a

passing fad that has gained little if no long term market share from soft drinks.

Growth figures for the soft drink industry have been very steady since 1993,

and are projected to continue to be so into the last part of the twentieth

century. As can be seen in Figure 1, volatility was somewhat prevalent in the

1980’s but has since lessened and leveled off (Valueline, 1996). Figure 1


‘92′92-’93′93-’94′94-’95 Growth5.7%5.2%2%


Over the past ten years soft drinks have gained 5 percent of total

beverage sales, putting them over the 25 percent share level for all

beverage sales. As for new and emerging markets, both Coke and Pepsi are

attacking the international environment. Coca-Cola generates 80 percent

of its revenues abroad, and Pepsi is attempting but failing to put more

emphasis there as well. “Pepsi is losing customers to Coke in every major

foreign territory. The company has always struggled overseas, but in the past

few months it has lost key strongholds in Russia and Venezuela to Coke” (Sellers,

1996). Because of the consistent growth of both the domestic and foreign

markets, the soft drink industry is attractive for investment.

Fixed Costs

The S&P Industry Survey has shown the soft drink industry profit margin

to be on a steady incline over the past fifteen years. Levels in 1980 were near

14%, while as of year-end 1995 were over 20% and expected to flatten a bit.

This flattening effect may be an indication that fixed costs are on the rise due

to expansion

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