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
Introduction
Description
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 Pepper5.66.26.97.37.6 Root
2.72.82.32.72.7 Orange2.32.3
2.62.32.3 Other7.87.27.98.69.2
Source: Industry Surveys, 1995
Caveats
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.
Socio-Economic
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
1982162642.485.27.84
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
CADBURY/SCHWEPPES93949596 ASSETS2963100
326690035015004595000 SALES33724003724800
40296004776000
NET INCOME195600236800261900300000 Sales/Income5.80%6.36%
6.50%6.28% Income/Assets6.60%7.25%7.48%6.53%
COKE ASSETS11051934120210001387300015041000 SALES
13073860139630001618100018018000
NET INCOME1664382217600025540002986000
Sales/Income12.73%15.58%15.78%16.57% Income/Assets15.06%18.10%
18.41%19.85%
PEPSI ASSETS20951200237058002479200025432000 SALES
21970000250210002847240030421000
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
leaders.
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
entry.
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.
Conclusion
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.
Suppliers
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
industry.