Cola Wars
Key Take-aways
Explaining differences in firm-level profitability
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Historically, the CP industry has been very profitable,
while the bottling industry has been less so
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Exhibit 5: pretax margin 35% vs. 9%
Exhibit 4: average ROE 20-25% vs 5-10%
Five forces analysis is a good starting point in
explaining these differences
Key factors that differ between these two industries:
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supplier & buyer power
rivalry
How intense was the Cola War? How do Coke
and Pepsi compete with each other?
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The competitive front:
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shelf-space
advertising
direct store delivery
selective discounting downstream
Concentrate prices rising (Ex. 6)—CPs do not
compete on price
Factors that mitigate the intensity of rivalry

By the 1980s any move made by one player can be
matched by the other
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ad campaigns:
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Vertical integration
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Coke buys and recapitalizes bottlers
Pepsi does same
New products:
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Pepsi--Michael Jackson then Britney Spears
Coke--Bill Cosby then Harry Potter
Coke: C2
Pepsi: Pepsi Edge
…
Most games played to a stalemate
How did Pepsi catch up?
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Pepsi’s Strategy
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Why didn’t Coke respond more aggressively?
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Take-away market; lower price; youth emphasis  different segment
Pepsi Challenge
Fat/happy/lazy(?), arrogant(?), focused on international expansion
Lessons:
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Indirect attack
Exploit inflexibility
Different segment
Exploit (technological) change (i.e., growth of supermarkets)
Vertical integration in the beverage industry

Historically, CPs wrote (semi-)exclusive contracts with bottlers,
but did not own them
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contracts gave bottlers ‘correct’ incentives
non-integration kept the capital requirements of the CP industry small
In the 1980 and 1990s, CPs moved toward “anchor bottler” model
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ownership over bottlers allowed CPs to reap economic efficiencies
as well as to ensure that bottlers would adapt to changing product
strategies (intro of many new products, new packages, competition in
a growing number of channels, etc.)
equity market’s appetite for new offerings allowed CPs to do this
relatively cheaply
Summary

Coke and Pepsi are examples of how firms can create
and exercise market power
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they didn’t inherit this business, they created it
future success will depend on their ability to structure the
industry as well as their own businesses
Coke and Pepsi are smart

when they go to war, they kill the bystanders, not themselves!
Will these factors change as the basis of competition expands
to include non-carbs?
Buy, Sell, or Hold?
Company
Beta
P/E (Forward)
Mean Analyst
Recommendation
Coca Cola
.23
19.0
2.6
Pepsi
.35
18.3
1.8
Cadbury Schwepes
.28
14.5
2.8
Source: Yahoo Finance, 3/17/2005
How much does industry matter?

10-20% of the variation in firms’ profits accounted for
by the industry in which the firm competes

Analysis based on accounting profits in publicly held
companies
How much does industry matter really?
Average Economic Profits of U.S. Industry Groups, 1978-1996
Value Line Industry Groups
ROE-Ke Spread
Toiletries/Cosmetics
Pharmaceuticals
Soft Drink
20%
15%
Tobacco
Food Processing
Household Products
Electrical Equipment
Financial Services
Specialty Chemicals
Newspaper Integrated Petroleum Electric Utility - East
Bank
Retail Store
Telecom
10%
5%
0%
(5%)
(10%)
(15%)
0
100
200
300
Tire & Rubber
Electric Utility - Central
Medical Services
Machinery
Auto & Truck
Computer & Peripheral
Paper & Forest
Air Transport
Average Invested Equity ($B)
Steel
400
500
600
700
800
900 1,000 1,100 1,200 1,300
Source: Ghemawat, Strategy and the Business Landscape, p20.
Objectives of industry analysis

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Explain the differences in profitability across industries
Identify the drivers of industry-level profitability

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Establish a foundation for making a strategic choice

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Who in the value chain captures the value generated by the
industry?
e.g., decisions about entry, exit, or expansion
Highlight important relationships that need to be
managed

Rivals, buyers, suppliers, complementors, potential entrants
Industry analysis has traditionally been a major
input into portfolio analysis for diversified firms
GE / McKinsey Nine-Block Matrix
Industry Attractiveness
Business Strength
High
High
Investment
and
Growth
Medium
Low
Medium
Low
Selective
Growth
Selectivity
Selective
Growth
Selectivity
Harvest/
Divest
Selectivity
Harvest/
Harvest/
Divest
Divest
Harvest/
Harvest/
Divest
Divest
Porter’s Five Forces
Threat of New Entry
Bargaining Power
of Suppliers
• Differentiation of inputs
• Switching costs
• Presence of substitute
inputs
• Supplier concentration
• Importance of volume to
supplier
• Cost relative to total
purchases
• Impact of inputs on cost or
differentiation
• Threat of forward
integration
• Economies of scale
• Proprietary product
differences
• Brand identity
• Switching costs
•
•
•
•
•
Capital requirements
Access to distribution
Absolute cost advantages
Government policy
Expected retaliation
Rivalry Among
Existing Competitors
• Industry growth
• Fixed costs / value
added
• Overcapacity
• Product differences
• Brand identity
•
•
•
•
•
•
Switching costs
Concentration and balance
Informational complexity
Diversity of competitors
Corporate stakes
Exit barriers
Threat of Substitutes
• Relative price performance of substitutes
• Switching costs
• Buyer propensity to substitute
Bargaining Power
of Customers
•
•
•
•
•
•
•
•
•
•
•
Buyer concentration
Buyer volume
Buyer switching costs
Buyer information
Ability to integrate
backward
Substitute products
Price / total purchases
Product differences
Brand identity
Impact of quality /
performance
Buyer profits
Source: Michael E. Porter,
Competitive Advantage
(New York: Free Press, 1985)
Biotech Supply Industry: Investment thesis for
Invitrogen
Threat of New Entry
Bargaining Power
of Suppliers
• Many new research tools
come out of university labs
– must be licensed but
universities have limited
bargaining power since
they can’t commercialize
these products themselves
• Internal R&D ??
• Patents and physical control over biological
materials (such as cell lines) limits entry
• Exclusive licenses to sell some products
• Economies of scope makes it difficult to enter
with a half-full product line
• Niche entry feasible
Rivalry Among
Existing Competitors
• Growing industry
•
• Some products highly
differentiated (although
some are commodities) •
Switching costs high in
some lines of business
(bio-informatics SW)
Informational
complexity
Threat of Substitutes
• None – these products are absolutely
critical to biotechnology research
Bargaining Power
of Customers
• Varies by segment
• University research labs –
fragmented, buy based on
grant money – have little
information and little
incentive to bargain down
price
• Biotech research industry
is also fragmented, but has
more bargaining power –
especially when sharing
procurement effort across a
variety of products
Invitrogen performance
Rivalry
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How hard firms compete on price (or increase quality
levels at a given) price depends on:
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Concentration and balance
Industry growth
Fixed (or storage costs)/Value added
Product differences
Brand identity
Switching costs
Intermittent over-capacity
Diverse stakes
Exit barriers
Threat of Entry
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Factors that create barriers to entry include:
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Economies of scale
Proprietary product differences
Brand image
Switching costs
Capital requirements
Access to distribution
Absolute cost advantages
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Learning curve
Access to necessary inputs
Low cost product design
Government policy
Expected retaliation
Threat of Substitutes

The ability of the industry as a whole to profitably raise
price (the elasticity of the industry’s demand curve)
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Tobacco & pharmaceuticals – inelastic demand
Steel – elastic demand
Likely to change over time with technological changes
or changes in consumer tastes
Determined in part by relative performance / price of
substitutes
Buyer power
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Intrinsic Strength
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Buyer concentration
Buyer volume
Switching costs
Buyer information
Ability to backward
integrate
Substitute products
Pull through
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Price Sensitivity
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Price/Total purchase
Product differences
Brand identity
Impact on
quality/performance
Buyer profits
Decision maker’s
incentives
Supplier Power
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Mirror image of buyer power
Amount of value chain captured by suppliers
influenced by:
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size and concentration of suppliers
degree to which suppliers provide commodity vs. custom
inputs (differentiation)
availability of substitute inputs
ability to backward integrate
importance of volume to suppliers
Dynamics
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Industry analysis provides a “snapshot” of current
conditions in an industry
As we saw in Coors, the industry “landscape” is
subject to “tectonic shifts” over time.
Some of these shifts are under the control of the
players in the industry

Coke and Pepsi shaped the terrain with respect to their
bottlers
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Franchising
Exclusivity
Consolidation and spin-off
An example of industry dynamics
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Industry structure is
frequently changing
Many, but not all,
industries follow
predictable patterns
corresponding to
product life-cycles

Number of Firms, Entry and Exit
In the US Tire Industry
(1905-1980)
S-curve adoption
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Introduction
Growth
Maturity
Decline (?)
Source: Klepper and Simons (2000). “The Making of an Oligopoly: Firm Survival
and Technological Change in the Evolution of the U.S. Tire Industry” Journal of
Political Economy. 108:4, p. 731
Some common long-run dynamics
A major challenge for industry analysis is where
to draw the boundaries

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Typically, industry analysis will be motivated by some choice or
set of possible strategic choices
Horizontal scope

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Vertical scope

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Which product markets?
How many vertically-linked stages in the value chain should be
considered?
Geographic scope

Which geographic markets?
“Everything should be made as simple as possible, but no simpler”
— Albert Einstein
Final words on industry analysis

A starting point for many types of strategic decisions


Strategy should fit the external business environment
In the long run, the business environment is not fixed


It can be shaped by the strategic choices taken by a firm and
its rivals
It also changes based on factors over which the firm has little
control

The role of the strategist is to identify these changes and adapt the firm’s
strategy to them