*Dr.P.Shanmukha Rao **Dr.N.V.S.Suryanarayana
Soft drink market size for FY00 was around 270mn cases (6480mn bottles). The market witnessed 5- 6% growth in the early‘90s. Presently the market growth has growth rate of 7- 8% per annum compared to 22% growth rate in the previous year. The market size for FY01 is expected to be 7000mn bottles.
Soft Drink Production area
The market preference is highly regional based. While cola drinks have main markets in metro cities and northern states of UP, Punjab, Haryana etc. Orange flavored drinks are popular in southern states. Sodas too are sold largely in southern states besides sale through bars. Western markets have preference towards mango flavored drinks. Diet coke presently constitutes just 0.7% of the total carbonated beverage market.
Growth promotional activities
The government has adopted liberalized policies for the soft drink trade to give the industry a boast and promote the Indian brands internationally. Although the import and manufacture of international brands like Pepsi and Coke is enhanced in India the local brands are being stabilized by advertisements, good quality and low cost.
The soft drinks market till early 1990s was in hands of domestic players like Campa, Thumps up, Limca etc but with opening up of economy and coming of MNC players Pepsi and Coke the market has come totally under their control.
The distribution network of Coca cola had 6.5lakh outlets across the country in FY00, which the company is planning to increase to 8 lakhs by FY01.
On the other hand Pepsi Co’s distribution network had 6 lakh outlets across the country during FY00 which it is planning to increase to 7.5Lakh by FY01.
Types of soft drinks
Soft drinks are available in glass bottles, aluminum cans and PET bottles for home consumption. Fountains also dispense them in disposable containers Non-alcoholic soft drink beverage market can be divided into fruit drinks and soft drinks. Soft drinks can be further divided into carbonated and non-carbonated drinks. Cola, lemon and oranges are carbonated drinks while mango drinks come under non carbonated category.
The market can also be segmented on the basis of types of products into cola products and non-cola products. Cola products account for nearly 61-62% of the total soft drinks market. The brands that fall in this category are Pepsi, Coca- Cola, Thumps Up, diet coke, Diet Pepsi etc. Non-cola segment which constitutes 36% can be divided into 4 categories based on the types of flavors available, namely: Orange, Cloudy Lime, Clear Lime and Mango.
The soft drink industry is so profitable
An industry analysis through Porter’s Five Forces reveals that market forces are favorable for profitability. Defining theindustry Both concentrate producers (CP) and bottlers are profitable. Thesetwo parts of the Industries are extremely interdependent, sharing costs in procurement, production, marketing and distribution. Many of their functions overlap; for instance, CPs do some bottling, andbottlers conduct many promotional activities. The industry is already vertically integrated to some extent. They also deal with similar suppliers and buyers. Entry into the industry would involve developing operations in either or both disciplines. Beverage substitutes would threaten both CPs and their associated bottlers. Because of operational overlap and similarities in their market environment, we can include both CPs and bottlers in our definition of the soft drink industry. In 1993, CPs earned 29% pretax profits on their sales, while bottlers earned 9% profits on their sales, for a total industry profitability of 14% (Exhibit 1). This industry as a whole generates positive economic profits
Revenues are extremely concentrated in this industry, with Coke and Pepsi, together with their associated bottlers, commanding 73% of the case market in 1994. Adding in the next tier of soft drink companies, the top six controlled 89% of the market. In fact, one could characterize the soft drink market as an oligopoly, or even a duopoly between Coke and Pepsi, resulting in positive economic profits. To be sure, there was tough competition between Coke and Pepsi for market share, and this occasionally hampered profitability.
For example, price wars resulted in weak brand loyalty and eroded margins for both companies in the 1980s. The Pepsi Challenge, meanwhile, affected market share without hampering per case profitability, as Pepsi was able to compete on attributes other than price.
Through the early 1960s, soft drinks were synonymous with “colas” in the mind of consumers. Over time, however, other beverages, from bottled water to teas, became more popular, especially in the 1980s and 1990s. Coke and Pepsi responded by expanding their offerings, through alliances (e.g. Coke and Nestea), acquisitions (e.g. Coke and Minute Maid), and internal product innovation (e.g. Pepsi creating Orange Slice), capturing the value of increasingly popular substitutes internally.
Proliferation in the number of brands did threaten the profitability of bottlers through 1986, as they more frequent line set-ups, increased capital investment, and development of special management skills for more complex manufacturing operations and distribution. Bottlers were able to overcome these operational challenges through consolidation to achieve economies of scale. Overall, because of the CPs efforts in diversification, however, substitutes became less of a threat.
Power of Suppliers:
The inputs for Coke and Pepsi’s products were primarily sugar and packaging. Sugar could be purchased from many sources on the open market, and if sugar became too expensive, the firms could easily switch to corn syrup, as they did in the early 1980s. So the suppliers of nutritive sweeteners did not have much bargaining power against Coke, Pepsi, and their bottlers. NutraSweet, meanwhile, had recently come off patent in 1992, and the soft drink industry gained another supplier, Holland Sweetener, which reduced Searle’s bargaining power and lowering the price of aspartame. With an abundant supply of inexpensive aluminum in the early 1990s and several can companies competing for contracts with bottlers, can suppliers had very little supplier power. Furthermore, Coke and Pepsi effectively further reduced the supplier of can makers by negotiating on behalf of their bottlers, thereby reducing the number of major contracts available to two.
With more than two companies vying for these contracts, Coke and Pepsi were able to negotiate extremely favorable agreements. In the plastic bottle business, again there were more suppliers than major contracts, so direct negotiation by the CPs was again effective at reducing supplier power.
Power of buyers:
The soft drink industry sold to consumers through five principal channels food stores, convenience and gas, fountain, vending, and mass merchandisers (primary part of “Other” in “Cola Wars…” case). Supermarkets, the principal customer for soft drink makers, were a highly fragmented industry. The stores counted on soft drinks to generate consumer traffic, so they needed Coke and Pepsi products. But due to their tremendous degree of fragmentation (the biggest chain made up 6% of food retail sales, and the largest chains controlled up to 25% of a region), these stores did not have much bargaining power. Their only power was control over premium shelf space, which could be allocated to Coke or Pepsi products. This power did give them some control over soft drink profitability. Furthermore, consumers expected to pay less through this channel, so prices were lower, resulting in somewhat lower profitability. National mass merchandising chains such as Wal-Mart, on the other hand, had much more bargaining power. While these stores did carry both Coke and Pepsi products, they could negotiate more effectively due to their scale and the magnitude of their contracts. For this reason, the mass merchandiser channel was relatively less profitable for soft drink makers.
The least profitable channel for soft drinks, however, was fountain sales. Profitability at these locations was so abysmal for Coke and Pepsi that they considered this channel “paid sampling.” This was because buyers at major fast food chains only needed to stock the products of one manufacturer, so they could negotiate for optimal pricing. Coke and Pepsi found these channels important, however, as an avenue to build brand recognition and loyalty, so they invested in the fountain equipment and cups that were used to serve their products at these outlets.
As a result, while Coke and Pepsi gained only 5% margins, fast food chains made 75% gross margin on fountain drinks. Vending, meanwhile, was the most profitable channel for the soft drink industry. Essentially there were no buyers to bargain with at these locations, where Coke and Pepsi bottlers could sell directly to consumers through machines owned by bottlers. Property owners were paid a sales commission on Coke and Pepsi products sold through machines on their property, so their incentives were properly aligned with those of the soft drink makers, and prices remained high. The customer in this case was the consumer, who was generally limited on thirst quenching alternatives.
The final channel to consider is convenience stores and gas stations. If Mobil or Seven-Eleven were to negotiate on behalf of its stations, it would be able to exert significant buyer power in transactions with Coke and Pepsi. Apparently, though, this was not the nature of the relationship between soft drink producers and this channel, where bottlers’ profits were relatively high, at $0.40 per case, in 1993. With this high profitability, it seems likely that Coke and Pepsi bottlers negotiated directly with convenience store and gas station owners. So the only buyers with dominant power were fast food outlets. Although these outlets captured most of the soft drink profitability in their channel, they accounted for less than 20% of total soft drink sales.
Barriers to Entry:
It would be nearly impossible for either a new CP or a new bottler to enter the industry. New CPs would need to overcome the tremendous marketing muscle and market presence of Coke, Pepsi, and a few others, who had established brand names that were as much as a century old. Through their DSD practices, these companies had intimate relationships with their retail channels and would be able to defend their positions effectively through discounting or other tactics. So, although the CP industry is not very capital intensive, other barriers would prevent entry. Entering bottling, meanwhile, would require substantial capital investment, which would deter entry.
Further complicating entry into this market, existing bottlers had exclusive territories in which to distribute their products. Regulatory approval of intra brand exclusive territories, via the Soft Drink Inter brand Competition Act of 1980, ratified this strategy, making it impossible for new bottlers to get started in any region where an existing bottler operated, which included every significant market in the US. In conclusion, an industry analysis by Porter’s Five Forces reveals that the soft drink industry in 1994 was favorable for positive economic profitability, as evidenced in companies’ financial outcomes.
Compare the economics of the concentrate business to the bottling business
In some ways, the economics of the concentrate business and the bottling business should be inextricably linked. The CPs negotiate on behalf of their suppliers, and they are ultimately dependent on the same customers. Even in the case of materials, such as aspartame, that are incorporated directly into concentrates, CPs pass along any negotiated savings directly to their bottlers. Yet the industries are quite different in terms of profitability.
The fundamental difference between CPs and bottlers is added value. The biggest source of added value for CPs is their proprietary, branded products. Coke has protected its recipe for over a hundred years as a trade secret, and has gone to great lengths to prevent others from learning its cola formula. The company even left a billion-person market (India) to avoid revealing this information. As a result of extended histories and successful advertising efforts, Coke and Pepsi are respected household names, giving their products an aura of value that cannot be easily replicated. Also hard to replicate are Coke and Pepsi’s sophisticated strategic and operational management practices, another source of added value.
Bottlers have significantly less added value. Unlike their CP counterparts, they do not have branded products or unique formulas. Their added value stems from their relationships with CPs and with their customers. They have repeatedly negotiated contracts with their customers, with whom they work on an ongoing basis, and whose idiosyncratic needs are familiar to them. Through long-term, in depth relationships with their customers, they are able to serve customers effectively. Through DSD programs, they lower their customers’ costs, making it possible for their customers to purchase and sell more product. In this way, bottlers are able to grow the pie of the soft drink market. Their other source of profitability is their contract relationships with CPs, which grant them exclusive territories and share some cost savings. Exclusive territories prevent intrabrand competition, creating oligopolies at the bottler level, which reduce rivalry and allow profits. To further build “glass houses,” as described by Nalebuff and Brand enterer (Co-petition, p. 88), for their bottlers, CPs pass along some of their negotiated supply savings to their bottlers. Coke gives 2/3 of negotiated aspartame savings to its bottlers by contract, and Pepsi does this in practice. This practice keeps bottlers comfortable enough, so that they are unlikely to challenge their contracts. Bottlers’ principal ability is to use their capital resources effectively. Suchoperational effectiveness is not a driver of added value, however, as operational effectiveness is easily replicated.
Between 1986 and 1993, the differences in added value between CPs and bottlers resulted in a major shift in profitability within the industry. Exhibit 1 demonstrates these dramatic changes. While industry profitability increased by 11%, CP profits rose by 130% on a per case basis, from $0.10 to $0.23. During this period, bottler profits actually dropped on a per case basis by 23%, from $0.35 to 0.27. One possibility is that product line expansion in defense against new age beverages helped CPs but hurt bottlers. This would be expected if bottler’s per case costs increased due to the operational challenges and capital costs of producing and distributing broader product lines. This, however, was not the case; cost of sales per case decreased for both CPs and bottlers by 27% during this period, mostly due to economies of scale developed through consolidation. The real difference between the fortunes of CPs and bottlers through this period, then, is in top line revenues. While CPs were able to charge more for their products, bottlers faced price pressure, resulting in lower revenues per case. These per case revenue changes occurred during a period of slowing growth in the industry, as shown in Exhibit 2. Growth in per capita consumption of soft drinks slowed to a 1.2% CAGR in the period 1989 to 1993, while case volume growth tapered to 2.3%. In an struggle to secure limited shelf space with more products and slower overall growth, bottlers were probably forced to give up more margin on their products. CPs, meanwhile, could continue increasing the prices for their concentrates with the consumer price index.
Coke had negotiated this flexibility into its Master Bottling Contact in 1986, and Pepsi had worked price increases based on the CPI into its bottling contracts. So, while the bottlers faced increasing price pressure in a slowing market, CPs could continue raising their prices. Despite improvements in per case costs, bottlers could not improve their profitability as a percent of total sales. As a result, through the period of 1986 to 1993, bottlers did not gain any of the profitability gains enjoyed by CPs.
Contracts between CPs and bottlers taken the form they have in the soft drink industry:
Contracts between CPs and bottlers were strategically constructed by the CPs. Although beneficial to bottlers on the surface, the contracts favored the CPs’ long-term strategies in important ways. First, territorial exclusivity is beneficial to bottlers, as it prevents intrabrand competition, ensures bargaining power over buyers and establishes barriers to entry. But it is also beneficial to CPs, who are also not subject to price wars within their own brand. The contracts also excluded bottlers from producing the flagship products of competitors. This created monopoly status for the CPs, from the bottler perspective. Each bottler could only negotiate with one supplier for its premium product. Violation of this stipulation would result in termination of the contract, which would leave the bottler in a difficult position. Historically, contracts were designed hold syrup prices constant into perpetuity, only influenced by rising prices of sugar. This changed in 1978 and 1986, as contracts were renegotiated, first to accommodate for rises in the CPI, and then to give general flexibility to the CP (Coke) in setting prices. Coke could negotiate this more flexible pricing because its bottlers were dependent on it for business. It further ensured that its bottlers would be captive to its monopoly status by buying major bottlers and then selling them into the CCE holding company, which would only produce Coke products. Coke would capture 49% of the dividends from CCE, without the complications of vertical integration.
Should concentrate producers vertically integrate into bottling Given the data in Exhibit 1, indicating the CP business has grown more profitable over the last seven years, while the bottling industry has struggled to retain any profitability, it would not be advisable to vertically integrate. Stuckey and White indicate that a firm should “Integrate into those stages of the industry chain where the most economic surplus is available, irrespective of closeness to the customer or the absolute size of the value added.” In the soft drink industry, CPs generally miss out on the profits earned through fountain sales. Pepsi, realizing that fast food chains were capturing most of the value of fountain sales, entered the fast food business by purchasing Taco Bell, Pizza Hut, and KFC. These mergers allowed the firm to capture more value from its soft drink sales, but these mergers could also be problematic. For example, PepsiCo might not have a core competency in food sales or a strong position in the industry. Because it might not be able to effectively transfer skills or share activities with its fast food businesses, the mergers might not be successful in the long run. Stuckey and White also point out that “high-surplus stages must, by definition, be protected by barriers to entry.” So it could be difficult for Coke to enter the fast food business. It could be prohibitively expensive to purchase McDonalds or Burger King, and developing a chain of its own against such formidable competition would be extremely risky. So integration into this phase of the value chain would be difficult or impossible for Coke.
As Stuckey and White say, “don’t vertically integrate unless it is absolutely necessary to create or protect value.” We shall address each of these individually to formally refute the plausibility of vertical integration of CPs into bottling. (1) “The market is too risky and unreliable.” On the contrary, the concentrate
Market is highly stable and will be for a long time to come. “Companies in adjacent stages of the induct chain have more market power than companies in your stage.” The opposite is true, CPs already have more market power than bottlers, so they should not vertically integrate. “Integration would create or exploit market power by raising barriers to entry or allowing price discrimination across customer segments.” In fact, CPs already have market power through efficient barriers to entry, and effectively price discriminate through various retail channels. (4) “The market is young and the company must forward integrate to develop a market, or the market is declining and independents are pulling out of adjacent stages.” The market is neither young nor declining. Having determined that a vertical integration strategy fails all four of Stuckey and White’s tests, CPs should not pursue vertical integration into bottling.
NEW DELHI — One of India’s leading voluntary agencies, the center for Science and Environment (CSE) said Tuesday that soft drinks manufactured in India, including those carrying the Pepsi and Coca-Cola brand names, contain unacceptably high levels of pesticide residues.
The CSE analyzed samples from 12 major soft drink manufacturers that are sold in and around the capital at its laboratories and found that all of them contained residues of four extremely toxic pesticides and insecticides–lindane, DDT, malathion and chlorpyrifos.
”In all the samples tested, the levels of pesticide residue far exceeded the maximum permissible total pesticide limit of 0.0005 mg per liter in water used as food, set down by the European Economic Commission (EEC),” said Sunita Narain, director of the CSE at a press conference convened to announce the findings.
The level of chlorpyrifos was 42 times higher than EEC norms, their study showed. Malathion residues were 87 times higher and lindane–recently banned in the United States–21 times higher, CSE scientists said. They added that each sample was toxic enough to cause long-term cancer, damage to the nervous and reproductive systems, birth defects, and severe disruption of the immune system.
Samples from brand leaders Coca-Cola and Pepsi had almost similar concentrations of pesticide residues in the CSE findings. Contaminants in Pepsi samples were 37 times higher than the EEC limit while its rival Coca-Cola exceeded the norms by 45 times, the same findings showed.
The chiefs of the Indian subsidiaries of Coca-Cola and Pepsi were quick to refute the charges made at the press conference. Sanjeev Gupta, president of Coca-Cola India, called the revelations made by CSE ”unfair” and said his company was being subjected to a ”trial by media”.
”All Coca -Cola products are repeatedly tested for safety norms. This is unacceptable,” he said over the telephone. Gupta and the chief of the Pepsi India, Rajiv Baksh, have called for an independent inquiry led by India’s top scientists to settle the issue.
Coca-Cola, the world’s ”most valuable brand” at $70 billion, is already defending charges made by British Broadcasting Corp Radio 4 last month that waste sludge distributed to farmers from its plant at Plachimada in southern Kerala state has high concentrations of the toxic metal cadmium. In a joint press conference by Pepsi and Coke here Tuesday evening, Bakshi and Gupta said they were contemplating legal action against the CSE because the revelations had harmed the industry.
”We expect a temporary setback for about a week or so and then we are sure the consumers will have the same confidence in us they have always shown,” said Bakshi. But Narain said the CSE stood by its findings.
Six months ago, CSE announced findings that nearly all bottled mineral water manufactured in India, including brands owned by Pepsi and Coca-Cola had large amounts of pesticides. This led to a massive government crackdown. At the time, Delhi state health minister A K Walia, a qualified physician himself, upheld the CSE findings and its laboratory. ”They (CSE) are using sensitive, internationally accepted methods,” he said. CSE scientists H. B. Mathur and Sapna Johnson, who were present at the press conference, said their basic inference was that, as with the bottled mineral water, the soft drink manufacturers were drawing their water supplies from groundwater that is heavily contaminated by years of indiscriminate pesticide use.
High pesticide residues were reported in groundwater around Delhi two years ago, when the government’s Central Ground Water Board (CGWB) and the Central Pollution Control Board (CPCB) carried out a study which also reported excessive salinity, nitrate and fluoride content besides traces of lead, cadmium and chromium. Independent surveys have shown that tap water in the capital drawn from the Yamuna river and treated by Delhi Jal Board, the state-owned water utility, was loaded with bacteria that can cause cholera, typhoid and hepatitis. It also contained unacceptable amounts of solids and dissolved matter.
Narain said it was not easy to take the companies to court because they hide behind a ”meaningless maze” of government regulations concerning the manufacture of soft drinks, which are completely ineffective and designed to help the soft drink industry rather than consumers.
The Prevention of Food Adulteration (PFA) Act of 1954 and the Fruit Products Order (FPO) of 1955–both aimed at regulating the quality of contents in beverages – do not even provide scope for regulating pesticides in soft drinks Lax standards on food products are cited as one reason why India has not been able to make a dent in the international market. Last week, a European agency ordered alerts on chili powder imported from India because samples were found to be adulterated with banned carcinogenic dyes. Significantly, the CSE laboratories tested samples of soft drink brands popularly sold in the United States as control–and found that they did not contain any pesticide residue.
In 2001, Indians consumed over 6.5 billion bottles of soft drinks Their growing popularity means that children and teenagers, who glug these bottles, are drinking a toxic potion, activists say. CSE found that the regulations for the powerful and massive soft drinks industry are much weaker, indeed non-existent, as compared to those for the bottled water industry. The norms that exist to regulate the quality of cold drinks are inadequate, leaving this “food” sector virtually unregulated.
So pampered is the lucrative soft drink sector that it is exempted from the provisions of industrial licensing under the Industries (Development and Regulation) Act, 1951. A one-time licence from the ministry of food processing industries includes a no-objection certificate from the local government as well as the state pollution control board, and a water analysis report. There are no environmental impact assessments or sitting regulations, so the industry’s use of water is not regulated.