Strategic Management Coke & Pepsi: Industry Analysis and Firm Performance

Professor Jeff Dyer BYU, Marriott School Coke & Pepsi Summary n This case provides an understanding of the underlying economics of an industry and its relationship to average industry profits. The concentrate industry is, on average, more attractive than bottling. n The reason there is not more entry into the concentrate industry (even though only $30-50 million plant investment to serve the U.S) is largely due to barriers to entry: – Brand equity – Brand equity: cost to keep up with Coke & Pepsi ad spending is roughly $2-4 billion over 10 years (Coke brand valued at $70 billion in 2001; Pepsi brand valued at $6.5 billion). – Bottling/franchise system – Bottling/franchise system: cost of national distribution ( plants) is $ billion. Must be niche player or be big. – Limited shelf space, fountains, vending slots – Limited shelf space, fountains, vending slots: cost of slotting allowances estimated at $1-5 million per chain for 3 linear feet (there are major chains); fountains may be impossible due to long term contracts/vertical integration.

Professor Jeff Dyer BYU, Marriott School Coke & Pepsi Summary n Relative to bottling, the concentrate industry also has: – fewer substitutes (bottlers have aluminum, steel, plastic, glass) – greater bargaining power over suppliers (the raw materials for concentrate) and buyers (buyers are fragmented). – This all adds up to a more attractive industry structure for concentrate. n Successful entry will likely require either: – Highly differentiated products (new flavors) in niche markets; or – Circumventing the barriers to entry through alliances (e.g., piggybacking on an existing distribution system; e.g., beer; or with an existing brand name; e.g., Virgin Cola). – Acquisition of existing players (but you will likely pay a premium)

Professor Jeff Dyer BYU, Marriott School Sources of Superior Profitability Superior Profitability Attractive Industry Firm Resources & Capabilities

Professor Jeff Dyer BYU, Marriott School Return on Equity Minus Cost of Capital (ROE-Ke)

Professor Jeff Dyer BYU, Marriott School “Industry Structure” Perspective “Five Forces” Analysis of Competitive Strategy Bargaining Power of Suppliers Threat of New Entrants Rivalry among Existing Competitors Bargaining Power of Buyers Threat of Substitutes

Professor Jeff Dyer BYU, Marriott School Barriers to Entry What factors keep potential competitors out? n Scale economies – e.g., aerospace industry n Scope economies – e.g., retailing n Capital requirements (combined with uncertainty) – e.g., aerospace industry n Switching costs (due to learning, prior investment, network effects) – e.g., Windows operating system n Access to scarce resources (e.g. inputs, distribution, locations) – e.g., DeBeers (diamonds), Coke (distribution) n Product Complexity – e.g., supercomputers, microprocessors n Learning Curve – e.g., Honda motorcycles (motors) n Entry deterring regulations – e.g., Tobacco D A BC Industry

Professor Jeff Dyer BYU, Marriott School Threat of Substitutes What alternatives are available to customers n Direct substitution with similar or the same functionality – diesel vs gas engines – DirecTV vs cable A B C Industry Customers D

Professor Jeff Dyer BYU, Marriott School Nature and Focus of Rivalry Why industries are more or less “competitive”? n Factors – Number of direct competitors & substitutes n Ease of signaling, sharing the market – Industry growth rates n Fast versus slow growth – Exit barriers n e.g., specialized assets, emotional barriers – Fixed costs n e.g. capacity increments – Lack of product differentiation n e.g. differences in functionality, performance – Switching costs n How easy can customers switch? A B C Industry Competitive rivalry can focus on many factors, including price, quality, technology, features, service, etc.

Professor Jeff Dyer BYU, Marriott School Supplier or Buyer Power How can my suppliers or customers extract value Buyer Power n Buyer concentration – Few vs many customers n Volume of purchases – Large vs small purchase decisions n Available alternative products – Competitive products n Threat of backward integration – Ability to become a competitor n Switching costs – Threat of switching suppliers Supplier Power n Supplier concentration – Few vs many suppliers n Supplier volume – Large vs small purchase decisions n Product differences – Dependence on unique features n Threat of forward integration – Ability to become competitor n Switching costs – Limitations on ability to change suppliers

Professor Jeff Dyer BYU, Marriott School How Industry Structure Influences Profitability Percent of Market Others (>10,000) ConAgra (1%) Stouffer (34%) Swanson (25%) Campbell (17%) Green Giant (4%) Others (>10) (20%) Safeway (4%) Kroger(3%) American (2%) Others (>1000) (90%)

Professor Jeff Dyer BYU, Marriott School SUPPLIER POWER HIGH strong labor unions concentrated aircraft makers THREAT OF ENTRY HIGH entrants have cost advantages moderate capital requirements little product differentiation deregulation of governmental barriers INDUSTRY RIVALRY HIGH many companies little differentiation excess capacity high fixed/variable costs cyclical demand THREAT OF SUBSTITUTES MEDIUM Autos/train for short distances BUYER POWER MEDIUM/HIGH Buyers extremely price sensitive Good access to information Low switching costs Example: Airlines Source: J. de la Torre

Professor Jeff Dyer BYU, Marriott School SUPPLIER POWER LOW THREAT OF ENTRY LOW economies of scale capital requirements for R&D and clinical trials (more than $300 million per drug). product differentiation control of distribution channels patent protection INDUSTRY RIVALRY LOW-MED high concentration product differentiation patent protection steady demand growth no cyclical fluctuations of demand THREAT OF SUBSTITUTES LOW No substitutes. (Changing as managed care encourages generics.) BUYER POWER LOW Physician as buyer: Not price sensitive No bargaining power. (Changing with managed care.) Example: Pharmaceuticals Source: J. de la Torre

Professor Jeff Dyer BYU, Marriott School Successful Strategies Should: n Minimize buyer power – (e.g., build customer loyalty) n Offset supplier power – (e.g., alternative source(s)) n Avoid excessive rivalry – (e.g., attack emerging vs entrenched segments) n Raise barriers to entry – (e.g., make preemptive investments) n Reduce the threat of substitution – (e.g., incorporate their benefits)