Cola Wars

1
Cola Wars

• Key Take-aways

2
Explaining differences in firm-level profitability

• Historically the CP industry has been very
  profitable while the bottling industry has been
  less so
• 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
• supplier buyer power
• rivalry

3
How intense was the Cola War How do Coke and
Pepsi compete with each other

• The competitive front
• shelf-space
• advertising
• direct store delivery
• selective discounting downstream
• Concentrate prices rising (Ex. 6)CPs do not
  compete on price

4
Factors that mitigate the intensity of rivalry

• By the 1980s any move made by one player can be
  matched by the other
• ad campaigns
• Pepsi--Michael Jackson then Britney Spears
• Coke--Bill Cosby then Harry Potter
• Vertical integration
• Coke buys and recapitalizes bottlers
• Pepsi does same
• New products
• Coke C2
• Pepsi Pepsi Edge
• Most games played to a stalemate

5
How did Pepsi catch up

• Pepsis Strategy
• Take-away market lower price youth emphasis
  different segment
• Pepsi Challenge
• Why didnt Coke respond more aggressively
• Fat/happy/lazy() arrogant() focused on
  international expansion
• Lessons
• Indirect attack
• Exploit inflexibility
• Different segment
• Exploit (technological) change (i.e. growth of
  supermarkets)

6
Vertical integration in the beverage industry

• Historically CPs wrote (semi-)exclusive
  contracts with bottlers but did not own them
• 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
• 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 markets appetite for new offerings
  allowed CPs to do this relatively cheaply

7
Summary

• Coke and Pepsi are examples of how firms can
  create and exercise market power
• they didnt 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
8
Buy Sell or Hold
Source Yahoo Finance 3/17/2005
9
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

10
How much does industry matter really
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Objectives of industry analysis

• Explain the differences in profitability across
  industries
• Identify the drivers of industry-level
  profitability
• Who in the value chain captures the value
  generated by the industry
• Establish a foundation for making a strategic
  choice
• e.g. decisions about entry exit or expansion
• Highlight important relationships that need to be
  managed
• Rivals buyers suppliers complementors
  potential entrants

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Industry analysis has traditionally been a major
input into portfolio analysis for diversified
firms
13
Porters Five Forces
Threat of New Entry

• Economies of scale
• Proprietary product differences
• Brand identity
• Switching costs

• Capital requirements
• Access to distribution
• Absolute cost advantages
• Government policy
• Expected retaliation

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

• 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

• 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

Source Michael E. Porter Competitive
Advantage (New York Free Press 1985)
14
Biotech Supply Industry Investment thesis for
Invitrogen
Threat of New Entry

• 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

Bargaining Power of Suppliers

• Many new research tools come out of university
  labs must be licensed but universities have
  limited bargaining power since they cant
  commercialize these products themselves
• Internal RD

• 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

• Switching costs high insome lines of business
  (bio-informatics SW)
• Informationalcomplexity

Threat of Substitutes

• None these products are absolutely critical to
  biotechnology research

15
Invitrogen performance
16
Rivalry

• How hard firms compete on price (or increase
  quality levels at a given) price depends on
• Concentration and balance
• Industry growth
• Fixed (or storage costs)/Value added
• Product differences
• Brand identity
• Switching costs
• Intermittent over-capacity
• Diverse stakes
• Exit barriers

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Threat of Entry

• Factors that create barriers to entry include
• Economies of scale
• Proprietary product differences
• Brand image
• Switching costs
• Capital requirements
• Access to distribution
• Absolute cost advantages
• Learning curve
• Access to necessary inputs
• Low cost product design
• Government policy
• Expected retaliation

18
Threat of Substitutes

• The ability of the industry as a whole to
  profitably raise price (the elasticity of the
  industrys demand curve)
• 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

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Buyer power

• Intrinsic Strength
• Buyer concentration
• Buyer volume
• Switching costs
• Buyer information
• Ability to backward integrate
• Substitute products
• Pull through

• Price Sensitivity
• Price/Total purchase
• Product differences
• Brand identity
• Impact on quality/performance
• Buyer profits
• Decision makers incentives

20
Supplier Power

• Mirror image of buyer power
• Amount of value chain captured by suppliers
  influenced by
• 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

21
Dynamics

• 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
• Franchising
• Exclusivity
• Consolidation and spin-off

22
An example of industry dynamics
Number of Firms Entry and Exit In the US Tire
Industry (1905-1980)

• Industry structure is frequently changing
• Many but not all industries follow predictable
  patterns corresponding to product life-cycles
• S-curve adoption
• 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. 1084
p. 731
23
Some common long-run dynamics
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A major challenge for industry analysis is where
to draw the boundaries

• Typically industry analysis will be motivated by
  some choice or set of possible strategic choices
• Horizontal scope
• Which product markets
• Vertical scope
• How many vertically-linked stages in the value
  chain should be considered
• Geographic scope
• Which geographic markets

25
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 firms strategy to them