Case 2: Is the Cola Industry Attractive?

An industry is deemed to be attractive for new entrants when they can envision profitability in long-term. There are several determinants of the Cola industry profit which include customers’ demand, the intensity of competition, and the bargaining power of the concentrate producers relative to their suppliers. In term of demand, U.S. sales volume of CSD grew at a rate of 1% or less in the years 1998 to 2004. That is in contrast to the annual grow rate of 3% to 7% during the 1980s and early 1990s. The flat demand is observed to be indifferent in global market sales. Unless new entrants could enlarge the consumption market for the Cola industry, it is hard to say that this industry is still attractive.  That is not to weigh in competition and suppliers’ bargaining power which will create additional barriers for new entrants.

CSD consumptions seem to reach its peak in 1998 with 54 gallons per capita in the U.S. market. After 1998, CSD demand gradually declines perhaps due to customers awareness concerning children obesity and the growing of other alternatives such as bottled water and energy drinks. In response to public concern alleging CSDs as the largest source of obesity-causing sugars in the American diet, the industry  developed Diet Coke, Pepsi Zero and Sierra Mist Free using artificial sweetener such as aspartame. This is also the beginning for the introduction of non-carbonated beverages including bottled water and energy drinks. These alternatives garnered a higher profit margin than cola products; even though the demand for these alternatives are only one third the demand of cola products. Comparing the profit margin in the early 2000s, Pepsi’s Aquafina garnered a profit of 22.4% as opposed to 19.0% for a bottle of Pepsi-Cola. The switch to alternatives had a chain effect explaining the decline in cola products’ consumption.

In term of competition, the industry comprises of three major producers Pepsi, Coke and Cadbury which make up about 90% U.S. market and 80% world market of CSDs. Concentrate producers also pay a lot attention on advertising and marketing, composed of 43% net sales. Even though there is less capital investment requirement for concentrate producers of about $25-50 million than that of about $40-75 million for bottlers, a triopoly industry structure with high advertising and marketing cost will raise the barrier for entrants higher and eliminate their growing possibility. That is not to mention the restriction of access to channels of distribution. With Coke captured fountain sales and Pepsi focused on sales through retail outlets, there is less likely that new rivals can compete shelve spaces and product placement with them effectively. The high pretax profit of 30% applied for concentrate producers is meaningless unless rivalry between established competitors less intense.

The root of intense competition might come from the nature of the cola product itself. These products are virtually indistinguishable as the result of blind testing claimed by both Pepsi and Coke. The more similar the offerings among rival firms, the greater incentive for firms to cut price to increase sales. Competition and concentration of major rivals in one geographic market make it harder for new entrants to penetrate an established industry. Cadbury had to grow through strategic acquisition to gain momentum and economic scale. The only chance that new enterprise has is to create new demands by redefining the industry, overcome intense competition and quickly acquire the bargaining powers. The impossibility of such plan make the cola industry to be unattractive to new investors.

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