MBA299: Strategy

1
MBA299 Strategy

• Cola Wars
• Take-aways
• March 16, 2006

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
• Lemon Cola Coke 2001, Pepsi 2001
• Vanilla Cola Coke 2002, Pepsi 2003
• C2/Pepsi Edge Coke 2004, Pepsi 2004
• Lime Cola Coke 2004, Pepsi 2005
• 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
Why did bottlers go from a reasonably strong to a
very poor position over the 20th Century?

• Early period Coke/Pepsi needs them
• Offers reasonably attractive terms (fixed price
  contracts, only semi-exclusivity)
• Creates incentive for bottlers to enter
• Bottler margins/profitability fairly good
• Coke and Pepsi vs Bottlers Who has the most
  valuable or exclusive assets?
• CPs Branding, Product Formula, Product RD
• Bottlers manufacturing and distribution (almost
  like contract manufacturing)
• Even though bottlers have BTE, they are subject
  to extremely strong supplier power
• What could bottlers have done differently?

8
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?
9
Post-script What may threaten this relatively
polite war?

• Smaller players extinguished
• Substitutes
• Market not growing
• The next generation may not be the Pepsi
  generation or the Coke generation, for that
  matter. For years, soda has been the
  quintessential American drink, considered the
  perfect thirst quencher, morning pick-me-up or
  accompaniment to lunch or dinner.
• But that is slowly changing.
• As Americans look for greater variety in their
  drinks and strive for healthier diets,
  consumption of soda with its 250 calories and
  67 grams of sugar in a 20-ounce bottle is
  slipping.
• Data released yesterday by Beverage Digest, the
  industry trade publication, shows that for the
  first time in 20 years, the number of cases of
  soda sold in the United States declined. Case
  volume in 2005 was down 0.7 percent, to 10.2
  billion cases.
• Coke's flagship brand, Coca-Cola Classic, was
  down 2 percent, and original Pepsi from PepsiCo
  was down 3.2 percent.
• - Soda Sales Fall for First Time in 20 Years,
  New York Times, March 9, 2006
• Greater balance

10
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

11
How much does industry matter really?
12
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

13
Industry analysis has traditionally been a major
input into portfolio analysis for diversified
firms
14
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)
15
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

16
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
• Network externalities

17
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

18
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

19
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

20
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

21
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?

22
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