Soft Drinks
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 .10 to .23. During this period, bottler profits actually dropped on a per case basis by 23%, from .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