Friday, July 11, 2003

Soft drinks: Suppliers and vendors I found an interesting case analysis on the Web, posted by a Berkeley graduate business faculty member, Professor Meghan Busse. The apparent identity of the writer is a previous student, and the paper is posted as a model for a class in Competitive Strategy. Here's the URL. The paper is entitled "Why is the soft drink industry so profitable?" One of the reasons identified is Coke and Pepsi's relationship to suppliers and to buyers. Here are some salient points and a few comments: The inputs for Coke and Pepsi's products were primarily sugar and packaging. Sugar could be purchased from many sources on the open market, and if sugar became too expensive, the firms could easily switch to corn syrup, as they did in the early 1980s. So suppliers of nutritive sweeteners did not have much bargaining power against Coke, Pepsi, or their bottlers. NutraSweet, meanwhile, had recently come off patent in 1992, and the soft drink industry gained another supplier, Holland Sweetener, which reduced Searle's bargaining power and lowering the price of aspartame. In other words, the oligopsony of Coke and Pepsi had real power over a fragmented market with too many alternatives. Coke and Pepsi could take or leave any particular supplier; but the suppliers did not want to miss out on some of the biggest worldwide users. The same principle is true, the analysis documents, for aluminum and plastic containers. Supermarkets, the principal customer for soft drink makers, were a highly fragmented industry. The stores counted on soft drinks to generate consumer traffic, so they needed Coke and Pepsi products. But due to their tremendous degree of fragmentation (the biggest chain made up 6% of food retail sales, and the largest chains controlled up to 25% of a region), these stores did not have much bargaining power. Their only power was control over premium shelf space, which could be allocated to Coke or Pepsi products. The tables are turned. Even the power over shelf space is muted when the buyer absolutely needs the product and can't get a substitute elsewhere. While a supermarket may be able to refuse to sell some products, Coke and Pepsi and their principal allied brands, certainly aren't among them. The supermarket oligopsony can push around the little guys for fees and steep discounts, but not the juggernauts. The least profitable channel for soft drinks, however, was fountain sales. Profitability at these locations was so abysmal for Coke and Pepsi that they considered this channel "paid sampling." This was because buyers at major fast food chains only needed to stock the products of one manufacturer, so they could negotiate for optimal pricing. Coke and Pepsi found these channels important, however, as an avenue to build brand recognition and loyalty, so they invested in the fountain equipment and cups that were used to serve their products at these outlets. Of course, Pepsi once owned some fast food franchises just to capture more of the income, until it realized the problems of dealing with that business model. It's interesting to see the market power that exists when there's a real choice. A limited number of big food chains have the oligopsony power that the supermarkets lack. Vending, meanwhile, was the most profitable channel for the soft drink industry. Essentially there were no buyers to bargain with at these locations, where Coke and Pepsi bottlers could sell directly to consumers through machines owned by bottlers. Property owners were paid a sales commission on Coke and Pepsi products sold through machines on their property, so their incentives were properly aligned with those of the soft drink makers and prices remained high. Thus, vending machines are a form of vertical integration, a way of selling direct to the customer without having someone taking a major toll in-between. This method avoids wily buyers (and the small, independent vending companies don't have that much buying power. Vending machines can be located almost anywhere, encourage impulse buying, and can be company-exclusive. IThey also allow for prices as high as the traffic will bear. 4:36:22 PM

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