Softdrinks industry analysis - (PepsiCo. and Coca Cola)

TO:  Mr. Warren Buffet

FROM: Ibrahim AbdelMoteleb, Coursera student

DATE: May 17, 2020

SUBJECT: Soft drink industry analysis

Researches have shown that a firm’s industry predicts around 13 percent of its profitability. Understanding a firm’s industry helps us predict its profitability and how attractive it is, and may help us find a better business model. In addition, it helps to figure out our “pivotal force” which is the greatest threat out of the five forces. Management can intervene to reshape the pivotal force or mitigate it which has a direct impact on profitably.  

 Five forces framework industry analysis:

The Five Forces framework identifies and analyzes five competitive forces that shape every industry and helps determine an industry's weaknesses and strengths. Five Forces analysis is frequently used to identify an industry's structure to determine corporate strategy. Depending on your analysis, you will be able to adjust your strategy to increase profit and mitigate or resolve the pivotal force.

The framework helps us see beyond the actions of the organization’s competitors and examine what other factors could impact the business environment.

It is critical to properly identify the industry before analysis.

You may skip the next part if you understand the framework.

The five forces are:

Rivalry among industry firms: this refers to the number and strength of the competitors in the industry. High rivalry means companies will fight for market share using price wars and price competition which ends results in low prices and low profitability. Firms need to find other ways to compete that are harder to imitate other than lowering prices which can be done by anyone.

Threat of new entrants: this refers to the ease of entrance to an industry. If an industry is easy to access, the number of new firms entering it will be high and this lowers profitability.

Threat of substitutes: this refers to other products in other industries that may act as a substitute for your product. Thus, it can limit profitability by setting constraints for the product’s price.

Bargaining power of buyers: this refers to the buyer’s ability to bargain away potential profit. Buyers have more bargaining power if the product is now important, changing costs are low, or the buyer can produce the product himself.

Bargaining power of suppliers: this refers to the supplier’s ability to bargain away potential profit. It is like the mirror of the power of the buyer.

Analysis of the soft drinks industry five forces framework:

My scope for the industry is the carbonated soft drinks only.

Rivalry among industry firms: there is a fierce rivalry in the soft drinks industry even though the industry concentration is high and that is because the two industry pioneers, Coca Cola and PepsiCo, have been in a competition for more than 100 years. Product differentiation is low; it only depends on brand name and marketing, market growth rate is relatively low, high exit barriers due to high fixed costs and binding contracts. All of these factors create a temptation for a price war.

Threat of new entrants: anyone can enter the soft drinks industry, but it is extremely difficult to gain a foothold like PepsiCo or Coca Cola. Existing companies have huge economies of scale and scope. High capital is required to cover bottling, distribution, and storage. The major brands already control the main distribution channels. PepsiCo and Coca Cola are known to retaliate to new entrants and force them out.

Successful new firms tend to pioneer new beverage categories

Threat of substitutes:  there is a large number of substitutes for soft drinks like water, coffee, juices, tea, beer, and sports drinks. Consumers wouldn’t suffer from switching costs as most of the time it is low.

Coca Cola and PepsiCo created their own bottled water, power drinks, and juices to try to combat substitutes in their market.

Threat of substitute products is countered by the soft drink industry through huge advertising, brand equity, and making their product easily available for consumers, which most substitutes cannot match.

Bargaining power of buyers: buyers have a fair amount of bargaining power as it is easy to find other suppliers in the industry and there are several large volume buyers in the industry.

Supermarkets are the main distribution channel for soft drinks. Providing the companies premium shelf space and they command lower prices. The companies fight for shelf space to ensure visibility for their products. Usually, Coca Cola and Pepsi get priority because they sell the most volume.

Large restaurants such as McDonald’s and KFC use fountains. Fountains are the least profitable and the restaurants have large leverage in negotiation. PepsiCo primarily considers this segment “Paid Sampling” with low margins.

Backward integration exists as we can see generic brands.

Bargaining power of suppliers: the bargaining power of suppliers is minimal as there are many suppliers in this industry. Concentrate, which is the key determinant of the taste, is made from basic commodities. So, suppliers have no power over the pricing hence the suppliers in this industry are weak.

* In Coca Cola’s case, that purchases acesulfame potassium from Nutrinova Nutrition Specialties & Food Ingredients, and that is considered the only viable source by Coca Cola.

My opinion

I believe that the soft drinks industry will remain profitable in the next 5-10 years for several reasons.

The giants of the soft drinks industry, PepsiCo and Coca Cola, have branched out into other substitutes such as energy drinks and juices which are growing properly.

The MENA region is a very huge consumer market for the aforementioned companies as the geological factors influence it (e.g. hot weather). These markets also have a proper GDP and population growth. In 2015, The annual per capita consumption of soft drinks exceeds 200 liters in Kuwait, Qatar, Saudi Arabia, and the UAE.

Even if the growth is slow in the 1st world market it is pushed by the robust growth in other markets, especially Africa and the middle east.

In contrast, more people are becoming health-conscious, the threat that buyers will substitute a different drink for carbonated soft drinks looms as a real possibility. But I believe that for this to heavily influence the sales of soft drinks requires more than 10 years. Why? The decline in growth in the American market happened due to “health craze” among American consumers. They're shunning ingredients that they perceive as unhealthy, causing sales of Pepsi and Coca-Cola to fall. However, Americans still adore junk food.

Sales of snacks such as Doritos nacho chips and Cheetos cheese puffs have been successful sellers for PepsiCo. They have helped the company expand its profit margin for 15 straight quarters, according to The Wall Street Journal in 2016.

The Journal also noted that Doritos, Cheetos, and Lays are the world's three largest snack brands and have averaged annual growth of more than 5% over the past five years. The health craze will fade out slowly sooner or later, in my opinion.

With that in mind, I believe that PepsiCo would be a wiser investment than Coca Cola. PepsiCo has grown tentacles into the snacks business (Lays, Cheetos, Doritos) which are growing normally. Most importantly, PepsiCo continues its push into healthy products (Baked Lays, recent acquirement of Bare Foods Co, Quaker Oats, Tropicana).

PepsiCo seems to have a magic combination right now that is winning with the quixotic tastes of Americans: healthy drinks and unwholesome snacks. That opens up a great opportunity to grab shares of a company that is a consistent and safe performer. As other soda companies scramble to make up for lost sales, PepsiCo, with a very diverse portfolio of food and drink, continues to shine.