Coke War

Question 2: How have contracts – rather than integration – been employed to reduce problems (opportunism, hold up, incentives, information, etc.) that could appear in the vertical relationship between the concentrate producer and the bottlers?

Topic 1: History and key points of the Master Bottlers Contracts

As the concentrate producer and the bottler are next to each other in the production line they must interact with each other efficiently. Originally in 1899, Coca-Cola franchise contract was a fixed price contract even when the ingredient cost changed. In 1980, Congress enacted the Soft Drink Interbrand Competition Act, which preserved the right of concentrate makers to grant exclusive territories. In 1987, Coca-Cola established a long term contract with their bottlers. The main contract they use is the 1987 Master Bottler Contract, which gives Coke the right to set the price of the concentrate based on CPI that changed quarterly but didn't oblige them to input marketing or advertising costs. Franchise agreements of both Coca-Cola and Pepsi allowed bottlers to handle non-cola brands of other CPs, have the choice to introduce new beverages introduced by CPs but of new directly competing brands.

Topic 2: Create more opportunities in production for bottlers with current contract

Under current Master Bottlers Contract, bottlers are allowed to choose production of a competitor's non-cola product over the analogous franchise product. But a complete vertical integration would require that bottlers produced only the products of the owner. The market between the concentrate producers and bottlers is prone to vertical market failures because there are very few concentrate producers who are more powerful compared with the large number of bottlers. This may lead to a market dominance by the concentrate producers, who may abusively manipulate the transactions and "hold-up" the profit from bottlers in a vertical integration scenario. In this way, the contracts between the concentrate producers and bottlers, although favorable to concentrate producers, are meant to be long-term and predictable, in attempt to standardize the numerous transactions.

Topic 3: Avoid to lose "economic surplus" and to bear the high fixed costs and rising plastic price for concentrate provider in a vertical integration

In order for vertical integration to be a good idea, it has to be that the integration would change something about what you do, not just the price you face. As we can see from Exhibit 4 that the Costs of Sales consists of 60% for bottlers while it is only 17% for concentrate providers. This stems from the Coca-Cola and Pepsi's competitive advantage by owning the formula and brand that customers desire for. This also empowers Coca-Cola and Pepsi a significant amount of power in negotiating with bottlers