Compare the Economics of the Concentrate Business to That of the Bottling Business

1. Compare the economics of the concentrate business to that of the bottling business. Structurally, why is the profitability so different (i.e., think five forces)?

From the case pack, it is clear that the operating margins of the bottlers were of the order of 8%, which were about a third of concentrate producers’ operating margins. The significant difference in the profitability of the concentrate producers and the bottlers could be attributed to the following factors. To begin with, the bottling industry was much more capital intensive compared to the concentrate producing industry. Also, the exit costs were high for the bottlers. Additionally, relative to concentrate producers, the bottlers had higher operating expenses (investments in trucks, distribution centers etc). Furthermore, concentrate producers enjoyed both the buyer power while purchasing the raw materials to produce the concentrate and also the seller power, while selling the concentrate to bottlers. Thus, they had the pricing power while purchasing the raw material from their suppliers and while selling the concentrate to the bottlers. Also, the concentrate producers were highly concentrated relative to the bottlers. Finally, the cost of switching between bottlers was low for the concentrate producers. All these factors suggest that the profitability of the bottlers would be lower compared to the profitability of the concentrate producers.

2. If you were to recommend entry into one of these sectors (i.e., concentrate business or bottling business), which would you recommend and why?

                I wouldn’t recommend entry into either of the bottling business or the concentrate business for the following reasons. To begin with, both the industries are highly concentrated now. Though the bottling industry was less concentrated earlier, with bottler consolidation in the 21st century, it is much more concentrated with the top 10 bottlers accounting for 94%, 89% and 79% of domestic production volume for Coke, Pepsi and DPS respectively. Also, the barriers to entry for both the industries are very high. The fixed costs in both the industries are high which imply lower profits. A new entrant is competing against well established players who enjoy economies of scale, brand name, and access to distribution networks. Also, the concentrate producers are involved in very high strategic competition. The exit barriers are high for both the industries because of the high capital investments involved. Also, the CSD industry is facing slow industry growth, which would affect both the concentrate producers and the bottlers. The bottlers are also facing issues with the concentrate producers getting involved in backward integration i.e. entering the bottling industry. Finally, my conclusion from the case pack is that the result of the fierce competition between Coke and Pepsi is that rather than killing each other, they kill the new entrants.