Porter’s five forces analysis: Bottlers
Threat of new entrants
For bottling companies, the threat of new players, i.e. new bottlers entering the market was low. This was primarily because of the prohibitively high fixed costs involved. The cost of setting up an efficient large plant with four lines, automated warehousing, and a capacity of 40 million cases was $75 million in 1998. Moreover, among the top bottlers in 1998, the variable costs included packaging (roughly half of the cost of goods sold), concentrate (one-third), nutritive sweeteners (one-tenth), and the remaining variable cost was labor. Apart from this, bottlers had to invest capital in distribution networks and trucks. As a result of these cost structures, bottlers operated on razor thin margins.
Another barrier to entry for new entrants was that the established brands had gone on to create their own independent bottling subsidiaries (e.g. CCE and PBG). As these subsidiaries were handling the major share of volumes for Coke and Pepsi respectively, it became increasingly difficult for new bottlers to enter into exclusive contracts with established brands. For bottlers, due to the capital intensive nature of bottling industry, it was important to enter in contracts with brands that will utilize capacities fully. In the case of Coke and Pepsi, their incumbent bottlers were acquired by the giants to form their own independent bottling subsidiaries, therefore creating even greater barrier to entry for new players.
Threat of substitutes
For bottling companies, substitutes would be fountains (where CSD is offered in cups) and vending machines (where CSD was offered in cans). However, there was low threat from these substitutes as the focus on fountain and vending machines had been low relative to sales through supermarkets and convenience stores (i.e. bottle sales).
Bargaining power of buyers:
For bottling companies, the buyers were retail chains, food stores and super markets (vending machines). These potential buyers were powerful as they had more bargaining power and freedom to control price fluctuations. Retail chains, food stores and super markets were distinct groups of buyers who differed in bargaining power relative to the product (Coke or Pepsi). For example, since Coke had a major share of its revenue from food stores and super markets, the bottling companies that catered Coke to these outlets become vulnerable to them as they exercise more bargaining power. Also the retail chains, food stores and super markets tended to play one type of bottling company (Coke/Pepsi) against another (Pepsi/Coke) because they believed they could always find an equivalent product. The retail chains, food stores and super markets faced few switching costs in changing vendors. The buyer group was price sensitive as the beverages constituted a significant portion of retailer’s profit. The retailer would always want to push and allocate more shelf space to the product that offered higher margins. So, if the bottling companies did not provide enough incentives to the retailers, the buyers would shift to other products.
Bargaining Power of Suppliers
The supplier side in this context was comprised of the Concentrate Producers (CPs), namely Coke and Pepsi. Both had huge bargaining power driving down the bottlers’ operating margins to a meager 9% of sales while commanding 35% themselves. There were several factors contributing to this situation. These were as follows:-
1. The supplier side was more concentrated. The supplier side duopoly and relatively large number of players in the Bottler market made it easy for them to dictate terms. The CPs had very stringent contracts in place with the bottlers making it legally impossible for them to bottle many competitor products. Coke had the “Master contract” with effect from 1987 which allowed it to determine concentrate price and other terms of sale. Moreover, they were not legally obligated to share advertising costs anymore. Pepsi too had the “Master bottling agreement” which allowed the CP to set the terms and conditions at which the bottler could purchase raw materials. In fact both Pepsi and Coke raised the concentrate prices from 1988 to 2000 (with minor decreases in the late 1990s)
2. The switching cost for Bottlers was very high. It cost them a minimum of 25 million to build a plant and office space, and at least 80 plants were required for distribution across the US. This required an initial investment of 3.2 billion for the most basic bottling system. The products were differentiated with regards to packaging and switching CPs would result in heavy cost overloads for the Bottler.
3. Credible threat from forward integration by the supplier was another important consideration. Coke created an independent bottling subsidiary (CCE) in 1986. By 2000, CCE (Coca Cola Enterprises) was coke’s largest bottler handling 70% of its volume in North America. The same was true for Pepsi. The number of Pepsi bottlers decreased from 400 to 200 through the 1980s-1990s. Pepsi owned about half of these bottling operations and had stakes in many others. In 1990, Pepsi too adopted the anchor Bottler model in the form of the PBG (Pepsi Bottling Group).
Competitive Rivalry
As evident in the case, bottling industry was capital intensive with razor thin operating margins. It involved high cost to set up a bottling plant and then manage to enter into a preferred franchisee contract with Coke or Pepsi, who had a distinct upper hand in such contracts. Also, the assembly lines were specialized which meant they could be used for only one type of bottles. This meant that switching costs for bottlers to a different brand was quite high. With this knowledge, the concentrate producers could very well frame long term rate contracts in their own favor. When the costs for a concentrate producer and a bottler are compared, | Concentrate Producer | Bottler | Cost of Sales | 17% | 65% | Pre-tax profit | 35% | 9% |
The above table shows that although the cost of sales are high compared to a concentrate producer the pre-tax profit is considerably lower than that of a concentrate producer. As a result the competition in the bottling industry had consistently decreased. The number of bottlers came down from 2000 in 1970 to less than 300 in 2000. On top of that, the over-arching contracts with and dominated by the concentrate producers and the allocation of exclusive territories had further reduced any scope of intra-brand competition amongst the bottlers. Thus competitive rivalry amongst bottlers had faded due to absence of overlap in servicing suppliers and buyers.