Corporate Finance

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October 29, 2020
Economics
October 29, 2020

Question, Why is the soft drink industry so profitable?

These 1-5 are the answer to this question. Please revise and describe your own words.

There has always been demand for soft drinks since early ages when the substitutes for them were only water. But gradually people started demanding something more, which means quenching the thirst with freshness. Thus the need for soft drinks came in. we will analyze this with the help of Porter’s Five Forces. Porter’s Five Force analysis reveals that market forces are favorable for profitability in this industry. The cost to produce soft drinks is extremely low and they make a profit at any price. Porter's Five Forces Analysis –

1. Soft Drink Industry Bargaining Power of Buyers
 The soft drink market is the largest group in the larger beverage industry. The soft drink industry is worth $60 billion dollars. Three firms control 89% of the United States soft drink sales. To say the least there is plenty of the pie to go around but it is hard to gain market share.
 There are a large number of customers with the average American consuming over 56 gallons of soda a year. The average soft drink costs under $2 which makes each individual purchase relatively insignificant.
 Because the soft drink industry is very competitive, switching suppliers is relatively easy and the price difference is rather small. Difference can occur based on geographic location and how far the products need to travel.
 There is no need for information on how to use the product it is a simple task.
 The buyer is not aware of the need for additional information because all the information that is needed is provided. There are no steps to using the product and all nutrition facts and ingredients are listed on the label.

2. Bargaining Power of Suppliers
 The distribution of CSDs took place through Supermarkets, fountain outlets, vending machines, mass merchandisers, convenience stores, drug chains and gas stations and other outlets.
 The main distribution channel is the Supermarket where bottlers fight for shelf space to ensure visibility for their products. In this ever-expanding array of products offered by existing players, there would be intense competition for the new entrant.  The mass merchandisers include warehouse clubs and discount retailers like Wal-Mart. These companies sell popular and leading products like Coke and Pepsi, so for a new entrant to find itself, a merchandiser is difficult task.
 Competition for fountain accounts is very intense and often CSD companies sacrificed profitability in order to land and keep those accounts. Coke and Cadbury Schweppes have long retained control over fountain sales. Ex: Coke supplies for Subway, McDonald’s and Burger King whereas Pepsi took over Pizza Hut, Taco Bell, and KFC. In this case, new entrant has huge competition to face.
 In vending channel, Coke and Pepsi have their dominance by giving financial incentives to encourage investment in machines. It would very challenging for a new entrant to compete.

3. Threat of New Entrants
The existing players in the soft drink industry have much advantage relative to new entrants. First, supply-side economy discourages new entrants by forcing them to enter the market in large scale. CSD’s demand side benefits of scale also make it difficult for new entrants to be accepted by the public. In 2002, a survey found that 37% of respondents chose a CSD because it is their favorite brand, while only 10% said so about bottled water. This demonstrates CSD customers’ high brand loyalty and their lack of desire to buy from new entrants. In terms of capital requirement, concentrate manufacturers only requires $25~$50 million to set up a plant that can serve the entire United States of America. Yet, new entrants may have difficulties competing with major players’ well-established brands and their large scale unrecoverable (therefore, hard to finance) spending on advertising. There is also unequal access to bottlers and retail channels for newcomers. Most bottlers are in long-term contracts with major CSD brands; also, the largest distribution channel, supermarkets, consider CSD a “big traffic draw”, thus provide little to no shelf space for newcomers. In addition, strong fear of retaliation from major players also makes newcomers hesitate to enter.

4. Threat of substitutes:
A substitute performs the same or a similar function as an industry’s product by a different means. The threat of substitution is downstream or indirect, when a substitute replaces an industry’s product. 1. This industry has large numbers of substitutes like water, beer, wine; coffee, milk, tea, juices etc are available to the end consumers. 2. The soft drink companies diversify business by offering substitutes themselves to shield themselves from competition. Ex: Pepsi produces Mug Root Beer (1.4% market share), Slice fruit juice (0.3%) and Tropicana fresh juices. Coke produces Barq’s and Diet Barq’s (0.4%), Minute Maid brands producing fresh fruit juices (1.5 %). By diversifying the business, the market share of the company raises to greater high. Coke recorded a high of 43%, after diversifying from 33.4%, when it was restricted to only Coca-cola. And Pepsi rose from 20% to 31%. And Cadbury rose from 4.7% to 14.5%. 3. Threat of substitute product is countered by soft drink industry by huge advertising, brand equity, and making their product easily available for consumers, which most substitutes cannot match. .

5.Rivalry among Existing Players;
 Coca-cola was started way back in 1890s and after a period of nearly 40 years, in 1939 Pepsi was launched. When Pepsi was launched, it was called the ‘imitator’ by the coke group, but soon it became a dominant force in the of decline of coke’s market share. Pepsi mainly aimed on packaging. When it was launched, it came out with a campaign of— “Twelve full ounces, that’s a lot. Twice as much for a nickel, too”, which forced Coke to launch three new packages: King-sized ten-ounce, the twelve ounces, and the twenty-six ounces Family size.
 In 1985, Coke announced that it has changed the 99-year old Cola formula. Pepsi claimed that the new coke mimicked Pepsi in taste, which promoted an outcry from loyal customers to bottlers. And, this forced the Coke to bring back its original formula.
 Pepsi mainly concentrated on advertising and marketing with film-stars to sports celebrities for promoting their products, which became very successful. Many other new players followed this later.
 In terms of marketing, the rivalry between Coke and Pepsi heated up with “Pepsi Challenge” in Dallas. This was responded (by Coke) with an ad campaign questing the validity of the test. It also introduced rebates and retail price cuts.
 In terms of Retail channels, Coke and Pepsi fought over fountain sales to acquire more national accounts. Competition remained vigorous: In 2004, Coke won the Subway account away from Pepsi, while Pepsi grabbed the Quiznos account from Coke. Coke however continued to dominate the channel with 68% share of national pouring rights, against Pepsi’s 22% and 10% for Cadbury.  In 1966, Coke had market share of 33.4%, Pepsi with 20.4% (Cadbury was not launched then) and in 2004, Coke has 43.1%, Pepsi has 31.7%, Cadbury with 14.5% and other companies with 5.2%. The Intra-rivalry has had an impact on the sales figures of industry players. The discounts given to the retailers reduced the overall profit margins. This forced the companies to search for alternative supplies (like corn syrup instead of sugar)

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