1) Why, historically, has the soft drink industry been so profitable?
The soft drink industry has been so profitable mostly due to the high consumption of Carbonated Soft Drinks (CSD) in United States and the companies’ market strategies.
Firstly, the annual consumption of CSDs by the Americans was 23 gallons and had been growing by an average of 3% per year over the next three decades. The increase in the availability of CSDs and introduction in diet and flavored varieties of CSDs had played an important role in the consumption growth. In addition, lowering the real price of CSDs has made CSDs more affordable to be consumed by the Americans. Although there are a great deal of alternatives to CSDs, Americans still consumed more CSDs than any other beverage. Besides, although the consumption hit a new low in 2009, the average consumption of CSD by Americans was still 46 gallons annually, which is still pretty high compare to the other beverages.
In addition, the intensive competition between Coke and Pepsi has played an important role in the profitability of Soft Drink industry. As the former CEO of Pepsi mentioned, they would not have gone so far without the competition with Coke. By the time Coke was becoming more and more successful, Pepsi had no choice other than sharpening themselves to ensure their survival in the market. By implementing and financing marketing programs jointly with bottlers and having Customer Development Agreements (CDAs) with nationwide retailers, it actually ensured the soft drinks market coverage and sales volume over the other beverages. The evidence can be seen by the market share of CSDs in 2009. Although the market share has dropped from 71% to 55%, it still maintained its dominance in the beverage market.
2) Compare the economics of the concentrate business to that of the bottling business: Why is the profitability so different?
The profitability of concentrate producers and bottlers is different mainly due to their business process and their cost structure.
A concentrate producer’s normal business process includes blending raw materials ingredients, packing the mixture and shipping to bottlers. A concentrate manufacturing plant that can serve the whole United States costs only $50 to $100 million to build, which invests relatively low capital in machinery, overhead and also labor. The significant costs for a concentrate producer were cost of advertising, promoting, market researching and bottler supporting (mostly variable costs). A concentrate producer negotiates CDA with nationwide retailers, employing large staff of people working with bottlers (and also running a franchise bottling system) and negotiating directly with the bottlers’ major suppliers to ensure the shelf space, achieve reliably supply, improve store delivery services and maintain low prices. By such negotiation with each parties, the concentrate producers achieve a higher efficiency with a lower cost.
While for bottlers, a normal business process includes purchasing of concentrate, adding carbonated water and high-fructose syrup, bottling and canning the product and also delivering it to the selling spots. Bottlers play an important role in negotiating with smaller regional retailers by developing relationship in between and paying an agreed-upon percentage of promotional and advertising costs to ensure the sales of products. Besides, the cooperative merchandising agreements between retailers and bottlers was also an important key for the sales of CSDs. In addition, franchising with the big companies such as Coke and Pepsi has allowed bottlers to handle non-cola brands of other concentrate producers as long as they were not competing brand. In such case, a franchise bottler had the final say in decision about the retail pricing. However, the cost structure if bottlers is different from the concentrate producers since it was highly capital intensive and involved high-speed production lines. Which means that, the production lines are hardly to change unless the products were in similar type and size. A singular production line cost from $4 to $10 million to build, and a large one even cost a hundred of millions to build. Therefore, the cost for a bottler is relatively higher and the cost structure is relatively fixed compared to a concentrate producer.