1. Cola Wars
Key Take-aways

2. Explaining differences in firm-level profitability
Historically, the CP industry has been very profitable, while the bottling industry has been less so
Exhibit 5: pretax margin 35% vs. 9%
Exhibit 4: average ROE 20-25% vs 5-10%
Five forces analysis is a good starting point in explaining these differences
Key factors that differ between these two industries:
supplier & buyer power
rivalry

3. How intense was the Cola War
How intense was the Cola War? How do Coke and Pepsi compete with each other?
The competitive front:
shelf-space
advertising
direct store delivery
selective discounting downstream
Concentrate prices rising (Ex. 6)—CPs do not compete on price

4. Factors that mitigate the intensity of rivalry
By the 1980s any move made by one player can be matched by the other
ad campaigns:
Pepsi--Michael Jackson then Britney Spears
Coke--Bill Cosby then Harry Potter
Vertical integration
Coke buys and recapitalizes bottlers
Pepsi does same
New products:
Coke: C2
Pepsi: Pepsi Edge …
Most games played to a stalemate

5. How did Pepsi catch up? Pepsi’s Strategy
Take-away market; lower price; youth emphasis  different segment
Pepsi Challenge
Why didn’t Coke respond more aggressively?
Fat/happy/lazy(?), arrogant(?), focused on international expansion
Lessons:
Indirect attack
Exploit inflexibility
Different segment
Exploit (technological) change (i.e., growth of supermarkets)

6. Vertical integration in the beverage industry
Historically, CPs wrote (semi-)exclusive contracts with bottlers, but did not own them
contracts gave bottlers ‘correct’ incentives
non-integration kept the capital requirements of the CP industry small
In the 1980 and 1990s, CPs moved toward “anchor bottler” model
ownership over bottlers allowed CPs to reap economic efficiencies as well as to ensure that bottlers would adapt to changing product strategies (intro of many new products, new packages, competition in a growing number of channels, etc.)
equity market’s appetite for new offerings allowed CPs to do this relatively cheaply

7. Will these factors change as the basis of competition expands
Summary
Coke and Pepsi are examples of how firms can create and exercise market power
they didn’t inherit this business, they created it
future success will depend on their ability to structure the industry as well as their own businesses
Coke and Pepsi are smart
when they go to war, they kill the bystanders, not themselves!
Will these factors change as the basis of competition expands
to include non-carbs?

8. Mean Analyst Recommendation
Buy, Sell, or Hold?
Company
Beta
P/E (Forward)
Mean Analyst Recommendation
Coca Cola
.23
19.0
2.6
Pepsi
.35
18.3
1.8
Cadbury Schwepes
.28
14.5
2.8
Source: Yahoo Finance, 3/17/2005

9. How much does industry matter?
10-20% of the variation in firms’ profits accounted for by the industry in which the firm competes
Analysis based on accounting profits in publicly held companies

10. How much does industry matter really?
Average Economic Profits of U.S. Industry Groups,
Value Line Industry Groups
Source: Ghemawat, Strategy and the Business Landscape, p20.

11. Objectives of industry analysis
Explain the differences in profitability across industries
Identify the drivers of industry-level profitability
Who in the value chain captures the value generated by the industry?
Establish a foundation for making a strategic choice
e.g., decisions about entry, exit, or expansion
Highlight important relationships that need to be managed
Rivals, buyers, suppliers, complementors, potential entrants

12. Industry analysis has traditionally been a major input into portfolio analysis for diversified firms
High
Low
Medium
Selectivity
Harvest/
Divest
Industry Attractiveness
Business Strength
Selective
Growth
Investment
and
GE / McKinsey Nine-Block Matrix

13. Rivalry Among Existing Competitors
Porter’s Five Forces
Threat of New Entry
Economies of scale
Proprietary product differences
Brand identity
Switching costs
Capital requirements
Access to distribution
Absolute cost advantages
Government policy
Expected retaliation
Bargaining Power
of Suppliers
Bargaining Power
of Customers
Differentiation of inputs
Switching costs
Presence of substitute inputs
Supplier concentration
Importance of volume to supplier
Cost relative to total purchases
Impact of inputs on cost or differentiation
Threat of forward integration
Rivalry Among Existing Competitors
Industry growth
Fixed costs / value added
Overcapacity
Product differences
Brand identity
Buyer concentration
Buyer volume
Buyer switching costs
Buyer information
Ability to integrate backward
Substitute products
Price / total purchases
Product differences
Brand identity
Impact of quality / performance
Buyer profits
Switching costs
Concentration and balance
Informational complexity
Diversity of competitors
Corporate stakes
Exit barriers
Threat of Substitutes
Relative price performance of substitutes
Switching costs
Buyer propensity to substitute
Source: Michael E. Porter,
Competitive Advantage
(New York: Free Press, 1985)

14. Biotech Supply Industry: Investment thesis for Invitrogen
Threat of New Entry
Patents and physical control over biological materials (such as cell lines) limits entry
Exclusive licenses to sell some products
Economies of scope makes it difficult to enter with a half-full product line
Niche entry feasible
Bargaining Power
of Suppliers
Bargaining Power
of Customers
Many new research tools come out of university labs – must be licensed but universities have limited bargaining power since they can’t commercialize these products themselves
Internal R&D ??
Rivalry Among Existing Competitors
Growing industry
Some products highly differentiated (although some are commodities)
Varies by segment
University research labs – fragmented, buy based on grant money – have little information and little incentive to bargain down price
Biotech research industry is also fragmented, but has more bargaining power – especially when sharing procurement effort across a variety of products
Switching costs high in some lines of business (bio-informatics SW)
Informational complexity
Threat of Substitutes
None – these products are absolutely critical to biotechnology research

15. Invitrogen performance

16. Rivalry
How hard firms compete on price (or increase quality levels at a given) price depends on:
Concentration and balance
Industry growth
Fixed (or storage costs)/Value added
Product differences
Brand identity
Switching costs
Intermittent over-capacity
Diverse stakes
Exit barriers

17. Threat of Entry Factors that create barriers to entry include:
Economies of scale
Proprietary product differences
Brand image
Switching costs
Capital requirements
Access to distribution
Absolute cost advantages
Learning curve
Access to necessary inputs
Low cost product design
Government policy
Expected retaliation

18. Threat of Substitutes
The ability of the industry as a whole to profitably raise price (the elasticity of the industry’s demand curve)
Tobacco & pharmaceuticals – inelastic demand
Steel – elastic demand
Likely to change over time with technological changes or changes in consumer tastes
Determined in part by relative performance / price of substitutes

19. Buyer power Intrinsic Strength Price Sensitivity Buyer concentration
Buyer volume
Switching costs
Buyer information
Ability to backward integrate
Substitute products
Pull through
Price Sensitivity
Price/Total purchase
Product differences
Brand identity
Impact on quality/performance
Buyer profits
Decision maker’s incentives

20. Supplier Power Mirror image of buyer power
Amount of value chain captured by suppliers influenced by:
size and concentration of suppliers
degree to which suppliers provide commodity vs. custom inputs (differentiation)
availability of substitute inputs
ability to backward integrate
importance of volume to suppliers

21. Dynamics
Industry analysis provides a “snapshot” of current conditions in an industry
As we saw in Coors, the industry “landscape” is subject to “tectonic shifts” over time.
Some of these shifts are under the control of the players in the industry
Coke and Pepsi shaped the terrain with respect to their bottlers
Franchising
Exclusivity
Consolidation and spin-off

22. An example of industry dynamics
Industry structure is frequently changing
Many, but not all, industries follow predictable patterns corresponding to product life-cycles
S-curve adoption
Introduction
Growth
Maturity
Decline (?)
Number of Firms, Entry and Exit
In the US Tire Industry
( )
Source: Klepper and Simons (2000). “The Making of an Oligopoly: Firm Survival and Technological Change in the Evolution of the U.S. Tire Industry” Journal of Political Economy. 108:4, p. 731

23. Some common long-run dynamics

24. “Everything should be made as simple as possible, but no simpler”
A major challenge for industry analysis is where to draw the boundaries
Typically, industry analysis will be motivated by some choice or set of possible strategic choices
Horizontal scope
Which product markets?
Vertical scope
How many vertically-linked stages in the value chain should be considered?
Geographic scope
Which geographic markets?
“Everything should be made as simple as possible, but no simpler”
— Albert Einstein

25. Final words on industry analysis
A starting point for many types of strategic decisions
Strategy should fit the external business environment
In the long run, the business environment is not fixed
It can be shaped by the strategic choices taken by a firm and its rivals
It also changes based on factors over which the firm has little control
The role of the strategist is to identify these changes and adapt the firm’s strategy to them