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A brief description of the strategic situation (why is the specific firm so successful or unsuccessful?) WWW [What Went Wrong? / What MAY go wrong?] i

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1. A brief description of the strategic situation (why is the specific firm so successful or unsuccessful?)
2. WWW [What Went Wrong? / What MAY go wrong?] i.e., current problems and possible threats
3. The general lessons learned from this case are ...
4. It reminds me of .... (link the present case to other cases we have analyzed. You want to show how the current case is similar to other cases. Briefly mention also the generalizable differences.)

For the exclusive use of s. hurmiz, 2021. 9-711-462 REV: MAY 26, 2011 DAVID B. YOFFIE RENEE KIM Cola Wars Continue: Coke and Pepsi in 2010 For more than a century, Coke and Pepsi vied for “throat share” of the world’s beverage market. The most intense battles in the so-called cola wars were fought over the $74 billion carbonated soft drink (CSD) industry in the United States.1 In a “carefully waged competitive struggle” that lasted from 1975 through the mid-1990s, both Coke and Pepsi achieved average annual revenue growth of around 10%, as both U.S. and worldwide CSD consumption rose steadily year after year.2 According to Roger Enrico, former CEO of Pepsi: The warfare must be perceived as a continuing battle without blood. Without Coke, Pepsi would have a tough time being an original and lively competitor. The more successful they are, the sharper we have to be. If the Coca-Cola company didn’t exist, we’d pray for someone to invent them. And on the other side of the fence, I’m sure the folks at Coke would say that nothing contributes as much to the present-day success of the Coca-Cola company than . . . Pepsi.3 That relationship began to fray in the early 2000s, however, as U.S. per-capita CSD consumption started to decline. By 2009, the average American drank 46 gallons of CSDs per year, the lowest CSD consumption level since 1989.4 At the same time, the two companies experienced their own distinct ups and downs; Coke suffered several operational setbacks while Pepsi charted a new, aggressive course in alternative beverages and snack acquisitions. As the cola wars continued into the 21st century, Coke and Pepsi faced new challenges: Could they boost flagging domestic CSD sales? How could they compete in the growing non-CSD category that demanded different bottling, pricing, and brand strategies? What had to be done to ensure sustainable growth and profitability? Economics of the U.S. CSD Industry Americans consumed 23 gallons of CSDs annually in 1970, and consumption grew by an average of 3% per year over the next three decades (see Exhibit 1). Fueling this growth were the increasing availability of CSDs and the introduction of diet and flavored varieties. Declining real (inflationadjusted) prices that made CSDs more affordable played a significant role as well.5 There were many ________________________________________________________________________________________________________________ Professor David B. Yoffie and Research Associate Michael Slind prepared the original version of this case, “Cola Wars Continue: Coke and Pepsi in 2006,” HBS No. 706-447. This version was prepared by Professor David B. Yoffie and Research Associate Renee Kim. This case was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2010, 2011 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-5457685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. 711-462 Cola Wars Continue: Coke and Pepsi in 2010 alternatives to CSDs, including beer, milk, coffee, bottled water, juices, tea, powdered drinks, wine, sports drinks, distilled spirits, and tap water. Yet Americans drank more soda than any other beverage. Within the CSD category, the cola segment maintained its dominance, although its market share dropped from 71% in 1990 to 55% in 2009.6 Non-cola CSDs included lemon/lime, citrus, pepper-type, orange, root beer, and other flavors. CSDs consisted of a flavor base (called “concentrate”), a sweetener, and carbonated water. The production and distribution of CSDs involved four major participants: concentrate producers, bottlers, retail channels, and suppliers.7 Concentrate Producers The concentrate producer blended raw material ingredients, packaged the mixture in plastic canisters, and shipped those containers to the bottler. To make concentrate for diet CSDs, concentrate makers often added artificial sweetener; with regular CSDs, bottlers added sugar or high-fructose corn syrup themselves. The concentrate manufacturing process involved relatively little capital investment in machinery, overhead, or labor. A typical concentrate manufacturing plant, which could cover a geographic area as large as the United States, cost between $50 million to $100 million to build.8 A concentrate producer’s most significant costs were for advertising, promotion, market research, and bottler support. Using innovative and sophisticated campaigns, they invested heavily in their trademarks over time. While concentrate producers implemented and financed marketing programs jointly with bottlers, they usually took the lead in developing those programs, particularly when it came to product development, market research, and advertising. They also took charge of negotiating “customer development agreements” (CDAs) with nationwide retailers such as Wal-Mart. Under a CDA, Coke or Pepsi offered funds for marketing and other purposes in exchange for shelf space. With smaller regional accounts, bottlers assumed a key role in developing such relationships, and paid an agreed-upon percentage—typically 50% or more—of promotional and advertising costs. Concentrate producers employed a large staff of people who worked with bottlers by supporting sales efforts, setting standards, and suggesting operational improvements. They also negotiated directly with their bottlers’ major suppliers (especially sweetener and packaging makers) to achieve reliable supply, fast delivery, and low prices.9 Once a fragmented business that featured hundreds of local manufacturers, the U.S. soft drink industry had changed dramatically over time. Among national concentrate producers, Coke and Pepsi claimed a combined 72% of the U.S. CSD market’s sales volume in 2009, followed by Dr Pepper Snapple Group (DPS) and Cott Corporation (see Exhibits 2, 3a and 3b). In addition, there were private-label manufacturers and several dozen other national and regional producers. Bottlers Bottlers purchased concentrate, added carbonated water and high-fructose corn syrup, bottled or canned the resulting CSD product, and delivered it to customer accounts. Coke and Pepsi bottlers offered “direct store door” (DSD) delivery, an arrangement whereby route delivery salespeople managed the CSD brand in stores by securing shelf space, stacking CSD products, positioning the brand’s trademarked label, and setting up point-of-purchase or end-of-aisle displays. (Smaller national brands, such as Shasta and Faygo, distributed through food store warehouses.) Cooperative merchandising agreements, in which retailers agreed to specific promotional activity and discount levels in exchange for a payment from a bottler, were another key ingredient of soft drink sales. The bottling process was capital-intensive and involved high-speed production lines that were interchangeable only for products of similar type and packages of similar size. Bottling and canning 2 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Cola Wars Continue: Coke and Pepsi in 2010 711-462 lines cost from $4 million to $10 million each, depending on volume and package type. But the cost of a large plant with multiple lines and automated warehousing could reach hundreds of millions of dollars. In 2010, DPS completed construction of a production facility in California with a capacity of 40 million cases at an estimated cost of $120 million.10 While a handful of such plants could theoretically provide enough capacity to serve the entire United States, Coke and Pepsi each had around 100 plants for nationwide distribution.11 For bottlers, their main costs components were concentrate and syrup. Other significant expenses included packaging, labor, and overhead.12 Bottlers also invested capital in trucks and distribution networks. For CSDs, bottlers’ gross profits routinely exceeded 40% but operating margins were usually around 8%, about a third of concentrate producers’ operating margins (see Exhibit 4). The number of U.S. soft drink bottlers had fallen steadily, from more than 2,000 in 1970 to fewer than 300 in 2009.13 Coke was the first concentrate producer to build a nationwide franchised bottling network, and Pepsi and DPS followed suit. The typical franchised bottler owned a manufacturing and sales operation in an exclusive geographic territory, with rights granted in perpetuity by the franchiser. In the case of Coke, territorial rights did not extend to national fountain accounts, which the company handled directly. The original Coca-Cola franchise agreement, written in 1899, was a fixed-price contract that did not provide for renegotiation, even if ingredient costs changed. After considerable negotiation, often accompanied by bitter legal disputes, Coca-Cola amended the contract in 1921, 1978, and 1987. By 2009, 92% of Coke’s U.S. concentrate sales for bottled and canned beverages was covered by its 1987 Master Bottler Contract, which granted Coke the right to determine concentrate price and other terms of sale.14 Under this contract, Coke had no legal obligation to assist bottlers with advertising or marketing. Nonetheless, to ensure quality and to match Pepsi, Coke made huge investments to support its bottling network. In 2009, for example, Coke contributed $540 million in marketing support payments to its top bottler.15 The 1987 contract did not give complete pricing control to Coke, but rather used a formula that established a maximum price and adjusted prices quarterly according to changes in sweetener pricing. This contract differed from Pepsi’s Master Bottling Agreement with its top bottler. That agreement granted the bottler perpetual rights to distribute Pepsi’s CSD products but required it to purchase raw materials from Pepsi at prices, and on terms and conditions, determined by Pepsi. Pepsi negotiated concentrate prices with its bottling association, and normally based price increases on the consumer price index (CPI). Over the last two decades, however, concentrate makers regularly raised concentrate prices, often by more than the increase in inflation (see Exhibit 5). Franchise agreements with both Coke and Pepsi allowed bottlers to handle the non-cola brands of other concentrate producers. Bottlers could choose whether to market new beverages introduced by a concentrate producer. However, concentrate producers worked hard to “encourage” bottlers to carry their product offerings. Bottlers could not carry directly competing brands, however. For example, a Coke bottler could not sell Royal Crown Cola, yet it could distribute 7UP if it did not carry Sprite. Franchised bottlers could decide whether to participate in test marketing efforts, local advertising campaigns and promotions, and new package introductions (although they could only use packages authorized by their franchiser). Bottlers also had the final say in decisions about retail pricing. In 1971, the Federal Trade Commission initiated action against eight major concentrate makers, charging that the granting of exclusive territories to bottlers prevented intrabrand competition (that is, two or more bottlers competing in the same area with the same beverage). The concentrate makers argued that interbrand competition was strong enough to warrant continuation of the existing territorial agreements. In 1980, after years of litigation, Congress enacted the Soft Drink Interbrand Competition Act, which preserved the right of concentrate makers to grant exclusive territories. 3 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. 711-462 Cola Wars Continue: Coke and Pepsi in 2010 Retail Channels In 2009, the distribution of CSDs in the United States took place through supermarkets (29.1%), fountain outlets (23.1%), vending machines (12.5%), mass merchandisers (16.7%), convenience stores and gas stations (10.8%), and other outlets (7.8%). Small grocery stores and drug chains made up most of the latter category.16 Costs and profitability in each channel varied by delivery method and frequency, drop size, advertising, and marketing (see Exhibit 6). CSDs accounted for $12 billion, or 4% of total store sales in the U.S., and were also a big traffic draw for supermarkets.17 Bottlers fought for shelf space to ensure visibility for their products, and they looked for new ways to drive impulse purchases, such as placing coolers at checkout counters. An ever-expanding array of products and packages created intense competition for shelf space. The mass merchandiser category included discount retailers, such as Wal-Mart and Target. These companies formed an increasingly important channel. Although they sold Coke and Pepsi products, they (along with some drug chains) could also have their own private-label CSD, or sell a generic label such as President’s Choice. Private-label CSDs were usually delivered to a retailer’s warehouse, while branded CSDs were delivered directly to stores. With the warehouse delivery method, the retailer was responsible for storage, transportation, merchandising, and stocking the shelves, thereby incurring additional costs. Historically, Pepsi had focused on sales through retail outlets, while Coke commanded the lead in fountain sales. (The term “fountain,” which originally referred to drug store soda fountains, covered restaurants, cafeterias, and any other outlet that served soft drinks by the glass using fountain-type dispensers.) Competition for national fountain accounts was intense, especially in the 1990s. In 1999, for example, Burger King franchises were believed to pay about $6.20 per gallon for Coke syrup, but they received a substantial rebate on each gallon; one large Midwestern franchise owner said that his annual rebate ran $1.45 per gallon, or about 23%.18 Local fountain accounts, which bottlers handled in most cases, were considerably more profitable than national accounts. To support the fountain channel, Coke and Pepsi invested in the development of service dispensers and other equipment, and provided fountain customers with point-of-sale advertising and other in-store promotional material. After Pepsi entered the fast-food restaurant business by acquiring Pizza Hut (1978), Taco Bell (1986), and Kentucky Fried Chicken (1986), Coca-Cola persuaded competing chains such as Wendy’s and Burger King to switch to Coke. In 1997, PepsiCo spun off its restaurant business under the name Tricon, but fountain “pouring rights” remained split along largely pre-Tricon lines.19 In 2009, Pepsi supplied all Taco Bell and KFC restaurants and the great majority of Pizza Hut restaurants, and Coke retained deals with Burger King and McDonald’s (the largest national account in terms of sales). Competition remained vigorous: In 2004, Coke won the Subway account away from Pepsi, while Pepsi grabbed the Quiznos account from Coke. (Subway was the largest account as measured by number of outlets.) In April 2009, DPS secured rights for Dr Pepper at all U.S. McDonald’s restaurants.20 Yet Coke continued to lead the channel with a 69% share of national pouring rights, against Pepsi’s 20% and DPS’ 11%.21 Coke and DPS had long retained control of national fountain accounts, negotiating pouring-rights contracts that in some cases (as with big restaurant chains) covered the entire United States or even the world. Local bottlers or the franchisors’ fountain divisions serviced these accounts. (In such cases, bottlers received a fee for delivering syrup and maintaining machines.) Historically, PepsiCo had ceded fountain rights to local Pepsi bottlers. But in the late 1990s, Pepsi began a successful campaign to gain from its bottlers the right to sell fountain syrup via restaurant commissary companies.22 4 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Cola Wars Continue: Coke and Pepsi in 2010 711-462 In the vending channel, bottlers took charge of buying, installing, and servicing machines, and for negotiating contracts with property owners, who typically received a sales commission in exchange for accommodating those machines. But concentrate makers offered bottlers financial incentives to encourage investment in machines, and also played a large role in the development of vending technology. Coke and Pepsi were by far the largest suppliers of CSDs to this channel. Suppliers to Concentrate Producers and Bottlers Concentrate producers required few inputs: the concentrate for most regular colas consisted of caramel coloring, phosphoric or citric acid, natural flavors, and caffeine.23 Bottlers purchased two major inputs: packaging (including cans, plastic bottles, and glass bottles), and sweeteners (including high-fructose corn syrup and sugar, as well as artificial sweeteners such as aspartame). The majority of U.S. CSDs were packaged in metal cans (56%), with plastic bottles (42%) and glass bottles (2%) accounting for the remainder.24 Cans were an attractive packaging material because they were easily handled and displayed, weighed little, and were durable and recyclable. Plastic packaging, introduced in 1978, allowed for larger and more varied bottle sizes. Single-serve 20-oz PET bottles, introduced in 1993, steadily gained popularity; in 2009, they represented 35% of CSD volume (and 52% of CSD revenues) in convenience stores.25 The concentrate producers’ strategy toward can manufacturers was typical of their supplier relationships. Coke and Pepsi negotiated on behalf of their bottling networks, and were among the metal can industry’s largest customers. In the 1960s and 1970s, both companies took control of a portion of their own can production, but by 1990 they had largely exited that business. Thereafter, they sought instead to establish stable long-term relationships with suppliers. In 2009, major can producers included Ball, Rexam (through its American National Can subsidiary), and Crown Cork & Seal.26 Metal cans were essentially a commodity, and often two or three can manufacturers competed for a single contract. The Evolution of the U.S. Soft Drink Industry27 Early History Coca-Cola was formulated in 1886 by John Pemberton, a pharmacist in Atlanta, Georgia, who sold it at drug store soda fountains as a “potion for mental and physical disorders.” In 1891, Asa Candler acquired the formula, established a sales force, and began brand advertising of Coca-Cola. The formula for Coca-Cola syrup, known as “Merchandise 7X,” remained a well-protected secret that the company kept under guard in an Atlanta bank vault. Candler granted Coca-Cola’s first bottling franchise in 1899 for a nominal one dollar, believing that the future of the drink rested with soda fountains. The company’s bottling network grew quickly, however, reaching 370 franchisees by 1910. In its early years, imitations and counterfeit versions of Coke plagued the company, which aggressively fought trademark infringements in court. In 1916 alone, courts barred 153 imitations of Coca-Cola, including the brands Coca-Kola, Koca-Nola, and Cold-Cola. Coke introduced and patented a 6.5-oz bottle whose unique “skirt” design subsequently became an American icon. Candler sold the company to a group of investors in 1919, and it went public that year. Four years later, Robert Woodruff began his long tenure as leader of the company. Woodruff pushed franchise bottlers to place the beverage “in arm’s reach of desire,” by any and all means. During the 1920s and 1930s, Coke pioneered open-top coolers for use in grocery stores and other channels, developed 5 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. 711-462 Cola Wars Continue: Coke and Pepsi in 2010 automatic fountain dispensers, and introduced vending machines. Woodruff also initiated “lifestyle” advertising for Coca-Cola, emphasizing the role that Coke played in a consumer’s life. Woodruff developed Coke’s international business as well. During World War II, at the request of General Eisenhower, Woodruff promised that “every man in uniform gets a bottle of Coca-Cola for five cents wherever he is and whatever it costs the company.” Beginning in 1942, Coke won exemptions from wartime sugar rationing for production of beverages that it sold to the military or to retailers that served soldiers. Coca-Cola bottling plants followed the movement of American troops, and during the war the U.S. government set up 64 such plants overseas—a development that contributed to Coke’s dominant postwar market shares in most European and Asian countries. Pepsi-Cola was invented in 1893 in New Bern, North Carolina, by pharmacist Caleb Bradham. Like Coke, Pepsi adopted a franchise bottling system, and by 1910 it had built a network of 270 bottlers. Pepsi struggled, however; it declared bankruptcy in 1923 and again in 1932. But business began to pick up when, during the Great Depression, Pepsi lowered the price of its 12-oz bottle to a nickel—the same price that Coke charged for a 6.5-oz bottle. In the years that followed, Pepsi built a marketing strategy around the theme of its famous radio jingle: “Twice as much for a nickel, too.” In 1938, Coke filed suit against Pepsi, claiming that the Pepsi-Cola brand was an infringement on the Coca-Cola trademark. A 1941 court ruling in Pepsi’s favor ended a series of suits and countersuits between the two companies. During this period, as Pepsi sought to expand its bottling network, it had to rely on small local bottlers that competed with wealthy, established Coke franchisees.28 Still, the company began to gain market share, surpassing Royal Crown and Dr Pepper in the 1940s to become the second-largest-selling CSD brand. In 1950, Coke’s share of the U.S. market was 47% and Pepsi’s was 10%; hundreds of regional CSD companies, which offered a wide assortment of flavors, made up the rest of the market.29 The Cola Wars Begin In 1950, Alfred Steele, a former Coke marketing executive, became CEO of Pepsi. Steele made “Beat Coke” his motto and encouraged bottlers to focus on take-home sales through supermarkets. To target family consumption, for example, the company introduced a 26-oz bottle. Pepsi’s growth began to follow the postwar growth in the number of supermarkets and convenience stores in the United States: There were about 10,000 supermarkets in 1945; 15,000 in 1955; and 32,000 in 1962, at the peak of this growth curve. Under the leadership of CEO Donald Kendall, Pepsi in 1963 launched its “Pepsi Generation” marketing campaign, which targeted the young and “young at heart.” The campaign helped Pepsi narrow Coke’s lead to a 2-to-1 margin. At the same time, Pepsi worked with its bottlers to modernize plants and to improve store delivery services. By 1970, Pepsi bottlers were generally larger than their Coke counterparts. Coke’s network remained fragmented, with more than 800 independent franchised bottlers (most of which served U.S. cities of 50,000 or less).30 Throughout this period, Pepsi sold concentrate to its bottlers at a price that was about 20% lower than what Coke charged. In the early 1970s, Pepsi increased its concentrate prices to equal those of Coke. To overcome bottler opposition, Pepsi promised to spend this extra income on advertising and promotion. Coke and Pepsi began to experiment with new cola and non-cola flavors, and with new packaging options, in the 1960s. Previously, the two companies had sold only their flagship cola brands. Coke launched Fanta (1960), Sprite (1961), and the low-calorie cola Tab (1963). Pepsi countered with Teem (1960), Mountain Dew (1964), and Diet Pepsi (1964). Both companies introduced non-returnable glass bottles and 12-oz metal cans in various configurations. They also diversified into non-CSD industries. 6 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Cola Wars Continue: Coke and Pepsi in 2010 711-462 Coke purchased Minute Maid (fruit juice), Duncan Foods (coffee, tea, hot chocolate), and Belmont Springs Water. In 1965, Pepsi merged with snack-food giant Frito-Lay to form PepsiCo, hoping to achieve synergies based on similar customer targets, delivery systems, and marketing orientations. In the late 1950s, Coca-Cola began to use advertising messages that implicitly recognized the existence of competitors: “American’s Preferred Taste” (1955), “No Wonder Coke Refreshes Best” (1960). In meetings with Coca-Cola bottlers, however, executives discussed only the growth of their own brand and never referred to its closest competitor by name. During the 1960s, Coke focused primarily on overseas markets, apparently basing its strategy on the assumption that domestic CSD consumption was approaching a saturation point. Pepsi, meanwhile, battled Coke aggressively in the United States, and doubled its U.S. share between 1950 and 1970. The Pepsi Challenge In 1974, Pepsi launched the “Pepsi Challenge” in Dallas, Texas. Coke was the dominant brand in that city, and Pepsi ran a distant third behind Dr Pepper. In blind taste tests conducted by Pepsi’s small local bottler, the company tried to demonstrate that consumers actually preferred Pepsi to Coke. After its sales shot up in Dallas, Pepsi rolled out the campaign nationwide. Coke countered with rebates, retail price cuts, and a series of advertisements that questioned the tests’ validity. In particular, it employed retail price discounts in markets where a company-owned Coke bottler competed against an independent Pepsi bottler. Nonetheless, the Pepsi Challenge successfully eroded Coke’s market share. In 1979, Pepsi passed Coke in food store sales for the first time, opening up a 1.4 share-point lead. In a sign of the times, Coca-Cola president Brian Dyson inadvertently uttered the name Pepsi at a 1979 bottlers’ conference. During this period, Coke renegotiated its franchise bottling contract to obtain greater flexibility in pricing concentrate and syrups. Its bottlers approved a new contract in 1978, but only after Coke agreed to link concentrate price changes to the CPI, to adjust the price to reflect any cost savings associated with ingredient changes, and to supply unsweetened concentrate to bottlers that preferred to buy their own sweetener on the open market.31 This arrangement brought Coke in line with Pepsi, which traditionally had sold unsweetened concentrate to its bottlers. Immediately after securing approval of the new agreement, Coke announced a significant concentrate price increase. Pepsi followed with a 15% price increase of its own. Cola Wars Heat Up In 1980, Roberto Goizueta was named CEO of Coca-Cola, and Don Keough became its president. That year, Coke switched from using sugar to using high-fructose corn syrup, a lower-priced alternative. Pepsi emulated that move three years later. Coke also intensified its marketing effort, more than doubling its advertising spending between 1981 and 1984. In response, Pepsi doubled its advertising expenditures over the same period. Meanwhile, Goizueta sold off most of the non-CSD businesses that he had inherited, including wine, coffee, tea, and industrial water treatment, while retaining Minute Maid. Diet Coke, introduced in 1982, was the first extension of the “Coke” brand name. Many Coke managers, deeming the “Mother Coke” brand sacred, had opposed the move. So had company lawyers, who worried about copyright issues. Nonetheless, Diet Coke was a huge success. Praised as the “most successful consumer product launch of the Eighties,” it became within a few years not only the most popular diet soft drink in the United States, but also the nation’s third-largest-selling CSD. 7 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. 711-462 Cola Wars Continue: Coke and Pepsi in 2010 In April 1985, Coke announced that it had changed the 99-year-old Coca-Cola formula. Explaining this radical break with tradition, Goizueta cited a sharp depreciation in the value of the Coca-Cola trademark. “The product and the brand,” he said, “had a declining share in a shrinking segment of the market.”32 On the day of Coke’s announcement, Pepsi declared a holiday for its employees, claiming that the new Coke mimicked Pepsi in taste. The reformulation prompted an outcry from Coke’s most loyal customers, and bottlers joined the clamor. Three months later, the company brought back the original formula under the name Coca-Cola Classic, while retaining the new formula as its flagship brand under the name New Coke. Six months later, Coke announced that it would henceforth treat Coca-Cola Classic (the original formula) as its flagship brand. New CSD brands proliferated in the 1980s. Coke introduced 11 new products, including CaffeineFree Coke (1983) and Cherry Coke (1985). Pepsi introduced 13 products, including Lemon-Lime Slice (1984) and Caffeine-Free Pepsi-Cola (1987). The number of packaging types and sizes also increased dramatically, and the battle for shelf space in supermarkets and other stores became fierce. By the late 1980s, Coke and Pepsi each offered more than 10 major brands and 17 or more container types.33 The struggle for market share intensified, and retail price discounting became the norm. Consumers grew accustomed to such discounts. Throughout the 1980s, the growth of Coke and Pepsi put a squeeze on smaller concentrate producers. As their shelf space declined, small brands were shuffled from one owner to another. Over a five-year span, Dr Pepper was sold (all or in part) several times, Canada Dry twice, Sunkist once, and A&W Brands once. Philip Morris acquired Seven-Up in 1978 for a big premium, racked up huge losses in the early 1980s, and then left the CSD business in 1985. In the 1990s, through a series of strategic acquisitions, Cadbury Schweppes emerged as the third-largest concentrate producer—the main (albeit distant) competitor of the two CSD giants. It bought the Dr Pepper/Seven-Up Companies in 1995, and continued to add such well-known brands as Orangina (2001) and Nantucket Nectars (2002) to its portfolio. Then in 2008, Cadbury’s beverage business was spun off into an independent company, Dr Pepper Snapple Group. Bottler Consolidation and Spin-Off Relations between Coke and its franchised bottlers had been strained since the contract renegotiation of 1978. Coke struggled to persuade bottlers to cooperate in marketing and promotion programs, to upgrade plant and equipment, and to support new product launches.34 The cola wars had particularly weakened small, independent bottlers. Pressures to spend more on advertising, product and packaging proliferation, widespread retail price discounting—together, these factors resulted in higher capital requirements and lower profit margins. Many family-owned bottlers no longer had the resources needed to remain competitive. At a July 1980 dinner with Coke’s 15 largest domestic bottlers, Goizueta announced a plan to refranchise bottling operations. Coke began buying up poorly managed bottlers, infusing them with capital, and quickly reselling them to better-performing bottlers. Refranchising allowed Coke’s larger bottlers to expand outside their traditionally exclusive geographic territories. When two of its largest bottling companies came up for sale in 1985, Coke moved swiftly to buy them for $2.4 billion, preempting outside bidders. Together with other recently purchased bottlers, these acquisitions placed one-third of Coke’s volume in company-owned operations. Meanwhile, Coke began to replace its 1978 franchise agreement with what became the 1987 Master Bottler Contract. Coke’s bottler acquisitions had increased its long-term debt to approximately $1 billion. In 1986, the company created an independent bottling subsidiary, Coca-Cola Enterprises (CCE), selling 51% of its shares to the public and retaining the rest. The minority equity position enabled Coke to separate 8 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Cola Wars Continue: Coke and Pepsi in 2010 711-462 its financial statements from those of CCE. As Coke’s first “anchor bottler,” CCE consolidated small territories into larger regions, renegotiated contracts with suppliers and retailers, merged redundant distribution and purchasing arrangements, and cut its work force by 20%. CCE also invested in building 50-million-case production lines that involved high levels of automation. Coke continued to acquire independent franchised bottlers and sell them to CCE. “We became an investment banking firm specializing in bottler deals,” said Don Keough. 35 In 1997 alone, Coke put together more than $7 billion in such deals.36 As of 2009, CCE was Coke’s largest bottler. It handled about 75% of Coke’s North American bottle and can volume, and logged annual sales of more than $21 billion. In the late 1980s, Pepsi acquired MEI Bottling for $591 million, Grand Metropolitan’s bottling operations for $705 million, and General Cinema’s bottling operations for $1.8 billion. After operating the bottlers for a decade, Pepsi shifted course and adopted Coke’s anchor bottler model. In April 1999, the Pepsi Bottling Group (PBG) went public, with Pepsi retaining a 35% equity stake in it. By 2009, PBG produced 56% of PepsiCo’s total volume, while the total number of Pepsi bottlers had fallen from more than 400 in the mid-1980s to 106.37 Bottler consolidation made smaller concentrate producers increasingly dependent on the Pepsi and Coke bottling networks for distribution of their products. In response, DPS in 1998 bought and merged two large U.S. bottling companies to form its own bottler. In 2009, Coke had the most consolidated system, with its top 10 bottlers producing 94% of domestic volume. Pepsi’s and DPS’ top 10 bottlers produced 89% and 79% of the domestic volume of their respective franchisors.38 Adapting to the Times Starting in the late 1990s, the soft drink industry encountered new challenges that suggested a possible long-term shift in the marketplace. Although Americans still drank more CSDs than any other beverage, U.S. consumption began to fizzle (see Exhibit 1). That stood in contrast to annual growth rates of 3% to 7% during the 1980s and early 1990s.39 This shift in consumption patterns evolved around the growing linkage between CSDs and health issues such as obesity and nutrition. New federal nutrition guidelines, issued in 2005, identified regular CSDs as the largest source of obesity-causing sugars in the American diet.40 Schools throughout the nation banned the sale of soft drinks on their premises. Several states pushed for a “soda tax” on sugary drinks like sodas and energy beverages. A U.S. government study suggested that a 20% tax could cut the calorie intake from sugary drinks by up to 49 calories a day per person in the United States.41 As of April 2010, 29 states already taxed sodas and around 12 more states were considering the measure.42 In addition, a greater number of consumers started to perceive highfructose corn syrup as unnatural and unhealthy. According to one market research study, 53% of Americans were concerned that the ingredient posed a health hazard in 2010, compared to 40% in 2004.43 In fact, Coke’s 2009 annual report identified obesity and health concerns as the number one risk factor to its business.44 In face of dwindling CSD sales (see Exhibit 7), Coke and Pepsi tried to stem the tide by enticing consumers with stepped-up innovation and marketing. In Coke’s case, the company revealed a new Freestyle soda machine in 2009 which could create dozens of different kinds of custom beverages; restaurants had to pay a 30% premium for the Freestyle compared to a regular soda fountain. 45 Coke also placed a greater emphasis on promoting its brands, such as spending $230 million in advertising for its flagship Cola-Cola drink (see Exhibit 8). It also upped spending on sponsorships and global marketing, including $600 million for the World Cup in 2010.46 Meanwhile, Pepsi redesigned its logo in 2008 with a three-year rebranding plan that could cost over $1 billion to rejuvenate its image. Pepsi 9 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. 711-462 Cola Wars Continue: Coke and Pepsi in 2010 focused on promoting the company’s overall portfolio as a snack and beverage company, such as through “The Power of One” concept. Market surveys on brand loyalty indicated that more consumers preferred Coke over Pepsi as their favorite CSD brand towards 2010, a slight setback for Pepsi after it had significantly narrowed the gap in the late 1990s.47 The Quest for Alternatives Expanding the product mix offered another avenue for growth. Diet sodas, for example, rose to capture 30% of the CSD market in 2009 compared to 24% a decade ago.48 Coca-Cola Zero became the most successful new CSD product launched in the second half of the decade. The beverage, which offered the “real Coca-Cola taste with zero calories”, experienced consecutive double-digit growth since its introduction in 2005. It was primarily marketed to younger men around the world who shunned the “diet” label. At the same time, both Coke and Pepsi intensified their efforts to use alternative sweeteners. Pepsi replaced high-fructose corn syrup with natural sugar for its brands, Pepsi Throwback and Mountain Dew Throwback. Another possible alternative was Stevia, an herb that could be used as a natural, zero-calorie sweetener. Coke and Pepsi both developed their own versions of a Stevia-based sweetener, which were approved to be used as a food additive by the U.S. Food and Drug Administration in 2008. New Stevia-based product releases followed, including Pepsi’s reducedcalorie Trop 50 (orange juice), and Coke’s Sprite Green, with plans to expand to more CSDs as well. Despite some success with diet drinks, Coke and Pepsi realized that growth would involve “noncarbs”—a category that included juices and juice drinks, sports drinks, energy drinks, and tea-based drinks—and also on bottled water (see Exhibit 9). In 2009, while CSDs accounted for 63% of U.S. nonalcoholic refreshment beverage volume (down from 81% in 2000), the remaining volume was made up of bottled water at 20% (up from 7%) and non-carbs at 17% (up from 13%).49 Initially, Pepsi was more aggressive than Coke in shifting to non-CSDs. Declaring itself to be a “total beverage company,” Pepsi developed a portfolio of non-CSD products that outsold Coke’s rival product in several key categories, such as sports drink (Gatorade) and tea-based drinks (Lipton). Between 2004 and 2007, 77% of Pepsi’s new products released in the U.S. market were non-carbs compared to Coke’s 56%.50 But starting in 2007, Coke aggressively expanded its non-carbs product portfolio through acquisitions. Most notable was its $4 billion purchase of Energy Brands, maker of the popular Vitaminwater drinks. The deal was the biggest acquisition Coke had ever made. Coke also entered the business of supplying coffee and tea to fountain/foodservice customers. By 2009, Pepsi had 43% of the U.S. non-carbs market share compared to Coke’s 32%.51 In the $14 billion bottled-water category, both Pepsi (with Aquafina, 1998) and Coke (with Dasani, 1999) had introduced purified-water products that had surged to become leading beverage brands. Using their distribution prowess, they had outstripped competing brands, many of which sold spring water. However, the economic downturn in the late 2000s dampened future prospects for what had been the fastest growing beverage category between 2000 and 2007.52 Price-sensitive consumers sought cheaper alternatives such as private label bottled-water or tap water, exhibiting little brand loyalty compared to CSDs. Environmentalists also became more vocal in their criticisms against the use of plastic bottles, known as PET, which had a recycling rate below 25%.53 Bottled water started to generate negative operating profit margins. Coke also saw its market share in this category slip to 15% in 2009 (compared to 22% in 2004) while Pepsi’s fell to 11% (compared to 14%).54 10 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Cola Wars Continue: Coke and Pepsi in 2010 711-462 Internationalizing the Beverage Wars As U.S. demand for CSDs softened, Coke and Pepsi also looked abroad for new growth. The United States remained the largest market, accounting for a third of global CSD consumption, followed by Mexico, Puerto Rico, and Argentina.55 But improved access to markets in Asia and Eastern Europe stimulated new demand. In particular, China and India emerged as future battlegrounds with a large, growing middle class population. Each company planned to invest about $2 billion in China over the next few years to build up their market presence. Coke flourished, and also relied upon, international markets far more than Pepsi. Through steady expansion, the Coca-Cola name had become synonymous with American culture. Served in more than 200 countries, Coke derived about 80% of its sales from international markets.56 Pepsi, on the other hand, depended on the U.S. for roughly half of its total sales.57 Earlier efforts to go after Coke in core international markets generated relatively little success. By the early 2000s, Pepsi chose to focus on emerging markets that were still up for grabs. Several of its top CSD markets were in Asia, Middle East, and Africa. Since CSD consumption abroad was generally lower compared to the United States, Coke and Pepsi aggressively pursued non-carbs opportunities in global markets. For instance, juice was a popular category—its retail value in China was expected to grow 94% by 2012 compared to 30% for CSDs.58 In Russia, Pepsi and PBC paid $1.4 billion for a 76% stake in Russia’s largest juice producer, OAO Lebedyansky, in 2008. International operations, however, encountered several obstacles, including antitrust regulation, foreign exchange controls, advertising restrictions, and local competition. In one high-profile incident, the Chinese government rejected Coke’s $2.4 billion bid to buy Huiyan Juice, a leading juice company in China. At the same time, overseas markets enabled Coke and Pepsi to broaden the scope of innovation. To tailor to local tastes, Coke offered Sprite Tea, which blended green tea with Sprite, while Pepsi experimented with beverages made out of Chinese herbs. New approaches to packaging abounded as well.59 In China and India, use of small returnable glass bottles allowed Coke to reach poor, rural consumers at a very low price point, while boosting revenue-per-ounce.60 Evolving Structures and Strategies Both at home and abroad, the growing popularity of alternative beverages brewed complications for CSD makers’ traditional production and distribution practices. Concentrate companies became more directly involved in the manufacturing of several non-CSDs, ranging from Gatorade to Lipton Iced Tea. Such finished goods required a smaller but specialized production process that were challenging for bottlers to make with their existing infrastructure. As the popularity of non-carbs continued to grow, bottlers were frustrated that they were not fully participating in the new growth businesses. Coke and Pepsi sold the finished goods to their bottlers, who distributed them alongside their own bottled products at a percentage markup. In addition, Coke and Pepsi distributed some non-CSDs directly to the retailers’ warehouses, bypassing bottlers. Energy and sports drinks promised better margins than CSDs because they commanded premium prices and were usually chosen for immediate, single-serve consumption (see Exhibit 10). In convenience stores, energy drinks had an average case price of $34.32 compared to CSD’s $8.99.61 Yet volume for such products, while growing fast, remained small in comparison with CSD volume. This created issues with DSD, which worked best with high-volume, high consumer demand products. All CSD companies faced the challenge of achieving pricing power in the take-home channels. In particular, the rapid growth of the mass-merchandisers, led by Wal-Mart, and various club stores 11 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. 711-462 Cola Wars Continue: Coke and Pepsi in 2010 posed a new threat to profitability for Coke, Pepsi, and their bottlers. Consolidation in the retail sector meant that the top ten customers represented as much as 40% of Coke’s U.S. package volume.62 In the case of Wal-Mart, it not only used its size to exert pricing pressure, it also insisted on negotiating marketing and shelving arrangements directly with concentrate makers. This left bottlers feeling vulnerable in their traditional practice of distributing products in their exclusive territories. In addition, bottlers had to manage an ever-rising number of stock-keeping units (SKUs).63 For instance, Pepsi wanted its bottlers to carry 47 different Gatorade SKUs in exchange for gaining distribution rights to smaller but more profitable channels like convenience and dollar stores.64 Many non-CSDs sold in relatively low volume, leading to an increased use of “split pallets.” By loading more than one product type on a pallet (the hard, wooden bed used to organize and transport merchandise), bottlers incurred higher distribution and sales costs. Some of Coke’s biggest bottlers saw their cost of goods sold (including operating expenses) reach 90% of their sales, the highest level in more than two decades.65 Not surprisingly, bottlers complained over Coke’s practice of charging a flat rate for its concentrate in the U.S. market. Coke’s profits were tied to volume growth while bottlers’ profits were driven by package types and where the drinks were sold.66 Then in 2003, Coke and CCE moved toward “incidence pricing”, an approach that Coke often used with its overseas bottlers, whereby Coke agreed to vary concentrate prices according to prices charged in different channels and for different packages. By 2009, around 90% of Coke’s total volume was covered under incidence pricing agreements. Annual price negotiations were also replaced with multi-year concentrate-price agreements. With some bottlers, Coke pursued more 50-50 joint ventures. Motivating its independent bottlers became critical, especially for Coke, as they accounted for nearly 90% of Coke’s worldwide sales volume.67 Bottler Consolidation, Again In 2009, Pepsi announced that it would buy two of its biggest bottlers, PBG and PepsiAmericas, in a transaction worth $7.8 billion. The offer came just about ten years after Pepsi had spun off PBG into an independent company. The merger would consolidate more than 80% of Pepsi’s North America beverage operations under one roof.68 One analyst noted that the deal acknowledged the “changing realities of the North American beverage business.”69 Then Coke, which had been a loyal defender of the franchise bottling system, surprised the world with its decision to buy CCE’s North American operations in February 2010. The deal brought back 90% of Coke’s North America business under its control. In return, CCE bought Coke’s own bottling operations in Norway and Sweden, and received the option to buy Coke’s stake in its German bottling business at a later date. Future of the Cola Wars? Declining CSD sales, declining cola sales, and the rapid emergence of non-carbonated drinks appeared to be changing the game in the cola wars. By spending billions of dollars to bring bottling operations under Coke and Pepsi’s direct control again, observers couldn’t help but wonder: was this a fundamental shift in the cola wars or was this just one more round in a 100 year rivalry? 12 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. 182.5 68.0 114.5 22.7 22.8 18.5 ? 35.7 6.5 5.2 ? ? 1.3 1.8 3,090 22.7 12.4% 182.5 56.0 126.5 26.3 21.8 21.6 1.2 33.0 6.8 7.3 ? 4.8 1.7 2.0 3,780 26.3 14.4% 1975 182.5 49.2 133.3 34.2 20.6 24.3 2.7 27.2 6.9 7.3 ? 6.0 2.1 2.0 5,180 34.2 18.7% 1981 182.5 36.0 146.5 40.3 24.0 25.0 4.5 26.9 8.1 7.3 ? 6.2 2.4 1.8 6,500 40.3 22.1% 1985 182.5 28.7 153.8 46.9 24.0 24.2 8.1 26.2 8.5 7.0 ? 5.4 2.0 1.5 7,780 46.9 25.7% 1990 182.5 31.0 151.5 50.9 21.9 22.8 10.1 21.3 8.9 6.8 1.3 4.5 1.8 1.2 9,000 50.9 27.9% 1995 182.5 31.6 150.9 53.0 21.8 21.3 13.2 16.8 9.5 7.0 2.2 3.0 1.9 1.2 9,950 53.0 29.0% 2000 182.5 27.6 155.2 51.7 21.4 20.3 19.5 16.4 8.2 7.0 4.2 2.6 2.2 1.4 10,220 51.9 28.3% 2005 182.5 24.8 155.9 49.3 22.0 21.7 22.5 16.0 8.1 7.1 4.9 2.2 2.5 1.4 9,920 49.3 27.1% 2007 182.5 28.9 152.7 47.4 21.7 21.4 21.4 15.9 7.6 7.3 4.6 2.3 2.6 1.4 9,620 47.4 26.0% 2008 e This analysis assumes that each person consumes, on average, one half-gallon of liquid per day. d For pre-1992 data, sports drinks are included in “Tap water/hybrids/all others.” c For 1985 and afterward, coffee and tea data are based on a three-year moving average. b Bottled water includes all packages, single-serve as well as bulk. a One case is equivalent to 192 oz. Source: Compiled from Beverage Digest Fact Book 2001, The Maxwell Consumer Report, Feb. 3, 1994; Adams Liquor Handbook, casewriter estimates; and Beverage Digest Fact Book 2005. Data for 1990 and afterward comes from Beverage Digest Fact Book 2005 and 2010, which reports that some of that data has been “restated compared to previous editions of the Fact Book.” Totale Tap water/hybrids/all others Subtotal Carbonated soft drinks Beer Milk Bottled waterb Coffeec Juices Teac Sports drinksd Powdered drinks Wine Distilled spirits U.S. Liquid Consumption Trends (gallons/capita) Casesa (millions) Gallons/capita As share of total beverage consumption 1970 U.S. Beverage Industry Consumption Statistics Historical Carbonated Soft Drink Consumption Exhibit 1 182.5 31.8 150.7 46.0 21.0 21.5 20.6 15.8 8.1 7.3 4.0 2.4 2.6 1.4 9,420 46.0 25.2% 2009 711-462 -13- For the exclusive use of s. hurmiz, 2021. This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. 711-462 Exhibit 2 Cola Wars Continue: Coke and Pepsi in 2010 U.S. Soft Drink Market Share by Unit Case Volume (%) 1970 1980 1985 1990 1995 2000 2005 2009Ea Coca-Cola Company Coca-Colab Diet Coke Sprite and Diet Sprite Caffeine Free Coke, Diet Coke Fantac Barq’s and Diet Barq’s Minute Maid brands Tab Others Total 28.4 ? 1.8 ? ? ? ? 1.3 3.2 34.7 25.3 ? 3.0 ? ? ? ? 3.3 4.3 35.9 21.7 6.8 4.7 1.7 0.9 ? ? 1.1 2.6 39.5 20.7 9.3 4.5 2.9 0.7 ? 0.7 0.2 2.8 41.1 20.9 8.8 5.7 2.6 0.7 0.2 0.7 0.1 3.3 42.3 20.4 8.7 7.2 2.2 0.2 1.2 1.5 ? 4.2 44.1 17.6 9.8 6.3 1.8 1.6 1.1 0.1 ? 4.9 43.1 17.0 9.9 6.1 1.4 1.8 1.1 ? ? 4.6 41.9 PepsiCo, Inc. Pepsi-Cola Mountain Dew Diet Pepsi Sierra Mist Diet Mountain Dew Caffeine Free Pepsi, and Diet Pepsi Mug Root Beer Slice and Diet Slice Others Total 17.0 0.9 1.1 ? ? ? ? ? 0.8 19.8 20.4 3.3 3.0 ? ? ? ? ? 1.1 27.8 19.3 3.1 3.9 ? ? 2.5 ? 1.4 0.1 30.3 17.6 3.9 6.3 ? 0.5 2.3 0.3 1.4 0.1 32.4 15.0 5.7 5.8 ? 0.7 2.0 0.3 1.2 0.2 30.9 13.6 7.2 5.3 0.1 0.9 1.7 0.8 0.6 1.2 31.4 11.2 6.5 6.0 1.4 1.4 1.4 0.7 0.1 2.7 31.4 9.9 6.7 5.6 1.3 1.9 1.0 0.7 0.1 2.7 29.9 Dr Pepper Snapple Groupd Dr Pepper (all brands) 7UP (all brands) A&W brands Sunkist Canada Dry Schweppes Others Total 3.8 7.2 ? ? ? ? ? 11.0 6.0 6.3 ? ? ? ? ? 12.3 4.5 5.8 ? 1.2 1.5 0.5 1.5 15.0 5.2 3.9 ? 0.7 1.2 0.6 0.7 12.3 6.8 3.3 0.9 0.7 1.0 0.5 1.9 15.1 7.5 2.8 0.9 0.8 0.9 0.4 1.4 14.7 7.6 1.7 1.0 1.1 0.8 0.4 2.0 14.6 8.3 1.6 1.1 1.2 1.0 0.5 2.7 16.4 Cott Corporation Royal Crown Cos. Other companies ? 6.0 28.5 ? 4.7 19.3 ? 3.1 12.1 ? 2.6 11.6 2.7 2.0 7.0 3.3 1.1 5.4 5.4 ? 5.5 4.9 ? 6.9 Total case volume (in millions) 3,670 5,180 6,385 7,780 8,970 9,950 10,224 9,416 Source: Compiled from Beverage Digest Fact Book 2001, 2005, and 2010; The Maxwell Consumer Report, February. 3, 1994; the Beverage Marketing Corporation, cited in Beverage World, March 1996 and March 1999. a Expected market share. One unit case is equivalent to 192 oz. b Between 1985 and 1995, market share includes Coca-Cola Classic. Coca-Cola drops the name “classic” in 2009. c For the period before 1985, Fanta sales are included under “Others.” d For the years preceding 1988, Dr Pepper and 7UP brand shares refer to the shares of the respective independent companies, the Dr Pepper Company and the Seven-Up Company. Then, Cadbury Schweppes acquired A&W brands in 1993, Dr Pepper/Seven-Up Cos. brands in 1995, and Royal Crown brands in 2000. In 2008, Cadbury Schweppes’ beverage brands came under the control of the Dr Pepper Snapple Group. 14 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. 2,368 10.3% ? ? ? ? 5,975 4.4% 20.0% 31.0% ? ? ? ? 2,709 4.6% 18.0% 35.0% 5,475 7.7% 20.0% 10.0% 2,773 9.0% 21.0% 3.0% 1,065 10.4% 2,349 21.0% ? ? 7,585 5.6% 30.0% 36.0% ? ? ? ? 2,725 10.4% 5,879 12.3% 24.0% 23.0% 2,677 22.9% 1,865 11.6% 1985 17,515 6.2% 22.0% 33.0% ? ? 1,489 6.3% 5,035 13.4% 10,236 13.5% 36.0% 8.0% 6,125 29.4% 2,461 16.5% 1990 19,067 7.5% 19.4% 35.9% ? ? 3,040 3.9% 7,427 16.7% 18,127 16.5% 55.4% 7.6% 12,559 29.1% 5,513 15.5% 1995 20,438 10.7% 30.1% 12.8% ? ? 1,981 8.0% 6,171 22.3% 20,458 10.6% 23.4% 4.0% 12,588 27.1% 7,870 17.9% 2000 32,562 12.5% 28.6% 7.3% ? ? ? ? 9,146 22.3% 23,104 21.1% 29.8% 3.9% 16,345 35.4% 6,676 23.3% 2005 39,474 14.3% 32.8% 12.1% 11,090 22.4% ? ? ? ? 28,857 20.7% 27.5% 7.6% 20,778 33.2% 7,836 21.6% 2007 43,251 11.9% 42.5% 21.8% 10,937 18.5% ? ? ? ? 31,944 18.2% 28.4% 6.9% 22,611 35.2% 8,280 19.1% 2008 43,232 13.8% 35.4% 18.6% 10,116 21.5% As of 2000, data for “Beverages, North America” combined sales for what had been the Pepsi-Cola and Gatorade/Tropicana divisions. In 2003, PepsiCo ceased reporting its international beverage business separately from its international food business. In 2007, Pepsi merged its North America beverage sales with Latin America sales, and started to report their combined financial under PepsiCo Americas Beverages. b PepsiCo’s sales figures included sales by company-owned bottlers. In 1998, PepsiCo began reporting U.S. data as part of a North American category that included Canada. in its consolidated net income figure. In 1994, Coke began reporting U.S. data as part of a North American category that included Canada and Mexico. ? ? ? ? 30,990 22.0% 27.5% 10.4% 22,231 34.6% 8,271 20.5% 2009 a Beverage sales consist mainly of concentrate sales. Coke’s stake in CCE was accounted for by the equity method of accounting, with its share of CCE’s net earnings included Source: Company annual reports and Capital IQ database, accessed June 2010. PepsiCo, Inc.b Beverages, North America: Sales Operating profit/sales Beverages, International: Sales Operating profit/sales PepsiCo Americas Beverages: Sales Operating profit/sales Consolidated: Sales Net profit/sales Net profit/equity Long-term debt/assets 1,486 11.1% 1980 ? ? 1975 Financial Data for Coca-Cola and PepsiCo ($ millions) Coca-Cola Companya Beverages, North America: Sales Operating profits/sales Beverages, International: Sales Operating profit/sales Consolidated: Sales Net profit/sales Net profit/equity Long-term debt/assets Exhibit 3a 711-462 -15- For the exclusive use of s. hurmiz, 2021. This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. ? ? ? ? ? ? ? ? ? ? 1980 ? ? ? ? ? ? ? ? ? ? 1985 ? ? ? ? ? 3,933 8.3% 2.4% 6.0% 39.0% 1990 ? ? ? ? ? 6,773 6.9% 1.2% 5.7% 46.3% 1995 7,982 7.4% 2.9% 13.9% 42.3% 14,750 7.6% 1.6% 8.3% 46.7% 2000 11,885 8.6% 3.9% 22.8% 34.2% 18,743 7.6% 2.7% 14.0% 36.1% 2005 13,591 7.9% 3.9% 20.3% 36.4% 20,936 7.0% 3.4% 14.8% 30.7% 2007 13,796 4.7% 1.2% 12.1% 36.9% 21,807 -28.9% -20.1% NA 46.5% 2008a 13,219 7.9% 4.6% 25.3% 40.5% 21,645 7.1% 3.4% 85.1% 48.1% 2009 -16- PBG’s net earnings was included in PepsiCo’s consolidated net income figure. 2009’s data does not reflect PepsiCo’s purchase of PBG, as announced that year. c PBG financial data for the pre-1999 period refer to the PepsiCo bottling operations that were combined and spun off to form PBG in 1998. From 1999, PepsiCo’s share of operations to Coke and CCE’s purchase of Coke’s bottling operations in Norway and Sweden. CCE’s consolidated financial statements reflect wide fluctuations, affected by issues such as, but not limited to, debt write-offs, reassessments of franchise intangible assets to fair market value, and tax charges related to restructuring activities. b Data represents CCE’s consolidated financial data, as reported in CCE’s annual reports, and does not reflect the combined financial data of the new CCE, following the sale of CCE’s North America a In 2008, CCE wrote off $7.6 billion to readjust the fair value of the company’s intangible franchise assets and goodwill contracts, which resulted in a significant losses for the fiscal year. For more information, see “Notes to Consolidated Financial Statements” in CCE’s 2008 annual report. Source: Company annual reports. ? ? ? ? ? Pepsi Bottling Group (PBG)c Sales Operating profit/sales Net profit/sales Net profit/equity Long-term debt/assets (CCE) 1975 ? ? ? ? ? Enterprisesb Financial Data for Coca-Cola and PepsiCo’s Largest Bottlers ($ millions) Coca-Cola Sales Operating profit/sales Net profit/sales Net profit/equity Long-term debt/assets Exhibit 3b 711-462 For the exclusive use of s. hurmiz, 2021. This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Cola Wars Continue: Coke and Pepsi in 2010 Exhibit 4 711-462 Comparative Costs of a Typical U.S. Concentrate Producer and Bottler, 2009 Net sales Cost of goods sold Gross profit Direct marketing expense Selling & delivery expense General & admin expense Operating income Concentrate Producer Dollars Percent per casea of net sales $0.98 100% $0.22 22% $0.76 78% $0.21 21% $0.00 0% $0.24 25% $0.30 32% Bottler Dollars per casea $4.63 $2.67 $1.97 $0.45 $0.85 $0.31 $0.36 Percent of net sales 100% 58% 42% 10% 18% 6% 8% Sources: Compiled from estimates provided by beverage industry source, October 2010. a One case is equivalent to 192 oz. Exhibit 5 U.S. CSD Industry Pricing and Statistics, 1988-2009 1988 $10.79 — -1.4% 1994 $8.48 -3.9% 1998 $7.63 -1.7% 2002 $7.57 -0.1% 2006 $7.47 -0.2% 2008 $7.66 0.4% 2009 $7.98 0.7% Concentrate price per casec Change in concentrate price Total Change 1988-2009: $0.79 — 3.6% $1.00 4.0% $1.14 3.3% $1.35 4.3% $1.50 2.7% $1.59 3.0% $1.65 3.8% Volume (cases, in billions) Change in volume Total Change 1988-2009: 7.40 — 1.2% 8.70 2.0% 9.90 3.3% 10.09 0.3% 10.16 0.2% 9.62 -2.7% 9.42 -2.1% Consumption (gallons/capital) Change in consumption Total Change 1988-2009: 40.30 — 0.6% 50.00 2.7% 54.00 1.9% 52.60 -0.4% 51.10 -0.7% 47.40 -3.7% 46.00 -3.0% Consumer Price Index (2005=100) Change in CPI Total Change 1988-2009: 60.57 — 2.9% 75.91 2.9% 83.48 2.4% 92.11 103.22 2.5% 2.9% Retail price per case, adjusted for inflationa Change in retail priceb Total Change 1988-2008: 110.23 109.88 3.3% -0.3% Source: Compiled from Beverage Digest Fact Book, 2001, and every edition between 2006 and 2010. a Refers to a 192-oz. case. Prices reflect inflation using the inflation calculator tool, U.S. Bureau of Labor Statistics website, http://data.bls.gov/cgi-bin/cpicalc.pl, accessed June 2010. b All change figures are calculated using Compounded Annual Growth Rate (CAGR). c For the purpose of this item only, concentrate price refers to a 288-oz. case. Concentrate price data for previous years appear in aggregated form in Beverage Digest Fact Book 2003, p. 64. After 2004, price is based on a weighted average of concentrate prices for the top 10 CSD brands, as released in Beverage Digest Fact Book, Appendix G, and based on the brands’ market share for the given year. Concentrate prices were also affected by specific ingredients, such as corn and ethanol, which varied significantly from CPI in certain years. 17 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. 711-462 Exhibit 6 Cola Wars Continue: Coke and Pepsi in 2010 U.S. Refreshment Beverages: Bottling Profitability per Channel, 2009 Supermarkets Share of industry volume 37% Index of bottling profitabilityb Net price 1.00 Variable profit 1.00 Convenience Superretail centersa Mass retailersa Club storesa Drug Fountain, stores vending, Total and other 10% 11% 2% 7% 2% 31% 100% 2.24 1.24 1.13 1.24 1.10 1.39 0.93 1.37 1.23 1.68 2.09 1.56 NA NA Source: Compiled from estimates provided by beverage industry source, October 2010. All figures refer to the entire refreshment beverage industry. a “Supercenters” include Wal-Mart Supercenter stories and similar outlets. “Mass Retailers” include standard Wal-Mart stores, Target stores, and the like. “Club Stores” include Sam’s Club, Costco, and similar membership-based retailers. b Using supermarket information as a baseline, these figures indicate variance by channel of both by-volume pricing and by- volume profit. The variable profit figures take into account cost of goods sold as well as delivery costs. Exhibit 7 Non-Alcoholic Refreshment Beverage Megabrands, 2004 and 2009a Brand (Owner) Coke (Coke) Pepsi (Pepsi) Mountain Dew (Pepsi) Dr Pepper (DPS) Sprite (Coke) Gatorade (Pepsi) Aquafina (Pepsi) Dasani (Coke) Poland Spring (Nestlé Waters) 7UP (DPS) Minute Maid (Coke) Sierra Mist (Pepsi) Lipton (Pepsi/Unilever) Crystal Geyser (CG Roxanne) Arrowhead (Nestlé Waters) PowerAde (Coke) Nestlé Pure Life (Nestlé Waters) Barq’s (Coke) Sunkist (DPS) 2009 Cases Category (mil) CSD 2,913.1 CSD 1,681.5 CSD 900.1 CSD 784.0 CSD 573.0 Non-Carb 553.7 Water 325.0 Water 289.7 Water 280.1 CSD 150.9 CSD/Non-Carb 95.5 CSD 149.9 Non-Carb 235.3 Water 223.7 Water 156.4 Non-Carb 177.6 Water CSD CSD 469.4 103.7 116.9 2009 2004 Share Cases (%) (mil) 19.6% 3,272.3 11.3% 2,098.4 6.1% 871.1 5.3% 738.3 3.9% 683.2 3.7% 546.0 2.2% 251.0 1.9% 223.0 1.9% 217.0 1.0% 186.7 0.6% 176.4 1.0% 166.9 1.6% 164.0 1.5% 135.5 1.1% 127.0 1.2% 122.7 3.2% 0.7% 0.8% 113.2 112.5 105.2 Annual Annual 2004 Volume Change in Share Changeb Market Shareb (%) 2004–09 2004–09 23.4% -2.3% -3.5% 15.0% -4.3% -5.5% 6.2% 0.7% -0.3% 5.3% 1.2% 0.0% 4.9% -3.5% -4.5% 3.9% 0.3% -1.0% 1.8% 5.3% 4.1% 1.6% 5.4% 3.5% 1.5% 5.2% 4.8% 1.3% -4.2% -5.1% 1.3% -11.5% -14.3% 1.2% -2.1% -3.6% 1.2% 7.5% 5.9% 1.0% 10.5% 8.4% 0.9% 4.3% 4.1% 0.9% 7.7% 5.9% 0.8% 0.8% 0.8% 32.9% -1.6% 2.1% 32.0% -2.6% 0.0% Source: Compiled from Beverage Digest Fact Book 2005 and 2010; and casewriter estimates. a Beverage Digest Fact Book defines a “megabrand” as a “brand or trademark with total volume of more than 100 million 192-oz cases.” A megabrand encompasses all varieties (Coke Classic, Diet Coke, Cherry Coke, and so on) of a given trademark (“Coke”). Only single-serve products are included here. b All changes calculated using compounded annual growth rates. 18 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Cola Wars Continue: Coke and Pepsi in 2010 Exhibit 8 711-462 Advertising Spending for Selected Refreshment Beverage Brands (in $ thousands) Market sharea 2009 2008 Coca-Cola Pepsi-Cola Mountain Dew Dr Pepper Gatorade 15.3% 8.8% 4.6% 4.1% 3.1% 15.2% 9.0% 4.5% 3.9% 3.6% Advertising spendingb 2009 2008 234,000 136,000 24,000 76,000 119,000 Per 2009 share pointc 254,000 145,000 31,000 64,000 162,000 $15,294 $15,456 $5,217 $18,537 $38,387 Source: Created by casewriter based on “Special Report: 100 Leading National Advertisers,” Advertising Age, June 21, 2010. Share of the total single-serve non-alcoholic beverage market. Advertising Age’s market share data may slightly differ from Beverage Digest’s data, seen in case Exhibit 2. a b Spending as measured across 19 national media channels using data tracked by Kantar Media and Kantar Media's Marx. Exhibit 9 U.S. Non-CSDs Unit Case Volume (in millions) Packaged water Juice & juice drinks Sports drinks Ready-to-drink tea Energy drinks 2002 3,221.6 3,030.5 488.1 430.7 28.9 2004 3,785.6 3,034.2 620.5 455.2 63.7 2006 4,588.1 2,612.2 912.3 556.6 135.3 2007 4,847.2 2,534.9 950.4 625.4 177.0 2008 4,712.1 2,512.4 856.9 623.7 217.3 2009 4,588.9 2,498.8 843.3 706.1 218.0 Source: Compiled from estimates provided by beverage industry sources, September 2010. One case is equivalent to 192 oz. Exhibit 10 Gross Profit Margins for Selected Beverages (%) Ready-to-drink coffee Ready-to-drink tea Energy Sports Juice Water CSD Retail’s gross margin 35% 35% 35% 35% 25% 35% 30% Brand’s gross margin 60% 60% 70% 65% 35% 45% 70% Source: Compiled by casewriter using data from Marc Greenberg, “Coca-Cola Company Presentation” Deutsche Bank Securities Inc., April 12, 2010, p. 7. 19 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. 711-462 Cola Wars Continue: Coke and Pepsi in 2010 Endnotes 1 2 Beverage Digest Fact Book 2010, p. 15. Beverage Digest’s definition includes energy drinks. See Exhibits 1, 3a, and 3b in this case. 3 Roger Enrico, The Other Guy Blinked and Other Dispatches from the Cola Wars (New York: Bantam Books, 1988). 4 5 Beverage Digest Fact Book 2010, p. 24. Robert Tollison et al., Competition and Concentration (Lexington Books, 1991), p. 11. 6 Beverage Digest Fact Book 2010, p. 42. 7 Unless otherwise noted, information on industry participants and structures comes from Michael E. Porter (with research associate Rebecca Wayland), “Coca-Cola versus Pepsi-Cola and the Soft Drink Industry,” HBS No. 391-179 (Boston: Harvard Business School Publishing, 1994); Andrew J. Conway et al., “Global Soft Drink Bottling Review and Outlook: Consolidating the Way to a Stronger Bottling Network”, Morgan Stanley Dean Witter, August 4, 1997; and from casewriter interviews with industry executives. 8 Casewriter conversation with industry insider, October 2010. 9 Ibid. 10 “Dr Pepper Snapple Group Breaks Ground on $120 Million Production Facility in Southern California,” Dr Pepper Snapple Group press release (Victorville, CA, October 22, 2008). 11 Coca-Cola 2009 Annual Report (Atlanta, The Coca-Cola Company, 2010), and PepsiCo 2009 Annual Report (Purchase, PepsiCo, 2010). 12 Bonnie Herzog and Daniel Bloomgarden, “Coca-Cola Enterprises”, Salomon Smith Barney, February 19, 2003, pp. 31–32; Bonnie Herzog and Daniel Bloomgarden., “Pepsi Bottling Group”, Salomon Smith Barney, February 24, 2003, pp. 26–27. 13 Timothy Muris, David Scheffman, and Pablo Spiller, Strategy, Structure, and Antitrust in the Carbonated Soft Drink Industry (Quorum Books, 1993), p. 63; Beverage Digest Fact Book 2010, p. 73. 14 Coca-Cola 2009 Annual Report, p. 7. 15 Coca-Cola Enterprises 2009 Annual Report (Atlanta: Coca-Cola Enterprises, 2010), p. 50. 16 Beverage Digest Fact Book 2010, p. 40. 17 Casewriter conversation with industry observer, October 2010. Total store sales include those from supermarkets, mass merchandisers, and drug stores. 18 Nikhil Deogun and Richard Gibson, “Coke Beats Out Pepsi for Contracts with Burger King, Domino’s,” The Wall Street Journal, April 15, 1999. 19 “History” section of entry for PepsiCo, Hoover’s Online, http://www.hoovers.com, accessed December 2005; Beverage Digest Fact Book 2005, p. 62. 20 Beverage Digest Fact Book 2010, p.60. 21 Ibid, p.59. Market shares do not include duel outlets, such as those where Coke’s pouring rights overlap with Dr Pepper’s. If such outlets were included, Pepsi and DPS’ market share would be higher. 22 Ibid, p. 63. 23 Casewriter examination of ingredients lists for Coke Classic and Pepsi-Cola, November 2005. 20 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Cola Wars Continue: Coke and Pepsi in 2010 24 25 26 711-462 Casewriter conversation with industry analyst, January 2006. Beverage Digest Fact Book 2010, p. 69. Ibid, p. 70. 27 Unless otherwise attributed, all historical information in this section comes from J.C. Louis and Harvey Yazijian, The Cola Wars (Everest House, 1980); Mark Pendergrast, For God, Country, and Coca-Cola (Charles Scribner’s, 1993); and David Greising, I’d Like the World to Buy a Coke (John Wiley & Sons, 1997). 28 Louis and Yazijian, The Cola Wars, p. 23. 29 David B. Yoffie, Judo Strategy (Harvard Business School Press, 2001), Chapter 1. 30 Pendergrast, p. 310. 31 Ibid, p. 323. 32 Timothy K. Smith and Laura Landro, “Coke’s Future: Profoundly Changed, Coca-Cola Co. Strives to Keep on Bubbling,” The Wall Street Journal, April 24, 1986. 33 Muris, Scheffman, and Spiller, p. 73. 34 Greising, p. 88. 35 Ibid, p. 292. 36 Beverage Industry, January 1999, p. 17. 37 Beverage Digest Fact Book 2010, p. 73. 38 39 Ibid, p. 74. Beverage Digest Fact Book 1999, p. 38. 40 Rosie Mestel, “Soft Drink, Soda, Pop: Whatever You Call Them, These Sugar Drinks Are Getting Nutritional Heat,” The Evansville Courier, September 26, 2005, p. D1; Scott Leith, “Obesity Weighs Heavily on Colas,” The Atlanta Journal-Constitution, February 6, 2005, p. C1; Raja Mishra, “In Battle of Bulge, Soda Firms Defend Against Warning,” The Boston Globe, November 28, 2004, p. A1. 41 “Coke and Pepsi Are Vulnerable to Tax on Soda,” Forbes.com, September http://blogs.forbes.com/investor/2010/09/10/coke-and-pepsi-are-vulnerable-to-tax-on-soda/, September 13, 2010. 10, 2010, accessed 42 Tom Graves and Esther Y. Kwon, “Industry Surveys: Foods & Nonalcoholic Beverages,” Standard & Poor’s, June 10, 2010, p. 4. 43 Melanie Warner, “For Corn Syrup, the Sweet Talk Gets Harder,” The New York Times, May 1, 2010. 44 The Coca-Cola Company 10K filing for fiscal year ending December 31, 2009, p. 14. 45 Jeremiah McWilliams, “Coke Bets of Freestyle Growth,” The Atlanta Journal - Constitution, August 1, 2010, via Factiva, accessed September 2010. 46 Valerie Bauerlein and Robb M. Stewart, “Coke Pours the Pressure on in World Cup of Marketing,” The Wall Street Journal, June 29, 2010. 47 “A Growing World of Refreshment,” Coca-Cola Investor Relations Overview, 2010, http://www.thecocacolacompany.com/investors/pdfs/investor_relations_overview.pdf, accessed October 2010. 48 Beverage Digest Fact Book 2010, p. 48. 21 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. 711-462 Cola Wars Continue: Coke and Pepsi in 2010 49 Beverage Digest Fact Book 2001, p. 11, Beverage Digest Fact Book 2005, p. 11, and Beverage Digest Fact Book 2010, p.11. 50 Marc Greenberg, “Beverage Industry, A Cup Half-full: Gulping the US Profit Pool,” Deutsche Bank, May 17, 2007, p. 22. 51 52 Beverage Digest Fact Book 2010, p. 102. Ibid, p. 25. 53 Bob Keefe, “Coke’s Bottle Recipe Sweet: New Material Includes Sugarcane, Molasses,” The Atlanta JournalConstitution, May 14, 2009. 54 55 Beverage Digest Fact Book 2010, p. 110. Ibid, p. 87. 56 Christopher Williams, “Coke’s Fortunes are Set to Pop,” Barron’s, August 17, 2009, via Factiva, accessed September 2010. 57 Citigroup Global Markets Research, “PepsiCo”, October 17, 2010. 58 Sky Canaves, Geoffrey A. Fowler, and Betsy McKay, “Coke Bets $2.4 Billion on Chinese Juice Market,” The Wall Street Journal Asia, September 4, 2008. 59 Caroline Wilbert and Shelley Emling, “Obesity Weighs on Coke,” Atlanta Journal-Constitution, October 27, 2005, p. A1. 60 Leslie Chang, Chad Terhune, and Betsy McKay, “As Global Growth Ebbs, Coke Makes Rural Push into China and India,” The Asian Wall Street Journal, August 11, 2004, p. A1. 61 Beverage Digest Fact Book 2010, p. 46. 62 “The Coca-Cola Company and Coca-Cola Enterprise Inc. Announce Strategic Advancement of Their Partnership in North America and Europe,” Thomson StreetEvents Final Transcript, February 25, 2010. 63 “CSDs Have Most—and Proliferating—SKU’s, but Number Is Small Relative to Volume,” Beverage Digest, November 22, 2002, http://www.beverage-digest.com/editorial/021122.php, accessed December 2005; casewriter communication with industry analyst, November 2005. 64 Beverage Digest Newsletter, September 24, 2010, p. 3. 65 Beverage Digest Fact Book 2010, p. 86. 66 Chad Terhune, “Advertising: Coke Bottler in Mexico Threatens to Cut Marketing,” The Wall Street Journal, November 1, 2005. 67 Christopher Williams, “Coke’s Fortunes are Set to Pop,” Barron’s, August 17, 2009, via Factiva, accessed September 2010. 68 PepsiCo, “Q4 2009 PepsiCo Earnings Conference Call” transcript, February 11, 2010, p. 4. 69 “Special Issue: PepsiCo Seeks to Buy Two Big Bottlers,” Beverage Digest, April 20, 2009, vol. 54, no. 9. 22 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Harvard Business School 373–080 Timex Corporation Professor Hugo Uyterhoeven prepared an earlier version of the case under the title “U.S. Time Corporation,” copyright 1968 by l’Institut pour l’Etude des Methodes de Direction de l’Entreprise (IMEDE), Lausanne, Switzerland. Frederick Knickerbocker, lecturer, revised and updated the case. All the information reported in this case has been obtained from published sources. This case has been prepared as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. From Industry Upstart to Industry Leader I n 1950 the United States Time Corporation of Middlebury, Connecticut, introduced its line of inexpensive Timex watches into the U.S. marketplace. Neither American nor foreign manufacturers took much notice of the new competitor. In the eyes of the traditional manufacturers, after all, the Timex line consisted of nothing more than cheap pin-lever watches destined, at best, to meet the needs of a minor part of the U.S. market. Twenty years later the same firm, renamed now after its world-famous Timex brand,1 had sales in the range of $200 million, plants scattered all over the world, 17,000 employees, and rival manufacturers taking notice of its every move. In fact, Timex had become such a potent factor in the world watch industry that the Federation of Swiss Watchmakers, having studied its rival in minute detail, published a monograph entitled “The Timex Formula.” Timex had grown to be the world’s largest manufacturer of pinlever watches and a principal manufacturer of other types of watches. With its inexpensive watches it had stormed the U.S. market and so fixed the name Timex in the American consumer’s mind that by 1970 every other watch bought in the United States was a Timex. Starting in the early 1960s, Timex had marched into one after another foreign market to the point where it became almost as prominent in the watch industry overseas as in the United States. How did Timex do it? How did Timex first reshape the watch industry in the United States and then reshape the watch industry on a worldwide basis? How have other manufacturers responded to the 1. In 1969 the firm changed its corporate name from United States Time Corporation to Timex Corporation. Copyright © 1972 by the President and Fellows of Harvard College To order copies or request permission to reproduce materials, call 1-800-545-7685 or write Harvard Business School Publishing, Boston, MA 02163. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. Rev. September 1, 1983 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Timex Corporation Timex challenge? And where does Timex go from here? These are the questions that are taken up in the pages that follow. The Early Days of Timex The Company’s Founder Since its inception, Timex has been guided by Joakim Lehmkuhl. Born in 1895 in Norway, Lehmkuhl had studied engineering in the United States, receiving degrees from Harvard and M.I.T. in 1918 and 1919, respectively. He then had returned to Norway to direct a small shipbuilding firm and eventually to publish a political newspaper. In 1940, in advance of the German invaders, he fled with his family to England. Shortly thereafter, he was sent to New York by the Norwegian government in exile to take charge of the wartime Norwegian Shipping Center. Recognizing that his assignment was temporary, Lehmkuhl soon set about looking for another opportunity to use his talents. The Birth of Timex In 1942 Lehmkuhl found his opportunity. Seeing the need for fuse timers for bombs and artillery shells, he and a group of businessmen acquired a majority interest in the virtually bankrupt Waterbury Clock Company in order to convert the firm to fuse production. Prior to the war, the Waterbury Clock Company had manufactured the $1 Ingersoll pocket watch. With Lehmkuhl as its president, the firm quickly became the largest producer of fuses in the United States. After the war, as disappearing defense orders emptied its shop, Waterbury’s total sales dropped from $70 million to $300 thousand. Lehmkuhl reconverted his company from wartime production to watch production “because it seemed the only thing to do!” But the days of the $1 Ingersoll watch were over. The U.S. market for such a watch had largely disappeared, and what market did exist was being flooded by cheap Swiss imports. On top of this, inflated costs prevented his or any firm from producing a watch to retail at $1. Lehmkuhl was still convinced that a good, inexpensive watch could be produced by combining the precision tooling techniques used in making fuse timers with a high degree of mechanization. He gave Waterbury’s engineers the task of designing a quality watch that could be mass-produced. By 1949 they had succeeded in upgrading 373–080 the simple mechanism used in children’s watches into the prototype for the Timex watch. It had one feature of particular importance: Picking up a development that came out of the World War II research effort, the engineers substituted new hard alloy (Armalloy) bearings for jewels in the movement. According to the company, this feature made the watch the equal of many jeweledlever models and better than the other pin-lever models then available. In the meantime, Lehmkuhl dropped the tarnished Ingersoll name, changed the company’s name to United States Time, and adopted the brand Timex for the new product line. Timex Through the 1950s Product Policy The Timexes put on the market in 1950 were men’s watches designed to retail at $6.95 to $7.95. Their simple, tasteful styling and modernistic lines represented an innovation in the low-priced field. Gradually, the company added watches with more features and slightly higher prices. First came Timexes with sweep-second hands. Then the firm introduced models that were shockproof, waterproof, and antimagnetic. In 1954 Timex brought out a line to retail at $12.95; calendar and selfwinding models soon followed. All of the Timex models, regardless of features, carried a one-year guarantee. In 1958 Timex introduced its first line of women’s watches. Promotion of the line was keyed to the idea that a woman could buy an entire wardrobe of watches—one for dress, one for sports, and one for general use—for less than $50. The company claimed that by the early 1960s it had attained more than 36% of the under-$50 women’s watch market. Robert Mohr, who was vice president of sales at the time, discussed Timex’s early product policy in the following terms: People wonder how we make a watch and sell it for as little as we do. That’s all to the good. We promote the idea that the watch is not just a gift-season item—something you buy for the June graduate, or at Christmas time, Father’s Day or Mother’s Day. Basically, we promote the watch as something for everyday use, that people don’t have to worry about because the cost is low. 2 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Timex Corporation 373–080 It works out in our favor, because when you sell more watches than anyone else, you can do more.2 Distribution Policy Mass distribution was the keystone to Timex’s marketing strategy. At the outset, because it lacked the funds for extensive promotion of its line, the company set out to get widespread retailer support for its watches. Timex initially approached jewelers, the traditional outlet for watches. But many jewelers were reluctant to handle the Timex line. Their reluctance was based on various reasons: Some downgraded the Timex line because of its price range or because of its simple pin-lever movements, others objected to the fact that they would only make a 30% margin on the retail price with the Timex line compared with the 50% margin they usually made on their other lines. Rebuffed in general by the jewelry trade, Timex tried other channels of distribution. As a result, the company started to market its watches directly through 20,000 retail accounts, the bulk of which were drugstores. In the early days almost 80% of Timex’s sales were made by drugstores. Over the years, Timex constantly increased both the number and type of retail outlets for its watches. At its high point, Timex had almost 250,000 retail accounts on its books. In its approach to retailers, Timex routinely emphasized the importance of stock turnover. It also stressed retail price maintenance, even though its suggested retail prices and markups were well below those traditional in the jewelry trade. Mohr described the distribution strategy: We taught jewelers that markups don’t mean a thing if you don’t have the turnover. That was our story, and we preached it hard. Jewelry stores have a 1.5 average watch turnover per year. That wasn’t enough for us. We put watches into drugstores, hardware and tobacco stores. Today Timex watches are sold in 80,000 of these stores. We don’t sell discount, and we maintain a fair trade price, enforcing it wherever possible. We have a low price to begin with, so why cut it more?3 2. “New TV Commercials Will Give It Even Harder to Those Hardy Timexes,” Advertising Age, December 10, 1962. 3. Ibid. Timex management claimed that its retailers’ average turnover was six times per year. “Timex’s sales approach,” according to Time, “was based completely on showmanship unheard of in the conservative watch business.” Timex salespeople visiting retailers slammed the watches against walls and dunked them into buckets of water to illustrate their shockproof and waterproof qualities. In 1954 the company designed a showcase for point-of-purchase display with levers which could dunk a Timex in water and smash it against an anvil. According to Lehmkuhl, these promotional tactics largely accounted for the rapid rise in sales in the early 1950s. Then in the mid-1950s Timex turned to television. Advertising Policy Prior to 1956, Timex’s advertising had been on a small scale and limited mainly to magazines. In 1956 it began intensive advertising on network television. It was estimated that Timex’s annual advertising budget grew from about $200,000 for the year 1952 to around $3 million for the years at the end of the decade. About 85% of the advertising budget was allocated to television. Timex’s commercials hammered home the themes of product durability and low cost. The company became renowned, first at home and then abroad, for its so-called “torture test.” Its commercials featured news commentator John Cameron Swazey showing a Timex which, under varying circumstances, “took a licking and kept on ticking.” In one of the early torture tests, done live, a Timex was fastened to an outboard engine propeller. In the water, the Timex inadvertently slipped off the spinning propeller. It was recovered, running, and Timex ended up with yet another highly favorable bit of publicity for its watches. One torture test followed another. The watches were shown ticking away after being fastened to the hooves of galloping horses, after surviving 135-foot dives at Acapulco, and after being attached to surfboards and amphibian airplanes. For critics of the unorthodox advertising campaign, the company had its answer: “Timex is a watch designed for active people; then why not show it undergoing rugged tests?”4 4. “Rigors of Hawaii Are Setting for New Timex Tests,” Advertising Age, October 21, 1963. 3 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Timex Corporation Manufacturing Policy Timex could sell its watches the right way because it could make them the right way. Manufacturing in Timex was characterized by mass production with relatively unskilled labor and by constant management attention to production efficiency and to quality control. Business Week described the company’s manufacturing operations in the following terms: “The entire operation adds up to an almost textbook example of how to run a taut ship.”5 The “simple but strict” production formula was based on (1) rigid standardization, with full interchangeability of parts; (2) maximum mechanization to reduce human error and to minimize labor costs; and (3) centralized quality control. According to George Gelgauda, then technical director, “Parts fit together whether they are made here in Middlebury, Connecticut, or in Germany.” To insure standardization and the most advanced mechanization possible, the company employed 500 toolmakers who designed almost all of the firm’s production equipment. Control was centralized even to the point of keeping the records on all its tools at the U.S. headquarters. Keeping the product simple was another key element in Timex’s manufacturing policy. For example, the frame of the basic Timex watch went through 6 manufacturing operations as contrasted with 100 for an imported watch. The Timex movement had 98 parts held between 2 plates, whereas foreign movements frequently had 120 parts held together by a series of 5 plates. The Timex had 4 screws; other watches had as many as 31. Of course, industry rivals tried to turn this simplicity against Timex. For instance, they pointed out that the cases of the Timex watches were riveted together, making repairs impossible. The American consumer, as will become apparent, paid little attention to these criticisms. Another example illustrates how management achieved low-cost production. As many operations as possible were mechanized so that the end product needed little adjustment. According to William J. O’Connell, an assistant division manager: “When we put a watch together with relatively unskilled labor, it must be able to run accurately the minute the last wheel is put in place. We can’t afford the petty, troublesome adjustments that are found in the handmade watch 5. “A Time Bomb for Watchmakers,” Business Week, November 16, 1963. 373–080 industry.”6 After seeing the Timex manufacturing operations, more than one observer was prone to describe Lehmkuhl as the Henry Ford of the American watchmak- ing industry. Timex managed its inventories as strictly as it managed its production operations. Sales forecasting and inventory control were centralized. Sales were pinpointed through warranty cards, and estimates were constantly revised at a data processing center in Middlebury. Parts and workin-process inventories were updated daily at headquarters, and finished goods inventories were kept at rock bottom. By the end of the decade, Timex employed about 7,000 people in its home office and in its three U.S. and six European plants. Stateside, in addition to its main plant in Middlebury, Connecticut, it had factories in Little Rock, Arkansas, and Abilene, Texas. Overseas, it had plants in England, Scotland, West Germany, and France. Its French plant, in Besan;alcon only 27 miles from the Swiss border, was located in a region rich in the tradition of watchmaking. Though the company had not actively sought diversification, the firm also became an important supplier of parts for the Polaroid Land Camera. Furthermore, Timex moved back into defense business. It maintained a $1 million research laboratory in Irvington-on-Hudson, New York, which featured “the cleanest room in the world” for the manufacture of gyroscopes and for testing timing devices. Competitive Reaction: Too Little or Too Late Competition did not stand absolutely still as Timex carved up the U.S. watch market throughout the 1950s. Yet many of Timex’s rivals continued to focus most of their energies on their traditional market segments—watches in the $30 to $100 range. And when they did try to defend against Timex by adding lines of inexpensive watches, they seldom could take on Timex in head-to-head competition. Some tried, like Benrus, and eventually gave up. They lacked both Timex’s manufacturing and mass distribution capabilities; without these, it made no sense for them to match Timex’s intensive advertising campaigns. The other major American watchmaker, Bulova, did try to answer the Timex threat with its own Caravelle line, jeweled-lever watches retailing in the $10 to $30 range. But even though 6. Ibid. 4 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. 373–080 Bulova started to gear up for this counteroffensive in the late 1950s, it did not attain national distribution of its Caravelle line until 1963, 13 years after Timex hit the U.S. market. By and large, therefore, Timex stood alone in its segment of the U.S. marketplace throughout the 1950s. Its performance statistics as it moved into the early years of the next decade reflected this fact. Sales and Financial Results The first Timex watch was put on the U.S. market in 1950. A decade later, the company was selling around 7 million watches annually. In 1962 an Alfred Politz research study indicated that one watch out of every three sold in the United States carried the company’s trade name of Timex. Though Timex did not publish its financial data, its 1961 sales and after-tax income were reported by Advertising Age as being $71.2 million and $2.9 million, respectively. Ac- cording to President Lehmkuhl, the company was completely free of debt, had financed all recent expansions out of earnings, and intended to continue to do so. Clearly, the Timex strategy had paid off in terms of dollars and cents. Timex Through the 1960s Upgrading the Product Line Having established a strong foothold in the low-priced segment of the U.S. market, Timex took a number of important steps in the 1960s to broaden its product line. Its first move in this program had actually taken place in 1957 when Timex introduced a line of 17-jewel watches designed to retail at $17.95. Despite predictions that Timex could not sell watches at this price level through outlets such as drugstores, the line was a success. Then in 1962 Timex followed with a 21-jewel watch line priced at $21.95. These watches, in part because they carried a higher markup than usual for Timex, were reported to have eased the entry of the firm into distribution through the jewelry trade. Slowly Timex won over jewelers’ begrudging acceptance. Timex’s next step was a response to the competitive threat posed by the electric watch. The first of these had appeared in the U.S. market in 1957, and by the early 1960s many different models were available. While the electric watch did not represent a significant technical improvement over conventional watches, it did endanger the Timex Corporation sales growth of those firms completely committed to mechanical watches. Timex responded in typical fashion. In 1963 it introduced a line of electric watches retailing at $39.95, about half the price of that of its nearest competitor. Consumer’s Bulletin had this to say about the electric Timex: Although the Timex is very low in price for an electric watch, it was found to keep surprisingly accurate time during the first three months of operation, up to the time this issue of the Bulletin went to press. . . . While the case and the flexible bracelet were of lower quality than found on more expensive watches, they were judged to be satisfactory and gave a good appearance.7 After selling about 200,000 men’s electric watches at $39.95 in 1964, Timex introduced a women’s electric watch and a men’s electric calendar watch in 1965, both at $45. With the higherpriced additions to the line, Timex began to run prestige advertising in national magazines. Some industry observers suggested that Timex was headed for trouble by moving up out of its traditional low-priced market niche. Lehmkuhl didn’t see it that way. When asked during a 1968 interview, “Do you face any risk in moving into higher-priced watches?” Lehmkuhl replied: “No, no. We are already the largest producers of electric watches at a higher price. That just built up the name for the lower-priced watches, too.”8 Swiss watchmakers, too, didn’t see Timex headed for trouble by following this policy. To the contrary, they saw it as a threat to their U.S. market position. The 1969 annual report of the Swiss Watchmakers Association, discussing mounting competition in the United States, posed the problem in these terms: As to marketing, we must take into consideration a new fact, the selling-up policy started by Timex, by adding to its range of products a certain number of more costly articles, either because they are made with higher quality movements, or because they are of a different technical construction. This new factor could possibly lead to profound changes in the market as was the case in 1950. 7. “Timex Electric Watch,” Consumer’s Bulletin, March 1964. 8. “Making the Most of Time,” Nation’s Business, September 1968. 5 This document is authorized for use only by shakra hurmiz in BUS444-SU2021 taught by OFER MEILICH, California State University - East Bay from Jun 2021 to Jul 2021. For the exclusive use of s. hurmiz, 2021. Timex Corporation Going International At the same time that Timex was upgrading its product line, it was also spreading out into foreign markets. Timex first established operations in Canada and England; promptly, it transplanted its marketing techniques to these new markets. Even though Timex’s sales figures were not broken down for domestic and overseas markets, it was estimated that by 1965 its market share in these countries was comparable to its share in the United States. Regardless of where it was used, Timex’s “torture test” advertising campaign captured the fancy of local consumers. In South Africa, for example, Timex was an unknown brand in 1962. Timex launched its campaign there and in the month of December 1963 alone it sold 10,000 watches in that market. Timex then entered the French market, selling its line under the Kelton trade name, and by the mid-1960s Timex was ready to knock over the large West German market. The West German story highlights how effective Timex had become as an international marketer. The company applied the same marketing formula, modified in several important ways, that had been successful in over 30 countries. As in many other markets, the manufacturers selling in West Germany concentrated on watches in the medium- and upper-priced ranges, ignoring...