Coke and Pepsi’s Uncivil Cola Wars-Case Study Analysis

Money is better than poverty, if only for financial reasons–Woody Allen

Besides understanding economies of scale, the next area you need to master is understanding the prisoner’s dilemma and how companies coexist or compete within barriers to entry.

The case readings were presented here:

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The case study discussion in a PDF because of financial tables. Go here:

 Pepsi and Coke’s Uncivil Wars

Chapter 9 in Competition Demystified: Uncivil Cola Wars: Coke and Pepsi Confront the Prisoner’s Dilemma

What are the sources of competitive advantages in the soda industry?

First we should look at industry structure. The cola companies buy raw materials of sugar, sweeteners and flavorings from many suppliers then they turn the commodities into a branded product which consists of syrup/concentrated combined with water and bottles. The companies are joined at the hip with their bottlers/distributors who then sell to many retail outlets.  Selling bulky and heavy beverages lends itself to regional economies of scale advantages.

The soda companies cannot operate successfully unless their bottlers and distributors are profitable and content whether company-owned or franchised.

The existence of barriers to entry indicates that the incumbents enjoy competitive advantages that potential entrants cannot match. In the soft drink world, the sources of these advantages are easy to identify. First, on the demand side, there is the kind of customer loyalty that network executives, beer brewers and car manufacturers only dream about. People who drink sodas drink them frequently (habit formation), and they relish a constancy of experience that keeps them ordering the same brand, no matter the circumstances.

Both Coke and Pepsi exhibit the presence of barriers to entry and competitive advantage—stable *ROE can be influenced by whether bottlers’ assets are off or on the balance sheet

Second, there are large economies of scale in the soda business both at the concentrate maker and bottler levels. Developing new products and advertising existing ones are fixed costs, unrelated to the number of cases sold. Equally important, the distribution of soda to the consumer benefits from regional scale economies. The more customers there are in a given region, the more economical the distribution. A bottler of Coke, selling the product to 40% to 50% of the soda drinkers in the market area, is going to have lower costs than someone peddling Dr. Pepper to 5% to 56% of the drinkers.

During the “statesmen” era of Pepsi and Coke, what actions did each of the companies take? Why did they help raise profitability?

Note the stability of market share and ROE. ROE dipped in 1980 and 1982 as Pepsi and Coke waged a price war. Yet, market shares did not change as a result of the price war—both companies were worse off. Pepsi gained market share in the late 1970s versus Coke. Coke was slow and clumsy to respond.

Price wars between two elephants in an industry with barriers to entry tend to flatten a lot of grass and make customers happy. They hardly ever result in a dead elephant. Still, there are better and worse ways of initiating a price contest. Coke chose the worst. Coke chose to lower concentrate prices on those regions where its share of the cola market was high (80%) and Pepsi’s low (20 percent). This tactic ensured that for every dollar of revenue Pepsi gave up, Coke would surrender four dollars.

Coke luckily developed New Coke which allowed it to attack Pepsi in its dominant markets in a precise way—minimizing damage to Coke’s profits–and force a truce in the price wars.

They made visible moves to signal the other side that they intended to cooperate. Coca-Cola initiated the new era with a major corporate reorganization. After buying up many of the bottlers and reorganizing the bottler network, it spun off 51% of the company owned bottlers to shareholders in a new entity, Coca-Cola Enterprises, and it loaded up on debt for this corporation. With so much debt to service, Coca-Cola Enterprises had to concentrate on the tangible requirements of cash flow rather than the chimera of gaining great hunks of market share from Pepsi. PepsiCo responded by dropping the Pepsi Challenge, toning down its aggressive advertising and thus signaling that it accepted the truce. Profit margins improved. Operating profit margins went from 10% to 20% for Coca-Cola. Pepsi gain was less dramatic but also substantial.

Both companies focused on ROE rather than market share and sales growth.

The urge to grow, to hammer competitors and drive them out of business, or at least reduce their market share by a meaningful amount, had been a continual source of poor performance for companies that do have competitive advantages and a franchise, but are not content with it.

5 responses to “Coke and Pepsi’s Uncivil Cola Wars-Case Study Analysis

  1. The framework(s)/approaches in the XRX case study notes and comments shared by readers were really helpful. I’m trying to do the same for Pepsi (Lay’s are awesome, but I always feel really lethargic and grossed out after going through 25% of the tube; anyone else notice the quality control is uneven?)

    PEP has 28bil LT debt + other liabilities due staggered till 2017. It earns around 8bil cash flow before mcx. It’s capitalized at double debt capacity. Though its slowly decreasing its LT debt, it’s financing by issuing unsecured notes. Less its cash, investments, receivables, and a bit of goodwill, it’s looking like they HAVE to keep rolling over borrowing.

    Can someone else go through the 10k quickly to see if they are over leveraged. Am I looking at things wrong? Thank you.

    Unlike XRX, PEP is using its debt for “general corporate purposes.”

    • Dear Kevin:

      I haven’t looked at Pepsi, but rolling over debt is OK as long as you have a margin of safety in terms of cash flow to pay down your debt over time. How stable are the free cash flows (cash flow above MCX)–I bet with Pepsi pretty stable. Look at the amount of debt the company has had over several cycles, check their bond ratings. Debt is simply a tool which can be dangerous if you apply too much of it.

  2. Thanks John. You always have insightful suggestions.

    You mentioned in another post taking a test as part of some plans you have cooking in the background. Did you take the JOCRF test? Was it what you expected?

  3. Yes, I took the JOCRF test. It can clarify or reinforce what you know about yourself but overlook. We sometimes dismiss the obvious–like the Purloined Letter (Sherlock Holmes).

    Another emphasis is vocabulary. Mick Jagger has a large, wide-ranging vocabulary and so does Andrew Carnegie. No matter what the profession, they found that people who had a high level of vocabularly could better distinguish their ideas and thoughts. Interesting.

    But if you are clear on your aptitudes, then you can skip it.

  4. “Coke chose to lower concentrate prices on those regions where its share of the cola market was high (80%) and Pepsi’s low (20 percent). This tactic ensured that for every dollar of revenue Pepsi gave up, Coke would surrender four dollars.”

    Did Coke choose to lower their prices in their dominant markets because they felt they had scale and lost-cost production advantages there? If so, why did their strategy fail? If Coke’s network was denser, they would operate more cheaply and they should drive Pepsi out of the market at the low prices. Was Pepsi just willing to subsidize those losses with profits from other markets?

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