Four arena analysis of the soft drink industry

To illustrate the power of viewing competition in each of these four are­nas, this chapter first examines how to use the four arenas to analyze the strategic maneuvering of competitors in a single industry: soft drinks. This first approach—which will be called a Four Arena analysis—is a study of the progression of a single industry by looking at its progress through each of four arenas over a very long period of time. A second approach—a Four Lens analysis—examines the impact of a single event in an industry ( the introduction of laser printers, for example) and considers its impact on each of the four arenas. This second approach will be discussed in the lat­ter half of this chapter.

The Four Arena analysis, presented below, has been focused on the de­velopment and escalation of competition in the soft drink indust_ry. This analysis is intended to

• show how the four arenas and escalation ladders discussed in Chap­ters 1 to 4 can be used to increase your understanding of the dynamic strategic interactions between competitors
• help predict future actions of competitors
• identify which competitor has seized the initiative in each of the arenas and determine why
• identify the arenas that have remained dormant for years but that might be reopened
• point out opportunities for restarting or jumping arenas that have not been used recently
• identify the battleground of the future, by showing where the inter­actions have not yet reached the top of the escalation ladders
• open the reader’s mind to seeing the rise and fall of different compet­itive advantages as part of a dynamic market process
• illustrate how a market becomes more and more hypercompetitive as rivals seek to outmaneuver each other in new and more aggressive ways

Consider the long and winding evolution of the dynamic rivalry be­tween Coke and Pepsi through the frame of these four arenas, as summa­rized in Figure 5-1.¹

FIGURE5-1

HISTORY OF THE SOFT DRINK INDUSTRY IN EACH OF THE FOUR ARENAS

1. Hypercompetition: The Real Thing

Coke and Pepsi have been competitors for nearly a century. But it has only been in recent decades that the competition has escalated to what journal­ists and authors have labeled “the cola wars.”

In the first seventy years of the industry, aggressive dynamic strategic interactions were infrequent. Perhaps the most aggressive move was Pepsi’s halving the price of its twelve-ounce bottle in 1933 to offer twice as much soda as Coke for the same price. Even so, it took Coke more than twenty years to introduce a twelve-ounce bottle. Competition was much less intense.

But the 1960s ushered in a new wave of aggressive product proliferation and price competition. After sticking to Coke and Pepsi for virtually all of their histories, suddenly the two soft drink giants began a series of new product introductions, with competition focused on the timing of the in­troductions and the know-how associated with developing new tastes. Coke and Pepsi entered the lemon-lime market in the 1960s with Coke’s Sprite (1961) and Pepsi’s Mountain Dew. Royal Crown’s development of diet cola in 1962 launched the diet war, stimulating the introduction of Tab (1963), Diet Pepsi (1964), and Diet Coke (1983). During the 1970s and 1980s this process had accelerated to the point where Coke and Pepsi alone introduced more than thirty-four new products. If Seven-Up, Dr Pepper, and Royal Crown are included in the count, the major soft drink makers launched nearly one hundred new products in those two decades.

Advertising spending has soared in the 1980s and 1990s. At the same time, competition has driven prices lower and lower. As an indication of the intensity of this competition, the inflation-adjusted price of a case of soda has dropped from $6.19 in 1965 to $3.99 in 1988.²

These wars and their increasing intensity illustrate the escalation of competition in each of the four arenas. This industry also shows the com­plexity of the dynamic strategic interactions between the two players and the interrelation between the different arenas. Interestingly, the progres­sion of competition has moved across the four arenas in the same orderly progression as presented in Chapters 1 to 4. But now that the industry is more mature, the locus of competition will probably focus on the strong­hold arena in the future. The ebbs and flows of battle are illustrated in each of the four arenas below. The initiative in each arena has shifted back and forth between Coke and Pepsi for decades in ways that are becoming increasingly aggressive over time.

2. Analysis of Arena 1: Cost-Quality

Coca-Cola began its life in 1886, quickly becoming the king of the cola market. Pepsi, which appeared in 1893, was one of many young upstarts, most of which fell by the wayside. Pepsi’s sweeter taste, then viewed as a disadvantage, left Pepsi outmaneuvered by Coke. (See Figure 5-2.)

In 1933, Pepsi-Cola was struggling to stave off bankruptcy. Then it dropped the price of its ten-cent, twelve-ounce bottle to the same nickel price as Coca-Cola’s 6.5-ounce bottle, making it a better value. (See Fig­ure 5-3.) At that time cola was cola, so more soda meant a better value. Pepsi advertised “twice as much for a nickel,” and the company came back from the brink. A survey showed that its advertising jingle was better known in the United States than “The Star-Spangled Banner.”³ Coke couldn’t counter this move without changing its bottle design or its nickel soft drink machines. Its strength was turned against it. Pepsi rushed past Royal Crown and Dr. Pepper to become the number-two player in the industry.

Pepsi kept its price advantage through the 1960s and 1970s, when Pepsi-Cola charged its bottlers 20 percent less than Coca-Cola for its con­centrate. In the early 1970s Pepsi changed the rules of competition by rais­ing its price to equal Coke’s, giving Pepsi a war chest to fuel its aggressive advertising campaigns that attacked Coke on quality. (See Figure 5-4.)

FIGURE5-4

PEPSI BEGINS THE ASSAULT ON COCA-COLA BY HITTING NICHES WITHIN COKE’S POSITION

With rising ingredient costs, Pepsi no longer could offer twice as much soda for the same price.

The battle had clearly shifted away from price to quality. It was ad-dressed through advertising that associated youth with Pepsi (“the choice of a new generation”). Later, through the Pepsi Challenge, a blind taste test that proved soda drinkers preferred Pepsi to Coke, Pepsi began a clear campaign to outmaneuver Coke’s entire position because consumer tastes had changed, preferring Pepsi’s sweeter formula. Coke countered with an ad campaign touting its position as “the real thing,” implying that as it was the originator of the cola industry, no other player was as good as the orig-inal. (See Figure 5-5.)

As both colas’ perceived quality caught up with each other, the deeper-pocketed and lower-cost Coca-Cola initiated a fierce price war. Coca­Cola made price cuts in selective markets where Pepsi was weak in the 1970s. Under Coca-Cola CEO Roberto Goizueta, price promotion reached new levels of intensity, and Pepsi responded with its own dis-counts. At the end of 1980, an estimated half of Coke and Pepsi in food  stores was sold at a discount.⁴

As Coke and Pepsi wrestled their way up the price-quality escalation ladder, other companies moved into the low end of the cola market. These included Royal Crown and generic and store-brand colas, which had a lower perceived quality and a correspondingly low price. However, this low-end niche was outmaneuvered as the two industry leaders forced their prices down to the point of ultimate value. (See Figure 5-6.)

FIGURE5-5

MANEUVERING FOR THE

HIGH-QUALITY POSITION IN THE

COLA MARKET

FIGURE 5–6

LOW-END ENTRANTS SURVIVE UNTIL
THE POINT OF ULTIMATE VALUE WAS
REACHED

In a desperate move to reestablish dominance and break out of the price spiral shown in Figure 5-6, Coke reformulated its product, introducing New Coke. The intent was to create a major quality jump that would cap­ture many Pepsi drinkers (who preferred sweetness) while keeping Coke’s loyal customers. (See Figure 5-7.) However, the market rejected the new formula, forcing Coke to return to Classic Coke and locking Coke and Pepsi into a continuous battle over the ultimate-value position.

In order to avoid this endless warfare and to restart the cycle in the price-quality arena, the major players in the cola market have tried to take advantage of changing perceptions of quality that are creating emerging niches. When Coca-Cola was first developed, the fact that it allegedly contained caffeine, cocaine, and sugar was seen as a positive product char­I acteristic. Then cocaine went out of style and had to be removed. Finally, caffeine went out of style, and caffeine-free colas were developed. Sugar also has gone out of style. As consumers have become increasingly diet conscious, sugar-free versions of the colas have formed an important part of the market.

FIGURES-7

NEW COKE’S FAILED ATTEMPT TO
OUTMANEUVER PEPSI

Each shift in the definition of quality provided an opportunity to renew the battle on a new playing field and to restart the escalation ladder in this arena. But now the players have replicated each other’s moves, leaving little room to maneuver in the saturated cola market where competitors battle over fractions of a percent. So price competition continued, and the firms are stuck at a point of ultimate value due to cutthroat discounting and inability to improve quality any further. Price and quality continue to I   be central factors in competition, but they are becoming less and less pow-erful as the perceived quality and the cost structures of the two rivals con-verge on the ultimate-value point. Despite their large market share, the two colas retain a precarious hold on the industry, as variety-seeking con­I  sumers become anxious to try new beverages. The locus of competitive initiative in the industry has now moved to the next arena, where new  noncola formulas are developed, tested, and imitated.

3. Analysis of Arena 2: Timing-Know-how

In the soft drink industry, perhaps the most basic and important know­how is the knowledge of how to invent a formula with a taste customers like and to package that formula in a way customers want. These skills involve a mixture of industrial design, chemistry, and cooking knowledge that is as much an art form as it is a science.

However, this type of know-how is hard to protect in the soft drink in­dustry. The “Merchandise 7X” recipe for Coca-Cola was strictly guarded.

It was never written down. The labels were scratched off the bottles of ingredients, and the formula was mixed in back rooms by a handful of se­I  nior executives in the old days.

But Pepsi, entering second, found a way around this know-how hurdle. The know-how in this industry was much more easily duplicated than might be expected. Pepsi simply developed its own formula (in a new-sized bottle) that was not the same as Coke’s. In fact, because Pepsi’s new for­mula was about 9 percent sweeter than Coke’s, it actually had an advan­ tage in blind taste tests, later allowing Pepsi to develop the Pepsi Chal­lenge.

Perhaps because of its belief in the strength of its formula and its strong reputation, Coca-Cola fiercely resisted new product or packaging intro­ductions until the mid-1950s. It held onto its single product in a single­sized bottle. It wasn’t until 1955, against the protests of its bottlers, that it finally introduced larger bottles to counter Pepsi’s packaging initiative.

In the meantime competitors seized the initiative by developing new know-how and being first to market with new formulas. One of the most significant innovations in the industry was the development of diet sodas. This innovation initially came from neither Coke nor Pepsi. It provides an example of a first mover advantage that was unable to be sustained. Royal Crown introduced its Diet Rite Cola in the early 1960s, three years before Coke or Pepsi rolled out diet products. Royal Crown’s market share in diet colas initially equaled or exceeded Coca-Cola’s.⁵ But with the introduc­tion of diet soft drinks by Pepsi and Coke, that position was eroded. By the end of 1983, Diet Coke had become the largest selling diet soft drink.⁶ Royal Crown also was the first to launch a decaffeinated diet cola in 1980, but again it was counterattacked by offerings from Coca-Cola and Pepsi.⁷

Sweeteners used in diet sodas shifted from saccharine to aspartame, and each innovation in sweeteners provided a temporary advantage until it was copied. When Pepsi introduced aspartame (sold under the Nutrasweet brand name) into its diet soft drinks in 1984, it had only a six-week lead over Diet Coke. Pepsi used this lead to aggressively promote Diet Pepsi. Coca-Cola countered with a national campaign claiming that it also had 100 percent aspartame (but didn’t say that it was available in only certain packages and markets). Pepsi then responded with point-of-purchase dis­plays stressing that it contained Nutrasweet in all its markets and package sizes. But this was a short-lived advantage because Diet Coke eventually added aspartame in all its markets.

Another entrant into the battle was Seven-Up, which positioned itself as a caffeine-free alternative to colas. Sales went up 15 percent in the first year of the campaign. Seven-Up was not in direct competition with the colas, but by positioning itself as the “uncola,” it challenged them to a fight. Fight they did. Less than six months after the launch of the no­caffeine campaign, Pepsi introduced its Pepsi Free. Coke and other makers were quick to follow. Both Coca-Cola and Pepsi introduced lemon-lime soft drinks (Sprite and Slice) to compete directly with Seven-Up.

Coke could no longer take decades to follow in product or bottling in­novations and turned to innovations of its own. These innovations were not always successful. Pepsi’s relentless comparisons of its cola to Coke

eventually drove Coca-Cola into creating a major product reformulation. Unfortunately New Coke was a dismal failure. The new product was met with disapproval by loyal Coke drinkers, but Coca-Cola couldn’t abandon the new group of customers who liked New Coke. This led to the relaunch of the original Coke as Coke Classic, forcing Coca-Cola to offer two sim­ilar sodas with similar names in an already crowded market.

By the 1980s new flavors proliferated at an alarming rate. Coke intro­duced Cherry Coke. Pepsi introduced Cherry Pepsi. Coca-Cola intro­duced Minute Maid Orange soda and Pepsi expanded its Slice line to in­clude Mandarin Orange Slice. The speed at which Coke and Pepsi responded to each other increased until neither could gain any real advan­tage. Moreover, as the number of new tastes increased, each new product focused on narrower and narrower niches while making bottling more ex­pensive due to the need for more complex bottling operations and order/delivery systems. Ultimately, maneuvering in the know-how-timing arena reached a point of diminishing returns.

Soft drink companies also competed on packaging know-how and dis­tribution skills. Glass bottles have been replaced by tin cans, aluminum, and plastic bottles. Product innovations by one competitor have been cop­ied by others, but they often provide a temporary advantage. In the 1950s Pepsi introduced the first twenty-four-ounce bottle for family consump­tion. Seven-Up came up with the liter bottle. After the introduction of the two-liter bottle, Pepsi rolled out a three-liter bottle in 1984. It took Coca-Cola only four months to obtain supplies of bottles to copy the inno­vation.⁸ In 1960 only two container sizes were offered. By 1975 consumers had a choice of ten sizes, from 6.5 ounces to two liters. Cans, which ac­counted for just 4 percent of all sales in 1960, rose to 35 percent in 1975.⁹

But this growth of product and packaging variety also may have led to some product cannibalization. After Coke introduced its Diet Coke, sales of its diet soft drink Tab fell from 4.0 percent of the market (by volume) in 1982 to 1.6 percent in just two years.¹ 0 The market share for Coke also fell during the same period. This suggests that some of the gains of Diet Coke were made at the expense of existing products.

Each taste and packaging innovation in the soft drink industry is now quickly copied by competitors, despite patents or attempts to keep formu­las secret. Because the barriers to imitation are very low, it is hard to sus­tain a product advantage for long before it is eroded by competitors. Since Royal Crown’s three-year lead in entering the diet cola market, there have been few opportunities for first movers to gain long leads in launching new products or packages.

One of the latest product battlefields between Coke and Pepsi ( and the rest of the world) has been the sports-drink industry. Gatorade, which reigned over the $800 million U.S. market, suddenly found itself under attack, the Wall Street Journal reported. In 1992 Pepsi moved into super­markets with a carbonated beverage called All Sport, using blind taste tests against Gatorade similar to its earlier Pepsi Challenge. Coca-Cola, a “lap or so” behind Pepsi according to the Journal, rolled out tests for its new PowerAde.¹¹

With both Pepsi and Coke carrying very similar full lines of products and imitation time getting shorter and shorter, gaining advantage based on know-how and timing has become almost impossible. So opportunities for gaining advantage in the soft drink market have shifted to the third arena—creating and controlling strongholds by using entry barriers and then battling for turf in the strongholds of others.

4. Analysis of Arena 3: Strongholds

In soft drinks the key to creating and controlling a geographic stronghold is distribution. Extensive penetration and exclusive control over territo­ries give a firm a safe haven that others cannot enter easily. If all the retail outlets in an area are already satisfied by one of the competitors, then entry by a rival is difficult to pull off. Building an expensive distribution network into an already saturated area is less attractive than moving to a virgin territory.

THE BATTLE FOR CONTROL OF THE U.S. TURF

Early on, both Coke and Pepsi granted bottling franchises based on geo­graphic regions. The franchises were granted in perpetuity and often passed down within families. The franchisees were given exclusive rights to market the company’s soft drinks in the territory but had to agree not to sell products of direct competitors.

In the early 1900s Coca-Cola pushed to make its cola available every­where, “within the arm’s reach of desire.” The penetration of Pepsi’s early network of franchisees was much less extensive, perhaps because Pepsi was losing in the price-quality arena (as shown in Figure 5-2). In addition, Coke’s head start in the lucrative fountain market gave Coke a dominant position in distribution through theaters, drugstores, restaurants, and other nongrocery vendors.

Despite building elaborate entry barriers based on distribution channels and production facilities around the country and despite Coke’s advertis­ing economies of scale resulting from its dominance in North America, Coke’s U.S. stronghold was vulnerable to entry by the guerrilla methods discussed in Chapter 3.

The network of geographic franchises left the franchisees room to bot­tle noncola soft drinks from companies that were not in direct competi­tion with Coca-Cola or Pepsi-Cola. So Seven-Up, a leader in the lemon- lime market, could piggyback on Coke’s bottling system. Coke introduced Sprite as one means to block Seven-Up’s access to Coke’s bottlers and fountain distributors. Finally, when Seven-Up took on the colas, position­ing itself as the “uncola,” it became a more direct competitor and aggres­sively attacked Coca-Cola’s Sprite to lure bottlers and fountain outlets away. Coca-Cola responded with a lawsuit against Seven-Up to try to shore up its turf barrier.

Seven-Up, as a noncola product, did overcome the entry barriers that kept colas out of the picture. Seven-Up used its access to Coke and Pepsi franchisees to achieve national distribution. Unlike Coke and Pepsi, Seven-Up did not initially distribute through fountain sales. But after en­tering fountain sales in the 1960s and aggressively pursuing fast-food chains, it brought its product into nine out of ten chains.

Another intense guerrilla battle was fought over the demographic turf of the youth market. Pepsi went after this market aggressively with its “taste of a new generation” campaign. It used rock stars such as Michael Jackson and actors such as MichaelJ. Fox in its endorsements. Coke’s em­phasis on tradition (“the real thing”) gave it a natural appeal to older drinkers. But the fast-growing youth market could not be ignored. Coke rolled out its own endorsements from rock stars to counter the Pepsi offen­sive.

Pepsi also breached Coke’s seemingly impregnable entry barriers around the fountain market. Pepsi made inroads into Coke’s fountain stronghold by acquiring several fast-food chains, like Taco Bell and Pizza Hut. However, Coke responded by forcing its way into competitor fast­food chains, like Wendy’s, that had previously carried Pepsi products, and Burger King. Pepsi lost these accounts as Coke attacked with the argu­ment that PepsiCo was a major competitor of these fast-food chains.

Another attack designed to weaken Coke’s control over its U.S. strong­hold occurred in the 1970s. Regulators at the Federal Trade Commission took action to try to weaken the exclusive territorial agreements of Coke’s and Pepsi’s franchise networks, which it charged were anticompetitive. But a ruling by an administrative law judge went in favor of Coke and Pepsi.¹² The intervention may have been unnecessary. Supermarket ware-houses and beer distributors offer alternative distributions systems that allow competitors to circumvent the franchise networks. Even with the franchise networks of Coke and Pepsi, entry barriers in the industry are actually quite weak, as evidenced by the more than five hundred carbon­ated beverages introduced in 1988 and 1989. There are also geographic and product niches where small players can enter and grow through access to bottlers and distributors. New entrants now have access to an array of companies that can produce concentrate, bottle the soda, and distribute it to stores, restaurants, or warehouses. R. J. Corr Naturals, Incorporated, in­troduced a natural soda with a twelve hundred dollar investment in 1978 and had built a ten million dollar business a decade later.¹³ While Coke and Pepsi have not lost their dominance of the U.S. market, their margins are eroding and their market share is in jeopardy for the first time in decades.

Of course, not all entry attempts are successful. Seven-Up’s launch of a caffeine-free cola, Like, in 1982 proved the difficulties of overcoming bar­riers to entry into the cola market. Despite a twelve million dollar adver­tising budget, Like gained only 0.3 percent of the market in its first year. Court rulings that it was a cola shut it out of the Coke and Pepsi distribu­tion channels that had helped make Seven-Up a national brand. It couldn’t achieve economies of scale, distribution, or market share, and it folded.

Despite this successful defense against Seven-Up in the cola segment, Coca-Cola and Pepsi found that even this part of the market is not im­pregnable. Although Seven-Up could not compete directly against the colas with a new product, it could reposition its existing product as an uncola. In addition to challenging the colas, Seven-Up’s “uncola” cam­paign was also aimed at the sixteen- to twenty-four-year-old group of customers.

With Coke and Pepsi each sparring for access to the other’s markets ( through attacking the youth segment and with new flavors positioned against the colas) and with easy entry for niching concepts, entry barriers are falling. Moreover, the demand for colas is declining in the 1990s so that barriers around the cola segment are becoming less important for keeping and gaining market share in the soft drink industry. The juice, cola, uncola, all-natural, and perhaps even wine cooler markets are merg­ing. Established manufacturers face threats from other beverage makers, such as juice maker VeryFine, which jumped into competition with soft drinks by positioning its advertising against soft drinks such as Pepsi. Turf in the soft drink industry has become very difficult to defend, as any man­ufacturing company with a bottling system and a distribution network can continue to use its synergies to capture market share from the traditional soft drinks, carbonated beverages.

In response to the numerous attacks on Coke’s and Pepsi’s turf, Coke and Pepsi have used synergies from their soft drink distribution network to expand the boundaries of their U.S. turf into sports drinks. Coke’s and Pepsi’s networks of vending machines and distribution lines give them an advantage in their attack on long-time market leader Gatorade. Even so, Gatorade’s recognition and hold on the fountain market make it a tough competitor to unseat. Their success will depend on Pepsi’s and Coke’s will­ingness to use their deep pockets to overcome Gatorade’s resistance, a topic covered below.

With the increasing difficulty of excluding competitors from the U.S. turf, the ability to seize the initiative in soft drinks has now shifted to a new territory—international markets.

THE BAffiE FOR TURF IN INTERNATIONAL MARKETS

In the 1960s and 1970s growth in the soft drink industry outside the United States was greater than growth in domestic markets. Coke achieved dominance in European and Asian markets by following U.S. troops in World War II. Responding to a request by General Eisenhower that Coke be available to troops anywhere in the world for a nickel, Coca­Cola built bottling plants in Europe and Asia, satisfying the needs of servicemen while building the structures for its future growth. In 1959 Coke built 30 new foreign bottling plants, bringing its total to 647. By 1960 Pepsi had driven its total up to 237 plants in 37 countries (from only 67 plants in 23 countries a decade earlier).¹⁴

Pepsi followed diplomats into the Soviet Union and China, staking out its claim in those territories. With the help of Richard Nixon, Khrushchev took a highly publicized sip of Pepsi in Moscow in 1959, opening the So­viet market. But by mid-1972 Rumania was’ the only Eastern European country without a Coke plant.¹⁵ In 1972, through shrewd diplomacy, Pepsi built the first bottling plant in the U.S.S.R., in partnership with the Soviet government. Still, Coca-Cola dominated overseas markets. By 1980 inter­national sales accounted for 62 percent of Coke’s soft drink volume while amounting to only 20 percent of Pepsi’s.

In the future, dominance and growth will be determined by who con­trols the near-term growth markets in newly industrializing nations and long-term growth markets in high-population-growth nations. Coke’s and Pepsi’s aggressive competition in the United States may distract attention away from these growth markets. However, the future will focus on the geographic turfs that have not yet reached hypercompetitive conditions.

Winning these battles over U.S. and international markets will in part be determined by who has the deeper pockets. With the price-quality, timing-know-how and stronghold arenas all but lost in the United States, the dominance of the U.S. market will be determined by who can throw the most resources into the battle. Moreover, the aggressiveness of expan­sion into foreign growth markets will also be influenced by the level of each competitor’s resource base. This brings us to the assessment of the four arenas.

5. Analysis of Arena 4: Deep Pockets

As noted above, deep pockets will be as important in the future as they were in the past when Coca-Cola initially used its resources to drive out other competitors such as Bola-Cola and a host of other pretenders. It used its deep pockets in court to defend its name at every tum. It had the re­sources to advertise heavily. Early on, it was spending very heavily on ad­vertising, with a fifteen million dollar ad budget in 1939.

But the deep pockets were not always an advantage. Coke had used its deep pockets to invest a lot of money into promoting its bottle design and into building its distribution system. The distinctive design of the Coke bottle was used in advertising and became almost synonymous with the drink itself. Its nickel soft drink vending machines increased the accessi­bility of Coke. But, as we saw, these advantages became disadvantages when Pepsi-Cola cut its price to a nickel, offering twice as much soda for the same price as Coke. Because of its size Coca-Cola would have faced high costs in moving to a new bottle (both in the physical production of new bottles and the name recognition) or changing its prices (because of the need to replace or retool its vending machines). Pepsi used Coke’s inflexibility (which arose from use of its deep pockets) to its own advan­tage in introducing a larger bottle for the same price.

Deep pockets are, nevertheless, becoming crucial to survival in the soft drink industry. The industry has become increasingly concentrated in the hands of major players. By 1988 Coca-Cola and Pepsi held more than 71 percent of the soft drink market, up from 64 percent just six years earlier. ¹⁶ Both Pepsi and Coke used their deep pockets to purchase bottlers at an increasing pace in the 1970s and 1980s and have moved into other indus­tries.

In January 1986 PepsiCo announced its plans to purchase Seven-Up, but the Federal Trade Commission intervened on antitrust grounds. Pepsi was permitted to acquire Seven-Up operations in Canada. Coca-Cola, fol­lowing Pepsi’s lead, announced plans to purchase the Dr Pepper Company a month after Pepsi’s . announcement. But when Pepsi’s bid for Seven-Up was shot down, Coke backed off its plans to acquire Dr Pepper.¹⁷

Both Coke and Pepsi increased their ownership of bottling plants through vertical integration. In 1986 Pepsi bought up several franchises so that it owned 32 percent of its bottlers. Coke also increased its ownership of its bottlers from 11 percent to 38 percent in the same year.¹⁸ Coke was working to consolidate its bottlers into a deep-pocketed player that it could spin off to the public, while Pepsi was hoping to own its distribution networks so that it could consolidate control, capture distribution syner­gies, and offer new services to its customers. Either way, each player needed deep pockets to carry out its distribution strategy.

Some smaller competitors worked around the deep-pocketed players through attacking regional markets. Dr Pepper, for example, was a strong regional producer in the Southwest. Smaller firms also used resource esca­lation and countervailing power by piggybacking on existing bottling net­works. Before the 1960s, however, Dr Pepper was considered a cola, so Coke and Pepsi franchisees were barred from carrying it. The resources of Coke and Pepsi—their franchises of bottlers across the country—allowed them to shut out Dr Pepper’s growth. But the little guy often has the courts on his side. Dr Pepper prevailed in 1962 when a U.S. court ruled that it was not a cola, opening access to Coke and Pepsi bottlers.

A more far-reaching attack on the franchise system held by the two deep-pocket players was action against the system by the Federal Trade Commission in 1972. The FTC alleged that the system kept soft drink prices artificially high and prevented price competition between brands. But the industry, particularly the franchisees, successfully fought this at­tack.¹⁹ As it turned out, with the government’s intervention price wars would become common due to the dynamics of strategic interaction that played themselves out in the three arenas discussed above.

To overcome Coca-Cola’s overall size advantage in the soft drink in­dustry, Pepsi branched out, diversifying intofast food and snacks. It used the deep pockets from its soda business to move into other areas and used these areas to further build its soft drink empire. For example, as restaurant fountain sales continued to increase, Pepsi’s ownership of Pizza Hut and Taco Bell gave it an assured channel for selling its products.

Countervailing power has also developed, as bottlers develop the ca­pacity to manufacture syrup. These bottlers can also sell off their excess capacity to smaller noncola brands in strategic alliances with syrup mak­ers. This makes it very easy for a small player to enter the market. Instead of building its own syrup-making know-how, the bottling companies can now rely on partnerships with syrup manufacturers.

Entering the 1990s, the size advantage of Coke over Pepsi has been vir­tually eliminated. Not only are these two biggest players in the soft drink industry on a more equal resource footing, their size is not always an ad­vantage against the many new small players entering the soft drink mar­ket. While deep pockets are no longer the advantage they were when Coke crushed Bola-Cola out of the business, they will be important if used to win the battles being foroht in the stronghold arena.

6. Hypercompetition in the Soft Drink Industry

One might also expect that, with such high concentration of power in the industry, the major players would be docile and congenial. The “conven­tional antitrust paradigm (structure-conduct-performance) would predict … that the carbonated soft drink industry would not be competitive … [ that is, in an industry where] price increases outstripped costs, there was little price discounting, no new product development occurred, produc­tion inefficiencies abounded, and demand was stagnant or falling. This same paradigm would predict that PepsiCo and Coca-Cola would perceive their mutual interest to be served by nonaggressive, nonthreatening be­havior, particularly toward one another. But this conventional wisdom does not hold up here.’²⁰ There is intense competition, real prices have continued to fall, and many new varieties of soft drinks have been intro­duced.

Why is competition so intense when there are so few players? First, soft drinks are not only competing with other soft drinks but also with other beverages such as coffee and juices. The industry is also open to entry and expansion by fringe players, as has occurred regionally and nationally over the years. None of these new entrants have gained significant national share, but their existence and potential for success forces the major players to be extremely competitive to prevent new players from gaining a foot­hold. Overall, the intense competition is driven, at least in part, by a cul­ture of rivalry between Coke and Pepsi and “the tenuous nature of their hold on a substantial number of consumers.”²¹

The intense competition—hypercompetition—in the soft drink indus­try continues to keep all players moving quickly from advantage to advan­tage and trying to seize the initiative in each of the four arenas. This ex­ample also points out the declining need for legal intervention to keep an industry competitive. At least in this case, an intense and aggressive mar-ketplace protects consumers far better than laws against collusion or “anti­competitive” behavior. This issue will be explored in more detail in the conclusion to the book.

Coke and Pepsi are now in a fiercely competitive market. They are forced to continue to introduce new products to meet demands of customers. But these products are imitated quickly, and their success often comes at the expense of sales of existing products. When Coke introduced Diet Coke, the new soft drink grew quickly, but Tab and regular Coke suffered corresponding losses in market share. The competition has also left the shelves full of diverse caffeinated and caffeine-free, diet and non­diet, classic and nonclassic colas. So both players have broad, comparable lines.

Both companies (especially Pepsi) continue to succeed by moving from advantage to advantage more rapidly, shifting between the arenas to keep ahead of their opponents.

7. A Series of Temporary Advantages

PLAYING OFFENSE: PEPSI SEIZES THE INITIATIVE

Pepsi’s rise in the cola wars from a bit player to the industry leader was accomplished by seizing the initiative in two arenas—cost and quality and timing and know-how—through a series of temporary advantages. Each advantage moved it a little farther forward. Coke, because it thought that its dominant position and resources suggested that it should defend its stronghold, was often slow to respond to these initiatives by Pepsi, giving the upstart time to gain a strong foothold. As Figure 5-8 indicates, Pepsi’s advantages have become increasingly short-lived as competition heats up. Over time, Pepsi has sought to create a series of advantages that sustain and build its long-term position.

PLAYING DEFENSE: COKE TRIES TO PROTECT ITS fuMINANCE

Coca-Cola, on the other hand, maintained the initiative in the remaining two arenas—strongholds and deep pockets—at least at first. It defended its turf and created new strongholds by throwing up entry barriers, such as introducing Sprite to keep Seven-Up out of its distribution network and expanding into new international geographic territories. These barriers were not completely successful, however. Coke eventually lost share to Pepsi’s assault on the youth market and held the lead in resources only until Pepsi’s success in the other arenas, along with mergers and acquisi­tions, tended to even the field. Although it may seem that Coca-Cola’s domination of the industry rested on one steady foundation (i.e., its secret cola formula), it in fact has defended its position through a series of advan­tages used to reseize the initiative or neutralize the series of temporary ad­vantages created by Pepsi (as illustrated in Figure 5-8). Even though Coke had few product innovations in its early history, it developed new distribu­tion channels and advertising messages that protected its position. If Coca-Cola had continued to sell its product through pharmacies, the com­pany would now be little more than a footnote in history. Instead it changed distribution channels, packaging, and advertising. The advantage that Coke had in the 1920s is very different from the advantages it had in 1950, 1960, 1970, and 1980.

FIGURES-8

PEPSI SEIZES THE INITIATIVE AND COKE RESPONDS: SHRINKING CYCLES OF ADVANTAGES

(A Few Representative Examples)

A METAPHOR FOR AMERICAN LOSSES
TO AGGRESSIVE FOREIGN COMPETITORS

While Pepsi used a largely offensive strategy, Coca-Cola (as the market leader) used a more defensive approach, responding to first moves by Pepsi or other players. This defensive posture caused trouble when Coke, under the constant pressure of Pepsi’s attacks in the first two arenas, tried its boldest effort to respond to the threat. Coke issued New Coke to imitate Pepsi’s sweeter taste because consumer tastes were shifting to sweeter sodas. This move, which Coca-Cola thought would seize the initiative against its competitor, actually ended up losing it. While it was a good idea to neutralize Pepsi’s advantage, this move failed in part because it was an admission that Coke lost the Pepsi Challenge. Instead of seizing the initia­tive, it clearly signaled both the loss of the initiative to Pepsi’s superior taste and Coke’s poor position, as illustrated in Figure 5-7.

Coke’s defensive strategy is similar to the way many large, dominant American firms compete with aggressive foreign firms. IBM and General Motors, for example, both lost the initiative in the first two arenas (cost- quality and timing-know-how). Both saw foreign competitors with equal or better quality enter with lower-cost products. Both lost the edge in in­troducing new products and, even though both had superior technological know-how in their labs, they failed to apply it to their products and prod­uct process as fast as their more nimble competitors did. Instead, both firms tried to use their deep pockets and distribution barriers to hold onto their strongholds for as long as they could.

Over the long haul, winners play offense in all four arenas, because only by staying one step ahead of their competitors do they continue to main­tain the initiative.

IF ONLY COKE HAD DONE A FOUR ARENA ANALYSIS

If Coke had done a Four Arena analysis, it would have realized that

1. Pepsi had the initiative in the price-quality arena, despite Coke’s lower costs ( which it was not using to lower price earlier on)
2. Pepsi—and especially the smaller players—had the initiative in the timing-know-how arena, where Coke was introducing products mainly to defend against inroads made by competitors
3. sustaining strongholds through the use of entry barriers is not going to win the game over the long haul, because entry barriers can be breached
4. if Coke loses in the first three arenas, its deep pocket would eventually be neutralized

These realizations might have radically altered Coke’s behavior. By the time Coke finally attempted to seize the initiative with New Coke, it didn’t know how to disrupt the marketplace. Disruption takes practice and knowledge of how to do it. The New 7-S’s, discussed in Parts II and III, are designed to provide guidance for managing disruptions.

Source: D’aveni Richard A. (1994), Hypercompetition, Free Press.