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Pick an industry. Now use Michael Porter's industry structure analysis to analyse the industry. How will your analysis help the CEO of the largest firm in your industry?
A company in any industry will require a strategic position to gain market share and ensure its long run profitability. In order to determine the best strategy for the firm, it is essential to first analyse the structure and competitiveness of the industry. Michael Porter argues that there are five main forces which influence the type and degree of competition. These forces are the threat of new entrants into the market, the bargaining power of customers, the bargaining power of the suppliers to the market, the threat of substitutes and the jockeying among contestants within the market. Any firm wishing to join the industry, or an existing firm wishing to improve its position, must first consider these issues.
I will now look in more depth at the carbonated soft drinks industry and consider the effects of the mentioned forces on the competition within the market. Currently there are three main players in the industry competing for greater market share. These are The Coca-Cola Company, Pepsi-Cola and the Dr Pepper/7 Up (owned by Cadbury Schweppes). Between them, these firms produce many different flavours of beverage currently available in the market. According to an industry report of 00 in "Beverage Industry" publication, the market leader is The Coca-Cola Company with a market share of 7%. Pepsi-Cola Company is the second largest firm in the market with a market share of 4.8%, leaving Dr Pepper/7 Up with 17.%. Other labels only make up 7.% of the market.
Let us first consider the threat of entry into the industry by looking at the magnitude of the barriers to entry. There are several factors which may restrict the ease with which firms can enter an industry. One such example may be the economies of scale gained by the existing firms, hence making it difficult for new firms to compete with their low costs. As there are only main competitors in the large soft drinks industry, it is clear that each firm is benefiting for a large amount of economies from scale. As a large business, the firms may have invested large amounts on market research and developing new flavours to offer to the market.
A second barrier to entry into an industry can often also be product differentiation. A company may be able to brand their product through various marketing techniques to increase customer loyalty and increase demand. This is clearly the largest barrier to entry in the beverage industry. All three of the main firms have spent a great deal of money on advertising and marketing campaigns promoting their products. According to Ken Hein in "Brandweek", the prime-time network spending on the carbonated soft drinks industry was $0 million. This type of branding poses a huge problem for potential entrants as they would have to invest large amounts to try and create a brand name to compete with the leading names. In 14, Virgin entered the cola market using their existing brand name to try and compete with the huge forces already in the industry. The new product did not reach the expected success of the company, especially in the US where demand for it was very low despite the investment on its promotion. When the brand was launched in 18 on the West and East Coasts, it frankly didnt meet the high standards set for the launch, says Bob OBrien, managing director at Virgin Drinks USA, Wilton, Conn.
Virgin tried to increase their sales by introducing two new flavours Virgin Lemn Lime and Virgin Orange. It also introduced a new image with the 16.-ounce Cur-V bottle to the United States nicknamed Pammy in the U.K., after actress Pamela Anderson Lee. However, despite Virgin's efforts, it was not able to compete with the leading names and holds a very small percentage of the market share.
The existing product differentiation also means that an entrant will incur high sunk costs to enter the industry as it will have to invest heavily in advertising and marketing. This will deter entry as firms may not want to take the risk of loosing their investment should they decide to leave the industry at a later stage.
Another factor affecting the firm's decision to enter is the availability of distribution channels. The main companies hold a large amount of "shelf space" in most of the retail outlets and a new company may have to pay more for a retailer to sell its product. Many retailers already have contracts with the existing companies and will therefore not be able to sell the new product. For example, Burger King, which is the second largest fast food chain customer to The Coca-Cola Company, is currently in the 5th year of a 10 year contract to supply its cola. Therefore a new firm would not be able to access these very important distribution channels.
Other reasons for entry to the industry being difficult are that the incumbents have sufficient power and resources to fight back. The firms may increase their investment on branding, or offer promotional price cuts which will drive the new firm out of the industry. The other main problem is that it is a mature industry and hence the growth rate is very low. According to the Coca-Cola Company's profile, there is an expected annual growth rate in carbonated soft drinks of .8%, while the rate for all soft drinks is expected to be 4.%. This slow growth will further deter entry as there is no ability for the market to create space for the new firm.
The next two forces laid out by Porter to determine competition levels is the bargaining power of suppliers and buyers. The Coca-Cola Company, founded in Atlanta, Georgia in 1886, awarded exclusive bottling rights to a company in 18. Since then the company has had an independent bottling system, hence reducing its costs and eliminating problems with bottling price negotiations. The other firms in the industry have similar arrangements whereby they do not incur inefficiencies due to unnecessary bottling costs.
Due to the small number of firms in the industry, each firm has a great deal of bargaining power with its suppliers and buyer. The intense product branding means that the leading firms hold significant power over other firms for negotiating with buyers. However, due to the intense competition between the firms, each firm will have to fight for their desired distribution channels. For example, Pepsi was the sole supplier of cola to Burger King in the 180s, however, Coca-Cola is now engaged in a 10 year contract with BK. McDonald is also currently supplied by Coca-Cola, accounting for 7-8% of the company's sales. Therefore, in this industry it is extremely important to negotiate contracts with buyers as there is a fierce threat to the firms that the buys will choose to be supplied by the competitor. Although product differentiation does help in the bargaining power of the firm, in this case although the colas are heavily branded, both have engaged in an advertising war, where both are popular brands.
A fairly substantial problem in this industry is the threat of substitute products. Although the market for carbonated soft drinks has dominated the soft drinks industry, there are an increasing number of customers who are switching to other forms of non-alcoholic beverage. The sector which is growing most rapidly at the moment is the sector for "energy" drinks. The most popular of these drinks is currently Red Bull, which holds 54.8% of the market share in energy drinks. Percentage sales for Red Bull have risen 40.4% alongside similarly high growth rates for sales of other energy drinks including Pepsi-Cola's Amp drink.
There are still many other substitutes to carbonated drinks such as fruit juice and water. Both Pepsi and Coca-cola have branched out into both the energy drink sector and the juice sector, with Pepsi's Tropicana and Coca-Cola's Minute Maid. However, the firms face greater competitions in these sectors of the soft drink industry and are not market leaders in these. Another substitute is also canned and bottled teas. In this sector, Lipton Brisk is the market leader with 18.6% of the market share.
There have been increased health warnings about carbonated drinks causing tooth problems as well as being linked to obesity. Increasingly in the US, nutritionists and physicians appear on media shows claiming that carbonated drinks are to blame for America's "obesity epidemic". Despite Coca-Cola's report entitled "Your Power to Choose. Fitness. Health. Fun", consumers are turning to more healthy drink options such as mineral water and energy, high vitamin drinks. Although this has not yet resulted in a significant decline in demand, it causes more problems in the future if more people become worried about health related issues.
The final and perhaps most important factor to consider in this industry is the way in which firms jockey for position in the industry. Porter outlines market criteria which may lead to intense rivalry in an industry. The first of these factors is if competitors are roughly equal in size and power. Clearly Coca-Cola and Pepsi are very similar and size and strength suggesting intense competition exists. Another factor he outlines, which is again relevant to this industry is if growth is slow. This is again true as discussed earlier and as the firms are trying to expand in order to increase sales and profit, competition between them grows.
Both Coca-cola and Pepsi have introduced a wide range of different products within the industry to try and gain more power and expand into other areas. Coca-cola introduced Diet Coke in 18. Over the following 0 years, the company launched many different versions of the classic cola including cherry cola, diet coke with lemon, coke with vanilla, decaffeinated cola, etc. The coca-cola company also owns the label Sprite the lemon-lime flavoured drink. The company launched an expensive advertising campaign for Sprite, giving it the famous slogan "obey your thirst". Coca-cola also increased differentiation by changing the shape of their packaging. In 115, the well-known contour shaped bottle was designed in response to a number of rivals launching imitation products.
Pepsi-Cola also launched various other drinks, competing with Coca-cola. These include, Diet Pepsi, Pepsi Max, Mountain Dew, Mountain Dew Code Red and many others. Although most of the drinks offered by the company are heavily branded, both firms tend to enter the market with very similar products. Dr Pepper entered the industry with a carefully designed strategy to avoid competing in price with the "Big Two". It differentiated its product on the unique taste of its product, hence avoiding many of the problems with entering an industry with such competitive forces. It then invested in a strong advertising campaign to promote the product and secure its place in the industry. Although it cannot then take advantage of the main-stream demand in the industry, by targeting a smaller audience it has been able to build a strong brand name and great customer loyalty.
The leading brand is currently coca-cola although this is only by a very large margin. By considering Porter's 5 forces determining competition, it is clear that rivalry in the industry is fierce. Although the company is currently investing heavily in promotion of its products through advertising, this is not giving it a great advantage as its rivals are doing the same. The current strategy is effective as it has also launched various different flavours within the carbonated drinks market in an attempt to broaden the target audience. It also has specific flavours for different locations which is beneficial, for example the local flavour Thumbs Up is very popular in India.
I think that the main problem it may face is that as people are drawn away from carbonated drinks and towards more healthy options it will suffer as Pepsi-cola has a more diverse profile than it. Although Coca-Cola has been successful in collaborating with companies such as Nestle to develop iced teas and coffees, I think it is vital for the firm to obtain a greater hold over these substitute markets to ensure its leading position in the future.
Porter's industry structure analysis is a valuable tool in determining the competitiveness of an industry. Without this type of analysis it would be hard for the managers of the firms in the industry to develop a successful market strategy. It is sometimes easier for companies to enter a market as from the outside them may be able to identify a niche in the market which is hard to see from inside it. Dr Pepper is a good example of this as neither of the "Big Two" were able to spot this gap in the industry.
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