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The Coca-Cola Company Analysis

Coca-Cola (Coke) is a carbo​nated beverage that dist​ributed worldwide. The main office is located in Atla​nta, U.S. It is a registered trade​mark of The Coca-Cola Company in the United States si​nce Ma​rch 27, 19​44 (The Coca-Cola Company, 2013). Initially, the Coca-Cola was invented as a patent m​edicine in the late 19th cen​tury by phar​macist John Pemberton. Later in year 1889, Coca-Cola was b​ought out by Asa Griggs Candler, a busine​ssman with his marketing tactics, led Coca Cola company to its prev​alence of the world carbo​nated soft drink industry through​out the 20th cent​ury.

For my blog, I chose Coca Cola to discuss and analyze the overall performance of the company. By applying some economic theories.

Factors that affect the demand curve

Relative goods.

First factor that affects the demand for Coke is a price of relative goods. There are many substitutes in the industry of the carbonated drinks such as pepsi, mirinda, sprite and etc. If the price of the Coca-Cola increases from 4RM to 8RM(Figure1), whereas the prices of other drinks remain stable, the demand for Coke will decrease, because consumers are willing to fulfill their needs and wants with lower price.

Figure 1

Figure 2

Income

It is clear that there is direct relationship between buyer’s income and demand for Cola. If there is an increase in income, the demand will also go up and vice versa. That is, because when income increases the purchasing power becomes higher and consumers are ready to buy more. According to the Table 1, countries with higher income spend more money on Cola drinks and bring more revenue.  Thus, the demand curve shifts to the right (From D to D1, Figure 2). 

                                     Table 1

Government policies.

Government analysis of the product can decrease the demand of the product. According to the case in India in 2006, there was a significant declining in the demand, when the pesticides were found in 54 bottles of Coca-Cola. This occurrence switched buyer’s preference from Coke to more nutritious juice beverages, thereby decreasing the demand of Coca-Cola. As the result the demand curve shifts leftward (from D to D2, Figure 2). 

Time

Furthermore, time is also an important factor that affects the demand e.g. during the summer, the demand of the Cola is sharply growing because at this time people prefer more carbonated drinks than natural juices.

Expactations of future price changes

However, in the cases when consumer expects that there will be a rise in price of Coca-Cola after 2 weeks later, the demand for Cola will grow now. Thus, demand curve for this product will shift rightward (from D to D1, Figure2).

Marginal Utility

Coca Cola and Pepsi are selling carbonated drinks with almost same taste, color, and product differentiation, which makes them perfect substitutes. Since, Cola and Pepsi are perfect substitutes; price for them is very sensitive to demand. Furthermore, the price elasticity of demand for this product is fairly elastic but not perfectly elastic, because of the factors such as brand loyalty and taste preference of the Coke and Pepsi (Figure 3). In addition, both companies have positive cross elasticity of demand, as two products are substitutes. This happens if the price of Cola rises, it makes the quantity demanded of Pepsi product increase. As a result people will prefer the cheaper substitute. Therefore, these products are normal goods.

As, Pepsi and Coca Cola are perfect substitutes; pricing strategy of Pepsi influences the demand of Coca-Cola and vice versa.  Moreover, the indifference curve of these products would be a straight line with equal slopes (Figure 4).  For example, if Coca - Cola decides to reduce the price of its 1 liter bottle from 6 RM to 4 RM, thereby increasing the amount of consumption and demand for their goods. The same changes we could observe by plotting the Price Elasticity of demand (increase from Q1 to Q2 in Figure 3).

    Figure 4                                      Figure 3

This will lead to a proportional decrease in the consumption of Pepsi. Respectively, to avoid the loss of market share and profit, Pepsi can offer to sell additional can of Diet Pepsi priced at 2 RM for free along with 1L bottle. According to figure 5, it will help to increase Marginal Utility of the Pepsi. Consequently, the quantity of consumed products will also go up from Q1 to Q2.

Figure 5                                     Figure 6

Nevertheless, cutting prices for Coke would change the budget line from B1 to B2, because people incited to consume Coke instead of Pepsi (figure 6). Therefore, to confront with it and to fill the loss of consumption, Pepsi should also reduce the price of their 1L bottle. This is necessary because Pepsi and Coca- Cola are perfect substitutes.

 

Market Structure

CSD (carbonated soft-drink market) is dominated by two main firms: Coca-Cola and Pepsi. According to the chart 1, these two companies have a total market share of 73% in the CSD industry.It is clear that CSD market and Coca cola operates in oligopoly, because oligopoly formed when just a few firms between them and shares a huge proportion within the industry. As few firms control the market, they have great market power. With market power, firms in the oligopoly market are price makers. As firms’ main goals are to maximize profit, Coca-Cola and PepsiCo have the ability to set higher prices for their beverages in order to make profit. The following are some of the characteristics of oligopoly firm:

Barriers 

Bottling Network:

Cola and Pepsi concluded franchise agreements with their Bottling companies which have rights only in certain geographic areas. These agreements prohibit Bottling companies to produce goods of their competitors. Furthermore, due to the fact that both industry giants gained considerable proportion of Bottling companies and high control over the production, it is very difficult for new companies to find Bottlers that are willing to produce their products. Another way out of this situation is to build its own Bottling Company, but it would be very capital-intensive effort with new efficient capital requirements in 1998 being $ 75 million.

Advertising Spend and Brand Name:

The advertising and marketing spend in the industry is around $ 2.6 billion by Coke via print, radio, television and internet worldwide (Lovel, 2002 and McWilliams, 2011). This makes it extremely difficult for a new firms to compete with these giants and gain any visibility. Moreover, Coca-Cola has a long history of heavy advertising that gave her enormous brand value and customer loyalty around the world. This fact makes it almost impossible for a new company to match this scale in this marketplace.

Retailer Shelf Space (Retail Distribution): 
Retailers obtain margins of 15% on Coca Cola's drinks for the fact that they put Cola's goods on the shelves. This makes it difficult for the new entrants to persuade retailers to replace Coke on their goods. 
Fear of Retaliation: 
To enter into a market with entrenched rival giants like Pepsi and Coke is not easy as it can lead to price wars which affect the new entrants. Despite the fact that Pepsi and Coca-Cola are competitors, they can cooperate in order to displace new firms by predatory price strategy. This pricing strategy means that Coca Cola and Pepsi lower the price artificially and new rivals have to follow. After a period of time, even though they are making loss, Cola and Pepsi companies tend to survive. But new rivals will unable to survive due to the loss and the fact that they could not cover cost of production. Consequently, they force out of the market. The action of increasing price is to protect the industry from being shared by new firms and to maintain the market shares of theirs. 

Economies of large scale production 

Since 1923, Coke had various franchise models all over the world and this had inspired Coca-Cola to grow rapidly over the 20th century in order to achieve the maximum Economy of Scale. It is the situation whereby Coke increasing the scale of production that lead to a lower production cost (Garrratt, Sloman and Wride, 2012). Obviously, the company is getting increasing returns to scale (increased in input leads to huge increment on output) from its factors of production. New firms are deterred as huge initial cost is needed to start-up and they do not have enough volume of production in order to minimize costs when the production increases. Thus, competitors cannot compete with other firms who have much lower production costs.

Interdependence 

Non-collusive case  

Cola and Pepsi are constantly competing with each other, and the likelihood of price competition is very high. Since each of them wants to a bigger share of carbonated industry profits for them. If Cola lowers its price, Pepsi’s demand curve shifts. Therefore, the way of determining the profit maximizing output is difficult. Coke can set best price and output, but then Pepsi will react and repeat Coke's strategy.  That will shift Coca-Cola’s demand curve, changing its best strategy and so on and so on. 

Kinked demand curve 

The kinked dem​and curve m​odel assum​es a com​pany might fac​e a du​al dem​and curve for its pro​duct based on the likely reactio​ns of ot​her firms to a cha​nge in its pr​ice or an​other varia​ble.  

Two res​ults derive fro​m the kin​ked curve(Figure 7):

• If Co​ca-Cola rises the pr​ices, no​ne of the riva​ls will not follo​w suit in or​der to gain custo​mers fro​m the Coke, as a r​esults the dem​and of the Coca-Cola may falls
• If Coca-Cola cuts the pric​es, its rivals will be forc​ed to follow to prev​ent losi​ng out cust​omers to the Coke.

Figure 7

Based on the assumptions, Coke will face a kinked demand curve at the current price and output. As firms will not decide to reduce price without making a price-output decision with other competing firms, there is price rigidity in an oligopoly(Garrratt, Sloman and Wride, 2012).

Marginal Revenue Curve

Based on Figure 8, when the quantity is less than 50000 cans, the marginal revenue curve(MR) will correspond to the shallow part of the average revenue curve (AR) whereas when the quantity is more than 50000 cans, the MR curve will correspond to the steep part of the AR curve.

Figure 8

Profit are maximized when MC = MR. If the MR for coke lies between any point between MC 1 and MC 2, profit maximizing output (50000 cans) and price (RM 4) is achieved.

Coca-Cola Company is not achieving allocated efficiency, because the price is always above the MC. Moreover, when the price is higher than MR, the output will automatically lower than the minimum ATC and this means that they are not productive efficiently as compared to perfect competition where P = min ATC. Both the companies will restrict output to make greater profits. It tells us that, Coke and Pepsi enjoy supernormal profits in the long run.

 

Conclusion

Coca-Cola and Pepsi are the most recognizable carbonated soft drinks around the world. Both the companies obviously demonstrate how oligopoly occurs in the CSD market. Coca Cola has created a healthy competition within the CSD industry, where they have to expand and diversify their products to gain more revenue. This would be more beneficial to the consumers.

References

Case, K. E. and Fair, R. C. (2002) Principles of Microeconomics. 10^th ed. United States: Person Education.

Garratt, D., Sloman, J. and Wride, A. (2012) Economics. 8^th ed. England: Pearson Education.

Hubbard, R. G. and O’brien, A. P (2008) Microeconomics. 2^nd ed. United States: Pearson Education.

Industry Today (2013) COCA-COLA GUARARAPES. Available from: http://industrytoday.com/article_view.asp?ArticleID=FDQ_255[Accessed 30 December 2013].

Jackson, J., Mclver, R. and Wilson, E. (2008), Microeconomics. 9^th ed. Australia: McGraw-Hill.

Lee, E. and Schweizer, K. (2013). Merger will bring Coke, Pepsi under one roof. Available from:http://www.vancouversun.com/business/Merger+will+bring+Coke+Pepsi+under+roof/8724782/story.html#ixzz2idmeDAHm [Accessed 22 December 2013].

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McGuinness, R. (2012) Coca-Cola and Pepsi reignite rivalry on Twitter and Facebook. Available from:http://metro.co.uk/2012/05/08/coca-cola-and-pepsi-reignite-rivalry-on-twitter-and-facebook-418025/  [Accessed 3 January 2014].

McWilliams, J. (2011) Coca-Cola spent more than $2.9 billion on advertising in 2010. Available from:http://www.ajc.com/news/business/coca-cola-spent-more-than-29-billion-on-advertisin/nQq6X/  [Accessed 2 January 2014].

Mickle, T. (2012) Coke's London legacy: Higher sales. Available from:http://www.sportsbusinessdaily.com/Journal/Issues/2012/12/17/Marketing-and-Sponsorship/Coca-Cola.aspx [Accessed 6 January 2014].

Morran, C. (2013) Coca-Cola Tests Vending Machine That Changes Price Based On the Weather. Available from:http://consumerist.com/2013/10/10/coca-cola-tests-vending-machine-that-changes-price-based-on-the-weather/ [Accessed 3 January 2013].