The Shifting Landscape of the Carbonated Soft Drink Industry

Introduction
Following 100 years of growth, the carbonated soft drink (CSD) industry was a $36 billion market (see Exhibit 1), and Coca-Cola and Pepsi had the top selling soft drinks in the world. In 2015, sales of Pepsi and Coca-Cola products made up 70.8 percent of sales in the US CSD industry (see Exhibit 1).
The year 2016 marked the 124th anniversary of Coca-Cola. After ten consecutive years as the world’s most valuable brand, Coca-Cola slipped for the last five years to number three.1 Coca-Cola products were sold in more than 200 countries. It had the world’s largest beverage distribution system and owned or licensed more than 500 beverage brands. The company esti- mated that more than 1.7 billion servings of beverages bearing trademarks that it owned or licensed were consumed worldwide every day. Coca-Cola’s 140,000 employees worked to gen- erate nearly $42 billion in revenue in 2016,2 and the company had paid an increasing dividend to shareholders for the past 49 consecutive years.3
Although the Coca-Cola brand was valued at $70 billion and the Pepsi brand was valued at only $14 billion,4 PepsiCo was the second-largest food and beverage company in the world. It owned or licensed 19 brands that each generated at least $1 billion in annual revenues. Its top brand, Pepsi-Cola, reached over 2 billion in sales in 2016 through retail channels alone. The company’s total 2016 revenues were more than $62 billion (see Exhibit 3).5 Pepsi employed more than 285,000 people and was listed on both the Forbes and Fast Company lists of the World’s Most Innovative Companies in 2011. (See Exhibit 3 for each company’s historical revenues.)
But the picture was not as rosy as it might appear. The carbonated soft drink market was no longer growing as it had a few decades earlier, during the 1970s and 1980s. In fact, the CSD market was in decline. Sales of carbonated soft drinks in the largest market, the United States, had been weakening since the turn of the century, declining over 8 percent between 2000 and 2010, with forecasts of continued weak sales (see Exhibit 4).6 After a small bump in sales in 2011, the industry continued its slow downward slide.7 This trend continued through 2016, even in the diet soft drink segment of the market, a segment that Coke and Pepsi both thought would be more impervious to changing consumer tastes. From 2012 to 2013, regular soft drink sales dropped 2.2 percent, continuing a trend begun in 2000, while diet drinks plunged 6.8 percent, shaking the confidence of executives in both firms.8 Entering 2017, Coca-Cola and Pepsi both faced important questions of how to continue their success despite the changes they were fac- ing in the CSD industry.

C-12

EXHIBIT 1 Selected US CSD Company and Brand Market Share Figures (At Current Prices, in Millions)*

Company 2008 2009 2010 2011 2012 2013 2014 2015
Sales Market Sales Market Sales Market Sales Market Sales Market Sales Market Sales Market Sales Market Share Share Share Share Share Share Share Share
CSD market total† $13,401 $13,500 $13,343 $37,430 $36,890 $36,070 $36,020 $36,050
CSD Companies
Coca-Cola $5,128 38.27% $5,103 37.80% $4,955 37.14% $7,647 39.00% $7,572 39.00% $7,465 45.6% $7,551 40.2% $7,576 40.5%
PepsiCo $4,288 32.00% $4,290 31.78% $4,036 30.25% $6,120 31.20% $6,029 31.20% $5,834 31.0% $5,770 30.7% $5,693 30.3%
Dr. Pepper $2,649 19.77% $2,699 19.99% $2,862 21.45% $4,124 21.00% $4,082 21.10% $4,000 22.2% $3,999 21.3% $4,058 21.5%
Private Label $819 6.11% $874 6.47% $940 7.04% $1,191 6.10% $1,096 5.70% $971 5.1% $574 4.6% $823 4.4%
Other $517 3.86% $534 3.96% $550 4.12% $528 2.70% $537 2.80% $637 3.4% $552 3.0% $595 3.2%
Selected CSD brands
Coke Classic Coca-Cola $1,870 13.95% $1,880 13.93% $1,758 13.18% $2,988 15.10% $2,970 15.30% $3,261 17.0% $3,363 25.9% $3,426 25.9%
Pepsi Pepsi $1,430 10.67% $1,415 10.48% $1,290 9.67% $1,958 9.90% $1,897 9.80% $2,067 10.9% $2,130 16.4% $2,125 16.1%
Diet Coke Coca-Cola $1,179 8.80% $1,183 8.76% $1,152 8.63% $1,712 8.90% $1,660 8.60% $1,934 10.4% $1,830 31.8% $1,759 31.8%
Mountain Dew Pepsi $745 5.56% $772 5.72% $747 5.60% $1,384 7.00% $1,414 7.30% $1,537 8.0% $1,608 12.4% $1,658 12.5%
Diet Pepsi Pepsi $779 5.81% $744 5.51% $697 5.22% $953 4.90% $907 4.70% $1,097 5.9% $1,056 18.4% $1,004 18.2%
Dr. Pepper DPSG $602 4.49% $615 4.56% $638 4.78% $1,117 5.70% $1,121 5.30% $1,220 6.4% $1,226 9.4% $1,266 9.6%
Sprite Coca-Cola $551 4.11% $547 4.05% $541 4.05% $919 4.70% $921 4.80% $946 5.0% $983 7.6% $1,030 7.8%
Diet Dr. Pepper DPSG $297 2.22% $295 2.19% $338 2.53% $485 2.50% $472 2.40% $519 2.8% $488 8.5% $483 8.7%
Diet Mountain Dew Pepsi $273 2.04% $293 2.17% $314 2.35% $539 2.80% $549 2.90% $564 3.0% $554 9.6% $534 9.7%
Coke Zero Coca-Cola $199 1.48% $251 1.86% $299 2.24% $491 2.60% $507 2.70% $595 3.2% $583 10.1% $568 10.3%
Caffeine Free Diet Coke Coca-Cola $329 2.46% $312 2.31% $295 2.21% $360 1.90% $337 1.80%
7 UP DPSG $217 1.62% $215 1.59% $198 1.48% $258 1.30% $255 1.30% $292 1.5% $297 2.3% $281 2.1%
Sunkist DPSG $196 1.46% $206 1.53% $160 1.20% $218 1.10% $213 1.10% $210 1.1% $214 1.6% $210 1.6%
Caffeine Free Diet Pepsi Pepsi $210 1.57% $190 1.41% $159 1.19% $176 0.90% $156 0.80%
Sierra Mist Pepsi $181 1.35% $181 1.34% $131 0.98% $181 0.90% $169 0.90% $153 0.8% $130 1.0% $108 0.8%
Fanta Coca-Cola $105 0.78% $116 0.86% $119 0.89% $222 1.10% $244 1.30% $240 1.3% $278 2.1% $290 2.2%
Diet 7 UP DPSG $116 0.87% $118 0.87% $113 0.85% $139 0.70% $138 0.70% $146 1.3% $138 2.4% $130 2.4%
$171 0.90% $158 0.80% $147 0.8% $144 2.5% $139 2.5%
$154 0.80% $137 0.70% $109 0.6% $86 1.5% $74 1.3%
$97 0.50% $90 0.50% $90 0.5% $74 1.3% $71 1.3%
$70 0.40% $67 0.30% $65 0.4% $54 0.9% $43 0.8%
*The data for 2008–2010 are derived from FDMx sales data, which is Food, Drug, and Mass sales data excluding Walmart sales. This and other exhibits based on FDMx data are not reflective of the entire beverage market.
†The data for 2011–2015 are based on MULO sales data from Information Resources, Inc., InfoScan Reviews. MULO is defined as Multi Outlet, representative of the following channels: total U.S. Grocery, Mass, Total U.S. Drug, Total Walmart, Dollar, Military, and Club. MULO data are much more complete. That is why there is such a big difference in the sales numbers from 2010 to 2011.
Figures may not equal 100% as some data is only available for particular years and some small labels are left out of the table. Source 2008–2010: Mintel Group Ltd., “Non-Alcoholic Beverages: The Market – US” (April 2011).
Source 2011–2015: Information Resources, Inc., InfoScan Reviews/Mintel. At the time of printing data was not yet available for 2016 and beyond.

Current Industry Dynamics
The carbonated soft drink industry encompasses carbonated, nonalcoholic beverages, includ- ing colas and noncola drinks, such as root beer, orange, lemon-lime, and other flavors. Ameri- cans consume, year in and year out, more soft drinks than any other category of drinks even with the move toward BFY (better for you) beverages.
The CSD Industry saw an annual growth of roughly 10 percent between the early 1970s and late 1990s.9 Americans consumed an average of 23 gallons of CSD annually in 1970, and consumption grew by 3 percent per year for the next 30 years.10 By the early 2000s, however, attitudes toward soda had begun to change. Americans were down to drinking roughly 46 gal- lons of CSD per year, significantly less than their consumption levels in the late 1980s. Cola was still the majority of CSD consumption, but it dropped from 71 percent of all CSD in 1990 to 55 percent in 2009.11 US CSD sales further fell by 0.2 percent in 2005, 0.6 percent in 2006, and
2.3 percent in 2007.12 Citing decreasing consumer spending in general and increased consumer preferences for healthier foods, industry analysts expected CSD industry revenues to decline even more, by 2 percent per year from 2011 through 2021.13
Some of the decline in sales is due to the rise of substitute products. Many substitute products are available at varying price points, including water, dairy, juice, coffee, tea, energy drinks, and more (see Exhibits 2A and 2B). Take Red Bull, for instance. Red Bull entered the US soft drinks market in 1997 with a niche product: a carbonated energy drink retailing at $2 for an 8.3-ounce can—twice what you would pay for a Coke or a Pepsi. The company designed its cans as narrow, tall cylinders, so retailers could stack them in small spaces. It started by selling Red Bull through unconventional outlets such as bars, where bartenders mixed it with alcohol, and nightclubs, where 20-somethings gulped down the caffeine-rich drink so they could dance all night. After gaining a loyal following, Red Bull used the pull of high margins to elbow its way into the corner store, where it now sits in refrigerated bins within arm’s length of Coke and Pepsi. In the United States, where Red Bull enjoyed the highest market share of the $12 billion energy drink market in 2015, its sales are growing at about 35 percent a year. Red Bull is privately held, but all the signs suggest that it’s profitable.
Although substitutes have taken a large bite out of Coca-Cola and Pepsi’s profits, com- panies trying to directly enter the CSD market haven’t been as successful. For instance, in 1998, Virgin Drinks launched its own cola, advertising heavily and trying to get into all the retail outlets that stocked the leading brands. At Virgin Cola’s US launch, Virgin Group CEO Richard Branson drove a tank through a wall of cans in New York’s Times Square to symbolize the war he wished to wage on Coca-Cola and Pepsi. However, the leaders’ viselike grip on shelf space in grocery stores and other retail outlets proved impossible for Virgin Drinks to break. In July 2000, the company’s marketing vice president admitted to a trade publication that “There are people who are saying, ‘We’ve been looking for years, and we can’t find it [Virgin Cola].’” Virgin Drinks was never able to garner more than a 1 percent share of the US cola market.
For both new entrants and established firms such as Coca-Cola and Pepsi, the process of CSD production is similar. It essentially involves combining raw ingredients and packaging for shipment to its buyers. Participants in the process include raw material suppliers; manu- facturers of concentrates—flavor syrups not yet diluted with carbonated water—who purchase some raw materials; bottlers, who purchase concentrate and additional raw materials; and retailers. Concentrate manufacturers and bottlers are the two major players during the pro- duction process.

Coca-Cola and Pepsi as Concentrate Manufacturers
At the heart of each company are its concentrate manufacturing plants, where raw materials are blended, packaged into containers, and then shipped ready for bottling.14 The raw mate- rials used in producing concentrate are highly guarded secrets for each company, but they

EXHIBIT 2A Selected US Nonalcoholic Beverage Segment Sales (At Current Prices, in Millions; overall market includes CSDs and is in millions to be comparable to segments)
2010 2011 2012 2013 2014 2015 2016
Overall Market Sales $1,180,000 $1,240,000 $1,270,000 $1,310,000 est
Selected Segments
Dairy $18,033 $19,358 $18,869 $18,627 $19,191 $17,840 est
Juice $19,278 $19,471 $19,587 $19,519 $19,787 $20,023 est
Bottled Water $12,231 $13,116 $13,369 $14,156 $15,501 $16,492 est
Energy Drinks $8,072 $9,018 $10,143 $10,533 $11,184 $12,074 est
Coffee $9,459 $10,685 $11,306 $11,881 $12,919 $13,738 est
Nutritional and Sports Drinks $9,491 $10,475 $11,500 $11,843 $12,360 $13,068 est
Source: Based on Information Resources Inc., InfoScan Reviews; USDA Economic Research Service; CSPnet “Category Management Handbook”; SPINS; BevNet; US Census Bureau, Economic Census/Mintel.

Others 21%

Coca-Cola 17%

Private label 11%

PepsiCo 13%

Beverage Holdings 2%
Brynwood Partners 2%
Citrus World 3%
National Grape Cooperative Association 3%
Dr. Pepper/Snapple Group 5%

Note: Data may not equal totals due to rounding

Ocean Spray Cranberries 6%

Kraft Foods Group 10%

Campbell Soup 7%

EXHIBIT 2B MULO sales of 100% juice, juice drinks, and smoothies, by leading companies, 52 weeks ending May 15, 2016
Source: Information Resources, Inc., InfoScan Reviews/Mintel.

primarily consist of commodity ingredients such as citric acid, caffeine, and caramel coloring. Concentrate manufacturers typically add artificial sweetener to concentrates for diet products and sell concentrates for “regular” soft drinks to bottlers unsweetened, so that bottlers can add sweeteners, such as sugar or high-fructose corn syrup, during the bottling process.

EXHIBIT 3 Financial Data for Coca-Cola and Pepsi
Coca-Cola Co., All Values in USD (millions)
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Revenue $28,857 $31,944 $30,990 $35,119 $46,542 $48,017 $46,854 $45,998 $44,294 $41,863
Cost of Goods Sold (Cost of Revenue) $10,406 $11,374 $11,088 $12,693 $18,216 $19,053 $18,421 $17,889 $17,482 $16,465
Gross Profit $18,451 $20,570 $19,902 $22,426 $28,326 $28,964 $28,433 $28,109 $26,812 $25,398
Operating Expenses
SG&A $11,199 $11,774 $11,358 $13,158 $17,440 $17,738 $17,310 $17,218 $10,237 $9,439
Other $350 $313 $819 $732 $447 $895 $1,183 $7,847 $7,333
Total Operating Expenses $11,199 $12,124 $11,671 $13,977 $18,172 $18,185 $18,205 $18,401 $18,084 $16,772
Operating Income $7,252 $8,446 $8,231 $8,449 $10,154 $10,799 $10,228 $9,708 $8,728 $8,626
Interest Expense $456 $438 $355 $733 $417 $397 $463 $483 $856 $733
Taxes $1,892 $1,632 $2,040 $2,384 $2,805 $2,723 $2,851 $2,201 $2,239 $1,586
Net Income $5,981 $5,807 $6,824 $11,809 $8,572 $9,019 $8,584 $7,098 $7,351 $6,527
Source: Coca-Cola Co. annual statements.

PepsiCo. (includes snack division), All Values in USD (millions)
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Revenue $39,474 $43,251 $43,232 $57,838 $66,504 $65,492 $66,415 $66,683 $63,056 $62,799
Cost of Goods Sold (Cost of Revenue) $18,038 $20,351 $20,099 $26,575 $31,593 $31,291 $31,243 $30,884 $28,384 $28,209
Gross Profit $21,436 $22,900 $23,133 $31,263 $34,911 $34,201 $35,172 $35,799 $34,672 $34,590
Operating Expenses
SG&A $14,208 $15,901 $15,026 $22,814 $25,145 $24,970 $25,357 $26,126 $24,885 $24,735
Other $58 $64 $63 $117 $133 $119 $110 $92 $1,434 $70
Total Operating Expenses $14,266 $15,965 $15,089 $22,931 $25,278 $25,089 $25,467 $26,218 $26,319 $24,805
Operating Income $7,170 $6,935 $8,044 $8,332 $9,633 $9,112 $9,705 $9,581 $8,353 $9,785
Interest Expense $224 $329 $397 $903 $856 $899 $911 $909 $970 $1,342
Taxes $1,973 $1,879 $2,100 $1,894 $2,372 $2,090 $2,104 $2,199 $1,941 $2,174
Net Income $5,658 $5,142 $5,979 $6,338 $6,462 $6,214 $6,787 $6,558 $5,591 $6,379
Source: PepsiCo. annual statements.

EXHIBIT 4 US Carbonated Soft Drink Pricing
1994 1998 2002 2006 2009
Inflation-adjusted retail price per case $8.48 $7.63 $7.57 $7.47 $7.98
Change from previous year −3.9% −1.7% −0.1% −0.2% 0.7%
Concentrate price per case $1.00 $1.14 $1.35 $1.50 $1.65
Change from previous year 4.0% 3.3% 4.3% 2.7% 3.8%
Source: Beverage Digest Fact Book editions 2001, 2006, 2007, 2008, 2009, and 2010.

The concentrates are typically priced at a high margin above the cost of the raw mate- rials.15 The primary customers of the concentrate manufacturer were originally its franchised bottlers. Bottlers are still the largest group of buyers, but by the late 1990s, that customer base had expanded to include wholesale distributors, grocery stores, mass merchandisers, and hotels and restaurants. Fountain syrups, which are dispensed directly into a consumer’s cup from a fountain machine, are also typically produced by the concentrate manufacturer and then delivered directly to a fountain wholesaler or to the fountain location.16
The largest costs for CSD manufacturers, including Coca-Cola and Pepsi, were advertising, promotional materials, market research, and support for bottlers, including local advertising and negotiating with the bottler’s raw material suppliers and their primary customers, retail stores. In 2017, the concentrate manufacturer was primarily responsible for product development and innovation, as well as concentrate production. CSDs were differentiated through branding that was strengthened by heavy advertising.17 The concentrate manufacturers also made significant investments into protecting their trademarks and supported their bottlers by working out agreements for shelf space with major retailers, such as Walmart. In addition, Coca-Cola and Pepsi provided financial incentives to their customers for promotion and distribution of the prod- ucts, including volume rebates, product placement fees, and investment in displays. Although they provided little in the way of price concessions to bottlers, both Pepsi and Coca-Cola offered considerable product discounts and promotional payments, particularly to fountain accounts. Fountain accounts are companies that distributed CSD products through fountains (mixing concentrate and carbonated water on the spot) rather than in cans or bottles. Restaurant chains, such as McDonald’s or Burger King, were important fountain customers. In 2010, Pepsi and Coca- Cola respectively recorded $29 billion and $5 billion of such incentives as reductions in revenues.18 Coca-Cola and Pepsi conducted numerous transactions with their bottlers, which included
the sale of both concentrate and finished goods to be distributed. The companies received roy- alties for the use of trademarks on certain products, such as charging a bottler to use Pepsi’s Aquafina brand of bottled water.19 While the majority of fountain accounts were serviced by the concentrate manufacturer, some bottlers were paid fees to distribute products to fountain accounts. Coca-Cola serviced almost all of its international fountain accounts through bot- tlers.20 Pepsi had costs of $3.922 billion in 2009 and $4.049 billion in 2010 due to such transac- tions.21 Coca-Cola paid nearly $540 million to its largest bottler for marketing support in 2008.22

The State of the Bottling Industry: The Primary Customer for Concentrate Manufacturers
CSD bottlers purchase concentrate from the manufacturers, add sweetener and carbon diox- ide, and then package the mixture into bottles or cans. Raw materials for bottlers include con- centrate, sweetener, PET resin (to make plastic bottles), aluminum and steel for cans, packag- ing, labels, cartons, cases, and carbon dioxide.
Because the cost of transporting beverages is relatively high compared to the product value, Coke and Pepsi placed bottling plants in various locations throughout the markets they served.23 Such placement of bottlers gave both Coca-Cola and Pepsi the ability to market to a very broad audience, while maintaining a localized approach. Bottlers were responsible for local marketing and customer interactions. Bottler salespeople secured shelf space, positioned trademarks, and set up displays at the ends of supermarket aisles. The bottler was also respon- sible for developing the shelf-space agreements with small retailers.
Bottling plants are far more capital-intensive than concentrate-manufacturing plants. A concentrate plant with the capacity to serve the entire United States would cost somewhere between $50 million and $100 million. A typical bottling plant could cost hundreds of millions; a single bottling line costs between $4 million and $10 million to build.24 In 2008, the Dr. Pepper Snapple Group, a competitor of both Coca-Cola and Pepsi, opened a plant with a capacity of 40 million cases per year, enough to service California and some Southwestern markets, at a cost

of $120 million.25 For every dollar that a bottler spends on labor, roughly 30 cents is spent on capital. Although Coca-Cola and Pepsi’s largest bottlers took in considerable revenue, margins were significantly lower than they were for concentrate manufacturers. (See Exhibits 5A, 5B, and 6.) Given that the CSD market was relatively mature, bottlers sought cost advantages, and bottler capital intensity was thus expected to increase for the foreseeable future.26

EXHIBIT 5A Financial Data for Coca-Cola and Pepsi’s Largest Bottlers Prior to and After Mergers
Coca-Cola Bottling Co. Consolidated, All Values in USD (millions)
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Revenue $1,436 $1,464 $1,443 $1,515 $1,561 $1,614 $1,641 $1,746 $2,306 $3,156
Cost of Goods Sold (Cost of Revenue) $815 $848 $823 $874 $932 $960 $983 $1,041 $1,405 $1,941
Gross Profit $621 $615 $620 $641 $629 $654 $659 $705 $901 $1,216
Operating Expenses
SG&A $539 $487 $525 $544 $542 $566 $585 $619 $803 $1,088
Other $0 $68 — — — — — — — —
Total Operating Expenses $539 $556 $525 $544 $542 $566 $585 $619 $803 $1,088
Operating Income $82 $59 $95 $96 $88 $89 $74 $86 $98 $128
Interest Expense $48 $40 — — — — — — —
Other Expense −$2 −$2 −$37 −$35 −$36 −$35 −$29 −$30 $1 −$35
Taxes $12 $8 $17 $22 $29 $22 $12 $29 $34 $36
Other — — −$2 −$3 −$3 −$4 −$4 −$5 −$6 −$7
Net Income $20 $9 $38 $36 $29 $27 $28 $31 $59 $50
Source: Coca-Cola Bottling Co. consolidated annual statements.

Pepsi Bottling Group, All Values in USD (millions)
2007 2008 2009
Revenue $13,600 $13,800 $13,200
Cost of Goods Sold (Cost of Revenue) $6,700 $7,590 $6,740
Gross Profit $6,890 $6,210 $6,480
Operating Expenses
SG&A $5,150 $5,150 $4,790
R&D
Depreciation $669 $673 $637
Other $0 $412 $0
Total Operating Expenses $5,820 $6,230 $5,430
Operating Income $1,070 −$24 $1,050
Interest Expense $274 $289 $303
Minority Interest $94 $60 $94
Taxes $177 $112 $43
Net Income $532 $162 $612
PepsiCo. bought Pepsi Bottling Group in late 2009. From 2010 the Income Statements are merged for the PepsiCo. and the Pepsi Bottling Group.
Source: Pepsi Bottling Group, Annual Statements.

EXHIBIT 5B Common Costs for Concentrate Manufacturers and Bottlers (2009)
Concentrate Manufacturer

Dollars Per Case % of Net Sales Bottler
Dollars Per Case % of Net Sales
Net Sales $0.98 100% $4.63 100%
Cost of Goods Sold $0.22 22% $2.67 58%
Gross Profit $0.76 78% $1.97 42%
Direct Marketing Expense $0.21 21% $0.45 10%
Selling & Delivery Expense $0.00 0% $0.85 18%
General & Admin Expense $0.24 25% $0.31 6%
Operating Income $0.30 32% $0.36 8%
Source: D. Yoffie and R. Kim, “Cola Wars Continue: Coke and Pepsi in 2010,” Harvard Business School Case 9-711-462 (May 26, 2011).

For the majority of Coca-Cola and Pepsi’s histories, independently owned, franchised bot- tlers were the companies’ primary source of distribution and sales. The number of independent bottlers had been significantly diminished by 2016, but they were still an important business partner for the concentrate manufacturers. The bottlers acted as independent contractors and were given exclusive contracts (lifetime contracts for the early bottlers) to sell certain products within an exclusive geographic area. Coca-Cola and Pepsi then protected their bottlers’ terri- tories from other franchised bottlers’ sales.27
Both Coca-Cola and Pepsi used contracts to regulate their relationships with bottlers. Pepsi’s contracts stipulated that it had the right to charge bottlers for its concentrate product and to specify the bottling process. Pepsi’s bottler agreements also detailed the funding and incentives it would provide to its bottlers. Funding and incentives were renegotiated annu- ally.28 Historically, Coca-Cola’s first franchise agreement, drafted in 1899, was a fixed-price contract that allowed bottlers no opportunity to renegotiate, even if the prices of materials were to change. By 2016, there had been many updates since the 1899 agreement. At times, the updates were completed only after significant disagreement, even legal action, between the bottlers and Coca-Cola. Coca-Cola’s current master bottler contract was drafted in 1987. It grants the bottlers permission to prepare specific trademarked beverages. In return, it gives Coca-Cola complete flexibility to determine the price and other sales terms for the products sold to its bottlers.29 In practice, the prices that Coca-Cola and Pepsi charged their bottlers for concentrate were roughly similar.
Prior to 2000, Coca-Cola and Pepsi had both gone through decades of rapid bottler consol- idation, but that pace slowed to roughly one consolidation per year in the years 2000–2010. By 2010, Coca-Cola had reduced its number of independent bottlers in the United States to about 70 and its worldwide total to around 300.30 Roughly half of Coke’s US bottlers had been in business for more than 100 years, and about 25 percent of those long-term bottlers had been under the same family ownership the entire time.31 Pepsi had reduced its numbers to roughly 90 inde- pendent bottlers in the United States by 2010.32
Originally, both Coca-Cola and Pepsi stayed out of the business of bottling because of the low profit margins, but both companies made drastic adjustments to that strategy by purchasing their largest bottlers. Coca-Cola purchased Coca-Cola Enterprises in 2010 for $13 billion.33 Prior to the purchase, CCE was responsible for roughly 75 percent of US volume and essentially all of Canadian volume from Coca-Cola’s bottlers.34 After its purchase of CCE, Coca-Cola controlled more than 90 percent of its own sales and distribution.35 PepsiCo purchased PepsiAmericas and Pepsi Bottling Group in 2009 for a total of $7.8 billion. After the purchase, Pepsi was in control of 80 percent of its domestic bottling and distribution.36
The two soft drink companies made the decisions to dramatically consolidate as they did for a variety of reasons. Coca-Cola hoped to increase the strength of its brand by consolidating

its disparate global brand portfolio under one cohesive image.37 The move also allowed Coca-Cola more flexibility to manage niche brands and billion-dollar brands at the same time.38 Coca-Cola expected that its purchase of CCE would save it $350 million annually by 2014.39 Pepsi, recognizing that customer tastes were changing quickly, and the relatively low costs for them to switch products, purchased PepsiAmericas and Pepsi Bottling Group to be more nimble and able to shift as tastes changed.40 Pepsi also hoped to defend better against the small CSD manufacturers that had successfully established operations in niche markets all across the United States.41
The moves to forward-integrate into bottling also offered Coca-Cola and Pepsi some pro- tection against the shifts in the size of retailers. Retailers got significantly larger during the 1970s and 1980s, as chains began to consolidate and companies such as Walmart and Target grew. In 2010, supermarkets made up 48 percent of the CSD market.42 By 2016 that number had dropped to 42 percent but was still high enough to cause problems for Coca-Cola and Pepsi.43 Pepsi stated in its 2010 annual report that “retail consolidation and the current economic envi- ronment continue to increase the importance of major customers.” Pepsi’s sales to Walmart in 2010 represented 12 percent of Pepsi’s global net revenues. In the same year, 31 percent of Pepsi’s North American net revenue came from its top five retail customers.44 Increasingly, one retailer was controlling the sale of multiple brands of products, and some big-box retailers, such as Walmart, were making demands, such as requiring companies to establish a single point of contact with them. In the past as many as one dozen bottlers had been responsible for the sales to one retailer.45 Coca-Cola and Pepsi’s goals included bringing some of that control back into their own hands.
By the early 2000s, doubts had risen as to whether bottlers would be able to meet the demands of the current market. The market was moving toward demand for noncarbonated beverages, which most small bottlers weren’t set up to produce.
Thus, bottlers were tasked with figuring out how to either sustain themselves in the face of the diminishing demand for CSDs or to manage the significant costs to retool their operations. Tom Pirko, president of Bevmark, in California, predicted that bottlers were “going to have to respond, but I don’t think they can. They have a tremendous challenge, and I don’t think they can meet it.”46

The Changing Structure of the CSD Industry: How Will It Affect Coke and Pepsi?
The strong rivalry between Coca-Cola and Pepsi throughout the twentieth century became known as the cola wars. For decades, both sides made significant efforts to take more of the CSD market. In 1976, Pepsi created its highly successful “Pepsi Challenge” advertising cam- paign, which pitted Pepsi Cola against Coca-Cola in a taste test and featured customers pro- claiming Pepsi as their preferred choice.47 In 1985, Coca-Cola made the move to reformulate its classic cola, introducing New Coke. Following one of the largest consumer backlashes in history, Coca-Cola brought back the original Coca-Cola flavor, now called Coca-Cola Classic, less than three months later.48
These two rivals were responsible for some of the most memorable marketing campaigns in history. Pepsi created its “Choice of the New Generation” campaign in 1984, featuring a multitude of celebrities such as Michael Jackson and Joe Montana.49 Coca-Cola’s critically acclaimed 1979 “Mean Joe Green” advertisement was ranked as late as 2011 as the best Super Bowl commercial of all time in a poll by Ad Age.50
Although the average profit of the CSD industry as a whole was expected to drop from 20.2 percent in 2006 to 14.9 percent in 2011, Coca-Cola and Pepsi maintained their profit margins, due in large part to intense advertising.51 Indeed Coca-Cola only dropped to 18 percent in 2011

EXHIBIT 6 CSD Brand Advertising Expenditures Worldwide ($ in millions)
2008 2009 2010 2011 2012 2013 2014 2015 2016
Coca-Cola Co. $2,450 $2,340 $2,900 $3,260 $3,342 $3,266 $3,499 $3,980 $4,000
PepsiCo. $1,700 $1,700 $1,900 $2,400 $2,200 $2,400 $2,300 $2,410 $2,530
Dr. Pepper, Snapple Group $356 $409 $445 $460 $481 $486 $473 $473
Source for 2008 & 2009: B. Johnson and M. Carmichael, “100 Leading National Advertisers,” Advertising Age
(June 21, 2010).
Source for 2008-2011 PepsiCo: PepsiCo. Annual Report, 2010, p. 80.
Source for 2010 Coca-Cola: Anonymous, “How Much Money Does Coca-Cola Spend on Advertising?,” Reference.com, accessed March 22, 2017.
Source for 2016 Coca-Cola: T. Wadlow, “Top 20 Companies with the Biggest Advertising Budget,” Europe Business Review
(May 19, 2006), accessed March 22, 2017.
Source for PepsiCo. 2012, 2014–2016: PepsiCo. 2016 Annual Report, p. 3, 87.
Source for Dr. Pepper, Snapple Group 2012–2014: Olson, E. G. “Dr. Pepper: A Scrappy Survivor in a Sea of Struggling Soda Giants,” Fortune (April 23, 2015), accessed March 22, 2017.
Source for Dr. Pepper Snapple Group 2012, 2014–2016: Dr. Pepper Snapple Group 2015 Annual Report, p. 62. Source for Dr. Pepper Snapple Group 2009–2011: Dr. Pepper Snapple Group 2011 Annual Report, p. 62.
Source for Dr. Pepper Snapple Group 2008: Dr. Pepper Snapple Group 2008 Annual Report, p. 63.

and declined to 16 percent in 2016. Still, the long slow decline created great difficulties for both the concentrate manufacturers and their bottlers. In order to combat the decline in sales, Pepsi spent $29.1 billion on sales incentives to its customers, up from $12.9 billion in 2009. Pepsi’s advertising and marketing expense was $1.7 billion in 2009 and rose to $2.53 billion by 2016, a 67 percent increase.52 Coca-Cola spent $2.34 billion in 2009 and increased its advertising to
$4 billion by 2016, a 59 percent increase, all in an effort to staunch the bleeding and maintain the level of sales they had been accustomed to.53 Much of the money was going into changing the way the companies delivered their marketing content.54 (See Exhibit 6 for company brand advertising expenses.)
The decline in profits was mostly due to the US market. As a consequence, most CSD manufacturers were increasingly invested in overseas markets. Mexico, for example, had the highest per-person consumption rate of Coca-Cola products in the world (the United States was ranked fourth). Coca-Cola and Pepsi each earned about 25 percent of their revenue from international operations in 2010. With 80 percent of its unit case volume from sales outside the United States, Coca-Cola sold a much higher percentage of its products internationally. In 2010, 31 percent of Coca-Cola’s unit case volume came from Mexico, China, Brazil, and Japan (78 percent was CSD).55 Both companies also were growing in Russia. In 2010, Coca-Cola also saw enormous success with 26 percent growth in sales there.56 The same year, Pepsi made its largest- ever acquisition of an international company in a $3.8 billion purchase of a dairy in Russia.57 While diversification lowered the risk of decline in any single market for both companies, it did pose problems in 2014 and 2015 as the dollar strengthened worldwide against most currencies, causing cola products shipped from the United States to be more expensive.
International growth came with additional problems. In 2014 Coca-Cola was forced to close a 15-year-old bottling plant in northern India over accusations that it was illegally using too much groundwater and polluting the area with toxic runoff. Most of the local inhabitants were farmers, and the problem of decreasing groundwater was so severe that at one point in 2006 local farmers engaged in a three-month hunger strike in an attempt to force the closure of the plant. The provincial government finally ordered the plant closed. “As part of the withdrawal of consent, we were not allowed or even asked to present any facts or explain our position,” the company said in a statement.58 Coca-Cola had 58 other plants in India and faced the same problem in other locations. The problem of water use could raise its head as well in the United States for both Coca-Cola and Pepsi in the future as groundwater levels in various regions are being used up at alarming rates.59

Even with international growth, however, carbonated soft drinks were representing a smaller and smaller portion of the product mix for Coca-Cola and Pepsi. By 2016, both Pepsi and Coca-Cola had expanded to extensive juice lines and were continuing to move toward non- CSD drinks. Coca-Cola’s most recent billion-dollar brand was not a new CSD but instead the juice drink Minute Maid Pulpy.60
Pepsi also made the move into new products, and it even moved beyond beverages. By 2010, it sold almost as many snacks as it did drinks (49 percent snacks and 51 percent drinks). Pepsi believed that consumers would usually reach out for a snack when they reached for a drink. Pepsi hoped to take advantage of that consumption relationship by marketing snacks and drinks together. Pepsi also expected its wider range of products to be valuable to retailers and hoped that offering a wider range of products would better keep consumers within its brand portfolio as they inevitably switched preferences.
CSDs had faced significant pressure as consumer interest in healthier drinks had led to a number of new companies entering the beverage market. While the CSD market was contract- ing, the overall beverage market was expanding by about 0.7 percent per year. On top of that, many state governments were seeking restrictions on the sale of CSDs to children at school.61 This was no small problem for carbonated soft drinks. People throughout the United States were turning to healthier options. And many were wondering if sugary soft drinks were part of the problem, particularly with children (see Exhibit 7).62

20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
1972

1976 1980 1984 1988 1992 1996 2000 2004 2008

EXHIBIT 7 Growth in Childhood Obesity, 1971 to Present

Pepsi’s response was to make limiting such distribution and the production of healthier foods part of its core values. (See Exhibits 2A and 2B for beverage sales trends.) Pepsi had broken its portfolio of products up into “Fun-For-You,” “Better-For-You,” and “Good-For-You” categories. In 2010, more than 15 percent of its revenues came from nutrition products,63 and Pepsi hoped to expand and take a large share of the $500 billion packaged-nutrition market by moving its product mix further toward “Good-For-You” foods.64
In contrast, Coca-Cola’s CEO, Muhtar Kent, admitted in 2009 that the company had “missed the boat” a bit by not recognizing earlier the changes that were happening in the market. Kent stated, “There was a period when our company did lose its way. We were too internally focused and not focused enough on the changes taking place with our consumers and customers. In essence, we were too busy looking at the dashboard and not sufficiently paying attention to the world outside our windshield.” In response, Coca-Cola developed its 2020 Vision Plan, which stated that, by the year 2020, Coca-Cola would increase total revenues to $200 billion, increase the number of servings of its products consumed every day to 3 billion, and, specifically, get away from the cola war to focus on the changing consumer.65 The year over year decline in all carbonated soft drinks, not just Coca-Cola’s, made this vision nearly impossible. By 2016 Coca- Cola earned revenues of $41.9 billion, a long, long way from the goal of $200 billion.

In fact, Coca-Cola and Pepsi both stated that they no longer found the rivalry between the two companies relevant to their strategic goals. The difference in directions was emphasized by Pepsi’s unique take on its own goals for the year 2020. Rather than focus on revenues and market growth, Pepsi wanted to triple its portfolio of offerings, increase healthy food revenues from $10 billion to $30 billion, reduce the average sugar content per serving by 25 percent, and reduce the average saturated fat per serving by 15 percent.66 Regarding the state of the cola wars in 2010, Hugh Johnston, CFO of PepsiCo, said, “When it comes to the everyday lineup of bev- erage portfolios—sure—it’s good fun, and I think consumers find it interesting. And if they find it interesting, we find it interesting. But if you think about where we are as a company—half of our business is in snacks and foods—outside the beverage space.”67 Of course, when core markets shrink rivalry tends to increase as firms fight over ever smaller pieces of the pie. In 2016 Pepsi reignited the Cola Wars by bringing back its famous “Pepsi Challenge” advertising strategy.
Although Coca-Cola and Pepsi were changing their sales mixes and the dynamics of the com- petition between them, it wasn’t likely that the two companies would soon forget about each other, or that CSDs would be made irrelevant any time soon. Pepsi still noted in its annual reports that Coca-Cola “has a larger share of CSD consumption.” Furthermore, Pepsi Cola was still more than twice the size of Pepsi’s next-largest brand, which was also a CSD, Mountain Dew.68 Coca-Cola may have been expanding its product line away from CSDs, but the sparkling beverages still made up 76 percent of its portfolio. In 2011, Diet Coke had passed Pepsi Cola as America’s number-two most popular CSD (second to Coca-Cola), and it remains in second place at present.69
Coca-Cola and Pepsi Cola have defined the CSD market for over a century. Although they were no longer the fastest growing beverages on the market in 2016, they still held dominant positions, both domestically and internationally. The question is, then, given all the changes in substitutes, new entrants, retailer buyer power, and bottler consolidation, what will the long-term effect be on profit margins in the CSD industry, and how will Coca-Cola and Pepsi respond?
One parting thought: In all the upheaval and the decline in revenue and profits, Coke’s stock is up 37 percent over the last five years. Pepsi’s is up 55 percent, even beating the market average during what has been a period of high market growth. So, what is going on? And which tells the correct the story—the stock market or the income statements?70

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