Tax Foundation



Market Analysis of the Carbonated Soft Drink Industry

Vaclav Vlcek

ECO 401

12/02/2009

The carbonated soft drink industry is the biggest beverage industry in the United States. According to Beverage Digest, an authoritative publication covering the beverage business, the total volume of sales in 2008 exceeded 9.6 billion 192-oz cases worth approximately $72 billion. Per capita consumption of carbonated soft drinks (“CSD”) reached 760 eight-ounce servings which accounted to about 30% of total liquid consumption in the United States.[1]

The carbonated beverage industry is highly concentrated and profitable. Today, about 90% of the CSD market is controlled by only three companies - Coca-Cola, PepsiCo and Dr Pepper-Snapple. In 2008, Coca-Cola Company was the biggest out of “the big three” with market share of 42.7%.[2] Despite the ongoing economic crisis, Coca-Cola Company was able to attain net income of almost $6 billion during the same year.[3]

The high concentration and high profits in the CSD industry has raised some concerns about the level of competition within the market. In last three decades, the Federal Trade Commission has conducted several investigations on horizontal and vertical acquisitions in the industry, and the Department of Justice has brought several price-fixing cases against some CSD companies.[4]

In order to fully understand the current situation and be able to predict likely future path of the carbonated soft drink industry, it is necessary to explain the historical background of the product and the level of competition within its market. Carbonated soft drink can be defined as flavored syrup combined with carbonated water. All non-alcoholic, non-carbonated and non-diary beverages manufactured by combination of these two ingredients are considered as a carbonated soft drink and consequently belong to CSD market.[5]

According to Harold Saltzman, the early history of the CSD industry can be examined by focusing on history of the most successful and innovative soft drink firm ever – the Coca-Cola Company.[6] In 1886, John Pemberton, an Atlanta pharmacist, created a new beverage by combining originally flavored syrup and carbonated water. The beverage was initially advertised as a medicinal drink and was sold in Jacobs’ Pharmacy for five cents a glass. In late 1880’s, Asa Griggs Candler, a local businessman, purchased the Coca-Cola brand for $2,300 and became the first president of the newly created company. In next ten years, Candler, a gifted salesman, transformed the new soft drink from “an invention into a business” by promoting Coca-Cola as a refreshing beverage rather than a medicinal drink. This transformation proved to be a crucial moment not only for the Coca-Cola Company, but also for the carbonated soft drink industry as a whole.[7]

During the 19th century, there were many companies selling many various flavored carbonated drinks. Majority of them were advertised as medicinal tonics and were sold from soda fountains in local stores and pharmacies. According to Greer, there were more than one hundred independently owned CSD brands during that period of time.[8] This indicates that the level of concentration in the CSD market was low and competition high.

But that significantly changed after Asa Candler transformed the Coca-Cola Company. After the Atlanta businessman engaged in an innovative advertising campaign and allowed his unique drink to become more portable, the Coca-Cola Company became the largest soft drink firm in the United States. Right after the purchase of the brand and creation of the company in late 1880’s, Candler engaged in an aggressive advertising campaign to attract new customers. To promote the new drink and gain reputation for the company, he hired celebrity spokepersons, “gave away coupons for complimentary first tastes of Coca-Cola, and outfitted distributing pharmacists with clocks, urns, calendars and apothecary scales bearing the Coca-Cola brand.”[9] He also brought several trademark infringement suits against other cola makers and introduced a new patented swirl bottle to distinguish Coca-Cola from its competitors.[10]

In addition, Candler was convinced by Benjamin Thomas and Joseph Whitehead “to grant them the exclusive right, in perpetuity, to bottle and sell Coca-Cola throughout most of the United States.”[11] The two Chattanooga lawyers than expanded Coca-Cola’s business geographically by dividing the United States into territories and granting exclusive licenses to independent local bottling companies.[12]

The granting of perpetual exclusive territories to bottlers combined with effective advertising campaign proved to be a very successful strategy. The company grew rapidly and significantly increased its CSD market share. By 1920, Coca-Cola was bottled in more than 1,000 plants and the soft drink was even sold outside the United States in countries such as Canada, Panama, Cuba and France.[13] The growth of the Coca-Cola brand resulted in the company’s dominant position in the carbonated soft drink industry. In 1940, Coca-Cola accounted for about half of CSD sales.[14]

Coca-Cola’s success and strategy inspired many other companies involved in the CSD industry. New companies like PepsiCo, Royal Crown and Seven-Up “were founded after Coca-Cola, and became its main competitors.”[15] During the first half of the 20th century, the three companies began to challenge Coca-Cola’s dominant position by engaging in vigorous advertising and following Coca-Cola’s model of distribution. By 1960, the Coca-Cola Company, PepsiCo, Royal Crown and Seven-Up accounted for about 75% of total CSD sales, with Coca-Cola holding about 37% of the market. In 1962, Dr Pepper, a regional brand established before Coca-Cola, entered the national market and became the fifth largest CSD company. In 1980, these companies controlled approximately 80% of the CSD market.[16]

According to Saltzman, the level of competition within the CSD industry has been affected by the system of distribution and relatively small number of competitors. During the 1970’s, the Federal Trade Commission (“FTC”) issued several opinions that concluded that exclusive CSD bottling territories have anti-competitive character and violate antitrust law. For example, the Federal Trade Commission order from 1978 concluded that CSD bottling territories “were unreasonable restraints of trade because they lessened both intrabrand and interbrand competition”[17] and ordered the Coca-Cola Company and its bottlers “to cease imposing in any manner territorial limitations or class of customer restrictions on its licensed Coca-Cola or allied product bottlers, in connection with the sale or distribution of soft drink products sold in other than refillable containers.”[18]

The FTC challenge to the unique supply system allowing bottlers of different CSD companies to be exclusive distributors and have full control over certain territories was brought down by Congress. In 1980, Congress passed the Soft Drink Interbrand Competition Act which declared that “exclusive territorial arrangements made as a part of a licensing agreement for the manufacture, distribution, or sale of a trademarked soft drink product are lawful under the antitrust laws provided such product is in substantial and effective competition with other products for the same general class in the relevant market or markets.”[19] According to Saltzman, officials from both the Federal Trade Commission and the Department of Justice opposed the act and described it as a “special exemption” to the antitrust laws. For example, William S. Comanor, former Director of the FTC’s Bureau of Economics testified “that intrabrand CSD competition should not be restricted by exclusive bottling territories because there was considerable monopoly power among interbrand competitors in the CSD industry.”[20]

After the controversial exclusive territory licensing was upheld by Congress, the FTC began to focus on other contentious issues within the industry. During the 1980’s and 1990’s, the CSD industry went through a major structural change that led to several investigations by the regulatory agencies. In particular, the FTC focused on the issues of vertical and horizontal integration.[21]

The vertical integration became an issue after many independent bottlers holding exclusive rights to bottle the major CSD brands were acquired by their franchisors during the 1980’s and 1990’s. The number of independent bottlers fell by more than one-half during that period of time which caught the attention of the FTC. The regulatory agency engaged in investigation of Coca-Cola and PepsiCo vertical bottler consolidations and found “such manufacturer/distributor acquisitions as pro-competitive or competitively neutral.”[22] Similarly, Harold Saltzman, Roy Levy and John C. Hilke found that the vertical acquisitions by the Coca-Cola Company and PepsiCo did not lower the level of competition within the market but instead resulted in lowering of CSD prices by 4.3%. [23]

During the same period of time, the FTC also engaged in investigation of horizontal merger cases. According to Saltzman, the regulatory agency “treated various CSD parent company consolidations differently, depending on the circumstances that were involved.” For example, in 1986, the FTC challenged proposed mergers between PepsiCo and Seven-Up, and Coca-Cola and Dr Pepper. The FTC concluded that such mergers would decrease the level of competition and engaged in actions that ultimately led to the failure of both consolidations. In contrast, the regulatory agency did not challenge the merger between Seven-Up and Dr Pepper which resulted in formation of a new company called DPSU in late 1986. Similarly, the FTC did not oppose the merger between Cadbury, the owner of brands such as Canada Dry, Sunkist and A&W, and DPSU in 1995. The agency also allowed Coca-Cola’s acquisition of Barq’s, one of the biggest root beer syrup producers.[24]

In summary, it appears that the Federal Trade Commission allowed the major CSD companies to acquire smaller syrup producers and expand their vertical integration into CSD bottling. In contrast, the agency opposed mergers between syrup producers controlling major share of the CSD market. Consequently, the CSD industry has become more concentrated which has led to lowering of the competition level in recent years.

During the same period of time, the Department of Justice brought dozens of cases against price-fixing practices within the industry. According to Saltzman, the Department of Justice “had obtained more than forty bottler and individual guilty pleas (or convictions) in ten states (Florida, Georgia, North Carolina, Ohio, Maryland, South Carolina, Tennessee, Virginia, West Virginia, and Washington) and Washington, D.C.” The defendants, consisting mostly of Coca-Cola and Pepsi bottlers, generally pleaded guilty to “meeting and discussing promotional CSD prices, agreeing to set those prices, and monitoring and enforcing their agreements.” For example, bottlers of Coca-Cola and Pepsi supplying the Baltimore area colluded for more than three years between 1982 and 1985.[25] Considering the number of price-fixing cases and the fact that the majority of information about price-fixing practices is not publicly available, it appears that collusion among bottlers was frequently practiced during the last two decades of the twentieth century.

Recent history of the CSD market suggests that the level of competition has been gradually decreasing since early 1980’s. As mentioned on the beginning of this paper, the current level of competition is very low. The three largest firms, the Coca-Cola Company, PepsiCo and Dr Pepper-Snapple control 88.8% of the CSD market. Coca-Cola remains the dominant company with market share of 42.7%. PepsiCo and Dr Pepper-Snapple follow with 30.8% and 15.3% respectively. The remainder of the market is covered by Cott Corp., National Beverage, Red Bull and many other small companies.[26] Appendix A provides additional detail on the market share of the top ten companies. In addition, the 2008 Herfindahl-Hirschmann Index for the industry was 3039 which indicates very high concentration and low level of competition.[27]

All of companies try to attract more customers by differentiating their products through advertisement and product innovation. The CSD companies use advertisement to build brand loyalty among current and prospective customers. For example, Coca-Cola “stresses the use of advertising to build up a long-term brand image for its products and company. The company also uses integrated marketing communication strategy to portray the brand and keep the brand fresh in the minds of current consumers.”[28] In 2006, the Coca-Cola Company spent approximately $2.6 billion worldwide on advertising of its products.[29] Coca-Cola’s long term investment in brand recognition made the company the most recognized and most valuable brand in the world.[30]

The largest CSD companies have also engaged in product innovation to attract new customers. In last three decades, the producers have introduced many new products that vary in flavor, color or formula. Diet Coke, Mt. Dew and Diet Pepsi are the three most successful new products introduced by the Coca-Cola Company and PepsiCo. Appendix B provides additional detail on the CSD market share of the top ten brands.

It appears that there are no ongoing issues concerning the level of competition in the carbonated soft drink industry. After the series of vertical and horizontal merger attempts during 1980’s and 1990’s, the situation within the market seems to be stabilized. The only current issue I came across while conducting research for this paper is the proposal of the so-called “soda tax.”

In recent years, a debate over the impact of high-calorie soft drinks on health has been on the rise. Some argue that soft drinks, especially the carbonated soft drinks, have a harmful impact on overall health and significantly contribute to obesity and tooth decay, especially in children. Some economists and nutrition experts advocate levying higher taxes on the sale of soft drinks to help finance the fight against obesity and health care reform. In May, 2009, some Senate leaders considered to add a soda tax into the current health care reform bill. The main purpose of the tax would be to generate revenue and discourage people from consuming high-sugar soft drinks.[31] But the soda tax was rejected several months ago and is not included in the health care reform bill currently pending in the Congress. According to Kenneth Thorpe, a health policy researcher at Emory University, “the politics of health reform are too delicate right now to provoke an attack from the sugar and beverage industries.”[32]

Considering the current situation within the CSD market, it appears very unlikely that the level of competition is going to change anytime soon. There are no signs that the Federal Trade Commission and the Department of Justice want to change the current situation and increase the level of competition through regulation. At the same time, the possibility of a new company joining the market and challenging the three largest firms seems highly unlikely. The dominant position of Coca-Cola, PepsiCo and Dr Pepper-Snapple is largely based on brand recognition which would be very expensive and hard to achieve in a short period of time. In addition, economies of scale play an important role in the CSD market. The producers have been able to decrease their average costs throughout the time and benefit from increase in economies of scale.[33]

In my opinion, the current level of regulation of competition is not satisfactory. Only three companies control overwhelming majority of the CSD market which makes it hard for new competition to emerge. In addition, considering the anti-competitive behavior in past decades, I believe that the existing companies will engage in collusion and try to prevent new companies to enter the market once again. Consequently, the regulatory agencies of the federal government should focus on behavior of CSD companies and try to prevent them from engaging in anti-competitive behavior.

Appendix A

2008 Market Share of Top 10 CSD Companies

|Rank |Companies |Market Share |Cases Sold (millions) |

|1 |Coca-Cola Co. |42.7 |4107.6 |

|2 |PepsiCo |30.8 |2960.4 |

|3 |Dr Pepper Snapple |15.3 |1471.2 |

|4 |Cott Corp. |4.7 |448.0 |

|5 |National Beverage |2.6 |247.5 |

|6 |Hansen Natural |0.8 |79.0 |

|7 |Red Bull |0.7 |67.2 |

|8 |Big Red |0.4 |43.6 |

|9 |Rockstar |0.4 |40.2 |

|10 |Private label and other |1.6 |156.3 |

Source: Beverage Digest 54, no. 7, (accessed November 28, 2009).

Appendix B

2008 Market Share of Top 10 Brands

|Rank |Brands |Market Share |Cases Sold (millions) |

|1 |Coke (Coke) |17.3 |1664.6 |

|2 |Pepsi-Cola (Pepsi) |10.3 |990.9 |

|3 |Diet Coke (Coke) |10.0 |960.3 |

|4 |Mt Dew (Pepsi) |6.8 |653.0 |

|5 |Dr Pepper (DPS) |6.1 |586.1 |

|6 |Diet Pepsi (Pepsi) |5.7 |550.3 |

|7 |Sprite (Coke) |5.6 |536.7 |

|8 |Fanta (Coke) |1.8 |175.8 |

|9 |Diet Mt Dew (Pepsi) |1.8 |169.6 |

|10 |Diet Dr Pepper (DPS) |1.6 |157.6 |

Source: Beverage Digest 54, no. 7, (accessed November 28, 2009).

Bibliography

Fu-Ling Hu. “How Can Different Brand Strategies Lead to Retailers’ Success?” Journal of Global Business Issues, 3, no. 1 (Spring 2009), 129-135.

Pendergrast, Mark. For God, Country, and Coca-Cola: The Definitive History of the Great American Soft Drink and the Company That Makes It (New York: Basic Books).

Saltzman, Harold et al. Federal Trade Commission. Transformation and Continuity: The U.S. Carbonated Soft Drink Bottling Industry and Antitrust Policy Since 1980 (November 1999). (accessed November 28, 2009).

Sicher, John. “Top-10 CSD Results for 2008.” Beverage Digest 54, no. 7. (accessed November 28, 2009).

The Coca-Cola Company. (accessed November 28, 2009).

The Federal Trade Commission. In the Matter of Coca-Cola Co., 91 FTC 517 (1978). (JA NUARY_-_JUNE_1978)PAGES_504-679.pdf#page=14 (accessed November 28, 2009).

The Library of Congress. Soft Drink Interbrand Competition Act Summary. (accessed November 29, 2009).

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[1] John Sicher, “Top-10 CSD Results for 2008,” Beverage Digest 54, no. 7, 1-2, (accessed November 28, 2009).

[2] Ibid.

[3] The Coca-Cola Company, “Financial Overview 2008,” ourcompany/ar/financialoverview.html (accessed November 28, 2009).

[4] Harold Saltzman et al., Federal Trade Commission, Transformation and Continuity: The U.S. Carbonated Soft Drink Bottling Industry and Antitrust Policy Since 1980 (November 1999), 6, reports/softdrink/softdrink.pdf (accessed November 28, 2009).

[5] Ibid., 5.

[6] Ibid., 6.

[7] The Coca-Cola Company, “Heritage Timeline,” (accessed November 28, 2009)

[8] Greer cited in Saltzman, 7.

[9] The Coca-Cola Company, “Heritage Timeline.”

[10] Mark Pendergrast, For God, Country, and Coca-Cola: The Definitive History of the Great American Soft Drink and the Company That Makes It (New York: Basic Books), 62.

[11] Ibid., 7.

[12] Ibid.

[13] The Coca-Cola Company, “Heritage Timeline.”

[14] Saltzman, 8.

[15] Ibid.

[16] Ibid., 9.

[17] Ibid., 12.

[18] The Federal Trade Commission, In the Matter of Coca-Cola Co., 91 FTC 517 (1978), decisions/docs/vol91/FTC_VOLUME_DECISION_91_(JANUARY_-_JUNE_1978)PAGES_504-679.pdf#page=14 (accessed November 28, 2009).

[19] The Library of Congress, Soft Drink Interbrand Competition Act Summary, (accessed November 29, 2009).

[20] Saltzman, 13.

[21] Ibid., 12.

[22] Ibid., 13.

[23] Ibid., viii.

[24] Ibid., 13-15.

[25] Ibid., 20-22.

[26] Sicher, 2.

[27] HHI computed by using data published in Beverage Digest 54, no. 7, 1.

[28] Fu-Ling Hu, “How Can Different Brand Strategies Lead to Retailers’ Success?” Journal of Global Business Issues, 3, no. 1 (Spring 2009), 133.

[29] The Coca-Cola Company, “FAQs – Advertising,” /contactus/faq/advertising.html (accessed November 30, 2009).

[30] Emily Fredrix, “Coca-Cola Still Viewed as Most Valuable Brand,” USA Today Online, September 18, 2009, (accessed November 30, 2009).

[31] Janed Adamy, “Soda Tax Weighed to Pay for Health Care,” The Wall Street Journal Online, May 12, 2009, (accessed December 1, 2009).

[32] Kenneth Thorpe cited in “Experts: Penny Per Ounce Soda Tax to Fight Obesity, Health Costs,” USA Today Online, September 18, 2009, (accessed December 1, 2009).

[33] Saltzman, 10.

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