Question: Why, historically, has the soft drink industry been so profitable?

Use Porters
Five Forces to analyze the soft drink industry based on the information in the case.
Soft drink industry had been profitable, historically, because of a favorable industry
structure. On one end, there was low supplier power and minimal threat from new
entrants. On the other, intermediate and end customers didnt have an upper edge
while the threat from substitutes remained low. Rivalry among existing customers
remained intense; however the basis of competition didnt erode profitability.
Supplier Power
Packaging suppliers had low power. First, metal-can industry was less concentrated
than concentrate manufacturing industry. Second, metal-can industry depended heavily
on CSD business for revenues - they were their biggest customers. Few additional
factors included, low switching costs between cans, glass, and plastic bottles
substitutes existed; metal-cans were essentially a commodity with little differentiation;
no threat of forward integration from packaging suppliers, but backward integration
was always an option for concentrate manufacturers.
Sweetener suppliers didnt create price pressures. Both coke and Pepsi switched to low
cost alternative high fructose corn syrup- and then developed their own stevia based
sweetener for some products.
Since cost for concentrate ingredients (caffeine, citric acids etc.) were relatively low,
none of the suppliers affected profitability significantly total cost of goods sold was
only 22% (Exhibit 4).
Threats from New Entrants
The biggest barriers to entry were huge investment required for marketing and
unequal access to distribution channels. A typical concentrate maker spent 21% of
revenues towards direct marketing expenses (Exhibit 4), amounting to $1.7Billion spent
by Coke in 2009 for North-America region alone (calculated -Exhibit 3a). Moreover,
legal agreements with bottlers limited sales of competing brands whereas contracts
with Retail outlets (Walmart etc.) maximized shelf space, blocking new entrants. Other
barriers to entry include demand side benefits of scale (bottlers preferred large volumes
to attain economies of scale), customer switching costs (retail industry valued direct
store door (DSD) arrangements minimizing distribution costs), capital requirements for
building inventories, and incumbency advantages such as established brand identity
and cumulative experience.
Moreover, any new entrant expected retaliation from incumbents which was not
only evident from existing rivalry, but also because each possessed significant
resources to fight threats.
Buyer Power
There were some retail segments - Supermarkets (Walmart etc.) and fountain outlets
(McDonalds etc.) with higher power than the rest, mainly because they purchased in
large volumes and could influence purchasing decisions of end customers. However,
these threats came late and concentrate manufacturers were successful in maintaining
profitability by focusing on customer value over price discounts. There was no threat of
backward integration from bottling industry, however concentrate manufacturers could
always forward integrate and they did. As for end customers, since the product was not
expensive relative to income, they were not very price sensitive.
Threat of Substitutes

Till mid-2000, there was no real threat of substitutes. Americans continued to enjoy soft
drinks over any other drinks available in the market. To counter any threats,
concentrate manufacturers maximized accessibility through several channels - big
account fountain outlets, shelf space contracts with retail outlets, vending machines.
Increased accessibility meant less alternative options for end customers. Secondly, they
also diversified their own product portfolio - bottled water, energy drinks etc. - to keep
shelves crowded with their own products. This strategy maintained profitability and
minimized threats from substitutes.
Rivalry among Competitors
There was intense competition among biggest players - Coke and Pepsi. Normally
intense competition leads to price wars, eroding profitability. However, the fact that
there were only two major players in the industry, offered enough room for both to earn
profits and maintain a healthy return on investments in a growing market. Moreover,
since the competitors stayed away from price wars and focused on providing customer
value through increased marketing spend, value added services like direct store door
DSD, and product innovations in the form of freestyle soda machines, they were able to
increase price each year. All this not only improved customer value, but also increased
product value relative to substitutes and new entrants.