Comparative Analysis of Pepsi and Coca-Cola Company

COMPARATIVE ANALYSIS OF PEPSI AND COCA-COLA COMPANY

Comparative Analysis of Pepsi and Coca-Cola Company

Inthe beverages industry, there are two giants that exist in themarket, Coca-Cola and Pepsi. The two big companies have been incompetition for decades. From the year 2004-2008, Pepsi Companyachieved a slightly better rate of growth in net returns. Coca ColaCompany, however, has been able to maintain better profit marginswith a lower cost in sales. Both companies have well-establisheddistribution channels, brand names and a respectable consumerloyalty. The two products, Coke and Pepsi, are perfect substitutes.They dominate the market with a total market share of 73% with Cokeregistering a 43% and Pepsi 30%. They both exist in an oligopolistictype of market setting characterized by few large firms which are incompetition for the market dominance. The price elasticity of demandfor the two products is perfectly elastic although some factor maycause it to be fairly elastic. When Coke raises its price, most ofthe customers will switch to Pepsi. Therefore, both companiesexperience a cross elasticity of demand. Coca-Cola has outpaced itsrival considerably over the years. The major differences between thetwo companies arise from the differences in cost of production(Yoffie, 2008).

Inan oligopolistic setting, firms are mutually interdependent meaningthat the profits gained are not only dependent on the prices, butalso on the prices that relate to the marginal costs. Pepsi and Cokeconsider the reaction of each other whenever either wants to make amove. Oligopolies tend to have non-price competition as seen from theextensive advertising for their products that greatly affects thefinal price while improving sales.

TheCoca-Cola and Pepsi Company are actively involved in the creation ofbarriers to entry by other firms in the industry. This is because ofthe majority market share owned by Pepsi and Coke that is largeenough to control the industry. Coke has been dominant in the marketever since 1886 while Pepsi followed twelve years later. The advancedtechnology that they use in their operations greatly reduces the costof production. When a firm in an oligopoly setting increases theprice of its products, the competitors do not follow because theywill gain more buyers from their low prices. It is only after adecrease in price that will make the competitors follow suit to avoidlosing out.

Considerthe illustration below Above Po, there is an elastic market demandbecause consumers will switch to the rivals` brand. However, below Poit is inelastic since firms will lower their prices together anddemand is not affected. The price, as shown, is beyond the marginalcost which proves that the firms are allocative inefficient. Pepsiand Coke have the power to set their prices at very high levels forthem to maximize profits. In addition, when the price is higher thanthe marginal cost, the output is lower than the minimized averagetotal costs.

Fig.1.0

PepsiCompany (Average statistics of period 2004-2008 taken twice per year)

Notethat all figures are in USD (millions)

Fig,1.1

Q

FC($)

VC($)

AFC

AVC

ATC

MC

TC

0

5000

0

0

0

0

0

5000

6000

5000

5000

0.83

0.83

6

6

10000

7500

5000

807

0.66

0.12

0.78

0.8

5807

11200

5000

1354

0.45

0.12

0.58

0.2

6354

10976

5000

1966

0.46

0.18

0.63

0.6

6966

16500

5000

2643

0.35

0.16

0.46

0.5

7643

20000

5000

3427

0.25

0.17

0.46

0.4

8427

24580

5000

4308

0.21

0.18

0.38

0.4

9308

Fig.1.2

Coca-ColaCompany (Average statistics of period 2004-2008 taken twice per year)

Q

FC($)

VC($)

AFC

AVC

ATC

MC

TC ($)

0

4000

0

0

0

5

0

4000

8000

4000

4800

0.5

2.63

6

2

8800

9200

4000

5000

0.43

5.43

4

3

9000

1000

4000

1520

4

1.52

7

5

5520

1200

4000

2100

3.33

3.33

3.8

6.84

6100

18000

4000

3282

0.22

0.18

4

3.05

7282

22000

4000

3680

0.18

0.17

4

4

7680

ProductionCosts

Theinitial costs in Pepsi are classified into manufacturing andnon-manufacturing costs. The manufacturing cost is incurred duringthe process of production and involves the direct and indirect costs.The direct materials are the raw materials used in the production intheir required ratio while direct labor every input by the employeesin the various departments. The other major element of themanufacturing costs is the overheads such as electricity, gas,utility expenses, and repair and maintenance costs.

Non-manufacturingcosts are the costs that are not incurred in the process ofmanufacturing the product. Examples of these costs are the salariesand advertising expenses. The non-manufacturing costs are generallyclassified into marketing and administrative costs. The marketingcosts secure orders from the customers. These order-getting costscover the commissions and placement costs.

Pepsi,unlike Coke, owns its distribution and bottling companies. Thus, whenthe commodity prices increase, the bottling and distributioncompanies absorb the costs that affect the company`s cost ofproduction negatively.

Thereare two factors that reduce the production cost of Coca-Cola comparedto Pepsi. One, the ingredients used are not expensive and are easy tocome by. Moreover, they have managed to keep their recipe as a secretgiving them an edge in production. The company also produces in largescale thereby keeping the costs at a bare minimum. The unit costprice drops with an increase in production. The Coca-Cola companyoutsources bottling and distribution to other companies. It alsosells a concentrated version of the patented formula to the factoriesthat supply its needed raw materials which by doing so is able tocurb any unnecessary increase in commodity prices. However,additional expenses such as advertisement costs, shipping, taxationand storage affect the overall cost of production (Yoffie, 2008).

Fixedand Variable costs

PepsiCompany has a range of fixed costs. The fixed costs include mortgagesor property leases, buildings, vehicles, rent and utility bills likecommunications and disposal which contain fixed rates and insurance.By the year 2008, Pepsi Company`s plant, equipment and property madeabout 32% of its total assets. Total fixed costs are the costs that acompany has to pay regardless of whether it produces or not. Inaddition, the variable costs are liabilities that do increase ordecrease depending on the needs of the company. The total variablecosts are the costs that vary with the production quantities. Anexample of these in Pepsi Company would be sugar.

Thecost structure that shows the fixed costs is well-distributed inCoca-Cola Company. The fixed costs include lease payments, salariesto executive workers, machine insurance and property taxes of theirfactories. In the same period of 2004-2008, Coca-Cola operated on alower plant, property and equipment percentage, about 21% of all itsassets. The variable costs include raw materials like plastics andmetal for the cans, delivery fees, hourly wages and utilities (Louis,2009).

Marginaland Average Costs

Pepsiand Coca-Cola are strategically and mutually interdependent thatmeans that price or marginal cost decisions are influenced by actionsof the respective companies. The Lerner’s index which shows theexcess of price levels over marginal cost was used in 2010, and theresults showed that Coca-Cola sells at an average of 64% more thanits cost of production. Pepsi Company also sold 56% more than thecost of production.

Fig1.3

PROFITABILITYANALYSIS

PEPSI

Q

P

TR

MR

TC

MC

PROFIT (TR-TC)

0

4

5236

152

5000

0

236

6000

7

11157

98

10000

6

1157

7500

5

1435

379

5807

0.8

-4372

11200

4

2678

436

6354

0.2

-3676

10976

3

11337

263

6966

0.6

4371

16500

4

10872

550

7643

0.5

3229

20000

5

12335

113

8427

0.4

3908

24580

3

17243

151

9308

0.4

8115

Fig1.4

COCA-COLACOMPANY

Q

P

TR

MR

TC

MC

PROFIT

0

3

22358

202

4000

3

18358

8000

4

13456

367

8800

4

4656

9200

3

14561

438

9000

3

5561

1000

4

24237

125

5520

4

18717

1200

7

15663

499

6100

7

9563

18000

9

8549

336

7282

9

1267

22000

8

8443

261

7680

8

763

Summary

Itis evident that Coca-Cola has an upper hand in production gains overPepsi. The advantage can be attributed to the fact that it controls alarger market share and it acts as the leader while Pepsi Companyfollows. The profit margins of Coca-Cola Company outnumber Pepsi`s.For Coca-Cola to maintain its advantage, it should produce an averageof 1000 tonnes of its product and charge at a range of $ 5.8 to $6.2.

Toillustrate on profitability versus price and quantity, the priceearnings ratio from 2004-2008 were analyzed in a study that brokedown the market share of the beverage industry. The recorded revenueand cash flow data was as shown below from the results in thestatistics table:

Fig1.5

Revenueincreases with increase in sales from the year 2004-2008 from $20000in 2004 to above $45000 in 2011. Coca-Cola’s price earningsincreased in 2007 and decreased in 2008. The drop, as concluded inthe review, was attributed to the recession. Pepsi Company priceratio increased from 2006-2007 and fell slightly in 2008. The 2008economic recession impacted the beverages` prices for both companieswhere Pepsi`s prices fell by 28% despite its growth in revenues.

Thereview shows that the prices between 2004-2008 ranged from $3.8 to $7depending on the marketing strategies adopted by either company. Thefigure below illustrates clearly that as Coca-Cola Company’s salesincrease, the price also decreases up-to a certain point that it canno longer decrease. The marginal cost function is influenced by theefforts of the companies to differentiate their products and reducethe demand associated with cross-elasticities. Consider the graphbelow Coca-Cola Company has continuously reduced its prices from the$7 to $4 mark. The result will be an expansion in the demand in theshort run because it is cheaper than Pepsi. If Pepsi allows it tocharge the low prices, it will lose its consumers in the long-run(Deans, 2009).

MarginalCost changes due to increased Sales (Coca-Cola Company)

Themarginal cost curve is seen to be decreasing up-to $3.8 where itbegins to rise again.

Theincome statements of 2004 through to 2008 show Pepsi sales marginincreasing at a steady rate from 42% in 2004 to 47.01% in 2008. Themarginal costs also increased rapidly over that period. It is evidentthat both companies maximize profits by taking into consideration themarginal costs and never the average cost. Their long run and shortrun average costs rely on the quantity of commodities produced(Deans, 2009).

References

`Deans(2009). Stretch!:How great companies can grow in tough times.New York: John Wiley and Sons Ltd.

Louis(2009). Thecola wars.New York: Everest House.

Stoddard, B. (2010). Pepsi: 100 years. Los Angeles, Calif: General Pub. Group.

Yoffie, D. B. (2008). Cola wars continue: Coke vs. Pepsi in the twenty-first century. Boston: Harvard Business School.