When considering the economics of both the concentrate business and the bottle business, its impossible not to compare these two business at a cost level. Taking a high level overview of the costs related to each business, the bottling business maintains extensively high fixed and variable costs and is capital intensive in comparison to the concentrate business. Bottling companies require a wide array of fixed costs ranging from land, a factory with high production capacity, high tech mechanical machinery, and skilled technicians to run the factory, trucks for distributions. Similarly, the variable costs are high, in comparison to the concentrate business for example large quantities of raw materials like tin, plastic, or glass and extensive amounts of water. As the costs related to the bottling business are high, relating to Porter’s Five Forces, the barriers for a competitor’s entry are low, protecting the market share of current established bottling companies.
In addition, as the barriers of competitor’s entry are high this allows for few customer switching as there is less competition in the market. Concentrate business, on the other hand, maintains fixed and variable costs relatively small. Concentrate is a blend of raw materials like sugar, flavoring, and carbonation.
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These raw materials are packaged into storage bags or canisters and provided to the bottling companies. The profitability of these businesses are different mainly from a cost perspective. In order for a company, like Coca Cola or Pepsi be profitable in the bottling business, they need to have large amounts of capital that they are able to invest in bottling factories and need produce massive amounts of product to cover these upfront costs. While concentrate businesses do not have nearly as much costs upfront and thus do not face the same pressures to sale massive quantities of product. When a bottling business is able to produce massive about of produce, like Pespi or Coca Cola, then the gains can far exceed the costs and the profitability in the bottling business can be extremely profitable.
Historically, Coke and Pepsi have been the two most profitable market leaders in the carbonated soft drink (CSD) industry, owning their concentrate business and starting in 2004 both auditioned large stakes in bottling businesses. Some muse that this action is a fundamental shift based on declining soda sales and the rapid emergence of non-carbonated drink, however it’s a fact that the non-carbonated drink is a niche market comprised of only a fraction of drink production giants, Coca Cola and Pepsi. The industry giants are not shifting their fundamental approach to the war on market share, but simply taking the practical steps to vertical integration. By investing billions of dollars to acquire bottling operations, they are looking to leverage economies of scale to become even more profitable. The non-carbonated drink rapid emergence could have played a small role in influencing Coke and Pepsi to consider alternative ways to become more profitable, however this move is more of a calculated business strategy to reduce costs long term than a change in their fundamental approach to business.