THE COLA OLIGOPOLY

               In the carbonated soft drinks industry, when we narrow down to the cola market, there are two well-known giants existing in the market, which are Coca-Cola and Pepsi Cola. Coke and Pepsi are selling cola drinks with similar taste and color, therefore they are perfect substitutes. Both the companies have been competing strongly against each other for decades. The market is dominated by these two industry leaders with a total market share of 72%; Coke’s market share is 42% and Pepsi’s 30% (Russell, 2012). This is known as an oligopoly market, where there are few large firms competing with each other in the industry (McConnell et al., 2009). 

               Since Coke and Pepsi are perfect substitutes, the price elasticity of demand should be perfect elastic. However, there are some factors that results in a fairly elastic demand. When Coke increases its price, most of its customers that are highly sensitive to price changes will switch to Pepsi due to the similarity of the taste. Nevertheless, part of its customers that are highly loyal are willing to pay more for Coke because they placed Coke as their only preference. This can be proven in a blind test between Coke and Pepsi which Pepsi conducted to determine the preferences of cola drinkers. The results shows most of the participants preferred the taste of Pepsi but they still argued that Coke is their brand of choices (Tanner, 2012). This experiment has clearly shown that Coke has a strong brand loyalty and its customers tend to stay even though the price has increased. Therefore, the price elasticity of demand is just fairly elastic, when price increases, consumers will seek for substitutes and hence, the quantity demanded decreases, but not zero. In addition, both giants experience positive cross elasticity of demand, where customers of Coke tend to switch to Pepsi when price increases, and vice versa.

               In an oligopolistic industry, firms are mutual interdependence, where the profit gained is depending not only on the prices but on the other firms (McConnell et al., 2009). Coke and Pepsi have to consider the reaction of each other when one of them wants to make a move. For example, when Coke lowers its price, it will grab more customers from Pepsi and Pepsi lose profits, Coke has to think about Pepsi’s reaction against the price decrease. According to the corporate news in Business Daily, Coke is going to lower its price to battle with Pepsi and defend its market share. The price cut has resulted in a reaction for Pepsi. Pepsi is currently offering a 350ml bottle at a same price with Coke 300ml (Otuki, 2013). When Coke reduces its price, Pepsi tends to follow to avoid customers switching to Coke. Mutual interdependence can be described as a chess game, when player X makes a move, it has to think that how player Y reacts to this move, will the next move affect X and etc. Coke and Pepsi are both engaging in strategic behavior, where both of them have to think before making a move and be aware of the reactions of another that might affect the company’s profitability.

               Instead of having price cuts, oligopolists tend to have non-price competition. Both the companies will invest a lot on extensive advertising to differentiate their products and gain higher sales. There are minor differences between both of them, which is Coke contains lesser sugar and calories as compared to Pepsi. They differentiate themselves by the nutrition level of the cola. Besides that, Coke concentrates on creating happiness by placing magical ‘Happiness Machines’ in campuses (Arandilla, 2011). Pepsi focuses on celebrities like Beyoncé to promote its products. The economic profits that they earned is sufficient to finance their research and development of products and improve the existing ones. Coke has come up with Diet Coke to gain more market share as compared to Pepsi, which is standing alone and competing with the two Coke products. In the cola wars back in 2010, Coke has successfully gain more sales by the regular Coke as #1 (sales of 1.6 billion) and Diet Coke as #2 (sales of 927 million), whereas Pepsi as #3 (sales of 892 million) in the entire industry (Cardenal, 2013). Diet Coke has successfully grown the business and captured more market share in the industry. The expenditures that both companies spent on advertising will shift the demand curve to the right, results in a higher price and output as compared to perfect competition.

               Coke and Pepsi have created high barriers to entry in the industry. In oligopoly, the smaller the number of firms, the more difficult for new rivals to enter the market. This is due to the majority market share is owned by Coke and Pepsi and they are large enough to serve and control the entire industry. Coke has been dominated the market since 1886 and followed by Pepsi 13 years later. They are now well established, they have the most advanced technology to reduce the cost of production; they know their customers very well; their products are widely available. They also have their own well-managed distribution channels, suppliers and bottlers. Most importantly, Coke and Pepsi are the two main dominants that serve the entire market so they will get a large sales volume. Thus, they gain supernormal profits and experience significant economies of scales over the years. When new rivals enter the market, they will lower the price and new rivals have to follow. After a period of time, even though they are making loss, they tend to survive; but new rivals will unable to survive due to the loss and quit. The action of increasing price is to protect the industry from being shared by new firms and to maintain the market shares of theirs. Besides that, brand loyalty is what kills the new rivals. Coke and Pepsi are both very strong brand and they have high recognition across the globe as well as copyrights and registered trademarks as their legal protections by the government. Hence, it is not easy to beat them down. There are still chances to enter the market but new rivals have to been through hard times and put in a lot of efforts in the beginning. 

(Russell, 2012)

               There is a breakdown of collusion between these two industry leaders resulting in a price war. Coke and Pepsi were both involving in a price war back in the 1990’s. It was a hot summer season in Atlanta and both companies has kicked off a summer promo. They had similar price cuts; Coke has cut 20 cents to $5.47 with giving away cash promotions and at the same time, Pepsi cut 20 cents to $5.43 and giving away clothing, bikes and trips (Roush, 1997). As a result, 66% of US consumers prefer Coke’s promotion while only 30% prefers Pepsi. This case claims that these two giants have the power of control over price. Coke and Pepsi can decide on setting the prices and outputs levels to maximize their profits. Thus, they are the price makers in the industry. Similar to monopoly, they tend to get positive economic profits in the long run by setting the prices on their own.

               In an oligopoly, there is an assumption that when one firm increases the price, the competitor does not follow because it will gain more customers with its price; when one firm decreases the price, the competitor will follow to avoid losing customers. The market demand is elastic above P₀ because customers will switch to competitor’s brand; it is inelastic below P₀ because firms decrease price together and it will not affect the demand. This results in a kinked demand curve which is uniquely applied to oligopolistic market only. Oligopolistic firms are not allocatively efficient because the price is always above the marginal cost. The price is always higher than perfect competition because oligopoly does not apply the profit maximizing rule of marginal revenue equals to marginal cost in perfect competition. Coke and Pepsi are the two main giants that control the industry, they have the power to set the price higher to maximize profits. Moreover, when the price is higher than marginal cost, the output will automatically lower than the minimum average total cost and this explains they are not productively efficient as compared to perfect competition where P = min ATC. Both the companies will restrict output to make greater profits. The efficiencies above prove that Coke and Pepsi enjoy supernormal profits in the long run. 

               Coca-Cola and Pepsi Cola are the most recognizable cola brands around the world. Both the companies clearly demonstrate how oligopoly occurs. There are still a number of cola sellers in the market but Coke and Pepsi seems to be the dinosaurs that capture majority of the market shares, thus they are known as oligopolists. Both of them have created a healthy competition within the cola market, where they have to expand and diversify their products to gain more sales. This would be more beneficial to the consumers. Consumers will be offered by various choices as compared to monopoly where consumers have no choice.

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References

Arandilla, R. (2011) Coca-Cola Advertising Through the Years. [online] Available at: http://www.1stwebdesigner.com/inspiration/coca-cola-advertising-history/ [Accessed: 6 Jun 2013].

Cardenal, A. (2013) The Battle of the Soda Giants: Coke vs. Pepsi. [online] Available at: http://beta.fool.com/acardenal/2013/04/10/the-battle-of-the-soda-giants-coke-vs-pepsi/29803/ [Accessed: 6 Jun 2013].

McConnell, C., Brue, S. and Flynn, S. (2009) Economics: Principles, Problems, and Policies. 18th ed. United States of America: McGraw-Hill.

Otuki, N. (2013) Coca-Cola mulls price cut in market battle with Pepsi. [online] Available at: http://www.businessdailyafrica.com/Corporate-News/Coca-Cola-mulls-price-cut-in-market-battle-with-Pepsi/-/539550/1748326/-/9oe99n/-/index.html [Accessed: 3 June 2013].

Roush, C. (1997) Pepsi, Coke waging price war. Observer Reporter, [online] 13 June. Available at: http://news.google.com/newspapers?nid=2519&dat=19970613&id=11peAAAAIBAJ&sjid=TWENAAAAIBAJ&pg=3084,5004818 [Accessed: 3 June 2013]. 

Russell, M. (2012) How Pepsi Went From Coke's Greatest Rival To An Also-Ran In The Cola Wars. [online] Available at: http://www.businessinsider.com/how-pepsi-lost-cola-war-against-coke-2012-5?op=1 [Accessed: 2 June 2013].

Tanner, K. 2012. Brand Loyalty: Why do people prefer Coca-Cola? - B2B Marketing. [online] Available at: http://www.hm-marketing.com/Blog/September-2012/Brand-loyalty-Why-do-people-think-they-prefer [Accessed: 6 Jun 2013].