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Coca-cola vs. Pepsi: The Economics behind Coke’s Dominance


Henry Lin

By

October 17th, 2012


Why is Coke dominating Pepsi, even though they taste and cost the same?


In microeconomics, the first thought that springs to mind when we talk about perfect substitutes is Coca-cola and Pepsi. Since these two essentially taste the same and have similar pricing, we would expect that demand for both products are similar. However, until recently, the market share for Coca-cola and Pepsi has heavily favoured Coca-cola in Australia. It is estimated that Coca-Cola outsells Pepsi Cola by around three times in Australia and New Zealand supermarkets, and around five to six times in the whole cola market.

The two firms had an interesting past during the great depression, where Pepsi went into bankruptcy twice, until being bought out by Loft Inc, a candy manufacturer. On 3 separate occasions between 1922 and 1933, Coca-cola was offered the opportunity to purchase Pepsi however declined every time, a decision that could have potentially resulted in Coca-cola enjoying decades of pure monopoly profits and market power. From this point onwards the long history of fierce competition started, which included things like the billions of dollars they spend on advertising, the Pepsi blind taste test TV advertisement, the vast array of celebrity endorsements, and the ‘Share a Coke’ campaign. So why is Coca-cola dominating the market now? To make the article easier to follow, I provide a diagram below.

Firstly, if you haven’t noticed it yourself, it seems like Coke is available everywhere compared to Pepsi. For example, at Union House, you can only find Pepsi at the mini supermarket Foodworks, while Coke can be bought at all other food outlets. Vending machines too are almost exclusively Coca-cola and the same applies to the city. Food outlets like McDonalds, Subway, Nando’s, sushi outlets etc all sell Coke (compared to only KFC who sells Pepsi). It is possible to find Pepsi in places such as 7-eleven, supermarkets and petrol stations however these places also sell Coke as well. The list of places you could buy Pepsi from is small compared to the amount of places that sell Coke.

Suppose you were in the city with no specific preference between the two and you wanted a cola soft drink. Also assuming there is a cost to travelling to purchase the drink, as you would be better off walking less, and that both have the same price. You could purchase Pepsi but it’ll take effort and some traveling (say 500 meters) to try and find a 7-eleven or a KFC to purchase, or you could purchase Coke which is widely available within a smaller radius (e.g 50 meters). As a rational consumer you would choose Coke, saving time and money to minimize your travel costs. Hence Coke has a convenience advantage. The convenience advantage belonged to the company which established itself first in the market, and whether it offered exclusive deals to businesses such as bulk purchases.

Due to this advantage, a consumer would purchase Coke more often and thus leads to brand loyalty and continued consumption of Coke. This is because over time as we constantly purchase Coke, our minds tend to think of Coke rather than Pepsi whenever we want a cola soft drink. This is evident whenever we order at a restaurant, the waiter asks ‘would you like anything to drink?’ and your response would typically be ‘yes, I would like a Coke thanks’.

The way soft drinks are sold also play a role here. Aside from 7-elevens, supermarkets and Petrol stations, food outlets typically only hold one of the two brands. For example when you walk into a McDonalds, or dine at a restaurant on Lygon Street, only Coke is available to the consumer rather than both brands competing against each other. This results in an in-store monopoly effect, which means that consumers don’t exactly have a choice to make between Coke and Pepsi, and so there is small narrow monopoly Coke operates within each food retailer (except KFC) and restaurants.

As Coke is the only option in most food retailers and restaurants, we tend to drink it more and thus forms the brand loyalty effect. So even in places such as 7-eleven and supermarkets, where both brands are offered unbiasedly, we tend to have a bias to purchase Coke over Pepsi. The store owners/managers who are also consumers in the market, are also under the effects of brand loyalty, so they will also purchase Coke to sell to the consumer. As brand loyalty leads to higher demand for Coke, food outlets would rather purchase Coke for their inventories, rather than Pepsi. Therefore as more businesses stock Coke instead of Pepsi it amplifies the convenience advantage, and thus creates Coke’s Dominance Chain, shown above.

There are of course many other factors that make Coke dominant over Pepsi such as its pricing strategies, marketing, product design etc. However the Coke Dominance Chain can be largely attributed to Coca-cola’s dominance over Pepsi. This is because if we swap Coke and Pepsi around to form the ‘Pepsi Dominance chain’, it is likely that we would all be buying Pepsi instead of Coke. This is due to the fact that they are perfect substitutes and we have no individual preference between the two in the first place, and so as Pepsi is widely available it creates the convenience effect and then the dominance chain.

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

  • Jeff Lee

    What an interesting read! I actually haven’t thought about the widespread dominance of coke over pepsi and the product differentiation of coke based on location. :)

    • Henry Lin

      thnx jeff, yea got the idea whilst studying the linear city model in ECON20005 competition and strategy

  • Qamar Hassan

    very nice work…

    • Henry Lin

      thnx Qamar :)

  • Ryan Doyle

    Exactly. The Coke vs Pepsi thing is the perfect metaphor for not only business, but so much of life itself. Often we choose things that have no real intrinsic superiority but they are convenient. The secret message of every marketing campaign or singles bar is, “I’m the same as the other, but you should choose me anyway”

  • Ted Mittelstaedt

    Only problem with this analysis are people like me who took the Pepsi challenge multiple times and correctly and instantly identified Coke over Pepsi every time. Coke simply tastes better to me. (by the way I was raised in a no-soda pop household, my mother was a terror on soda pop for kids, so don’t think my preferences were set when I was a kid)
    What your completely missing with food flavoring is that Pepsi and Coke are both locked into their current flavors. If Pepsi changes its flavor to be more like Coke then Pepsi will lose customers that like it’s flavor. If Coke tries changing to be more like Pepsi then it will lose customers (that’s what happened to New Coke, which given your picture happened before you were born so it’s understandable you don’t know about it) That’s why both brands don’t change their flavors.
    If the Pepsi Challenge really worked to prove that more people liked Pepsi, then Pepsi would still be doing it.
    If people really couldn’t tell the difference then Pepsi would drop prices for the next 5 years and hand out free Pepsi’s on the street corners. It’s called buying market and it works.
    Please read up on Occam’s Razor. The reason Coke dominates is simply that more people like it’s taste.

    • Henry .lin

      hello Ted, thanks for leaving a comment, you are absolutely right with your perspective in the taste battle. Some people have their own preferred taste, its the reason why certain people choose the brand of the plain bottled water they prefer despite the minimal difference and also the reason why some people purchase pepsi over coke when they are sold together. For this very reason my analysis tried to avoid bias based on ‘taste’ but rather on the companies business tactics.

      • Ted Mittelstaedt

        It is not “some people” Henry it is “most people”
        If your analysis was looking at cow’s milk then it might have some substance. Pasteurized 2% cow’s milk from different dairies is literally a perfect substitute. (the mixing of milk from different cows destroys the uniqueness) But there’s very different tastes between Coke and Pepsi and I will repeat – more people prefer Coke’s taste then Pepsi.
        Pepsi has had plenty of opportunity to dominate in the soft drink market but they have chosen to invest in other businesses (like Burger King) because they know what I’ve said above – fewer people prefer Pepsi. It is not because “everyone drinks Coke” It be because of that indefinable thing we call “flavor” Someday scientists will analyze flavor and understand how to craft designer flavors, and will be able to pull a genetic analysis and determine before you taste something you have never tasted before whether you will probably like it or not. But until that day comes, flavor is something in the food industry that once a company is able to reliably craft a particular flavor repeatedly, they will hang on to it and seek a market – and a market will become created – or it won’t.
        Understand also that there are some flavors that simply cannot be duplicated in mass-production. For example the flavor of home-made strawberry jam that someone makes in small batches in their kitchen, from berries picked the same day they make the jam. It cannot be duplicated by the food industry. The only reason the major jam makers like Smuckers are able to sell product at all is because so many kids today never got a chance to experience the real stuff. But I guarantee if you feed a kid the real stuff for 3-4 months, he will never go back to the mass produced stuff.
        This does not bother Pepsi in the least. Their market is still millions and millions of consumers who are drinking sugar water with a specific flavor and paying exorbitant amounts of money for it. That’s a cash cow like no other product, the markup on it is thousands of percent. They can use the cash from that cow to invest in other businesses and make more money in 10 seconds than any of us will make our entire lifetimes.
        Out on the Oregon Coast in Cannon Beach is this small seafood place. They used to carry Coke. But the owner is a Pepsi fan. So when their contract came up they switched to Pepsi in their soft drink fountain. That happened a few years ago. Since that time they have had to give up a lot of floor space for several new refrigerators that hold – you guessed it – bottled drinks (like orange and apple juice, etc.) which are sold for the same amount of money as the fountain drinks because they got so many complaints. And their margin on the bottled stuff is a quarter what it is on the fountain drinks. The name of the place is Ecola Seafood. No matter how much the owner tried ramming Pepsi down his customers throats it didn’t matter – it simply didn’t work. And most of the customers of that place are tourists from out of town.
        Sometimes the best business decision is to come to terms with the fact that your second-best and you will never be the best – but that’s OK you can still make money. Apple Computer discovered that with the Macintosh.

  • Richard

    It is estimated by who? It is estimated that Coca-Cola outsells Pepsi Cola by around three times in Australia and New Zealand supermarkets, and around five to six times in the whole cola market.

  • SG

    Elegantly argued Henry. As a abstainer from all forms of lolly-water who recently purchased a large (for me) shareholding in CCL, reading this sort of stuff is comforting after a recent trip to the supermarket where I was spooked by an empty soft-drink aisle.

  • JACK WILLIAMS

    UM. Are we just yapping about Australia or is this a World-Wide article? Im interested in coke vs pepsi in general, but being that im in the US, if this is specific to Australia, it wont mean much to me!

  • Al Bhat

    what if it is a same company creating an artificial competition leaving no space for anyone else in the business and selling more and more of their products after all it will create a win win situation for them as wherever customer goes its their product that is being sold doesn’t matter coke or pepsi. Which wouldn’t have been possible if they had officially acquired pepsi

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