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

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.