Home  BADM449   Handout #9 Joseph T. Mahoney

College of Business
Department of Business Administration
BADM449  Strategic Management/Business Policy

Resources and Capabilities/ Value-Chain Analysis

Appraising Resources
Resource Characteristics Indicators
Financial Resources Borrowing Capacity
Internal funds/generation
Credit rating
Net cash flow
Physical Resources Plant and equipment
Raw materials
Land and buildings
Market value of
fixed assets
Scale of plants
Human Resources Training, experience,
adaptability, commitment
and loyalty of employees
pay rates, turnover
Technological Resources Patents, copyrights, know-how.
R&D facilities
Technical and scientific employees
Number of patents owned.
Royalty income
R&D expenditure
R&D staff
Reputation Brands
Stability of customer base
Reputation with suppliers
Brand equity
Product price premium

Identifying Organizational Capabilities:
A Functional Approach
Function Capability Exemplars
Corporate Management Financial control
Strategic control
Motivating and coordinating business units
General Electric
MIS Speed and responsiveness through rapid information transfer American Airlines
L.L. Bean
R&D Research capability
Development of innovative new products
Manufacturing Efficient manufacturing
Continuous improvement
Design Design capability Apple
Marketing Brand management Procter & Gamble
Sales and Distribution Promoting reputation
Responsiveness to market trends
American Express
Sales promotion
Speed of distribution
Customer Service
Federal Express

Value Chain Analysis for Soft Drink Industry

The following analysis is based on the $46 billion Soft Drink Industry case for 1991.

Coca-Cola versus Pepsi-Cola and the Soft-Drink Industry

Four reasons to like the business:

  1. Selling concentrate requires little capital;
  2. Selling concentrate produces superb returns;
  3. Selling concentrate demands minimal reinvestment; and
  4. Selling concentrate spills an ocean of cash.

Value Chain Analysis

A systematic way of examining all the activities a firm performs and how they interact is necessary for analyzing the sources of competitive advantage. In this handout, the value chain is introduced as the basic tool for doing so. A firm's value chain and the way it performs individual activities are a reflection of its history, its strategy, its approach to implementing its strategy, and the underlying economics of the activities themselves.

A generic value chain includes primary activities such as inbound logistics, operations, outbound logistics, marketing sales and service, and support activities such as firm infrastructure, human resource management, technology development, and procurement.

In this handout, we are going to focus on the vertical linkages between the firm's value chain and the value chains of suppliers and channels. In particular, we will focus on the dynamics of the value chain in the soft drink industry.

Value Chain:

Suppliers --> Concentrate --> Bottlers --> Retailers:
Producers Independent,
Multi-Brand Franchise,
Diversified Franchise
Supermarkets, vending warehouses, superstores, fast food

1. The soft drink industry evolved with a franchised bottler system. For most of the industry's history the concentrate producers nurtured and preserved the system. Why?

The main features of the franchised bottler system are as follows:

Exclusive territories. There is an exclusive bottler in each area or territory;

Bottlers are given franchises in perpetuity;

Exclusive Dealing. Bottlers are prohibited from marketing competing brands. Thus, a Coke bottler cannot bottle Pepsi. [This arrangement technically violates antitrust norms, and it required a special act of Congress to adopt it.]
This setup has been nurtured by concentrate producers, primarily because it benefits them in a number of ways:

Entry Barriers. The arrangement raises entry barriers into the industry. Bottlers are a major distribution channel. Potential competitors to Coke and Pepsi are shut out of this channel by the prohibition against carrying competitive brands (i.e., market foreclosure).

Risk Sharing. Bottlers absorb the risk associated with heavy capital investments and new technological developments. Bottling is a capital-intensive process and involved specialized, high-speed lines. Moreover, innovations in packaging have increased the rate of obsolescence of bottling lines. The franchise system means that bottlers bear these expenses and associated risks, not the concentrate producers. [Bottling and canning lines cost from $100,000 to several million dollars.]

Economies of Scale. The high fixed costs associated with bottling create the maximum incentive for bottlers to build volume in order to amortize those costs. In other words, the incentive structure of the arrangement favors the concentrate producers, who want the bottlers to be aggressive in pushing their product.

The concentrate producers still retain control over the valuable asset -- the concentrate. Thus, the concentrate producers are in a powerful bargaining position relative to the bottlers. [NOTE: In 1990, Coke had 40.4% market share in the United States and PepsiCo had 31.8% market share.]

Hence, the franchise "organizational mode" enables concentrate producers to build entry barriers and to capture rents (i.e., achieve competitive advantage), without requiring them to become involved in a capital-intensive production process where there is a high risk of technological obsolescence. However, it is important to understand that this organizational mode does impose some costs on the concentrate producers, although for most of the industry's history these costs have been relatively minor compared to the benefits. Specifically:

  1. The concentrate producers are not in direct control of point-of-sale marketing. This marketing function is controlled by the bottlers.

  2. The concentrate producers must pursue bottlers to add products and packaging. Despite their bargaining power, they cannot dictate terms to the bottlers with regard to new products and packaging.

  3. Thus, the concentrate producers do not have complete control over bottlers. While the structure of the organizational mode does give bottlers an incentive to build volume, it is possible that bottlers might become inefficient -- particularly given that bottlers are granted franchises "in perpetuity."

Four organizational modes:

  1. Privately owned
  2. Large, publicly owned multibrand franchise firms
  3. Coke and Pepsi franchisees
  4. Operations of concentrate producers themselves

2. Recently the major soft-drink companies have begun to acquire bottlers. Why?

As noted in the case, both Coca-Cola and Pepsi have been purchasing bottlers in recent years -- integrating forward into bottling and distribution. Given the advantages of the franchised system articulated above, this development is most likely explained by a shift in the benefit-cost equation with regard to franchising versus vertical integration. What appears to have occurred is that as the end market has become more competitive due to the intensification of the cola wars, and as the rate of new product introductions has increased, both Pepsi and Coke have felt the need for greater control over bottlers. Controlling bottlers enables both companies to ensure that bottlers adopt new products, new packaging, and aggressive point-of-sale marketing.

A second reason for the forward shift into bottling is that the structure of the bottling industry itself has been changing in recent years. Most significantly, multiple franchise owners started to purchase more bottlers. The total number of bottling plants had fallen from 2,613 (1974) to 1,522 (1984), and 780 (1990). In 1989, the seven largest bottlers operated 176 plants and produced 46.5% of industry volume. By purchasing more bottlers, they started to change the bargaining power between bottlers and concentrate producers (multiple franchise bottlers are more powerful than single franchise bottlers). The forward integration into bottling and distribution by concentrate producers may in part have been an attempt to stop this trend from going too far.

NOTE: Activity-based Accounting can be useful in determining the cost drivers in a Value- Chain Analysis


	Traditional Accounting:

	Salaries:                $ 371,917
	Fringes:                 $ 118,069
	Suppliers:               $  76,745
	Fixed costs:             $  23,614
	Total                    $ 590,345

Activity-based Accounting:

	Processing sales-orders             $ 144,646
	Sourcing parts                      $ 136,320
	Expediting supplier orders          $  72,143
	Expediting internal processing      $  49,945
	Resolving supplier quality          $  47,599
	Reissuing purchase orders           $  45,235
	Expediting customer orders          $  27,747
	Scheduling intracompany sales       $  17,768
	Requesting engineering changes      $  16,704
	Resolving problems                  $  16,848
	Scheduling parts                    $  15,390

	Total                               $ 590,345

An Illustrative Production-Cost Chain Comparing the Cost Competitiveness of U.S. Steel Producers and Japanese Steel Producers in 1976 (Source: FTC)

Per-Ton Cost for Cold-Rolled Sheet Steel
Cost Chain
Typical U.S. Producer Typical Japanese Producer Net Cost Advantage
Coking coal $52.15 $41.45 $10.70 (Japan)
Other energy 30.25 21.49 8.76 (Japan)
Scrap steel 20.80 21.75 0.95 (United States)
Iron Ore 47.90 27.60 20.30 (Japan)
Subtotal $151.10 $112.29 $38.31 (Japan)
Manufacturing Labor $142.93 $52.25 $90.66 (Japan)
Capital charges for facilities 55.95 63.88 $7.93 (United States)
Profit margin 4.90 3.50 1.40 (Japan)
Subtotal $203.78 $119.63 $84.15 (Japan)
Trans-ocean shipping
Import duties
$ 0 $ 36.36
Price-paid by U.S. end-user $354.88 $268.28

Last Update: January 05, 2006