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| By Yap May Tin |
INTRODUCTION
Coca-Cola
(Coke) is a carbonated soft drink product that being distributed worldwide by The Coca-Cola Company,
in Atlanta. It is a registered trademark of The Coca-Cola Company in the United
States since March 27, 1944 (The Coca-Cola Company, 2013). Originally, the Coca-Cola is invented as a patent medicine in the late 19th century by
pharmacist John Pemberton. Later
in year 1889, Coca-Cola was bought out by Asa Griggs
Candler, a businessman with his marketing tactics, led Coke to its dominance of the world soft-drink
market throughout the 20th century.
Since economic resources are
scarce, these resources must be used efficiently by the company to
generate the greatest benefit with limited resources. According to the
Coca-Cola Company, resources like water has an impact towards their production.
Now, they are utilizing the global system in an efficient way by reducing the
amount of water it uses per liter of product produced, even as the
level of production increases (Reduce the ratio of water use to produce
more). They are allocating ground water, municipal water, rain water and others for the production. Furthermore,
the company has to decide how the
goods are being produced. In
Brazil, the company had invested heavily in technology, production capacity and
the sales force to maximize their level of production. Over the recent years, a
trade-off such as employing more workers or investing
more machines has been made. According
to Sahota (2012) and Industry Today (2013), they had spent millions of money on
the operation to enhance their production methods and moving
forward expecting to create 10,000 new jobs in Mexico over the next five
years.
Law of demand states that there is an inverse
relationship between the price of a good and the quantity of the good demanded
(Hubbard and O’brien, 2007). As shown in Figure 1,
by holding everything else constant, when the
price of coke falls, the quantity demanded will increase whereas
when the price of coke rises, the quantity demanded will decrease.
FACTORS AFFECTING QUANTITY DEMANDED OF COKE
THE CHANGE IN PRICE OF RELATED GOODS
In this case, there are numerous substitution goods
that are present in the market, such as Pepsi, a big competitor of Coke for many
years (Yglesias, 2013).
Figure 2 illustrates that when the price of Coke
increases from RM 2 to 3 while the price of PepsiCo remains unchanged, there is a reduction in the quantity
demanded for Coke (Qd 1 to Qd 2). Figure 3 shows that if both Coke and PepsiCo are substitutes, the higher
price charges for Coke will cause an increment in the demand for PepsiCo,
FACTORS AFFECTING DEMAND OF COKE
A. EXPECTATIONS OF FUTURE PRICE CHANGES
If the consumers become convinced that
there will be a price increment of coke in three months later, the demand for
coke will increase now. Demand curve for coke will shift rightward.
B. TASTE AND PREFERENCES
If the consumers have no taste or preference
of coca cola, then if the price increases the demand decreases, consumer might
go for Coke’s substitutes.
According to Natural News (2013), Coca-Cola
contains harmful levels of
aspartame, pesticides and other chemicals. These
issues raise up the consumers’ health
concern and might prefer more on natural health
drinks. The demand for Coca-Cola decreases.
C. TIME
The demand for coca cola goes up during
festive seasons and during summers or during events such as Olympics (Mickle,
2012), the demand and the sales boost up fast during these particular time.
D. AGE
GROUP OF THE POPULATION
This product is meant for the children, adults and also for the
old people so the age group does not much affect the demand of the product. Therefore the demand
remains same and
with the increase in the population, the demand of the product also increases.
FIGURE 4 IS FORMED BASED ON A TO D
FIGURE 4 IS FORMED BASED ON A TO D
Market Structure
According to
Lee and Schweizer (2013), soft-drink market is dominated by two main firms: Coca-Cola
and PepsiCo.
They are oligopoly, the highest-profile competitors. Oligopoly formed
when just a few firms between them and shares a huge proportion within the
industry. Coca-Cola and PepsiCo are interdependent
on each other before making any pricing decisions.
CHARACTERISTICS OF OLIGOPOLY
1. Keeps barriers for new competitors to entry à maintain their position of dominance
Economies
of large scale production, EOS
Since 1923, Coke had diverse into
franchise model globally and this had encouraged Coke to grow rapidly over the
20th century while achieving the EOS. It is the situation
whereby Coke increasing the scale of production leads to a lower cost per unit
of output (Liu, 2009). Clearly, the company is getting increasing returns
to scale (increased in input leads to huge increment on output) from its
factors of production (Garrratt, Sloman and Wride, 2012). New entrants
are deterred as huge initial cost is needed to start-up and they do not have a
large volume of production to minimize costs as production increases.
Advertising
Coca-Cola had spent billions of money on advertising via print, radio,
television and internet worldwide (Lovel, 2002 and McWilliams, 2011). This had boosted Coke as a strong brand.
A strong brand
According
to The Library Congress (2013), Coke has a long history of heavy advertising
and this has earned them huge amount of brand equity and loyal customers all
over the world. This makes it virtually impossible for a new entrant to match
this scale in this market place.
These make entry difficult as they favor existing firms
who have won the contracts or own the licenses. For example, contracts between
suppliers and retailers can exclude other retailers from entering the market (Hubbard and O’brien, 2008).Exclusive contracts, patents and licences
2. Interdependence of Coke with its rivals à The firm is affected by rivals' behaviors
Strategy à To compete or collude, to raise, lower or keep price relatively constant
Non-collusive case
According to
McGuinness (2012) and Mutegi (2013), Coca-Cola and Pepsi often competing to
each other and the likelihood of price competition is high in order to gain a
bigger share of industry profits for themselves.
If Pepsi changes its price, Coca-Cola’s demand
curve shifts. Thus, the way of determining the profit maximizing output is
complicated. Coke can decide on its best
price and output, but then Pepsi will react and change its price or
output. That will shift Coke’s demand
curve, changing its best strategy and so one and so on.
Kinked demand curve model theory à dual
demand curve might happen in a firm for its product based
on the likely reactions
of other firms to
a change in its price
According to Jackson, Mclver and Wilson (2008), two results derive from
the kinked curve:
- If a firm increases the prices, none of the rivals will keep the same price in order to gain customers from the first firm, the demand of the first firm may falls
- If a firm cuts the prices, its rivals will be forced to follow to prevent losing out customers to the first firm
Based on the assumptions, Coke will face a
demand curve that is kinked at the current
price and output.
Marginal Revenue Curve
According to Case and Fair (2002), Coke’s marginal revenue curve associated with the kinked-demand curve contains three distinct segments as shown in Figure 6.- Top Segment: MR corresponds to the elastic demand generated when price increases above RM 2 and for quantities less than 20,000 cans.
- Bottom Segment: It’s the steep bottom portion of the marginal revenue and corresponds to the less elastic demand generated when price decreases below RM 2 and for quantities greater than 20,000 cans.
- Middle Segment: The vertical middle segment connecting the top and bottom segments that occurs at the output quantity of 20,000 cans corresponds with the kink of the curve.
Profit are maximized when MC = MR. Hence, if the Marginal Cost Curve for
coke lies between any point between MC 1 and MC2, profit maximizing output
(20000) and price (RM 2) is achieved. (See figure 7)
Kinked
demand theory creates a situation of price stability for Coke, as an oligopoly firm, might likely keep their price relatively constant to achieve profit maximizing level as there is a
resistance to a change of price (Garrratt, Sloman and Wride, 2012).
PRICE DISCRIMINATION
Coca-Cola
has introduced price discrimination (Business Week, 2003), by setting the price
of goods at different prices to different customers whereby their production
costs remain unchanged. According to Morran (2013) and Seward
(2013), the price adjustment for Coca-Cola vending machines are based on
the weather temperatures, a new technology and practiced in
several countries like Spain.
For
instance, in terms of time pricing, third-degree price discrimination is being practiced.
Coca-Cola had tested on the vending machine that would
raise prices during a hot day and lower prices when the weather is cool.
Customers are placed intro different groups based on the weather conditions and charges at
a different price.
By
considering price discrimination, Coca-Cola is able to identify whether
the
discriminatory prices should impose and at what level of output should be
produced (Garrratt, Sloman and Wride, 2012).
From (i), the demand is less elastic. However, due to the hotness
of weather, customer might have greater utility while purchasing Coke to
overcome thirsty issue.
From (ii) the demand is elastic since the price of Coke is
lower, customers are willing to purchase more despite of the conditions of
weather (Seward, 2013).
From (iii) whereby the MC=MR, with the output of 3000 and
6000 (9000 in total), Coke’s revenue would raise by RM 2 per unit sold, in each
market. Therefore, profit-maximizing output and prices are determined by using third-degree price discrimination.
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