7. Case: Coke and Pepsi refrigerators

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Do curso por National Research University Higher School of Economics

Industrial Organization: Strategy and Competition in Business

3 classificações

National Research University Higher School of Economics

Industrial Organization: Strategy and Competition in Business

3 classificações

Industrial Organization is the area of economics that studies the markets as institutions, the state of competition and strategic interaction among firms, the industrial policy and the business decisions firms make within the market framework. The course looks at the markets from three different perspectives: the economic theory, the applied business perspective and the institutional and legal perspective. The focus of the course is split equally between the economic theory and business perspective but there is a significant legal component incorporated in various topics. The course includes economic modeling, game theory, numerous real life examples and several case studies. We explore interesting topics of market organization such as negotiations, antitrust, networks, platforms, electronic markets, intellectual property, business strategies, predation, entry deterrence and many others. The basic objective of the course is to enable the student to understand the structure of markets and the nature of strategic competition. Knowledge in this course will be valuable for the students in acquiring managing and governance skills, enriching their understanding of the institutional framework of business, and improve their analytical ability in negotiations. Prerequisites: The course requires understanding of basic economic modeling, knowledge of intermediate microeconomics (especially production/cost theory), knowledge of basic concepts and methodologies of game theory, intermediate econometrics and basic calculus.

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Vertical relations

So far, we have mostly examined the markets in the context of the “firm – customers” relationship. In this lecture our analysis extends to more complicated relationships such that of “manufacturer – retailer – customers”. We will also generalize our setting to include all kinds of vertical relations between firms. When firms are vertically related, we observe an interesting phenomenon that creates tension between the two partners. This phenomenon is referred to as “double marginalization” and creates a vertical externality at the upstream market. Additionally, the opportunity of a retailer to provide demand stimulating pre-sale services may create a horizontal externality, causing the provision of service to end up sub-optimal. We will talk about resale price maintenance, exclusive dealing, exclusive territories and the importance of modern distribution systems. We will also present two interesting case studies: the Levi’s Strauss case and the “free corporate refrigerators” case.

6. Exclusive dealing4:07

7. Case: Coke and Pepsi refrigerators11:35

8. Exclusive territories and modern practices6:35

9. Distribution systems and Policy6:06

Conheça os instrutores

Kosmas Marinakis
Assistant Professor
ICEF and Faculty of Economics Sciences, HSE

Let's see an example about how exclusive dealing has worked.

This is the Coca-Cola and Pepsi refrigerator case.

Have you noticed that when you go to

the convenience store and you want to buy a beverage,

then Coca-Cola and Pepsi are held in separate refrigerators?

There is a different refrigerators for Coke drinks,

and a different one for Pepsi drinks.

Why does this happen?

Why does this happen all the time in every convenience store, in every country?

The most important reason,

for the success of those two brands, Coke and Pepsi,

was not so much that the recipe that they had was

so nice and so much better than anything else existed in the past.

Has to do also with the marketing that they're doing, the advertisement,

but one more factor,

the ingenious contractual agreements that they had with retailers and dealers.

So, the Coca-Cola company especially,

was the leader in creating contractual agreements that

will help in dominating specific markets.

Coca-Cola was the leader in implementing

contracts of exclusive dealing with distributors.

I remember when I was a kid and I was going to my mom's summer house in Greece,

they had a very small coffee shop there which sold beverages,

and they only sold Coca-Cola drinks,

Coca-Cola and other Coca-Cola company beverages.

They never had Pepsi.

So, some people they preferred Pepsi over Coke coming back

from Athens to this small summer place.

They would like to buy a Pepsi and then they would go to the store and they say,

"Hey, there is a big demand for Pepsi,

why don't you also bring Pepsi?"

And the guy that owned the store was very hesitant to talk.

But what actually happened was that,

Coca-Cola had a contract with the store that prohibited this particular store

from having serving any other competitive drinks to Coca-Cola.

So, Coca-Cola would have

exclusive dealing agreements straight up in countries where this was allowed by law,

or through some indirect ways like offers in the countries that this was not allowed.

For example, in the United States,

exclusive dealing was prohibited from the Clayton Act in 1914.

You could not require someone to not carry competitive products in their store.

This practice that Coca-Cola did,

the direct exclusive dealing or the indirect one,

this practice was quite effective in the 70s.

But towards the end of 70s,

the antitrust authorities started looking into such kinds of agreements.

They said maybe this create some excess market power and creates artificial barriers to

entry to other companies that they also want to come into

this industry and make the dead weight loss lower.

So, they started to seriously looking into these cases and soon,

Coca-Cola saw the FTC coming behind them and they said,

"Maybe we should stop doing that because we have

other open cases with them and let's try to be a little bit more careful."

So, they stopped doing offers for exclusive dealing.

Some people they say that they did that because they had

a very good alternative to the exclusive dealing agreements. What was that?

Free refrigerators.

If you have a convenience store,

buying a refrigerator is an extra cost,

the serious extra cost to the capital of your business.

Instead of doing exclusive dealing,

Coca-Cola decided to supply companies refrigerator,

refrigerators to those firms,

to small convenience stores, to kiosks,

or other smaller firms

that they would stock a sufficient amount of Coca-Cola soft drinks.

They said, "Listen, we're going to make you an offer.

If you store this much Coca-Cola drinks per month,

we're going to give you a free refrigerator now.

As long as you're buying that much from us,

you'll get to keep this refrigerator for free.

And not only keep it, but we're going to service it and

maintain it just for free for you."

However, there was one catch,

one term that no competing brands should be stored inside this refrigerator.

You could not get Coca-Cola's refrigerator and store Pepsi inside this refrigerator.

Coca-Cola was meticulous in monitoring these kind of agreements.

They had people that they would travel even to

the most remote places and check

if the owners of the store would obey the contract or not.

They would do that repeatedly so they will

enforce this kind of agreement with the owners.

This practice led effectively to exclusive dealing.

This was because of two reasons.

The first was space limitations,

especially in big cities where they are crucial for establishing a trend for the product.

Small retailers like kiosks, or convenience stores,

or small restaurants, or fast foods,

they did not have enough space to store more than one refrigerators.

Since Coca-Cola went there first and they caught the space with the Coca-Cola fridge,

Pepsi could not go after them and say,

"Oh, yeah, why don't you have another fridge?"

"Because I have not enough space to have different fridges here."

So, this effectively helped into a situation that reminds us of exclusive dealing.

A second reason is,

demand constraints, that is,

small retailers did not have enough sales so they will be able to cover

the necessary quantities that they should store in

order to get free fridges for more than one companies.

Coca-Cola will understand how much your demand is because in most of the cases,

they were selling to you before so they know how much you're selling.

And if you're selling, for example,

100 cans a day,

they will come to you and say,

if you buy 3,000 cans a month from us,

we'll give you a free fridge.

Meaning that, we'll cover your entire demand if you want the free fridge,

not leaving any more spaces for the competitors.

So, because of space limitation and demand constraints,

this method with the fridges was a very clever loophole that allowed Coca-Cola

to circumvent the antitrust law for an additional 40 years.

These were several billions of profit due to this trick.

However, eventually, you cannot get away with everything.

Eventually, you are going to be having to deal with the authorities.

Pepsi followed the policy but it came second.

The fridge trick became very big.

Other industries followed.

The ice cream industry will give you free freezers.

The beer companies will also give you free refrigerators.

Hard alcohol companies, even today,

they will give you different kind of gadgets, sometimes refrigerators.

Like the other day, I was at the nightclub,

of course doing research for this case,

and I saw that Jagermeister, this liquor,

will give you a very cool looking small fridge, so small freezer,

that supposedly keeps the drink to the minus,

I don't know how many degrees that it should be drink.

So, they give you this fridge,

you have to have it on the bar visible.

It's actually very cool for the decoration of the store also,

but this helps in the exclusive dealing.

You cannot have an infinite amount of those fridges

up there because you have again a space limitation.

Frozen foods also followed this trick and they will give

you their own freezers in which you could not store other brands in there.

The technique expanded to include other irrelevant items also.

So, they started a new campaign that they would give you store sign.

So they would write the name of your convenience store but in the two sides,

they would have like the Pepsi sign,

or the Fanta sign,

or the Coca-Cola sign,

or something like that.

Elaborate stands that they will get the sufficient amount of space in

your store and always a stand had to be full of the product.

And even gun companies,

companies that they were selling weapons,

they would follow this trick and they would give to gun stores,

they would give them a safe.

So, they supposedly keep the arms in the

safe in order to not be stolen or to look like they are so available to the customers.

And they were giving other merchandise in order to

cause this effect of the exclusive dealing which,

per se, was deemed illegal by the law.

In 2004, European Union effectively grounded the practice of the fridges.

The court ruled that sponsored fridges could be

used to store competitive brand products up to 20 percent of their capacity.

It was a big loss for the practice.

I told you before, you can get away with something for some time but not forever.

A fine to Coca-Cola for this case was never disclosed but there was litigation and there

was out of court compromise between Coca-Cola and the authorities.

And similar cases have been filed in other countries,

most prominently in Mexico,

for which also there is research.

So, exclusive dealing is a very effective technique but creates excess market power,

and the authorities, they do not really like that,

so they are after it.

However, firms, they try,

they always work on the margin of the law,

especially the most profitable firms.

They always work in the margin of the law and they try

to impose alternative policies that they create the same effect.

Another policy that we will talk in the next segment is

exclusive territories. Stay with us.

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