Competitive Strategies of Two Companies - Case Study Example

Competitive Strategies of Two Companies Researchers studying Target Costing (TC) often consider a link to firm strategy to be an important factor of this cost management tool (e.g, Lowson, 2002, p. 34; Kim et al., 2004, p. 19). Kim et al. state that TC is closely connected to an organization's competitive strategy. However, the nature of the link between TC and firm strategy has not been empirically researched. This study examines the competitive environment and strategy of firms that have been defined as implementers of TC to determine if specific environmental forces coupled with firm strategy can be traced to a firm's choice to adopt the tool. Strategy can moderate the link between competitive environment and the decision to adopt TC. So, the choice if to adopt TC often depends on firm's strategy. "The competitive strategy (1) a corporation chooses to pursue identifies the manner with which management intends to compete successfully in its product markets and provide superior value to customers" (Susman 1992, p. 114). The firm's competitive environment affects its capacity to implement a defiinite strategy productively. "For example, a low-cost provider strategy works best when price competition among rival firms is especially intense and when the industry's product is standardized. Alternative competitive forces allow a product differentiation strategy to be effective. Examples include diverse needs or uses for the item or service, or relatively few competitors pursuing a similar differentiation approach" (Wolburg 2003, p. 340). The firm's planned vision is put into action by means of different tools, methods, and corporate policies. One such tool that is being adopted by firms all opver the world is the cost management system of TC. As Trebilcock et al. (1990) explain, the link between a firm's competitive strategy and use of TC exists primarily because TC provides the means for achieving the firm's goals of satisfying market demands at an acceptable level of profitability. A TC system provides a means for managing a company's future profits by integrating strategic variables to simultaneously plan how to satisfy customers, capture market share, generate profits, and plan and control costs (Kean, 1998, p. 47). Several large international corporations have been identified as TC adopters, including Coca-Cola and Pepsi-Cola; however, U.S. companies have been slower to adopt the technique. Reasons for this include TC being "not well known in Corporate America" and the existence of both cultural and organizational barriers to developing a broad team-oriented strategy TC requires (Hope & Maeleng, 1998, p. 130). The concept of TC ("Genkakikaku" in Japanese) originated in Japan at Toyota Motor Corporation in the 1960s. Since that time it has become recognized as a dynamic, comprehensive system for cost reduction and strategic profit planning. TC is not a costing system such as activity-based costing (ABC) or absorption costing. Rather, it is a program aimed at reducing the life-cycle costs of new products, while ensuring customer requirements of quality and reliability are met. "For controlling costs of new products, TC takes place at the design stage of new product development and considers all ideas for cost reduction during the product planning and research and development process" (Eckhouse 1999, p. 218). Several researchers (e.g., Covin & Morgan, 1999, p. 47) have noted changes in current economic and competitive conditions that create a need for a market-oriented cost management system. External powerful factors that have led to this need involve a growing number of competitors, high standards of competitors, globalization in the present economic situation, aggressive price competition, and shorter product life cycles. Coupled with a high rate of technology diffusion and innovation, these factors indicate the market must accept new products at a price that will generate an acceptable rate of return to the company. Thus, processes must be efficient, effective, and optimized to produce the highest-possible quality products at the lowest possible cost. Information systems are developing from a usual view of cost accounting, focused internally and fixed on cost centers and predetermined accounting periods, to a market-driven system. This new system is based on production processes and has a forward-looking, life-cycle orientation. TC is one example of a market-driven costing system. As a market-driven quotation system, cost planning under TC begins with the customer. At its easiest, TC can be explained as subtracting the firm's needed profit margin from the competitive market price (Gould et al. 2001, p. 41). The conditions of the market determine the price at which the product will sell successfully, and therefore the voice of the customer is paramount. As the product is conceptualized and worked-out, customer needs for quality, cost, and time are incorporated into product and development specifications. TC systems are very dissimilar from usual approaches to income and cost planning. Traditional methods, or cost-plus approaches, typically estimate design and production costs, then add a profit margin to determine market price. If, after product introduction, customers are unwilling to pay the assigned price, cost reduction efforts begin. Some companies employ a conventional Western approach, in which the expected profit margin is the unknown. To determine this profit margin, expected production costs are subtracted from the planned selling price. This calculation is made after product functionality and specifications have been determined, so this expected product cost is not a target cost. In contrast, TC starts a market price (based on customer research) and a planned profit margin (based on profit required for long-run firm survival) for a product. The difference between the market price and required margin is the allowable cost. If expected costs exceed allowable costs, cost reduction efforts begin, during the product design and development stage, to ensure this allowable cost is achieved (Kim et al, 2004, p. 19). Porter's (1985) typology of strategies for firms to pursue in order to create a sustainable competitive advantage describes, in a broad sense, two alternatives: firms can choose to compete with a low-cost leadership (CL) strategy or can pursue a product differentiation (PD) strategy. Following either strategy does not imply the focus of the other is ignored, but the firm is not relying on the other factor to achieve a competitive advantage. Therefore, the product differentiator cannot ignore cost, but does not attempt to compete on the basis of cost or price. Rather, the product differentiator competes on the basis of the quality or functionality of the product it offers. Alternatively, the cost leader cannot ignore product quality, but produces a product at the lowest possible cost for an acceptable level of product quality and functionality. Muris et al. (1993) pose a third possible strategy based on current competitive forces that he terms a confrontational strategy (CF). The goal of this strategy choice is to produce high-quality items at the lowest possible cost. This study investigates whether one of these strategies is more predominant for TC adopters chosen by us, thus, between Coca-Cola and Pepsi-Cola. Only thirty years ago, the competitive environment of the carbonated softdrink (CSD) industry was based on a recognition of and implicit acquiescence to the dominance of The Coca-Cola Company. Beginning in the 1960s, however, Coca-Cola's dominance has been increasingly challenged, particularly by Pepsi-Cola. The new competitive environment is well publicized and intense. The "Cola Wars" were declared and the battle continues. Pepsi-Cola and Coca-Cola are widely recognized as being two of the premier marketing companies in the world. A great variety of new products and package types have been introduced. Celebrity advertising has been raised to a new level. Coca-Cola even changed the formula for Coke. These and other positive changes in the CSD industry came about from major changes in strategy by Pepsi-Cola and Coca-Cola (Wolburg, 2003, p. 340). To some extent these strategic changes arose from Pepsi's challenge to Coke's dominance of the industry. In addition, several factors external and internal to the industry have been important catalysts for these changes. Rather than simply reacting to a changing competitive environment, PepsiCo and The Coca-Cola Company have worked-out and fulfilled strategies that turned the new environment to their benefit. Although Pepsi-Cola attacked Coca-Cola's dominance and achieved near parity with Coke in bottled soft drinks, both Coke and Pepsi have benefited from fighting the Cola Wars-because the battle between them has stimulated continuing growth in an industry regularly pronounced by the experts for many years to be on the verge of maturity. As the industry existed in the early 1970s, the reasons for predictions of impending maturity were not difficult to see. The apparent limits of the human stomach argued strongly against further significant growth of per capita consumption of soft drinks. Certainly, substantial growth in sales of the limited number of products offered by Pepsi and Coke appeared unlikely (Trebilcock, 1990, p. 217). The competitive advantages of the two industry leaders were built on delivering a few unchanging, high-quality products through a distribution system that, although complicated, was effective. In the face of the predicted maturation of their domestic market, the prudent course appeared to be a holding action in the United States, with attention and resources shifted to offshore markets and diversification - a classic cash cow strategy. New strategies, such as joining the parade of product modifications and introductions of other food manufacturers, and bringing what had long been a very effective independent distribution system in-house, required basic major modifications of the competitive advantages of Pepsi-Cola and Coca-Cola. Such strategies appeared to be "bet-the-ranch" propositions (Stern, 2001, p. 87). Nonetheless, Pepsi-Cola and Coca-Cola took the bets. Each escalated the Cola Wars to new forms of pricing and promotion, and each launched a great number of new products, including new versions of their flagship brands. Finally, each company undertook a fundamental change in its distribution system from networks of independent bottlers to company-owned bottling systems. The result of these and other new strategies has been a continued, rapid expansion of Pepsi's and Coke's domestic sales. The limits of the human stomach have not yet been found, and all other liquids, from coffee to water, face continued competitive pressure from Pepsi and Coke (Wolburg, 2003, p. 347). Of all the major strategic decisions made by Pepsi-Cola and Coca-Cola in recent years, the still-evolving transformation of their distribution systems has received the least attention. The purpose of this study is to remedy the relative inattention to this important change in the industry. As we will see, the transformation of distribution systems has been essential to the effective implementation of the higher-visibility strategies of new product and package introductions and new forms of pricing, promotions, and advertising. Although not as glamorous as a Michael Jackson commercial, the shift from independent bottlers to captive distribution meant fundamental changes in the corporate cultures of the two industry leaders--changes that required skillful leadership to minimize the potentially disruptive costs of resistance. 4 In his path-breaking book, Strategy, Structure, and Antitrust in the Carbonated Soft-Drink Industry, Muris et al. hypothesized that successful firms develop strategies to take advantage of new opportunities, and that those strategies then determine the organizational structure required for effective implementation. As we will see in this study, the transformation of the distribution organizations of Pepsi-Cola and Coca-Cola confirms Chandler's hypothesis. The independent bottling systems were a unique form of organization that, although complicated, was extremely effective for many decades. The new strategies that Pepsi-Cola and Coca-Cola devised to deal with a changing external environment, however, could not effectively be implemented without major changes in their distribution organizations. The move to captive distribution was a major organizational change. The independent bottling networks have existed almost as long as have Pepsi-Cola and Coca-Cola (more than 100 years). Although Pepsi and Coke always faced problems in distributing their products through a system of independent bottlers whom they could not directly control, the advertising and marketing of Pepsi-Cola and Coca-Cola and their systems of independent bottlers built the business. Thus, along with the secret formulas for the concentrates and syrups, the independent bottlers were seen as linchpins of competitive advantage within Pepsi and Coke. To understand the magnitude of the decision to move to captive distribution, consider what the industry was like just 30 years ago. At that time, Pepsi and The Coca-Cola Company, as concentrate manufacturers (CMs), played somewhat limited roles relative to their independent bottlers. The CMs' duties were essentially threefold: to supply concentrate for a few, unchanging products; to decide on the theme of infrequently changing, national advertising campaigns (in consultation with the bottlers); and to try to maintain or increase the selling fervor of their bottlers (Knutsen, 2003, p. 225). Thirty years ago the typical bottler operated a fairly simple manufacturing and sales operation in a small territory. He handled a limited number of products and packages and used infrequent promotions, and his customers were generally small. The bottler was king in his territory, crowned by his perpetual, exclusive territorial contract. All the important decisions--on prices, packages, carrying of allied brands, and local promotions - were his to make. Even in the early 1960s, most of a bottler's business was with customers who were happy to purchase within one territory. Given the information systems of the time, most retailers were unable to track volume and turnover of their soft-drink sales. For example, the typical supermarket largely relied on bottlers to determine the volume of the product its stores sold (Kean et al. 1998, p. 47). The world of the CSD bottler is far more complex today. A typical bottler's business is no longer so small or simple. Increased economies of scale in bottling and canning, reduced transportation costs, and the demise of the returnable container have led to a substantial increase in the minimum efficient scale in bottling. Each bottler handles many more products, in multiple packages, requiring efficient exploitation of economies of scope. Moreover, the bottler's promotional environment is much more difficult because of his parent CM continuously changing national advertising and promotional campaigns--campaigns that work best when coordinated with local promotion. The usual bottler's main customers-supermarkets, mass merchandisers, and leading fast-food franchises - have become larger and more sophisticated over the past 30 years; indeed, these retailers are among the most powerful purchasers in our economy. The increased sophistication of the major customers has resulted from their increased size and purchasing clout and the power of modern information technology. For example, scanners now give retailers of food products great control over and knowledge of the movement of individual products on their shelves. Consequently, supermarkets and other sophisticated customers have much more say (many grocery manufacturers would suggest virtually all the say) in the retail promotion of grocery products such as CSDs. Finally, new customers have become prominent, including fast-food franchisors, convenience stores, drug stores, gasoline service stores, and large companies that provide CSDs to their employees at work (Lowson, 2002, p. 115). All these alterations needed bottlers to become bigger and more sophisticated, and led to a main consolidation of bottlers during the 1960s and 1970s. Individual bottling operations became much larger, bottlers developed cooperative packaging operations, and large, independent multifranchise operations (MFOs) were formed. Several factors contributed to franchise consolidations. These include exploitation of increased economies of scale and of scope, the sale of franchises by the original franchisees' descendants, tax advantages of capturing capital gains in bottling, and franchisee concern over an attack on exclusive territories during the 1970s by the Federal Trade Commission (ibid.). The CMs "brokered" some of this consolidation, particularly for inefficient bottlers, by acquiring some bottlers and reselling them or arranging purchase by other, more efficient bottlers. The acquiring bottlers generally achieved greater economies of scale and scope and a better ability to deal with the rapidly changing industry. Both companies also were the bottler of last resort, on occasion purchasing franchises that no one else wanted or that were the subject of bankruptcy proceedings. Pepsi and Coke bottled about 20 percent and 10 percent of their sales, respectively, in the early 1970s. The consolidation of bottlers resulted in a stronger bottler network. Many of the MFOs, however, particularly those later acquired by Pepsi and Coke, became inefficient over time. This was due in part to the fact that the parents of many of the MFOs had entered the soft-drink bottling industry as part of a diversification strategy, with bottling being only a minor part of their operations. For example, General Cinema Corp., which sold its Pepsi based MFO to PepsiCo in 1989, derived less than a third of its revenues from bottling. When PepsiCo acquired Allegheny Bottling in 1985, bottling accounted for only about 40 percent of Allegheny's revenues (Susman, 1992, p. 94). And when The Coca-Cola Company purchased North American Bottling from Beatrice in 1986, total soft-drink sales were only 10 percent of Beatrice's total sales. A lack of focus on the soft-drink parts of their businesses by some of the major MFOs contributed to their failure to develop and modernize their bottling operations during the rapidly changing 1980s. In some cases the MFOs used their bottling operations as cash cows--a practice at variance with the drive by Pepsi and Coke for sales growth and share leadership. These were two oft-stated reasons for MFO acquisition by the two CMs. Of course, the new competitive environment made the business of Pepsi-Cola and Coca-Cola much more complicated, also. The two companies needed to develop successful new products and packages, and to manage many more products and package types. The new marketing strategies required ever more sophisticated use of advertising, particularly television, with a greatly stepped-up pace of new promotions (ibid.). The marketing campaigns of PepsiCo and The Coca-Cola Company are widely recognized as among the most innovative, sophisticated, and aggressive of all major advertisers. The new strategies also involved changing packages and ingredients, and introducing new products and packages - all of which required the cooperation of independent bottlers. The increased size of the bottlers that had resulted from bottler consolidation was a two-edged sword. A more efficient bottler was a benefit to the parent CM. The new strategies adopted by Pepsi and Coke in the 1970s, however, did not just require greater efficiency and sophistication of the bottler in its territory. They also required much more coordination among bottlers and between bottlers and their parent CM. More than ever before, the two CMs needed cooperative bottlers, because the independent bottlers controlled distribution--which was critical to implementing the new product, packaging, and marketing strategies. The increased size of the new bottling operations increased the costs of a bottler pursuing a strategy that ran counter to the CM's strategy and the rest of the bottling system. The bottler still remained contractual king in his now larger territory, even though the well-being of his CM and of other bottlers was increasingly more intertwined with his actions (or inactions). Successfully implementing the fast-moving tactics required by the new strategies of Pepsi and Coke required quick, effective execution through the manufacturer's distribution system (Hattie et. al, 2004, p. 354). To the extent that individual bottlers attempt to operate as local or regional businesses, the ability of today's CM to execute its strategies and the ability of other bottlers to participate in those strategies can be significantly hindered. One substantial bottler who refuses to cooperate on the terms of a sale to a major customer that overlaps several bottlers' territories can lose that sale for the whole bottling network. One substantial bottler who refuses to participate in a particular promotion with a large supermarket chain (or a mass retailer such as K-Mart, or a major fast-food franchisor) may cripple or even kill the whole promotion. Finally, bottler cooperation is obviously of critical importance to the successful test marketing and rollout of new products and packages (ibid.). Even with the smaller number of bottlers after consolidation, PepsiCo and The Coca-Cola Company each had to negotiate with ever-increasing frequency with over 100 bottlers about product and package introductions and promotions. This increasingly untenable situation required a change in CMbottler relationships. The result, beginning in the late 1970s, was that Pepsi and Coke created new captive distribution organizations. They both began to acquire their largest MFOs through large, widely publicized transactions. Coca-Cola formed Coca-Cola Enterprises (CCE) as a publicly owned bottling operation, with Coke holding a 49 percent interest in CCE. PepsiCo did not form a separate publicly traded corporation for its captive bottling. Instead it enlarged and revamped its "bottler of last resort," arm, Pepsi-Cola Metropolitan Bottling Company, and renamed it Pepsi-Cola Bottling Group (PBG). This reconstructed organization was to manage acquired bottling operations (Gould et al. 2000, p. 41). In addition to obtaining many of their independent bottlers, during the late 1970s and the 1980s, Pepsi and Coke both entered into joint ventures with a number of their franchisees. Today, PBG bottles about 50 percent of Pepsi-Cola sales and has an equity interest of 15-20 percent in franchises that bottle another 20 percent. CCE bottles just over 43 percent of Coke's sales, and Coke owns a 65 percent equity share in Coke New York, which bottles 6.5 percent, and a minority share (20-30 percent) in other franchises bottling 15 percent. Thus, both Pepsi-Cola and Coca-Cola own or have an equity interest in bottlers selling about two-thirds of their volume (Fleisher & Blenkhorn, 2001, p. 119). The upshot of these many changes is that the CSD industry is no longer a simple combination of concentrate production and national advertising with local bottling. The business of soft drinks has become like that of most other major branded food products, which have generally always consolidated manufacturing and distribution. There is one important difference, however. In many major branded food products the new competitive climate of more product introductions and discount pricing promotions has generally been a treadmill that requires ever-faster running just to stay in place. Because of the diffuse competition they face in the "stomach" market, however, the new strategies of Pepsi and Coke have led to a significant expansion of their market. Thus, we see that cost leaders may be more likely to implement TC since they already are focused on reducing costs. These firms may relentlessly pursue opportunities for cost reductions and adopt new programs as managers become aware of them (Chalmers, 1993, p. 50). Alternatively, differentiators may tend to adopt TC. The strategy literature suggests differentiators are able to operate from a "customer perspective" and are better able to assess the desires of their customer market. In providing the features or quality customers desire, they achieve a competitive advantage and increased customer loyalty. However, in the presence of increasing competitive pressures and declining profits, product differentiators that historically have been able to charge premium prices for a guaranteed customer market may now have to emphasize cost reduction more than in the past. TC provides a means for cost reduction that allows these firms to focus on customers and provide the same quality and functionality, but at a lower cost and acceptable return. Douglas & Rhee (1999) argues that with increasing competition in a global marketplace firms may not attempt to achieve or be able to achieve a sustainable competitive advantage. These firms, which he terms "lean enterprises," will develop and exploit temporary advantages by competing head-on with competitors. Cooper suggests that TC is a tool likely to be employed by lean enterprises pursuing a confrontational strategy. Conclusion Our major contribution is to provide early, preliminary data suggesting that the important existing strategy concept of generic strategies is relevant to and can be applied to a new business environment. Considering the predominance of case studies, we hope this study can provide a useful platform for further rigorous, empirical studies that draw on large samples of soft drink (CSD) industry firms. This study also offers some tentative implications for management practice. First, the results provide support for the viability and success of hybrid strategies. The study also suggests that the choice of strategy depends on company type. WORKS CITED Belderbos, Ren A. Multinationals and their Strategic Trade Policies. Oxford: Clarendon Press, 1997. Birkler, John, John C. Graser, Mark V. Arena, Cynthia R. Cook, Gordon Lee, Mark Loren, Giles Smith, Fred Timson, Obaid Younossi, and Jon G. Grossman. 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