Steve Kaus Econ. 335 paper

Pepsi’s Antitrust lawsuit against Coca-Cola Earlier this year Pepsi Co. filed an antitrust lawsuit against Coke. “Pepsi claims that Coca-Cola controls almost 90% of the market for fountain-dispensed soft drinks distributed through independent foodservice distributors.” (bevdigest) Pepsi believes that this is why many of the big players such as McDonalds, Burger King, and Dominos sell Coca-Cola exclusively. (Wendy’s will sell Coca-cola exclusively soon) The only foothold that Pepsi has in the market as of now is the formerly owned fast food companies; Pizza Hut, Taco Bell, and Kentucky Fried Chicken. Pepsi charges that coke has made independent foodservice distributors agree to contracts that restricts the sale of Pepsi products. This gives Coca-Cola the power to control prices in this market, and also gives them the power to exclude competition. Coca-Cola has not enforced their contracts in the past, but in 1997 they threatened to cut off service to foodservice distributors who ignore the contract due to the increased competition of Pepsi. Coca-Cola’s on the other hand, has responded to Pepsi’s law suit with the statement "No amount of rhetoric can make up for a defective market definition or for a failure to allege anti-competitive, exclusionary conduct. PepsiCo's remedy is to persuade a sufficient number of retail outlets ... to serve its products rather than Coca-Cola's ... PepsiCo has not done so yet. PepsiCo takes numerous potshots at our recitation of facts ... PepsiCo's case is defective as a matter of law (and) should be dismissed." (1) If Coca-Cola’s definition of the relevant market is use, then the Pepsi lawsuit will be much harder to prove since Coca-Cola has 65% of the fountain dispensed cola sales and not the staggering 90% stated earlier.

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In my paper I will examine the case brought forth by Pepsi Co. I plan to present a basic overview of the structure, conduct/history, and performance of the fountain dispensed soft drink market. This paper outlines the economic objections of exclusionary dealings, and also will come to a conclusion on the correct definition of the relevant market in this case. Once the relevant market has been defined this paper will explain what my judgement in this case would be, and this paper will justify my conclusion with economic reasoning. Throughout this paper I will refer to “fast food stores”. This is meant to include not only fast food stores such as McDonald’s and Burger King, but also movie theaters, sit down restaurants, bars, gas stations, and any other store that uses fountain dispensed drinks. The reason this paper uses the generic term “fast food stores” is that fast food chains make up a majority of the fountain dispensed cola sales.

Structure Pepsi and Coca-Cola have been battling each other in the cola industry for years. Coca-Cola has the edge over Pepsi with almost 45% of the domestic cola sales compared to Pepsi’s 30%. When these companies battle in the fountain dispensed cola industry things change a little. Each cola company sells their syrup to foodservice distributors. These distributors then sell cola and other supplies to the “fast food stores”. When we look the percent of independent foodservice distributors that sell Coca-Cola exclusively we see that Coca-Cola owns almost 90% of this market. Once the cola has passed through the foodservice distributors it reaches the actual stores where the end user will purchase the product, “fast food stores”. At this level Coca-Cola owns 65% of the market and Pepsi owns 25% of the market. (2) The reason for the dramatic change in market

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share is because Pepsi owned three of the top seven food store chains just one year ago. But because of Coca-Cola conduct, I expect these numbers to swing even farther towards Coca-Cola’s favor.

Conduct/History As recently as one year ago Pepsi owned three major food chains. This made it much easier for Coca-Cola to take a lions share of the market. Coca-Cola was able to do this by convincing the independent foodservice distributors and the food chains that by buying Pepsi they were helping their competitors. Pepsi was competing with the fast food industry with there three national chains; Taco Bell, Pizza Hut, and Kentucky Fried Chicken. Also Pepsi had one foodservice distributor who supplied all three of these companies exclusively, so in effect other foodservice distributors were not gaining from Pepsi’s involvement in the fast food industry. With this in mind it was quite easy for Coca-Cola to get the foodservice distributors to enter contracts that restricted the sale of Pepsi. In order to be more competitive in the fountain drink market Pepsi spun off the three food chain that they owned. Now that Pepsi was not competing with their would be customers, Pepsi would be on equal ground with Coca-Cola and would be able to aggressively attack the fountain drink market. Pepsi did aggressively attack this market by offering lower prices. Coca-Cola’s response was not to meet their competition with lower prices, but to start actively enforcing the contracts they had with foodservice distributors. Coca-Cola actually threatened to cut off food distributors who sold both Pepsi and CocaCola. (4) Most food distributors business would be dramatically lessened if Coca-Cola stopped delivering their product. One variation of from this market structure is the ability

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of each company, Coca-Cola and Pepsi to sell fountain syrup directly to national food service companies. This paper will cover the pit falls of the direct sales avenue in the next section.

Performance Since Pepsi spun off the three previously owned food chains; Pizza Hut, Taco Bell, and Kentucky Fried Chicken, Pepsi has experienced some success in the fountain drink industry. As recently as this May, Pepsi was celebrating big wins in Wendy’s system. On a local level Pepsi was able to persuade some franchisees to make the switch from CocaCola to Pepsi due to Pepsi’s lowered prices. But the prior ownership of three food chains, and the contracts Coca-Cola have with foodservice distributors, are having a lasting negative effect on Pepsi’s ability to compete nationally. Just three short months after Pepsi’s local wins in the fountain drink industry, Wendy’s announced that they would be going exclusively with Coca-Cola across the nation. This announcement means that 700 to 800 Wendy’s franchises that were once serviced by Pepsi will be lost. (3) One likely reason for Wendy’s national change of heart is that with one cola company Wendy’s will be able to take advantage of joint advertising. Coca-Cola will be pouring $42 million dollars into Wendy’s/Coca-cola joint advertising in the next year. (5) As I pointed out in the structure section of this paper, Pepsi has lower prices and could supply Pepsi on a national level. In fact Pepsi claims that “Pepsi executives weren't invited to bid, but they were preparing an offer that will exceed anything that's in front of them now, "spokesman Brad Shaw said. (3) This would seem to be irrational decision by Wendy’s, or would it? I believe that Wendy’s choice to go with Coca-Cola was a functional decision. Wendy’s

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saves a large amount of money by taking advantage of joint advertisement, and their individual stores can receive their entire supply order from one company. Taking orders from one company will save money because store managers spend a significant amount of time filling out order forms. Then when shipments are received even more time is spent on counting, documenting, and putting away deliveries. It is much easier and cost effective to fill out one order form and receive one delivery.

Economic objections The economic objections in this case are quite simple. Coca-Cola has entered into exclusive contracts with foodservice distributors. These exclusive contracts state that the foodservice distributors may not sell goods from Coca-Cola’s competitors, namely Pepsi. Because of the number of distributors that have entered into these agreements Pepsi has been put at a disadvantage in the fountain drink industry. Market foreclosure is at the heart of Pepsi’s law suite. If the current contracts Coca-Cola have are not done away with Pepsi will continue fighting an uphill battle. There are very few distributors who have not agreed to Coca-Cola’s contracts. Because of this, Pepsi is limited to only a few distributors to do business with. With these limits in place there is no way that Pepsi will be able to even get it’s product to the customer. This market foreclosure has already started to work in Coca-Cola’s favor when Wendy’s decided to do away with Pepsi all together. Under current conditions Pepsi would need to enter a second market in order to compete in the fountain dispensed cola industry. Pepsi would need to create a strong national foodservice distribution company in order to satisfy the national fast food industries needs for fountain drinks and other supplies. The fact that Coca-Cola’s

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competitors must enter two markets at the same time creates a barrier to enter the fountain dispensed cola industry. Also Coca-Cola’s competitors have much higher costs and risks associated with entering the market. The antitrust laws that would come into play in this lawsuit is Section 3 of the Clayton Act. Under this Section of the Clayton Act guilt will be determined by a “rule of reason”. (7) This means that each case must be looked at individually and the defendant must be proven to have restricted competition in order for a guilty verdict to be handed down.

Similar court case One similar court case was the case against Standard Oil of California. In this case Standard Oil required independent gasoline retailers to buy gasoline exclusively from them. The retailers were also forced to buy other accessories from Standard Oil. These contracts prohibited the retailers from purchasing anything from Standard Oil’s competition. The courts ruled that Standard oil of California had violated section 3 of the Clayton act. It was the courts hope that independent retailers would have “split-pump” stations. (6 pg. 277) Of course this did not happen, instead the oil companies entered the retail end of gasoline sales selling only their brand of gasoline at a given station. This case is very similar to the fountain dispensed cola industry. If courts ruled the same way we probably would not see “split-fountain” in fast food stores, but instead distributors who sold multiple brands of cola. This would allow Pepsi syrup to be delivered with all the other food service supplies. Because of this, Pepsi would be able to become equally competitive with Coca-Cola in attaining exclusive rights to supply fountain cola to national fast food chains. There are many companies Pepsi would then be able to service,

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such as Wendy’s, Burger King, Domino’s, and McDonald’s who have all gone with CocaCola as their exclusive cola distributor. I believe that the fact that all these companies have chosen and stuck with Coca-Cola even though Pepsi has lowered their prices and Coca-Cola has not, suggests how much of an advantage Coca-Cola with the current situations.

Relevant Market There are three different markets that we could look at when comparing Pepsi and Coca-Cola. The first would be cola sales in general. I believe that this would not be a good choice. This definition is too broad and takes bottled cola sales into account, something that this lawsuit has nothing to do with. A better definition of the relevant market would be the actual percentage of fountain drink sales Pepsi and Coca-Cola have in a given year from “fast food stores”. This definition is better because it focuses on fountain drink sales exclusively. But there is a problem with this definition also. The percentage of fountain drink sales is dependent on the ability of each company to get their product to the “fast food stores”. In other words, the ability of each cola company to sell their cola to foodservice distribution companies in order to get their cola to the “fast food stores”. For this reason I feel that this definition is inferior to the last definition of the relevant market. I believe that when looking at this case we must look at the market share of each cola company in the foodservice distribution industry. This gives us a more accurate feel for the competitiveness of each cola company in the fountain drink industry. If a cola company is closed out of the foodservice distribution industry, for whatever reason, this companies ability to compete in the fountain drink industry will be cut off also

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because there will be no way to get their product into the “fast food stores”. Unfortunately this is what has happened. According to Pepsi “Virtually every major foodservice distributor in America today has an agreement with Coca-Cola.” (1)

Comments & Conclusion With the information available to me, I would have to rule in favor of Pepsi. I will admit that much of the information that I had to work with was a little one sided, but I believe that Coca-Cola has attempted to foreclose Pepsi from the fountain dispensed cola industry. Even though Pepsi technically is not excluded from competing for any fountain dispensed cola customers, Pepsi is functionally excluded from competing because of the increased costs associated with “fast food stores” taking deliveries from multiple companies. A second reason why Pepsi looses out is that the national “fast food chains” can not take advantage of joint advertisement like they can if they choose Coca-Cola and Coca-Cola blocks Pepsi’s ability to service a new national chain with the contracts they have in place. A final reason why I feel that the contracts will no longer be able to be enforced; one way or another, is the fact that the cola industry is already a highly concentrated industry with only two major players. If the U.S. government allows CocaCola to dominate the market we may start to see higher prices because of their market control. Pepsi must be allowed to sell to any foodservice distributor they choose to do business with. Although I do have to side with Pepsi in this case, awarding damages, and treble damages is where I have to draw the line. Although Coca-Cola’s actions left unchecked will hurt Pepsi’s ability to compete in the fountain dispensed cola industry, I do not feel that Coca-Cola is to blame for Pepsi’s current market position. I believe that

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because Pepsi entered the “fast food industry” many companies chose not to give their business to a competitor. I do not think we can blame Coca-Cola for pointing out to other companies that by purchasing and selling Pepsi products, they would be helping their competitor. So in the end I would call for the end of the Coca-Cola’s contracts, but no further action.

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Bibliography 1 http://www.beverage-digest.com/980702.html. Soft drink Litigation Update 2 http://www.theonlineinvestor.com/pep_spotlight.shtml PepsiCo Cola War Turns Ugly 3 http://texnews.com/1998/biz/wendy0825.html. In Setback to Pepsi, Wendy’s Wants Coke For the Next Generation. By John Seewer 4 http://www.beverage-digest.com/980508s.html. Pepsi Sues Coke in Antitrust Action Over Fountain Business. Marineau: ‘War Against Coke.’ 5 The Pantagraph. 8/25/98 Wendy’s Filing up With Coke. Associated Press With Pantagraph Staff 6 Enterprise, government, and the Public. Walters, Stephen J. K. Ed. Strandford, Scott D, and Izzo Caroline. McGraw-hill. 1993 7 http://138.87.168.39/econ_web_pages/david_loomis?335web/reg6.html. Vertical Restraints. Loomis David.

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