In 1985 the Coca-Cola company made a well-publicized change in its formula for Coke. The company touted the change with a huge marketing campaign. In fact, the formula for Coke had been quietly changed six years earlier.
Because of worldwide shortages, the price of beet and cane sugar jumped from 19 cents per pound in September 1978 to 26 cents per pound in January 1979. While such a price hike does not dramatically affect most sugar buyers, for Coke it was catastrophic. A change of 1 cent per pound in sugar prices can cause a $20 million swing in Coke’s operating profits. The bottling empire is America’s largest sugar buyer, taking a million tons per year, or about 10 percent of all the sugar sold in the United States. Because of the efficiencies of corn production in this country, a sweetener made by refining corn into sugar makes high-fructose corn sweeteners about 10 percent cheaper than beet and cane sugar when prices are normal. By using a 55 percent fructose sweetener, Coca-Cola can realize substantial cost savings, particularly when sugar prices are abnormally high. Coke publicly announced the switch to corn sweeteners in January 1979, but other than sugar producers and traders, no one seemed to notice. Eight months later, 7-Up followed suit and decided to increase its use of corn sweeteners, and Pepsi also considered such a move.
The response of the soft drink companies to the increased price of sugar is typical of any firm faced with a price hike for an input. Firms try to reduce the use of inputs whose prices rise in order to maintain profits or to avoid having to raise the price of their products (and risk losing sales to competitors). The greater the increase in the price of an input, the more incentive there is for a profit-maximizing firm to conserve on its use of that input.
Case Study Questions
1. What type of market structure is Coca-Cola a part of; competitive, monopoly, monopolistic competitive or oligopoly? Explain your answer.
2. Draw a graph of the pricing model for Coca-Cola and the change that happened when beet and sugar prices jumped and when they switched to a new sweetener? (make sure you show all the ATC curves)
3. Discuss why it is important to find inputs that reduce costs. Will this market structure try to reduce costs if the price is above ATC? Is this socially efficient?
4. What substitutes would consumers find for Coca-Cola if they can’t reduce costs?