Question

Coca-Cola and PepsiCo are the leading competitors in the market for cola products. In
1960 Coca-Cola introduced Sprite, which today is among the worldwide leaders in the
lemon-lime soft drink market and ranks in the top 10 among all soft drinks worldwide.
Prior to 1999, PepsiCo did not have a product that competed directly against Sprite and
had to decide whether to introduce such a soft drink. By not introducing a lemon-lime
soft drink, PepsiCo would continue to earn a $200 million profit, and Coca-Cola would
continue to earn a $300 million profit. Suppose that by introducing a new lemon-lime
soft drink, one of two possible strategies could be pursued: (1) PepsiCo could trigger
a price war with Coca-Cola in both the lemon-lime and cola markets or (2) Coca-Cola
could acquiesce and each firm maintain its current 50/50 split of the cola market and
split the lemon-lime market 30/70 (PepsiCo/Coca-Cola). If PepsiCo introduced a lemon-
lime soft drink and a price war resulted, both companies would earn profits of
$100 million. Alternatively, Coca-Cola and PepsiCo would earn $275 million and
$227 million, respectively, if PepsiCo introduced a lemon-lime soft drink and Coca-
Cola acquiesced and split the markets as listed. If you were a manager at PepsiCo,
would you try to convince your colleagues that introducing the new soft drink is the
most profitable strategy? Why or why not? (LO1, LO2)

Answer 1

Coca-Cola has introduced a lemon-lime flavored drink and that is hugely popular now. Pepsico is the competitor of Coca-Cola and it competes with the company worldwide. Pepsico was not competing in the lemon-flavored drinks market with Coca-Cola and that is something absurd because it could have earned a good market share as well as profit given its brand value as well as marketing capabilities.
If Pepsico chooses not to compete in the lemon-flavored drinks market then its profit will be $200 million. However, if it decided to compete and there is a price war then the profit of both the companies will fall to $100 million each. In another scenario, if they split the lemon-flavored market with a 30-70 ratio in favor of Coca-Cola then their profit would be $275 million for Coca-Cola and $227 million for Pepsico.
This is similar to the game theory situation and we could say that splitting the lemon-flavored market is a kind of Nash Equilibrium situation where both the parties will have the incentive to stick to the position. The price war situation will be worse off both the parties and a $27 million rise in profit indicates the incentive to Pepsico to compete in the market.
Coca-Cola will choose to split the market for a $25 million decrease in profit rather than taking $200 million hit in the bottom line.

Pepsico would be better off by competing in the lemon-flavored drinks market.