Coke Pepsi

In CSDs’ vertical chain, one of important issues that can be solved partly due to contract is inefficiency arising from hold-up by concentration producers against their bottlers. For example, based on Pepsi’s Master Bottling Agreements with bottlers, Pepsi held its bottler up by raising its sales price according to the consumer price index, though bottlers retail decreased (see exhibit 5). In order avoid inefficiency such as distrust, noncooperation and negotiation, Pepsi support its bottler, PBG to excel in higher-margin channels to generate more profits. This arrangement mitigates problems related with hold-up. On the other hand, Coke struggled to adjust relationship with its bottlers.

Other issue is price distortion. Price war in the supermarket channel had highlighted a divergence of interest between concentration producers and bottlers. To compete against bargain private-label brands, bottlers pursued a low price strategy. On the other hand, CDS price increased according to rise in CPI based on their agreement with bottlers. In this context, a contract can solve price distortion by sharing profits between bottlers and concentration producers. For instance, Coke linked concentrate prices more tightly to CCE’s wholesale CSD prices and varied concentration price in different channels and package accordingly. This arrangement reduces price distortion.

Integration eliminates (re-)negotiation cost. As mentioned earlier, in the vertical chain, a party with strong power such as Coke and Pepsi holds up the other party (bottlers in this case) when there is difference between best available price and second best available price for downstream party (quasi-rent). In order for the upstream party to hold up downstream party, the upstream party tries to negotiate price that its profit will maximize while dwarfing downstream party’s quasi-rent. For example, Coke first used fixed-price agreements with its bottlers, however, in order to use agreement which...