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SEPTEMBER SEMESTER 2011
BPME7103 – ADVANCED MANAGERIAL ECONOMICS
ASSIGNMENT (50%)
LECTURER
PROF. DR. MOHD GHAZALI MOHAYIDIN
STUDENT
ANAS BIN ALAM FAIZLI
Cure for all ilnesses
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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___________________________________________________________________________
Read the following case and answer the questions given at the end of the case.THE GLOBAL FOODS SDN BHD (GFSB)___________________________________________________________________________
The Situation
The last of the color slides was barely off the screen when Bakar, the CEO of Global Foods Sdn Bhd, turned to his board of directors to raise the question that he had been waiting all week to ask. “Well, ladies and gentlemen, are you with me in this new venture? Is it a ‘go’? Shall we get into the soft drink business?”
“It’s not that easy, Bakar. We need some time to think it over. You’re asking us to endorse a very major decision, one that will have a long-term impact on the direction of the company.” “I appreciate your wish to deliberate further, Dr. Salleh,” Bakar responded, “but I would like to reach a decision today. As the president of a major university, you have been especially valuable in advising this company in matters relating to social and governmental policies. But we must diversify our business very soon in order to maintain the steady growth in profits that we have achieved in recent years. As my presentation showed, the manufacturing and marketing of our own brand of soft drink is one of the best ways to do this. It represents a significant diversification, yet it is very closely related to our core business: food.
“The economics of the soft drink market tell us that we would be foolish to pass up the kindof investment return that the market offers to those newcomers willing to take the risk. The food business is generally a mature one. On the other hand, our forecast indicates that there is still a lot of room for growth in the soft drink market. To be sure, there is a tremendous amount of competition from the ‘red team’ and the ‘blue team.’ But we already have expertise in the food business, and it should carry over into the beverage market.”
“That’s just it, Bakar,” interjected another board member, “Are we prepared to take this risk?You yourself acknowledged that the market power wielded by the two dominant companiesin this business is not to be taken lightly. Others have tried to take market share from themand have failed miserably. Moreover, the projections that you have shown for a growing softdrink market are based on the assumption that the growth rate will remain the same as it hasbeen in the past ten years or so. As we all know, the soft drink market has been growing, butis has also been very fickle. Only recently, Malaysians were on the health kick, and fruitjuices and bottled water along with health foods were in fashion. Now it seems that softdrinks are back in style again. Who knows what people will want in the future? Maybe we’llall go back to drinking five cups of coffee a day. And, what about all the money that we’regoing to have to spend up front to differentiate our product? As you well know, in theprocessed-food business, establishing brand recognition - not to mention brand loyalty – canbe extremely difficult and costly.”
“Well, ladies and gentlemen, all our concerns are certainly legitimate ones, and believe me; Ihave given much thought to these draw-backs. This is one of the biggest decisions that I willhave made since becoming CEO. My staff has spent hundreds of hours analyzing allavailable data to arrive at a judgment. Our findings indicate a strong probability of earning anabove-average return on an investment in the soft drink business, a return commensurate with
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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the kind of risk we know exists in that market. But if we could make all our decisions with 100 percent certainty simply by feeding numbers into a computer, we’d all be out of a job. To be sure, details on production, cost, pricing, distribution, advertising, financing, andorganizational structure remain to be ironed out. However, if we wait until all these detailsare worked out, we may be missing a window of opportunity that might not appear again inthis market for a long time. I say that we should go ahead with this project soon as possible.And unanimity among the board members will give me greater confidence in this endeavor”.
The QuestionsFor all the questions below,a. Deliberate on the situation;b. Ask yourself the key question;c. Identify related theories and concepts;d. Determine data, facts, and information needed; ande. Answer the key questions.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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1. INTRODUCTION:
a. The Firm and Its Goals. What should be the goals of GFSB?
b. The Value of the Firm
How GFSB can improve the value of the company, especially when analysts are judging
a company primarily on its ability to grow its revenue and profit?
This report is written succinctly to elaborate Global Foods Sdn Bhd (GFSB) decision making
process, methodologies and strategies executed prior to investment into a new market of
carbonated soft drink. It will address the goal and value of the firm, demand analysis,
production and cost of production, the market structure, the pricing strategy and the reasoning
behind the decision made after considering all these factors. The Encyclopaedia of Global
Industries (EGI) (2007) stated that the term soft drink was coined to distinguish flavoured
drinks from hard liquor. However, for this report, the product will only be considering on
carbonated soft drinks only and not the entire range of soft drink beverages. This report is an
important instrument as it forms the basis and the decision support for GFSB to enter the
carbonated soft drink market with its new honey cola taste carbonated soft drink. The 1
Malaysia cola drink proposal has been taken out from this as it carries its own economic
merit and can be evaluated as a separate project.
GFSB primary goals and objective is shareholder wealth-maximization which can be
achieved through profit earning. Shareholder wealth is the measure of the value of a firm,
which is measured by the present value of all future cash returns expected to be generated by
the firm for the benefit of its owners (McGuigan et al., 2011). Hence, it is imperative and is
most beneficial to GFSB to ensure shareholder wealth is maximized and eventually results in
maximizing the value of the firm. This will emulate Berkshire experience where its book
value has growth from $19.46 to $91,845.00 per share in 41 years period. This is achieved
by among many others, maximizing shareholder’s wealth where Berkshire’s managers and
directors own over 47% of the firm’s stock.
Shareholder wealth maximization implies that a firm needs to be forward looking, dynamic
with a long term outlook, anticipate and manage changes, and also acquire strategic
investment opportunities (McGuigan et al., 2011). This will contribute and continue growing
GFSB’s business and support the diversification initiatives. The new venture into the soft
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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drink market business and the economics that it offers is substantial and will be a strategic
investment opportunity. The return of investment is higher than the cost of capital which will
definitely support the decision. Thus, such decision will directly support the overall firm
objective in maximizing shareholder wealth and the end result will without no doubt increase
the value of the firm. It also promotes long term growth and firm survival, having taken into
account the interest of the shareholders. This will also ensure shareholders loyalty to the
firm.
The value of the firm is measured by the present value of expected future profits or cash
flows. It takes into account discounted rate at the shareholder’s required rate of return before
tax. Let us take a look at The Coca-Cola Company (TCCC) which is the world’s number one
leading soft drink brand. TCCC owns four of the top five soft-drink brands (Coca-Cola, Diet
Coke, Fanta, and Sprite). Its other brands include Minute Maid, Powerade, and Dasani water.
In North America it sells Groupe Danone's Evian; it also sells brands from rival Dr Pepper
Snapple Group (Crush, Dr Pepper, and Schweppes) outside Australia, Europe, and North
America. (The Coca-Cola, 2011)
Key numbers for fiscal year ending December, 2010 for TCCC:
Sales: $35,119.0M
One year growth: 13.3%
Net income: $11,809.0M
Income growth: 73.1%
These numbers are a good Key Performance Indicators to show TCCC values of the firm.
The formula use to calculate the form is shown below:
V = 8
1
)1/( te
t
kt
where,
V = present value of future profits
= expected future profits or cash flow
ek = discount rate or required rate of return
t = time (number of years)
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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Based on this formula it can be seen that if firm reduce the perceived risk of a firm, which
will result in a reduced in the required rate of return, ek this will increase the value of the
firm. In conclusion, there are two ways which will eventually increase the value of the firm,
one is to grow its revenue and profit as economic analysts like to point out, secondly is by
reducing the risk of a firm and the required rate of return. This investment decision can
support to achieve this objective. Investments can always be sorted in the list of highest risk
and the highest return. These two factors can be considered prior to making any investment
decision.
How GFSB will make decisions to invest in a new market? Boundaries and limitation to the
decision will be problems related to the three (3) key focus areas namely to incomplete
markets, asymmetric information, and unknown re-contracting costs. These complications
will be addressed in this report and will be among the many decision support instrument to
allow GFSB make an informed decision for this new venture and allow the maximization of
the present value to equity owners through the new strategic investment opportunity.
Figure 1.1 - The Decision Making Process (McGuigan et. al., 2011)
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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GFSB adheres to ensuring that decision making in the firm are made through a structured six
step decision making managerial economics process as illustrated in Figure 1.1. Each
decision seeks to support the firm’s primary objective. All managerial decision will be made
after carefully going through alternatives and opportunity costs and will select the best
decision that support the objective in the most efficient manner and taking into account all
risks and constraints.
This investment decision will also help establish GFSB brand name in the soft drink
industry and assist to continue growing the firm value. As a result of this expansion, capital
investment will be made, new manufacturing plant would be opened, more employees would
need to be employed and the opportunity will be made available to further grow the firm
value. This can be considered as a catalyst for improving the firm value by expansion and
diversification to soft drink industry which would lead to new business opportunities and
potentials.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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2. DEMAND ANALYSIS:
a. State the relevant managerial objectives.
b. How do you use demand analysis to serve the managerial objectives?
Demand analysis plays important role in delivering three key relevant managerial objectives
as follows:
i) Provides insight and information necessary for GFSB to manipulate, control and
benefits from demand.
ii) Helps GFSB forecast and guess estimate an accurate potential sales and revenue.
iii) Projects revenue stream portion of a firm’s cash flow stream for financial planning.
Prior to committing to a new strategic investment opportunity these three managerial
objectives and functions are required to effectively conclude the economics of any market,
new or old. The same goes to the soft drink industry. Prior to commitment to the business, a
demand analysis is required which will provide the required information for supporting the
decision. It is pivotal that the management of GFSB is made aware of the potential
forecasted unit sales the new business will be able to generate and hence the revenue which
will be critical for financial planning both capital and operational expenditures of the new
business.
Demand analysis also confirms the price elasticity of demand, which is required to accurately
measure a range of responsiveness of any change in the quantity demanded. Simply said,
price elasticity of demand gives the percentage change in quantity demanded when there is a
percentage change in price and vice versa. This remains true where all other determinants
constant of demand remain unchanged.
Figure 2.1 Law of Demand showing price in relation to Quantity demanded in Litre
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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The law of demand is governing to all products without exceptions and carbonated soft drinks
also are unable to shy away from this law. The higher the price, the lower the quantity of
demanded for the soft drink would be and vice versa, as reflected in Figure 2.1.
The carbonated soft drink market has grown tremendously over the past 100 years. The EGI
(2007) stated that the global soft drink industry is exclusively a marketing phenomenon. The
product is only a simple blend of water, sweeteners, flavors and other additives, yet however
the EGI (2007) complimented that the industry’s genius lies in getting billions of consumers
to drink soft drink instead of plain water or other beverages. Furthermore, from 1960 to 1990
the growth of soft drink outpaced the population growth for the period and per capita
consumption of soft drinks increased 2.5 times (Muris et al., 1993).
According to Euromonitor (Euromonitor International, 2011), F&N Coca-Cola hold the
biggest soft drinks share in Malaysia at 72% of the total market. This is contributed directly
by the Coca-Cola brand. There is strong determination from consumer to live better and
choose healthier drinks which is expected to give halt to the growing consumer base for soft
drinks. However, it is projected that the growth for soft drinks will continue to soar
contributed by two factors, the increasing number of working Malaysians which is expected
to reach thirteen millions by the year 2013 and the global economic downturn which leads to
professionals going for fast foods and soft drinks (Just the facts, 2011). Being a product of
modest price, the cost of soft drinks will remain non criterion for consumer to continue
consuming the product. Furthermore, in Malaysia, it is reported that 1000 cans of soft drink
is being drink every minute (Bernama, 2007).
GFSB adheres to the demand estimating using marketing research techniques, i.e consumer
surveys, consumer focus groups and market experiments. Surveys have been done to
understand consumer’s needs better and assist in gauging demand on soft drinks. A
consumer focus group and market experiments with the intention to experiment and test
market demand condition has also been executed. Soft drinks with GFSB logo that imitates
Coca-Cola red and white colour has been tested at various stores and indicates positive
results.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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Consumer surveys and statistics from statistic department has been collected. These data will
then be analyzed through marketing analysis technique, to name a few, i.e deterministic time
series analysis, barometric technique, econometrics models, forecasting output with input,
and polling techniques.
Table 2.1 Soft Drinks quantity demanded in litres for 2000-2010 and its growth, Adapted
from United Nations Report on Soft Drink for Malaysia
Table 2.2 Soft Drinks forecasted quantity demanded in litres using two techniques
Table 2.1 and 2.2 shows where statistical data can be used for forecasting. Table 2.2 shows
where the first forecast using technique a, called time series model is used to quantify the
quantity demanded for the next five years.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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The formula used is as follows:
Xt+1 = Xt + (Xt – Xt-1)
Technique b however used the average growth of the data for 10 years which is 6.44% and
assumes the same for the next five years.
Demand analysis can be used to serve the three key managerial objectives as mentioned
earlier. These will assists in sales forecasting, making financial decisions, setting the price,
making marketing decision and deciding the quantity of the production.
The soft drinks market consists of retail sale of bottled water, carbonates, functional drinks,
juices, RTD tea and coffee, and smoothies. The Malaysian soft drinks market generated total
revenues of $1.3 billion in 2010, representing a compound annual growth rate of 4.5% for
the period spanning 2006-2010. Carbonates sales proved the most lucrative for the Malaysian
soft drinks market in 2010, generating total revenues of $407.5 million, equivalent to 30.9%
of the total soft drink market's overall value. (Soft Drinks, 2011). These figures presented
shows promising space and room for more players and firms to engage and enter the
carbonated soft drinks market.
The market demand function for a product can be expressed as:
Product X = Qx = f (Price of X, Prices of Raw Materials, Price Changes Expectation,
Consumer Incomes, Population, Taste and Preferences, Advertising Expenses, etc)
The demand function illustrated above shows variables which are commonly used to run
regression to see the inter-relations between each variable. In the case of carbonated soft
drink industry the demand function can be as below:
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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Q = x1P + x2RM + x3CI + x4Pop + x5TP + x6AE
The equation above is a linear function that will try to evaluate the inter-relationship between
each variable, where a change in one variable will affect the outcome of the quantity
demanded to the soft drink.
The variables representation is shown below:
x1 = Price
x2 = Price of Raw Materials
x3 = Consumer Average Income
x4 = Population
x5 = Taste and Preference
x6 = Advertising Expenses
A 10 years historical data from the customer survey and statistics will be used to run the
regression analysis; as a result the previously unknown inter-relationship has been identified
as follow:
Q = -1000P + 100RM + 500CI + 50,000Pop + 20TP + 500A
The equation can be read as the quantity demanded for soft drink (litres) will fall by 1000 for
each RM 1 increase; rises by 100 with each change in raw materials (RM), increase by 500
for each RM 1 increase in average income (CI), and the quantity demanded increase by
50,000 with each additional 1 million persons in the population (Pop), and it increase by 20
upon enhancement of taste and preferences (TP) and increase by 500 with each RM 1 million
spent on advertising (A).
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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3. PRODUCTION AND COST OF PRODUCTION:
a. Managers are required to make resource allocation decisions. Identify the relevant
production theory for the above case.
b. Discuss the analysis that you would carry out to assist in the decision making.
Production and cost production remains one of the most important steps, in making a
managerial economic decision for a strategic investment opportunity. This is more important
if the decision revolves in entering a new market. A good historical data and market survey
is thus required to ensure that production can be done in the most efficient or the least cost
manner. There are many tools which will be deliberated further where these tools will assist
in recognizing how to produce at the most least cost. A production function will relate the
highest output which can be produced from a given input, namely the variables. These
outputs can assist in measuring the average and marginal product of each input. Some inputs
are fixed while some follows the Law of Diminishing Marginal Returns.
Another important factor to cost in is the time frame. A production function give different
results and is required to be calculated differently depending on the time frame which can
either be a short-run or a long-run production function.
Figure 3.1 – Data and Graph for Production Function
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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The input to a production function will be cost and labour. Output can be increase by either
increasing cost or labour or both. If both inputs can be changed to increase the production
that means the production function is in the long-run period. However, if one input is keep at
constant and while the other input is changed to increase production that means that the
production function is in the short-run period.
Figure 3.1 reflects in theory the most standard linkage showing total product (TP), marginal
product (MP) and an average product (AP) and also proven the law of diminishing marginal
returns. It is like a bell curve, it may vary from a production function graph to another, but in
essence it will always follow the same essential rules. The relationship in the graph is
summarised as follows (Mohayidin, 2011):
If MP is positive then TP is increasing.
If MP is negative then TP is decreasing.
If MP > AP then AP is rising.
If MP < AP then AP is falling.
MP=AP when AP is maximised.
L1, L2 and L3 are identified as three stages of production. Stage 1 indicates AP rising from
zero to maximum AP and this also equates elasticity as one. Stage 2 is when the AP is
declining while the MP remains positive. It starts from where AP is in its maximum until MP
is zero. Elasticity in this stage is between zero and one. Stage 3 is where the MP will
become negative and the TP starts to decline and the elasticity becomes less than zero. This
concludes that for a production cost in short run, it should only best to be operating in Stage
2. There are then other production functions in the long run, and with more than one variable
input and etc.
However, the most common used form of function used in empirical studies to affectively
understand GFSB resource allocation strategy and identify the labour and capital required
would be the two-input model used by Cobb and Douglas as per the following formula:
Q = αLbKc
Where,
Q = total production (can be presented as the monetary value of goods produced, RM)
L = labour input
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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K = capital input
a = total factor productivity
b and c = output elasticities of labour and capital respectively.
Output elasticity will measure the effect for an output to a change of either labour or capital
used in production, ceteris paribus. For example, if b = 0.8, a 1% increase in labour would
lead to a 0.8% increase in output.
To get value of b and c, see following equation:
Q = αLbKc
Log Q = Log ( α LbKc)
Log Q = Log α + Log Lb + Log Kc
Log Q= Log α + b Log L + c Log K
A regression run will derives the value of b and c.
In supporting GFSB firm’s objective and part of the shareholder wealth maximizing efforts,
an efficient pricing and output strategy is important as it will in return maximize the present
value of the future profit stream to the firm. There are many factors which will determine the
best strategy to maximizing wealth. It depends on the production capacity, cost levels,
demand characteristics and the potential for long term competition and anything immediate.
The most important step prior to being able to do this is first to understand the market
structure. This is the most important information to support all the other managerial decision
related to economics.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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4. MARKET STRUCTURE:
a. Determine the market structure this particular firm is in.
b. Support your answers.
c. How would you determine the optimal quantity and price under this market
structure?
Porter noted in his book in 1980 titled Competitive Strategy and followed by another, called
Competitive Advantage in 1985 offered Porter’s model of competitive analysis which
concluded that a business strategy in pricing or output should be based on the market
structure in which firms operate. Understanding the market structure supports in identifying
target markets, in this case the soft drink industry. The strategic investment opportunity can
only be successfully implemented if a proper market understanding is gained and recognizing
the changes it will make to the firm’s resources, capabilities and core competencies, which in
this case is the foods industry.
Pure Competition
Pure Monopoly Monopolistic Competition
Oligopoly
Number of firmVery large number of firms
One firm Many firms Few firms
Product typeStandardised products
Unique product Differentiated products
Standardised or differentiated products
Price controlNo control over price
Much control over price
Some control over price in a narrow range
Control over price circumscribed by mutual interdependence
Entry obstaclesNo obstacles to entry
Entry is blocked Relatively easy entry
Many obstacles to entry
Price competition
No non-price competition
Public relations advertising
Much non-price competition
Much non-price competition
Table 4.1 Market Structure Types and Comparison between Pure Competition, Pure
Monopoly, Monopolistic Competition and Oligopoly
Table 4.1 exhibits the attributes and characteristics between the four market structures
category namely pure competition, pure monopoly, monopolistic competition and oligopoly.
Going through the four characteristic of soft drink market will inevitably identify the market
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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structure of the soft drink industry. The soft drink market share in Malaysia is in short
divided between few major firms, F&N, Coca-Cola Company and PepsiCo, Inc. with the
latter having a smaller share of the market (Datamonitor, 2011). Globally, the soft drink
industry is dominated by give big companies, Coca-Cola, Cott, Cadbury, National Beverage
and Pepsi which in total accounted for 95% of soft drink sales worldwide (John and Carl,
2010).
Soft drink industry market structure is a monopolistic competition. Comparison and further
deliberations will be made further to prove this point to show why a soft drink market is not
an oligopoly. An oligopoly is the domination of the market by a few firms. Some might
argue that a soft drink market structure is a duopoly where only two firms dominate a market
which is not the case for the soft drink industry as there are more than two players but not as
many dominant more than the big five. Furthermore, there is no standardised product in a
soft drink market, hence a monopolistic competition.
Where an oligopoly exists, a few large suppliers will be dominating the market and industry
leading to a high degree of market concentration. This means the market share is taken by a
few leading firms as in the case of the soft drink industry. An oligopoly market offers high
barriers to entry. It will be difficult to make an entrance into the market. Consumer loyalty
and brand recognition has already been embedded in the market and will make it difficult for
new players to enter the business, and which is not the case for the soft drink industry as
shown in Table 4.2 where 36% consumers surveyed opt to try on new beverage.
Table 4.2 Surveys of Reasons for Trying New Beverage, Oct 2011
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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This often leads to a lack of price competition as the big players in the industry would be very
sensitive to play with the price. Any changes in price can lead to an informal collusion as
firms try to match their price and can lead to a price war. As an oligopoly market structure
involves few firms, any action by another firm will be noticed by the other competitor and the
competition will be more towards advertisement and marketing rather than through price. If
a firm cut the price, the other firms has to follow, this is an unhealthy practice in the business.
However, if a firm increase the price, other firms might not follow which can leads to losing
the market share and profits as per the law of demand and supply.
The soft drink carbonated industry is unquestionably the best example of monopolistic
competition structure. It is either a Coke or a Pepsi and perhaps a Sprite or 7-Up. It is a
much branded industry where every brand is recognized by the consumer. Any moves by any
of these firms are also likely to evoke a countermove by its rivalling competitors. The
famous Cola Wars is a classic example of this rivalling competition where each firm try to
outdo each other via advertisement and marketing (“Cola Wars,” 2011).
In conclusion the soft drink industry is in a monopolistic competition market structure due to
the reason that there are many firms, relatively easy entry, differentiated product, there is
some control over price in a narrow range and much non price competition.
Table 4.3 to 4.5 is a comparison of price summary statistics which is carried across the board
for various carbonated soft drink products.
Uri (1986) has undertaken a study to calculate beverage price elasticity where the result
shows all own-price elasticity were negative and significant at 1% level and demand for
whole milk -0.69, juice -0.52, soft drinks -0.80, coffee and tea -0.89 was inelastic.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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Table 4.3 Price Summary Statistics for Carbonated Soft Drinks, 1 RM for each 2 litres
Table 4.4 Own Price Elasticity Results and Share Equation Summary Statistics for
Carbonated Soft Drink New Product Introductions, 1 RM for each 2 litres
Table 4.5 Own Price Elasticity Results and Share Equation Summary Statistics for
Carbonated Soft Drink Sector Leaders, 1 RM for each 2 litres
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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It is important that an optimal pricing strategy is adopted for the new product in dynamic
monopolistic competition market. The two major factors which will influence GFSB’s new
product pricing would be diffusion effects on the demand side and the cost experience
effects. The demand side and diffusion effects refer to increase or cause the likelihood to buy
to increase. This includes words of mouth, improved reputation of the products via
advertisement and other factors. As more units of the new products are sold, the remaining
untapped market potential decreases. On the cost experience effects, it implies on the
learning curve effects. The unit production costs will decrease as cumulative output
increases, ie experience. Optimal price determination as discussed previously is in reality
more difficult, complex and complicated from the one presented in the literatures. The two
most important characteristics of real world markets are dynamics and competition. These
two characteristics have continuously shaped the pricing strategy required for new products
which however has always been neglected or treated inadequately in the pricing strategy.
Kalish (1983) pointed out that the main direction for future research in the area of dynamic
pricing is the incorporation of competition and competitive interdependencies. Thus, in order
to derive pricing for a new product, a marketing survey, a customer preference regressions
engulfed with the demand side and cost experience effects can determine the most optimal
pricing of the product.
An optimal pricing technique can be made by following several steps where GFSB would be
required to develop the market strategy, marketing decisions, estimate the demand curve,
calculate the cost for the product, understand the competitor, the pricing requirement and
objectives (revenue and profits) and finally with all the steps would be able to finalize the
best price for this new product.
Pricing methods that can be used includes cost-plus pricing, target return pricing, value-based
pricing and psychological pricing. Cost plus is where the production cost plus an agreed
profit margin would be the set price. Target return price is where the price would be the price
which allows return on investment. Value based pricing would where the price is based to
customer relative to other brands. Psychological pricing is based from consumer perspectives
where the consumer feels that the set price is fair.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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5. PRICING STRATEGY:
a. In reality, price determination is more complicated than the one discussed in
Question 4. Why?
b. Would you consider a more complex pricing technique for your product?
The demand curve in an oligopoly market structure will look like a peculiar demand curve
often called kinked demand curve. The curve is a downward sloping demand curve and the
price elasticity might depend on the reaction of rivals to changes in price and output. This
also suggests that demand curve is not straight. An increase or reduction in price will be very
sensitive and will take into consideration what other competitors might react. A price cut will
only if the potential that other firms will not follow. A price increase will however be done if
there are the potentials that other firms will follow to ensure prospects of losing market share
does not occur. In conclusion, an oligopoly market structure has little incentive to change
price.
Oligopoly market structure however has a different approach when it comes to pricing and
output determination as it needs to compare with its competitors. It is not as straight forward
as a monopoly market where the monopolist will need not to worry about pricing strategy by
its competitor as it has no rivals. The same goes in a pure competition market where pricing
by a firm is independent decision and does not affect other firm as there is no single firm that
is influential enough to bring effect to the market price. In order to maximize shareholder
wealth, it is important that in an oligopoly market structure, all rival responses remain an
important factor in decision making and especially in the pricing and output strategy.
The demand curve for a monopolistic competition will however looks differently. It slopes
downward due to product differentiation. The demand curve slopes downward from the left
to the right. In the short run, the demand curve for firms in the monopolistic competition
might vary. The profits can be categorized as super profits, normal profits or subnormal
profits as illustrated in Figure 5.1 to 5.3.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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Figure 5.1 – Monopolistic Competition Firm’s Super Normal Profit
Figure 5.2 – Monopolistic Competition Firm’s Normal Profit
Figure 5.3 – Monopolistic Competition Firm’s Sub-Normal Profit
In the long run however, a firm in the monopolistic competition would only earn normal
profit. This is due to normalization. Whenever a firm in a monopolistic competition indulges
A,B,R,F,C = Intersection PointsMC = Marginal CostMR = Marginal ReturnATC = Average Total CostAR = Average RevenueQe – Optimum Qty at the PointPe – Price at Point
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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in super profit scenario, this will indefinitely attracts a number of new firms to make entrance
to market. This would normalize the super profit firms to normal profits. In the event of sub
normal profit, some firm would leave the industry and again normalizing the other firms to
normal profits. Notice that the change from Figure 5.1 to 5.3 is only on the ATC which is
shift either upward or below which result in different intersection of the ATC with MR at Qe.
In a monopolistic competition market, the price determination can be more complicated as
there are many numbers of firms and due to the condition of easy entry and exit attribute.
Product differentiation also plays a major role which contributes to a difficult price
determination. Further factors which lead to difficulties in price determination are as follows:
1. Excess capacity.
2. Average cost equal to price (long run).
3. Product advertising (lead to non price competition).
As a result of all this factors, it is difficult to identify Marginal Return (MR) and Marginal
Cost (MC), and also the price point where MR = MC. Furthermore, the profit will be only
maximized at short-run profits.
Thus, a more complex pricing technique is required to further enhance the profits. Suggested
techniques include product bundling and the loyalty program. Price can means differently
under different context, it can be rent, tuition, fee, fare, interest, assessment, retainer fees,
salary, wages, and income taxes (Schwartz, 1981). It is also defined as the quantity or
amount of thing exchanged in sale or barter for another at the cost at which the object is
obtained. The pricing strategy is dependent on the very nature of the product, and in this case
a new product introduction of a different taste. A honey taste carbonated cola drink.
In the case of honey soft drink, market skimming and market penetration can be the pricing
strategy that should be employed for this product as it is innovative and new. This product
will need to be positioned in the marketplace in order to acquire profit. Kotler and
Armstrong (1991) noted that this kind of product can employ some of these options: product-
line pricing, optional-product pricing, captive-product pricing, by-product pricing and
product-bundle pricing. In economics, pricing strategy is objectively understood as a method
on how to set price under certain assumptions to maximize profits.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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Product bundling is a business strategy that packages physical product together, prices and
sells it as a single entity. This strategy is an effective instrument for price discrimination
which also presents opportunities to enhance revenue without increasing the input or raw
materials required to produce the end product. This is already a common practice across both
service and manufacturing industries. Bundling satisfy customers who many not be
interested in buying the individual product but might be keen to buy the either one of the
product in the bundle. GFSB can use this product-bundle pricing strategy to bundle its food
range of products with the new introduced honey drink.
Another strategy that can be adopted is loyalty or reward program. Soft drink industry is a
market with repeated purchases, it is common for a firm to offer different or special discount
to its repeat customers. This will also help entice customers to switch from their existing
brand and become GFSB customers.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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6. CONCLUSION:
Should Global Foods (GF) enter the soft drink business?
Figure 6.1 GFSB Revenues and Forecast, 2001-2010
Figure 6.1 exhibits the potential revenue generation by diversification into the soft drink
market. Data is presented based on the projected sales of the new product at a growth rate of
8% per year. The decision to expand into the soft drink market via honey cola which is
illustrated in Figure 6.2 will also enable future potentials and tap into potential new markets.
This would also assist in introducing other new products in the future, ie 1 Malaysia Cola.
GFSB revenue is forecasted to grow from the current RM 85 Million (2010) to RM 204
Million for year 2020.
Figure 6.2 Proposed Honey Cola Can Packaging
Cure for all ilnesses
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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The capital requirement for soft drink industry necessitates a USD 50 Million initial outlays
(McGuigan, 2011). This would be enough for the plant, bottling, manufacturing and
operations, transportation and distribution. GFSB budget for expansion as approved by board
is at USD 200 Million.
Table 6.1 New Carbonated Soft Drinks Products by Flavor, 2005-2010
Table 6.2 New Carbonated Drinks Products by Company
Carbonated soft drink industry is distinguished by product differentiation at attribute and
ingredient level. Anderson (2008) has noted that the pivotal key for beverage companies for
their product is differentiation. This is the most important factor of success for soft drink
products. Product differentiation can be driven by brand, flavour, calorie content, taste and
others. Ulrich and Eppinger (2000) noted that it is critical to understand customer
preferences, short product life cycles and fast technology changes for a successful
introduction of a new product. Furthermore, if multiple firms are producing similar products
pricing decision would become more complicated in such a dynamic environment.
Lazim & Hasliza (2011) concluded that in Malaysia there are four major factors in
consumer’s preferences over the selection of their soft drinks: branding, validation and prices,
packaging and taste, respectively while branding is proven to be the dominant factor in
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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customer preferences. Understanding these factors would be pivotal key decision factors to
make entrance to the soft drink market. As mentioned earlier, soft drink growth will continue
as working Malaysians reach thirteen millions by the year 2013 and the global economic
downturn which leads professionals going for fast foods and soft drinks (Just the facts, 2011).
The cost of soft drinks will remain non criterion for consumer to continue consuming the
product. The Malaysian soft drinks growth rate is 4.5% for the past five years where
carbonated sales are 30.9% of the total soft drink market's overall value. (Soft Drinks, 2011).
These figures presented shows promising space and room for more players and firms to
engage and enter the carbonated soft drinks market.
GFSB acknowledge that a product should be different and thus after concluded the consumer
survey and would introduce a honey taste carbonated soft drink which will have cola and also
caffeine in the ingredient. The new honey carbonated soft drink proposed to be introduced to
the new market by GFSB is unique, appealing and is very different. Plus, it has the health
catchphrase which can be used as ‘honey is the cure for all illnesses’. This goes very well
with the latest public health trending. Table 6.1 and 6.2 illustrated that such taste (honey) has
never been introduced and it also show how the big player in the industry is trying so hard to
introduce new product every year to capture the ever growing market, where others have
failed, GFSB will succeed.
It is identified that the main feature of the soft drink industry is that the product is either
bottled or in can and GFSB will package the honey drink in the same method. While
economics of scale remain an issue, GFSB will leverage on its existing manufacturing
capacity for its food production and will be able to optimize and produce within this
constraint for large scale production and reduce the average cost for each amount of litre
produced.
Access to raw materials would not be an issue to GFSB as it already has existing price
agreement contract with supplier of sugar, caffeine, cola, aluminium cans, bottles and
plastics.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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Table 6.3 Profit Margin of Coca-Cola, PepsiCo and Nestle, 2006-2010
As part of GFSB promise to the shareholder wealth in achieving a minimum of 5% profit
margin for new investments, Table 6.3 exhibits that soft drink industry is returning a
minimum profit margin of 10% and above illustrated by the three giants in the soft drink
industry.
As a conclusion, it is suggested that GFSB enters the carbonated soft drink industry as part of
its diversification plan. It is an opportunity lost if GFSB do not venture into the soft drink
business as the return of investment offered is higher than the capital cost. The product
produces by GFSB would be very different, in fact, even to a global scale. It would be
something even new to the whole world; a honey taste carbonated cola soft drink.
The proposed 1 Malaysia Cola proposal will be presented in another report after concluding
with the studies and report expected to be out in six months time. Negotiations and
discussion with the government has been initiated and a subsidy formula from the
government is expected.
BPME7103 – Advanced Managerial EconomicsSeptember Semester 2011 Prof. Dr. Mohd Ghazali MohayidinStudent Name: Anas Alam Faizli Student ID No.: CGS00621129Centre of Graduate Studies DBA Intake: September 2011
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