Analyzing Porter's 5 Forces on Coca-Cola (KO)

The Porter's five forces model is used to examine a company or industry's competitors. By using the simple framework, analysts and would-be investors can get a powerful idea of what factors could affect a company’s profitability. The Porter's five forces model cuts through a lot of the noise when looking at the competition by asking five direct questions. Some look at internal factors while others look at external factors. Together, they explain the competitive forces that could impact how a company does business.

Frameworks such as the Porter's five forces model seem very simple, but it is important to understand how a company competes in an industry and what factors could complicate that competition before investing, especially for longer positions. That way, you can evaluate the likelihood the company will meet its sales targets. Plus, you could identify a breakout area of growth within its industry that could net you even greater returns.

The Coca-Cola Company (NYSE: KO) is a perfect example of a company that you should analyze with a qualitative analysis tool such as the Porter's five forces model before investing.

When you think of Coca-Cola and competitors, Pepsi is probably one of the first rivals to come to mind, and rightfully so. The two companies have been in competition with each other since the late 19th century. They have very similar ingredients in their marquee products and some very similar offerings: Coke and Pepsi. The two companies also have similar non-soda interests, such as orange juice and bottled water. Pepsi also owns Doritos, Quaker Oats and Rice-A-Roni, which changes the way it competes. Most notably, if trends go against soda and bottled drinks, Pepsi may be able to hedge its bets with its other lines. Coca-Cola does not have the same opportunity.

Coca-Cola also competes directly against the Dr. Pepper Snapple Group. While Dr. Pepper Snapple does not have a cola, it does feature some big brands in the soft drink and juice markets, including its namesakes Dr. Pepper and Snapple as well as A&W Root Beer and Sunkist. In some ways, not having a cola could work to the Dr. Pepper Snapple Group's advantage. As popular as Coca-Cola is, a trend towards beverages with less caffeine could leave its sales in that product line depressed.

As consumer trends shift, Coca-Cola could be left vulnerable, but the beverage company does have a loyal following. The risk in this area is moderate.

New entrants to the beverage industry are another possibility. While companies such as Coca-Cola and its rivals do have special licensing deals, including having their products sold in fast food chains, and different distribution deals, another company could gain a foothold if it hit into the trends at the right time. Granted, it would have to have a very positive and very viral image or spend a fortune to create the type of brand recognition Coca-Cola enjoys, but it is not impossible.

Moreover, as consumers move towards healthier options, it would not necessarily have to be a single new entrant that causes a problem for the beverage behemoth. Several new entrants to the industry at once could fragment it to the point that it affects Coca-Cola’s bottom line. As smaller companies attempt to enter the beverage market, this threat becomes more of a possibility. It may not be very likely, but anyone investing in Coca-Cola should at least keep an eye on the competitive landscape.

Similarly, Coca-Cola also has to contend with what buyers could purchase instead of its products. For instance, customers could start drinking coffee instead of Coke. If the rise of Starbucks has shown anything, it is that people really do love coffee in the right environment and with the right flavorings. Coca-Cola does have a stake in Green Mountain Coffee Roasters, the maker of Keurig, possibly for just this reason.

Buyers could also choose beverages such as freshly made smoothies or fresh-pressed juices instead of Coca-Cola's bottled beverages. As more people become health-conscious, the threat of a trend forming in which buyers substitute a different drink for Coca-Cola products becomes more of a possibility. Again, Coca-Cola is popular the world over, but investors need to make sure they are aware of the competitive landscape in which the company operates if they are going to make informed decisions about whether to invest and how long to hold on to their investments if they do.

When it comes to the bottled beverages market, buyers have a fair amount of bargaining power, and this affects Coca-Cola's bottom line directly. Coca-Cola does not sell directly to its end users. Instead, it mostly deals with distribution companies that service fast food chains for fountain services, vending machine companies, college campuses and grocery stores. Demand leads the purchases, but Coca-Cola also has to keep an eye on what that end price will be. Ultimately, Coca-Cola has to sell its products to distribution networks and other customers at prices low enough that they can sell to the end user at a price that keeps them coming back.

Moreover, Coca-Cola's pricing is also somewhat consistent with each outlet. After all, McDonald's does not sell a Coke for 99 cents one day and $1.03 the next. As Coca-Cola's cost of goods sold (COGS) fluctuates due to materials, transportation or manpower, either the beverage company or those companies to which it distributes have to absorb the changes in price.

This leads to the final competitive force: Coca-Cola’s suppliers. As big as the beverage company is, and as many contracts as it likely has with its suppliers securing pricing, suppliers still have some power, and some of it may be out of their hands. After all, sugar is a commodity; like other commodities, its price varies over time and with availability. A few natural disasters could affect sugar cane harvests and impact Coca-Cola's raw materials costs. Thanks to contracts the company likely has in place, the effect would be minimal unless those disasters occurred repeatedly over the course of several years.