How much would Pepsi pay to get Coke’s secret formula?

A few days back some dastardly Coca-Cola employees got nabbed trying to sell corporate secrets to Pepsi. Pepsi turned the bad guys in and cooperated in the sting operation.

Did the executives at Pepsi give up the chance to make huge profits at Coke’s expense in order to “do the right thing?”

I had lunch with my friend and colleague Kevin Murphy yesterday. He made an interesting point: knowing Coke’s secret formula is probably worth almost nothing to Pepsi. Here is the logic.

Let’s say that Pepsi knew Coke’s secret formula and could publish it so that anyone could make a drink that tasted just like Coke. That would be a lot like what happens to prescription drugs when they go off patent and generic drug companies come in. The impact would be that the price of real Coke would fall a lot (probably not all the way to the price of the generic Coke knockoffs). This would clearly be terrible for Coke. It would probably also be bad for Pepsi. With Coke now much cheaper, people would switch from Pepsi to Coke. Pepsi profits would likely fall.

So if Pepsi had Coke’s secret formula, they wouldn’t want to give it away to everyone. What if they instead kept it to themselves and made their own drink that tasted exactly like Coke? If they could really convince people that their drink was identical to Coke, then the new Pepsi-made version of Coke and the Real Thing would be what economists call “perfect substitutes.” When two goods are essentially interchangeable in consumers’ minds, that tends to lead to fierce price competition and very low profits. Neither Coke nor the Pepsi knockoff of it would be very profitable as a consequence. With the price of Coke lower, consumers would switch away from the original Pepsi to either Coke or the new Pepsi-made Coke knockoff, which would be far less profitable than original Pepsi anyway.

In the end, both Coke and Pepsi would likely be worse off if Pepsi had Coke’s secret formula and acted on it.

So, maybe the executives at Pepsi were acting morally and honorably when they turned in the criminals stealing Coke’s secrets.

Or maybe they are just good economists.


meteorplum

In Mark Pendergrast's "For God, Country and Coca-Cola", Pendergrast actually includes a version of the Coke recipe from sometime in the early 20th century, found in the Coca-Cola Corporation's archives. When he went to a Coke exec to get confirmation and permission to include it in the book, the exec proposed a thought experiment, wherein Pendergrast would get the most contemporary version of the Coke recipe. The exec than asks what a cola-baron wannabe would do with the recipe? He can't call his product "Coke", he might be able to say that it's the same recipe, but unless he is able to produce and sell product in the same quantities as a Coke or Pepsi, he can't get his costs low enough to make any money.

As others have already mentioned (and Pendergrast makes abundantly clear in his book), people aren't buying Coke because it's a better cola. They certainly aren't buying Coke glasses, signs, clothing, and other non-soft drink paraphernalia because they keep choosing Coke in blind taste tests. Coke is synonymous with America (USA if you want to be picky, but the picky ones don't usually like Coke) and a certain way of life, or at least symbolic with a desire for a certain way of life.

It's also worth noting the recent Wikipedia entry on "Inca Cola", and the business disaster Pepsi suffered in Peru with the Pepsi Challenge. The suggestion there is that even though most people picked Pepsi over Coke in blind taste tests (a result that seems universal, and unchallenged by Coke), Coke drinkers didn't like being proven "wrong".

All of these would seem to contradict Dr. Levitt's suggestion that Coke and Pepsi are fundamentally fungible. Generic colas *are* fungible, but for most people, Coke and Pepsi are miles apart, despite the efforts of flavor consultants.

And anyway, "Coke" doesn't even taste like Coke anymore. High fructose corn syrup is much sweeter cane sugar, and also gives a smoother "mouth feel". If someone in the US wants to get a taste of the "real thing", circa pre-"Classic Coke", they can either head down to Mexico (where they'll also get a more vanilla-flavored Coke), or pick up some Passover Coke from a Jewish grocer. Corn (even in syrup form) is a leavening and is considered not kosher for Passover, so Passover Coke is make with real sugar.

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blog_Er

Stuff is all poison. Who cares?

Okay.. That might be a bit strong, and I drink it so I hope not.

I just wanted to say that the incentive structure is intact. That is, as long as people keep drinking fizzy caramel stuff they'll(meaning whomever is making money by selling it) keep marketting it.

Just like to see some more real freakonomics. Or perhaps a Freakonomics II, or is the sequel always a disappointment?

Can't help but think of even numberred Startrek's.

shmoo

For ease of reading, I'm going to quote tqbf first:

The things Coke's competitors can't copy are the brand and, more importantly, the distribution channels (retail placement, soda machines, fast food fountain service, etc). I don't think the secrecy of the formula plays much into the cola industry these days.

I agree that the "secret formula" is unimportant, though I wouldn't downplay the brand as much as you do. Coke and Pepsi both spends huge amounts of money on advertising each year, but it only comes to pennies per can sold. If a new entrant were to come in, even if they had Coke's secret formula, there's no way they could get their name out there because the amount of advertising they'd need to do to compete would be too expensive for their basically non-existent sales. It's effectively a barrier to entry, much greater than any secret formula (which apparently isn't that necessary since Pepsi's obvously doing fine).

All the above is stolen from my Competitive Strategy professor by the way.

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Jerry

Mr. Levitt

Has this story become to cold for me to comment on?

I worked for one of the companies mentioned here and delt with their "secret" formulation daily.

Some of the above comments came pretty close to the truth of it all. Just thought you might like hearing it from someone that was on the inside.

sam

I would like to patent my new invention, a new top can opener,
it has a completely new approach of can opening, and much convenient than
the existing now.
whom shall I refer to patent it?

Merrick S.
topqwest@yahoo.com

akon

how much does 2 cases of coke cola cost in south africa.

ChrisV

The Coca-cola and pepsi brand are so well known they waste Millions of Dollars every year on advertising.

If Coca-Cola really wanted to bolster it's performance they should just STOP ADVERSTISING FOR 6 MONTHS. During those Six-Months lower the cost of there product to under Pepsi-Cola. Pepsi-cola would try to take advantage spend a lot more money on advertising and sales of Coca-Cola would go up.

These mega-corporations are so stupid. They don't need to advertise anymore.

As far as the secret recipe goes. It's no secret.. The secret recipe's are the chemicals that go into the diet brands- Those are much harder to reverse engineer.

Rihanna

Im Donating 500,000 to CocaCola

Everett Beal Rph

1979 Atlanta Journal stirs up a little dust by writing about my cherished formula I inherited for Coca-Cola.I am a pharmacist & owned two pharmacies.
Next day I was offered $10,000 for the historical value.
Since then I have had offers of $15,000, $20,000 and a $300,000 home.
Like others with a cherished formula, I know I do have the real thing with many ways of proving the authenticity.One day soon it will be a fact.We shall see?

Tariq F

I'm shocked the only #17/18's comments "get it" (in my view). Pepsi managers act out of their own self-interest, which includes avoiding breaking the law.

I don't dispute that it's poor economics for Pepsi to try to torpedo Coke. That much is likely true.

But that's all beside the point - what matters is that to use the stolen trade secrets would be illegal. If you want to study incentives, put yourself in the shoes of the senior decision-maker (say, Pepsi CEO) considering the decision. He already makes millions by keeping this mature business chugging along efficiently. Even assuming that Pepsi gets some kind of small profit bump by exploiting the stolen trade secret, the potential benefit to him is a marginal increase in pay relating to incentive compensation (say, his share-based compensation). The potential risks, on the other hand, if it goes wrong are career disrepute, criminal charges and even imprisonment.

Why would he ever take that risk? Anyone who reaches that level understands cost/benefit well enough to know that you don't risk killing the golden goose like that for a risky, marginal benefit.

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dwindle

Even if Pepsi were literally 100% identical to Coke, I doubt it would affect patronage.

Jacob

This means that cola is actually a product in a state of oligopoly, not monopolistic competition.

Willie

Pepsi and Coke are not inherently superior to the generic brands out there....we're just used to them and have been buying them for a lot longer. I don't think buying habits would change much at all even if a generic, exact replica of Coke hit the market. It's all about the marketing.

Adam

In the world of ideas and branding, filling ecological niches is just as important as biology.

Just as Pepsi can't profit by attempting to fill Coca-Cola's shoes, mother nature doesn't often produce two species in the same environment that fill the same exact niche.

Instead, the first organism in that environment to fill the niche gets it, and equal latecomers are forced out due to the originals being more established.

Of course, if Pepsi could make Coke and make it cheaper than Coke, it would be a different story. But why waste energy fighting over an already-filled niche, when it might be possible to find niches not yet filled? Pepsi is likely looking for the next flavor, or "species" of soft-drink that will create/fill a niche in the consumer market.

Natural Selection is at work here, friends.

Aliza

Coke and Pepsi do taste different, and mostly appeal to the customers who are accustomed to those flavors. For that reason, some store-brand sodas offer both a "Blue Cola" (Pepsi clone) and a "Red Cola" (Coke clone).

Whether the flavor is more important than the color of the can is arguable, of course, as anyone who's ever eaten a cherry-flavored yellow lollipop can attest.

Jonathan Katz

A competent and well equipped food chemist can determine the "secret" formula. In fact, the list of ingredients is widely available. They are all available to the trade, but most are not sold at retail. The quantities aren't, and change occasionally, without announcement, either as their prices vary or in response to experience marketing unpublicized variants. "Secret" is only a marketing gimmick.

Jackie C. Aldridge

Well, I'm glad to know that Coke has orange and Pepsi has lemon. It explains why I like Coke and my brother likes Pepsi.

Rick A

I drink Diet Coke, but not because it's in a Coke can. I prefer it to Pepsi. I believe that while they are both colas, they have a distinctly different taste, which different people will define in different ways.

My taste buds prefer Diet Coke over Diet Pepsi, and all other diet cola brands for that matter.

It's got nothing to do with branding or pricing for me.

mevs

I'm with Jonathan Katz. Wouldn't a quick little chemical analysis give anyone who really wanted to know that answer to that question?

I prefer Diet Coke as well, even though I always rather suspect it of having some addictive agent added, as I am not sure if I really actually like the taste or not.

Carolncarolina

And, maybe this is just too obvious, but couldn't any reputable lab [or high school (freshman level) chemistry student] break down their alleged top secret formula for a nominal price? And, really, when push comes down to shove, if someone wanted to go up against Coke and all of their lawyers in court, this would have been done years ago!