Coke & Pepsi: Raising the Bar in Soft Drinks

How two companies used advertising to endogenously raise the minimum efficient scale of their industry—winning share from everyone else.

The Puzzle

If we consider production costs alone, there is no particular reason why Coke and Pepsi should sell most of the world’s soft drinks. At the end of the 19th century, Americans consumed 227 million servings annually prepared by thousands of independent soda fountains. Even after mass-production bottling, local sellers dominated.

Endogenous Sunk Costs

John Sutton observed that creating and maintaining brands requires significant sunk investments. Unlike production technology, the size of these investments is determined by the firms themselves. He called them “endogenous sunk costs.”

The Arms Race

When Coke and Pepsi escalated advertising spending in the mid-1970s, their combined market share increased from 54.4% in 1970 to 73.2% in 1995. Both grew at the expense of smaller competitors who couldn’t spread fixed advertising costs over enough volume.

A Modern Coda

The internet has lowered the fixed costs of advertising and allows firms to target niches more efficiently. The MES of establishing a brand is lower today. Consumer markets may not evolve the same way they did for soft drinks.