There are times when global companies with bulging product portfolios have to face an unexpected enemy: themselves. A case in point: the recent discovery of Coca-Cola being sold in Spain without the blessing of the U.S. soft drink giant’s local subsidiary, which saw its market invaded by a product that is essentially the same but competing head-on with a lower price. Universia Knowledge at Wharton spoke with experts about this phenomenon and what subsidiaries can do to defend themselves against such "cannibalization."

Coca-Cola España — the largest agribusiness company in the country and Coca-Cola’s second-largest unit in Europe after Germany — is well aware of the arrival of the recent imports. The soft drinks tend to be independent consignments sent to hotel management companies that market them largely in Catalonia, the northeastern region that has the easiest and cheapest access to much of the rest of Europe. Using the Internet, distributors and hotel management companies can acquire the product in large quantities from countries such as Egypt and Poland for between 26 euro cents and 30 euro cents, compared with about 45 euro cents for the Coca-Cola bottled in Spain.

Currently, the new arrivals account for 4% of Coca-Cola sales in Spain, reducing the Spanish subsidiary’s annual revenue — which issome €3 billion (around US$4.4 billion) — by about 2%. So how should Coca-Cola’s executives back at the head office in Atlanta respond?

Their situation, though not common, isn’t unique. “A head office can look for internal competition among its subsidiaries by making them compete with each other," says Joaquín Garralda, professor of strategy at the IE Business School. "This happens frequently when a particular brand enjoys a high market share in a protected market, and the barriers to entry are very high so it doesn’t have to be efficient. In such cases, this forces a subsidiary … to boost its performance” if it has become too comfortable in its market-leading position. But, he says, “this sort of behavior is not common.”

The real winners are often the big distributors, which benefit from the lower prices they paid in a foreign market for the same product. Because it means lower overall profit margins for a company, however, the head office has an interest in seeing local markets buy locally made products.

The Common Market

But it’s not always straightforward for headquarters. In the European Union, companies cannot prevent the free circulation of goods, and as Jordi Brunat, professor of corporate policy at ESADE, explains, “legally, you cannot prohibit these marketing policies, since the EU imposes severe fines on companies that restrict competition within its borders.” Garralda adds, “So companies need to look at things differently than when they are trying to preserve their local markets.”

This is the phenomenon of “the parallel market,” which is widespread in the EU’s pharmaceutical sector with legislation in each country establishing different price policies for the same products. Every three months, the EU publishes the prices of products among its member countries with the expectation that prices will equalize over time. Still, Brunat notes that in other sectors, the situation is different since “the main difference you find is in the various types of taxes that countries put on products, especially Value Added Tax (VAT) and other indirect taxes.”

In other parts of the world, it can be more complicated. When there is no market for free competition and circulation of goods, selling the same product in a foreign country isn’t necessarily going to be a money-maker because the price could be affected by tariffs and other taxes on products coming from outside the country. As Brunat notes, even inside the EU the existence of a free market is not a sufficient condition for distributors to acquire products in cheaper countries to sell elsewhere. “It is complicated because in spite of legislation and lack of tariffs, you have to take into account the costs of transportation and warehousing, which make the product more expensive and reduces margins.”

Since trade restrictions are not legal in the EU, head offices cannot negotiate with the distributors. Nevertheless, it is a problem for companies such as Coca-Cola, whose production is done in each country under agreements with national bottlers. This forces big distributors to negotiate country by country. “What really pays off for Carrefour, Wal Mart and other [large retailers] is to negotiate with each country where they have a presence," explains Garralda. "But the structure of companies like Coca-Cola makes these negotiations more complicated.”

Coca-Cola is a localized company, with its head office in Atlanta being “nothing more than the brand,” notes Garralda. Atlanta sells the syrup to its national bottlers, and the beverage itself is manufactured independently in each country according to various quality controls. So Coca-Cola isn’t produced the same way in every country, in part because local ingredients, including water, are used. The localized structure requires distributors to forge separate agreements with each subsidiary, rather than a single, global agreement with head office, which could provide them with more advantageous terms.

In Spain, to prevent consumers from buying products from other countries, Coca-Cola has begun an advertising campaign to boost consumption of the locally produced soft drink. The campaign reminds Coca-Cola drinkers that their rights to information as consumers are guaranteed and that the retail price they pay is the same regardless of where any of its soft drinks is produced. It also points out that by consuming soft drinks bottled locally – there is always a bottler within a radius of 200 kilometers (or120 miles) – consumers are helping the environment: the shorter the distance a bottle has to travel to get to a consumer, the less pollution the journey generates.

The campaign was given a boost recently when the Spanish subsidiary beat all of Coca-Cola’s subsidiaries worldwide for the first time in an internal quality ranking. Overall, the communications strategy has helped give the Spanish unit its own identity, one that differentiates it from the rest of the group, while enabling it to reduce any negative effects that the imported soft drinks have had.

The Same But Different

But generally, multinational companies face a tricky challenge when tailoring similar products to specific market needs. That’s the case in textiles, when a company such as Inditex has many brands targeting different consumer segments based on socio-economic factors. The automotive sector is another example, Brunat notes. “Although these products are similar, they cannot be perfect substitutes for one another; they don’t address the same [market] segment.”

When a company launches the same product to different market segments through its subsidiaries, it makes sense from a cost perspective for the subsidiaries to share product parts, marketing and other activities. Lowering costs improves the company’s competitiveness, and potentially enables it to offer similar products at lower prices. But while “in the short term, these strategies pay off, the brands begin to overlap in the long term,” Brunat notes.

In other words, the products gradually lose their differentiation. “This is what happened at General Motors, before the U.S. government intervened," he says. "The automotive giant went on acquiring different companies that, at the beginning, were different. Nevertheless, through synergies, they were losing their individual identities. Ultimately, the only difference [between models] was their chassis design,” adds Brunat. It’s confusing for consumers, who think, “Why pay more for the same product?” In the end, he says, the only brands that survive are the more emblematic ones, which can hopefully absorb the others.

For companies to avoid such a situation, they need to determine the level of synergies that is realistic, “because efficiency destroys differentiation.” Brunat concludes that it only makes sense to have subsidiaries compete with one another if the revenue generated by the process is greater than the investment the company makes in it. If a company doesn’t manage to expand its market, competition among its subsidiaries only promotes damaging price cuts, as headquarters suffers lower revenues from the price war initially intended to win more customers and expand market share.

The big lesson: the more similar a company’s products, the lower the profit margin. So the key lies in product differentiation, which enables a company to preserve all of its brands over the long term, while addressing the needs of different market segments.