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.
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To confuse this with some theft of the “formula for Coke” is a red herring of the first order.
First, the myth of the “secret forumla” is probably worth a great deal, maybe to both companies, but the actual formula for Coke isn’t worth anything. The myth of the “secret formula” is a marketing gimmick. There is no way that Pepsi doesn’t already know the exact composition of Coke. This is pretty simple flavor chemistry. Even if there were some unusual natural product involved, the quantities that are required to produce Coke on a worldwide scale are so large, and production has been going on for so long, that the “secret” is long out of the bag.
In any case, Levitt misunderstands what happened in this case. This isn’t about the formula for Coke, the drink with the mythical secret formula, it is about the forumula for a new and different product. As such, it has nothing to do with the competition between the two beverages Coke and Pepsi, but rather with the competition between the two corporations.
What the PepsiCo executives gave up was the possible advantage of an early notification of this new Coke product. This early notification is probably worth something. They could have seen what marketing gimmicks Coke was considering.
But whatever that advantage might be, it has nothing to do with the fact that “knowing Coke’s secret formula is probably worth almost nothing to Pepsi.”
To confuse this with some theft of the “formula for Coke” is a red herring of the first order.
First, the myth of the “secret forumla” is probably worth a great deal, maybe to both companies, but the actual formula for Coke isn’t worth anything. The myth of the “secret formula” is a marketing gimmick. There is no way that Pepsi doesn’t already know the exact composition of Coke. This is pretty simple flavor chemistry. Even if there were some unusual natural product involved, the quantities that are required to produce Coke on a worldwide scale are so large, and production has been going on for so long, that the “secret” is long out of the bag.
In any case, Levitt misunderstands what happened in this case. This isn’t about the formula for Coke, the drink with the mythical secret formula, it is about the forumula for a new and different product. As such, it has nothing to do with the competition between the two beverages Coke and Pepsi, but rather with the competition between the two corporations.
What the PepsiCo executives gave up was the possible advantage of an early notification of this new Coke product. This early notification is probably worth something. They could have seen what marketing gimmicks Coke was considering.
But whatever that advantage might be, it has nothing to do with the fact that “knowing Coke’s secret formula is probably worth almost nothing to Pepsi.”
Assuming it was the original formula, and still secret, how does the equation change if Pepsi gives it to a 3rd party?
Assuming it was the original formula, and still secret, how does the equation change if Pepsi gives it to a 3rd party?
I’ll admit I know nothing about flavor science, but if Yesteray’s claim is true that the secret to Coke’s formula is actually out there, I’d think that a non-Pepsi competitor would have great incentive to start selling a perfect substitute. I’m not sure how it would come to be that Pepsi would know the formula and other companies wouldn’t. It’s not like Pepsi’s the only one with access to soda-analyzing technologies.
With regard to Levitt’s question about whether Pepsi would want to start producing a Coke knockoff, my understanding is that Pepsi and Coke are currently engaged in monopolistic competition whereas by producing perfect subsitutes they’d become engaged in pure competition. Monopolistic competition tends to be more profitable for all competitors, which is why branding is such a big deal.
It’s interesting that in this case Pepsi seems to be acting morally by not engaging in espionage, but is also acting immorally by preserving a state of competition that is not economically optimal.
I’ll admit I know nothing about flavor science, but if Yesteray’s claim is true that the secret to Coke’s formula is actually out there, I’d think that a non-Pepsi competitor would have great incentive to start selling a perfect substitute. I’m not sure how it would come to be that Pepsi would know the formula and other companies wouldn’t. It’s not like Pepsi’s the only one with access to soda-analyzing technologies.
With regard to Levitt’s question about whether Pepsi would want to start producing a Coke knockoff, my understanding is that Pepsi and Coke are currently engaged in monopolistic competition whereas by producing perfect subsitutes they’d become engaged in pure competition. Monopolistic competition tends to be more profitable for all competitors, which is why branding is such a big deal.
It’s interesting that in this case Pepsi seems to be acting morally by not engaging in espionage, but is also acting immorally by preserving a state of competition that is not economically optimal.
2 items:
A. Suppose you are Pepsi execs and someone approaches you with a secret formula.
What do you consider?
worth to yourself.
worth to your company.
risk of discovery
penalty for discovery
In this case it seems like the perpetrators may have been flaky and thus highly likely to be discovered. i.e. high risk
B. One possible use Pepsi might make of a Truly Secret formula.
Use the secret formula as a starting point for internal research and _possibly_ discover a similar formula that is actually “better”.
2 items:
A. Suppose you are Pepsi execs and someone approaches you with a secret formula.
What do you consider?
worth to yourself.
worth to your company.
risk of discovery
penalty for discovery
In this case it seems like the perpetrators may have been flaky and thus highly likely to be discovered. i.e. high risk
B. One possible use Pepsi might make of a Truly Secret formula.
Use the secret formula as a starting point for internal research and _possibly_ discover a similar formula that is actually “better”.