Analyzing PepsiCo's Crisis Using Game Theory Principles

This case study analyzes PepsiCo's strategic crisis in 1931, when the company faced its second bankruptcy. The assignment explores the application of game theory principles to understand the company's challenges and strategic responses. It focuses on the decision to sell 12-ounce bottles at a lower price than its competitor, Coca-Cola. The study examines the law of demand, modeling the impact of price changes on demand and revenue. The assignment provides a detailed analysis of the economic interpretation of the demand law and the impact of price on demand. The study highlights the importance of considering economic factors when formulating strategies and demonstrates how PepsiCo successfully turned around its fortunes by adjusting its pricing strategy and understanding the law of demand. The assignment concludes by emphasizing the role of strategic decision-making in overcoming financial crises and achieving business objectives.

Running head: GAME THEORY
Game Theory
Name of the Student:
Name of the University:
Authors Note:

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Contents
Introduction:....................................................................................................................................2
Description of the topic and the reason behind choosing the topic:................................................2
Modelling:........................................................................................................................................3
Solution:...........................................................................................................................................7
Economic interpretation:.................................................................................................................9
Conclusion:....................................................................................................................................10
References:....................................................................................................................................11

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Introduction:
The framework to be followed by an organization in order to achieve the long term goals and
objectives of the organization can be defined as a strategy for the organization. Efficient and
effective utilization of different resources within an organization is necessary to successfully
achieve these goals and objectives in the future. The plan to execute these objectives and goals is
cumulatively known as the strategy of an organization. Generally, the executive management
within an organization is the body responsible to formulate an effective strategy to successfully
achieve the organizational goals and objectives. In this context a detailed discussion shall be
made to study a real life organizational crisis to assess the importance of modelling in
formulating an effective strategy to deal with organizational crisis.
Description of the topic and the reason behind choosing the topic:
The case study topic selected for the purpose of this objective is the desperate condition of Pepsi-
Cola in the year 1931. This is the year when the company for the second time in its history
entered into bankruptcy. In fact Charles G. Guth, the president of Pepsi at that time even
considered selling it to its rival, Coca-Cola Company. The deal fell apart due to the
unwillingness of the Coca-Cola Company to take over almost a doomed company. The above
topic has been mentioned in the book and it is page number 8 from where the above case study
has been started (Besanko, Dranove, Shanley and Schaefer, 2015).
The problem of Pepsi started after the company purchased large supply of recycled 12 ounce
bottles during the above period with the objective of reducing costs. During this time both Pepsi
and Coca-Cola were selling colas in 6 ounce bottles. Subsequent to this, Pepsi decided to sale the
12 ounce bottles at 10 cents. Compared to the existing price of 6 ounce bottles this cost was

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almost twice of that amount. However, despite the above strategy the company failed to boost its
sales.
The company entered bankruptcy for the second time within 12 years and experienced
nightmares as its financial condition deteriorated fast with its ever dwindling sales numbers.
The model used by the company to come out of the above situation shall be discussed here to
provide the readers an in-depth understanding about the particular model and its benefits to come
out of financial crisis and achieve the organizational goals in the future.
Modelling:
Basic primer principle model:
If Economy is tough on the one side and then it’s equally easy on the other side provided one
makes an effort to understand the subject. There is innumerous benefits of economic and its
knowledge in dealing with practical situations in business management. The primary rule of
economy which is also known as the rule of demand and supply is universally acceptable as the
most effective law for dealing with financial and economic difficulties within an organization
(Besanko, Dranove, Shanley and Schaefer, 2014).
As mentioned earlier that the company, i.e. Pepsi Company was in huge distress as it filed for
bankruptcy in the year 1931 subsequent to the failure of the company to discharge its creditors
and other liabilities which were due. The 1931 bankruptcy was the second bankruptcy in the
history of the company as the same situation was experienced by the company in 1919. Thus,
company needed remodeling of its strategy or to formulate a completely new strategy to deal
with desperate condition the company was facing (Besanko, Dranove, Shanley and Schaefer,
2012).

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The model here is to design an effective strategy for the company to increase its revenue and
profits from business operations subsequent to the failure of the company to achieve greater sale
with the purchase of 12 ounce beer bottles. As already mentioned that the economic reality and
financial conditions must be considered and given due importance while framing a strategy to
ensure that it is effective and beneficial for the organization. It is also important to note that even
the rival Coca-Cola Company showed no interest in acquiring the debt-ridden Pepsi Company.
Taking into consideration the above issues the most suitable model for the company is explained
and depicted below (Besanko, Dranove, Shanley and Schaefer, 2012)
The law of demand model:
The law of demand model states that the demand of a product would increase significantly if its
price reduces and vice a versa provided all other variables are equal and unchanged. Thus, if all
other variables are fixed then if the price of a good is reduced then the demand for the good will
definitely be increased and it is other way round in case the price of the good is increased. There
are number of variables that directly and indirectly affects the demand of a product and the law
of demand model assumes that except the price of the product everything else will remain
stagnant and fixed. Thus, the assumptions in the model is quite unrealistic as in reality there are
significant changes in different variables that affect the demand of a product along with its price
(Besanko, Dranove, Shanley and Schaefer, 2011). The decision model is depicted below.

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Model 1: When the price of a product increases.
Model 2: Decrease in price of the product will increase the demand provided others remain
unchanged.
Low demand
Increase in price of the product
Other variables remaining unchanged
High demand of the product
Decrease in price of a product
Other factors remain unchnaged

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In 1931 the number of bottles sold by the Pepsi to its customers at 10 ounce per bottle was
around 127,000 bottles. The company was looking to increase its revenue as well as profit and
thus, it was necessary to formulate an effective strategy for the company to achieve both of these
objectives. As mentioned earlier that law of demand states that the demand of a product would
increase significantly with the reduction in price of the product if the other factors are
unchanged. Following are the important factors that directly and indirectly affect the demand of
a product. Thus, it is important to note that one of the biggest criticism of law of demand theory
is the assumption that says that the impact of price on demand will only be relevant as per the
theory if the other factors are unchanged and unaffected. The other variables which are assumed
to be unchanged are as following and must remain unchanged if the law of demand is to be
proven (Besanko, Dranove, Shanley and Schaefer, 2010).
Price of substitute goods:
The price of substitute goods must remain unchanged in order to law of demand to be true for the
particular good in question. However, if the price of substitute goods also changes then the law
of demand will not hold true for the particular product (Pentecost and Turner, 2018).
Preference of customers:
The preference of customers is an important factor in determining the demand for any particular
product. Thus, if the customer preference changes for a product then the law of demand will not
be effective.
Quality of product:

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The quality of product must remain unchanged in order for the law of demand to be effective.
Thus, if there is change in quality of goods along with the changes in prices then the desirable
impact on demand of the product will not be experienced even with decrease in price of such
goods (Besanko, Dranove, Shanley and Schaefer, 2009).
Let us now proceed towards successfully devising a solution for the problems experienced by the
Pepsi Company
Solution:
The three main aspects that are directly in relationship with the problems and possible solutions
to these problems are costs, demand and prices and the law of demand. Giving attention to these
problems helped the company to overcome of the drastic situation of the company and to deal
with bankruptcy.
Since, decision of purchasing 12 ounce beer bottles and selling coke at 10 ounce per bottle back
fired on the company it was only a matter of time that the company has to make necessary
arrangements to deal with the situation. Guth, then president of the company understanding the
problem decided to sell the 12 ounce Pepsi at merely 6 ounce instead of 10 ounce. Subsequent to
the decision of selling the Pepsi at 6 ounce the company started experience significant increase in
its sales. The decision to sale 12 ounce bottles at 6 ounce proved to be an extremely successful
idea for the company as the sales of the company increased significantly. The sales almost shoot
upward by the end of the decade, i.e. 1930’s. In addition the profit of the company also increased
drastically. This is despite the reduction in sales price of Pepsi bottles to only 6 ounce per bottle.
In 1931 where the company was looking down the barrel and considering dissolution end up
earning a significant profit of $2.1 million in the year 1936. Further, the profit of the company

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shoot upward to 4.2 million, i.e. exactly double from 1936 to be precise in 1938. This was a big
achievement as the company experienced a phenomenal growth of 100 in profit within two
years.
The decision model used by then president, Guth is to undercut on the prices of Coca-Cola which
is its biggest competitor in the market. This helped the company immensely as it immediately
experienced a huge growth in its revenue as well as its profit. The law of demand clearly states
that the price of goods has a direct and inverse relationship with demand of the goods
(Bookshelf.vitalsource.com, 2019).
The above demand curve clearly shows the impact of sale price on the demand of a goods
provided other conditions and underlying variables are unchanged. Similarly, the undercut
strategy of Pepsi Company has certainly yield divided for the company as immediate
improvement in the sales of the company as well as its profit.

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Economic interpretation:
Economic interpretation of demand law is simple and basic as per as microeconomics are
concerned. Thus, if all the other determinant factors remain unchanged then with increase in
price of a product its demand will decrease. In case the price of a product is decreased then the
demand for the product would increase if the other variables are unchanged. The graph below
clearly shows the impact of decrease in sales price of a product on its demand.
As can be seen from the above that with increase in price of a good there would be simultaneous
decrease in the quantity of goods demanded. The blue line shows how the increase and decrease
in price of a goods influence its demand. The two green dots attaching where the demand and
price lines touched each other indicates the equilibrium demand for a particular price. The top
arrow pointing downwards in the above diagram shows the impact of price decrease on the
demand of a product if the other variables remain unchanged. The discussion of the case study
on the Pepsi Company’s dismal position and turnaround, beautifully explains the impact of price
decrease on the demand of a good. As the arrow at the left hand corner of the graph pointing
downward indicates how the quantity demanded increases significantly with a price decrease.

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Thus, the demand law model has proven to be extremely effective for the Pepsi Company as the
strategy helped the company to improve its operating performance significantly.
Conclusion:
Taking into conclusion the discussion on the impact of prices on the demand of a product it is
clear that the law of demand holds true if the other factors are not changed and remain more or
less same. In this case the complete turnaround in Pepsi Company’s fortune is mainly due to the
decision of then President Guth to undercut Coca-Cola. Subsequently, the economic reality of
the company changed as it started earning higher amount of profit with each passing year since
its decision to undercut its biggest rival, Coca-Cola.

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References:
Besanko, D., Dranove, D., Shanley, M. and Schaefer, S., 2009. Economics of strategy. John
Wiley & Sons. 4th ed. New York: W.W. Norton.
Besanko, D., Dranove, D., Shanley, M. and Schaefer, S., 2010. Economics of strategy. John
Wiley & Sons. 5th ed. New York: W.W. Norton.
Besanko, D., Dranove, D., Shanley, M. and Schaefer, S., 2011. Economics of strategy. John
Wiley & Sons. 6th ed. New York: W.W. Norton.
Besanko, D., Dranove, D., Shanley, M. and Schaefer, S., 2012. Economics of strategy. John
Wiley & Sons. 7th ed. New York: W.W. Norton.
Besanko, D., Dranove, D., Shanley, M. and Schaefer, S., 2014. Economics of strategy. John
Wiley & Sons. 8th ed. New York: W.W. Norton.
Besanko, D., Dranove, D., Shanley, M. and Schaefer, S., 2015. Economics of strategy. John
Wiley & Sons. 9th ed. New York: W.W. Norton.
Bookshelf.vitalsource.com. (2019). VitalSource Bookshelf Online. [online] Available at:
https://bookshelf.vitalsource.com/#/books/9781119174776/cfi/31!/4/4@0.00:39.0 [Accessed 29
Aug. 2019].