Sudan, gum arabic, and the markets for Coke and Pepsi

The Telegraph reported last week:

Coca-Cola and Pepsi supplies are under threat after access to a key ingredient was thrown into doubt as Sudan is torn apart by fierce fighting.

Gum arabic is mostly grown in Sudan, with up to 70 per cent of the world’s supply transported through small towns to the capital Khartoum, the scene of mass violence.

As chaos escalates in Africa’s third-largest country, twelve exporters, suppliers and distributors told Reuters trade of the natural gum, which helps bind together food and drink ingredients, had ground to a halt.

Experts fear stockpiles could run out within five to six months.

Mohamad Alnoor, who runs Gum Arabic USA, told Reuters it is "impossible” to obtain additional gum arabic from rural parts of Sudan because of the turmoil and road blockages.

How will a lack of gum arabic affect the markets for Coke and Pepsi? First, let's consider the world market for gum arabic. There has been a reduction in supply due to the unavailability of production from Sudan. This is shown in the diagram below. Before the current conflict in Sudan, the supply of gum arabic was S0. The equilibrium price of gum arabic was P0, and the equilibrium quantity of gum arabic traded was Q0. Now, supply has decreased to S1. This increases the equilibrium price of gum arabic to P1, and decreases the quantity of gum arabic traded to Q1.

How does that affect the market for Coke, and the market for Pepsi? Gum arabic is an input into the production of Coke and Pepsi. With gum arabic now more expensive and difficult to obtain, the costs of production will increase for both Coke and Pepsi. That reduces the supply of Coke and Pepsi. The effect on those two markets is actually the same as shown in the diagram above. We can expect the price of Coke and Pepsi to rise, and less Coke and Pepsi to be sold. [*]

[HT: New Zealand Herald]

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[*] Will Coke and Pepsi really raise their price? They may do, or they may just swallow the increased production costs and keep price the same. This is the advantage that a firm with market power has (and both Coke and Pepsi have market power, because they are selling a differentiated product) - they can choose their price, rather than relying on the market to determine the price. Keeping their price the same avoids the menu costs of a price change, and avoids any negative press and customer negative reactions (and may even generate positive press and customer reactions). Also, Coke and Pepsi probably have a stockpile of gum arabic that they can use to smooth any short-term fluctuations in the price and avoid the worst of the increase in production costs.