Case study analysis and findings

PepsiCo Case

PepsiCo ("Pepsi") has the choice of two companies that are available for purchase. One is Carts of Colorado, a manufacturer of mobile food carts/kiosks. The other is the casual dining chain California Pizza Kitchen. PepsiCo can purchase both, either or neither. At the core of the issue is the strategic fit between these prospective purchases and PepsiCo.

Both of these potential purchases are successful companies, but the purchase price is expected to be similar to the net present value of their future expected cash flows. To justify a purchase, PepsiCo must be able either to add value to these companies or vice versa. In order to make the decision, PepsiCo must understand where they stand as a firm today, and what potential synergies these companies can add.

PepsiCo Today

Pepsi operates in several different sectors. Domestically they are the second largest soft drink maker, the second largest quick service restaurant operator and the fourth largest food service company. The company has several key strengths and a handful of weaknesses.

In terms of strengths, Pepsi has successful implemented a decentralized organizational structure. This has encouraged the different companies under the Pepsi umbrella to develop their own operating systems. These systems historically have been tailored to the needs of the operating company. This has resulted in strong growth, and the development of unique ideas.

Another strength of Pepsi is its competitive culture. This has focused management on the development of strong growth and solid results. It has also focused them on their competitors. PepsiCo is generally focused on its larger competitors, so this cutthroat mindset has served them well, and sets a constant goal to be achieved.

A third strength is their financials. The company has achieved a strong rate of growth despite operating in several relatively mature industries. For example, in the mature U.S. soft drink industry Pepsi turned in 11.8% sales growth between 1989 and 1991, but profit growth was 29.2% in the same period. Despite some stumbles, particularly in the snack food business, they have attained strong growth in both revenue and profits in the past two years. In the restaurant business, both Taco Bell and Pizza Hut have achieved very high rates of growth in recent years, though KFC has struggled. All three are industry leaders in their respective segments.

Despite its many strengths, Pepsi has some weaknesses. Chief among them is the decentralized structure. While this structure has yielded many advantages, there are times when it works against Pepsi's best interests as well. For example, there is significant duplication of staff functions between the different businesses. Also, decentralization has become entrenched in the Pepsi culture to the point where some managers are resistant to collaboration because they feel it will inhibit flexibility and/or autonomy. This resistance hampers efforts to implement programs that will result in cost savings.

Another weakness is market saturation. In the core U.S. market, most of Pepsi's business lines are relatively saturated. Additionally, the industries are relatively mature. This means that despite strong historic growth rates, the potential for future growth in domestic markets in limited. This reality changes the nature of Pepsi's business. Pepsi has traditionally viewed itself as a growth company but as opportunities for top line growth diminish, the company must shift its focus to bottom line growth through cost reductions and increased efficiency.

Despite the apparent challenges, there remain many challenges in Pepsi's environment. The most important opportunity is infill. This is especially important in the Pepsi's restaurant businesses. Pepsi is in the business of selling food, not running restaurants. That prophetic statement illustrates the potential for infill growth. If the burden of physical restaurant facilities is removed, there remains substantial room for growth within the quick service category. PepsiCo companies have successfully moved into factories and targeted other similarly previously unavailable locations such as campuses, cafeterias and stadiums.

The second key opportunity is international expansion. To this point, both KFC and Pizza Hut have done well with international expansion plans, but international markets are far from saturated. Taco Bell does not have a significant international presence. Other businesses also have room for international growth, such as PepsiCo Food Systems and Snack Foods.

A third key opportunity that PepsiCo can exploit is greater coordination between units. As the driver of profitability in Pepsi's core businesses shifts towards improved efficiency, greater coordination becomes a more important opportunity. In past, the cost savings from coordination efforts have been moderate, but potential savings are estimated to be at least $100 million per year. Given the historical autonomy of PepsiCo businesses, there appears to be substantial room for improvement of operational efficiency based on greater inter-company cooperation.

There are a few threats faced by PepsiCo as well. The first is competition. In general, competition in Pepsi's businesses is intense. In soft drinks, they are number two. In quick service food, they are number two despite dominating their three main segments. In food service, they are number four. Each of these markets is either mature or nearing maturity. In snack foods, soft drinks and quick service customers have low switching costs and a multitude of substitute options. The result is that Pepsi operates in industries that are characterized by intense competition.

Another threat faced by Pepsi is that of a low level of diversification. At this point, Pepsi has a decent amount of geographic diversification, but focuses largely on mature Western markets. In terms of product, they are almost entirely focuses on very low end food. Pepsi has little presence in segments driven by anything other than volume growth. This allows them to play to their strengths, but it also limits their growth potential.

Carts of Colorado

Carts of Colorado (COC) represents an interesting proposition for PepsiCo. In terms of financials, the company has grown profits significantly over the past few years. However, they have not grown sales. Most of the growth in profits has come from improvements to the gross margin. This relatively sluggish sales growth is cause for concern.

COC brings several strategic benefits to Pepsi. The most important is that the company's technology can be used to help Pepsi with its infill strategy. The carts/kiosks allow for greater flexibility in terms of location development for Pepsi franchises. This will help to grow a wide range of Pepsi businesses including quick service, PFS, and soft drinks. This represents a strong strategic fit because it allows for a degree of synergy between COC, existing Pepsi businesses and potential strategic objectives. Pepsi has already moved towards exploring the possibilities offered by infill; purchasing COC would improve their ability to pursue this opportunity.

Another advantage to buying COC is that they are the leading firm in the industry. They have recently purchase their number two firm to consolidate their position of strength. There are other players in the industry, but COC has a technological advantage. They have what is estimated to be an 18-month lead on their competitors in terms of technological development. Among the key differences are that COC kiosks meet FDA safety requirements, and that they are wired for modern information systems. This will allow Pepsi's franchisees to operate the kiosk operations the same way as they do their full-sized operations.

Given that COC is 18 months ahead of all competitors in terms of technology, it is assumed that any purchases of kiosks would go through them. Therefore, one of the key considerations with regards to the purchase will be the additional benefits Pepsi would gain from owning COC vs. using them to supply kiosks. In terms of external sales, it appears that Pepsi will be able to attain these. COC kiosks would likely be marketed through PFS, which represents an improvement over COC's current distribution network. The current network is undisciplined, and has hampered COC's expansion efforts.

Another point in favor of the purchase is that the culture at COC appears to be relatively congruous with that of Pepsi. The firm has been creative in finding ways to excel. Historically, when faced with a problem, they have responded with creative solutions that have increased their revenues and provided new sources of competitive advantage.

The price of COC is going to be reasonable. They purchased their competitor, a $2.5 million company for $65,000. That puts the price tag for COC so low that almost any benefit would make it a good purchase. However, the price may ultimately be no different than developing the technology on their own. COC has achieved an 18-month technological advantage over their competitors with little in the way of capital investment. Pepsi has the financial capacity to close this gap quickly should they choose to pursue kiosk development without purchasing COC. Additionally, many of COC's achievements have come from the ideas and energy of the founders. They are the greatest source of competitive advantage for COC. In light of how quickly Pepsi could probably close the technology gap, it seems reasonable that any purchase of COC would in essence be a purchase of the Gallery brothers.

A strategic alliance with COC would be tantamount to a purchase. Pepsi is vastly superior in terms of size and financial strength. Additionally, they would represent the vast majority of COC's sales volume. For COC, a strategic alliance with Pepsi may hold appeal as it would allow them to continue to build their company by giving them the financial strength to meet the needs of other customers. For Pepsi, a strategic alliance would have little benefit in terms of operations. There would be one potential benefits, however. One is that the Gallery brothers would still have a stake in the business. They are the main source of value in COC so there continued presence is essential. One caveat to that is with a large and stable customer like Pepsi they may lose their drive to create. Most of their major innovations have been responses to crises. In times of stability they have generally rested on their laurels, which would not benefit Pepsi nor would it fit with their culture. A drawback to a strategic alliance is that it would allow COC to have access to Pepsi's competitors. The main benefit of a purchase would be to shut down this possibility, thus preserving a potential source of competitive advantage for Pepsi.

California Pizza Kitchen

For Pepsi, California Pizza Kitchen (CPK) would represent an entry in to the casual dining market. While Taco Bell still retains some growth potential, Pepsi's other major food brands are left with infill to achieve growth in the domestic market. CPK, however, has significant room for expansion.

What CPK brings to the table is a concept that has seen dramatic growth over the past couple of years. The chain had experienced 55% top line growth in the past year; along with bottom line growth of 41.6%. Customer response to the concept has been generally positive and the concept has been successful in a range of geographic areas.

In terms of strategic fit, CPK gives Pepsi a stake in the casual dining industry. This represents much-needed diversification for PepsiCo's food business. It provides more accounts for PFS and the soft drink business. However, Pepsi has little experience in this business besides the small sit-down component of Pizza Hut. The casual dining and quick service industries are different, in the estimation of one key Pepsi executive, and the skill sets for the two segments are likewise different. Pepsi would thus have a learning curve to endure. They failed with their sit-down Mexican concept and would need to perform much better with CPK in order to justify their investment. In terms of staff functions, there appears to be limited synergy with other PepsiCo divisions. Much of the purchasing is still down by individual groups, eliminating many cost-saving opportunities.