Admin Issues and Policies (MBAM 613) Case Study – Pepsi Co. Submitted To: Prof: Dinesh Iyer On: 19th November, 2008 Submitted By: TEAM 6 – (Section A) Team Members: Abhijeet Gupta Astha Kumbhat Devika Prasad Kavitha Porwal Lakshmi Lukose Sandhya Lakshmi Ohio University – Christ College, Academy for Management Education Executive Summary:
This case presents a scenario where PepsiCo, a company known for its successful acquisitions of food chains to expand its business, has to weigh its options whether or not to acquire Carts of Colorado, a merchandiser of mobile food carts and kiosks and California Pizza Kitchen, a big name in the casual dining segment. PepsiCo, established by Caleb D Bradham in 1907 was one of the largest food and beverage companies. The company adopted a decentralized organization structure. The company’s relationship with its people and their willingness to move people within and across divisions was a practice that worked well for PepsiCo.
Through its innovative practices, it has built various competitive advantages for itself. The success of PepsiCo can be attributed to the fact that they can establish for themselves, a distinct image in every business they carry out. PepsiCo’s corporate strategy is to concentrate their resources on growing beverages snack foods and fast food restaurants businesses, through internal growth of each divisions and carefully analyze different companies which are favorable for acquisition, thereby having an edge over its competitors.
In the case, Senior Management of PepsiCo is evaluating the potential acquisition of two companies – Carts of Colorado and California Pizza Kitchen, in order to expand the company’s restaurant business. If indeed PepsiCo decides to pursue the acquisition of one or both, they must decide how to align each of these business units in its historically decentralized management approach and how to forge relationships between the acquired business units and existing business units.
After a thorough qualitative analysis by considering the benefits and demerits to both PepsiCo and the target companies and financial analysis by computing the growth rate in sales, growth rate in operating profit and operating margin for the target companies and comparing them with PepsiCo, we recommend PepsiCo should go ahead with the acquisition. The issues to be addressed in case are given below: • Should PepsiCo acquire Carts of Colorado and/or California Pizza Kitchen? • Will COC and CPK’s culture fit with PepsiCo’s organizational culture? • Does PepsiCo add value to its business by the acquisitions?
Pepsi Co. ’s Strategy: Pepsi Co. , the giant operates in three segments – soft drinks, snack foods, and restaurants. These three segments were considered as three flagships and were allocated resources according to their belief of where it could achieve the highest returns. Soft drinks, snack foods and restaurants were all under a single umbrella, the operational relatedness between these three segments worked well for PepsiCo, every time they planned to expand. If the expansion did good to one business, the benefits would show in the other two segments also.
For acquisition, PepsiCo targeted the chains which were leaders in their segments. Pizza Hut had a big share in the Pizza market of USA, Taco Bell had 70% of the USA’s quick service Mexican style category and KFC had half of the quick service chicken restaurant category. Hence, it is quite evident that PepsiCo played their cards well while choosing the right companies to acquire. Also, these target companies had strong international presence which would work well for Pepsi. PepsiCo’s strategic planners believed that quick service restaurants would remain the largest segment over the following decade.
The industry trends were a positive sign for PepsiCo to go ahead with the acquisitions. Evaluating various trends like convenience becoming more important to diners, health and nutrition trends etc. , PepsiCo thought that the quick service, casual dining and take-out segments would be attractive opportunities for investment. The timing of acquisition by PepsiCo was well planned because the target companies were losing their market share during that time period and the offer of an acquisition by PepsiCo was accepted with a hope to drift back into the market.
Consistent with PepsiCo’s decentralized structure and the emphasis the firm placed on entrepreneurial management, Pizza Hut, Taco Bell, and KFC each operated with a great deal of autonomy. PepsiCo did not interfere in their businesses unless they thought that their interference was necessary for the strategic growth. How does Pepsi’s corporate strategy create a competitive advantage for them? Pepsi’s corporate strategy was to follow a Related Linked Diversification (mixed related and unrelated) because there are only limited links between businesses.
They went ahead with expansion through acquiring other firms only when they believed that the product of the target firm was a complement to their product i. e. the soft drink. The acquisition of Frito Lay also took place because Pepsi believed that snack chips went well with soda. Similarly, this corporate relatedness and operational relatedness can be seen in the acquisitions of Pizza Hut, Taco Bell and KFC. Their practice of letting the managers navigating across the businesses holding different responsibilities worked well for PepsiCo.
This way, transferring core competencies across the businesses becomes much easier for PepsiCo when they acquire new companies. Once they strongly adhered to their corporate strategy, it started taking the shape of a competitive advantage for Pepsi. The Broad based coordination amongst the PepsiCo businesses was a huge competitive advantage for PepsiCo. A consultant report estimated that the three chains Pizza Hut, Taco Bell and KFC could save about $100 million annually if they coordinated purchasing more extensively and shared some very general headquarters tasks, such as data management and real estate functions.
The Objectives of Acquisition for PepsiCo: Like any other company, PepsiCo also has a definite set of objectives before it decides which company to acquire. The following are few such reasons that drive PepsiCo on an acquisition spree: ? The company’s strategic plans to expand their business drive them to acquire companies. ? When an acquisition gives more access to distribution channels, it would be keen to acquire that company. The purchase of Pizza Hut and Taco Bell was intended to get better access to outlets for its fountain Business. When Pepsi thinks, an acquisition will help to beat competition and enhance its brand as an aggressive one; it will choose to acquire another firm. ? Increasing its international presence was another attraction for PepsiCo. For Ex: PepsiCo acquired Kentucky Fried Chicken (KFC) when KFC had a strong international business and largest chicken chain and by doing this, PepsiCo restaurant sales were 2nd Highest than McDonalds and leapt ahead of McDonalds in number of outlets. ? When a business showed potential to support the sales growth of Pepsi, acquisition would seem an attractive investment.
For Ex: Quick-service restaurants. ? When an existing business would benefit and grow from an acquisition, Pepsi would be interested in an acquisition. For Ex: In order to increase Taco Bell’s points of distribution, PepsiCo wanted to have something like Taco Bell Grill and so acquired Hot’ N Now, a hamburger chain. The Cultural Facet of the Acquisitions by PepsiCo: Pepsi’s Organizational Culture: Pepsi co was a people oriented organization. The company backed the people not the project, in its resources allocation decisions, and these decisions were made quickly.
The company was packed with workaholics who had all learnt beating the competition was Pepsi’s way of survival. The organizational structure was decentralized where even the bottom level employee had powers to take decisions, which increased their efficiency. This kind of culture helped the employees to build a sense of identification with PepsiCo. Hard work and intense competition co- existed at Pepsi and this was not just for the bottom level employees, it was the same throughout the organizational structure.
The top executives always set examples for the juniors. PepsiCo afforded managers the opportunity to move within and across the various PepsiCo businesses so that they could tackle a broad array of challenges. At PepsiCo they believed that they had a responsibility to contribute to the quality of life in the communities. This philosophy is expressed in the company’s vision “PepsiCo’s responsibility is to continually improve all aspects of the world in which they operate – environment, social, economic — creating a better tomorrow than today. The blend of Pepsi’s culture with Pizza Hut, Taco Bell and KFC: The acquisitions of Pizza Hut, Taco Bell and KFC worked out positively for PepsiCo also because their work cultures blended well with that of PepsiCo. Supporting the employees and constant training programs were a common practice in Pepsi and its acquired companies, all of which had a loyal staff working for the respective firms. Like Pepsi encouraged the employees to move across the firm and serve in different roles, KFC and Taco Bell had a similar practice.
The adaptability of Pizza Hut to the vivid cultures of the countries, all around the globe was very similar to PepsiCo which was also an international player and got a feel for the various cultures, in which it was present. This similarity in working and operating behavior was beneficial to PepsiCo, which did not require them to make changes in working style of the target companies. Will Carts of Colorado (COC) and California Pizza Kitchen (CPK) fit with Pepsi’s culture? Yes, they will.
Since PepsiCo already has an experience of coordinating with Pizza Hut to unify the organizational culture, it is well prepared to handle the human resource of PepsiCo. Since PepsiCo is known for its non interference in the acquired companies’ businesses, CPK will be able to continue its operation as an autonomous entity, but still supporting the objective of PepsiCo’s acquisition, an increase in sales volume. COC, though a new type of business PepsiCo will be entering into, they do not follow a totally ambiguous organizational culture since they would be well acquainted with the food and beverage companies who are their customers.
Hence, PepsiCo would not have to fear cultural resistance from either of the companies’ human resource. Various mergers and acquisitions by Pepsi: The merger with Frito Lay: Donald M. Kendall, Pepsi-Cola’s CEO in 1963 merged Pepsi-Cola with Frito-Lay Company with a belief that snack chips went well with soda. The unification of Pepsi-Cola and Frito Lay gave birth to the entity PepsiCo. The Pizza Hut Acquisition: PepsiCo purchased Pizza Hut, the 3100-unit chain which was a quick service, eat-in/carry-out family style operation.
At the time of this acquisition, PepsiCo was facing increasing competition from regional chains; they were experiencing a sharp decline in the market share. At the same time, Pizza Hut was also facing stiff competition from Domino’s Pizza. The Taco Bell Acquisition: This acquisition plan was taken up with a plan to increase its number of outlets rapidly. When PepsiCo bought Taco Bell in 1978, it was the country’s largest chain of quick service Mexican restaurants. The chain did grow in size but sales were slumping and profits were losing stream.
At that time, Taco Bell was deficient in ways of conducting its business and it needed new products on board. Employees got little training. PepsiCo came in at this time, took control of the situation to benefit its own end profits ultimately. The KFC Acquisition: In 1986, PepsiCo purchased Kentucky Fried Chicken. PepsiCo purchased KFC, the chain that had international business and the largest chicken chain in the world at that time. With this acquisition, PepsiCo’s sales topped and it became second to McDonald’s. Cranor, CEO of KFC wanted to restructure its U. S and international operations.
Combined with Pizza Hut and Taco Bell, the purchase made it the international leader in number of restaurant units. In 1991, PepsiCo’s restaurant segment attained the highest revenue of the company’s three segments, surpassing the soft drinks for the first time. Its management believed that its reputation and willingness to move people within and across divisions gave it a competitive advantage in restaurants. Other acquisitions: Under Calloway’s leadership, PepsiCo spent $4. 6 billion to acquire several of its franchised bottlers, including some of its largest ones.
It also acquired the international operations of Seven-up. In 1989, it purchased ‘two UK snack company-smith Crisps, Ltd. and Walker Crisps, Ltd. It also acquired 70% of Empresas Gamesa, Mexico’s largest cookie maker in the following year. The darker side of PepsiCo’s acquisitions: Not all the acquisitions by PepsiCo were successful. Although it successfully expanded its large chains, PepsiCo had difficulty expanding La Petite Boulangerie, a three-unit bakery chain. Realizing that they made all the mistakes a big dumb company will make, they sold this bakery chain taking a loss.
However, they learned a great deal from that experience and were cautious not to repeat it. After considering that PepsiCo was both successful and faced problems with its acquisitions, Is Carts of Colorado a good target for acquisition? Carts of Colorado in 1990 accounted for about 20% of PepsiCo sales which got PepsiCo thinking about the acquisition to expand its business and also increase its access to distribution channels. They believed COC was not the lowest cost cart and kiosk manufacturer, yet it was 18 months ahead of its competitors in terms of engineering and design.
Acquisition of COC would give PepsiCo a chance to aggressively pursue new and non-traditional distribution channels. This acquisition will definitely mean Pepsi will enforce its control on COC and prevent it from catering to the competitors of PepsiCo, like CocaCola, Burger King Etc. Also, COC’s acquisition is in line with their combination of related and unrelated diversification. The benefit to COC would be a certain rise in sales because of its association with Pepsi. COC will be able to grow to a significant position in the international food service equipment arena.
The acquisition will mean PepsiCo itself and as well as all of PepsiCo’s business units like KFC, Pizza Hut and Taco Bell who will become the major customers and purchase carts, kiosks and nontraditional units to their distribution systems. After a qualitative analysis, we conclude COC will support the growth of PepsiCo’s business and hence recommend they should go ahead with the acquisition. The justification through financial analysis is stated later in the report. Is California Pizza Kitchen a good target for acquisition?
Next potential PepsiCo acquisition was California Pizza Kitchen (CPK). CPK was more into the premium pizza segment as its restaurant were located in affluent, urban and sub-urban shopping and entertainment areas and targeted young, upscale singles and couples, families and seeking a moderately priced yet comparable-quality alternative to fine dining restaurant. In 1992, when PepsiCo was interested in CPK, the owners were on the verge of taking their company public. Capital constraints had been limiting their ability to expand the chain.
CPK managers Flax and Rosenfield, who wanted to raise funds and also retain ownership thus thought PepsiCo’s proposal was worth considering. PepsiCo’s deal reflected an effective market value for CPK of $145. 5 million, proportionally higher than the chain was likely to get in an initial public stock offering. CPK’s shareholders will be open to this acquisition idea, which will definitely boost their stock price. PepsiCo’s officials appreciated CPK’s ability to attract, retain and train front line service workers and believed the learning would mean a lot for PepsiCo.
This acquisition will give PepsiCo, a Purchase-based conglomerate with learning opportunities to upgrade its full-service businesses. CPK already known for its moderate prices, high per unit sales and a trendy outlook, evolved as a restaurant offering good quality and consistent service. An acquisition with CPK would mean an entry into the midscale segment of the Pizza Market. CPK operated in upscale malls, office buildings and freestanding urban locations in affluent parts of major markets nationally, with a concentration in the Los Angeles area.
CPK owned and operated all restaurants, except for two franchised Las Vegas outlets. Since 1985, CPK has developed a loyal following and grown in rapid strides, with per-unit sales hovering at $3 million and per-person checks averaging about $8. 50 at lunch and $11 at dinner. These numbers meant good potential for Pepsi to increase its sales with the growing stride at CPK. CPK’s owners wanted to retain control and quoted: “It is our business, will be done our way, with their cooperation. ” PepsiCo echoed the sentiment. “They are going to run the business.
They are going to decide what they can do. ” CPK’s acquisition is in line with PepsiCo’s combination of related and unrelated diversification, since the operational relatedness is moderate and corporate relatedness is low. After a qualitative analysis, we conclude that CPK will bring good business for PepsiCo and hence recommend they should go ahead with the acquisition. The justification through financial analysis is stated later in the report. Relating the case to the Chapter Concepts, How will PepsiCo benefit from these acquisitions? 1.
Increased Market Power: Acquiring California Pizza will give Pepsi increased market power, along with the already existing eating joints of Pepsi like Pizza Hut, Taco Bell and KFC. This is a related acquisition, as Pepsi has a presence in the Pizza quick service restaurant category. 2. Entry Barrier: Acquiring Carts of Colorado is a method to avoid entry barrier. Pepsi has not operated in this segment before. This can also be viewed as a form of forward integration by company. COC’s carts were self contained units with built in plumbing and electrical systems.
The carts ranged from $1200- $6500 according to the amenities it had within. Pepsi was one of its major customers it bought 20% of their carts. 3. Increased diversification: Using acquisitions to diversify a firm can be the quickest and typically the easiest way to change its portfolio of business. Increased diversification is exactly what Pepsi wants to do by acquiring COC’s and California Pizza. Acquiring COC can be seen as a way of unrelated diversification where as acquisition of California Pizza related one. 4.
Reshaping Firm’s Competitive Scope: By acquiring CPK, Pepsi is reshaping firm’s competitive scope, i. e. they are trying to reduce the negative effect that California Pizza might have on Pizza Hut’s financial performance. With this acquisition Pepsi is also trying to enter the customer segments untapped by Pizza Hut, thus reducing company’s dependence on specific markets and alter their competitive scope. 5. Learning and developing new capabilities: Acquiring COC is one way for Pepsi to gain capabilities that the firm does not possess.
Thus by learning and developing new capabilities, which differ from its own helps Pepsi to gain access to new knowledge and remain agile. What might be the likely issues, PepsiCo will face, if it acquires the two companies? We have already analyzed earlier in the report that the cultural environment at COC and CPK and concluded that there are very little chances of cultural resistance from the target companies. If any, they might face difficulties of integrating the two companies with regard to linking different financials and control systems.
Keeping this in mind, if Pepsi acquires either of the two companies they have to look into integration activities. They should ensure effective coordination exists between the key personnel of Pepsi and the acquired companies so that the operations of the merged entity is conducted as smooth as expected. Pepsi should acquire COC and CPK only if it promises a synergy of efficiencies and resources after acquisition. Will the financial analysis support our recommendations so far? Our approach for the financial analysis is as follows.
Basically a comparison of the growth potential of COC and CPK as against the US industry standards and PepsiCo’s businesses is done. (Please see Appendix for detailed calculations) Step 1: The Net Sales of US industry as a whole, the international restaurants’ sales, PepsiCo’s sales and specifically Pizza Hut, Taco bell and KFC’s sales volume of the last three years 1989, 1990 and 1991 are recorded as a basis for comparison. (Exhibit 4) Step 2: Regression has been applied on the collected data to arrive at an estimate value of Sales for COC and CPK
Step 3: Accuracy factor has been computed by calculating the regression coefficient. The accuracy factor turns out to be very low for COC and CPK estimations. Hence, it is not reliable to estimate the sales volume by that method. We proceed by an alternative method. Step 4: Average Growth Percentage and 5 year growth percentage has been computed. The average growth rate in sales for COC is 8. 67% and CPK is 55. 04% as against Pepsi’s 13. 47%. Therefore from the above we see that the growth of COC is below PepsiCo’s average and that CPK is a good prospect, as it is on the growth curve.
However COC has synergy benefits which make it worthwhile Step 5: The Operating Profit of US industry as a whole, the international restaurants’ operating profit, PepsiCo’s operating profit and specifically Pizza Hut, Taco bell and KFC’s profit volume of the last three years 1989, 1990 and 1991 are recorded as a basis for comparison. (Exhibit 4) Step 6: Regression has been applied on the collected data to arrive at an estimate value of operating profit for COC and CPK Step 7: Average growth rate of operating profit has been calculated.
The average growth rate in operating profit for COC is 71. 51% and CPK is 41. 63% as against Pepsi’s 9. 89%. From the above it is seen that both companies have high operating profit growth compared to PepsiCo’s performance. Step 8: The Operating Margin for the Year 1991 has been computed by dividing the Operating Profit value with the sales volume of the year 1991. Thus, since both COC and CPK are estimated to have a positive operating margin of 9. 08% and 2. 11% respectively, the recommendation still stays in favor of the acquisition of both Carts of Colorado and California Pizza Kitchen.
CONCLUSION: After a detailed analysis of qualitative factors computation of the growth rate of sales volume and operating profit of COC and CPK, we recommend PepsiCo to go ahead with the acquisition as one company (COC) brings value to PepsiCo by being a different type of business in Pepsi’s business portfolio and the other (CPK) will add value by increasing the sales for Pepsi. At the end of the report, we have tackled all the issues stated at the beginning of the case: • Should PepsiCo acquire Carts of Colorado and/or California Pizza Kitchen?
Yes, They Should. • Will COC and CPK’s culture fit with PepsiCo’s organizational culture? Yes, They will fit well with Pepsi’s culture. • Does PepsiCo add value to its business by these acquisitions? Yes. Both the acquisitions will add value to PepsiCo’s business. Appendix: Table 1: Computation of Growth Rate of Sales. Net sales | | | | | | | | | | |Restaurants | |PepsiCo | | | | | | | |US |International |Total |Pizza Hut |Taco Bell |KFC |COC |CPK | |1989 |4684. 8 |565. 9 |15242. 4 |2453. 5 |1465. 9 |1331. 3 |6. 55 | | |1990 |5540. 9 |684. |17802. 7 |2949. 9 |1745. 5 |1530. 3 |6. 372 |21. 696 | |1991 |6258. 4 |868. 5 |19607. 9 |3258. 3 |2038. 1 |1830. 5 |7. 65 |33. 638 | |Regression Equation |y = 786. 8x + 3921 |y = 151. 3x + 403. 8 |y = 2182. x + 13186 |y = 402. 4x + 2082 |y = 286. 1x + 1177 |y = 249. 6x + 1064 |y = 0. 55x + 5. 757 |y = 11. 94x + 9. 754 | |Accuracy |R? = 0. 997 |R? = 0. 984 |R? = 0. 990 |R? = 0. 982 |R? = 0. 999 |R? = 0. 986 |R? = 0. 631 |R? = 1 | |Avg. Growth |15. 61% |23. 92% |13. 47% |15. 34% |17. 92% |17. 28% |8. 67% |55. 04% | |5 yr % Growth in Sales | | |77. 6% |81. 00% |83. 00% |60. 50% |56. 38% | | | Graph to compute the regression equation for the given data. [pic] Table 2: Computation of Growth rate of Operating Profit Operating Profit |Restaurants | |PepsiCo | | | | | | | |US |Inter national |Total |Pizza Hut |Taco Bell |KFC |COC |CPK | |1989 |356. 5 |57. 8 |901. 4 |205. 5 |109. 4 |99. 4 |0. 292 | | |1990 |447. 2 |75. 2 |1076. 9 |245. 9 |149. 6 |126. 9 |0. 282 |0. 502 | |1991 |479. 4 |96. 2 |1080. 2 |314. 5 |180. 6 |80. 5 |0. 695 |0. 711 | |Avg. Growth |16. 32% |29. 01% |9. 89% |23. 8% |28. 73% |-4. 45% |71. 51% |41. 63% | | Table 3: Computation of Operating Margin Operating Margins |Restaurants | |PepsiCo | | | | | | | |US |Inter national |Total |Pizza Hut |Taco Bell |KFC |COC |CPK | |1991 |7. 66% |11. 08% |5. 51% |9. 65% |8. 86% |4. 40% |9. 08% |2. 11% | | References: http://www. cgu. edu/pages/2353. asp http://www. oppapers. com/essays/pepsico/157391 http://www. pepsico. com/PEP_Company/History/index. cfm# http://findarticles. com/p/articles/mi_m3190/is_n9_v26/ai_11913168 http://www. pepsico. com http://www. kfc. com