Pepsi: Evaluating Opportunities for Integration.
Pepsi: Evaluating Opportunities for Integration
Recall the simple rule that we use to evaluate whether activities should be integrated: if ?(A+B) > ?(A) + ?(B) then activities A and B should be done within the same firm. We want to be very specific about what the synergy between activities A and B might be, and also consider any additional costs that might be incurred if the two activities are done within the same firm.
For Pepsi, we consider activity A to be the manufacture and promotion of concentrate. In turn, we will look at three "Activity B"s - snack foods, fast-food restaurants and bottling.
I. Pepsi and Snack Foods
Pepsi and Frito-Lay is a horizontal integration issue. Pepsi purchased Frito-Lay in the mid-60s, and seized a latent opportunity.1 As in soft drinks, Pepsi saw that increasing the brand equity of snack foods would generate plenty of consumer B (benefit) because image is a great complement to products used for "mood-enhancement." Advertising displays quite dramatic economies of scale. Per consumer reached, national advertising is significantly cheaper than regional advertising. Adding image to a national snack food is much more cost effective than adding image to a regional good.
The question we ask next, however, is "In the present, is the market value of Pepsi and Frito-Lay as a single firm greater than the sum of Pepsi and Frito-Lay separately? In other words, is the whole still greater than the sum of its parts? Since Frito-Lay is now a ubiquitous, strong brand on its own, there must be some other synergy in the activities of the two businesses. Pepsi is currently exploring this with their "The Power of One" campaign, which intends to capitalize on the following synergies between Pepsi and Frito-Lay.
* Shared overhead. Until recently, Pepsi and Frito-Lay essentially shared no infrastructure. Pepsi corporate now plans to tie these divisions more tightly together.
* Power over suppliers. Any inputs (such as advertising time) these companies share might be negotiated at lower prices if the two divisions act as one.
* Power over buyers. As a seller of two important brands Pepsi may be able to leverage more desirable shelf space at retail stores.
* As the owner of both brands, Pepsi can effectively "tie" the products together in the minds of consumers leading to higher market shares of both goods.
Qualitatively, these possible synergies might seem quite compelling. However, the value captured from these synergies may be smaller. Why?
. The soft drink and snack foods divisions separately garner lots of power over suppliers - each is already quite large. Combining efforts may not result in much in the way of additional power or savings.
2. Buyer power, on the other hand, has historically been a challenge. Since, retail outlets (mega-supermarket chains, Walmart, etc.) have been consolidating, their power to negotiate lower wholesale prices has increased. Let's assume that Pepsi and Frito-Lay (herein called P-F) hits on a great cross promotion campaign-by great I mean that the campaign leads to the generation of increased consumer willingness-to-pay. To the extent that P-F relies on retailers to implement this campaign, P-F may find itself at the mercy of the retailers. If P-F needs the retailer to implement the campaign, and the retailer sees that the campaign is moving the products and creating profits for P-F, the retailer would like retain some of the gain for itself (particularly if the increased sales of P-F come at the expense of the supermarket's sales of other colas and chips). As retailers consolidate, they are indeed more empowered in negotiating lower wholesale prices. To the extent the retailer sees a manufacturer earning higher profits and to the extent the retailer itself provides activities that are essential in generating these higher profits, we expect to the profits from any synergy in P-F promotional activities to be shared with retailers
Recall the simple rule that we use to evaluate whether activities should be integrated: if ?(A+B) > ?(A) + ?(B) then activities A and B should be done within the same firm. We want to be very specific about what the synergy between activities A and B might be, and also consider any additional costs that might be incurred if the two activities are done within the same firm.
For Pepsi, we consider activity A to be the manufacture and promotion of concentrate. In turn, we will look at three "Activity B"s - snack foods, fast-food restaurants and bottling.
I. Pepsi and Snack Foods
Pepsi and Frito-Lay is a horizontal integration issue. Pepsi purchased Frito-Lay in the mid-60s, and seized a latent opportunity.1 As in soft drinks, Pepsi saw that increasing the brand equity of snack foods would generate plenty of consumer B (benefit) because image is a great complement to products used for "mood-enhancement." Advertising displays quite dramatic economies of scale. Per consumer reached, national advertising is significantly cheaper than regional advertising. Adding image to a national snack food is much more cost effective than adding image to a regional good.
The question we ask next, however, is "In the present, is the market value of Pepsi and Frito-Lay as a single firm greater than the sum of Pepsi and Frito-Lay separately? In other words, is the whole still greater than the sum of its parts? Since Frito-Lay is now a ubiquitous, strong brand on its own, there must be some other synergy in the activities of the two businesses. Pepsi is currently exploring this with their "The Power of One" campaign, which intends to capitalize on the following synergies between Pepsi and Frito-Lay.
* Shared overhead. Until recently, Pepsi and Frito-Lay essentially shared no infrastructure. Pepsi corporate now plans to tie these divisions more tightly together.
* Power over suppliers. Any inputs (such as advertising time) these companies share might be negotiated at lower prices if the two divisions act as one.
* Power over buyers. As a seller of two important brands Pepsi may be able to leverage more desirable shelf space at retail stores.
* As the owner of both brands, Pepsi can effectively "tie" the products together in the minds of consumers leading to higher market shares of both goods.
Qualitatively, these possible synergies might seem quite compelling. However, the value captured from these synergies may be smaller. Why?
. The soft drink and snack foods divisions separately garner lots of power over suppliers - each is already quite large. Combining efforts may not result in much in the way of additional power or savings.
2. Buyer power, on the other hand, has historically been a challenge. Since, retail outlets (mega-supermarket chains, Walmart, etc.) have been consolidating, their power to negotiate lower wholesale prices has increased. Let's assume that Pepsi and Frito-Lay (herein called P-F) hits on a great cross promotion campaign-by great I mean that the campaign leads to the generation of increased consumer willingness-to-pay. To the extent that P-F relies on retailers to implement this campaign, P-F may find itself at the mercy of the retailers. If P-F needs the retailer to implement the campaign, and the retailer sees that the campaign is moving the products and creating profits for P-F, the retailer would like retain some of the gain for itself (particularly if the increased sales of P-F come at the expense of the supermarket's sales of other colas and chips). As retailers consolidate, they are indeed more empowered in negotiating lower wholesale prices. To the extent the retailer sees a manufacturer earning higher profits and to the extent the retailer itself provides activities that are essential in generating these higher profits, we expect to the profits from any synergy in P-F promotional activities to be shared with retailers
