The key question is whether PepsiCo should expand its restaurant business by pursuing the purchase of CARTS OF COLORADO, a $7 million manufacturer and merchandiser of mobile food carts and kiosks, and CALIFORNIA PIZZA KITCHEN, a $34 million restaurant chain in the casual dining segment.
II. Analysis of the main problemPepsiCo has 3 main segments: soft drinks (35% of PepsiCo’s sales and 39% of its operating profits in 1991), snack foods (29% of PepsiCo’s sales and 35% of its operating profits) and restaurants (36% of PepsiCo’s sales and 26% of its operating profits). In the early 1990’s PepsiCo’s three restaurant chains (KFC, Taco Bell and Pizza Hut) were the leaders in their respective segment. PepsiCo’s senior management believes its ability to move people within and across divisions gives PepsiCo a competitive advantage in the restaurant segment. PepsiCo believes their restaurants perform due to their strong management teams; which are developed within the corporation. PepsiCo would like to utilize their competitive advantage in running restaurants with PepsiCo managers by adding California Pizza Kitchen and CARTS OF COLORADO to the PepsiCo portfolio.
Despite PepsiCo’s success with KFC, Taco Bell and Pizza Hut it had difficulty expanding La Petite Boulangerie, a three-unit bakery chain it purchased in 1982. The large overhead for La Petite Boulangerie made the company unprofitable and Pepsi sold it in 1987 for a $13 million loss. The unsuccessful venture into La Petite Boulangerie suggested that although PepsiCo managers were gifted and could be easily moved across divisions; the moves would not always guarantees a successful business expansion.
Therefore, the main problem for PepsiCo management is to decide whether it can successfully purchase and administer CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO. This is in light of the fact that PepsiCo believes it has a competitive advantage in the skillfulness of its managers that was not borne out in the unsuccessful La Petite Boulangerie bakery endeavor.
PepsiCo can be categorized as a related diversifier. Approximately 30% of its revenue is split between its 3 main industrial categories. PepsiCo’s business units share common resources and skills. Historically companies that take a corporate strategy of related diversification perform the best (GBS_634M lecture notes). Therefore on the surface it would appear that diversification by acquiring CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO would be an excellent strategic decision.
However, in arguments described below; the evidence does not support a recommendation for PepsiCo to purchase Carts of Colorado or CALIFORNIA PIZZA KITCHEN.
IV. Justification for recommendations
PepsiCo is a lucrative company and therefore does not need to diversify into CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO to maintain it profitability. From 1987-1991 PepsiCo’s sales doubled, income from continuing operations grew at a compound rate of more than 20%, and the company’s value on the stock market tripled (PepsiCo restaurant Case, pg. 4, and Exhibit 3).
Eight key reasons NOT to diversify into CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO.
It is poor rationale for PepsiCo to diversify into CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO simply to reduce risk. The restaurant business is cyclical. Some restaurants will be profitable, while some will not be profitable. PepsiCo’s shareholders can diversify risk by purchasing shares in CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO themselves. Furthermore, it is not an appropriate strategy for PepsiCo management to over-diversify to protect their personal wealth.
Maintaining growth is not a good basis to diversify into CALIFORNIA PIZZA KITCHEN or CARTS OF COLORADO. Most shareholders would rather hold shares in a small profitable company, not a big unprofitable company. As a shareholder, there is only a benefit if PepsiCo makes a profit. Currently PepsiCo is making a profit. Although managers benefit from growth regardless of profit or loss , growth for the sake of growth is not an appropriate reason to diversify.
Although PepsiCo can use CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO to balance cash flow by funneling cash from its large business units to the smaller CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO business units; this is not recommended. Even thought PepsiCo has the capability of doing this an individual shareholder can do this for himself. The counterargument would be that PepsiCo managers can do a better job balancing cash flow than shareholders because the corporation can be more tax efficient than the individual shareholder. But this alone is not a sufficient reason to diversify.
The acquisition of CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO will not create synergy within the PepsiCo corporate strategy. PepsiCo already has a Pizza segment (i.e. Pizza Hut) and does not have experience in the mobile food cart segment. Diversifying into these two market segments will not produce corporate synergy where the whole is greater than the sum of the parts.
One good reason for PepsiCo to diversity into CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO is the sharing of infrastructure and to create economies of scope. PepsiCo is currently saving money because they are competing in several different industries (ie. Soft drinks, snack foods, and restaurants). These business units share the support structure and therefore the reduced costs. While Pepsi’s economy of scope can be used to distribute chips just as well as soft drinks it is not apparent that they can deliver well in the niche restaurant market like CALIFORNIA PIZZA KITCHEN (refer back to La Petite Boulangerie misfortune).
If PepsiCo were to sell two or more different products simultaneously that would be beneficial by creating an economy of scope. For example, if PepsiCo could distribute Pepsi soft drinks and California Pizza from a cart they would have justification for the acquisition of CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO because they would be sharing common infrastructure that would make them unique. The uniqueness would make it very difficult for competitors to imitate and would be a reason to diversify. But there are currently no mechanisms to sell California Pizza’s from a cart. Therefore at this time, sharing of infrastructure is not a good justification for PepsiCo to diversify into these two markets.
It is not apparent that PepsiCo will increase its market power if they acquire CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO. PepsiCo already has multiple business units that buy from the same set of suppliers and sell to same set of customers. They have used this to gain market power. It is not apparent that adding CALIFORNIA PIZZA KITCHEN or CARTS OF COLORADO to the fold will increase PepsiCo’s market share significantly.
It could be argued that by acquiring CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO PepsiCo is exploiting core competence. Although this is generally a good reason to diversify by generating more revenue opportunity and competing in several markets; this is not a good initiative for PepsiCo in the situation with CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO. In order to exploit core competencies, PepsiCo’s business units must be related, so they share the same set of skills. In order for this strategy to be successful, the benefits to PepsiCo have to be unavailable to PepsiCo’s competitors.
If PepsiCo’s competitors can gain the same advantage, then PepsiCo will not have a strategic benefit. Although the Colorado Carts are unique, they can be duplicated by the competition (e.g. California Carts, All-Star Carts, Creative Mobile systems). With regards to CALIFORNIA PIZZA KITCHEN, other pizza restaurants can reproduce the unique flavors and styles of pizza. Therefore, PepsiCo will not be exploiting its core competence and should not diversify.
If PepsiCo is contemplating CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO as good ‘turnaround projects’ then this is not a justification for diversification. CALIFORNIA PIZZA KITCHEN is a profitable company. CALIFORNIA PIZZA KITCHEN has increased both sales and net income from 1990 to 1991. CARTS OF COLORADO has also shown an increase in sales and operating income from 1985-1991. The management teams of both companies appear to be performing well. Therefore the ‘turnaround’ potential is not a good reason to diversify.
CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO do not fit into the PepsiCo Corporate strategyWhere does PepsiCo compete?There may be a market opportunity for PepsiCo in the acquisition of CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO, but that does not necessarily imply that PepsiCo should take the opportunity. The overall scope of PepsiCo is on convenient foods and beverages. The acquisition of CARTS OF COLORADO would certainly be in-line with PepsiCo’s focus of providing foods and beverages at well-situated locations. However, PepsiCo does not have experience in the placement of mobile food carts and therefore PepsiCo would be at a disadvantage to those more experienced in the mobile cart business.
There is even less evidence for a distinctive market opportunity for PepsiCo with the acquisition of CALIFORNIA PIZZA KITCHEN. PepsiCo already owns Pizza Hut and therefore has a place in the dine-in and take-out pizza business. Although CALIFORNIA PIZZA KITCHEN is suited for more upscale markets with unique flavors and tastes, Pizza Hut could introduce similar unique flavors and tastes. In addition Pizza Hut has stores across the United States and internationally, while CALIFORNIA PIZZA KITCHEN has a limited geographic scope. It currently operates only 25 restaurants in eight states (PepsiCo case, pg. 15). The offbeat pizzas may not sell well across the United States and internationally. For example, jerk-chicken pizza may sell very well in Beverly Hills, CA but not sell well in Peoria, Illinois or Duesseldorf, Germany.
How does PepsiCo compete?PepsiCo’s corporate strategy allows for transfer of resources (i.e. managers) across their business units. PepsiCo’s philosophy is “We take eagles and teach them to fly in formation” (PepsiCo case, pg. 3). Therefore PepsiCo may have a strategic advantage by transferring managers from one of its current business units to CALIFORNIA PIZZA KITCHEN or CARTS OF COLORADO. For example, one manager could transfer her knowledge from a position at Pizza Hut to CALIFORNIA PIZZA KITCHEN relatively transparently; although it may be more difficult to transfer knowledge from Pizza Hut to the food carts and kiosks; the business of Colorado Carts.
PepsiCo does transfers resources which fit well with the CARTS OF COLORADO enterprise. PepsiCo can place a Cart outside a shopping mall on the street selling food. At some carts PepsiCo could offer KFC or Taco Bell while offering a Pepsi soft drink; maybe put forward some Frito lays chips. But this strategy does not fit well with the idea of the upscale CALIFORNIA PIZZA KITCHEN being directly near a KFC or Taco Bell in a mega-mall food court.
How does PepsiCo execute?PepsiCo, although a very large corporate office, has an execution strategy in which they let the managers go at their own pace. They have a ‘decentralized organization’ (PepsiCo case pg. 4). PepsiCo managers are rewarded on a two-phase system; reporting performance first to direct managers then to upper level managers. In order to be promoted managers of CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO would have to perform very well relative to all of the remaining PepsiCo restaurants. Because all of the other PepsiCo restaurants are at the top of their respective segments it will be a challenge for managers of CALIFORNIA PIZZA KITCHEN and CARTS OF COLORADO to surpass other PepsiCo business units. Therefore the managers will not be incentivized as well managing CALIFORNIA PIZZA KITCHEN or CARTS OF COLORADO.
Therefore, diversifying into California Pizza Kitchen and CARTS OF COLORADO is not copasetic with the PepsiCo corporate strategy.
The acquisition of CARTS OF COLORADO and CALIFORNIA PIZZA KITCHEN will not lead toward the fulfillment of PepsiCo’s mission which is “To be the world’s premier consumer products company focused on convenient foods and beverages and seeks to produce healthy financial rewards to investors as they provide opportunities for growth and enrichment to their employees, their business partners and the communities in which they operate. And in everything they do, to strive for honesty, fairness and integrity.” (http://www.pepsico.com/PEP_Company/Overview/index.cfm)PepsiCo’s management should take the “guilty until proven innocent” approach and not diversify into these two business segments. As described in the preceding paragraphs at this time there is not sufficient and convincing evidence to support the need for diversification into CALIFORNIA PIZZA KITCHEN or CARTS OF COLORADO.
1. http://www.pepsico.com/PEP_Company/Overview/index.cfm2. www.cpk.com3. PepsiCo restaurants. HBS 9-794-078