Pepsico's restaurant business divestment

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Strategic Analysis: PepsiCo's Restaurant Business Divestment

Introduction

In 1997, Pepsi Co announced that it would spin-off its restaurant business into a separate publicly traded company through issuance of tax free new stocks. The argument put forward by the PepsiCo top management was that the firm would like to concentrate on its core carbonated beverage business. It would be complemented by the high profit yielding snack foods division of Frito Lays.

The figures below for FY '96, show that the restaurant business contributed the least to the profits earned by PepsiCo conglomerate. This was largely attributed to the sluggish growth in this segment.

PepsiCo was compelled to take the divestment route to boost its stock price and somewhat mollify the investors, analysts and the markets in general.

Revenue

Profit

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Pepsi Cola (Beverages)

35

41

Frito-Lay (Snacks)

28

45

Restaurant

37

14

The restaurant business consisted of the following entities and each of them showed modest or negative growth in revenues on YoY basis

Genre

FY '96 Revenue

($ billions)

YoY change

KFC

Chicken

3.9

+9%

Pizza Hut

Pizza

4.9

-6%

Taco Bell

Mexican cuisine

4.5

-1%

Roger Enrico, the then PepsiCo CEO opined that

I believe the new restaurant company will be a powerful organization with great potential. For the separated companies, independence would make them far more capable of improving their operations to create solid, sustainable growth.

PepsiCo emphasized that it already has taken steps to prepare its chains for independence, including consolidating their payroll, accounting, purchasing, data processing, construction and real-estate functions as well as unifying foreign operations under a single management team. Franchisees willing to comment on the spin-off gave upbeat assessments of the deal.

David Adelman, restaurant analyst at Dean Witter Reynolds predicted that -

Intangible boon to the spun-off restaurant company would be greater pride of ownership. Its managers could be inspired by a more direct compensation correlation between what the company earns and their rewards.

Larry Walker, controller for Holland Foods Inc., a 17-unit KFC franchisee in Texarkana, Texas, said that, after the spin-off, "These separate companies will have a clearer direction. PepsiCo's been a conglomeration; you get confused when you try to run that many businesses."

The new company was subsequently incorporated as Tricon Global Restaurants Inc (TGI) with the following assets under its possession -

Overseas operations

Outlets

Nations covered

% age operations

KFC

79

50

29712

Pizza Hut

88

31

Taco Bell

17

2

Besides TGI would benefit from certain advantages once it is spun off from PepsiCo -

Sound commercial credit rating

High cash flow contribution from franchising fees and royalties

Strong asset base in its real estate portfolio and ownership of nearly 13000 restaurants

Pepsi did not transfer any of its $9.5 billion outstanding debt to the new company

Tricon Global International (TGI)

Tricon Global International (TGI) is the holding company for the three restaurant brands of PepsiCo

  • Kentucky Fried Chicken (KFC)
  • Taco Bell
  • Pizza Hut

It owns, franchises or licenses the 29,000 worldwide branches of the three chains, whose worldwide sales exceeded $20 billion in FY '96 and was second only to $32 billion sales of McDonalds.

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The newly formed entity TGI would also be the world's largest chain in terms of the number of outlets under its management, with around 29000 units.

Kentucky Fried Chicken (KFC)

Kentucky Fried Chicken was started in 1939 in Corbin, Kentucky. After ownership changed hands through the decades, it was finally acquired by PepsiCo in 1986 and rechristened as KFC.

KFC primarily offers fried chicken recipes of which the iconic one is the Original Recipe - prepared with secret blend of 11 herbs and spices. It was devised by the restaurant chain founder, Colonel Harlan Sanders.

It later started to complement the mainstay product with add-ons like bread, potatoes, gravy, desserts and non-alcoholic beverages and also offered non-fried chicken dishes.

The food is prepared and delivered on made-to-order basis, as and when customers place orders.

KFC is the market leader in chicken QSR with 55% of the market share in the US in 1997.

The revenue share of the dining formats is as below

Format

%age share of revenue

(FY '96)

Dinner

66

Lunch

31

Snacks

3

The revenue share on the basis of customers is as below

Customer preference

%age share of revenue

(FY '96)

Take-away meals

71

Dine-in

29

As of 1997, KFC operates 10397 outlets in 79 countries.

In the US, KFC operates 5120 outlets either through franchises or through licensees. TGI is aggressively developing non-traditional outlets like educational campus, airports etc, where it expects to realize significant revenue that would reinforce sales from traditional outlets.

KFC also has a significant international presence, with its major markets as below

Taco Bell

Taco Bell was founded by Glen Bell in 1962 in Downey, California. It gradually grew into a restaurant chain specializing in Mexican food with a pan-American outlet network. The chain was acquired by PepsiCo in 1978 and made a part of its restaurant chain.

Taco Bell offers typical Mexican food like tacos, burritos, salads and nachos. The delivery is done after preparation of the order placed by the customer.

As of 1997, it was the dominant player in the Mexican fast food category, commanding 72 % share of the US market.

However Taco Bell competed with McDonalds, Burger King and is considered part of the sandwich segment in QSR. The market share and annual revenues for FY '96 is as below

Restaurant chain

Revenues ($ billions)

%age market share

McDonalds

16.37

35

Burger King

7.3

15.6

Taco Bell

4.5

9.8

Wendy's

4.3

9.3

The revenue share of the dining formats is as below

Format

%age share of revenue (FY '96)

Dinner

45

Lunch

49

Snacks

6

The revenue share on the basis of customers is as below

Customer preference

%age share of revenue

(FY '96)

Take-away meals

59

Dine-in

41

Taco Bell is primarily a US-based network, with 6841 outlets in 1997. Apart from traditional distribution centers, it is targeting to make inroads into new formats like gasoline stations to increase the topline.

The country-wise distribution of outlets is given below

Nation(s)

Outlets

USA

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6668

Canada

105

Honduras, Guatemala, Poland, Egypt, Saudi Arabia

68

Pizza Hut

Pizza Hut was started in 1958 by Frank and Dan Carney in Wichita, Kansas. At the time of its debut, pizza parlors - dedicated outlets for pizza was unheard of, and the concept soon caught up across the US. Business expanded, even went overseas (starting with Canada) and PepsiCo finally took over the firm in 1977, to make it an integral part of it restaurant division.

The main offerings are pizzas, appetizers, pasta, sandwiches, dessert and non-alcoholic beverages.

Pizzerias prepare the food after the customer places the order while express counters serve readymade pan pizzas.

The revenue share of the dining formats is as below

Format

%age share of revenue (FY '96)

Dinner

74

Lunch

23

Snacks

3

The revenue share on the basis of distribution mode is as below

Distribution mode

%age share of revenue

(FY '96)

Casual dining

37

Dine-in & Delivery

29

Exclusive Delivery/Carry-out (Delco)

34

Pizza Hut operated 12534 outlets worldwide of which 8698 were in the US and the rest spread over more than 90 countries

Future Roadmap

TGI would adopt the following strategy to re-invigorate the erstwhile restaurant business of Pepsi

  • The top priority was to addresses the high employee turnover endemic to the industry. To accomplish this goal, Tricon gave each Restaurant General Manager (RGM) a one-time, $20,000 stock option grant called YUMBUCKS. This plan provided an opportunity to earn even more options based on the RGM's restaurant performance, along with a unique program to recognize outstanding restaurant teamwork.
  • Through product innovation, advertisement, promotions and customer service, TGI would aim to increase same store sales growth. Tricon also would combine the three brands within single restaurants in an effort to give customers more choice under the same roof and increase the chance of a share of their wallet.
  • By working closely with top-performing franchisees and company operators, TGI would seek more effective ways to bring down costs. To leverage economies of scale, TGI purchases its food, paper goods and equipment for all its U.S. restaurants through a $4 billion cooperative. The company also uses new technologies that simplify operations and improve service time.
  • Tricon would focus on reducing complexity and redundancy, general and administrative expenses. In this regard, company leaders and franchisees from all three brands would meet to discuss Tricon's one-system approach, share best practices and explore bundled brand expansion opportunities.
  • Tricon would try to enhance shareholder value by investing in high return restaurant units and exiting persistently low return units. Besides there would be added focus on sales & margin growth, reducing redundancies and well thought out expansion plans.

PepsiCo has decided to align itself with a different strategy where its restaurant business would not fit into the scheme of things.

  • Restaurant business is more management-intensive and labor-centric compared to the beverage or snack food distribution business. PepsiCo's core strength is in marketing and distribution. It would be best put into effect in the other two divisions where it has historically yielded good returns. However the incompatibility between the requirements of restaurant business and PepsiCo's capabilities was pulling down the performance of Pepsi stocks and causing much angst to the investors and markets alike.
  • PepsiCo realized that the food-service business is becoming increasingly competitive with a large number of established players. Growth has started to plateau in the domestic market which is not helping to increase the group's revenues.
  • While other players mostly standalone, were aggressively pursuing overseas markets, TGI association with PepsiCo was not helping matters. There was bureaucratic delays and large lead time in decision making, being a division of a conglomerate.
  • PepsiCo could not tap into the fountain-dispensed soft drinks business, long dominated by Coke. It was partly due to Coke's monopolistic actions by which it did not allow food service distributors to deal with Pepsi. Food service distributors provide broad variety of consumable supplies like food, drinks, paper etc to restaurant chains, movie theaters etc. Also PepsiCo's ownership of food chains did not allow it to effectively pitch for fountain service business with firms which were essentially its rivals in food business.

Food Service Chain

Units

Cola

McDonald's

12,000

Coke

Subway

10,800

Coke/Pepsi

Pizza Hut

8900

Pepsi

Burger King

6900

Coke

Taco Bell

6000

Pepsi

Dairy Queen

5800

Coke/Pepsi

KFC

5100

Pepsi

7-Eleven

5000

Coke/Pepsi

Wendy's

4600

Coke/Pepsi

Domino's Pizza

4300

Coke

In the light of these, PepsiCo decided to concentrate only on business where its core strengths could be leveraged. Thus the renewed and exclusive focus on beverages and snack food segment which would entail divestiture of the restaurant business.

In the light of the above developments, it would be important to deliberate on the decision and its impact through different aspects of strategic management perspective

External Environment Analysis

The external environment can be further classified as

General environment

Industry environment

Competitive landscape

General environment deals with the broader society that influences the industry and the associated firms as a whole. The aspects captured along different dimensions is as below

Factor

Description

Business impact

Demographic

Rising single person household and working married women has led to increasing trend of eating-out rather than eating at home.

More disposable income in the hands of young professionals has stimulated impulse spending on fast food and take-away snacks.

Opportunity

Economic

Food costs were expected to rise by 5 percent primarily due to El Nino effect on agricultural produce and spike in beef prices

Labor cost were predicted to increase by 3-5 percent

Threat

Political/Legal

Health hazards of fast-foods may lead to legal liability

Reservations about GM crops or stock being used by food chains

Threat

Socio-cultural

Increased acceptance of American food habits like fast foods around the globe especially in developing economies

Resistance to adoption in continental Europe like France, Germany where there is strong, independent culinary tradition

Opportunity/Threat

Technological

Automatic-open drive-through windows for order convenience

Digital point-of-sale technology to facilitate ease of order

Innovations in food testing & handling, hand washing

Opportunity

Global

Perception of disruptive influence of American lifestyle on local traditions

Threat

Industry environment deals with set of factors that directly influences a firm and its competitive actions and responses. These can be captured through the Porter's Five Forces model

Factor

Description

Business Impact

Threat of new entrants

High fixed costs, startup costs in restaurant business

Complex legislation & licensing regime for F&B segment

Moderate

Threat of substitute products

Popularity of alternative take-away food in traditional cuisines like Continental, Indian, Chinese

High

Bargaining power of suppliers

Long term contracts with supply chain partners

Uncertainties reduced through contract farming, dedicated animal rearing

Low-moderate

Bargaining power of buyers

Low switching costs

Low-involvement purchase and fickle brand loyalty

Very high

Rivalry among competitors

Several established players in the 3 segments where TGI operates like McDonalds, Dominos Pizza

Stagnant growth in US markets and all firms looking for opportunities overseas

Very high

The analysis of the competitive landscape for TGI starts with an overview of the food& beverage segment. The food services sector in the US can be classified based on the mode of distribution

  • Full-service restaurant
  • Limited-service/Quick-service restaurant (QSR)
  • Cafeteria
  • Snack & non-alcoholic beverage bar
  • Food service contractor
  • Caterer
  • Mobile food service
  • Alcoholic drinking establishment

TGI falls under the category of QSR, for which an indicative classification is as below -

Hamburgers

McDonalds

Chicken

Kentucky Fried Chicken (KFC)

Pizza

Pizza Hut

Sandwiches

Subway

Mexican food

Taco Bell

In addition to this, there is considerable overlap with other business which act as non-traditional distribution centers and dispense food & beverage service -

  • Grocery or convenience stores
  • Gasoline filling stations
  • Supermarkets
  • Educational establishment

BusinessLevel Strategy

PepsiCo has followed a differentiation strategy at the business level due to the following reasons

  • The wide portfolio of products including carbonated beverages and snack foods help it reach out to a vast demography among the customer base. The assortment of choices enables various customers to meet their refreshment demands through PepsiCo products of their preference.
  • PepsiCo is a global company with operations in several countries. In order to obtain a share of wallet of consumers in different regions, it must provide products that are tuned to the tastes and preferences, prevalent in those local regions. This also explains the rationale behind having variety of products so that buyers perceive value for money through their preferred brands.
  • PepsiCo operates in a duopoly market competing with Coke only. It need not adopt a cost leadership strategy as both the cola majors take price signals from each other and adjust markup prices accordingly, to retain market share and revenue. There has rarely been an all-out price war between the two which would have ultimately bled both to huge losses. This allows both players to compete on the basis of differentiated products targeted at a wider and more diverse customer base

TGI on the other

    hand needs to follow an integrated cost-leadership and differentiation strategy due to the nature of the industry it operated in -

  • Dining is a higher involvement activity compared to purchasing cola or snacks. While rest of PepsiCo's business required more of a product marketing approach, the restaurant group was more of service business. Differentiation is the key in such a scenario to attract customers. Variety in terms of menu options, ambience etc leads to higher footfalls. Also the local divisions in foreign countries need to be geared up to cater to the local needs.
  • Unlike a duopoly in cola segment, restaurant business has many established competitors. This has led to pressure on the price front resulting in reduced margins. To stay competitive, all players have to minimize cost and pass on the benefit or risk losing customers.
  • As evident from the discussion above, the business level strategy for cola & snacks divisions and that of the restaurant division are divergent. PepsiCo would have conflict in its day to day operations as well as long-term planning while trying to manage the requirements of the business.

CorporateLevel Strategy

PepsiCo has been trying to adopt a corporate level strategy of related linked diversification due to the following reasons -

  • The cola and the snack food business would lead to synergy in the corporate activities. While beverages could be mass produced in bottling plants, separate and dedicated manufacturing facilities for snack foods would be required. The raw materials would also be procured through different routes. The ingredients of cola would primarily be water, sugar and chemicals and plastic or glass bottles. These could be obtained freely or from institutional suppliers like sugar mills, bottle manufacturers etc. The inputs for snack foods would be farmed vegetables sourced through the contract farming route.
  • In spite of the diverse operational requirements of both the business, there exists ample opportunity to leverage the core competencies of PepsiCo for both type of products - marketing muscle and wide distribution network. Both the products could be marketed by sharing the expertise within the divisions and the reach could be extended using the superior supply chain and logistics arrangements of PepsiCo.
  • Such a synergy would not benefit the restaurant business. It not only has operational divergence with the soft drinks and snack foods business, but also the core competencies of PepsiCo in marketing and distribution cannot be meaningfully transferred. More of a service orientation is required for the restaurant division apart from managing disparate supply chain, large base of fixed assets especially real estate. The human resource perspective would also be different as in managing workers who are service providers rather than working in production lines.

On the other hand, TGI would need to follow a corporate level strategy of dominant business

  • The mainstay would be restaurant business and each of the constituent brands can leverage the common pool of resources of the company. Existing real estate, previously being utilized by a single brand, can be shared among the others to focus on new store growth.
  • The supply chain can be streamlined through coordination with logistics providers to reduce redundancy in operations. Suppliers can be managed in an integrated manner to reduce costs through economies of scale. This can be achieved by consolidating the procurement process of the restaurant brands with TGI.
  • The business can be consolidated by working with top performing franchises to improve efficiency and drive shareholder value.

Conclusion

The above mentioned facts and ensuing analysis of PepsiCo's strategic decision to divest its stake in TGI, point to a few aspects that stand out.

  • The restaurant business is a dominant player in all the QSR categories it operates in - sandwich, pizza and chicken. There are also ample growth opportunities in overseas markets though the US domestic market is gradually maturing and growth is slowing down there.
  • Pepsi's core competencies in marketing & distribution do not fit well with the requirements of a service-oriented business like QSR. Also PepsiCo would like to pursue customers with differentiated products across a broad portfolio like beverages, snack foods, health & energy drinks etc. To this effect it would like to bring synergy in its manufacturing and customer reach for all products. This would necessitate diversifying into related categories and focus on growth in these.
  • TGI on the other hand, has to not only to offer differentiated service to its customer, but also needs to compete on the cost front more vigorously. The business of TGI is such that it is concentrated in the food service sector and there is not much scope or rationale for diversification. This would lead to loss of focus and much ground would be lost to the competitors.
  • There is evidently some incompatibility in the operational as well as corporate strategy of PepsiCo and TGI. This would hamper the prospects of both the groups in the long run and seriously undermine the global growth prospects of TGI which is so critical at this point of time.

That the divestment decision was well thought and done with lot of foresight, was vindicated by the more than average returns of both PepsiCo and TGI shares thereafter.

Pepsi was able to arrest the slide in its margin and seriously challenge its rival -Coke in many emerging markets like South Asia, Eastern Europe etc.

TGI on the other hand was able to maintain its dominant position in the QSR and also increase its global footprint substantially