APPLES AND ORANGES
Shoartly after my previous post on "Marketing Hell," I received an email from a friend who said:
Your point about monopoly pricing on syrup is right on the money. When I was doing work at KO this was a constant source of tension between the company and the rest of the Coca-Cola bottling system.
Then he added this really important question:
How do you take into account the components of Pepsi's business that are not competitive with Coca-Cola (e.g. Frito-Lay division)? Isn't this an apples and oranges comparison?
CUSTOMERS AND CAPITAL
The answer depends on whether you're talking about Coke and Pepsi's competition for customers. Or their competition for capital. I'm talking about their competition for both customers and capital. Because success (or failure) in capital markets feeds back on success (or failure) with customers. And vice versa.
An article on how "Buffet Helps Pepsi Beat Coke to get Gatorade" had this to say about Pepsi's 2000 acquisition of Quaker Oats:
So long the underdog to the ubiquitous Coca-Cola, Pepsi is starting to fight back. Last week saw PepsiCo, the world's second-ranked soft drinks maker, steal a march on its old rival by agreeing a takeover of Quaker Oats, the US company that controls the hugely successful Gatorade brand -- considered one of the hottest properties in soft drinks worldwide.
This article "Quaker Acquisition a Big Winner for Pepsi" recently appeared in Chicago Sun-Times:"
Five years ago, Pepsi bought Chicago-based Quaker to get its hands on the Gatorade brand. Today, the Quaker portion of the Quaker Tropicana Gatorade division is performing like a champ, with revenues up 10 percent. The food line is not quite out of the shadow of the powerhouse sports drink, but it's doing well enough to get its parent's attention -- and praise.
MARKETING AND MERGERS
What decisions that carry an important enterprise marketing component have the biggest, most immediate (as well as long term) impact on a company's market cap? The answer is mergers and acquisitions.
Wait you say, those are just financial decisions! That's precisely the problem. One of the reasons 50% to 80% of otherwise carefully vetted mergers and acquisitions fail to produce the predicted windfall to shareholders is they are treated as purely financial decisions. Even though they also have an important enterprise marketing component.
Unfortunately, CMOs are so focused on traditional marketing questions (read campaigns and segmentation) they rarely are consulted on M&A opportunities. Never mind identifying these opportunities in advance. And merger specialists are so focused on the financial details they fail to consider the enterprise marketing challenges.
Robert Bruner, Dean, Darden School of Business, in a post to his blog on March 11, 2007 titled "Sometimes Learning is Costly" concluded:
... my years of experience as an educator and my studies of merger failures and financial crises suggest that large errors tend to emanate less from shallow depth (the failure to dig deeply into arcane technical matters) than from too-narrow breadth (the failure to ask fundamental questions, often borrowed from other perspectives and disciplines).
After all, Warren Buffet, one of the greatest financial minds in the country and Coke's biggest shareholder at the time, reportedly blocked its intended acquisition of Quaker Oats on the belief that the foods division was a dog! As a result Pepsi won the bidding war for the company.
ACCOUNTING MAGIC
My friend's email concluded with this important comment:
Before its public offering Pepsi owned their bottling system in the US (COBO) outright unlike KO that "unbundled" their ownership of the heavy fixed capital parts of the system (i.e. Bottling plants). This was all part of Doug Ivestor's "49 percent solution" back in the 80's.
Here's what Morningstar had to say about Pepsi's public offering in 1999:
In spinning off its major bottler but retaining an equity interest between 20% and 50%, PepsiCo follows the lead of its rival Coca-Cola KO, which did the same thing back in 1986. Coke's spinoff of Coca-Cola Enterprises CCE was engineered by an accounting whiz named Douglas Ivester, who's now the company's CEO; it gave a considerable boost to the company's margins, since Coke's bottling operations are just as low-margin and capital-intensive as Pepsi's.
The author went on to explain how there's enough accounting magic in the parent retaining an "equity interest" in a spin-off to make up for the marketing hell created with its bottlers:
The reason has to do with the differences between the consolidation accounting method (used when the parent owns 50% or more) and the equity method (used when it owns 20%-50%). … The amount of profit is ultimately the same under the two methods, but reported revenue is less under the equity method, increasing the company's net margin (profit divided by revenue).
MARKETING HELL REDUX
How did the 1999 spin-off of Pepsi's company owned bottling group fair in the stock market? On December 31, 2006 the Pepsi Bottling Group (PBG), 42% owned by Pepsi, had a value/revenue ratio of 0.57; not much different that of Coca-Cola Enterprises (0.49) on the same date. Coke's v/r ratio was 4.60 and Pepsi's was 2.94. Looks like marketing hell is in the DNA of syrup based cola's! How do you avoid the syrup trap? Return the bottling companies to private ownership and get into health drinks and bottled water! Or, float brand bonds!
~V
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