Peltz and PepsiCo: A bad mix

PepsiCo nailed its earnings this week with impressive cost savings and solid margins. Investors cheered the news with a 3% jump in its share price, while questions started circling around the credibility of “activist investor” Nelson Peltz’s effort to split the company.

Bloomberg pointedly asked whether these results were enough to deter Peltz. Bill Schmitz, a Deutsche Bank analyst, replied that although he felt Peltz was wrong about the break-up, he would not likely back off “regardless of what Pepsi does”. Huh?

Operational Logic

Peltz likes to think he takes an operational view of activist investing, rather than just looking at the balance sheet for financial engineering tricks to make a quick buck. He seems to have been right about Heinz, for instance, where his activism took the form of pressing for more marketing and less retailer discounting. Fair enough for a simple situation like Heinz, where too much regional autonomy had left money on the table.

PepsiCo is in no way the same story. It already runs one of the best supply chains in the world, and although the Peltz pressure may well have pried some expenses out of the system, true operational improvements won’t come from firing people and extending payment terms to suppliers. In fact, according to Schmitz, the separation expense of splitting the drinks business away from the snacks business is likely to be between $800 million and $1 billion. This would be cutting off your nose to spite your face – hardly a clever operational tactic.

I have personally often been impressed by PepsiCo over the years, particularly around its eye-opening drill down into the use of advanced planning tools in the manufacturing operation at Frito-Lay all the way back in 2000, and a breakthrough innovation in bottling operations around 2008 that radically reduced water usage.

I remember a pan-PepsiCo branding change that was smoothly executed over Christmas a few years back, seamlessly swapping out hundreds of SKUs from Gatorade to Cheetos. And who has a better direct store delivery (DSD) system than Frito-Lay? This supply chain has assets any CPG company would kill for.

Plus there is obvious synergy. The customer base for drinks and snacks is essentially the same. Both must source food ingredients, packaging materials and machinery. The brand-building dynamics are very similar. Even end-consumer challenges are nearly identical: healthy eating in developed markets and convenience in emerging markets.

How would splitting these two help either compete?

Platform for growth

Great CPG businesses, especially now in the age of digital demand, need to use platform strategies to accelerate innovation while controlling costs. At one level this means managing technical platforms for recipe formulation, food processing technology, package design and fill. At another level there are platforming opportunities in distribution centre design, DSD operations and customer exclusives support. 

Coping with the complexity driven by fragmenting consumer tastes, divergent retail formats and rising regulatory oversight demands separation of supply chain activities into platform elements that are robust to change and modular elements that are quick and easy to test. Zara does this. So does General Mills. Peltz doesn’t see this potential at PepsiCo, but I think he’s crazy.

Value creation for the long run depends on re-investing cash in products, brands, channels and supply chain assets to create profitable growth. In today’s consumer/retail sector this means grappling with dramatically more demand data, mastering complex materials handling technologies and keeping abreast of exploding knowledge around food science. Bigger is better when discovery is expensive and can be shared widely to sweeten the overall return on R&D.

Even if the break-up were free of charge, would PepsiCo’s separate snacks and drinks businesses be worth more alone? It’s hard to see how the resulting companies would avoid being acquired by some other CPG giant using its scale with suppliers and customers to earn a better operating margin.

Being smaller and nimbler sounds good in theory, but in practice the huge majority of branded facings in any grocery or convenience retail store are owned by a small number of big companies. This is a mature business. Why split the innovation burden when the payback can be shared?

Let’s hope Peltz finds another target for his “operational” activism.