Pepsi's Acquisition Disaster

The overall aim of companies’ implementing and investing in mergers and acquisitions (M&A) is to create shareholder maximisation. However, it is important that companies consider all the eventualities before ploughing headlong into often expensive and sometimes very costly business strategies.

It is imperative that when M&A’s occur, managers are able to integrate the two companies creating synergies. Ultimately though, keeping their promise to shareholders that the right decision was made is key to their success. So what happens when things don’t work?

This was the case for PepsiCo (Pepsi), when the company decided to diversify into the fast-food industry, acquiring Pizza Hut in 1977, Taco Bell a year later and Kentucky Fried Chicken (KFC) in 1986 (The Independent, 2012). Pepsi is a clear example as to why companies tend focus on ‘sector concentrated’ acquisitions rather than diversifying into unknown markets. Furthermore the concept of diversifying is extremely expensive to implement and from a shareholder perspective it is not viewed as advantageous or viable. Shareholders themselves can diversify, by broadening their portfolio of investments, which are both cheaper and a less risky strategy, than companies diversifying.

So what drove Pepsi to diversify? I think it is clear from their mission statement what the answer is, ‘Beat Coke’.  For as long as I can remember, there has always been a long-standing rivalry between the two soft drink companies, both willing themselves to ‘out do’ one another in order to gain more market share. I believe that Pepsi thought they had gained a competitive advantage when they acquired the three fast food companies and initially the acquisitions seemed lucrative, with the share price rising by 5% after they attained KFC.

Unfortunately for Pepsi they were unable to retain or recoup the expected benefits they believed they would achieve through the acquisitions. This is because they managed to alienate themselves, from their customers (other fast food chains), who had now become their competitor. Whilst the acquisitions guaranteed that Pizza Hut, Taco Bell and KFC were using Pepsi fountains, it drove potential customers to choose Coke. Furthermore Pepsi were suffering in the soft drinks industry, allowing Coke to consistently gain market share throughout the world.  What was meant to propel Pepsi into the fast-food industry as a major player was in fact costing them in the successful soft-drinks market, and playing straight into the hands of Coke (The Independent, 2012).

In 1997 statistics showed that although restaurants were Pepsis largest business with an estimated ‘36% of the group’s £19.6bn sales, they accounted for only about 22% of its £1.9bn profit’ (The Independent, 2012). It was these poor results that worried shareholders, as they called for Pepsi to sell off the underperforming restaurants. Pepsi started to consider the possibilities of a ‘demerger’, as the believed the way forward was to concentrate their efforts in the soft-drinks industry and the cut-throat competition with Coke.  Pepsi decided to ‘spin off’ its fast food business and in 1997 Yum Brands Inc. (formerly known as Tricon Global Restaurants Inc.) was created. This enabled Pepsi to assigning over its current £4.6 billion debt to the spinoff company (The New York Times, 2012). 

It’s quite ironic to think that back when Pepsi started their acquisitions into the fast-food industry the company hoped to create synergies, gain a competitive advantage over Coke and ultimately create shareholder wealth. In reality however all they did was lose focus of their core business strategies, help give Coke a competitive edge over them by isolating themselves in the fast-food industry and devaluing the companies reputation amongst their shareholders.

Obviously every company that chooses to diversify will not have to deal with the same problems Pepsi faced, but it does beg the question ‘Are companies creating shareholder wealth’? Furthermore there needs to be a distinction as to whether ‘diversification’ or ‘M&As’ or a mix of both can lead to a destruction in shareholder wealth?

In Pepsis case, their shares rose by 12% on The New York Stock Exchange a day after The Wall Street Journal announced that a spinoff was expected (The New York Times, 2012). This alone shows the confidence within Pepsi to create shareholder wealth as long as they are acting with in their ‘concentrated market sector’.  

I think it is clear what drove Pepsi to diversify, the arrogance of the management and their desire to ‘Beat Coke’. This left little or no regard for shareholder maximisation and resulted in their decisions being clouded.  Their longing to gain a competitive advantage over their biggest rivals, resulted in them losing concentration and allowing Coke to take advantage in the soft drinks industry.