Pepsi Gets Back into Bottling

PepsiCo says the $7.8 billion deal for two of its bottlers, which control 80% of U.S. distribution, will cut costs and help the soft drink maker compete in beverages

By Nanette Byrnes

After several months of haggling over price, PepsiCo (PEP) Chief Executive Officer Indra Nooyi announced Aug. 4 that the food and beverage giant will pay $7.8 billion in cash and stock for two of its bottlers, the Pepsi Bottling Group (PBG) and PepsiAmericas (PAS). Together they control 80% of Pepsi's U.S. distribution.

Besides $300 million in annual cost savings, Nooyi and her team are promising the deal will deliver growth, too. That's pivotally important to Pepsi, which has been having a tough 2009. The splashy makeover of its Tropicana and Gatorade brands seems to be lacking some fizz. Two weeks ago, the company reported a 7% revenue decline in its American Beverage business, affected by another quarterly decline in Gatorade sales.

The deal is $1.8 billion more than Pepsi's original offer in April, but the company justified the increase with higher expected cost savings and the fact that the bottlers' businesses have improved over the last few months as the economy has stabilized.

Streamlining Operations

Distribution is a capital-intensive business without high margins, which is why both Coke and Pepsi got out of the business years ago. Now, Pepsi is hoping that bringing its bottlers back in-house will help the combined enterprise figure out a more effective strategy to compete in the increasingly fractured beverage market.

These days, consumers are increasingly likely to grab a Red Bull energy drink or a bottled tea or water rather than a carbonated soft drink like Pepsi. Nooyi told investors and analysts on Aug. 4 that the operating model as it stands today cannot support independent bottlers and manufacturers and provide long-term profit growth for both. The merger "will allow us to vertically integrate our business, reduce costs, and focus our system resources on growth and innovation," Nooyi told them. "We believe we are taking a very important step to strategically reshape the North American beverage business."

Mike White, PepsiCo's vice-chairman and CEO of PepsiCo International, became the point person on the deal when the company first started exploring the option last winter. White notes that when PepsiCo spun off its bottlers a decade ago, carbonated soft drinks represented between 65% and 70% of packaged beverages; that share is now down to 45%. A structure where bottlers were focused primarily on high-margin, high-volume product left little room to nurture smaller brands that are now playing an increasingly important role in the market. "The supply chain and distribution need to adapt to a world in which people are as likely to drink a SoBe Lifewater as a Pepsi," White says.

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