Despite its global success, PepsiCo has not been as prosperous in the Chinese market as its rival Coca-Cola. But a recent alliance may give a boost to the U.S. soft drink giant.
On November 4, China’s instant noodle and beverage heavyweight Tingyi Holding Corp., a Taiwanese enterprise based in Tianjin, signed an agreement with PepsiCo Inc. to create a strategic business alliance in China. Based on the agreement, Tingyi’s affiliated company, Tingyi-Asahi Beverages Holding Co. Ltd., will be appointed PepsiCo’s franchise bottler in China.
For PepsiCo, its decision to team up with Tingyi came after its bottling business in China suffered losses from rising raw material costs.
“The alliance between PepsiCo and Tingyi came when PepsiCo’s financial stress became even more serious after the financial crisis in 2008. It allows PepsiCo to get rid of its loss-making China bottling business and boost PepsiCo’s profitability and market share in one of the world’s biggest and most competitive beverage markets,” said Chen Jing, an
analyst of the beverage industry with Beijing Orient Agribusiness Consultant Ltd.
However, their marriage has caused a stir in the Chinese beverage market. Its business prospects have been overshadowed by an anti-monopoly investigation, as the merger will account for 30 percent of the market share, asserting a major influence on the market.
The real winner?
According to industry insiders, PepsiCo and Tingyi began their contact as early as 2004. Real breakthroughs didn’t develop for another seven years.
Industry observers say the tie-up marks a long-awaited foray of Tingyi into the soft drinks sector after the company obtained a significant share in China’s market for instant noodles and beverages.
Tingyi hopes PepsiCo’s expertise and reputation in soft drink production can help the company enrich its beverage categories and strengthen its grip of the market.
Yet other experts doubt the benefits Tingyi can get from the deal, as the transfer did not include the production of the drink’s key ingredients.
“PepsiCo is the real winner of this deal. Tingyi was excellent in marketing, team and public relations which are the weak points of PepsiCo,” said Lei YongJun, General Manager of Beijing Putianshengdao Branding Consulting Co. Ltd.
According to a report released by Nomura Securities, even in 2009 and 2010 when most beverage makers were making hefty profits, PepsiCo saw consecutive losses.
“There are structural problems in PepsiCo’s operations in China, like high marketing expenses and mismanagement,” said a report released by Nomura Securities.
Different from its longstanding rival Coco-Cola, PepsiCo choose to establish bottling companies and subsidiaries with regional enterprises rather than international conglomerates that Coco-Cola has collaborated with, such as COFCO, Swire Group and Kerry Group. Currently, PepsiCo has 24 bottlers across China.
“PepsiCo’s problem is that its regional partners were not strong enough to win over regional markets,” said Chen Wei, an independent analyst of the beverage industry. He attributes PepsiCo’s losses in China to its loose control over its bottlers.
“Because PepsiCo does not hold stocks in most of its bottlers, its overall marketing and sales strategy can’t be implemented properly,” said Chen Wei.
In addition, the profit distribution between PepsiCo and its bottlers also triggered friction. The price surge of concentrate offered by PepsiCo has squeezed the meager profit margin of its bottlers.
“In the soft drink industry, the concentrate and other down stream phases took up more than 85 percent of the total profit, leaving the bottlers meager profits. The increasing price of concentrate in recent years has trapped its bottlers a tight spot,” said Chen Jing, an analyst of the beverage industry with Beijing Orient Agribusiness Consultant Ltd.
ChinaBottlers Ltd., the company that oversees PepsiCo’s 24 bottling factories in China, reported a loss of $220 million in the past two years.
As early as 2003, PepsiCo started a campaign to tackle the noncarbonated beverage market, foreseeing that carbonated beverages alone could not propel its future development. These efforts, however, did not pay off as expected.
In a bid to compete with the Coco-ColaNestle partnership in the tea drink market, in 2003, PepsiCo and Unilever formed a 50-50 joint venture—Pepsi Lipton International—to manufacture and market Lipton ice tea in 67 countries.
However, the efforts produced few returns. Two years later Lipton ice tea was withdrawn from the market. “Although PepsiCo and Unilever were both foreign giants, it is still hard to integrate their business successfully because their products have too many differences,” Chen said.
Challenges ahead
In spite of the assertion by PepsiCo’s Chairman and CEO Indra K. Nooyi that “this is a positive deal for Pepsi, Tingyi, our existing Chinese bottling partners and consumers in China,” analysts and industrial insiders see more challenges than benefits.
The biggest difficulty may come from the integration of different corporate cultures, according to Li Baojun, President of Societ Insights & Decision Co. Ltd. based in Shenzhen.
“Taiwanese enterprises value high efficiency and strict administration. The job cuts in PepsiCo’s bottlers after the alliance cannot be avoided, which will be their first test,” Li said.
Li’s worry was vouched by the recent strike at PepsiCo bottling plants around China. Employees at PepsiCo China’s bottling plants in Fuzhou of Fujian Province, Chongqing, Chengdu of Sichuan Province and Nanchang of Jiangxi Province protested against the strategic alliance, the Economic Observer reported November 14.
Production at many plants was seriously affected by the protests. Employees at Chongqing’s Pepsi-Tianfu Beverage Co. stopped working and shut down production lines.
“Whether the cooperation could achieve success was decided by whether the two teams could be integrated well. The strike cast a shadow on the cooperation,” Lei said.
“Tingyi has been expanding on the Chinese mainland more intrinsically, rather than by mergers and acquisitions. In this sense, Tingyi has got no experience in inte- grating acquired enterprises,” said Li.
Tingyi also faces the immediate challenge of turning around PepsiCo’s China businesses.
PepsiCo’s bottling business in China has lost money for the past two years amid soaring raw materials costs and intense competition from Coca-Cola, whose share of the Chinese market is more than triple that of PepsiCo. PepsiCo’s China bottling unit incurred after-tax losses of $175.6 million in 2010 alone.
“PepsiCo’s problems that undermine its profitability will surely affect its integration with Tingyi,” said Lou Xiangpeng, President of Beijing-based Fulai Branding Consulting Co. Ltd.
Given that PepsiCo is not the only controller of its bottling operation in China, Tingyi’s new move in reforming its bottling sector will have to face negotiations with other investors. “This is going to be another big problem critical to successful integration. If it’s not dealt with properly, turning around PepsiCo’s loss-making bottling business will be impossible,” Lou said.
Lou also said Tingyi and PepsiCo both produce soft drinks and it is essential for Tingyi to form a new product portfolio by repositioning its products.
According to Wei Ing-chou, Chairman of Tingyi, it will take three to five years to turn around PepsiCo China.
“China’s beverage industry will face a tough market for the rest of this year and next as a result of tapering economic growth and fiercer price wars,” said Wei.
Anti-monopoly review
According to China’s Anti-monopoly Law, in a corporate merger if annual sales of the two merged enterprises exceed 10 billion yuan ($1.6 billion) and the sales of any party surpass 400 million yuan ($63 million), the merger must be subject to anti-monopoly constraints.
The marriage of two beverage giants has yet to win the nod from the Ministry of Commerce (MOFCOM). In March 2009, MOFCOM blocked Coca-Cola’s acquisition of China Huiyuan Juice Group after a yearlong investigation.
Even though the two sides preferred to call their deal a strategic alliance or equity swap rather than merger or acquisition, their weighty market share will not make them exempt from an anti-monopoly investigation.
“The cooperation will further strengthen Tingyi’s leading position in China’s soft drink market. Given its already high market share, its importance and significance in Chinese market will be enhanced,” said Guo Risheng, an analyst with Beijing-based Guotai Junan Securities.
“We doubt the possibility of the approval from MOFCOM,” said Guo.