Pepsi: AB InBev Pt. 2?

Ramon Laguarta, Pepsi’s CEO discussed the company’s strategy going forward. Market share and efficient distribution are central to maintaining Pepsi’s competitive advantages. Discussing these factors, Mr. Laguarta said the following:

“…Whoever wins in e-commerce now and is able to capture those families that are trying this e-grocery service for the first time, I think, is going to win those families in the future. So we’re investing heavily in trying to be the first in that channel and trying to — and again, the investments that we made in the last few years, last year in particular, are helping us both from the data availability, the agility of our infrastructure to supply those channels, etc. So, e-commerce is a key area where we think we can gain market share.

Second is the strength of our DSD system and our ability to service the stores directly. I think it’s a capability that is quite unique, and it gives us the advantage to keep the supply chain going in spite of all the challenges we’re all facing. So that’s also an area where we plan to double down. That improves our execution in store and the inventory in store. And that is also a sustainable advantage.

The third one is brands. I know we have — we’re seeing consumers going back to brands that they trust, and we have quite a lot in many markets that consumers trust. There’s big brands that have been around for some time. We’ve modernized them. We’ve kept them relevant to the consumer.”

All of that sounds great. It’s all logical from Pepsi’s perspective. However, the underlying assumption is that Pepsi can win share of mind in an e-commerce world. While brands are objectively important, it will be interesting to see which brands are the winners. Will customers think of Pepsi or Amazon/Walmart when they think of grocery shopping on the internet?

The key issue will be whether Pepsi’s brands have the strength to pull consumers to those products going forward. The challenge Pepsi (and others) will continue to face is the internet is not the grocery store isle. There is unlimited “shelf space” and the distributor is the entity that owns the share of mind on the internet. To be fair, traditional distributors (grocery stores) also owned share of mind. However, the internet is different because the attention seems to trend toward natural monopolies.

Interestingly, barriers to entry to create a new e-commerce distributor are minimal. On the other hand, barriers to scale and mind share are immense. Thus, barriers to entry are minimal but barriers to success are huge. Therefore, successful, large scale e-commerce companies may be able to increase their bargaining power over Pepsi, Coke, and other CPG companies.

That said, the large CPG companies are going to have the ability to purchase the prime advertising slots on Facebook, Instagram, Google, Amazon, and Walmart. They will be able to release brands quickly and tailor ads to local consumers. Will the economics of these relationships be similar to traditional slotting fees? Maybe. Maybe not.

Regardless, it will be very interesting to watch. There’s always been a middle man between large CPG companies and the consumer. CPG has combatted that via advertising and owning shelf space. However, those company strategies were extremely effective in a world where attention aggregation was much easier (think TV and barriers to shopping outside a local area) than it is today.

It’s hard to argue Pepsi is thriving like it would have if the internet didn’t exist. These financial results, while acceptable, are far from stellar. That said, Pepsi has a heck of a business and returns on capital are improving.

It appears returns on capital have improved driven, at least in part, by improving the cash conversion cycle from 13.57 days in 2014 to -18.33 days in 2019. Straight out of the AB InBev playbook. Interestingly, Pepsi referenced zero based budgeting in the 2Q20 earnings call.

“As it relates to becoming stronger, we are putting an even greater emphasis on our businesses to have a zero-based spending mindset in which we must earn our budgets.”

This will be an interesting one to watch going forward.

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