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Enterprise Integration: The Pepsi Challenge

PepsiCo is a giant consumer foods corporation with 2005 sales of $32.5 billion and a net profit of $4 billion. Its main divisions are PepsiCo Beverages North America, with soft drink sales of more than $9.1 billion (second only to Coca-Cola, with $23 billion in 2005); its Pepsico International, with sales of $11.4 billion; Frito-Lay North America, its munchies division, with $10.3 billion in sales; and Quaker Foods North America, with sales of $1.7 billion (also known as QTG for Quaker Foods/Tropicana/Gatorade). It has computer systems in more than 700 offices worldwide. Yet it is a company that has experienced its share of problems. PepsiCo's gross profit margin fell from 58 cents in 1998 to 54 cents in 2002, a $1 billion drop in gross profit if its 1998 gross margin had not declined.

It is a far more competitive marketplace than it used to be. In the beverage business, Pepsi had lost some momentum to Coke and to bottled waters and fruit juices; in snacks, consumers are putting a lot of pressure on pricing. The Pepsi Bottling Group, a publicly-traded spin-off of PepsiCo since 1999 (PepsiCo retains a 45% equity interest), saw sales dropp 3 percent in the first quarter of 2003. In 2005, soda sales in the United States dropped for the first time in 20 years. Coca-Cola sold 2% fewer cases, and Pepsi's total case volume decreased by 3.2%. Frito-Lay's sales growth fell from 11 percent in 2000 to 7 percent in 2001 to only 5 percent in 2002. One reason was that its private-label snack competitors were selling their products at lower prices than Frito-Lay. In addition, Frito-Lay was moving into healthier snacks, such as baked chips, putting Frito-Lay in stiff competition with companies such as General Mills and Kraft. PepsiCo realized it had to find ways to increase its profit margins. Today, there are hundreds of Pepsi product and packaging configurations, compared to 50 only several years ago, and store shelf space has not increased to accommodate all these items. Pepsi must find better ways to sell, price, promote, and deliver its soft drinks and other products at far less cost.

PepsiCo's approach to dealing with these challenges is summed up in what it calls "the power of one," which involves the integration of selling operations and distribution logistics. The power of one is a principle espoused by Roger Enrico when he was PepsiCo CEO (1996-2001). PepsiCo maintains separate distribution systems for its divisions, even though they deliver their products to the same supermarkets and convenience stores in the United States. Other large diversified companies, such as Unilever, Newell Rubbermaid, and the Scotts Co., are eliminating separate sales and marketing teams and, in some cases, separate supply chains associated with each business unit. The objective is to make all divisions act together as a single company. Rather than facing four different trucks and salespeople from different divisions with PepsiCo products, each customer could receive single deliveries, one salesperson calling, and even one bill. Also, this approach makes cross-selling much easier, for example, by enabling the delivery person to display potato chips where the soft drinks are sold.

In order to realize "the power of one," PepsiCo has to overhaul its information technology (IT) infrastructure and install enterprise-wide systems. These measures would further reduce PepsiCo's operating expenses and boost profit margins. Top leadership had allowed individual business units to establish their own information technology infrastructures. The divisions use different databases, different human resources systems, different financial applications, different distribution software, and different hardware. Company executives have said that different technology setups in different divisions can be very costly. There are unnecessary expenses in initial investments in different technologies, followed by additional costs for technology maintenance, as well as for data backups, software updates, and technology support. Other problems develop when divisions work independently, including duplication of work and the company's inability to bargain successfully for its supplies because of the large size of purchases from one company. For example, PepsiCo's several bottlers spent about $40 million on computer hardware in two years, whereas Frito-Lay spent $100 million in 2003. Their total, including software, was about $200 million. If the company were to combine its purchases and standardize on two or three applications, analysts claim the company would save 20 to 30 percent or $50 million in only these areas of technology in these two divisions. As Richard Waugh, a co-founder of B2Emarkets, which specializes in volume purchasing, said, "When you can bundle the purchase to include software, installation, service, and maintenance, the savings can be that much greater." If PepsiCo had unified its technology strategy, by 2002 its annual profits would have been $1.7 billion higher that its actual profits. One former PepsiCo executive said that individual divisions annually spend about $650 million in technology plus $300 million in shared services spending. Alinean LLC, a consulting firm that specializes in the value of information technology, puts the figure much higher at $1.6 billion annually.

Implementing both "the power of one" and a clear, decisive technology strategy has not been easy for PepsiCo. Senior management talked about "the power of one" for a number of years, but little was accomplished. Tom Pirko, the president of BevMark, a beverage marketing consultancy, said, "They've been talking forever about how they're going to streamline operations and integrate systems, and they're still talking. The commitment just hasn't been there." The company has struggled to integrate information systems across divisions, which largely operated as separate business entities. It is, therefore, not surprising that the company does not consistently implement best practices across its divisions. In 1986, Frito-Lay started issuing mobile handheld computer units to its delivery staffs. Its goal was to give them the power to set pricing and to promote products themselves. They were encouraged to make decisions on prices, quantities, and shelf space when a competitor's products created a need. This was a major changeover from recording delivery information on paper and entering it into computers at the end of the day, with decisions on changes made centrally once the information had been reported. Delivery staff now made decisions on the spot and uploaded the data to the Frito-Lay mainframe at the end of each day. Several years later they were able to transmit data instantly using wireless connections. Frito-Lay not only changed its whole delivery system but it also revolutionized delivery systems everywhere as many other companies followed its lead. Frito-Lay saw its revenues increase by 14 percent annually from 1986 through 1990, whereas its annual operating profits jumped by 30 percent for the same period, rising from $348 million to $934 million, with much of the increase attributable to the new delivery approach.

However, this delivery system spread to other PepsiCo units slowly, and when it did, those units turned to different handheld computers and different software. For example, some of Frito-Lay's delivery staff used handheld computers from Intermec Technologies and were still using later models of that brand in 2003, whereas other Frito-Lay employees began using Fujitsu handhelds in 1986 and were still using the same brand in 2003. In 2002, the three biggest Pepsi bottlers turned to yet another brand, handheld computers from Symbol Technologies. They are also all using different software on these computers, enabling some to monitor the inventory and pricing on a store's shelves.

In an attempt to unify key computer systems in PepsiCo, management established the Business Solutions Group (BSG) in the early 1990s. It was physically placed in Plano, Texas, on the Frito-Lay headquarters campus, in an attempt to build on Frito-Lay's past success with handheld and wireless technology. BSG was supposed to handle computing tasks shared by the various business units, including setting corporate infrastructure standards and standards for data center operations. The plan was to begin by installing standardized human resources, finance, and procurement systems as well as creating a central data mart. It was then to continue by integrating sales and marketing systems and creating a single supply chain management platform for almost all purchases and shipments of finished goods to customer stores. Its goal was to implement enterprise systems throughout all the divisions. BSG succeeded in some projects. For instance, it added a central procurement system to replace the divisions' separate purchasing systems. It also developed a common customer billing system, which produces reports showing a PepsiCo-wide view of its customers. It had to face such difficult tasks as unifying data names for all relevant systems so the data names would be the same, for example, "price" or "customer." BSG even established a central help desk, and if that group could not solve a user's problem, the central help desk would locate a local IT person to walk over to the employee's desk and solve the user's problem.

Nonetheless, the plan for BSG to centralize key IT systems mostly did not succeed. For example, five years later, technology infrastructures, a fundamental issue, remained different between all divisions. Why the failure? There were many reasons. For one, each business unit has its own information technology staff, and these staffs continually collided with the BSG. One former divisional CIO said, "It was a big job, a very tough assignment that required major cultural changes. And that's where things broke down." PepsiCo CEO Steve Reinemund said that they let the divisions set their own standards because the units were meeting their individual growth and profit targets, and so management did not want to interfere. Corporate sales were growing annually at nearly 7 percent in 2002 and 5 percent the previous year. As a result, for example, recently when one of the bottlers asked to take over its own technology, it was given permission. One former manager said the BSG thereby "lost the opportunity" to set the direction of an important PepsiCo unit. Upper management was certainly sending mixed messages by creating the BSG to unify technology while also permitting the people to manage the technologies of their own business units. Divisional management was rewarded for meeting its financial goals but not for sharing services or cooperating with each other or with the BSG.

BSG forced some of its views on the divisions, creating opposition rather than cooperation. For example, the BSG selected an IBM database for a large corporate data warehouse because of long-range relations with the company, even though several business units evaluated their warehouse technology and believed that the Teradata database was a far superior product. According to one unit manager, "When they came up with a standard for the data warehouse, they never asked us for input." The BSG demands were thus very contradictory. In another instance, when managers had cut the business unit costs by 17 to 20 percent, the BSG raised its chargeback prices for the services it was providing them. A manager protested, saying, "We're not paying more. We'll cut your services back." The unit lost the fight.

Quite naturally, the divisional managements did not want to surrender some of their authority, although that is a necessary part of centralization. In mid-2003, when Frito-Lay was purchasing a $100-million upgrade to its existing handheld computer systems, rather than taking the opportunity to turn to those used by the Pepsi bottlers, it purchased its own. The reason it gave for this decision was that its field team needed larger screens because the Pepsi bottlers' products are displayed in several places in a store.

The PepsiCo CIO position has been empty since 2000, and the corporation has experienced a high turnover rate of technology managers. As they left, the CIOs' complaints usually involved the lack of a clear technology strategy from the top. Frito-Lay has had six CIOs in the past 10 years.

With the "power of one" on hold, Reinemund tried to achieve some of its objectives by establishing a business process optimization plan in February 2003. He appointed Indra Nooyi, PepsiCo's president and CFO, to take charge of the effort. The optimization plan called for the divisions to copy many of Frito-Lay's systems and some core management techniques from Quaker. The plan included merging some of the distribution centers, enabling various PepsiCo products to be delivered in the same trucks for some customers. It also called for migrating all the divisions to one enterprise software platform. The corporation was to use Oracle enterprise software first to manage human resources, then finance, then inventory. All divisions were required to use the implementation strategy Quaker was using to install its SAP enterprise systems, which used project management teams staffed and led by people from all affected business areas, as well as information systems staff. Nooyi said that the optimization plan would reduce costs by $800 million from 2003 through 2005.

The optimization plan had problems. The Frito-Lay project was not completed, but Frito-Lay had already spent $60 million reorganizing its supply chain. It had put computers on all trucks so the company could track the load on the truck, the location of the truck, and its arrival time. Frito-Lay said it had gained $200 million in productivity, and much of that work would have to be undone. Quaker would have to cancel its SAP implementation even though it was nearly 40 percent completed, the company having already installed the e-procurement application at 26 sites. PepsiCo would lose $40 million to $100 million by canceling that project. Quaker had to return to using a wide variety of homegrown applications that had caused it to move to SAP originally.

In the spring of 2003, Reinemund made it clear that he did not want to push the project too far. For example, he said, "We have big brands and big businesses. You can't run that in a centralized fashion. You have to do it the way we have grown up doing it. That's part of our culture." The corporation also did not alter its compensation system. Jeanne Ross, a principal researcher at the MIT Sloan School of Management, observed, "As long as the corporate management is saying autonomous business units are measured on business-unit successes, the IT people associated with that business unit will do what the business unit wants and needs for it to measure up." She concluded, "The good ideal of sharing and working with a central IT department will always fall to second place." As one former PepsiCo executive put it, "They've got one foot on the gas and one on the brake."

In contrast, Colgate-Palmolive, a $9.5 billion consumer products company, has taken nine years to set up its enterprise systems. During that period, it installed its SAP systems in 53 countries and eliminated 75 data centers around the world, leaving it with only one computer center plus a backup. The company also reduced the 80 national CIOs around the world to 8 regional ones. The result has been $225 million in direct savings and its gross profits over those years have risen from 48 cents to 55 cents. A similar 7-cent gross margin increase would add $1.7 billion in gross profits each year for PepsiCo. In June 2004, SAP announced that PepsiCo was adopting the MySAP Business Suite, which includes ERP, CRM, and SCM software, in order to integrate and unify the legacy systems across its divisions.

Complementing its "power of one policies," PepsiCo moved to change its sales and delivery system to what is called a "presell" system. PepsiCo had been using a traditional direct store delivery (DSD) system, in which the same person delivers and stocks the products and also takes new orders. For example, under DSD the Pepsi Bottling Group delivery staff would go to the same store four or five times a week, spend a total of 75 minutes, 4 minutes of which would be devoted to sales. The presell system separates out the order-taking portion and gives it to the sales staff, thereby facilitating the salespeople's selling time while the delivery people deliver and stock. According to presell, the salespeople go to a store every few days but spend 20 minutes each time at store selling. The PepsiCo bottlers switched to this system, hoping it would both increase sales and provide information to reduce haulback costs. Haulbacks-unsold soda that drivers have to bring back to the warehouse at the end of each day-can run as high as 30 to 40 percent of each delivery truckload, and they add to inventory and handling costs. If bottlers fully switch to a presell system, haulbacks should be largely eliminated.

One major problem with switching to presell is that it results in a pay reduction for the delivery staff because they will no longer earn sales commissions. So far, bottlers have introduced presell both in areas where labor relations are excellent and in nonunion areas where the company can simply change the pay of the delivery staff. Another problem with this is that store managers are often too busy to spend much time listening to sales pitches. They do not want to spend 20 minutes with someone who is trying to sell them something in which they are not interested.

To address this problem, the Pepsi Bottling Group and PepsiAmericas proposed switching handheld computers to a Symbol wireless computer with 64 megabytes of memory, enough to enable the sales staff to use color images of store displays, new products, and new packaging. These computers can also store a year or more of a specific customer's buying history. These systems include suggestions on ways to sell more product by offering information on product shipments, price, and point-of-sale activity, including seasonal and holiday trends and geographic buying patterns. However, Pepsi Bottling Ventures is using different hardware for presell (it upgraded its Intermec computers), and Pepsi Bottling Group and PepsiAmericas use different sales software on their Symbol handhelds.

PepsiCo management believed that preselling, combined with the business process optimization plan, could bring sales and delivery people closer to realizing the "power of one." PepsiCo plans to finally move Pepsi soda, Quaker breakfast foods, Frito-Lay snacks, and Tropicana juice as if the different products come from a single company.

In 2005, the corporation began preparations for the deployment of its Business Process Transformation (BPT) initiative, which also aimed to integrate key business processes, such as finance, consumer insight, purchasing and supply chain, as well as customer service. Reinemund described the deployment as having "common Information Technology applications, linking our systems so that key pieces of data supporting al our businesses flow seamlessly from system to system." The first phase of the initiative rolled out in early 2006 when several North American plants and the Global Procurement team received streamlined tools for and processes for purchasing materials other than commodities, packaging, and ingredients.

Sources: Melanie Warner, "Soda Sales Fall for First Time in 20 Years," The New York Times, March 9, 2006; PepsiCo Annual Report on Form 10-K for the fiscal year ended December 31, 2005, accessed through Yahoo! Finance on March 8, 2006; www.pepsico.com, accessed on March 8, 2006; www.pbg.com, accessed on March 8, 2006; Rick Whiting, "Analysis Tool Cuts Bottler's Costs," InformationWeek, August 1, 2005; Antone Gonsalves, "SAP Joins the Pepsi Generation," InformationWeek, June 9, 2004; Matt Hines, "SAP Siphons Pepsi Away from Oracle," ZDNet, June 9, 2004; Kim S. Nash and Mel Duvall, "PepsiCo: No Deposit, No Return," Baseline, May 1, 2003; Kim S. Nash, "Roadblock: The Business Unit CIO," Baseline, May 1, 2003; Mel Duvall, "Fanatical Focus on Integration," Baseline, May 1, 2003; Kim S. Nash, "Bumps and Grime," Baseline, May 1, 2003; Marcia Stepanek with Debra D'Agostino and Anne Field, "Case Study: The Pepsi Challenge," CIO Insight, April 14, 2003; and John Foley, "Beverage Makers Seek Efficiencies," InformationWeek, February 17, 2003.

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