CASE 23
“Breaking Up is Hard to Do”: PepsiCo in 2014
Author’s Teaching Note by Ram Subramanian
I. Case Synopsis
In April 2014, PepsiCo, the Purchase, New York–based snack food and beverages
company, faced a call for breaking up the company into two separate units by
an activist investor. Nelson Peltz, the head of Trian Funds, argued that
there were inadequate synergies between Frito–Lay, the snack foods business
II. Case Objectives and Placement
PepsiCo is an example of a diversified company. When a company chooses to
diversify, it makes the choice to diversify into related or unrelated
industries. While both types have their pros and cons, in general, research
has indicated that related diversification is more beneficial to the firm
than unrelated diversification. This case is an example of a firm that has
diversified (starting out as a beverage firm, PepsiCo diversified by merging
with Frito–Lay in 1961) and presumably thrived. However, Nelson Peltz argues
that the diversification has not paid off and that the firm should break up.
Given this background, the following are the objectives of the case:
1. To examine the economic logic that underpins a firm’s decision to
diversify.
This case is best used after the course has moved from business–level
strategy to corporate–level strategy and the subject of diversification has
been covered.
III. Teaching Plan
There are three main topic areas (or pastures) to be covered in this case:
PepsiCo as a diversified firm, the nature of Nelson Peltz’s charges, and the
company’s suggested plan of action. Underlying these topics is the concept of
corporate governance or the role of managers when there is a separation of
CASE 23
“Breaking Up is Hard to Do”: PepsiCo in 2014
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A good ice–breaker question could be this:
When you eat a salty snack how often do you reach for a cold beverage?
This question is important because while it is likely to get a lot of
IV. Discussion Questions and Answers
1. How is PepsiCo organized? Is it a related diversified firm or a
conglomerate?
2. Why does Nelson Peltz call for breaking up PepsiCo? Does he have a strong
case?
3. Should PepsiCo break up? How should the company respond to Peltz’s
charges?
4. How is PepsiCo organized? Is it a related diversified firm or a
conglomerate?
From its inception in 1893 (in Caleb Bradham’s store) till 1961, PepsiCo was
a single business company because it operated only in the beverage industry.
Its merger with Frito–Lay, Inc. in 1961 made it a diversified firm. At first
Upon deeper analysis, though, commonalities between these businesses emerge:
Both businesses involve selling branded products that consumers consume.
CASE 23
“Breaking Up is Hard to Do”: PepsiCo in 2014
could demand more shelf space from the retailer because it also sells Lays
and Doritos.
Of the three, market power appears to be the strongest in the case of
PepsiCo. However, it is important for the class to understand that there are
no “rules” to classify a firm as related or unrelated. The company has the
burden of proof to convince the investment community that it is related or
that it is a conglomerate. Very often, though, the investment community
discounts the value of a conglomerate (called the conglomerate or
diversification discount) by giving it a value (in the form of its stock
price) that is less than the sum of its parts. To avoid the tag of a
conglomerate, many firms make every effort to publicize that it is a related
diversified firm.
Why does Nelson Peltz call for breaking up PepsiCo? Does he have a strong
case?
It is important for the class to get an idea of who Peltz is and his
motivation to call for a breakup at PepsiCo. Peltz (and Trian Fund) is an
activist investor. Activist investors look for underperforming companies,
CASE 23
“Breaking Up is Hard to Do”: PepsiCo in 2014
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Managers are agents of the principals who are the owners of the firm. Agency
theory posits that the assumption holding this relationship is that managers
would subjugate their own interests to promote the interests of the
principals. If this assumption does not hold, then we have an agency problem.
Agency problems arise from adverse selection (selecting managers whose skills
don’t match the job requirements) and moral hazard (when managers take
advantage of information asymmetry).
It doesn’t appear that Peltz is arguing that PepsiCo is a conglomerate owning
unrelated businesses. The crux of his case can be summarized as follows:
There doesn’t appear to be significant synergies that come from owning
related businesses.
Whatever synergies the company gets are offset by the cost of owning these
businesses as one entity.
The second argument looks at the costs versus the benefits of owning multiple
businesses. In the Indra Nooyi quote in the case, it appears that owning both
beverages and snack foods results in cost savings of $800 million to $1
CASE 23
“Breaking Up is Hard to Do”: PepsiCo in 2014
A good question to pose at this point is:
It is clear that Frito–Lay is helping the beverage unit, but how is beverage
helping Frito–Lay?
In 2013, the FLNA unit (Frito–Lay North America) reported operating profits
of $3.621 billion on revenues of $13.3 billion or 27.23 percent. In contrast,
PAB’s (PepsiCo Americas Beverages) operating profit was $3.273 billion on
This is a good point to bring out the moral hazard issue. Obviously, PepsiCo
managers have access to far more information than what they are willing (and
obligated) to share with investors. Are they using this information asymmetry
to their advantage? Is Peltz operating with much less information than
PepsiCo’s managers?
Should PepsiCo break up? How should the company respond to Peltz’s charges?
The discussion in questions one and two set the stage for question three,
which is the decision question. At first glance, the easy option for PepsiCo
is dismiss Peltz’s charges and keep the company “as is.” Ian Cook’s letter of
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“Breaking Up is Hard to Do”: PepsiCo in 2014
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V. Wrap Up
This case involves a discussion of a firm’s corporate strategy (what is the
right mix of businesses) as well as its perspective on corporate governance.
The instructor should wrap–up the discussion by focusing on key takeaways:
While related diversification is considered a better option than unrelated
diversification, both come with costs that need to be balanced against the
benefits.