CASE 2
Suppliers Selection at PepsiCo Europe
"Our suppliers should understand that they are one more link in the PepsiCo supply chain."
Victor Pérez, Supply Chain Director, PepsiCo Europe or
In February 2018, Victor Pérez, supply chain director of PepsiCo Europe, was reviewing the
proposal made by Jerzy Migdalski head of purchasing for the beverages division in Eastern
Europe to start working with Gassner, a potential new supplier of carbon dioxide (CO₂).
Gassner had offered a very competitive price compared with current suppliers in Europe.
The proposal from Migdalski would definitely help Pérez reduce production costs a relief
given the mounting pressure for cost reduction made by the headquarters - although before
making a final commitment he wanted to ascertain that the new supplier could deliver on
other dimensions, such as quality, capacity, and service level; and how the new supplier
would fit the existing supply chain structure of Pepsico.
PepsiCo in Europe²
With a market value of $160 billion and sales of over $60 billion, the group PepsiCo, Inc. was
in 2018 the second largest firm of soft drinks and snacks in the world. One hundred years
after its predecessor, the emblematic Pepsi-Cola Company, started operations, the
corporation had business in more than 200 countries and employed more than a quarter of a
million people worldwide.
1. Some names and figures have been changed to protect confidentiality.
2. Source: PepsiCo Annual Report. http://secfilings.nasdaq.com/edgar conv
html%2f2018%2102%2F13%2f0000077476- 18-000012.html#FIS BUSINESS
(December 2018). https://www.nasdag.com/ (December 2018)
This case was prepared by Professor Alejandro Serrano, Nadjia Gassner and Humberto
Pardi, external collaborators, and Professor Albert Girbal Puig. February 2021
IESE cases are designed to promote class discussion rather than to illustrate effective or
ineffective management of a given situation.
The original company went bankrupt after 12 years of operations, but the syrup secret
formula was then bought by Charles Guth. In 1965, Pepsi-Cola Company merged with Frito-
Lay, Inc. and. became PepsiCo, Inc. As of 2018, the company manufactured and distributed
not only drinks - such as Pepsi, Gatorade, 7 Up, Mountain Dew, Lipton and Tropicana - but
also snacks, including Cheetos, Doritos, Lays, and Ruffles. Twenty of PepsiCo's brands sold
more than a billion dollars each. As of 2017, the company's gross margin was 55% and its
net margin was close to an enviable 20%.4
In Europe, the company started operations in 1930 and grew steadily since then.5 In 2018,
the ESSA (Europe plus Sub-Saharan Africa) region sold more than $10 billion in
65.countries. In the region, the company had more than 85 production, processing, and
bottling plants, some owned, some subcontracted, of which 22 most of them in Europe -
produced carbonated drinks. It also controlled some three hundred distribution and
warehousing sites
Customers
In 2018, PepsiCo made 18% of its revenues in the ESSA region, selling Pepsi-Cola
beverages, Frito-Lay snacks and Tropicana juices. The demand for carbonated drinks was
scattered all around Europe, although it varied significantly between countries.
PepsiCo sold its products through wholesalers and other distributors, but also sold directly to
grocery and convenience stores, mass merchandisers, hard discounters, and authorized
independent bottlers. Margins were sufficient to ensure profitability of all links in the supply
chain (for example, in the case of soft drinks, according to industry estimates, the price at
which a manufacturer sold was 60% of what the final consumer paid).
There was a clear seasonal pattern to consumer demand for carbonated drinks in Europe.
Sales were typically higher during the third quarter of the year, due to summer holidays and
higher temperatures. Sporting matches and other big events had also an impact on overall
consumption. Demand at the peak period, usually between May and September, was usually
40-60% above the mean demand in recent years.
The Production Process of Carbonated Drinks
Carbonated beverages are made with a mixture of water, carbon dioxide, sweeteners, and
several chemicals, which give color and flavor to the beverage and help conserve the drinks
(see Exhibit 1). Specifically, CO₂ contributes to the flavor and appearance of beverages,
making them refreshing and stimulating; it also acts as an inhibitor and preservative against
microorganisms. Water is also a key raw material: it can constitute up to 98% of the finished
beverage and therefore needs to be of good quality for the taste and health in the final
product.
The production process of a carbonated drink starts with a water treatment line where water
is clarified, filtered, sterilized, and dechlorinated before being sent to the next production
process (see Exhibit 2). The treated water is heated before the carbonation process begins,
then carbon dioxide is added. Afterwards, the carbonated water is sent to a mixer where the
syrup is added, together with other raw materials to create the desired flavor. After that, the
product is ready to be sent to the bottling line. The same C*O_{2} used to carbonate water is
used as industrial gas in some of the previous processes. Finally, bottles or cans are
packezd and sent to the finished goods warehouse.
The C*O_{2} Supply Chain in the Beverage Industry
Carbon dioxide is a colorless, non-toxic, tasteless gas at atmospheric pressure, but is
usually traded in the state of a liquified gas, which is achieved by compressing and cooling it.
Appropriate temperature and pressure must be maintained throughout the supply chain.
Even though the cost of C*O_{2} in a carbonated soft drink is much less than 5% of
production cost (see Exhibit 3), a very high quality, with a purity level of 99% is required
(e.g., hazardous particles such as benzene, nitrogen, or carbon monoxide must be
removed), and a specific infrastructure should be put in place to handle it appropriately. Only
this so-called food-grade CO2 is allowed to be used in the beverage industry.
C*O_{2} is commercially produced as a by-product (i.e. as an undesired output) of various
chemical processes, as in the process of acid neutralization in the cement and gypsum
industry or during the production of ethylene oxide. In breweries and distilleries, C*O_{2} is a
by-product of alcohol production. In addition, C*O_{2} can also be obtained in combustion
processes when a fuel such as natural gas, crude oil, coal, or coke is burned and the flue
gas is captured. This method is used for on-site C*O_{2} generation in some industries.
C*O_{2} also occurs as a result of geological processes in high purity natural wells. In
Europe, half of C*O_{2} comes as a by-product of hydrogen or ammonia production. In the
latter case, for instance, methane (or another hydrocarbon) reacts with steam over catalysts
to produce "synthesis" gases, such as hydrogen, carbon monoxide, or nitrogen. These
synthesis gases are further processed to obtain ammonia, which is in turn used to produce
fertilizers (demand for nitrogen-based fertilizers easily more than double in first and fourth
quarters). The by-product C*O_{2} is then removed to be sold separately
When food-graded C*O_{2} is needed, it is captured and purified at the point of production to
be stored and later sent to the customers' production plants in dedicated high-pressured 20-
ton tank trucks. As transportation costs represent roughly 30-40% of the price of C*O_{2}
plants should be relatively close to the C*O_{2} production location. Usually, only a few
certified sources within 1,300 km from a production plant are considered as economically
viable.
At soft drink production sites, CO₂ is stored in high-pressure tanks with a capacity of 25
metric tons. A small plant producing 100,000 Kl per year had two tanks with a coverage of
seven days each. A telematic system may be installed in the tanks to measure conditions
which drive periodic maintenance including the level of C*O_{2} within the tank, which sends
signals to management to trigger replenishment orders.
PepsiCo's C*O_{2} Current Supplier Base in Eastern Europe
The global market size of all industrial gases in 2017 was €92 billion in terms of sales and
was dominated by a few players. Four of them, namely Air Liquide, Linde, Praxair, and Air
Products, accounted for 72% of total revenues (see Exhibit 4). The market was slowly but
solidly growing with an expected compound annual growth rate of 6% up until 2022.
Around 10% of these suppliers' revenues came from the food and beverage industry. Other
main industries served, generating roughly 20% of revenue each, included healthcare,
manufacturing, and chemicals (see Exhibit 5)
In 2018, three main companies supplied roughly 95% of the CO₂ needs of PepsiCo's
Eastern European plants (see Exhibit 6).
MainGass had supplied Eastern Europe but also many other of Pepsi's plants in Western
Europe for more than twenty years. They were a very reliable supplier in terms of delivery,
although orders had to be made seven days in advance. The company made use of its
relative bargaining power to raise prices, given the smallest opportunity. In fact, the current
average price was 15% higher than competitors, a significant figure given that CO₂ was
considered a commodity.
FlexiGass also served most of PepsiCo's plants in Europe and stood out as a flexible
supplier and a prompt responder. It was able to fulfill urgent orders within 24 hours 80% of
the time, something appreciated by production sites, who experienced shortages from time
to time due to suppliers' capacity problems or sudden surges of demand.
LocalGass had come on board some five years previously when a policy to diversify
suppliers for commodities was in place. This relatively small supplier didn't cover the whole
of Eastern Europe as its production footprint was mainly restricted to Ukraine and Poland.
However, from there it was able to serve most plants (see Exhibit 7), although lead-times
were on average longer than those of other suppliers. LocalGass regularly incurred minor
delivery delays, which had not compromised production at PepsiCo's plants thus far,
although it was a point of concern among PepsiCo's purchasing team.
Gassner had approached the head of purchasing at the end of 2017 with an aggressive
proposal in terms of price. Migdalski found the price quoted highly attractive, and likely to
help his team achieve the raw material cost reduction goals for 2018 established by
headquarters. He worked with the supplier to ascertain that Gassner would be able to meet
PepsiCo's stringent quality standards, capacity needs - Gassner claimed it could deliver
50,000 tons per year, compared to MainGass' 1,500,000 tons (of which 5% was dedicated to
Pepsico) - and service requirements. Only then did Migdalski decide to go ahead and submit
a formal proposal to Victor Pérez. A weak point of Gassner was that, unlike other suppliers
(see Exhibit 6), it wouldn't provide PepsiCo plants with the gas tanks to store CO2. Pérez
estimated an investment of $100-150,000 per tank and a three-month lag to have them up
and running. The life span of the tanks was around fifteen years.
The Decision
Pérez reread Migdalski's report. Getting a price reduction was definitely very tempting.
However, how important were the other drivers beyond price? In particular, ensuring the
supply of CO₂ was unquestionable, as the cost of stopping production due to lack of product
would be enormous, both in terms of economic impact (contribution was estimated to be one
third of selling price) and customer service. Average prices in the industry had been coming
down progressively in the region of $140 per ton in 2014 to $100 per ton in 2017, apparently
due to abundant supply. Prices for 2018, however, were expected to rise slightly due to
increasing transportation costs, which were linked to oil prices.
It was also clear that adding Gassner as a CO2 supplier would imply removing one of the
existing suppliers. Corporate rules were clear on this, as a significant effort had been made
in the last couple of years to limit the supplier base so as to reduce complexity and increase
economies of scale and bargaining power. Therefore, if Gassner was added, which of the
existing suppliers should be removed? The current mix of suppliers seemed to have worked
just fine in recent years in terms of service, quality (to date, the three main extant suppliers
had proven themselves capable of delivering CO₂ of the finest quality) and flexibility. Pérez
didn't want to break that fine balance
Moreover, Gassner's fleet capacity was only around 150 trucks, and, if they PepsiCo would
need to own storage tanks again. Wouldn't that be a step degree of integration that had
been achieved with current suppliers?
