Nelson Peltz: No Fritos with My Pepsi.

Trian Fund Management, LP wrote a letter to Pepsi's board saying that as an owner of $1.2 billion in PEP shares and with experience in the food business, Pepsi should spin off its snack business to shareholders and leave the beverage business as a stand-alone company.

Trian spins its arguments specifically for the seven year period of current CEO Indra Nooyi's tenure, and this seems to coincide with the data points about Pepsi's under performance. Here are the really salient points in their argument:

"As a distant number two competitor in beverages, PepsiCo never had the luxury of following the same strategies as those deployed by industry leader Coke. But PepsiCo nevertheless competed extremely effectively The company did so, from its earliest days through the 1990s, and was known for being faster on its feet, quicker to introduce new products, more willing to take risks and more willing to occasionally fail by doing so. Pepsi not only survived in this role of “industry disruptor,” it thrived. 

Meanwhile, Frito-Lay was known historically for having one of the best corporate cultures in America. Its culture was separate and distinct from Pepsi, which made sense given different category and competitive dynamics – snacks versus beverages, push versus pull marketing, Frito-Lay as #1 in an industry with regional competitors versus Pepsi as #2 in an industry with one large competitor. Frito-Lay’s strong culture, combined with a dominant market share in an attractive category, created a force to be reckoned with in the food industry.

         On the corporate front, PepsiCo was known for running with low overheads, even after the company            moved to Purchase in 1970."

All of these points are on the money.  Pepsi has become the Microsoft of its snack foods and beverages business: a duopolist in colas and dominant in snack foods, but unable to innovate and  really leverage its assets into earnings growth.  Agility, culture and costs should be the bread and butter charters of the board and management and clearly these have to be addressed.

But, to go from here to a spinoff seems to hang on some pretty weak arguments, such as "We've seen Kraft and others do this, so ipso facto, it must be the best thing to do right away."  The board should address how costs are going to be cut visibly and faster, and the right people should be put into the right slots to make the businesses perform better with the assets they have.  Innovation is not as easy, but it's not rocket science either, because this isn't drug discovery, after all.

In recent quarters, Pepsi appears to have actually pulled a few earnings surprises.  It has also given its longer-term projections as being a low single digit revenue growth business with mid to high single-digit revenue growth, with cash flows for dividend growth. This is about all this business can be in the medium term.

Distribution channels in the food business are everything. Frito Lay was the best in breed, and I presume that it still is, abstracting from any overhead allocation issues. Pepsi owns 11 out of the top 15 snack food brands direct delivered to retail, and Fritos are at the top.  Buying its bottlers has been criticized, with Trian quoting the CEO as admitting it was a "mistake."  The argument for doing so was, in addition to competing better with Coke, to give the company flexibility in pushing new and niche volume products through the distribution chain as sugared colas are clearly a declining unit volume business. Independent bottlers wouldn't want to take on a line of new organic juices instead of the larger volume carbonated drinks, the argument would go,

The answers to these questions are nowhere near as clear as Trian's letter makes out. In the emerging markets, much is made of losing share in India: that has more to do with the dynamics of Indian distribution than it does with Pepsi's execution.  Pepsi, unlike Coke, is said to be gaining share in China.

Should Pepsi become leaner, more agile and more efficient?  Absolutely, no doubt, and in a hurry.  Is the holding company structure the best for Pepsi?  It should be, but it isn't because of the above failures of management. Is a structure of two independent companies the best?  Unclear.

I'll take that Diet Pepsi now, please.

More Thoughts on Windows Phone 8

For all our fuming about Windows Phone 8, it's important I remind readers what could be different this time around.

• The New CEO

Taking Satya Nadella's own words about the future being in software, mobile, and the cloud, then he surely isn't going to accept the dysfunctional culture he inherits from former CEO Steve Ballmer. He had said, it's "renew or die." That's where Microsoft is in mobile and tablets. But, in the words of Lawrence of Arabia, "Nothing is written."

• Stephen Elop

Reportedly returning to Microsoft to run a portfolio which includes Surface, Windows Phone and Xbox, this would be another smart move. He knows both Nokia and Microsoft. It would also free up the CEO to focus on bigger issues, once he has rounded up his senior executive team.  Mr. Elop, like the Microsoft CEO, realizes the amount of value waiting to be created from a transformation of the lumbering Microsoft.

• Nokia's Culture Could Invigorate Microsoft

Here what Nokia says about its cultural aspirations:
• Make it great for the customerEveryone in Nokia has a role to play in making it great for our customers. This involves listening and understanding before making the decisions that will provide a great customer experience. It’s about taking accountability, and holding others accountable, for keeping commitments and getting things done on time.• Challenge and innovateChallenging the status quo is a prerequisite for change and innovation. Innovation is the lifeblood of our future success and the cornerstone of our product making. This is about not accepting “what is”, but being curious and striving for “what could be”.• Achieve togetherResults matter, and we achieve more when we work together. This is about everyone at Nokia taking responsibility for achieving and collaborating across organizational or geographic boundaries to win. It’s about having a diverse and inclusive environment that promotes individual expression.• Act with empathy and integrityEmpathy and integrity are our guides for dealing with our customers and each other. It’s about us being honest, transparent and doing the right thing. We inspire trust by speaking frankly and having the courage to call things out on what matters.

 Consumers need more competition, innovation, and value in mobile: if Microsoft can help bring this about, value creation will follow as surely as day follows night.

Sony Bows Out of PCs

I've always admired Sony Corporation, from that day in eighth grade when my parents gifted me an AM pocket radio which was one-third the size of the better known radios from Zenith. It was a beautiful object with good sound for a great price, and I still have it, but alas no one makes the transistor which has burned out. In those days, nobody bought Japanese products because they were "cheap" and lacked our technology. Well, my radio was way ahead of its time, and Sony shook up our industrial smugness.

From there, I always admired the iconic CEO Akio Morita whose introduction of the Sony Walkman changed the way people interacted with their music.  Innovation and great design were hallmarks of the Sony brand.  I've had two of their Trinitron color televisions, each for about twenty years: the best color tube around, and they both still work.

So, it's a sad day today to learn that the new CEO, charged with rescuing Sony from its serial reorganizations and shuffling its business portfolio, announced a one billion yen loss and another restructuring which involves the sale of the Vaio computer business to a Japanese private equity group.  This line was innovative, well designed and always got high ratings from tech magazine reviewers.  Sales and market share never followed those great technical reviews.

So, yet another giant bows out of making machines which were commoditized and may be on their way to becoming dinosaurs.

Samsung, as I look at the Galaxy phone and their smart televisions, reminds me of today's Sony.  The fate of today's Sony though may be in doubt.

WSJ"s Similar Take on Google Sale to Lenovo

Today's WSJ carries a story whose main line is that Google has made a good strategic move selling Moto Mobility.  It's implicit in our post yesterday, so there's no disagreement.  Where we differ is that overall, it's really not great for developed market consumers, particularly in the U.S., and it puts pressure on Samsung to go its own way with its Tizen mobile OS, which may be a good move but one which will slow their momentum even more and carries risk of confusing their customers.

The story says,
"The deal also helps Google bring more balance to the Android ecosystem. Today, Samsung dominates the Android world, selling more than six times as many phones as its nearest rival. A combined Lenovo and Motorola can help offset Samsung's strength, reducing the risk that the Android world is dominated by a single hardware maker."

Balancing the Android world is a nice euphemism.  The sights are set to take the wind out of Samsung's sails, which is not great for consumer choice.

GM CEO Mary Barra: A Car Person Looks at Opel

GM CEO Mary Barra has a Herculean task on her hands turning around the flaccid and inward-facing culture at GM.  Her position on Opel sounds like the view of a person who likes and understands cars, which she does.  Apparently, she can throw a car around a test track with authority.  I can still see images of former GM CEO Roger Smith slow riding a Chevy Beretta around a track: you could feel the death of that car just watching it go down the track.

In 2009, we wrote about the relationship of GM's destruction of its own Saturn concept, and the sudden turn to Opel for new models.  One stupid strategic decision forced another set of sub-optimal decisions which hurt Opel in the longer term. Of course, the Federal government as owner once tried to force a divestiture of Opel. Note to self: the government should never own private businesses.

CEO Barra has to forge a new relationship with labor in Germany, and for this she needs some strong, accountable executive partners.  Next, there has to be a program of new model introductions that are not just reactive but innovative.  This seems to be where her interests lie, and she needs to prepare the dealer network to commit to her plans.

With all the talk about small SUVs and what the Brits call smaller "estates" it shouldn't be too hard to come out with products that consumers want to buy, and by that I don't mean electric vehicles.

Here's wishing her success.

GM Still Can't Manage Its Brands

We first wrote about Opel in 2009, when it was slated to be sold to parts behemoth Magna International. Opel's platforms, called Delta and Epsilon, found their way into some nice looking and riding cars in the U.S., including those badged as Saturns and Buicks, including the LaCrosse.

Then, after its successful IPO, the company decided to make the Chevrolet brand the American face of GM in Europe.  Huh?  Here in the U.S., it's an iconic brand which has made a nice recovery from a near death experience in the seventies and eighties when it put out unacceptably inferior cars. In Europe the brand would be met with a shrug of the shoulders.  Again, with irony, the Chevy Cruze platform here in the U.S. was an Opel platform.  Not a bad car either.

But, the financial management folks at GM have decided to pull the plug on the Chevy brand in Europe after its 1.6% market share post- introduction.  Of course, it's the only decision to make, because establishing the brand in the crowded and finicky European market would take too long and cost too many dollars.

Meanwhile, the Cruze and other Chevy platforms in the U.S. will now move to cheaper platforms from Daewoo in South Korea, except that rising wages there are complicating the pricing. Are you keeping this all straight?

What about the customers?  Won't they notice the difference between something produced by Opel technology and something from Daewoo?  What about the dealers?  Some in Germany, committed themselves to exclusively selling Chevrolets, in order to differentiate themselves from other dealers selling Opels.

This is another company that still can't get out of its own way.  The IPO may have gone well, and the balance sheet may be stronger, but the company still can't manage its dealers, brands or customers.  They all deserve better.

Best Buy Can Have A Dominant Role in Electronics

The almost universal assumption is that consumer electronics are a commoditized products that can be sold anywhere, from drugstores to specialty superstores.  Therefore, it follows, says the universal consensus, that players like Walmart and Amazon should dominate consumer electronics sales, because of their purchasing power, scale efficiencies, and convenience.  Products that fit this paradigm perfectly include VCR-DVD players, MP3 players, and even smaller flat screen displays.

Apple of course has pioneered its own approach.  It develops tightly integrated electronics with a proprietary operating system packaged with stylish, uniquely identifiable design.  They have carefully nurtured a worldwide consumer brand.  Their products are manufactured through a small, tightly controlled network of suppliers, protected by a large patent portfolio.  Their margins are enormous, and although their market share for smartphones may have peaked, their profits and profit margins continue to be nonpareil in the industry.

Smartphones are likely to become ubiquitous, but at least at the upper end, they may not become commodities along the historical lines of the VCR. VCR components were all the same--read/write heads, laser readers, rollers, generic circuit boards, power supplies, and a metal cabinet--and there was nothing around which to build a distinct brand.  Westinghouse units sold in a drugstore were equal to JVC units sold in a specialty store, and prices eventually collapsed. Smartphones offer the same of opportunities for design, innovation and technical integration that can make brands, like Samsung, stand out from Google/Nexus, for example.

Right now, we appear to be heading in a different direction.  Think about a $129 smoke detector for the "connected home."  This would replace a $12 unit available at a drugstore, hardware store, discount retailer, or a retailer like Home Depot.  Who on earth would make this trade?  Never mind that the initial setup is complicated and that a newspaper reporter couldn't hook up with her home wireless network.  She took out her $12 unit and tossed it out!  Nest is establishing a brand; after all, their founders came from Apple.  A smoke detector was the ultimate commodity, but it could become something else.

The more complicated the palette of consumer choice becomes for electronics--and it is inevitable that it will--the more the opportunity opens for brick and mortar retailers like Best Buy to dominate significant segments of the consumer electronics markets, broadly defined.

The Sears Way: Kill the Lands End Brand, Then Spin It Off to the Public.

My family and I were early customers of Lands End.  Did they sell the same kinds of polo shirts, trousers, and oxford dress shirts as many other retailers?  Yes.  But, the company's value proposition and culture were totally different, and once we were sold on this, our family could reliably buy our wardrobe staples through their catalogs. They even pioneered certain categories like duffel bags and winter wear, offering high quality at just above discount prices.  Their stuff lasted forever.

Two of their staples for men were the basic men's polo shirt and khaki trousers.  Quality of the basic fabrics was high, and they always had nice details like collars that lay flat and buttons that didn't break. Founder Gary Comer began his business career in advertising copy writing, and I confess that the catalogs themselves were fun to read.  They continuously reinforced in story the company's corporate messages:

• We provide wardrobe basics of the highest, department store quality, or better, at discount store prices, and we deliver to your door.
• Lands End spends a lot of time with our suppliers and designers to make the basics better.  We pay attention to detail, e.g. rolled collar dress shirts as opposed to fused collars. 
• If you're not satisfied, ship it back to us on our dime, no questions asked. And, this was actually true.
• You can always talk to us on the phone, and we're farm folks in Wisconsin who love to talk to our customers.

The customer service folks were women working out of their homes to earn a little extra money, and they knew the catalogs, loved the company, and really enjoyed helping customers with sizing and color questions. All of the above is a concrete example of a company's value proposition written into a corporate culture, which people were proud to advertise themselves.  This was the Lands End brand.

Now, it is been totally debased, and we've written about this before.  The clothes are awful.  If possible, they are a step below the early, trashy Target private label line Merona, and even worse than Penney's Stafford private label line.  Perhaps a step below Wal-Mart would be the appropriate comparison.  The customer service folks are gone, and they're generic call center people who probably handle dozens of catalogers. 

I would never need to call about returns, because no one in their right mind would buy this merchandise in a Sears store.  They are laid out like dump tables in an Odd Lots store. 

So, when the spin out story is put together, it will be an empty shell.  The folks who now provide the comparable quality merchandise are L.L. Bean or Eddie Bauer, but they are significantly more expensive. Lands End could never recapture their niche from these two, and other, competitors, of which there are many niche catalogers, like Duluth Trading.

So, today's story is about Sears trying to "unlock value" from Lands End.  Good retailing companies are about a sustainable value proposition, execution and a strong culture.  Sears has sucked all of these out of the company that Gary Comer founded.  Hedge fund managers can't operate companies, so beware of one who is selling one he operates.

Bill May Return to Microsoft, or Not.

With all the hot news stories--like the budget deal and the Middle East--cooling into sludge, it's the moment for the New York Times to opine about the "widespread fascination" about the future role of Microsoft Chairman Bill Gates.  The story tries desperately to titillate the reader about Mr. Gates' increased presence at product introduction meetings.

On the other end of the spectrum, I have to applaud two institutional shareholders who, according to the New York Times, approached the company to have it consider having Mr. Gates relinquish his Chairman's position because it would inhibit a new CEO from adopting radical changes from the existing strategies that have cemented the company's role as a tech follower, and a mediocre one at that.

I don't believe that either of the above two events will come to pass.  Mr. Gates is having too much fun with his philanthropic projects in education and global health to return to the drudgery of extracting this company from the mud and getting its culture jump-started again.  As a co-founder and large owner, he wouldn't countenance losing face by relinquishing the Chairman's role without some future bridge-building to a CEO whom he respects and who has produced some results.  Too early for this.

The CEO of Ford makes the current short list of successors to Steve Ballmer.  Sell the stock on the announcement of Mulally's appointment as Microsoft CEO.  Watch the exodus begin on the servers and tools sides of the business.  Damage control all around, because it makes no sense.  Nothing else looks new, except that people like former Motorola Mobility CEO Sanjay Jha don't appear on today's list.

On the Microsoft Surface side, it's interesting to hear some different views about the Surface RT.  About a year ago, writing about the launch, we made a couple of key points:

1. "The question now becomes, can they act like a consumer products company and tell their story to the customer?
2. "The cost of making every buyer happy is a better investment that buying back shares.  That cost is just another form of advertising and brand rehabilitation."  Can they commit to making buyers happy?

Unfortunately, the answer to both these questions has been "No."  We know that the company took a write-down, forget that.  Some British IT users call Microsoft's marketing of the Surface RT "absolutely shocking," which in American English would translate into a profane phrase.  Why?

We've written before that most people still use their iPads as photo albums, video cameras, and places to find maps or restaurant reviews.  They are not productivity tools, and far from it.  The British buyers don't care about the shortage of "rubbish apps that you download and never use again."  Rather, they do like being able to use Office for document work and to connect easily to printers.  This indeed is productivity.  So Microsoft produced something better, but they didn't communicate to users what they had produced and why it was better.  

Now, they're going to cut prices and release Windows 8.1. Okay, but what about those people who took the risk first and got hosed?  Bill Gates should send everyone of them a computerized, hand written note saying, "You took a bet on us, and we let you down.  We've learned and I promise you that it won't be at your expense.  Come to a Microsoft Store, let us swap you out to a new machine, transfer your data to Sky Drive, and we'll give you a coupon for the price difference that you can use at the app store. Bill"  Let the accountants get busy. No one will care, except for consumers who would be shocked by a show of customer care, strength and confidence. It won't happen, but it should. 

Passion, Joy and Joga Bonito

To clarify the last post, here is part of a memorable series of commercials by Nike which spawned a whole movement around Joga Bonito. (There is a video interspersed of two boys playing soccer in the street--not very interesting. Just move the dial past it.) Eric Cantona, the former French international, Manchester United captain, and beach footballer speaks about the joy, passion and beauty of the game.  All of these qualities were part of his game too, but he also added a little muscle and sometimes the passion went over the top, as with his his famous Kung Fu kick directed at a noisy English fan in the stands. Of course if passion doesn't go over the top from time to time, it's probably not really passion anyway.

PG's CEO Shuffle: Why Are Shareholders Giddy?

Several of our recently covered themes about corporate CEOs reverberate in the story about PG asking the much ballyhooed, former CEO A.G. Lafley to parachute in to save the company from shareholder discontent. 

First of all, it appears that PG has underperformed the Household Products sector in both the five and ten year horizons. Since mid-2012, it has trailed its peers, but the secular underperformance clearly reflects something beyond the performance of the current CEO. 

As we have written about before, the economic environment which is then reflected in stock market sentiment accounts for much of what is falsely attributed to "CEO performance."  Mr. Lafley clearly had a better environment for consumer sentiment, income and spending than did his hand chosen, personally mentored successor Mr. Bob McDonald. 

The famous stories about the revival of Tide detergent under Mr. Lafley are a great example of misleading attribution.  The sale of "concentrated" Tide for HE washing machines meant consumers would pay way too much more for marginally different performance.  It was clever, and it succeeded because of PGs control over shelf space and end caps, plus aggressive advertising and couponing.  When the economy turned south, consumers said,'Goodbye Tide' and 'Hello Arm and Hammer' generic low price detergent for their high efficiency machines.

As things turned south within the company, McDonald was coached on how to deal with investors by Mr. Lafley.  Unfortunately, sentiment inside the company got so bad that a former high ranking executive with the company "sent a 13-page letter to lead director Jim McNerney, Boeing Co.'s CEO, detailing a number of concerns about Mr. McDonald's leadership and calling on the board to split the CEO and chairman jobs. Dissent with Mr. McDonald's leadership was bubbling up through management's senior ranks, with some executives reaching out to board members asking for a change, people familiar with the matter said." (Wall Street Journal)

This kind of behavior by those current and former executives is not professional.  Note the comment to split the CEO and board Chair positions.  How did the board not have any idea about the sentiment among senior executives?  Wouldn't they be able to pick this up from meetings and social occasions with the executives during board sessions and retreats with management? 

So now Mr. Lafley is brought in to right the ship, which will probably right itself through some of the measures already in place, and to choose another successor. But since he recommended Mr. McDonald and coached him, why would a board hand the important task of CEO succession to Lafley? 

PG is famous for its bloated brand management structure which is mind numbing for bright new recruits and for middle managers alike.  After your Ivy League MBA, you can be the Deputy Assistant Brand Marketing Analyst for Dash detergent. Wow. If you can move around and luck into a hot brand and be seen through the layers, perhaps your career can advance after ten years.  Lafley didn't address the bloated corporate structure during his halcyon tenure, and his successor only made a weak start.

The board which has sat through secular underperformance, failed to insist on succession plans for the CEO, ignored corporate sclerosis, failed to stem the loss of future leaders, and could not take the pulse within its own organization. 

I don't understand why investors are so excited by today's developments. 

Lessons To Learn From J.C. Penney

I will wager if the question were asked of Wall Street brokers, bankers and analysts "When was the last time you or your family shopped at J.C. Penney?" the honest answers would be "Never," or "I don't remember."  Penney lost its way over decades, and suffered from the total neglect of its board and management.

There was a long-running experiment to become a poor shopper's Kohl's, but this experiment was an utter failure.  National branded apparel also gradually disappeared from the store, replaced by awful private label lines, including the once passable "Stafford" line.  Margin rate became the call word.  The worst private label apparel quality in the middle market segment belonged to Penney.

The stores themselves were dimly lit, understaffed, and were filled with what looked like dump tables rather than merchandise displays.  Customers armed with coupons from newspaper inserts probably felt they were getting a bit better quality and a wider assortment than at Odd Lots.  This, in my opinion, is the background against which to measure ex-CEO Ron Johnson's attempted transformation of Penney. Here are some lessons to be learned.

1. Bill Ackman was right about there being a significant opportunity to create shareholder value at Penney.  Sometimes, hedge fund managers, or other activist shareholders, are required to wake up sleepy managements who are letting their companies wither on the vine.

2. Ron Johnson's experience with Apple's retailing wasn't directly relevant to Penney, as Apple is a cult stock, a niche PC provider, and a company extracting huge economic rents from music and mobile computing.  His experience at Target should have been an asset, in terms of operational experience and relationships with suppliers, but any benefit was overwhelmed by mistakes.

3. "Every day low pricing" doesn't work in soft goods. Breaking the pricing into three tiers was a compromise and confusing for sales people to explain and for customers to understand. However, it was necessary to move customers away from the addiction of double couponing.  This transition should have taken a back seat to the remerchandising and repositioning of the stores.

4. The culture at Penney had to have been broken.  This transition takes time.  Commuting in from California and allowing senior executives to do the same was arrogant and should not have been permitted when Johnson was recruited.  The board, led by Bill Ackman, was foolish to allow this arrangement.

5. Academic studies have shown that the real advantage private equity owners provide over public ownership is not in making better decisions, but in taking them faster.  In this case, a public entity, driven by a private hedge fund owner, was driven to take decisions at "light speed," and a number of these decisions were deeply flawed.

6. Penney's operational structure was less like Target and more like a department store.  This means layers of unaccountable decision making and a bureaucratic mentality.  Communicating messages through this kind of network and weeding out the weak players takes time, and again speed probably killed here too.

7. Bill Ackman was wrong.  Hedge fund managers are really smart people: they are masters of chess, poker, and bridge.  They don't run companies very well at all.  The models for their enterprises, where they take the lion's share of their investors' cash no matter what their own performance, doesn't prepare them well for understanding who or what it takes to turn around moribund public companies.

From here, bringing back the previously ousted CEO, the company needs to clearly communicate to its investors how Penney can get back on its feet by taking the best of what's been done and rejiggering the model to adjust its profitability.  Starting a new experiment or returning to the past would be disastrous.