Internal Analysis: An Illustrative Comparison of Coca Cola and Pepsi
Overall Firm-Wide Asset Productivity
One area of internal analysis that is essential for any investor or competitor to investigate, arguably the most essential area of analysis, is basic productivity or asset productivity — measures of how well the company uses its assets to generate returns (Palepu, 2007). No company can remain in business over the long-term unless it is capable of converting current assets into revenue streams and thus producing cash flow that it can use to expand the business and to pay shareholders — to make a profit, in other words. Except in cases of accounting wizardry and outright fraud such as in the Enron debacle of a decade ago and certain issues noted in the recent collapse of the financial sector, determining firm-wide asset productivity and creating comparisons of such data is actually relatively easy, with the annual reports of publicly traded companies and even certain freely accessible summative websites presenting a at least a broad overview of general productivity.
There are several figures and ratios that can help both an investor and a competitor determine if a company has appropriate levels of asset productivity, and/or if there problems with asset productivity that weaken the competitor or make for a poor investment. Ratios are especially important in all areas of analysis as they tend to remove at least the direct effects of company size on performance and efficiency, including in areas of asset productivity; comparing the earnings numbers of a local corner store with a national supermarket chain wouldn’t make much sense, however comparing productivity ratios that involve earnings can lead to a reasonable comparison of how efficient each company at turning its assets into profits. One good measure of asset productivity for both investors and competitors alike is the profit margin, which simply measures how much of what the company takes in at the end of the day is left after all costs, taxes, and any other expenses are accounted for; 100% profitability would mean that for every dollar spent by the company in producing and selling it would receive two dollars in revenue, and 0% profitability would mean it cost just as much to make a sale (and pay taxes, etc.) as was received in revenue from that sale. The Coca Cola Company (Coca Cola hereafter) has a current profit margin of 18.42%, while PepsiCo (Pepsi hereafter) has a profit margin of 9.69%, a little more than half that of Coca Cola’s (Yahoo Finance, 2012; Yahoo Finance, 2012a). This means Coca Cola is clearly the more efficient of the two companies in terms of turning assets into profits, spending less to generate each dollar of profits than Pepsi does.
The return on assets (ROA) ratio is a similar measure that directly measures the actual assets of a company, not just its cost of sales, in terms of how much profit is generated. Interestingly, Coca Cola has a slightly lower ROA at 8.91% compared to Pepsi’s 9.2%, which has different implications for investors and competitors (Yahoo Finance, 2012; Yahoo Finance, 2012a). These figures in comparison with the profit margins suggest that Coca Cola is likely reinvesting large portion of its profits in the company rather than providing them to shareholders as dividends, meaning the company will likely become even larger and more efficient as a competitor to Pepsi but is actually less attractive to investors in the short-term as its asset productivity is not translating to direct value creation for shareholders (Palepu, 2007).
Productivity of Human Assets
Determining the productivity of human assets within a given organization can be a much more arduous task than determining overall firm-wide asset productivity, for two primary reasons (each with their own list of complicating sub-reasons). First, establishing an accurate, reliable, and consistent measure for human productivity can be difficult, especially as companies grow larger and more complex; not all labor hours are directly related to sales, nor are all jobs equal in either compensation or labor demands, and thus comparisons even within companies let alone between companies that don’t have exactly similar operations are crude at best (Fitz-enz & Davison, 2002). While it is possible to establish a single figure for the amount of human resources at an organization — either in terms of labor hours or expenditure, with the latter providing a more meaningful comparison — and to divide this by the output (revenue or profit) of the company to determine an efficiency ratio, this gives an incomplete picture of total human resource productivity. Second, finding information regarding human assets and their productivity can be more difficult than finding similar information regarding overall firm performance — it simply is not published as widely. These two obstacles do not prevent such assessments from being made, however.
According to the non-financial portion of Coca Coal’s most recent annual report, the company had approximately 146,200 “associates” (the company’s preferred term for its employees), while PepsiCo’s corporate website states that it has “over 285,000” employees — information that it does not publish in a more accurate fashion in the more heavily scrutinized annual report (Coca Cola, 2012; Pepsi, 2012a). While Coca Cola’s higher profit margin might make it initially seem that the company is more efficient in its human resource uses than Pepsi, given that the former company has about half the employees of the latter, a more accurate comparison comes from examining the actual operating revenue generated by each company, which is directly dependent on human resource activity and productivity (Fitz-enz & Davison, 2002; Palepu, 2007). Pepsi had $66.5 billion in net revenue in 2011, while Coca Cola only saw revenues of $46.5 billion, which is a smaller divide than what exists between the two companies’ employment numbers (Pepsi, 2012; Coca Cola, 2012). The employee-to-revenue ratio of Pepsi is 285,000/66.5 billion, or .000043, while for Coca Cola this number is 146,200/46.5 billion, or .000031. Again, the lower ratio suggests greater efficiency, but clearly the divide is not as significant as an initial cursory analysis of human resources and profit margins might suggest.
A noted above, however, this qualitative analysis gives only a crude understanding at best of the true human asset productivity at these companies. Given the differences in the scope and structure of their operations, one might conclude that Coca Cola is actually less productive with its human assets — much of the actual manufacturing and distribution operations are not handled by Coca Cola but by independent bottlers and distributors, meaning its human assets are more heavily concentrated in offices and white collar jobs (Coca Cola, 2012). Investors would still benefit from the increased quantitative efficiency, but competitors might be able to find an edge in terms of human resource management and efficiency.
This is another area of analysis that is difficult to carry out based on readily available information; in order to determine the true productivity of specific operational factories, plats, and equipment, audits of such facilities/equipment need to be carried out in which direct observation leads to conclusions about potential improvements in efficiency (Palepu, 2007). Again, however, there are certain ways that the information provided in the annual reports of most major companies can be utilized to determine an estimate of plant and equipment productivity, and thus how much the real assets of the company are utilized to their full potential. This enables both competitors and investors to gain an understanding of a business’s — or businesses’ — real operations and provides a rough way of estimating what growth for the company (or companies) in terms of actual production rates and/or new facilities building would look like in terms of both cost and revenue increases, which again has varying implications for those from both perspectives (Palepu, 2007).
A standard itemized item on any publicly traded companies’ consolidated balance sheet, which is included as part of their annual report, is Property, plant, and equipment. While this figure includes property such as office buildings that are not actually used in the direct production of goods for the company, this is the best available estimate of plant and equipment value commonly available to those outside the company — i.e. investors and competitors (Palepu, 2007). Comparing this number to operating revenue, just as was done with human asset estimations to determine human asset productivity, should allow for a rough estimation of plant and equipment productivity. In a scenario such as the present context when the figures are being used to compare two fairly similar companies, the numbers are actually more reliable despite the fact that they include property not directly involved with production, as both companies are likely to have properties that are close enough in value to essentially cancel each other out. For Coca Cola, the Property, plant and equipment value in 2011 was $14.94 billion, and for Pepsi this value was $19.7 billion (Coca Coal, 2012; Pepsi, 2012). Again, simply knowing that Coca Cola has higher profit margins than Pepsi initially suggests that the former company uses its plants and equipment more efficiently, as it has fewer resources and higher profitability, and again a calculation of the actual ratio (this time as property, plant, equipment-to-revenue) provides a more accurate perspective: Coca Cola’s ratio is .32, and Pepsi’s ratio is .29. These are close, but suggest that Pepsi is actually able to generate more revenue for every dollar of property and equipment it owns.
This makes sense given the operational differences at these companies; as noted above, Coca Cola does not actually own or operate all of the production elements for its products, thus it makes sense that is has much lower property values than its rival Pepsi, which is more fully integrated (Coca Cola, 2012; Pepsi, 2012). This also suggests, however, that Pepsi’s revenue generation and overall value is more tied to its physical properties, plants, and equipment than is Coca Cola, meaning expansion could ne more costly for the company (Palepu, 2007). In this way, productivity might not transfer into long-term efficiency and profitability, which is something both investors and competitors should consider.
If determining human resource and plant/equipment productivity was difficult, determining marketing productivity can be all but impossible for an outsider to a company, as these are not required line items on the financial statements prepared in keeping with government regulations of publicly traded companies (Palepu, 2007). Estimations of marketing expenditures are very difficult to make if they are not provided by the company, as the extent of marketing campaigns cannot be ascertained without extensive and detailed media information and the cost of various advertising media and placements can vary considerably. If a figure estimating marketing expenditures is not provided by the company being analyzed, it is possible that searching through trade magazines and research journals (if the company is sizeable enough) could yield some estimations of marketing costs, but these estimations are likely to be inaccurate and would be unsuitable for company comparison purposes. Regardless of how a marketing productivity measure is determined, this is a measure that is likely to be more meaningful to a competitive analysis rather than from an investor standpoint; though clearly an investor would be concerned with the efforts being taken by a company to boost sales and determining how effective those efforts are, this is of much more direct relevance to competitors that are competing for the same market share and are likely engaged in similar marketing endeavors.
Fortunately, many companies understand the importance of marketing expenses to investor analyses — and/or feel a need to explain the large portions of their operating budgets that are devoted to these marketing endeavors — and thus have taken to listing and describing marketing costs in the qualitative portion of their annual reports. Both Coca-Cola and Pepsi have done this, and a comparison of these expenses to the operating revenue — i.e. sales — that each company generated is a fairly reliable measure of how well marketing efforts were able to generate returns. Again, operating revenue for Coca Cola was $46.5 billion in 2011 and operating revenue for Pepsi was $66.5 billion in that same year according to the consolidated statements of income for these two companies; with estimates elsewhere in their annual reports of marketing expenses totaling $3.3 billion and $3.5 billion, respectively, marketing profitability ratios can be estimated at .071 for Coca Cola and .053 for Pepsi (Coca Cola, 2012; Pepsi, 2012). Here, Pepsi seems to clearly outstrip Coca Cola in terms of the effectiveness of its advertising, which seems odd given how ubiquitous Coca Cola’s advertising is.
The importance of a qualitative assessment of the reasons behind the numbers has been stressed above, and must be pointed out again here. Very different business models exist in these companies, such that marketing efforts for Coca Cola are not as directly related to sales, and for Pepsi the diversity of products means much less is being spent per brand on marketing while still yielding substantial results (Coca Cola, 2012; Pepsi, 2012). Competitors should certainly be wary of the sheer marketing clout that Coca Cola is able to wield without unduly damaging its bottom line, but investors might rightly be more attracted to the leaner (proportionally) and more effective strategies apparently employed by Pepsi.
Market segmentation cannot be accurately and consistently quantified unless very narrow parameters are implementable, and with large multinational companies that reach across a wide spectrum of socioeconomic an regional features it can be truly impossible. Other companies that operate only in specific niche and/or business-to-business industries can also be difficult to examine in terms of segment productivity, as their market segmentation is quite small and not necessarily something such businesses would be able to proactively and effectively manipulate (Palepu, 2007). When businesses do provide broad segment breakdowns of expenditures and earnings, as most multinationals do on what is essentially a continental basis (i.e. Europe is one segment, North America is another, Asia is typically split into smaller segments such as the Middle East and South East Asia, etc.), determining true segment productivity requires a detailed understanding of the market size and purchasing power of each segment. Of course, when an inter-company comparison is the goal, certain estimations of segment productivity can be made by comparing the revenues captured in each segment, assuming the companies’ segments are defined with the same borders and that similar proportions of expenditure are utilized in the segment(s) compared.
Unfortunately, Coca Cola and Pepsi do not report segmented earnings in the same way, making it impossible to conduct a meaningful comparison of segment productivity between the companies (Coca Cola, 2012; Pepsi, 2012). Coca Cola does not actually provide any concept of its segmented earnings, though again due to the company’s operational structure it is not as directly involved in or affected by sales in various market segments, as its distribution involvement is limited (Coca- Cola, 2012). Given the worldwide recognition of the Coca Cola brands and the company’s history of making inroads to untapped markets, however, it can be assumed that through its distribution partnerships Coca Cola does fairly well in all market segments. This purely qualitative and surface analysis would not suffice for a detailed competitive analysis nor for an institutional investor seeking to accomplish full due diligence before making a major purchase, but for the average investor it is actually a fair estimate of Coca Cola’s segment productivity and profit potential.
Pepsi, meanwhile, divides its operations not only by region but also by brand/product class, as the company has much more diverse product offerings and operations than does Coca Cola (Pepsi, 2012). This would make any direct comparison meaningless without specific product selection, anyway, and this would involved far more detailed industry reports than are available to the typical investor. Such reports can be purchased, but are often fairly expensive and are more likely to be utilized by competitors or institutional investors (Palepu, 2007). If actual sales numbers for specific segments could be identified, however, and especially if expenditures on marketing and operations could be broken down into the same segments, than a real quantitative analysis of segment productivity could actually be conducted. Given current resources, direct practical examples cannot be provided for this area of analysis, however with both companies showing strong international reaches it also would not be of immense importance except in segment-specific competition.
Coca Cola. (2012). 2011 Annual Report. Accessed 1 April 2012. http://www.thecoca-colacompany.com/investors/pdfs/form_10K_2011.pdf
Fitz-enz, J. & Davison, B. (2002). How to Measure Human Resource Management. New York: McGraw Hill.
Palepu, K., Healy, P., Bernard, V. & Peek, E. (2007). Business Analysis and Valuation. Mason, OH: Cengage.
Pepsi. (2012). 2011 Annual Report. Accessed 1 April 2012. http://www.pepsico.com/annual11/downloads/PEP_AR11_2011_Annual_Report.pdf
Yahoo Finance. (2012). The Coca Cola Company. Accessed 1 April 2012. http://finance.yahoo.com/q/ks?s=KO+Key+Statistics
Yahoo Finance. (2012a). PepsiCo. Accessed 1 April 2012. http://finance.yahoo.com/q/ks?s=PEP+Key+Statistics
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