Will Typhoons in Southeast Asia Stop You from Staying Hydrated This Summer?
Climate change is increasing the severity of typhoons in Southeast Asia — what does this mean for PepsiCo. as it looks to capitalize on exponential growth in the coconut water product category?
With the demand for coconut water skyrocketing — U.S. sales grew 350% 2011-2017 by volume — large beverage companies are looking to capitalize on this growth. [3] Analysts expect the $2.5bn coconut water market to exceed $5bn in global sales by 2021. PepsiCo.’s potential acquisition of Vita Coco, which represents ~25% of total global coconut water sales, for $1bn would make it the leader in the category, adding to the O.N.E Coconut Water, Kero-coco, and Tropicana labels that it owns today. [4,5]
This is the latest move in PepsiCo.’s diversification away from its traditional soft and sport drinks strategy, capitalizing on health-conscious consumer preferences. [3] With its prior acquisitions of O.N.E. Coconut Water and Naked — a producer of juices and smoothies — PepsiCo. was forced to rethink its supply chain operations to deal with increased complexity. Naked and coconut water are manufactured in geographically diverse areas increasing lead time and variability of supply due to dependence on natural ingredients. [1] Unlike the traditional soft drink supply chain, the coconut supply chain is global versus regional in nature — growers are in Indonesia and the Philippines; co-packers are in Asia; and products are sold mostly in the U.S. These healthy beverages typically need to be transported in cold environments and have a shorter shelf life. [2] The impacts of climate change, which include increasing severity of typhoons in Southeast Asia, complicate the already more complex supply chain management in the natural health drink category. [1,2]
Typhoon Haiyan in Eastern Philliphines Destroyed Coconut Farms and Livelihoods
Source: http://newsok.com/article/feed/621469
PepsiCo. has responded to this complexity by developing a supply chain resiliency program for coconut water to recover from disruptions quickly. As part this program, PepsiCo. carries higher inventory to prevent against stock outs and has implemented a seasonal inventory strategy. [1] An inventory buffer of 20 weeks is used based on supply chain leads times for production, testing, transportation, and redistribution. Maintaining higher inventory levels is costly — PepsiCo. attempts to minimize these costs by using historical data to strike the right balance of avoiding stock outs and reducing product expirations from overstocking. Copackers are the critical capacity bottleneck in coconut water production. To avoid disruption, PepsiCo. uses three copackers in Southeast Asia, all located far enough apart so that they are not impacted by the same typhoons. The company also has copackers in the U.S. that provide backup capacity and can be used, although at a higher cost, if shorter lead times are needed. Close partnerships with copackers create an early warning mechanism for disruptions and enhance the quality of the data exchange. Further complicating supply chain management, demand for coconut water is seasonal and higher in summer months as consumers turn to coconut water for hydration. PepsiCo has created a system of buffers around stock, capacity, and lead-time for higher demand months and begins its inventory prebuild for the peak summer season before the normal 20-week lead time to account for typhoon season. [2] As the Company scales up its coconut water business, the need to refine these programs to avoid stock outs, minimize costs, and reduce exposure to any one supplier increases.
Despite its best efforts, disruptions are not avoidable and PepsiCo. should use marketing to protect itself during stock outs and potential price spikes. Health conscious consumers generally also care more about sustainability. [2] For PepsiCo.’s Naked label, square recycled bottles are more efficient to ship, bottling facilities and offices are LEED certified, and fleet vehicles have been replaced to be more fuel efficient. [1] PepsiCo. should increase its use of sustainability metrics on its packaging and overall marketing to drive brand equity. However, brand equity only goes so far. The company should continue to use both historical data and predictive demand analytics to refine its inventory model. PepsiCo. should adopt a hedging strategy involving crops grown in the same region as coconuts that have a more liquid futures market. For example, if the price of rice spikes during a typhoon because of supply shortage, PepsiCo. should long rice futures during typhoon season. In the event of a typhoon, rising input costs in its core business will be offset by an appreciation in rice futures, avoiding the need to pass costs on to consumers. PepsiCo. should also consider expanding its current list of growers and copackers within the regions it currently operates to diversify risk and develop partnerships with growers and copackers in other regions closer to the U.S. (e.g., Central and South America) where coconuts grow well.
Coconut Water Packaging
Source: https://juicing-for-health.com/22-coconut-water-brands-reviewed-healthiest-avoid
In an increasingly global world that is increasingly impacted by disruptions due to climate change, how do companies balance the efficiencies gained through supply chain consolidation (e.g., increased purchasing power, streamlined transportation/logistics, and improved quality control) with the benefits of diversification? What role can brand equity play in consumer’s tolerance to stock outs and price increases, especially in healthier product categories that are potentially more sensitive to supply chain disruptions?
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Sources:
- Technology, M. (2016). A Fresh Take on Supply Chain Innovation. [online] MIT Sloan Management Review. Available at: http://sloanreview.mit.edu/article/a-fresh-take-on-supply-chain-innovation/ [Accessed 12 Nov. 2017].
- Banker, S. (2016). PepsiCo’s Practical Application Of Supply Chain Resilience Strategies. [online] Forbes.com. Available at: https://www.forbes.com/sites/stevebanker/2016/10/01/pepsicos-practical-application-of-supply-chain-resilience-strategies/#7121d6df6293 [Accessed 15 Nov. 2017].
- Purdy, C. (2017). Coconut water is the latest battleground between Pepsi and Coca-Cola. [online] Quartz. Available at: https://qz.com/1001599/pepsico-pep-wants-to-acquire-vita-coco-coconut-water-to-compete-with-coca-cola-ko/ [Accessed 13 Nov. 2017].
- com. (2017). How PepsiCo Can Benefit From Acquiring Vita Coco. [online] Available at: https://www.forbes.com/sites/greatspeculations/2017/06/01/how-pepsico-can-benefit-from-acquiring-vita-coco/#19b614d85651 [Accessed 13 Nov. 2017].
- Avery, B. (2017). Analysts: A PepsiCo/Vita Coco Deal Would Reshape Coconut Category. [online] BevNET.com. Available at: https://www.bevnet.com/news/2017/analysts-pepsicovita-coco-deal-reshape-coconut-category [Accessed 14 Nov. 2017].
Brand equity can only carry a brand so far in the face of increasing challenge associated with the manufacturing and distribution supply chain. While it may seem reasonable to diversify product offerings away from resources and manufacturing that are at the perils of climate change, profitability may not entertain localization of products. As demand for the product continues to grow, consumers will demand increasing quality and innovation to remain loyal. Under these circumstances, PepsiCo must continue providing the existing products or innovate new solutions that are more sustainable to replace. And as a result, I would expect that the consumer demands from the brand will increase.
Looking forward, PepsiCo will have to focus on what they can control. How can they leverage technology to extend product shelf life? How can they grow the market share of customers in markets that are not currently marketed? The greater the distance from resources to end customer, the greater the risk on profitability. I think to combat the economic impact of climate change, PepsiCo will have to engage the entire supply chain with other large companies to reduce the time it takes to solve sourcing challenges. By aggregating capabilities, resources, and consumer demand, companies should be able to balance variabilities across the world. Unfortunately, this may lead to seasonal price variations, which may be more manageable by brands as they leverage their brand power in the market.
Thank you Erin for doing a great job highlighting the supply chain challenges global beverage producers face due to climate change. Given these challenges in their supply chain in conjunction with sky-rocketing demand for these items, it is amazing producers have been able to keep Coconut water in stock profitability as much as they have! As Erin alluded to, hedging and buffers have been tremendously valuable for Pepsico in ensuring a constant supply despite the potential of increase costs. In an extremely crowded Coconut water field (as pictured), PepsiCo has clearly been willing to spend extra on inventory in order to ensure stock in its effort to win market share. The hedging of co-packing facilities is also an extremely interesting and effective way to diversify weather risks. While the hedging works well in this capacity, I am a bit worried about Erin’s proposal for PepsiCo to engage in large scale hedging of rice futures in Coconut growing regions. PepsiCo’s core competencies come in the form of producing, distributing, and marketing beverages and snacks. I am worried that engaging in hedging outside of their strengths may ultimately distract management and result in significant losses. In terms of leveraging brand equity, I think Erin raises a great opportunity for PepsiCo to leverage sustainability efforts to further market their new healthier products. With a fundamentally different customers base than typical soda consumers, PepsiCo will need to continue to differentiate its marketing approach and an emphasis on sustainability of its new products might be one way to do so.
Very comprehensive and informative article!
As you rightly pointed out, leveraging brand equity to weather the brand through stockouts and price hikes is not a long-term solution. It could work well for short-term issues, but ultimately – out of sight, out of mind – if consumers cannot find the product in store, they’ll just buy something else.
I’m a fan of both diversification (in terms of sourcing locations) and upstream consolidation. I’m wondering about the feasibility of growing coconuts in other parts of the world that have the same climate characteristics as Thailand, Indonesia and Philippines, e.g. regions in LATAM in the same latitude around the equator. This could greatly help Pepsico gain more control over its supply (if its helping in the development of these plantations and copackers), decrease the physical distance between suppliers and its distribution hubs in the US, and diversifies its sourcing locations even more so it is less susceptible to natural disasters.
Thank you for this article Erin! Super interesting read.
I came into this article bearish on coconut water, and reading about the climate risks on coconut supply exacerbates the concern for me. The question I ask myself is: Is the insanely high demand for coconut water indication of a new sustainable market, or a bubble waiting to pop? I worry that it’s the latter. There have been a number of reports challenging the actual nutritional value of coconut water. There have even been class-action suit against Vita Coco [1] and Harmless Harvest [2] related to false claims to the nutritional value of their product. On top of that, coconut water is an “acquired taste”, that is why the big players make the majority of their revenue from blended product, mixing coconut water with other more familiar flavors. On the supply chain side, climate concerns are just a portion of it. The nature of the fruit makes it difficult to scale up. Palm trees have a long grow cycle, and produce a small quantity of juice by square foot compared to other fruits [3].
For these reasons, I’d be a little concerned about PepsiCo aggressively hedging its coconut supply. If I were management, I would first my demand forecasts and think critically about the marketing dollars that would be required to continue to grow demand. Secondly, if I believe demand will continue to surge, I might look into alternative growing methods, investing in research around growing in a more controlled environment.
Sources:
[1] Business Insider, 2012 “Vita Coco Will Pay $10M To Settle Suit Over ‘Super-Hydrating’ Coconut Water”
[2] Forbes, 2017 “Coconut Water No Longer ‘Raw’ After $1 Million Class Action Settlement”
[3] Gro Intelligence, 2016 “Cuckoo for Coconuts: Demand Is Soaring, but Production Isn’t Keeping Up”
This was a great read! PepsiCo’s efforts to avoid stockouts seem comprehensive, although potentially very expensive. Since coconut water doesn’t perish quickly, it makes sense to diversify geographic risk by developing risks with copackers in many different locations. However, since the copackers are located near the coconut water manufacturers, I worry about the implications of having to open new factories in different regions, and whether the costs of this don’t outweigh the diversification benefits.
On a different note, I agree with the concerns of others about hedging. In particular, I’d worry about how hedging other crops, particularly commodities, is likely to be impacted by many factors other than local weather. For instance, rice is grown so globally that while a small area might see a short-term spike in prices following a typhoon, it’s unlikely that the rice futures market would re-adjust based on seasonal storms, and even more unlikely that it would predictably adjust based on seasonal storms. Additionally, hedging doesn’t seem to solve the core problem of a troubled operational model and a breach of the customer promise to distribute coconut water.
Finally, I think your point about how they can build up brand equity to help mitigate supply chain risks is interesting, because it raises the question of to what degree coconut water is a commodity versus a branded good. While I would have assumed that coconut water was a relative commodity, where customers might have brand preferences but likely not strong loyalties (similar to normal water), it seems to have become more branded in the past year [1]. This apparent move towards branded coconut water certainly speaks to the necessity of maintaining a steady supply chain.
[1] https://www.thrillist.com/drink/nation/best-coconut-water-brands
Thank you for this very thoughtful article, Erin! The article provided a clear and comprehensive overview of the beverage industry and provided a helpful picture of PepsiCo.’s value chain.
To be perfectly honest though, I don’t believe that PepsiCo should focus so much of its resources on coconut water specifically. While coconut water has become ubiquitous in the past few years, many health-food trends are quick to come and go and coconut water may fall victim to the same type of trend decline. Mangosteen drinks had their moment, but when was the last time you sought out mangosteen?
Even so, I do agree that there is an opportunity to invest in these geographies overall, but in a way that complements the company’s portfolio existing portfolio. In a way, it is somewhat analogous to the fragrance industry in that fragrance companies are continuously seeking out new, exotic ingredients to incorporate into its products to bring “new news” and innovation to consumers. PepsiCo can continue to explore these diverse regions to find alternative beverage options or ingredients when items such as coconut water experience a disruption in supply. Furthermore, efforts to invest in areas of Southeast Asia and to develop local communities could be used to build brand equity in both a sustainable and social way that consumers can appreciate.
This is a great article, thanks Erin!
I find very interesting that global CPG players face so many challenges in their supply chains that we cannot even imagine. Scale gains are important and that results in price advantage versus smaller or regional players, but these scale gains come with additional challenges and costs. As Erin pointed out, some large CPG companies are increasingly facing the challenge of sourcing products from different countries, with copackers located somewhere else, and sometimes even having to deal with short shelf life and refrigerated products. Global protein players, such as JBS, have economists and traders on their teams to minimize the impact of commodity prices on their bottom line. Leading global chocolate players are sourcing cacao from several different countries so they can protect themselves against local spikes in prices or lack of supply. There is evidence that these strategies are working and I can see all the benefits for them. Therefore, I agree with Erin’s suggestions on using available financial instruments, such as derivatives and futures, and also focusing on geographic diversification in order to reduce variability or prevent disruptions in these complex supply chains.
I think the point that Bruce raised is very valid, though. Companies have to use derivatives to protect their operations and not to speculate. In the last decade we had to emblematic examples in Brazil of large companies that incurred in huge losses and ended up being sold to competitors because they were using derivatives for speculation and not only for hedging. One of these companies was Sadia, a CPG company focused on ready-to-eat frozen meals. The company lost ~$900m after high variations in the exchange rate.[1] Instead of hedging its exporting business, the company was making directional bets on exchange rates.
[1] https://www.reuters.com/article/sadia/brazils-sadia-has-4th-qtr-loss-on-forex-derivatives-idUSN2728125120090327