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									Compañia Hule ra Goodyear-Oxo (A)
“New Times, Ne w Styles”
“With the Opening of Me xico’s Borders Our
Goal Is To Become Globally Competitive”
.
Company Background
Goodyear Tire & Rubber Company
Headquartered in Akron, Ohio, the company’s principal business was developing, manufacturing, distributing, marketing, and selling tires for most applications worldwide.
Goodyear Tire also manufactured and sold a broad spectrum of rubber products and rubber-related chemicals for various industrial and consumer markets, and provided auto
repair services. In 1993, Goodyear T ire operated 72 plants in 29 countries, and more than 1,800 retail tire and service centers and other distribution facilities around the
Globe. In 1992, Goodyear had approximately 95,700 employees worldwide, having cut its workforce by 12,000 since 1990. By the end of 1993, an additional 4,000
positions were eliminated, bringing the total to 91,754.

Historical Facts
In 1974, Goodyear T ire became the first tire maker to exceed $5 billion in sales. During the 1980s, Goodyear diversified its operations by acquiring the Celeron Corporation,
an energy company, and then investing $1.5 billion constructing the All-American Pipeline for natural gas and oil transmission. In 1986, Sir James Goldsmith, a European
financier, mounted a takeover attempt against Goodyear T ire. Fighting off this corporate raider raised the firm’s debt from $3.3 billion in 1986 to $5.6 billion in
February 1987.
In 1988, Goodyear T ire became the industry’s first $10 billion company. However, the recession of 1990-1991 sent the tire industry into a downward cycle. Reduced
original equipment sales, combined with severe price competition and the high cost of servicing its large debt, led to a loss of $38.3 million in 1990, which was Goodyear’s
first annual loss since 1932. By 1990, the company had a reputation in almost every market as a leader in research and development and a marketer of innovative products.
In 1977, it introduced the T iempo - the first all-season radial tire, and in 1981, it launched the Eagle, the first radial tire offering high-speed traction for sports cars. Its
technological leadership was demonstrated worldwide by the dominant use of Goodyear tires in auto racing. In June of 1991, Stanley C. Gault, former chairman of
Rubbermaid, became chairman of Goodyear. Gault’s mission was to revitalize the company and bring to Goodyear the same marketing expertise that made Rubbermaid
successful. Gault installed a new management team, sold off unrelated assets, and made new product development a central priority.

By the close of 1992, debt was dramatically reduced to $1.9 billion as a result of improved operations, additional stock offerings, and the sale of the polyester commercial
and industrial films businesses. Sales reached a new high of $11.9 billion. Major debt rating agencies upgraded the company’s long-term and short-term debt to investment
grade as 1993 got under way. In the replacement market, Goodyear sold through a network of more than 25,000 retail outlets worldwide, which included independent dealer
outlets, franchise tire centers, department store auto service centers, and company-owned and operated stores. In addition to its Goodyear flagship and premium brands, the
company also sold the Kelly-Springfield brand and a variety of competing associate and private brands positioned to serve the low-end markets.

The Tire Industry
The emergence of the modern tire industry occurred at the beginning of the twentieth century and paralleled the development of the automobile industry. The principal
markets for tires were the original equipment (OE) segment, the direct sale by the tire manufacturer to the vehicle manufacturer; and the replacement segment, where the tire
manufacturer sells to a retail tire outlet, automotive service center, or department store. The industry grew from a total shipment of two million tires in 1910 to
approximately 800 million units of truck and auto tires shipped worldwide, with total sales approaching $58 billion in 1992. The industry was dominated by the big six,
which accounteed for approximately 60% of total market revenues. The United States and Japan were the two largest producers. Table 2 presents production data of the top
world manufacturers.
After the early forays of international automobile manufacturers, the largest tire manufacturers had a significant international presence. The gradual removal of tariff
barriers, coupled with dramatic changes in production technology and a hard drive to achieve manufacturing economies of scale, led the
global tire companies to integrate their operations worldwide. T he impact of the 1990-91 recession and general over-capacity reverberated deeply throughout the industry.
After several rounds of cost -cutting measures, consolidating operations, and layoffs, the industry started to show the first signs of recovery.However, heavy clouds still
loomed in the horizon. Among the most critical challenges were the persistent increases in the prices of raw materials, particularly natural rubber, which had increased by

Rank Maker Country Sales ($m)
1 Michelin France 9,940
2 Bridgestone Japan 9,472
3 Goodyear USA 8,853
4 Continental Germany 3,719
5 Sumitomo Japan 3,223
6 Pirelli Italy 2,747
7 Yokohama Japan 2,522
8 Toyo Japan 1,296
9 Cooper USA 1,015
10 Kumko South Korea 876

over 50%, and the difficulty in passing the increase on to consumers. And, as if to magnify the challenges, the pressures were growing from the automobile manufacturers
for a proliferation of tire styles and sizes, further complicating the production runs to satisfy an increasingly fragmented aftermarket. In addition, the top manufacturers were
starting to feel the heat from the large South Korean manufacturers, who were targeting the worldwide replacement market with low-price tires. Leading
European and American tire manufacturers defended their market shares by launching second- and third-tier brands (associate brands) aimed at the growing low-end market.
To continuously reduce costs and operate at full capacity, companies were forced to consider new types of manufacturing alliances and look at more creative ways to take
advantage of their global presence, which included increased production utilization in lower-cost countries.

Mexico and NAFTA
On September 26, 1990, President Bush launched the first rounds of talks with Mexico for its admission into the North American Free Trade Agreement. The agreement
envisioned the elimination of all trade barriers among Mexico, the United States, and Canada over a period of 15 years. It would ensure the uninterrupted flow of goods
throughout North America and, consequently, accelerate the process of industrial and market integration among the three signatories. NAFTA would create the largest
freetrade community in the world. According to 1990 statistics, the agreement would constitute a market of over 360 million people, a gross domestic product (GDP) of
more than $6 trillion, and a volume of trade of nearly $230 billion. Also, it would give its members a stronger position to compete with the other trade blocs such as the
European Community and the Pacific Rim. The Agreement, if ratified, would be effective in 1994, and in the case of tires, tariffs would be removed gradually. There were
risks associated with the approval and ratification of NAFTA. In both Mexico and the United States, the opposition was making a great deal of noise. In the United States,
labor unions were concerned about the potential reduction in real wages and the loss of jobs that would migrate south.Environmental groups worr ied about lax Mexican
environmental standards and the transformation of that country into a dumping site for hazardous waste from the United States. There were, indeed, higher levels of
contamination around the border, and the fact that some maquiladoras had been cited for serious violations provided powerful ammunition for the environmental lobby.
Some NAFT A supporters defended the position that Mexico should be admitted only after democratic reforms and more equitable social programs were established.
In Mexico, it was argued by some that NAFT A would not bring additional economic benefits beyond the already established maquilas, which had provided almost no
benefits to the central and southern regions of the country.
Clearly, Mexican industry leaders recognized the importance of NAFT A for the Mexican economy; however, its competitive impact on domestic products was a source of
debate. In spite of these points, Pace believed the passage of NAFTA would provide advantages for the economy and the firm. In his view, the advantages included further
privatization of government -held businesses, economic restructuring, industrial modernization, technology transfer, increased foreign investment, infrastructure
development, enhanced employment prospects, and a broadening of the middle class. For Goodyear, the cross-border integration of automobile manufacturing would have
important competitive consequences. Ford, General Motors, and Chrysler could reduce manufacturing costs by rationalizing their product lines throughout their North
American factories. A streamlining of the Mexican vehicle manufacturers’ production lines could actually help Goodyear Oxo to focus its production for the local OE
accounts on a reduced number of tire sizes and types, with increased volumes. In the United States, billionaire Ross Perot was clearly intent on derailing NAFTA. The 1992
independent presidential candidate claimed that he ―could already hear a sucking sound to the south, drawing US manufacturing jobs out of the country.‖
Despite the internal and external challenges facing the Salinas administration, the overall attitude conveyed by the government and foreign investors was of tempered
optimism

Mexican President Salinas de Gortari
The President’s position on economic development was well-known by every Mexican citizen. When Carlos Salinas de Gortari became President of Mexico, he decided to
revolutionize Mexico’s economic structure to prepare the country for the 21st century. According to Salinas, the 1990s were going to be the decade of scarce capital, and
therefore Mexico needed to be in a better position to compete for such capital. Preparing and working towards the ratification of NAFT A would be precisely the way for
Mexico to attract additional foreign capital. After joining the General Agreement of T ariffs and Trade (GATT) in 1986, Mexico made considerable progress dismantling
tariff and nontariff barriers. In addition, Salinas worked intensely to reduce the size of government, diversify the Mexican economy (which was highly dependent on oil),
and increase privatization. In 1989 he liberalized foreign investment rules and renegotiated the country’s large international debt.
After a trip to Eastern Europe, Salinas realized how much had to be accomplished to compete with the opening of Eastern Europe, as well as the exploding growth in Asia.
As a result, he decided that reform needed to occur even faster. He knew that the low Mexican wages would be a source of competition and a magnet for attracting direct
foreign investment.

The Economy
Mexico’s economy was a mixture of state-owned industrial facilities (notably oil), private manufacturing and services, and both large-scale and traditional agriculture (see
Exhibits 3 and 4). In the 1980s the nation accumulated large external debt as world petroleum prices fell. Rapid population growth outstripped the increase in the domestic
food supply, and inflation and unemployment promoted emigration. However, growth in national output recovered, rising from 1.4% in 1990 to 3.6% in 1991. The United
States was Mexico’s major trading partner, accounting for almost three-quarters of its exports and imports. After petroleum, border assembly plants (Maquilas) and tourism
were the largest earners of foreign exchange.
Salinas’ transformation of the Mexican economy was defined by financial austerity and budgetary restraints. In mid-1993, the government showed no signs of loosening its
approach, even with the upcoming presidential elections in 1994. The government repeatedly stated its goal of achieving a budget surplus of 1.7% of GDP in 1993 and
maintaining a stable exchange rate by allowing one-year interest rates to climb to about 19%—ten percentage points above projected inflation for 1993. This tight economic
policy led to GDP growth of only 2.8%, significantly under the projected 6% promised by President Salinas de Gortari. In June 1993, the Central Bank reported an 11%
annualized inflation rate. The monthly rates were declining gradually, making single-digit inflation a real possibility by the end of the year. The Mexican authorities
admitted that the country’s growth potential was dependent on the ratification of NAFT A. If approved, it would bring considerable influx of fresh foreign investment.
With the growth of the Mexican trade deficit estimated to reach about $20 billion by the end of 1993 and the fear of a devaluation troubling the international financial
community, the new NAFTAdriven foreign investments would go a long way to alleviate the pressures on the peso. During this period, for reasons of economic principle,
policy consistency, and international credibility, the government vehemently defended its economic policy and swore off any possibility of a significant devaluation.

Goodyear Tire de Mexico
In 1943, Goodyear T ire merged with Hulera Oxo, and in the following year built its first plant in Mexico. After that time, the plant had increased its daily capacity from 225
tires to over 16,500 tires in 1993. These tires were produced for a diversified market of automobiles, trucks, buses, and tractors. T ire sales are split among the original
equipment (OE), replacement, and export markets. Goodyear’s industrial park is located in Lecheria, a major commercial region outside Mexico City, on an area of
approximately 111 acres. As one of the larger employers in Mexico, it had 2,000 workers. From its coordinated plant and three distribution depots, Goodyear supplied its
independent distribution network which fully served all corners of the Mexican Market. Hugh Pace had been the general manager of Goodyear since early 1992 following
assignments in Argentina as general manager and in Akron, Ohio, as director of sales and marketing for Latin America. Goodyear’s senior management had accumulated
many years of operations experience in emerging economies, particularly in inflat ionary environments. One of these managers was Eduardo Fortunato, director of sales and
marketing. A native of Argentina, where he began his Goodyear career, Fortunato had worked in Argentina as sales manager for industrial products and later sales manager
for tires. In Mexico, he had worked as business development manager.
Another experienced manager was Pat Pulford, marketing manager, formerly business development manager and OE sales manager in Mexico, who was previously sales
and marketing administrator for Latin America in Akron, Ohio, and OE sales manager in Brazil. As a matter of policy, Goodyear developed a management cadre of regional
specialists - people with an in-depth understanding of the economic and business culture of the region and the capability of interfacing effectively with the local
community including labor, media, government, and banking. The organization chart is presented in .

The Me xican Marke t for Tires
In 1993 there were 6.9 million cars, with 600,000 new cars being registered ev ery year. With a young and increasingly affluent population, the Mexican market was vibrant,
competitive, and profitable. Local tire sales were divided between the replacement market (70%) and the original equipment market (30%). The dominant players were
Goodyear, Euzkadi/General/Continental, Michelin/Uniroyal/BF Goodrich, Bridgestone/Firestone and Tornel. The number of competing brands had grown from seven
in 1989 to over fifty in 1993. Within the oval are the brands with a long history in the market, while outside the oval are the minor brands comprised of imports, associate
brands of major manufacturers, private labels, and tires from small foreign companies. Some of the minor brands with small market shares competed in the upper and upper-
middle end markets where they maintained premium positioning, e.g., Michelin. Exhibits 10 and 11 reflect the replacement and OE brand shares.
As for the key consumer preference factors in the replacement tire market, a study identified three major segments: quality, service and price. Quality and service
traditionally were the attributes of greater importance for 65-70% of the market. Tire brand and store loyalty tended to be higher among this group.
The price-oriented category represented approximately 30-35% of the market. These customers primarily sought the best price deals and obtained comparative pricing
information through newspapers, word-of-mouth, or street advertising. They were not brand-loyal, concerned with extended tire durability, or interested in the dealers’
automotive service offerings. The gradual reduction of import tariffs, coupled with the austerity measures imposed by the Salinas administration, contributed to an
accelerated growth of this category—nearly 30% between 1991 and 1993. Most consumers viewed tires as a negative purchase—a necessary expense to keep the vehicle on
the street. The average time between tire purchases was 2.5 years, and it was not uncommon to find older cars operating with bald tires. In general, buying tires was not
planned; it occurred when the need became evident by wear, puncture, or laceration. Most of the tires were bought in pairs: 45% pecent of the customers bought two tires at
the same time, 35% bought four tires, 15% bought one tire, and less than 5% bought three tires. The average Mexican customer, like other Latin American customers,
wanted tires that had an aggressive tread design. This is in contrast with American consumers who preferred tires with a smoother, conservative appearance.

Distribution of Tires
The replacement market represented about 70% of the local consumption of tires. The local manufacturers tended to distribute their tires through exclusive, single-brand
channels.

Distribution Channels
Tires usually reached the consumer markets via three major avenues: independent dealers, department stores, and talacheros (small repair shops). When the market opened,
new channels were developed, a variety of players entered the business, and existing players changed their approaches.
Supermarkets/hypermarkets joined the fray at the onset of the import craze by offering low-cost, no-service, import brands. In addition, the market saw the development of a
large number of automobile boutiques selling import accessories and performance-enhancing products. T hese boutiques, located in major urban areas, primarily catered to
upper-income, sports car owners wanting high-performance import tires. At the lower end of the market, a number of camioneros (street sellers) jumped into the market to
make a quick buck. These merchants sourced cheap import tires from large Mexican wholesalers or from U.S. dealers. They imported new as well as used tires and factory
rejects. They sold their inventory from trucks parked on empty corner lots of major thoroughfares. Their prices were rock-bottom, but they did not provide services or
warranties. Consumers bought at their own risk because there was no assurance that the merchant would be found at the same location the next day. In the crossfire that
followed the reduction of tariffs, the established main-brand dealers were caught unprepared. Accustomed to a gentlemanly way of doing business in a protected
environment that assured stable margins, they lacked the ability and vision to react. Goodyear distributors, like other local major-brand distributors, had been in the business
for many years, some since the company’s founding in 1943. Invariably, they had humble beginnings, usually led by one highly entrepreneurial individual who earned his
wings at the school of hard knocks. Distributors operated in a protected environment where competition was relatively tame, leaving customers with limited options. The
rules of competition were tacit and indirectly supported by government policy, and distributors were able to extract hefty margins. In this environment, manufacturers and
distributors flourished. Except for periods of economic crisis, demand had been greater than supply. A tire dealership was, in fact, a very coveted business. In general,
dealerships were family businesses, run by the elder man of the clan and his children. Decisions were centralized, and the operational environment was very paternalistic. It
was not uncommon to find a family owning several stores in the same city. As a rule, these were all very profitable businesses. This contributed toward a tendency to
reinvest very little into the business. As a common business practice of emerging economies where economic instability and economic crises were expected events, the
profits were quickly divided among the owners and invested in real estate and other fixed assets. When crisis struck, many dealerships, although owned by individuals with
high net worth, faced serious problems of liquidity and a dramatic reduction in operating margins because of the need to roll out debt at exorbitant interest rates. As one
distributor stated, ―This is my business, which is fully paid for, and I do not need to invest any more of my money into it.‖ It could be observed that many owners
were well-to-do financially, yet their businesses were in poor financial condition. These long-standing practices stood in the way of responding effectively to new consumer
expectations.As market dynamics shifted, distributors lacked the sophistication to study, analyze, and understand the changes taking place in their markets and their
traditional customer base. In many cases, their sales techniques were unimaginative, their people were not well-trained, administrative procedures were cumbersome, cost
structures were bloated, inventory mix was poorly controlled, and the concept of value-added within the product lines or service offerings was uncommon. The new
imported competition made quick inroads in the market. For Goodyear, the immediate challenge was to revitalize its distribution network and consider new distribution
channels and formats. The initial consumer infatuation with low-end import tires was short -lived. After nine months, it was obvious that these tire deals were not so sweet.
The tires had not been designed for the rough road conditions of Mexico. They required frequent repairs from punctures and impacts and wore out much sooner than
expected. The fact that the tires sold by camioneros had no warranty and the sellers were later difficult to locate made this market sour quickly. At the same time, the tire
manufacturers association mounted a public relations campaign to raise consumer awareness of tire safety and value. The fast growth of imports leveled off and their market
share stabilized. Only the brands that had the backing of a solid local sales organization kept a meaningful presence in the market.

Communications
The Goodyear tradition was founded on the concept of providing safe, high quality products tailored to Mexico’s road conditions. Although the company conveyed a
perception of technical and market leadership, management worried about the future trend of brand perceptions in the marketplace. In the face of an opening market, was the
Goodyear brand image powerful enough to retain existing customers and generate additional store traffic?
In March 1993, a market research study confirmed the leadership image of Goodyear in Mexico. While the market turmoil created by the recent entry of foreign competition
showed some negative Effects on the major brands serving the low-end market (e.g., Uniroyal), Goodyear maintained a strong presence in the minds of customers (see
Exhibit 12). This presence was anchored strongly in the attributes of quality, high technology, high performance and safety, as presented in Exhibit 13. This was
clearly evident in Goodyear’s high-market penetration of the quality-conscious consumer groupings.

The Compe tition
The global structure of the tire industry was replicated in the Mexican market. The leading players were international companies. The industry was dominated by
subsidiaries of MNCs plus one wholly Mexican owned concern. Production facilities of the major companies used advanced technologies and processes with product quality
at world-class levels. Customer service was strong and product offerings were hard to differentiate. Differentiation occurred primarily at the level of brand image, quality of
service, and distribution coverage.
In 1996, the present structure of tire production reflected a series of mergers and new entrants to the market in the late 1980s and early 1990s. The following table shows the
evolution of the Mexican tire industry during this period, which—much like the industry worldwide—went through a significant transformation.

Major Local Competitors

Tornel
A small family-owned and operated business with low-end and limited product lines. Over the years, Tornel had obtained a small but consistent market share using the
slogan ―Mexican T ires for Mexican Roads‖ (streets and highways were in poor condition by USA standards), although their product quality did not match the slogan. T he
company was also adept at carving out market niches; they were, for instance, the only producers of bicycle tires in Mexico. In 1994, Tornel began a limited venture into two
USA-Hispanic markets by opening a few retail stores called Tires & Llantas. Their plan was to expand into areas with significant Hispanic populations including T exas,
California, Florida, and Illinois.

Euzkadi/General/Continental
This association formed the largest manufacturer of tires in Mexico and was owned by Grupo Carso, a large Mexican conglomerate, which also owned the rights to
manufacture and distribute Marlboro Cigarettes, owned Sanborns (the largest coffee house/gift shop chain), and was the largest single shareholder of TELMEX (the
Mexican phone company), to name only a few of their holdings. In January 1993, Grupo Carso announced its tire subsidiary Hulera Euzkadi had signed a joint venture
agreement with the German tire manufacturer Continental A.G. As part of the agreement, Euzkadi acquired General T ire de Mexico from Continental for $40 million dollars
and created a new holding company, Corporacion Industrial Llantera. At the same time, Euzkadi and General Tire de Mexico signed a 10-year-agreement with Continental
A.G. and its U.S. subsidiary General T ire for exclusive brand and marketing rights along with technology and production assistance. Although Hulera Euzkadi and
Continental’s former subsidiary General T ire de Mexico combined production operations under Corporacion Industrial Llantera, marketing of Euzkadi and General brands
remained separate.
Their main distribution channel was through independent, exclusive dealer networks with two co-branding formats: Euzkadi/Continental and General/Continental.
The venture will produce and market tires while maintaining about 33 percent of the overall market. In 1994, the holding is expected to have $360 million in sales and 2,800
workers in two plants. Euzkadi is a well-recognized name by the consumer, as it was the first brand to launch a steel radial passenger tire in the late 1970s (BF Goodrich
technology at the time). The merger with General and Continental could create confusion in the minds of customers because the Euzkadi brand has been associated with BF
Goodrich for many years.

Michelin/Uniroyal/BF Goodrich
Michelin assumed management of the Mexican Uniroyal operation in 1989. As per the 1991 sales agreement between Euzkadi (Grupo Carso) and Michelin, Euzkadi
maintained the rights to the BF Goodrich name until January 1994, at which time the brand would pass to Michelin. As can be seen from Table 5, Euzkadi merges in
January 1993 with General/Continental and begins to use their technology instead of BF Goodrich’s. The Uniroyal name is perceived by consumers as a ―popular‖ brand in
the mid-range of quality and price. The BF Goodrich name is heavily associated with Euzkadi. Michelin management decided to identify all its independent dealer owned
retail outlets as Michelin/Uniroyal or Michelin/ BF Goodrich. Only a small quantity of imported Michelin brand tires are sold in these stores. Michelin does not
produce the Michelin brand in Mexico. Although the Michelin brand has had a very limited presence in the Mexican market through the years, it is known as an expensive
and good quality tire.
Bridgestone /Firestone
Bridgestone/Firestone is the third-largest tire maker in North America. Firestone was acquired worldwide by the Japanese company Bridgestone in 1988. They serve the
Mexican market offering a full product line, except tractor tires. They produce the Firestone brand in Mexico, while the Bridgestone brand is imported. In the Mexican
market, the company holds 17.5 percent of the replacement passenger tire market and 20 percent of the light truck tire market. In the OE segment, they are ranked second
with a 26% participation.

The Auto Industry
Logically, the tire industry relies heavily on the auto industry. In Mexico there are more than 6.8 million automobiles in use. In terms of sales, the top five auto makers are
Volkswagen, Nissan, Ford, General Motors, and Chrysler. The annual domestic automobile sales in 1993 were estimated to reach 603,000 units, with more than 50 percent
concentrated in small and mid-size cars. Mexico is considered by the major OE manufacturers to be a critical market because of its sheer size and manufacturing cost
advantages. With the opening of the market, Ford decided to integrate its Mexican operations into the North American region. General Motors and Chrysler announced they
would follow the same route but had not started the process by mid-1993. Volkswagen and Nissan, on the contrary, managed their Mexican production as independent units
within their Latin America region.

Meeting Pre paration
Hugh Pace spent the weekend reviewing several market scenarios, possible competitor initiatives and Goodyear’s options. A meeting was needed to examine the company’s
strategic alternatives and develop a statement of priorities for the next five years. Each manager knew that the dramatic changes in the competitive environment required a
call to action from those wanting to succeed in the new market. As a world leader in the industry, Goodyear Tire had to carefully evaluate its options in order to compete
successfully.

The Meeting
The air was still brisk when managers arrived for their 8:00 a.m. meeting. Pace began by summing up their competitive position, ―Since the admission of Mexico into GATT
and the beginning of the NAFT A negotiations with Canada and the United States, we have seen an accelerated change in our market. Competition is increasing; new and
low-priced brands are proliferating; traditional competitors have begun to import tires; and everyone is determined to gain market share,‖ explained Pace. ―We certainly
can question our competitors’ true strategic motivations, but the fact is they are serious and seem to be here to stay. To aggravate this tough competitive situation, the current
administration’s restrictive economic policy and the high interest rates have put a damper on economic growth.‖ Pace went on to explain that distributors were having
liquidity problems, and the Mexican consumers were growing more sensitive to prices, especially because they now had a variety of choices. ―Keeping in mind the trends of
change in consumer taste, the formation of new distribution channels, the growth of multi-brand formats, the invasion of imported brands, and the availability of so many
low-cost imports, it is only logical for us to assume the once-restricted and clearly defined Mexican tire market will soon and forever become a wide-open, anything-goes
battlefield, similar to the U.S. tire market. If you agree with my prediction, isn’t it equally logical that we must question our previously successful closed-market paradigms,
and question every aspect of the way we do business, of the way we market our products, and of the way our organization is structured, both internally and regionally?‖
The room fell quiet for a few moments while the group absorbed Pace’s comments. Breaking the silence, Sergio Escalante, traffic manager, noted that rationalizing the
Mexico plant with the North American division would certainly give Goodyear-Mexico a major cost advantage. ―Cross-border rationalization could be achieved by the
specialization of plants,‖ continued Escalante. ―Mexico would produce fewer tire types in longer production runs, importing and exporting significantly more volume and
tire types than at present.‖ ― It all sounds correct from a manufacturing, logistics, and even financial viewpoint since it would give us lower unit costs and a potentially
stronger profit position,‖ added Eduardo Fortunato, director of sales and marketing. ―However, I’m concerned about how far this rationalization can evolve. First and
foremost, tires designed for use in the U.S. will perform poorly on Mexican roads. We know that for certain because our designs, developed in Luxembourg, were created
especially for the road conditions found in Mexico. We’ve spent a great deal of time improving tire specifications to obtain durable and long-lasting tires, and it hasn’t been
easy,‖ he explained. ―Technically speaking,‖ added Fernando Mendoza, planning manager, ―I see no problem in rationalizing the manufacture of certain product lines
between our U.S. plants and our Mexico plant, as long as the respective design specifications are respected. For us to achieve consistent full production levels,
firm order commitments from the U.S. planning group will be imperative. To maximize local sales volume, import availability from the U.S. plants must meet our
requirements. We have to keep in mind that our production runs are just a drop in the bucket compared to any U.S. factory.‖ Another point that Escalante brought up related
to the composition of Goodyear-Mexico’s product line. ―Presently, we manufacture many brands and designs that aren’t produced in the United States.
In order to capture the true economy of scale benefits, how many lines should we concentrate on - two, three, four?‖ he asked. ―A move like this would imply that some
current U.S. production volume would need be shifted to Mexico. We could improve tonnage output and reduce plant costs with a rationalized production line-up running at
full capacity.‖ ―That’s a valid point,‖ interjected Pat Pulford, marketing manager. ―However, the stark reality is that we are part of the North American continent, and
hopefully, if President Clinton musters enough support in Congress, we will be part of NAFTA. Although we are Latins by culture and language, we are geographically part
of North America. Whether we do or do not remain in the Latin America structure of Goodyear doesn’t seem to be a key issue at this time. Besides, a northward approach to
manufacturing rationalization may not be best, since we have worked hard to gain long-term supply commitments with our Central American dealers, who rely on us to
make tire sizes and types which are exclusive to their markets. Would we discontinue this production, and drop our Central American market base? I truly think our major
challenge is not so much related to production rationalization with the north, but rather the aggressive marketing of tires in Mexico. Don’t you agree?‖ Fortunato quickly
added, ― I feel we must be more concerned about the import competition and develop strategies to protect our market share and enable us to recover the margin levels we
used to enjoy. Our Goodyear brand still commands a great deal of value. Even if our distributors are not performing at levels which meet our expectations, we can educate
them and change the situation. I think we should protect our high-end brand image and customer base, while putting additional energy into a parallel strategy to compete
more effectively for the low-end markets, where a real battle will be waged in the future.‖ ―Although I understand your positions, my experience in the field leads me to
question the amount of effort it will take to convince these distributors they must change their ways of selling tires,‖ said Mario Perez, finance manager. ― Selling
improvements in efficiency, productivity, and cost reduct ions isn’t going to be easy. Remember, some of these shops are guilty of shifting the costs for personal expenses
to their businesses, to avoid personal income tax.‖ Pat felt the focus should follow a different line. ―Distribution should involve creating n ew channels,‖ he said. ― Since the
current distribution channels are becoming less and less effective, we must create new distribution channels through new retail formats, or use new distribution like
supermarkets and warehouse clubs, or even think about acquiring and managing some of the larger competitive tire chains.‖
As the hours passed, the team generated more ideas about increasing export production, introducing new brands, developing alternative pricing strategies, and improving
inventory control. Some believed that brand extension could help the company recover in the low-end market, but others disagreed.
Pace adjourned the meeting at 1:00 p.m. ―Thanks for your ideas and your continued commitment to excellence. Goodyear has a history of successfully competing in open
and closed markets, of coping with economic turmoil, devaluations and high inflation, and of reorienting itself after a takeover attempt.

I am certain this period of change in Mexico will challenge our individual and corporate capabilities, giving us the opportunity to find new ways to extend our leadership
position in the market. Let’s reconvene after lunch to develop a comprehensive plan of action for Goodyear-Mexico.‖
DSL de Mexico S.A. de C.V. (A)

In late April 1996, Lane Cook, the 28 year-old General Manager of Distribution Services Limited de Mexico (DSL), had just finished a meeting with José Hernandez, the
traffic manager of SuperMart, a medium-sized Mexican retail company. DSL, a U.S.-based freight consolidator, had spent two years trying to build a Business in Mexico.

SuperMart seemed like an ideal prospect.

After several weeks of negotiations, Cook believed that he had won Hernandez over and that SuperMart would soon sign a contra ct turning all of the company’s Asian
shipping business over to DSL. Prices had been agreed upon and Hernandez gave every indication of wanting to work with DSL. Cook scheduled one last meeting in
ambition of finalizing all arrangements. As the meeting was drawing to a close, Hernandez brought up one last request.

He insisted that he, not DSL, select DSL’s trucking company sub-contractor for all of SuperMart’s business. Although this condition would not be included in the written
contract, Hernandez made it clear that Cook’s cooperation would be essential to cement the deal. Although surprised by the request, Cook asked for time to think about it.
After the meeting Cook did some investigating and through a contact learned that the company
Hernandez wanted to use had made arrangements to funnel payments back to Hernandez
on every shipment DSL managed. Cook realized that Hernandez was waiting for a response
and wondered what action to take.

Company Background
DSL was founded in 1978 by Philip Clarke, Sr. and Cobb Grantham. Both men served together in the Korean War and worked in Asia after the war for Sea-Land Corp.,
Based retail companies which were interested in accessing Asian markets
The pre-purchases represented considerable exposure for consolidators; many lost money when anticipated demand did not materialize. The more volume they could
guarantee, the lower the rates with the shipping lines. It became clear very early on that developing and maintaining an active and healthy client base with steady
transportation needs would be critical.

Working with Retailers
The norm for U.S. retail companies was to negotiate prices that were FOB at the supplier’s dock. By taking ownership of the goods overseas, retailers could handle
negotiations with the freight companies themselves. For large retailers like Sears, Wal-Mart, and J.C. Penney, substantial volume discounts could be secured on
massive volumes of goods being shipped.
To facilitate shipping and manage inspections, most large retailers established buying agents or representative offices throughout Asia. As a result, consolidators relied on
two types of retail customers: (1) small customers, including trading companies, that rarely ordered large volumes, and (2) larger retailers who, because of precise sales
projections and sophisticated inventory t racking systems, ordered mixed sized lots

DSL’s Growth
In the late 1970s and early 1980s, Over its first ten years, sales grew by an average rate between 15% and 20%. Gross margins hovered in the 15% range, a rate which was
considered very healthy in the industry. Over time, DSL opened offices in Taiwan, Korea, China, Singapore, and many other Asian origins.

DSL grew as Wal-Mart grew.

In 1977, it began using electronic data transmission technologies to link its major trading partners with its order desk s. The system, which became known as Electronic Data
Interchange (EDI), grew to include an elaborate network that linked suppliers, shippers, warehouses, and individual stores. Wal-Mart insisted that all
vendors and shippers upgrade their computer systems so they were compatible with Wal-
Mart’s state-of-the-art system.
By following Wal-Mart’s lead, DSL became entrenched in Wal-Mart technology and learned many key advantages in just-in-time (JIT) and inventory management earlier
than many competitors.

By the end of 1995, DSL had grown to a $200 million company. Of this amount, about $80 million was derived from Wal-Mart; another $50 million came from Target
Stores. The balance was derived from such retailers as Edison Brothers, JC Penney, Fingerhut, Shopko, Hills Department Stores, the American Retail Group, as well as
various U.S.-based trading houses.
As DSL grew, it began to encounter increasing competition. By the late 1980s a number of freight carriers began to move into the consolidation business. More efficient
inventory management by the retailers also squeezed consolidators.

Although Wal-Mart was DSL’s largest account, the profit margin on the account was not the largest.

Expansion to Mexico
In 1988, DSL’s regional director in San Francisco made contact with a large Bay-area trading company that did considerable business with a major Mexican retailer. The
trading company, which was buying goods in Asia and selling them to the Mexican retailer, asked DSL to assist in shipping, customs clearances, and the like. In response,
DSL in 1990 formed a joint venture with a Mexico City-based shipping agent to assist in managing the new business. DSL viewed the joint venture as a stand alone entity
and initially provided
little attention or investment.

Throughout the early 1990s trade between the U.S. and Mexico flourished in part because of the establishment of maquiladora indust ries. In August 1992, the Prime
Ministerof Canada and Presidents of Mexico and the U.S. announced the North American Free Trade Agr eement (NAFT A) which would come into effect on January 1,
1994. The passage of NAFTA clearly caught DSL’s attention as it promised a dramatic increase in trade between the U.S. and Me xico.
A small office was set up in Mexico City and Ryley began the DSL effort. Initial discussions with the largest retailers in Mexico—Gigante, Comercial Mexicana, and Grupo
Cifra – appeared promising. Gigante had the largest number of grocery and merchandise stores (over 100) in Mexico; Cifra had approxim ately 80 grocery and
merchandising stores but also owned restaurants and a variety of smaller specialty retail chains. Cifra’s
total retail revenues of over $U.S. 1.2 billion placed it as the largest overall retailer in Mexico.
Cifra was also regarded as the best run and most financially sound retailer in the country.

DSL de Mexico S.A. de C.V.
In October 1993, Wal-Mart opened its first store in Mexico as a 50-50 joint venture with Cifra. Within the month, DSL became incorporated in Mexico and began handling
not only Wal-Mart’s consolidated freight from Asia, but also its domestic consolidation of Mexican suppliers for delivery to its new Mexico Sup ercenters. In November
1993, DSL subcontracted the use of a small warehouse in Mexico City. DSL placed two employees in the facility to do administrative work but relied on subcontractors for
equipment and manual labor. DSL’s main accounts were Gigante, Comercial Mexicana, and the newly arrived Wal- Mart. For each of these accounts, DSL acted as the sole
consolidator of shipments from Asia to Mexico. To assist, DSL established a small operation in Laredo, Texas that would help process trans-shipments through the U.S. and
coordinate customs crossings to and from Mexico. In addition, DSL acted as Wal-Mart’s sole consolidator within Mexico, a role that included working with Wal-Mart’s
Mexican vendors by consolidating their small orders and sending full truck loads to the Mexican stores.
In the Summer of 1994, Wal-Mart announced an aggressive expansion plan that called for the opening of 100 stores in Mexico by late 1996. Shortly thereafter, DSL rented a
larger, 15,000 square foot warehouse facility in Mexico City.
In November 1994, Lane Cook was appointed General Manager of DSL de Mèxico.
Cook, 28, was hired by DSL in 1994 when he graduated with a Master’s degree from The American Graduate School of International Management -Thunderbird. DSL had
been impressed with Cook’s experience in Latin America, his Spanish skills, and his ability to work independently under difficult conditions. Cook’s first position with DSL
was in operations in Mexico.
            By early 1995, Wal-Mart had 33 stores in Mexico, including 22 Sam’s Clubs and 11 Wal-Mart Supercenters. In March 1995 DSL moved into a 75,000 square
foot, two-year old warehouse facility located in the northern outskirts of Mexico City. The new facility was near the main north-south highway connecting Mexico City with
Laredo, Texas and could effectively handle the loading and unloading of 25 trucks

Hard Times for DSL de Mexico: The Devaluation
T wo days after DSL signed a contract on the new warehouse, Mexico moved to devalue the peso. Between December 20, 1994 and February 1, 1995, the peso’s value fell
close to 40 percent against the U.S. dollar, and caused what most Mexican experts call the worst econ omic crisis in Mexico’s history. (See Exhibit 1 for a review of the
devaluation of the Mexican peso.) Given that the lease was denominated in pesos, the devaluation substantially lowered DSL’s warehouse cost in $U.S. dollar terms.
However, the devaluation also paralyzed the Mexican economy. Imports went into a tailspin, drying up DSL’s Asian consolidation
business.

Cook Responds
Cook had considerable latitude in responding to the crisis in Mexico. As General Manager, Cook reported to C.J. Charlton, DSL ’s regional director of Texas, Arkansas, and
Mexico. Charlton, 58, was based in Bentonville, Arkansas and had been an active supporter of DSL’s Mexican investments. Charlton in turn, reported to Executive Vice
President Darse Crandall, who was based at Corporate Headquarters in Long Beach, California. DSL’s management philosophy was founded strongly on the importance of
delegation. Cook saw Charlton three or four times per year—either in Mexico or in the U.S.

With business hurting, Cook moved quickly to cut costs. In May of 1995, the only other American manager (running operations) at DSL de Mexico was transferred back to
the U.S. By Summer 1995, DSL de Mèxico’s staff had been drastically reduced. Cook described his job as a cross between being operations manager, financial officer, sales
director, and warehouse manual laborer. The DSL de Mèxico warehouse staff went from 48 people on two shifts to a single shift of 14. The company also contracted
external firms to provide security.

Wal-Mart Goes it Alone
By late Summer of 1995, the Mexican economy was beginning to show signs of stability. Many at DSL believed that the worst was over. These hopes were shattered when,
in July 1995, Wal-Mart broke ground on its own distribution and warehouse facility only 1.5 miles from DSL’s building. In establishing an in-house distribution system,
Wal-Mart turned to its wholly-owned affiliate, McLane. Based in Temple, Texas, McLane, a national distribution and food processing company, was purchased by Wal-
Mart in 1990. With 1995 sales approaching $8 billion, McLane owned a nation-wide trucking operation, four food processing plants and two food storage warehouses.
McLane had little international experience and none at all in Latin America. As Wal-Mart grew in Mexico, it first invited McLane to assist with grocery distribution.
McLane did a surprisingly good job with groceries and soon pushed for the entire Wal-Mart distribution account. The decision to turn the entire distribution operation over
to McLane clearly caught DSL by surprise. Another surprise came in late 1995 when Wal- Mart and Cifra agreed to merge their distribution systems in Mexico. The new
joint venture distribution company, DCW, would be managed entirely by McLane. Some observers predicted that Wal-Mart would eventually purchase all of Cifra’s grocery
and merchandise stores.
By the summer of 1996, DCW was managing all of Wal-Mart’s and Cifra’s grocery and general merchandise distribution in Mexico. DSL continued to act as a consolidator
for Asian goods purchased by both companies but lost its domestic consolidation business.

Pressure to Raise Re venues
With so much unused capacity and costs cut to the bone, Cook was under enormous pressure to raise revenues. DSL’s U.S. offices helped considerably here. By the summer
of 1996, DSL had 20 offices in the U.S. and many of these had large accounts that did business in Mexico. The collapse of the peso brought about a significant increase in
U.S. imports from Mexico. DSL de Mèxico regularly received requests for transport price quotes from DSL U.S. offices. Despite this ongoing interest, Cook believed that
the key to growth lay within developing local business, including warehouse accounts. Here, the company faced steep competition .

The Supe rmarket Issue
With business off and significant overheads to cover, Cook began working overtime to build sales. In May 1996, Cook approached SuperMart, a medium-sized, Mexico
Citybased general merchandise retailer. SuperMart had a 60-year history in Mexico and revenues in excess of $U.S. 150 million. Initially Cook proposed that DSL engage in
a broad array of services with SuperMart. After several meetings with José Hernandez, SuperMart’s 58 year old traffic manager, Cook switched the proposal to the
management of SuperMart’s import shipments from Asia. Cook estimated that this would be a $U.S.60,000-70,000 business for DSL. Under normal practices, SuperMart
would take possession of the goods in Asia and contract with DSL for shipping to Mexico via the United States. DSL would in turn buy freight space across the Pacific to
Long Beach, California and then arrange ground transportation for the shipments through Laredo, Texas and on to Mexico City. As a result, DSL’s Hong Kong, Long Beach
and Laredo offices would all be involved in managing the shipments. Cook’s office in Mexico City would select the transportation company that would bring the freight
from the Laredo border to Mexico City and track the shipment for SuperMart. Hernandez seemed convinced of DSL’s capabilities and he and Cook sp ent considerable
time negotiating fees and other arrangements

DSL de Mèxico S.A. de C.V. (B)
After considerable thought, Lane Cook decided to let José Hernandez determine the selection of the trucking company for SuperMart.

Problems with Invoices
Within a month of resolving the SuperMart issue, Cook was confronted with a troubling dilemma involving another major customer.

DSL de Mèxico S.A. de C.V. (C)
After considerable thought, Lane Cook decided to notify the customer of the overbilling and offer a credit. DSL was not thanked for its honesty. Furthermore, the customer’s
scrutiny of DSL’s invoices continued; Cook wondered whether he had done the right thing.

Theft in the Warehouse
In July 1996, Cook uncovered what he thought was a theft ring in the warehouse. Dealing
with this was a major challenge.

DSL de Mèxico S.A. de C.V. (D)
Lane Cook decided to fire Raul.
Pe psiCo in Mexico:
Anatomy of an Affiliate’s Exposure
NO DEPOSIT, NO RETURN
The Latin Cola Wars
In 1993 PepsiCo was the second largest soft drink company in the world, with a 21% world market share to Coca-Cola’s 46%. PepsiCo, however, was determined to change
that. Many of the world’s industrial-country markets for soft drink products were already mature, but the host of emerging-country markets represented immense potential.
Countries such as China and India were only in the first stages of consumer product growth — the war would be waged in their markets for decades
to come.
But the markets of Latin America, already some of the world’s largest soft drink consumers, were thought to still contain substantial potential for growth. With rising per
capita incomes and a proven proclivity for soft drink consumption, Latin America was ripe for a cola war. In addition to cola drinks, an added feature of the Latin American
market was the growing popularity of flavored drinks. The flavored drink segment was thought to be still in its infancy in Latin America, and both Coke and Pepsi had
recently been expanding their soft drink product lines. Thankfully, sales of flavored drinks did not cannibalize cola drink markets, only the markets of other flavored drinks.
Pepsi saw Latin America as prime territory for a major initiative. With the exception of Venezuela, however, Pepsi was trailing Coke in everymajor country market in Latin
America.Pepsi’s market share ranged from as low as 8% in Brazil, to a high of 42% in Venezuela . With the exceptions of Argentina and Uruguay, Pepsi’s market share was
not only trailing Coke across the southern hemisphere, it was often third to other soft drinks. Late in 1993,the reality was that Pepsi — at best — was a distant second to
Coke.
PepsiCo’s Latin American initiative was spearheaded by PepsiCo’s Chief of International Operations, Chris Sinclair. Sinclair had taken over Pepsi-Cola International (PCI),
the international side of PepsiCo, Inc., in March of 1990 with the express purpose of doubling PepsiCo’s overseas business during the 1990s. Sinclair pursued a go-for-broke
expansionist strategy, attacking Coca-Cola head-on in every major market. Sinclair would be PepsiCo’s standard-bearer in the Latin cola wars.But a cola war is not easily
won. The first problem was the structure of the market. Soft drink companies like Coca-Cola and PepsiCo had traditionally serviced country markets via a two-stage
presence. First, the soft drink syrup concentrate was sold in-country via a local affiliate. This local affiliate was frequently wholly-owned or majority-controlled by
the soft drink parent. Access to the consumer, however, was through a second level of local bottlers and distributors. These companies had traditionally been local
franchisees in which the soft drink originator (e.g., Coca-Cola or Pepsi) had no real equity interest. They were cooperative joint ventures, not equity joint ventures. T hese
bottlers and distributors were granted exclusive regional rights, and operated independently in their own markets. This lack of control was frustrating for the strategists back
in the home offices of the major soft drink powers (Atlanta, Georgia for Coca-Cola; Purchase, New York for PepsiCo). In 1993 both Coca-Cola and PepsiCo had moved to
gain additional management control over their Latin American markets via a chosen anchor bottler (Coca-Cola) or super bottler (PepsiCo). Both Pepsi and Coke had
decided that if they were to effectively take market share from the other, they would need a single voice in the regional market. It was hoped that through a single
representative, the product would be able to gain market preferences from local retail distributors, as well as present a singular image to the consuming public.
The anchor bottler strategy was dependent on two critical components. First, the chosen bottler needed the resources to implement the strategy, a strategy which was often a
combination of technology, packaging, distribution, and marketing. Secondly, the bottler must have the product focus to see the strategy through in a highly competitive
marketplace. PepsiCo was now moving quickly to put both components in place. By taking an equity interest in these local bottlers, the soft drink makers intended to
have direct managerial and financial control in the implementation of their strategic goals. The equity injections associated with these joint ventures were to provide much of
the badly needed capital to upgrade the production and distribution facilities needed to compete
in an emerging Latin market. So venture they did. What PepsiCo — and specifically Chris Sinclair — did not anticipate, however, was the role that personalities and
families would play in the development of their Latin American strategy.

Argentina. Pepsi-Cola International (PCI) moved in October 1993 to gain a 26% equity interest in a number of its key bottlers across Latin America. In the late 1980s, a
group of investors led by Charles Beach had gained control of bottlers and distributors, first in Puerto Rico (1986), then in Argentina (1989). Buenos Aires Embotelladora
S.A. (Baesa), the firm for which Beach served as CEO, had been Pepsi’s greatest success story in th e early 1990s, as the local Argentine bottler had expanded market share
and influence to Brazil, Chile, and eventually Uruguay. Beach had increased Pepsi’s market share in Buenos Aires from about 1% to 39% by 1992. In exchange for several
existing Chilean and Uruguayan bottling operations, PCI pumped $35 million in cash into Baesa. Baesa was also guaranteed control over several expiring Brazilian bottlers,
most notably franchises in Rio de Janeiro and Porto Alegre (1994) and Sao Paulo (1996). Baesa undertook a massive expansion and recapitalization of its production
facilities throughout South America, raising over half a billion U.S. dollars between 1992 and 1994.

Venezuela. Hit de Venezuela, PCI’s primary bottling operation in Venezuela, was owned and operated by the Cisneros Group. Headed by Guastavo Cisneros and his brother
Oswaldo, the Cisneros Group was a highly diversified financial empire involved in businesses ranging from sporting good to telecommunications products and services.1
The Cisneros family, friends of PepsiCo’s President Roger Enrico and the holders of a franchise for over 50 years, was actively negotiating with PCI to sell the parent
company a sizeable equity share in the Venezuelan bottler. Although Venezuela was the only country in South America in which Pepsi held a larger share of the market than
Coca-Cola, the Cisneros Group believed that in order to continue to hold, and possibly expand, their market dominance, a sizeable capital injection would be necessary.
Negotiations with Pepsi had proceeded slowly, however, as PepsiCo was not comfortable with some of the Group’s ambitions to expand outside the Venezuelan borders into
other markets.
Mexico. In March 1993, concurrent with the adoption process of NAFTA, Chris Sinclair announced that PepsiCo was undertaking a $750 million investment initiative in
Mexico. The $750 million would be used over the next five years to bolster bottling and marketing efforts, recapitalize operations, and update bottlers with the latest
technology.2 The purpose was clear: to cut into Coca-Cola’s dominant Mexican market share. Coca-Cola had also been busy of late, taking a 30% interest in Fomento
Economico de Mexico (Femsa), and naming it Coke’s anchor bottler in Mexico. It takes at least three Diet Pepsis — Pepsi Lights, actually — to down your plate of
tacos al pastor, the delectable house specialty at El T izoncito. Pepsi has pouring rights at this popular chain, which brings seasoned proficiency to fast food throughout
Mexico City — and typifies the renewed battle for cola one-upmanship on the mean streets of the Mexican capital. Try getting near the place during ― lunch hour,‖
customarily between 3:00 and 5:00 PM. Source: ―The Mexican Insurrection,‖ Beverage World, August 1993. Approximately 80% of all soft drink sales in Mexico were
through mom-and-pop stores called tienditas. Market analysts believed that as long as the tienditas controlled the market, price wars between bottlers would be nearly
impossible. According to the President 1 The Cisneros Group held controlling interest in a number of U.S. and South American businesses including Spalding (sport
equipment), Evenflo (baby products), Galaxy Latin America (satellite T V services), and Pueblo (supermarkets). The first phase of the initiative was a US$115 million
equity interest in three Mexican bottlers: a 29% interest in Grupo Embotelladoras Unidas, a 49% interest in Grupo Protexa’s bottling subsidiary, Agral, and
a 20% interest in Grupo Rello. of Pepsi-Cola Latin America, ―The only way to win against a giant like Coke is to put them on the ropes. We’ve got to constantly innovate
and act very quickly.‖

Many in PepsiCo believed the key to taking market share from Coke was in packaging. Soft drink makers had long considered the Mexican market an emerging market, and
emerging markets consistently showed a preference for the refillable and returnable packages — the returnable glass bottle.4 The logic was simple, the returnable package
was the cheaper delivery vehicle for the product. But if Mexico was industrializing rapidly, and more of its high soft drink consuming populace grew increasingly affluent,
the desire of the affluent for convenience would grow. The convenient package was the slightly higher cost, nonreturnable package, the nonreturnable plastic bottle. Pepsi
was thinking plastics. Grupo Embotellador de Mexico (Gemex) was PepsiCo’s largest bottler outside of the United States, serving Pepsi’s largest market outside the United
States. Gemex had grown from a small bottling operation in the city of Acapulco in 1964 to a major player in one of the world’s largest metropolitan areas, Mexico City.
Gemex was owned and operated by Enrique C. Molina Sobrino and the Molina family. Gemex was considered the most successful of PCI’s Mexican operations, with a 1992
soft drink market share in the Mexico
City area estimated at 50.8%, as compared to Coke’s 49.2%. This made Gemex exceptionally
successful compared to other major PepsiCo bottlers, inside and outside of Mexico.
Agral was a joint venture of Grupo Protexa (51%), the sixth largest construction company
in Mexico, and Pepsi-Cola International (49%). This was PCI’s largest equity interest
in any of the regional bottlers, and reflected Pepsi’s grand ambitions for its market. Agral currently held a 20% market share in the Monterey market of northern Mexico,
the third largest city in Mexico. Monterey’s prospects centered on its ranking as one of the highest per capita consumption regions for soft drinks in the country.
Unfortunately, it was also one of Pepsi’s weakest markets. Although Agral’s prospects were considered good, Grupo Protexa itself was a US$1.2 billion conglomerate with a
multitude of interests, including telecommunications, rail transportation, petrochemicals, and heavy construction. Its commitment to expanding PepsiCo’s interests in the
region had been hotly debated both in northern Mexico and northern New York. The other regional bottlers were enjoying only modest degrees of success against the
historical dominance of Coca-Cola. Grupo Rello was the bottler and distributor in Toluca and T lanepantla, rapidly expanding suburbs of Mexico City. Although successful,
many suspected that it would be eventually absorbed into Gemex. Grupo Embotelladoras Unidas, located in Guadalajara, Mexico’s second largest metropolitan area, was
also a joint venture partner with PCI, but was suffering flat growth in sales. With PCI’s Chris Sinclair at the helm, PepsiCo was determined to launch a revitalized
attack on Coca-Cola throughout Mexico. Sinclair moved swiftly in 1993, acquiring a 20%equity interest in Grupo Rello. With the lone exception of Agral in northern
Mexico, it appeared from the start that Sinclair intended to lead his attack through Gemex. But the Molina family, the owners of Gemex, had rebuffed suggestions by PCI
that it take an equity interest in the other bottler.

Grupo Embotellador de Mexico (Gemex)
Gemex is a holding company which produces, distributes, and sells bottled soft drinks, mineral water, returnable plastic bottles, and a variety of other packaging materials
through its various subsidiaries. The Company’s flavored soft drink products include Pepsi Cola®, 7- Up®, Clearly Canadian®, Seagram’s Mixers®, Squirt®, Mirinda®, in
addition to two mineral water, Garci Crespo® and Electropura®. With its head office in Mexico City, Gemex owns and operates 97 soft drink warehouses and 23 bottling
plants in four regions around and including Mexico City and the cities of Iguala, Tehuacan (a city famous for its natural waters), Acapulco, and Cuernavaca. The Company
employs more than 15,000 people throughout Mexico, and holds the exclusive rights to the bottling and distribution of Pepsi products in these four regions.5
5 Gemex has exclusive rights to the following four regions:
1. Mexico City Area, which consists of Mexico City and portions of the states of Hidalgo and Mexico;
2. Southwest Area which consists of the states of Guerrero and Morelos;
3. Southeast Area which consists of the states of Campeche, Quintana Roo and Yucatan;
4. North Central Area which consists of the states of Aguascalientes, Durango, and Zacatecas.

Grupo Embotellador de Mexico was established on December 21, 1981, under the name Grupo Troika, by Enrique Molina and family.6 In 1984 Mr. Molina acquired the
exclusive right to produce and distribute PepsiCo soft drink products in the Mexico City area. In late 1991 the name of the Company was officially changed from Grupo
Troika to Grupo Embotellador de Mexico (Gemex). Over the following decade, the company acquired a number of soft drink and beverage bottlers and distributors
throughout Mexico.
Gemex was listed on the Mexico City stock exchange on December 17, 1991. One year later, it was listed on the London Stock Exchange via Global Depositary Shares
(GDSs) and the New York Stock Exchange (symbol GEM) through American Depositary Receipts .Gemex’s growth was rapid in the 1990s. In 1993, the company signed
two new exclusive agreements which expanded product lines and market areas. The first was with Seagrams & Company, giving Gemex the exclusive right to produce,
distribute, and sell Seagrams’ products throughout Mexico. The second was with Natural Beverage Company, in which Gemex obtained the rights to exclusively distribute
the Clearly Canadian beverage line. Gemex’s competitive position against other soft drink producers, such as Coca-Cola, strengthened, as it now possessed a wider product
line — flavored drink and bottled water segments — beyond the traditional cola segment. Sales and income continued to grow at healthy rates in 1993 and 1994. Although
the Mexican economy grew only 0.4% in 1993, the beverage and bottled water market grew 2.7%; Gemex’s sales volume itself grew 5.6%, and net revenues increased by
8%.8 Gemex’s Annual Report in 1993 highlighted how financially healthy the firm was:
Financial ratios show that Gemex is a sound profitable company. In terms of net income to net revenues, the ratio improved 7.5%, reaching 14.4% in 1993, from 13.4%
in 1992. Noteworthy is the growth in return on capital. The ratio of net income to stockholders’ equity increased 15.3%. Finally, it is a pleasure to inform you that the
annual increase in the market value of Gemex’s stock during 1993 was 109.6%, a percentage that is five times above the average investment instruments denominated in
new pesos in the Mexican market and 22% over the food, beverage and tobacco industry stock market increase.In 1994 the Company expanded once again. On January 14,
1994, Gemex purchased all of the shares of Grupo Seser, S.A. de C.V. and Electropura for a total of US$80 million. Certain operating subsidiaries of the Company had
previously been formed or acquired by Mr. Molina between 1964 and 1981. An American Depositary Receipt, or ADR, is a certificate of ownership issued by a U.S. bank
representing a claim on underlying foreign securities (such as shares of Gemex). Firms which are incorporated and traded on foreign stock exchanges wishing to have their
shares listed on U.S. stock exchanges are typically traded via ADRs. In the case of Gemex, each ADR (simultaneously termed a Global Depositary Receipt or GDR) was
equal to three Ordinary Participating Certificates (CPOs), which in turn was a combination of one B share, one D share, and one L share in Gemex. 8 Gemex’s financing
costs also decreased substantially in 1993, falling 14.6% from the previous year, mostly as a result of a successful Eurobond issuance at the end of 1992.
9 The Company also acquired the following bottling subsidiaries: Purificadora de Aqua Perula, S.A. de C.V.; Purificadora de Aqua Ecatepec, S.A. de C.V.; Purificador de
Aqua Los Reyes, S.A. de C.V.; Purificadora de Agua Andalucia, S.A. de C.V.; Purificadora de Aqua Cancun, S.A. de C.V. The Company also acquired real estate
subsidiaries (Inmobiliaria Operativa, S.A. de C.V., and Inmobiliaria Imalbi, S.A. de C.V.), plastic bottle subsidiary (Plasticos EP, S.A. de C.V.), and a distribution subsidiary
(Serviagua, S.A. de C.V).

10 Mexican consumer prices rose 11.9% in 1992, 8.0% in 1993, 7.1% in 1994, and 52.0% in 1995. According to Purchasing Power Parity, a country’s currency value
relative to other currencies should change in proportion to relative inflation rates. If Mexico’s inflation rate was higher than the U.S.’s inflation rate in 1993 and 1994 as it
was, the peso should have fallen in value relative to the dollar; it would probably have fallen gradually if allowed to trade freely. Electropura was the leading bottled water
company in the Mexico City market, and the most widely recognized name across Mexico. With the addition of Electropura, net revenues rose 28.5% over 1993 (although
not directly comparable due to the acquisition), reaching NP$2.07 billion. Growth required capital. The Company raised US$29.76 million in needed equity
through an ADR offering on March 29, 1994. The issue, representing 5,900,000 CPOs — Ordinary Participating Certificates (equivalent to 2,950,000 GDSs, Global
Depositary Shares) — was offered through Goldman Sachs, Merrill Lynch, and Oppenheimer, with Citibank, New York, acting as the depositary bank. At the same time as
the ADR issue in New York, 900,000 GDSs representing 1.8 million CPOs were offered outside the United States and Mexico, and 1.3 million GDSs were offered in
Mexico itself. Proceeds of the offerings were used to repay much of the debt associated with the Electropura acquisition two months prior, and for general corporate
financing. Towards the end of 1994, Gemex — and particularly Enrique Molina — felt that Gemex was making major market share inroads against arch rival Coca-Cola. It
continued to invest heavily in the latest production and distribution plant and equipment, positioning itself to thwart any new-found competitors with a cost structure which
would be the lowest in the region. Unfortunately, Gemex did not foresee the fall of the New Peso and its repercussions on Gemex’s competitiveness.

The Fall of the Peso
The value of the Mexican peso had fallen throughout the 1980s as Mexico continually fought high domestic inflation. Beginning in 1982, the value of the peso was allowed
to loat by the government within a narrow band, the ―controlled rate,‖ which allowed the currency’s value to depreciate slowly rather than fall freely. This exchange rate
control system allowed Mexican residents and companies to purchase foreign currency, and required them to sell foreign currency earned, at the official exchange rate
established daily by the Banco de México. But the peso’s value still fell continuously throughout the 1980s, approaching 3,000 pesos to the dollar in the early 1990s. Finally,
on November 11, 1991, after years of hardship and costly austerity measures, the Mexican economy and inflation rate stabilized sufficiently to allow the removal of the
controlled rate. On January 1, 1993, the Mexican government replaced the peso (Ps) with the New Peso (NP) and revalued it, with one New Peso equaling 1,000 Pesos.
The New Peso was allowed to fluctuate over a relatively narrow range during the following two years. Although the Mexican government allowed it to depreciate, the New
Peso’s value was not allowed to change proportionately in value to the domestic rate of inflation in Mexico.10 Any fluctuation in the New Peso’s value outside the
established limits Resulted in direct open market intervention by Banco de México — typically a buying of New Pesos on the open market with hard currency reserves such
as the U.S. dollar. The New Peso became increasingly overvalued, and contributed to a rapid growth in Mexico’s current account deficit. In 1994 a number of events led to a
crisis in the New Peso’s value. The Mexican current account deficit rose to 8% of Mexico’s Gross Domestic Product (GDP). At the same time, U.S. dollar-denominated
interest rates began rising due to the implementation of a relatively tight monetary policy by the U.S. Federal Reserve, making it more attractive to move out of New Pesos
into U.S. dollars. Finally, political events within Mexico, such as the armed insurgency in the southern Mexican state of Chiapas, led international investors to fear for the
stability of the government. On December 22, 1994, the New Peso was allowed to float (it sank) from NP$3.45/US$ to NP$4.65/US$. The Mexican government’s policy,
which allowed the New Peso to fall only a prescribed daily amount, had not kept the peso in line with economic fundamentals such as the consistently higher Mexican
inflation rate and the continually escalating merchandise trade deficit.11 The fall of the New Peso — in the eyes of many currency analysts — was inevitable.
The devaluation of the peso was devastating for Gemex, as it was for most multinational firms in Mexico. Gemex shares on the NYSE plummeted from a high of nearly $30
per share in mid-1994 to under $8 in January, 1995. The fall in Gemex share values reflected not only the lower U.S. dollar-value of Gemex’s Mexican peso-based earnings,
but also the fallen expectations for the Mexican economy and the purchasing power of the Mexican consumer, both factors leading to a downward revision in Gemex’s
earnings expectations.

On January 20, 1995, Gemex released a statement attempt ing to respond to numerous investor inquiries regarding how it had been impacted by the fall of the New Peso:12

¨ The company’s debt. Noting that the firm had switched the currency of denomination of the majority of its debt in 1992, Gemex now had U.S. dollar-denominated debt
totaling $264 million or 78% of total liabilities. Although offering no current strategies to manage the exposure, the company noted that it possessed significant additional
debt capacity (bank lines and an open Euro-Commercial Paper program) to assure liquidity.
¨ Capital expenditures. The increase in the firm’s debt had been used primarily for expansion and modernization of fixed assets. Although further future capital
expenditures would obviously be reduced, the firm felt that these assets would aid in its ability to maintain its competitiveness.
¨ Profit & loss impact. Although as ―a result of the devaluation, the dollar denominated debt will generate an estimated negative impact on the Company’s profit and loss of
approximately NP$260 million,‖ the company noted that it would enjoy a NP$100 million tax loss carry-forward.
¨ Financial statement and ratios. Even with the exposure of U.S. dollar-denominated debt, Gemex would still be in compliance with its Eurobond covenants requiring: a) a
consolidated debt/total capitalization ratio of no more than 0.55; it was 0.47; b) a fixed charge coverage ratio of at least 2.25 to 1, currently 3.79; and c) consolidated net
worth of at least NP$526.3 million, currently NP$1.5 billion (as of December 31, 1994).
¨ O pe rations. The cost structure of the Company was only slightly exposed to currency pressures, as 9% of cost of goods sold was sourced in U.S. dollars.13 According to
management, Gemex would offset the exchange rate-related cost increases by reducing sales discounts and enjoying newly-derived efficiencies from the intensive fixed
capital investment undertaken over the previous three years. Further, the firm’s integral cost of financing would increase substantially as a result of the higher effective
interest expenses arising from dollar-denominated debt.14 With the release of 1994 earnings and revenues on March 6, 1995, the full impact of
the peso’s devaluation on Gemex’s performance was revealed. Net income for 1994 was a sizeable loss of NP$163.3 million, despite a positive operating income of
NP$390.0 million. The difference was, predictably, the massive losses associated with the devaluation (listed under integral cost of financing), foreign exchange losses of
NP$508.4 million and interest expenses of NP$131.0 million.15 Operating profits indicated that the basic business of Gemex was still competitive, but its financing/financial
structure appeared to be a major liability. Gemex’s ADR prices on the New York Stock Exchange were down, and staying down .
The peso’s slide continued into the new year, falling from NP$5.5/US$ to just over NP$6.0/US$. Accompanying the first quarter results for 1995, Enrique C. Molina,
Chairman and President of Gemex, made the following statement:
This was a difficult quarter for Gemex. The peso’s devaluation increased our foreign exchange loss and cost of goods sold increased faster than our price in the first two
months of this year. In fact, margins in March reached 1994 levels due to the implementation of a price increase in mid-March but, given the timing of such increase, the
net sales figure for this quarter does not reflect the favorable effect we expect such increase to have on the net sales figure in the next quarter. To date, the pass-through of
exchange rate-related costs and losses to customers had not sustained the firm’s profitability. In the following months, Gemex’s actual sales volume fell as a result of price
increases. Second quarter results indicated a decrease in the sales volume of soft drink products of 5%, however, a 21% increase in the sales volume of purified jug water
sales buoyed firm earnings. But PepsiCo’s and Gemex’s relationship was about to change, and the result would hopefully allow Gemex to recover something of its former
glory.

The Joint Venture Agreement With PepsiCo
The next major step in Gemex’s evolution occurred before the dust from the peso’s fall had settled. In January 1995, Pepsi-Cola International (PCI) purchased a 10% interest
in Gemex’s bottling subsidiaries operating in the Southeast area of Mexico for NP$4.6 million. On July 27, 1995, PCI announced that it would be moving in principle to
acquire a 25% interest in Gemex for cash and ownership of several other Pepsi-Cola bottling enterprises in Mexico. The purpose of PepsiCo’s movement was to establish
Gemex as — officially and financially — Pepsi’s anchor bottler in Mexico. Market analysts now estimated that Gemex could soon account for over half of Pepsi’s sales in
the entire country, and PepsiCo’s senior management felt that it was critical to inject new life, and new capital, into its major Mexican bottler.17
Enrique Molina had previously rebuffed PepsiCo’s advances, but now conceded that his company’s dependence on U.S. dollar-denominated debt left it little choice in the
wake of the peso’s fall.
The investment by PepsiCo in Gemex contained five basic features:
1) Pepsi would contribute US$217 million in cash directly to Gemex;
2) Pepsi would transfer its company-owned bottling operations in several north central
cities to Gemex;
3) Pepsi would transfer its 10% equity stake in Gemex’s southeastern bottling operations
to Gemex;
4) Gemex would be granted bottling rights to white territories (i.e., areas where Pepsi was
not currently distributed) and would have the opt ion to acquire all other franchises
which became available;
5) Pepsi would participate in key Gemex management decisions.
There was one other notable feature of the transaction. The founding Molina family
of Gemex was to maintain operational control for seven years. At the end of the seven years,
the Molina family would sell all of its voting shares to PepsiCo.18 PepsiCo agreed to pay a
premium of US$50 million to the family for controlling interest.
The restructuring of corporate control was complex (see Exhibit 6). According to the
joint venture agreement, Mr. Molina, PepsiCo, and PepsiCo’s Mexican subsidiaries formed
the ―Molina/PepsiCo Gemex Shares Trust,‖ a Delaware statutory business trust.

On October 12, 1995, Gemex and PepsiCo confirmed the consummation of the joint venture agreement. In a press release, Gemex’s President Enrique Molina noted the joint
venture’s primary advantage to Gemex: ―It strengthens our balance sheet, reduces our leverage and opens greater access for Gemex in capital markets.‖ On October 18,
1995, Gemex announced a 3-for-1 stock split of its CPOs listed on the Mexican bolsa.19 As part of the new venture structure, Steve Lawrence was named President and
Chief Operating Officer, and would report to Gemex’s CEO and Chairman, Enrique Molina.20 The question for Lawrence was what to do?

Status 1996: The Cola War in Mexico
By late summer 1996, PepsiCo’s strategy in Mexico had begun to unravel. A review by Pepsi-Cola International of Gemex’s operations and performance to date was
unsettling. The full impact of the damage of the peso’s devaluation could now be accuretely assessed.

Ope rating Income & Integral Cost of Financing.. The rapid expansion in market share and business lines in the early 1990s had more than tripled operating inco me
from NP$117.0 million in 1991 to NP$390.0 million in 1994. In 1995, following the fall of the peso and the resurgence of competition from Coca-Cola, operating income
fell to NP$86.1 million. Operating income was in many ways a measure of the business’s basic competitiveness independent of financing expenses.
The integral cost of financing indicates the impact of the peso’s devaluation on the firm’s capital structure: total integral cost of financing had risen from NP$24.4 million in
1993 to NP$547.3 million in 1994 — immediately following the peso’s initial plunge —remaining high in 1995 at NP$220.8 million. Foreign exchange losses were
devastating:
NP$508 million in 1993 and NP$671 million in 1995. Interest expenses continued to rise, nearly tripling from 1994 to 1995. Because the peso’s fall was late in 1994
(December),most of the actual dollar-denominated interest payment impact was not fully felt until 1995. Net income for Gemex had now been negative for two full years.
With profits having peaked in 1993 at about NP$232 million, 1994 and 1995 witnessed losses of NP$163 million and NP$140 million, respectively. Given the significant
drop in income and the rising costs of financing, it appeared that structural changes in Gemex might be in order.
Ope rating Costs. Soft drinks are produced by mixing water, concentrate, and sweetener, and then injecting carbon dioxide gas to create carbonation. Cost of sales is
therefore dominated by two components, sweetener and the cost of concentrate. As part of its fran chise agreement with PepsiCo, Gemex is obligated to purchase all
concentrate and syrup for the 19 Although these same CPOs are the underlying security for the ADRs (or GDRs) traded on the New York Stock Exchange, it did not affect
the valuation of the ADRs due to a ratio change of the underlying shares from 2:1 to 6:1. 20 Mr. Lawrence had most recently served as Senior V.P. of Pepsi-Cola, Europe,
and President and CEO of PepsiCo International, Spain. Production of soft drink products from the franchisor (PepsiCo). Gemex purchases are made from Pepsi-Cola
Mexicana S.A. de C.V., at a unit price of 16.5% of the wholesale price (net of value-added taxes) of the finished product. Gemex buys all of its sugar from Consorcio
Industrial Escorpión S.A. de C.V. (Escorpión), a company owned and controlled by Mr. Enrique Molina. Escorpión accounted
for 45% of Mexico’s total refined sugar production in 1995.21 Escorpión’s agreement with

In August of 1996, PepsiCo’s anchor bottler in Caracas, Venezuela, owned by the Cisneros family, was lost to Coca-Cola. In an overnight coup, the Cisneros Group sold out
50% of the bottler’s ownership to Coca-Cola for approximately $500 million, turning Venezuela’s largest Pepsi-Cola bottler and distributor into Coca-Cola’s largest bottler
and distributor in a matter of hours.29 The turnabout was reportedly achieved out of Cisneros’ frustration in negotiating an equity injection from PepsiCo. Despite extended
negotiations, PepsiCo was unwilling to take a substantial equity position in the Venezuelan bottler. The problems with Pepsi, according to Cisneros, began twenty years
before when Pepsi began diversifying out of soft drinks into snacks and restaurants. ―Pepsi-Cola was a religion for them,‖ he said. ―Then it was no longer that important.‖30
Whereas Pepsi was unwilling to take more than a 10% to 20% stake in the Venezuelan bottler, Coca-Cola offered US$500 million for a 50% stake and would invest millions
in refrigeration equipment and trucks that the bottler believed it needed. Change was swift, with the former PepsiCo delivery 27 Gemex, Form 20-F, December 31, 1995, p.
31 On November 14, 1996, PepsiCo announced the establishment of a new joint venture bottling agreement
in Venezuela with Empresas Polar. Polar is Venezuela’s largest beer brewer with an estimated 80% to 90%
market share. Polar will hold 70% interest to PepsiCo’s 30%. Polar had 1995 sales of US$1.6 billion, 60%
derived from the sale of beer. Polar also has its own soft -drink brand, Golden, which holds a 5% market share
in Venezuela. PepsiCo intends to spend more than US$400 million in Venezuela in an attempt to retake its
market share.

Case Questions
1. What went wrong with PepsiCo’s Mexican strategy?
2. What role did capital play, and what role did business relationships play, in the process
of building and expanding PepsiCo’s presence in Latin America?
3. How did the peso interact with the structure of Gemex’s operations to impact Gemex’s
competitiveness in the Mexican marketplace?
4. What would you have done differently than Pepsi in the Mexican market?

								
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