FMCG

by Greg Thain

  How International Are They?

  Given the company’s precarious early existence, it was not until 1934 that Pepsi opened its first bottling plant outside the US, Montreal serviced French Canada, where Pepsi holds the lead over Coca-Cola to this day. Their next plants, in Cuba and the Dominican Republic, were typical of a ‘baby steps’ approach (i.e. keeping close to the US) by an American company expanding abroad. In 1940 Walter Mack poached William B. Forsythe from the Coca-Cola Export Corporation. He immediately expanded Pepsi’s overseas footprint, heading for markets where Coca-Cola was either absent or had not yet become firmly established. Thus Latin America, the Philippines, South Africa, the Middle East and the Far East all became strong markets for Pepsi. Between 1945 and 1950, Forsythe opened up fifty-six foreign markets for the Pepsi-Cola brand. This increased export sales by 45% in 1946 and another 70% the year after.

  Future president Donald Kendall made his name during the 1950s pushing the company’s export side. He put into action Alfred Steele’s strategy of expanding massively Pepsi’s overseas business. During Kendall’s first three years, Pepsi International opened a new bottling plant abroad at the staggering rate of one every 11.5 days. The outcome was that an international bottler network numbering 70 in 1957 had risen to 278 by 1962. Pepsi was now available in nearly a hundred countries and international sales accounted for half of Pepsi-Cola’s total revenue. Having run out of places to go where Coke wasn’t, attention turned to Europe and bottling partnerships with big local players such as Britain’s Schweppes, France’s Perrier and the Netherland’s Heineken.

  In 1966, Pepsi entered the large Japanese market followed by deals negotiated with Communist governments in Rumania and Yugoslavia. These were achieved soon after head cheerleader Richard Nixon poured Pepsi down Soviet leader Khrushchev’s throat in Moscow. But Kendall’s crowning glory came in 1972 when, following up on Richard Nixon’s Kremilin tasting, he negotiated Pepsi-Cola as the first foreign product sold with official approval in the USSR. It was a massive coup and gave Pepsi a huge advantage in what would become one of the world’s fastest-growing soft drinks markets. The only downside was that Pepsi got paid in vodka! They were given the exclusive rights to import Stolichnaya Russian vodka into the US.

  In 1973, Richard Nixon, now promoting Pepsi from the Oval Office, got the brand into Nationalist China and Cambodia ahead of Coca-Cola. However, a million-dollar bottling plant in Saigon did not survive long enough to pay back its somewhat optimistic investment. The company got serious about building an overseas business for its snacks division, setting up Foods International to markets snack foods abroad. Unlike many companies, Pepsi International took a hands-on role in marketing their brands overseas. They worked with one advertising agency, J. Walter Thompson, for all the various markets, but did not mandate the use of global ads everywhere. Footage from ads shot in various major markets was pooled together and local operating companies could make their own ads by using whatever snippets took their fancy.

  International expansion continued apace for the next decade. A highlight was the agreement with China to begin production of Pepsi-Cola in 1982. Three years later Pepsi beverages were available in nearly 150 countries while company snack foods had expanded at a rather more sedate pace - to ten international markets. The firm’s growing complexity prompted the first of several reorganisations: beverage operations were combined into one structural entity, PepsiCo Worldwide Beverages, while snack foods were combined under PepsiCo Worldwide Foods.

  After signing a joint venture agreement in India in 1988 to bottle Pepsi, international expansion focussed more on the snacks side. Partnerships and acquisitions were the preferred method rather than the difficult task of snack foods start-ups. They signed a partnership with Hostess Foods in Canada. In 1989, they acquired two of Britain’s leading snack food companies, Walkers Crisps and Smiths Crisps. While Smiths had seen better days, Walkers would become the leading light in the PepsiCo snacks empire, building up a dominant position in the British salty snacks category. The next year PepsiCo acquired a controlling interest in Mexico’s largest cookie company. In 1991 they entered the chocolate business, with the purchase of Poland’s leading local firm, Wedel SA, soon after the fall of the communist government. The same year PepsiCo and General Mills formed a joint company, Snack Ventures Worldwide, to tackle jointly the mainland European market.

  In 1995 PepsiCo began the process of making Lay’s a global brand. They introduced it into twenty markets around the world, although still met local needs, for example by producing a cheese-less version of Cheetos in China. More acquisitions achieved leading snack positions in several South American markets. Meanwhile the Tropicana brand, already significant in China and twenty-one other overseas markets, was rolled out into the huge Indian market. Due to the acquisitions of North American-centric companies such as Tropicana, Quaker Oats and SoBe, by 2003 the percentage of total sales coming from outside North America was down to a surprisingly low 32%.

  How Are They Structured?

  The evolution of the structure of PepsiCo has been driven by the company’s acquisition and international expansion policies. In 1984, when transportation and sporting goods were sold off, the company adopted a three-division structure: soft drinks, snack foods and restaurants. Each division had its own international unit. When the restaurants were spun off in 1997, the structure was reduced to two global divisions - snacks and soft drinks, each of which accounted for approximately 50% of company sales. 25% of beverages sales, compared to 33% of snack food sales, came from international markets.

  Following its acquisition, Tropicana was initially run as a third division, alongside the now renamed Pepsi-Cola and Frito-Lay soft drinks and snacks divisions. The next structural change came in 1999, when the company spun off 60% of its North American, Canadian, Russian, and other overseas bottling operations as the Pepsi Bottling Group. The combination of decades of above-average growth from Frito-Lay, strong snacks acquisitions and the spin-off of bottling meant that: the Frito-Lay division was contributing 62% of sales, Pepsi-Cola 26% and Tropicana 12%. While Pepsi-Cola was still sub-divided into Pepsi-Cola North America and Pepsi-Cola International; the greater size and greater complexity of the snacks side meant Frito-Lay was structured into Frito-Lay North America, Frito-Lay Europe/Africa/Middle East and Frito-Lay Latin America/Asia Pacific/Australia.

  Following its 2001 acquisition, Quaker Oats was effectively split into three. Frito-Lay North America created a unit dedicated to opportunities in the broader $50 billion market for convenient foods, combining Frito-Lay's cookies, crackers, nuts, meat snacks and Cracker Jack treats with Quaker's granola bars, fruit and oatmeal bars, energy bars and rice snacks. This unit generated nearly $1 billion in revenues.

  Gatorade was eagerly snatched up by the Pepsi-Cola division, which had also subsumed Tropicana. The remainder of Quaker, consisting mostly of breakfast cereals, grain products and the Aunt Jemima brand was run as a separate division. In a cosmetic change, the two main divisions were renamed worldwide snacks and worldwide beverages. In 2003, just to keep it interesting, all the business’s international components were consolidated into a new division, PepsiCo International, leaving Frito-Lay North America, PepsiCo Beverages North America and Quaker Foods North America to tackle the North American market.

  What Have They Been Doing Recently?

  2004

  Management’s challenge in 2004 was to move from a collection of acquired businesses to one cohesive new PepsiCo. Strategically, the new company defined its three distinct competitive advantages:

  · Big, muscular brands. Muscular was an interesting choice of words for an assortment of soft drinks, potato chips and granola brands. And PepsiCo did have a lot of them: sixteen with sales of over $1 billion, which was more than any other food and beverage company

  · Proven ability to innovate and create differentiated products. While this was undoubtedly true, it’s hard to demonstrate PepsiCo was better than any of their peer c
ompanies. The company divided its innovation efforts into three distinct types

  · Type A – flavour extensions, including seasonal in-and-out products such as Mountain Dew Pitch Black for Halloween

  · Type B – New sub-brands of existing brands, delivering additional benefits or meeting niche needs, such as Tostitos Scoops and Tropicana Light’n’Healthy

  · Type C – Completely new platforms such as Quaker Milk Chillers and Tropicana Fruit Integrity

  The pipeline would be skewed towards Types B and C (due to their greater longevity), although there was a higher failure rate, particularly in Type C’s powerful go-to-market systems. The new PepsiCo, thanks to its recent acquisitions, now had the full range of go-to-market systems. The crown jewels were the direct store delivery (DSD) capabilities in the US, UK and Mexico for the salty snack products. Nobody else in the category had anything this powerful: the Sabritas organisation in Mexico called on over 700,000 outlets, almost every store in the country.

  Naturally, given the acquisitions, benefits were sought in collaboration - between categories - within the retail environment and in back-office harmonisation. The in-store component, called PepsiCo’s Power of One, involved anything from joint Superbowl Sunday promotions between Pepsi and Frito-Lay, to Breakfast Bundling tie-ups between Quaker and Tropicana. Behind the scenes, the Business Process Transformation project was launched. This wide-ranging initiative aimed to harmonise billing, purchasing and logistics and also encompassed best practice harmonisation of sales and marketing processes, together with a consolidated approach to gleaning insights into consumers and customers.

  The new PepsiCo had a good 2004, growing volume by 6%, with revenues were 8% up to $29.3 billion. The new PepsiCo International division, operating in over 200 countries, was now marginally the largest in the company at 34% of sales. It delivered over 50% of the growth, justifying management’s faith that the majority of its future growth would come from abroad. However, margins would need to improve as the division only contributed 22% of operating profit. Frito-Lay North America was the goldmine, contributing nearly 40% of the profit from 33% of the sales. Within the total product portfolio, over a hundred lines displayed the Smart Spot logo, identifying products that contribute to healthier lifestyles. This range grew at double the rate of the remaining fun for you products. It was slated to provide over 50% of new product revenues from the North American market in the coming years.

  Within the divisions, Frito-Lay North America grew revenue 5% (coming on top of 6% in 2003). PepsiCo International’s revenue grew by 14%, (snacks volume up 8%, beverages up 12%), both product categories doing best in the Asia/Pacific region (growing 14% and 15% respectively). PepsiCo Beverages North America increased volume by 3% and revenue by 7%. These increases were driven by double-digit increases in Gatorade, Aquafina and Propel, together with the launch of a range of Tropicana branded fruit juices distributed via the bottler system. Within the US beverages business, nearly 70% of profit came from the 37% of sales accounted for by the non-carbonated brands. These accounted for almost all the division’s growth. Bringing up the rear, with a turnover of only $1.5 billion, was the Quaker Foods North America rump business, which had managed only a cumulative 4% growth over the previous two years.

  2005

  With volume up 7% and revenue by 11% (both boosted slightly by taking a 53rd week into its accounting year), progress in the new PepsiCo was more than satisfactory. Encouragingly, progress was made on all nearly all fronts - no division recorded less than a 4% volume increase. Pepsi International again led the way, growing snacks volume by 7% and beverages by 11%. A series of acquisitions in the European region boosted the company’s snacks presence in markets such as Poland and Germany. PepsiCo took full ownership of Snack Ventures Europe, Europe’s largest snack food company, from their partner General Mills. This gave more latitude to develop the European snack foods strategy as it saw fit. Snacks and foods now made up nearly three-quarters of PepsiCo International’s revenues.

  The three divisions operating in the US market encountered starkly different issues. The previously slumbering Quaker Foods North America was star of the show. It recorded a 9% volume increase on the back of growth in Oatmeal, Aunt Jemima, Rice-a-Roni, and Cap’n Crunch rising Kraken-like from the depths to record a high single-digit increase. Frito-Lay North America had another good year, helped by the addition of another 475 new distribution routes to the DSD system, the biggest increase for a decade.

  In PepsiCo Beverages North America, however, all was not well. The 4% sales increase was made up of a 16% increase in the non-carbonated range, compensating for a decline in the carbonated brands (although diet formats were still growing, in an above-average warm summer). The core brands of Pepsi-Cola and Mountain Dew were in decline, despite a host of innovations. While Pepsi was still the number two US supermarket food brand behind Coke, the acquisition strategy that had brought in the numbers three and four brands, Tropicana and Gatorade, was looking smarter by the day. Senior management shrugged off charges that they were competing in a declining soda category by switching attention to a 2.5% increase in a category they called Total Liquid Refreshment Beverages. As its definition excluded coffee, alcohol, trap water and bulk water, it really wasn’t all that total.

  Elsewhere, the Business Process Transformation project was ready to go live in January 2006. The Smart Spot initiative, applied to over 250 lines thanks to health-based product reformulations, also extended into the activity side of the calorie equation. PepsiCo was the first major food and beverage company to promote more active lifestyles via its S.M.A.R.T. programme: five steps for healthier living supported by a major television advertising campaign.

  2006

  With volume gains of over 5% and revenue up 8%, PepsiCo was a growth machine. It averaged 8% top-line growth over the previous five years, better than any other major food and beverage company. PepsiCo now had number one or number two positions in eighteen categories of snacks, beverages and foods. However, it was not all sweetness and light. Not only had the declines in the core US carbonated brands not been reversed, they had accelerated, down 2%. The booming non-carbonated side was bolstered by the acquisition of Naked Juice and an agreement with Ocean Spray to market, bottle and distribute single-serve cranberry juice products.

  In contrast to the US woes, beverages were doing quite nicely in PepsiCo International. They were up another 9% due mainly to double-digit increases in markets such as China - where Pepsi was the leading soft drink - Russia, Argentina and Venezuela. With the snacks side also growing 9% in many of the same markets, PepsiCo International now had 18 countries with revenues of at least $300 million. It was generating 41% of company sales and an improving 36% of operating profit. Gatorade was now in 42 markets. Tropicana, which was more difficult to extend internationally as it was not shipped to bottlers as a concentrate, was in 27 countries. This was only five more than when PepsiCo had bought it.

  Frito-Lay North America had a poor year by its standards, growing volumes only by 1% due to declines in both the Lays and Doritos brands. This was counterbalanced by growth in healthier offerings such as SunChips and Quaker Rice Cakes. The launches of Tostitos Multigrain and Flat Earth vegetable and fruit crisps showed which way the wind was blowing in the salty snacks category. PepsiCo was promoting a healthier eating agenda but Lays’ switch to sunflower oil was an unconvincing support. PepsiCo’s new initiatives in 2006 - working with the Clinton Foundation and the American Heart Association to develop policies for selling beverages and snacks in American schools - probably were not likely to drive growth of Lays or Pepsi. Two-thirds of the company’s growth in North America came from Smart Spot products. This prompted the company to target achieving 50% of total North American sales from such lines by 2010.

  PepsiCo had multiple routes-to-market. This meant they were not as dependent on their major retail customers as more traditional American food companies such as Kellogg’s and General Mills. Wal-Mart was their sing
le largest customer, accounting for 9% of total sales and 13% of sales in North America. Their next four biggest customers accounted for another 13% between them. Overall this represented a fairly healthy position for PepsiCo.

  2007

  While 12% growth looked amazing given the beginnings of the global economic crisis, the underlying figures were a bit more realistic. Only 3% of the growth came from volume. Robust price increases, particularly in North American beverages, added 4%. 3% came from a slew of small and mid-sized acquisitions while currency movements contributed the final 2%. Cause for celebration was a new addition to the list of $1 billion-plus mega-brands: Fritos Corn Chips.

  A change of CEO heralded the usual corporate restructuring in November 2007. PepsiCo International was shorn of its booming Latin American components. PepsiCo Americas Beverages was created to combine the North and Latin American businesses, as was PepsiCo Americas Foods, which brought together Frito-Lay North America, Quaker Foods North America, and the Latin American foods and snacks businesses. Despite being somewhat dismembered, PepsiCo International still managed to be the largest contributor to the company’s sales and profit growth (even when the numbers were recalculated into the new structure for the entire year). However, a shift took place. PepsiCo International’s biggest individual components, Sabritas in Mexico and the UK’s Walkers, both suffered declines. Walkers’ downturn was attributed to ‘market pressures’, something which shareholders might think their executives were paid to manage. However, double-digit growth in Russia, Turkey, China, India and the Middle East more than covered these losses. International beverages continued their usual trajectory, growing another 8%.