FMCG

by Greg Thain

  In North America, both Frito-Lay and Quaker had decent years, growing their volume by 3% and 2% respectively. However, another mid-single-digit decline in Lays compounded worries that there was an underlying market shift taking place. Fortunately, the company seemed well stocked with healthier snacks and had significant growth from both Doritos and SunChips. The worry in PepsiCo Americas Beverages was an accelerated decline in sales of carbonated soft beverages, this time 3% down. Pepsi was the main culprit as Mountain Dew held steady and Sierra Mist grew slightly. The good news was a booming still beverages portfolio. A double-digit increase for Lipton’s Tea prompted an extension of the contract with Unilever. Aquafina, Propel and SoBe Life Water enjoyed similar growth. There was much excitement with the Gatorade brand. This not only grew double digit but also developed an exclusive deal with Tiger Woods for a signature line of sports performance beverages, beginning with Gatorade Tiger. One hopes they employed a good contracts lawyer.

  2008

  Even more than the previous year, the impressive top-line growth of 10% masked a less appealing story. The business had mostly stagnant volumes (up 1%), and had pushed prices up (6%) well ahead of the overall inflation rate. They took the opportunity of the crisis to pick up some well-priced acquisitions (up 2%) and benefited slightly from a strengthening dollar (up 1%). Six percent price increases in the middle of the worst recession for decades are nice if you can make them stick and hold onto the volume, but it was definitely risky.

  In November 2007 PepsiCo had been re-organised into three divisions. One of these, PepsiCo Americas Foods, contributed nearly half the company’s sales. Most of the company’s performance monitoring happened at a lower level. This led to the suspicion that all the re-organisation had done was to add another layer. The six divisions that actually did the work were:

  · Frito-Lay North America

  · Quaker Foods North America

  · Latin American Foods

  · PepsiCo Americas Beverages

  · UK/Europe

  · Middle East/Africa/Asia

  Within the year, none of the Americas-based divisions managed to grow volume whereas UK/Europe – just as affected by the recession as North America – grew by 4%. Walkers enjoyed a turnaround, while the emerging markets (dominated by Middle East/Africa/Asia) grew volume by 13%, albeit heavily acquisition assisted. So what was going on at PepsiCo Americas Beverages? Volume again declined a depressing 3%. This performance, perhaps unsurprisingly, was made up of a reasonable-looking 4% growth in Latin America, offset by a somewhat shocking 5% decline in North America. Pepsi sank another 5% while the normally reliable Sierra Mist also fell back slightly. The non-carbonated range had previously been seen by the company as good for double-digit growth. But it actually declined by 6%. This was despite a complete brand makeover for Gatorade. Maybe such makeovers (also rolled out for Pepsi, Mountain Dew and Sierra Mist), were meant to make brand managers look busy whilst failing to understand the underlying problems. Similarly within Frito-Lay, the Lays brand was now in a rut of continued mid-digit declines. In this it had been joined by Doritos. Moves into nut products and dips were all well and good, but you cannot let your biggest brands keep declining year after year.

  Fortunately, all was in relatively good shape abroad. UK/Europe snacks volume grew by 16%, led by a double-digit increase in Russia. Beverages powered forwards 17%, of which half came from acquisitions. The most important of these was of Russia’s leading juice company, Lebedyansky, and the UK’s V Water. Within Asia/Middle East/Africa, both snacks and beverages grew volumes double digit with little to no help from acquisitions made within the year. The bad news for shareholders was that, despite an increase of 6% in the division’s operating revenue, total company operating profit was down 3% (thanks to PepsiCo’s share of a major restructuring charge within the Pepsi Bottling Group).

  2009

  The big news, coming only ten years after spinning off a majority stake in Pepsi Group Bottlers, was the announcement of the merging into PepsiCo of the two anchor bottlers, Pepsi Bottling Group and PepsiAmericas. This was at a cost in cash and shares of around $8 billion. The usual management-speak explaining the move, ‘to create a more agile, efficient, innovative and competitive beverage system’, can be read as, ‘given an even worse performance by PepsiCo Americas Beverages which declined 6%, if you can’t sell Pepsi-Cola then we will’. The merger, once finalised, would make PepsiCo a $60 billion company, although one that would now have to grapple with an asset-rich, margin-poor bottling empire.

  In anticipation of the deal being approved, a new strategy was outlined. It consisted of six key elements:

  · Expand the global leadership position of the snacks business. Right from day one of the original Pepsi and Frito-Lay merger, snacks had been the key category and by now beverages accounted for barely a third of sales. The snacks business had long been the more vibrant: with an ideal mix of global capability and the ability to tailor products to meet local tastes. Potato chips do not lend themselves to regional or global sourcing, given the short shelf life and transportation inefficiencies a fact PepsiCo had been leveraging to the full).

  · Ensure sustainable, profitable growth in global beverages. The key element to this part of the strategy was the hope that the bottling merger, plus the brand makeovers, would turn around a now slumping US business. Developing markets, emerging categories and positive nutrition beverages were seen as opportunities. Everyone else thought the same. So this element of the new strategy was more a hope than a clear path to growth.

  · Unleash The Power of One. Coming a mere 48 years after the original Pepsi / Frito-Lay merger created the potential for The Power of One, it was overdue for this be turned to a competitive advantage.

  · Rapidly expand the Good for You category. As less than 25% of the annual sales was accounted for by such products, this was another strategic thrust that was not before time. Key to its success was the newly announced R&D revamp. Here a new team of clinicians, epidemiologists and food scientists were recruited to take the company beyond formulation of new flavours into the actual underlying science of nutrition.

  · Continue to deliver on environmental and sustainability issues. Not new for PepsiCo and not market-leading, more the avoidance of negative press than a genuine growth strategy.

  · ‘Cherish our Associates and Develop the Leadership to Sustain Our Growth’. Generic stuff.

  The announced acquisition of the two main bottlers, together with a new strategy, raised the stakes for PepsiCo after a not very inspiring year. Total volume was down with another 5% piled onto pricing (which were eaten up anyway by adverse currency movements). Frito-Lay North America, by far the company’s largest profit contributor, inched volume ahead by 1%. This was entirely due to new ventures, including dips and the joint venture with Sabra. Lays was still in decline while Ruffles was down a high single-digit. PepsiCo Beverages North America had a dreadful year. Non-carbonated beverages portfolio fell off a cliff, down by a massive 11%. Chief culprits were Aquafina and Gatorade, both down double digit. Pepsi seemed to be coming off worse in the US water market, up against Danone, Nestlé and Coke’s Dasani while Gatorade was in the midst of a brand re-launch. The brand’s name was changed from Gatorade to the G series - GI, GII and GIII. Changing a brand name, especially such a well-established one, is always a big risk in a category with a lot of impulse purchasing. If busy consumers don’t see it or recognise it, they won’t go looking. One hopes the marketing department knew what they were doing. The only bright spot was in Asia/Middle East/Africa where snacks volume grew 9% and beverages 8%. Even this contained the worrying nugget that business in China had basically stalled.

  2010

  The impact of the bottling acquisitions - which cost the company the thick end of $1 billion in merger and acquisition charges and fees – was immediately apparent, and in several ways:

  · Top-line sales shot up 33% to nearly $58 billion

  · Operating profit margin perce
ntage shot down from 18.6% to 14.4%, reflecting the lower margins made by bottling operations

  · Beverages now accounted for 51% of total sales

  · The US market now accounted for 53% of sales

  · While PepsiCo Americas Foods was still the largest division at 37% of sales, PepsiCo Americas Beverages was now not far behind at 35%

  · The move lowered the margin and made the company more dependent on the US soft drinks market, which had been in the doldrums since 2007. Where were the upsides?

  Looking into the divisional performances, the eye was drawn to PepsiCo Americas Beverages, where top-line sales had more than doubled. Three key components made up this growth pattern:

  · Inclusion of the bottled sales rather than concentrate sales in the acquired bottlers.

  · The sales volume of brands distributed by the acquired bottlers and not owned by PepsiCo.

  · The organic sales volume performance of PepsiCo brands.

  Leaving aside the sales benefit of bottling brands - just a transfer of the bottlers’ net sales - total volume for the company increased by 10%. The bad news was that the inclusion of other companies’ brands more than accounted for the entire growth, meaning PepsiCo’s own brands had declined by 1%. Not exactly what the doctor ordered. Digging deeper, carbonated beverages did just as badly in the first year of PepsiCo running the bottling, as they did when the bottlers had been in charge - a 3% decline. But at least the rot was stopped on non-carbonated volumes. These grew 1%, although barely making a dent on recovering the cataclysmic losses of 2009. Gatorade, or G as we must learn to call it, recovered around half of the previous year’s losses, while Aquafina continued to go down the drain. A good increase in Lipton’s Teas was balanced by a poor year by Tropicana.

  Frito-Lay North America, now shorn of the Quaker snack bars, which were sent back to the Quaker Foods unit, slightly declined. For once this was not due to Lays, which had its first year of growth in a while. The unit was looking becalmed with brands taking turns to have good and bad years, plus the problem besetting Quaker Foods North America, which was going nowhere fast. Other divisions seemed to be able to do a better job with snacks. Latin America Foods grew by 4% while snacks in Europe grew by 2%. In Asia/Middle/East/Africa a 15% growth was due to strong performances in India, China and the Middle East. A similar story existed for beverages. They grew, net of bottler acquisitions, by 5% in Europe. This was driven by Russia (where PepsiCo acquired WBD, Russia’s largest food and beverage company) and Turkey, and by 7% in Asia/Middle/East/Africa. The company was gaining new traction in India and China.

  If sales performance after the bottling acquisition was debatable, it was clear the strategic issues facing the company were now mounting. One only has to look at some of the commitments the company made to see that their brand portfolio - bulging with nineteen $1 billion brands – was facing some strong consumer headwinds. A number of what were hoped to be key decisions were made:

  · Reduce the average amount of sodium per serving in key global food brands, in key countries, by 25% by 2015, compared to a 2006 baseline

  · Reduce the average amount of saturated fat per serving in key global food brands, in key countries, by 15% by 2020, compared to a 2006 baseline

  · Reduce the amount of added sugar per serving in key global beverage brands, in key countries, by 25% by 2022, compared to a 2006 baseline

  · Display calorie count and key nutrients on food and beverage packaging by 2012

  · Advertise to children under 12 only products that meet our global science-based nutrition standards

  · Eliminate the direct sale of full-sugar soft drinks to primary and secondary schools around the globe by 2012

  · Increase the range of foods and beverages that offer solutions for managing calories, like portion sizes

  · Invest in our business and R&D to expand our offerings of more affordable, nutritionally relevant products for under-served and lower-income communities

  Only a couple of these could be classified as growth strategies rather than decline preventatives. But leaving that aside, PepsiCo was late to the party compared to companies such as Nestlé. Re-segmenting a portfolio that in past times had been cheerfully labelled Fun for You into three categories: Fun for You, Better for You and Good for You did not change the fact that the company’s core sales and profitability rested on salty snacks and sugary beverages. The announcement of an increased R&D investment in sweetener technologies, next-generation processing and packaging and nutritional products was several years overdue.

  2011

  The acquisitions of the bottlers, WBD and the enhanced agreement with the Dr Pepper Snapple Group gave a good gloss to the top-line numbers, up almost $9 billion. In truth, it was hard to see much was changing at the operational level of the pre-existing businesses. The most important unit, Frito-Lay North America, finally got a bit of traction: growing volume by 3% and sales by 6%. Still this was no return to the heady days of earlier times. Quaker Foods North America, despite having more than its fair share of the nutrition products, lost a depressing 5% volume. This was partly because of its disadvantaged position in ready-to-eat cereals where it faced the much larger General Mills and Kellogg’s.

  How much longer Pepsi wanted to stay in this category was a question that perhaps the company should answer. Latin America Foods pushed forwards in its advantaged markets of Mexico and Brazil. In Europe (discounting the huge impact of the WBD acquisition that added 31% to the division’s volume), underlying snacks grew volume by 4%, thanks to the huge Walkers UK unit and 1% in beverages (when the 20% volume increase attributable to WBD was factored out). In Asia/Middle East/Africa, snacks were doing better than beverages, up 15% versus 5%.

  But still, the big question: how was the bottling acquisition in the US working out? Its raison d’être was to kick-start the core bottling brands back into life. Unfortunately, carbonated volume, which was the prime business segment of the bottling operation, fell back again by another 2%. That non-carbonated volumes increased by 4% to leave the unit largely flat on company-owned brands was not helpful, considering that $8 billion of shareholders money had been splashed out on buying up the bottlers. The good news for the marketing department was that the Gatorade re-launch was finally paying off, with the brand up double-digit. This essentially took it back to where it had been before the bright idea of a G Series had come along.

  What is Their DNA?

  If Coke is the American Southern Gentleman, courteous, polite and well-mannered, then PepsiCo is the brawler from the Bronx, brought up on the wrong side of the tracks, parents of questionable morals, had to fight for everything it has and anything it wanted. While this may seem an odd way to view the world’s second-largest food and beverage company, we believe its DNA does derive from a toilsome life committed to permanent struggle against a dominant and dominating competitor.

  Acts Like a Challenger

  For almost its entire corporate life, Pepsi-Cola and then PepsiCo has been the underdog, and even when it hasn’t been, has acted like it was. This mentality is still fed by its global number two cola position in a world where there is often only really room for one. While Coke sponsors World Cups and Olympics, PepsiCo is in the trenches battling it out on Superbowl Sunday. Even where the company is completely dominant, such as in the UK with the Walkers brand, or in Mexico with Sabritas, PepsiCo has kept those businesses at the top by never getting complacent or taking its success for granted.

  Irreverent

  PepsiCo has a history of not taking itself, or its product categories, too seriously. It has demonstrated a good sense regarding where their products sit in people’s lives, yet combines that with a fierce pride and passion for what it does. The company response to New Coke probably did more than anything to establish itself as both fun, but deadly. Similarly, PepsiCo’s marketing activities for the Walkers brand have been ground-breaking: capturing the fun and irreverence of the product category and turning them into powerful drivers o
f sales increases. PepsiCo still manages to make huge brands feel warm, friendly and approachable, no mean feat in modern, global vastness.

  Good Acquirers

  There is no doubt the original merger between Pepsi-Cola and Frito-Lay was one of the most harmonious and successful mergers of the latter half of the twentieth century. The subsequent success, particularly on the sales side, has been astounding. Similarly, the acquisitions made at the end of the century of Tropicana and Quaker gave the beverages portfolio a breadth and a strength that lifted the company away from being Coke’s Mini-Me. On the snacks side, Walkers and Sabritas have succeeded far beyond any potential apparent in the brands in the days before joining PepsiCo. This is in no small part due to the DSD business model for salty snacks, a model pioneered by the Frito-Lay Company before the original merger but taken to new heights by PepsiCo: they pioneered technologies such as nitrogen filled bags to improve freshness. The company has barely missed a step in its acquisition strategy.

  Summary

  The rise of PepsiCo within one person’s lifespan from serial bankrupt to the world’s second largest, and North America’s largest, food and beverage company is one of the business success stories of the modern era. While we are no fans of the heroic CEO idea, it cannot be denied that a series of bold and aggressive leaders successively remade the company. Each took PepsiCo to a new level, rather than the success stemming from the brand portfolio or the business model. It was only after the Frito-Lay merger that the company’s success became less dependent on the whims of forceful leaders.

  Since the merger, success has been inexorable, but perhaps too much so. As we have seen, at the core US market the company has latterly stalled, with a brand portfolio seemingly out of step with market trends towards healthy eating and hydration. The company has done little to get ahead of such trends. The bottler acquisition is in danger of looking more like an act of hubris than a sound use of $8 billion of shareholders’ funds. We fear that, of late, the company has actually drifted away from its DNA. It seems to regard being the second-largest food and drinks company in the world as a pinnacle of success, whereas the old Pepsi would have considered being the second-largest cola company as a grievous wrong to be righted. And are Nestlé looking over their shoulders and reacting to PepsiCo’s initiatives, as Coca-Cola was made to do? Quite the opposite. Nestlé have made health and wellness a core value, while PepsiCo sets modest targets to reduce bad ingredients by 2020. Nestlé’s water business is booming while Aquafina is floundering. Even Coca-Cola has stopped dancing to PepsiCo’s tune. PepsiCo needs to get back to the attitude that got it to where it is today.