The process of reshaping and refocusingPepsiCo, which commenced in 1996, is expected to leave the US-based soft drinks and snacksgiant in a stronger position as it enters the new millennium than it has been for manyyears. By Mike Rohan.

PepsiCo’s ambitious ‘ProjectBlue’ campaign signified the company’s last big play to try and catch up witharch rival Coca-Cola in global soft drinks. Having since accepted that Coca-Cola isunassailable in certain markets, PepsiCo has settled for making the most of being theworld’s second biggest soft drinks group and is now concentrating its efforts only onthose markets where it has the economies of scale and market share to compete effectivelywith its US rival. This has meant retreating or scaling back in certain international softdrinks markets – South Africa being a prime example where PepsiCo threw in the towel justthree years after re-entering the market in 1994.

In addition to a change in strategicdirection in soft drinks, PepsiCo has stepped up activity in snacks, where it is theworld’s leading player by far.

The reshaping of PepsiCo has involved refocusing and a radical restructuring of thebusiness, while simultaneously putting the group on a stronger financial footing toachieve sustained long term growth. To achieve a sharper focus on soft drinks and snacks,PepsiCo has divested non core businesses such as restaurants and a number of foodprocessing companies. The disengagement from restaurants, which involved spinning offbrands such as Pizza Hut, Taco Bell and Kentucky Fried Chicken, was completed in 1997 andraised $5.5 billion.

The proceeds from the sales have beenreinvested in strengthening the remaining PepsiCo business centred on snacks – Frito Lay -and soft drinks – Pepsi-Cola – and the recently acquired Tropicana. “These days youcan only succeed if you concentrate on what you do best and use your resources to theirgreatest advantage,” reasons Roger Enrico, chairman and chief executive officer ofPepsiCo.

The ailing international soft drinksbusiness – Pepsi-Cola International – has been restructured, involving a charge of over$500 million in 1996, in order to stem mounting losses, which soared to $846 million in1996. The change in direction is starting to pay off with international soft drinksvolumes up 6% in 1998, the best performance in three years, and for the first time in itshistory, the group sold more Pepsi in international markets than in the US. Pepsi-Cola hasalso improved its performance in the US where last year it achieved its biggest marketshare gain in nine years, as it increased volume by 6% – its best performance in fouryears.

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Developing Snacks
Snacks, however, offer probably the brightest prospects for long-term growth. Since UnitedBiscuits abandoned its global aspirations and decided to retrench in certain markets,Frito-Lay is clearly the world leader with a 35% share of the $36 billion global snackchip market, and control of 60% of the massive $13 billion US market. Indeed, lastyear’s acquisitions of United Biscuits’ snack operations in Australia andnorthern Europe significantly strengthened Frito-Lay’s standing in these regions.

The strategy is to continue to broaden thegeographical base and increase penetration in existing markets. “Frito-LayInternational represents one of our biggest opportunities for rapid growth on alarge-scale,” says Roger Enrico. “We are the world’s largest salty snackcompany. While we have our share of local competitors we face no major multinationalcompetition. Not only that, relatively low per-capita snack consumption in many countriesgives us tremendous room to grow. To exploit that opportunity fully, we need to buildgreater scale.”

Although Frito-Lay is the market leader inover half of the 42 countries in which it operates, the vast majority of its internationalsales and profits are generated in just three markets – Mexico, the UK and Brazil. In mostother countries, Frito-Lay lacks the size to realise true economies of scale and theassociated higher profit margins. He continues: “One of our strategic goals has beento enlarge those smaller operations, in part through acquisitions, so they can become moreimportant profit contributors. Not only will that improve our profit overall, it will makeus less dependent on a few key markets. That’s important when your goal isconsistency.” For example, the acquisition of Smith’s Snackfoods from UnitedBiscuits for $270 million last year allowed Frito-Lay to jump from number two to becomemarket leader in Australia. A combination of acquisitions and joint ventures has alsoallowed Frito-Lay to build its market share in South and Central America to over 50%.

Separating the Bottling Business
A crucial element in the transformation has been PepsiCo’s decision to follow theexample of Coca-Cola and separate the bottling operation from the soft drinks concentrateside of the business, leaving it free to focus on marketing and brand building. PepsiCohas retained a 40% stake in Pepsi Bottling Group, which was demerged earlier this year.Pepsi Bottling Group had sales of $7 billion last year but restructuring charges of $222million left it $146 million in the red, compared with net income of $59m in the previousyear.

The spin off of the bottling business hasleft a radically different looking PepsiCo. The streamlined soft drinks operation(Pepsi-Cola minus the bottling operating) now contributes just 30% of group operatingprofits, leaving Frito- Lay snacks as the dominant part of PepsiCo.

Freed from the burden of operating a highlycapital intensive but low margin bottling business, PepsiCo is in a much strongerfinancial position and also has proceeds of $5.8 billion from the sale of 60% of PepsiBottling Group and from the merging of franchises with the Whitman Corporation, to investin acquisitions, especially for Frito- Lay, and share repurchases.

Acquisition of Tropicana
In addition to strengthening its soft drinks business through separating its bottlingoperations, PepsiCo has also added Tropicana, the world’s largest branded juicecompany which was acquired from Seagram for $3.3 billion in August 1998. Tropicana is agood fit for PepsiCo’s existing soft drinks business. The acquisition broadensPepsi-Cola’s portfolio of international brands and also extends its reach into the’morning’ market, where consumption of traditional carbonated soft drinks isrelatively low. With orange juice featuring in only one in five US breakfasts, Tropicanahas plenty of room to grow, and the potential in Europe and other international markets iseven greater as per capita consumption is less than half of the US average.

Focus and Investment
PepsiCo’s strategy since 1996 has been all about ‘focus’ and’investment’. “Basically that means we’re focused on consumer packagedgoods businesses that play to our strengths – and we’re out of businesses that otherscan do better,” explains Roger Enrico. “Most important, we’ve investedbillions of dollars in the heart and soul of our business: brands. We’ve beenexpanding our distribution, creating innovative products and packages and adding powerfulnew brands to our portfolio.” He continues: “The whole point is to make ourbusiness much stronger and more competitive over the long term – and able to weathereconomic storms and marketplace skirmishes with minimal disruption.”

Last year, PepsiCo increased income fromcontinuing operations by 34% to $1.99 billion on net sales up by 7% to $22.34 billion.Progress has been continued in the first half of the current financial year. “Twoconsecutive quarters of double-digit gains in segment operating profit are a clear signthat PepsiCo today is strong and our strategy is on track. With a much sharper focus onthe marketplace we’re generating healthy volume gains, better returns and higherearnings growth,” points out Roger Enrico.

Contrasting Fortunes
The strategic transformation of PepsiCo and its subsequent rise in fortunes is in sharpcontrast to its great rival Coca-Cola, which dogged by economic turmoil in key markets,encountering problems with competition authorities and having been forced to recallproduct in several countries, is currently experiencing one of the worst periods of itsillustrious history (see Panel).

By the start of the new millennium, PepsiCowill have been fully transformed. “We’ll be a leaner, stronger company than afew years ago and much better equipped to achieve the consistent earnings growth to whichwe aspire,” he remarks. At this stage in its rehabilitation PepsiCo expects to havemore than 75% of its sales and profits generated in healthy, stable economies such as theUS, Canada and Europe, and to have a stronger balance sheet and the financial resourcesand flexibility to repurchase shares and make strategic investments. PepsiCo is alsoprojecting double digit operating growth from continuing operations by the end of 1999 andachieving a return on capital substantially higher than when the reshaping processstarted.

“In my view, PepsiCo is in the bestshape it’s been in years,” the PepsiCo chief concludes. “And I think thatwe’re in a great position to pursue the vast opportunities ahead of us.”

Problems Mount at Coca-Cola
Having suffered the ignominy of a product recall in several European countries, Coca-Colanow finds itself under investigation by the European Commission. The EC is examiningCoca-Cola’s sales practices in Austria, Germany and Denmark to see whether it isabusing its dominant market position in those countries. The EC is also probing thedealings of three of Coca-Cola’s bottling partners – London-based Coca-ColaBeverages, Coca-Cola Nordic Beverages (controlled by Carlsberg) and Coca-ColaErfrischungsgetranke in Germany. Earlier this year, Coca-Cola ran into EC opposition overits proposed acquisition of Cadbury Schweppes’ non-US bottling interests.

This deal, originally worth $1.85b, hassince been scaled back, with the exclusion of most of Cadbury Schweppes’ operationsin western Europe, and has now been completed with Coca-Cola acquiring CadburySchweppes’ soft drinks businesses in 155 countries for $705m (£433m) cash. Furtherpayment is also due if the sale goes through in countries such as Canada, Mexico, NewZealand and Australia, where regulators are still considering the implications.

The recent problems at Coca-Cola have beencompounded by the difficulties it was already experiencing last year when economicturbulence in many of its overseas markets resulted in the group’s first annual fallin earnings and revenue within living memory. After-tax profits declined 14% in 1998 to$3.53b on revenues down by $55m to $18.8b. The company was also thwarted by the Frenchcompetition authority in its initial attempt to acquire Orangina from Pernod Ricard.

Brand Power – Top Global Food andDrink Brands by Value

Source: Interbrand. Figures in bracketsindicate global ranking across all industrial sectors. Private companies such as Mars arenot included.