Pepsi’s grip over the carbonated drinks market loosens as the company increases focus on its foods business
emember the cola wars: the knock-down, drag-out bouts where the two cola giants would each urge the other to do their damndest — and they would? Now that you think about it, those punch fests have just fizzled out these past few years, haven’t they? There’s no more of the ‘we’ll fight in the streets, on TV, in restaurants and supermarket aisles’ attitude. And it’s not missing only in India. Sure, in the US, the ad campaigns still take weak potshots at each other, but it’s almost as if Pepsi and Coke are merely going through the motions, an obligatory show of strength like the Indian and Pakistani troops at the Wagah border, rather than really living the war.
There’s a good reason why the hostilities seem to have been suspended: there are no longer two cola companies. There’s the original, Coca-Cola, which is still selling gallons of the fizzy drink every hour; and then there’s PepsiCo, which over the years has become a foods and beverages company that also sells cola. That may sound blasphemous to advertising agencies and marketing gurus, but the numbers speak for themselves. At $66 billion, PepsiCo’s 2011 income was over 40% higher than Coca-Cola’s $46. 5 billion, but just half of that came from beverages, in which carbonated sodas have less than half share. So, Pepsi’s soda sales last year? Under $15 billion. The move away from carbonated drinks is visible in India, too. While Coca Cola India had cumulative sales of Rs 5,908 crore and net profit of Rs 368 crore in FY11, the share of snacks in PepsiCo India’s revenue grew from 15% to nearly 45% between FY09 and FY11. In the same period, Pepsi’s beverages business grew at a compounded growth of 22%, but its segment profit went down from Rs 50 crore to Rs 4 crore. On the other hand, profit from its snacks business grew from Rs 56 crore to Rs 95 crore. While FY12 numbers aren’t yet available, given that trend, it’s more than likely that snacks now account for a larger share of revenue or perhaps have even overtaken beverages (which, in any case, includes much more than fizzy drinks). Is this all part of a carefully-planned strategy or did Pepsi lose the plot somewhere along the way?
All shook up
The irony wasn’t lost on anyone. Here was a brand that had made its fortune by selling flavoured sugar water to millions of consumers for over 100 years and had topped that by also pushing salt-and-fat laden potato chips for the past 50. Now it wanted to reach out to the consumers’ conscience and hearts with products that were ‘good for you’. But it was 2006, PepsiCo had a new CEO and she had plans that wouldn’t just transform the company, they would turn it on its head. Indra Nooyi joined PepsiCo in 1994 and played a key role in its acquisition of Tropicana in 1998 and of Quaker Oats (which also owned sport drink Gatorade) in 2001. Five years later, she made those brands the pivot of a strategy that would focus more on ‘good for you’ and ‘better for you’ products than on Pepsi’s core, ‘fun for you’ portfolio. In her earlier role as Pepsi’s strategy and M&A chief, the vegetarian Nooyi had already helped the company spin-off its restaurant business (Pizza Hut, Kentucky Fried Chicken and Taco Bell, which now operate under Yum! Brands). Now as CEO, she brought in healthy, New Age-y foods like pita chips, hummus, and soy-based smoothies.
|In 2010, Pepsi skipped advertising in the superbowl and Spent that $20 million on community grants|
The timing seemed right. Americans were finally waking up to the obesity epidemic in the country and while they weren’t willing to let go of the soda and chips, they were at least willing to try other stuff. By 2010, good-for-you products were bringing in $10 billion and Nooyi’s ambitions soared further — over the next decade, she wanted that business to grow three-fold. And she went all out in her pursuit of that goal. She roped in an R&D specialist as PepsiCo’s first chief scientific officer and brought on board a former World Health Organisation official as senior vice president of global health and agricultural policy. Nooyi also shelled out billions on acquisitions in the nutrition products space: an American coconut-water company, a Russian dairy and juices player and a British fortified water manufacturer. Research was initiated on ways of cutting sugar and salt in the beverages and salty snacks, reducing sodium and calories and overall, increasing ‘permissibility’ of these forbidden, but oh-so-tasty foods. The ‘good for you’ theme crept into Pepsi’s advertising and marketing initiatives as well. In 2010, for the first time in 23 years, the company decided against advertising at the Super Bowl — the football match is the most-watched annual event on American television, making it the Holy Grail for advertisers in the country, despite a 30-second spot costing as much as $3.5 million. Instead, Pepsi announced the $20-million Project Refresh that would give grants to deserving community programmes and local schools.
Meanwhile, back in India, 2006 was the culmination of a series of bad years for both cola giants. It started in 2003 when an environmental group watchdog announced that it had found pesticide residues in Pepsi and Coca-Cola brands that were far in excess of allowed norms (thanks to excessive fertiliser and pesticide use in agriculture, a base level of residue is accepted). The two companies — fighting on the same side for once — cried themselves hoarse protesting against the findings of the study, questioning its validity and pointing out that even milk and tea had higher levels of pesticide contamination. The controversy had barely died down when in 2006, the Centre for Science and Environment was back with another study — and this one said pesticide levels in soft drinks were 30 times the proposed government standards.
The impact on Coke and Pepsi was disastrous, although Coca-Cola was perhaps a little better off because its portfolio included brands bought from Parlé. Thums Up, Limca and Mazaa were perceived as Indian brands and, therefore, escaped the worst of the multinational backlash. Pepsi, though, had to scramble to keep its place. The opportunity — or perhaps the mandate from headquarters — to reposition itself as not a mere soft drink manufacturer but a food and beverages company, then, must have seemed heaven-sent.
|Between 2008 and 2010, PepsiCo lost marketshare to Coke, which now has nearly 42% of the CSD market compared with PepsiCo’s 28.5%|
At the time, Tropicana and Frito Lay were already part of the Indian portfolio. In 2006, PepsiCo India launched non-carbonated drinks like Lipton Ice Tea (in association with Hindustan Unilever) and Nimbooz, and expanded its offerings in the pure juice segment through Tropicana. In the savoury snacks business, more variants of Lays and Kurkure were introduced and the company entered the regional snacks market with the Lehar brand. The following year, it brought in Quaker Oats. In 2009, the company introduced Aliva, a baked snack developed especially for India. The next year was the turn of Pepsi Max, a sugar-free variant of the cola as well as variants of sport drink Gatorade (Pepsi Max has since been discontinued). Even as the emphasis on foods increased, the focus on health and nutrition remained intact. “We not only want to invest in our core business, which is CSD [carbonated soft drinks] and Lays, we also want to be known as a great non-carbonated beverage company as well as a healthy food company,” confirms Deepika Warrier, executive director, marketing, PepsiCo India Beverages. Let’s take a look at how that’s played out for Pepsi, in India and globally.
|“Could we have done things differently? Sure" —Indra Nooyi, Chairman and CEO, PepsiCo
||“We not only want to invest in our core business, we also want to be known as a great non-carbonated beverages as well as a healthy food company" —Deepika Warrier, Executive Director, Marketing, PepsiCo India Beverages
|“Our strategy is to build a long term business in India that is focused on offering a variety of beverages, rather than merely battling out for market share" —T KrishnaKumar, CEO, Hindustan Coca-Cola Beverages
||“In a developed market, it is easier to run the bottling and distribution business but in an emerging market, one needs local expertise to handle logistics issues and people" —Ravi Jaipuria, Chairman, RJ Corp
|“We are competition aware, not competition focused. We still see enough scope to penetrate further in the sparkling category itself" —Debabrata Mukherjee, Vice president, strategy and innovation, Coca-Cola India
||“It’s not Pepsi’s business to make people healthier, unless it becomes a GSK whose primary business is healthcare. PepsiCo tried doing this globally and it has backfired" —Arvind Singhal, Chairman, Technopak
||“Pepsi was known as a youthful, irreverent brand" —Rohit Ohri, Executive Chairman, Dentsu
Losing its fizz
Remember our saying earlier that the average American was becoming more health conscious? That’s been showing up in the numbers as well. According to trade publication Beverage Digest, consumption of CSD declined in the US in 2011 for the seventh year in a row. The 1% fall last year was worse than 2010, when it was down 0. 5% and total CSD volume has dropped back to 1996 levels. But where Coca-Cola saw a 1% drop in volume, PepsiCo had a 3.9% fall. For the past two years, it’s also been relegated to the No. 3 slot in soda brands, behind Coke and Diet Coke. Between 2008 and 2010, PepsiCo constantly lost market share to Coke, which now has nearly 42% of the CSD market compared with PepsiCo’s 28.5%.
|Coca-Cola is ahead of pepsi in all beverage segments —carbonated soft drinks, fruit offerings & water|
It gets worse. In keeping with the health wave, over the past few years, non-carbonated drinks like bottled water, sports drinks, juice drinks and iced teas have overtaken CSD to become the bigger part of the liquid refreshment beverage (LRB) market. In 2011, not only was Coca-Cola the biggest CSD company, it was also the largest LRB player with 34% market share compared with PepsiCo’s 26.9% (it also grew 0.2% in volume, while PepsiCo de-grew 1.3%). PepsiCo’s financials for 2011 underline the impact of the foods focus: while snack volume was up 8%, the figure for beverages was just 5%. Meanwhile, the Pepsi stock has remained more or less flat for the past six years (while Nooyi’s been in charge), whereas Coke has nearly doubled. Of late, there is growing clamour from analysts and investors to split PepsiCo into separate snacks and beverages units to enhance shareholder value. “Coke is focused on cola and its trademark brand. But Pepsi ran away from its soft drinks heritage and pushed into more healthy products,” says Ali Dibadj, beverage analyst at Wall Street research firm Sanford Bernstein. The focus on wellness products and healthy snacks isn’t a bad idea, he clarifies. “The criticism is of the strategy to focus on health and wellness at the cost of [PepsiCo’s] core business.”
So, did the pendulum swing too far? Looks like it, and Nooyi herself is aware of the need to bring back balance. “Could we have done some things differently or better? Sure. …I wish we had stepped up our overall brand support, especially in North American beverages, earlier,” she said in a February meeting with high-profile investment analysts. “This is an and game, not an or game. …We have to focus on both growing the core, which is the fun for you products and the better for you products, and step up our investment in ‘good for you’ products.”
The India effect
What has been the impact of Nooyi’s gameplan on the Indian beverages market? The short answer: Pepsi lags behind Coke. According to a 2011 Euromonitor report, overall soda sales in India are around Rs 6,000 crore, where Coke brands account for 60% of the market and Pepsi for 37%. Coke’s brands Thums Up and Sprite are the leaders with 16.5% each, followed by Pepsi with 15% market share. Coke itself has just 8.8% market share.
When Coca-Cola returned to India in 1993 (having left in 1977), Pepsi had already been here four years, first as a joint venture with the Punjab government (when it was branded ‘Lehar Pepsi’) and on its own after 1991. But Coke’s opening gambit itself was a winner: it bought out Parlé’s homegrown CSD brands and immediately staked claim to over 70% of the market. Pepsi has clawed back some share of the market since then, but Coca-Cola’s initial advantage still remains.
|Over the past few years, Pepsi India has lost several key institutional accounts like Inox multiplex|
And that is due to Thums Up, the cola brand Coke tried to kill, but couldn’t. Finally, the American company gave up and started playing to the local brand’s strengths by pushing it in smaller towns and concentrating on building the flagship’s presence and brand image in the metros. But marketers believe Coca-Cola India still treats Thums Up — which has a 40% share in the cola market — like an unwanted stepchild, citing the most recent decision to lower the price of 200 ml Coke bottle from Rs 10 to Rs 8, while keeping Thums Up at the higher price. T Krishnakumar, CEO, Hindustan Coca-Cola Beverages, the bottling and distribution arm of Coca-Cola in India, rubbishes such theories. “Our goal is to ensure our brands are leaders in the mind of the consumer, who makes the final choice,” he says.
While PepsiCo has been transforming itself into a foods company, Coca-Cola has stuck to its knitting and remained a pure-play beverages company. Sure, it too has ventured further into the non-carbonated drinks category, but new product launches have been at a studied pace. Coca-Cola owns 3,500 brands world over, but after nearly two decades there are only 10 international brands in its India portfolio. “We are rather focused on offering a variety of beverages that consumers want to buy, than battling for market share,” says Krishnakumar.
As it turns out, consumers seem to be displaying a distinct partiality for brands from the Coke stable. The company is ahead of its arch-rival in all segments of the beverages market where both are present — whether it’s the various sub-categories of CSD (cola, orange, clear lime and cloudy lime), fruit-based drinks (Maaza is ahead of Pepsi’s Slice), lemonade (Nimboo Fresh vs Nimbooz), or bottled water (where Kinley beats Aquafina). Clearly, Pepsi’s increasing focus on foods has taken a toll here as well.
Message in a bottle
The lack of fizz in Pepsi’s beverage business may have something to do with the differing bottling strategies of the two companies as well. Coca-Cola in India is a nearly Rs 6,000-crore business, including the revenue of both the parent company, which focuses on marketing and selling the concentrate, as well as Hindustan Coca-Cola Beverages, through which it owns more than 70% of its bottling operations. PepsiCo, on the other hand, is a Rs 4,000-crore business that has franchised 55% of its bottling and distribution volume to the Gurgaon-based Jaipuria family. The rest is controlled by the company itself (it runs 14 bottling plants across the country). In-house bottling and distribution was an unusual strategy for both companies, which had spun off their American bottlers into separate companies several years earlier. “The reason both companies opted for company-owned operations was because the cost of entry into a developing market was high. The bottler didn’t have the resources to bear losses,” explains a former CEO of PepsiCo India. “When you’re investing in a growing market, it is better done when you control the sales and distribution operations.” Incidentally, in 2009, Pepsi brought its American bottling back into its fold and Coke followed suit some months later.
|Food business is Tougher to crack than carbonated soft drinks. The margins are lower and it’s very competitive|
Over the years, while Coke has strengthened its bottling operations in India, Pepsi has been gradually moving further into the franchise model. When it came to India, over 70% of the bottling business was company-owned but now that’s down to below 50%. “In a developed market, it is easier for the parent company to run the bottling and distribution business on its own but in an emerging market, one needs local expertise to handle logistics issues and even people,” says Ravi Jaipuria, chairman, RJ Corp. Usually, it’s a good move to separate the concentrate and the bottling businesses — both work to get the best possible deal and the company wins either way. At the same time, greater control over distribution can perhaps be best achieved when the company runs its own bottling and distribution. “Coke is far more focused and quicker,” says a top executive at Big Bazaar, India’s largest supermarket chain, pointing out that brand Coke has already gained 2% share between April and May across all Big Bazaar stores, thanks to offers like a 1.25 litre PET bottle of the cola free with the purchase of two more. “This has helped increase home consumption considerably,” he adds. British cash-and-carry retailer Booker, which has three stores across Maharashtra, claims it sells 1.2 million cases of Coca-Cola beverages compared with just 250,000-300,000 cases of Pepsi beverages every month. “When it comes to modern trade, Coke is far ahead,” declares a senior official. “Pepsi really needs to step up its distribution.”
It’s debatable which is more to blame for Pepsi’s beverage distribution woes — the divided focus or the bottling strategy — but without doubt, it is taking a toll. Over the past few years, Pepsi has lost several key institutional accounts like Inox multiplex, even though it continues selling at all Yum! Brand restaurants, courtesy - a global lifetime contract. Consider JSM Corp, the master franchisee of Hard Rock Café (HRC) in India. The company was a key Pepsi account from 2006 till 2008, when it switched to Coke, not just for HRC but also other restaurant brands like Shiro and California Pizza Kitchen. “Coca-Cola has always supported us immensely in marketing our brands to consumers,” says Jay Singh, co-founder, JSM, when asked why he chose Coke over Pepsi. “Hard Rock Café is all about music and we were looking for a partner who would support us in that.”
Does it matter if Pepsi’s cola business in India is fizzling out, considering the foods segment at least is doing well? In a word, yes. The company simply has no excuse to let its CSD and other beverages business slide. Not only does it have a century of experience in selling fizzy drink, it’s also not all that difficult a business to be in — at least, certainly not compared with foods. Per capita consumption of CSD in India is just 12 litres a year, while the global average is 92 litres. Even countries like Pakistan and China gulp far more soda: 80 and 60 litres, respectively. The potential, here as the cliché goes, is immense.
Coke certainly recognises the opportunity and continues to sink in billions. Its earlier write-offs and accumulated losses apart, it recently announced big bang plans to invest more. In the coming years, Coca-Cola plans to venture deeper into the Indian beverages market, with products like fortified water and juice-based variants. “We are competition aware, but we can’t be competition focused,” says Debabrata Mukherjee, vice-president, strategy and innovation, Coca-Cola India. “Our focus is to offer what the consumer needs. We still see enough scope in the sparkling category itself.”
No one can eat just one
Pepsi’s food business in India isn’t just about selling chips, Kurkure and breakfast oats. It’s also actively involved at the produce stage — the company works with over 24,000 contract farmers who grow potatoes and paddy for it. Last year, Pepsi bought over 200,000 tonnes of potatoes and intends to increase that by about 20% in FY13. The foray into contract farming started as a government pre-condition when Pepsi entered India, but it’s actually worked out quite well for the company; so much so that it continues the practice even though the obligation to export ended several years ago. It grows crops that can be used in the foods business — Pepsi started by growing tomatoes in Punjab in the early 1990s, to make ketchup for the Pizza Hut business (before the Yum spin-off). Currently, the company is involved in the cultivation of chillies, oats, paddy and potatoes and in the coming years, Pepsi plans to increase its cultivation of oats, a telling sign of the company’s intention to continue its focus on the nutrition and health segment.
But even if it’s got the ingredients in place, the foods business is a lot tougher to crack than soft drinks. Raw material constitutes a higher proportion of costs in this business, which means margins are likely to be lower. Moreover, food in India is a varied and immensely challenging field. Pepsi is aware of that. Vivek Bharati, executive director, agriculture and corporate affairs, PepsiCo India, says that the company now has a much wider field to play in, albeit with far more competition. “We fight it out with Coke only in the CSD space. In juices, our primary competition is Dabur, while we compete with Kellogg’s in the breakfast category. In snacks, we have not only the organised players like ITC to compete with, we also have regional players.” That’s not deterring the company, though: it plans to launch some 50 new Frito-Lay variants in the coming years.
Certainly, the foods business is all about complexity and variety. According to a February 2012 Edelweiss report, the snack foods market in India is worth Rs 40,900 crore, which includes biscuits, namkeen, noodles, pasta, chocolates, confectioneries, ready to eat upma, poha etc. “Munching between meals is common in the country with a variety of snacks — offered in mind-boggling regional specialties — gaining national acceptance,” the report says. Salty snacks, it adds, is a Rs 12,000-crore market that is likely to double over the next three years. To be fair, Pepsi’s done a good job of its foods business in India, launching products that suit local tastes and eating preferences. Kurkure, for instance, was a made-for-India innovation, but it’s also launched masala-flavour chips and, most recently, lemon and kesar flavoured instant oats under the Quaker Oats brand. In regional markets, Pepsi is betting heavily on its Lehar sub-brand as well as Uncle Chipps, the popular local brand it acquired in early 2000. But even the larger brands have products customised for specific markets. “We have introduced local variants of Kurkure such as Bengali Jhaal, which is only for the eastern market,” says Vidur Vyas, marketing director, India foods, PepsiCo India.
In 2010, in keeping with its health focus, the company made a huge push into the value foods and non-carbonated drinks space in a 50:50 joint venture with Tata Global Beverages. The NourishCo business has recently rolled out products like Tata Plus Water, fortified bottled water being sold at Rs 16, in Tamil Nadu. There’s also Tata Gluco Plus, a glucose drink at Rs 6 aimed at lower-income consumers, and Iron Chusti, an enriched snack in Rs 2-sachets. “We felt there is a large set of untapped consumers waiting to be served, commonly termed the ‘next billion’,” says Warrier.
If the foods focus has its critics, this emphasis on health and wellness has even more naysayers. The wellness category is a misfit for Pepsi, declares Arvind Singhal, chairman of retail consultancy Technopak. “It’s not Pepsi’s business to make people healthier, unless it becomes a GlaxoSmithKline whose primary business is healthcare. Pepsi tried doing this globally and it backfired.” But a former PepsiCo India head says the company didn’t have a choice when it adopted this approach. Pepsi has always had a fraction of Coke’s share in most markets and unless a CSD brand has at least 30-40% of the market, it will “get chewed”, he says. “Making noise about being healthy was a desperate attempt to capture market share, but Pepsi overdid it.”
Going by Nooyi’s actions back in the US, Pepsi is now attempting to redress the balance. As a start, Nooyi has announced a 15% increase in advertising and marketing spend ($500 million) this year. Pepsi has also signed up with Michael Jackson’s estate for featuring the late pop star in an advertising campaign and on a series of special edition cans. The company went back to the Super Bowl in 2011 and has gone a step further this year by becoming the halftime show’s title sponsor. “Pepsi is once again going back to its core, which is youthful and irreverent,” says Rohit Ohri, executive director at Dentsu who, in his previous job at JWT, had been in charge of the Pepsi account for several years. “This is good news since the company has under-spent on its core brand for a long time.”
Perhaps the biggest change has been the launch of Pepsi Next in March, a mid-calorie version that attempts to straddle the distance between regular and Diet Pepsi. “Research has shown that there is a segment of consumers who are resistant to both regular, full-sugar cola and diet cola offerings. These consumers love the taste of Pepsi but they don’t believe you can achieve full flavour taste with a diet cola. The launch of Pepsi Next in the US is intended to fulfil this unmet need in the category,” says Jeff Dahncke, spokesman for PepsiCo.
Will all this be enough to stop the flow of consumers away from Pepsi? “It will momentarily increase sales. Whenever they bring about some drastic change, it helps the company for a while,” says David Levitsky, professor of psychology and nutritional sciences at Cornell University. Sanford Bernstein’s Dibadj isn’t so sure. “I don’t know why there should be a medium positioning,” he says, referring to Pepsi Next. “I think it will be very difficult for them to be successful.” Certainly, it’s not the first time Pepsi’s attempted something like this — it launched Pepsi Edge some years ago, which was promptly countered by Coca-Cola’s C2. Both failed miserably. But if Pepsi Next succeeds in winning over a new generation of cola drinkers, it might well end up triggering another cola war.