Best in Class: Pepsi Takes on the World (Part 2)

From the Pepsi-Coke rivalry and Pepsi's ambitious nutrition expansion to its hotly debated bottling acquisitions, we peer inside the global food maker in an exclusive interview with Pepsi's CFO.
Publish date:

NEW YORK (TheStreet) --

The following is Part 2 of a two-part interview with Pepsi's CFO Hugh Johnston. Click here for part one.

TheStreet: How long is this integration process going to take?

Johnston: Well, you really do this in stages. You go through a very big stage initially, in terms of getting management re-aligned and set into place and redefining operating principals. And those are the pieces that, are in everyone's interest to get through very quickly. And in doing that, you're obviously realizing some cost synergies. The second phase is, you're still working on cost opportunities and figuring out how to operate and define processes even more tightly. But then you get into the revenue synergy side as well. Again some planning gets done on that work or on those synergies, but they take longer to execute. They typically touch more pieces of the organization, so they take a bit longer to align.

And the last piece -- I wouldn't necessarily categorize as integration, it's just what we do as PepsiCo -- is I expect we'll just continue to operate the combined businesses better and better in the same way that we run Frito-Lay better and better every year.

Certainly we've talked about a few years in terms of the synergies, but in some ways the integration goes on, and in some ways the integration is done earlier. It's really a balance of actions that we take.

TheStreet: What kind of benefits are you already seeing from these acquisitions?

Johnston: In terms of the year-one things, we talked primarily about benefits that would occur in the supply chain as we find opportunities to work more effectively together. We talked about the benefits in MG&A (merger and acquisition) and basically finding opportunities that operate more efficiently. And some of that is leveraging the fact that we've got multiple corporates coming down to one. We talked a bit about finding some quick hit revenue opportunities; and then basically those things are happening on a smaller scale internationally as well. So those were the biggest things. MG&A first, supply chain probably comes next and revenue will come third.

TheStreet: Do you have any smaller bottling acquisitions in mind?

Johnston: So where we are on that: we're not interested in actively going out and acquiring other bottlers, so we've got no strategy to go out and actively do that. That said, in the United States, we still have about 90 bottlers that are independent bottlers. We expect when we operate with them to have our normal franchise or franchisee relationship, which has really been quite strong over quite a number of years. But sometimes those businesses -- and often they're family businesses -- the families decide to sell. And if they want to sell their businesses, I expect we'll be there. If we can reach an agreeable price and an agreeable arrangement we would probably look to purchase them. That's exactly what PBG did as an independent company and that's exactly what PAS did. So again the short answer is there is no active strategy, but we're more than willing to talk if a bottler is interested in selling.

TheStreet: One of your other big announcements recently has been your greater push for nutritious food products. How important will your nutrition business be to your bottom line over time?

Johnston: I think it will be quite substantial. Even right now, as a company with about $60 billion in revenue -- about $10 billion of that revenue right now is in nutrition products. So it's already important to us from a profitability standpoint. The goal that we've set out was, we said in ten years from 2010 to 2020 we'd like that to grow from $10 billion in sales to $30 billion in sales, which is obviously a substantial increase. Along with that, we'd certainly expect to earn a good margin and a good return on invested capital so we think those businesses will be increasingly important over time to our growth, profitability and the aggregate of the PepsiCo portfolio. The thing about this is we really do believe that there's a wonderful business opportunity here to basically bring healthy, nutritious and great-tasting products to consumers because they want more of that.

TheStreet: Do you see your nutritious offerings appealing to a variety of niche markets or to the mass market?

Johnston: I actually think that it will be broadly appealing. I think there's a broad interest in that right now. The challenge that we face is how do we take what are fundamentally healthy substrates and bring them to consumers in a way that tastes great and in a way that's beyond tasting great -- and also is packaged in ways that that are convenient for them and are made available through our distribution systems in places where they are going to be. Most of those skills are skills that PepsiCo really has in-house.

The place where we obviously have made a substantial investment in is research and development, particularly around food products. But it's food and beverage on both sides of the equation, with the notion that the terrific research and development people that we brought on board will have the ability to help us build those products in a way that truly are nutritionally positive and can really be healthy, great-tasting, conveniently-packaged and accessible to all consumers, not just in the United States but around the world.

TheStreet: Are you going to phase out any existing products while bringing on the new ones?

Johnston: No, I wouldn't necessarily say that. I think when it comes to those types of things, we let the consumer decide. And I think the consumer would tell you 'I know when I want something that's a treat, that's fun food and I know when I want something that's healthy. And I'd like both of those to be made available to me in ways that are healthy, available, conveniently- packaged, branded well and tastes great. Let me make choices on when I choose to have something more indulgent and when I choose to have something that's nutritionally positive.

If you think about some of the things that we've done in the past, we've converted to no trans fat in our products, we've got a big diet beverage portfolio; we were the first ones to introduce naturally-sweetened zero-calorie products. So we've made investments in basically taking the products that we've had and also making them improved or better for you. But the essence of it is to make those products over time; taking out some of the things that people wanted less of and that's an ongoing journey. Something that we've talked about most recently is we've got an ability to add salt to potato chips, for instance, that is a more granulated salt. And as a result of that, we can add less salt and get the same flavor profile. And what we've said is we're going to basically take 25% of the salt out of potato chips in order to basically deliver the same, great tasting product, because consumers are telling us they want to consume less salt.

To me, that's a great example of what I would consider to be truly a world class R&D (research and development) function at PepsiCo.

TheStreet: How do you think your brand will be impacted by the growth of your nutrition business?

Johnston: I'd like people to see PepsiCo for exactly who we are and for exactly the things we are doing. I think there has been a tendency to connect Pepsi to one specific product in the portfolio. I think that people are starting to understand that Pepsi isn't the mirror image of Coke, but is a much bigger, broader place. I think people are starting to recognize things like performance with purpose, and where we talk about improving our product portfolio and really doing some terrific things for the environment. I think with even some of the work that we're doing inside the brands -- we talked a little bit about the Pepsi Refresh Project -- people are seeing that Pepsi and PepsiCo have actually been a cultural leader for a long, long time and I think people are starting to recognize that not just of the brand Pepsi, but of the company PepsiCo. And as they start to realize more of that, I think it's absolutely terrific for us and I think it's terrific for them to know that about us.

The Pepsi Refresh Project starts with an element of traditional marketing, but in a lot of ways it's about really making the Pepsi brand even more relevant to consumers because it's changing the way that people think about brands these days. Brand marketing used to be geared towards traditional television advertising, and now people really want to join brands. They want to feel that they're a part of that brand and they want to make sure that the brand is something that can connect to things that are important about us.

The Pepsi Refresh project is basically saying, look, PepsiCo wants to help in a set of areas -- the environment or community or other areas -- we want to take the money that we used to put on for the Super Bowl and we want to move that now and say, 'hey, let's have you, the consumer, decide how you'd like that money to be spent in order to really make things better.' And as we did that, we not only said 'you submit your ideas,' but we also said 'you, the consumers vote on these ideas; you will decide how the money's going to get allocated.' And I think it does connect into this core consumer desire to have brands do things that are important to them; not just to show them wonderful commercials. They like commercials too, if they're done properly. But they want a deeper relationship than that and I think a lot of what we're trying to do really is to accomplish that.

TheStreet: Now to China. It's a market that everyone wants to be in, but very tough to break into. What has Pepsi been doing right where others have failed?

Johnston: I think we bring to China what we bring to other countries as well so I don't want to make this exclusively a China comment, but I think we bring a very nice combination of products that people generally like. But at the same time, take those products and customize them to the local market. So whether it's with some of our non-carb products or with some of the flavors that we may use in the marketplace in terms of beverages or some of the seasonings that we may use in food and snack products, we actually have a very nice balance of bringing global what are typically appealing global flavors but then customizing them to a local market like China (ex. Lay's potato chips in flavors designed specifically for the Chinese market, such as cool cucumber and crispy prawn).

In addition to that, we bring not just broadly appealing substrates but also a set of capabilities and global platforms that are very leveragable in markets small and large. So if you think about the R&D capability that we have globally, where we just announced that we're going to open a substantial R&D center in China, if you think about some of the agricultural capabilities that we've developed around the world, we've said that we already have, and we're going to have an even more substantial agricultural presence in China ... We're going to work with farmers to basically make their farms more productive.

If you think about some of the manufacturing capability that we have, to become an official operator -- because by nature it's going to a very competitive market -- we bring a set of competencies that typically allow us to very competitive by virtue of the fact that we know how to do a lot of things that are somewhat unique in manufacturing and distribution. And even a branding capability that's obviously quite world class.

That's the thing that gives me confidence that all of those capabilities will allow us to compete effectively, combined that with the fact that we make products that people typically love around the world. I'm optimistic that we're going to be quite successful in China and we're going to be successful not in going in and fighting Coca-Cola, but quite successful in playing that game that PepsiCo plays and doing the things that we know how to do. And as a result of that, become an increasingly large food and beverage company over time.

TheStreet: How are you finding your talent in China?

Johnston: Clearly it's a place where we've been actually quite successful in bringing in lots of local Chinese talent and we have a nice blend of a few expats who are in and come with a set of experiences that are required elsewhere in the company; but a wonderfully large core base of local Chinese people who know that market and know the culture. And as a result, that blend I think has actually built a nice PepsiCo China culture, which I think is I think is an advantage for us. I really do.

TheStreet: Who will dominate in China? Pepsi or Coke?

Johnston: It's honestly not something that's first and foremost on our list but our goal is to win the game that we're playing and however the rest of things shake out, that's perfectly fine. If we can execute our plans, we're going to be successful.

TheStreet: There are concerns that pricing challenges in the emerging markets and the costs of building distribution infrastructure there could lead to lower profitability for Pepsi. Is this a valid argument?

Johnston: I worry about are we executing value creating strategies in all of the markets, and we look at them in that way. We don't look at them in big aggregations. We look at them in relatively granular ways. One of the things we're actually quite good at is starting with, in this market, in order to access a broad set of consumers, is that we think what is the pricing structure that will work effectively in that market and then manage our cost structure to meet that market's needs.

Now, what that says is you're going to make certain choices about manufacturing. You're going to make certain choices about distribution. You're going to make certain choices about what products are likely to be successful there and what products aren't going to be. So if you start with the notion that 'I know what I can price at in order to be in this market, I know I have to make a reasonable margin and a reasonable return in order to be successful as a company' -- I manage the middle of the P&L (profit and loss statement) in order to meet both of these needs successfully.

Given that's we're already in 200 countries at this point, I think we basically have a proven on a track record that says we're pretty successful at it and with those markets. As they get bigger and as they scale up -- of course the profit margins tend to improve over time -- and that's just a nice, natural source of growth for us as well. So we get the top line growth for entering new markets and then we get the margin expansion as the markets start to get more mature over time.

TheStreet: In general, where are you looking for new talent these days?

Johnston: It's the traditional places, but in new ways. We go to an awful lot of schools to bring young people in and then we go to places like other companies and consulting firms and banks -- in my world -- and obviously lots of other companies across sales and marketing and all the other functions. So we're pretty broad-based in where we look for talent. The thing we look for is basically, smart, creative, ambitious people who want to make a difference and we've been so far successful -- and we need lots more of them.

TheStreet: So, what's it like working with Indra Nooyi? Given your strong personalities, have you ever clashed on anything?

Johnston: I like to think of it honestly more as, when we bring different perspectives to the table, we get ourselves to a better answer. Indra's obviously a global CEO who has a tremendously broad set of skills and is quite intuitive as well about understanding things. Part of what I view my role as is to bring perspectives to her -- that are borne of the information that I have and the experiences that I have -- and I've got a level of confidence that she's going to be able to sort those things out very, very effectively.

We've worked together for a good, long period of time so I wouldn't necessarily get into clashes or disagreements. I think it's more a question of getting more information on the table and sharing perspectives. And at the end of the day as the CEO, she's going to make the decision on where she thinks we need to go. Our role is to help her sort that out.

TheStreet: What about the bottling acquisitions? Were there any differences of opinion there?

Johnston: No, quite the opposite. This is one where we were all quite aligned -- that the opportunities were very clear to us and we knew pretty well what needed to happen. And now, as you enter the discussions and get into talking to the other companies, obviously your thinking evolves and your points of views evolve. This was one where we knew this was the right strategy to follow and we like everything else -- when we all get ourselves aligned around the goal -- execute about as hard as you can possibly execute. It's a great example of the group really coming together and putting different perspectives on the table.

TheStreet: In general, what have been the joys and frustrations of being the CFO of one world's most well-known companies, which others might not be aware of?

Johnston: It's interesting, actually when it comes to frustration, I don't feel a whole lot of that. I think I've got one of the best CFO jobs in the world -- I really do. And it's a big, globally diverse company with interesting products, with wonderful opportunities to move forward. Like anyone else, you see so many great things and the big thing that you want to be able to do is to do more of them faster. To me, it's just an incredibly exciting job in a company that I think that is the best company that there is.

TheStreet: Now, to your Europe operations. Has Europe's sovereign debt crisis changed the way you manage your businesses in Europe?

Johnston: The way we're managing it -- really -- it's true of Europe, but it's also true of North America as well: we're managing assuming that the consumer is going to continue to face challenges. That was our planning assumption going into 2009 and that was our planning assumption going into 2010. If it turns out that the consumer does better than we expected, we're in a wonderful position to take advantage of the opportunities that that presents.

But right now, the operating assumption that we have is that you have a situation where you have relatively high unemployment in the U.S. and while month to month it's showing some signs of improvement, year-over-year it's still a negative number. Europe, for the most part, I think, is in a similar spot. So what we do in those situations is we manage for value and we know we need to do that, we know we need to manage the middle of the P&L (profit & loss statement) very, very tightly in order to be able to achieve the results that we've set out for ourselves; and we are very very acutely watching what happens with consumers and customers and are in a position to react to those things quickly.

So in terms of some of the sovereign debt challenges that are going on there right now, obviously those don't have a direct impact on us to the degree that they affect consumers; and we're already operating assuming that the consumer's going to be challenged. So it's something that's sort of a continuation of the way we've been managing for the last couple of years.

TheStreet: And how are you managing the volatility of the euro?

Johnston: We operate in so many countries and we manage very strong currencies and weak currencies; and we tend to operate the business effectively on a local level because that's the nature of our business. We do what we can to manage the currencies effectively so that's something we'll continue to watch and we obviously have financial strategies to try to manage our way through those things.

TheStreet: In the U.S., soda taxes have been proposed to help ease budget shortfalls. How do you feel about this?

Johnston: Obviously it's not something that we would love. Our perspective is governments clearly are challenged with their budgets right now and we certainly understand that. And as a company, our perspective is like everyone else; we're willing to do our part to deal with the issues and challenges that are out there. What we're not supportive of is a tax on a single product to try to close those budget gaps; so we're not in agreement with that. We've made our perspective pretty clear -- that we don't think that those are appropriate taxes.

TheStreet: What happens if this does occur?

Johnston: Remember we do have a fairly broad-based portfolio of beverages, so we don't just sell regular carbonated soft drinks. We have lots of lower calorie offerings, we have lots of zero calorie offerings, and if the consumer chooses to shift over to those products because of what could possibly happen, that's something that our business is well-positioned for as well.

TheStreet: You're in New York City to attend the UN Global Compact Leaders Summit 2010. What do you hope to get out of it?

Johnston: One, I think I'd like to help people understand all of the things that PepsiCo's done over the last couple of years from the perspective of the environment. Obviously some of this is very much geared towards the environment and to share some of the things we've done around using less water, some of the things we've done around using less energy -- also to help people understand some of the goals we've set out because we think we're still very much at the early part of this journey and we think we can do more -- and we've committed publicly to doing more. So that's number one -- to share some of our perspectives in that regard.

Number two: it's to learn. I'd like to understand what some other folks are doing and if there are some good ideas out there that I can bring back to our company to help us accelerate the journey we're on. Boy, that would be fantastic as well. That'd be a great use of my time. So those are really a couple of the big things that I'm trying to accomplish.

In terms of the specific goals that we put out there, we think we've challenged ourselves in a pretty substantive way around really decreasing our use of water, around decreasing our use of energy and to certainly care for the environment in a way that as members of society we would all want to do.

The important thing to understand as it relates to us is this isn't a new thing for us by any stretch of the imagination. This is a journey we've been on for probably the better part of the last decade, so while our progress is accelerating even more right now, it's something that's well embedded in the company. There is a great deal of passion for it inside of PepsiCo and it's great because when you have the inside of the company passionate about it and you have that sort of inside out desire to do more in the environment and you know you have your customers and consumers who have a great passion for it outside, there's a confluence to achieve an awful lot of terrific things.

TheStreet: Is all this usually more easily said than done?

Johnston: No, I think the further you get into it, the more creative you get at identifying opportunities; and what we've tried to do is really put some processes in place to encourage people to do this. Let me give you a very simple example in that regard: there are capital expenditures that have to be approved inside the organization. One of the things that we put in for operating capexes is we want an environmental element to the capital expenditure request.

Often times, before we did that, there were probably people thinking about the environment, but now all of a sudden you have to actually push yourself to put something down on paper: 'what is the environmental impact of this and what is it that we're doing in terms of making this a more environmentally friendly project?' Well, as you put that in a requirement you engage the hearts and minds of the organization to push a little bit harder. But at the same time, they're trying to do it in a way that's efficient and effective and uses the capital that we put out there in the best way possible.

So it's setting up those processes and nudging people to think a bit more about environmental impact as part of the things that they do every day, every month and every year, as part of a person inside PepsiCo. Multiply that by 285,000 people -- the impact is awfully big, awfully quickly.

Best in Class: Pepsi's Plan for Global Domination

Click here for part one

-- Reported by Andrea Tse in New York

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