Best in Class: Pepsi's Plan for Global Domination

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.
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) -- Last August,


(PEP) - Get Report

announced what would become one of the most highly discussed deals in the business world: the $7.8 billion acquisition of its two largest bottlers -- Pepsi Bottling Group and PepsiAmericas.

Completed in March, the deal has been hailed as one of Pepsi's shrewdest business moves. "With consumers in North America migrating from soda to healthier beverages, we think that owning its bottlers should allow Pepsi to be nimble in its route to market and give it the ability to react quickly to shifting consumer tastes," Morningstar analyst Philip Gorham recently said in an equity research report.

As predicted by many, it wasn't long before its arch rival


(KO) - Get Report

announced a bottling acquisition of its own: that of

Coca-Cola Enterprises'


North American bottling operations in February 2010. The announcements by two of the most dominant forces in the beverage industry set off what many loved to call "the soda wars."

But PepsiCo's new CFO and 23-year company veteran Hugh Johnston said that while he understands why it can be fun to pit two of the most successful beverage companies in the world against each other, a direct comparison between Pepsi and Coke isn't really that useful, given that Pepsi's scope stretches far beyond beverages.

"When it comes to the everyday lineup of beverage portfolios -- sure -- it's good fun and I think consumers find it interesting. And if they find it interesting, we find it interesting," Johnston told


when he was in New York City last month for a UN business leaders conference. "But if you really think about where we are as a company -- half of our business is in snacks and foods -- outside of the beverage space. So we really are, I think, far more diverse than Coke is."


Goldman Sachs

recently reiterated its conviction buy rating for PepsiCo, believing that the market has been undervaluing the company's Frito-Lay business despite its better growth and profitability outlook when compared with the other packaged food companies in Goldman's coverage universe.

If there's anyone who can define what Pepsi is today -- and where it's come from -- Johnston certainly fits the bill. Joining Pepsi straight out of the University of Chicago in 1987, where he studied finance and accounting, has more than two decades in the company, and has worked with Pepsi chairman and CEO Indra Nooyi for 15 years. He succeeded Richard Goodman when he stepped down as CFO at the end of March. Before becoming CFO, Johnston was vice president of global operations with additional responsibilities for the post-merger integration of the two bottling companies. He has served in mergers and acquisitions, general management and finance positions throughout his career at Pepsi.

And these are not uninteresting times for PepsiCo: the bottling acquisitions, the expansion into the world's most populous and coveted China market, and the ambitious plans to grow the company's $10 billion nutrition business into a $30 billion business by 2020.

Under the plan, Pepsi wants to respond to its increasing health-conscious consumers with the following goals:

Reduce the average saturated fat per serving in key global food brands in key markets by 15% by 2020

Reduce the average added sugar per serving in key global beverage brands in key markets by 25% by 2020

Reduce the average sodium per serving in key global food brands in key markets by 25% by 2015


spoke with Johnston on June 23, a day before he was to appear at the UN Global Compact Leaders Summit 2010 and meet with hundreds of other global leaders to discuss environmental and social responsibility. During the interview, he spoke about the Pepsi-Coke rivalry, the euro, China, Pepsi's ambitious plans for its nutrition business, the bottling acquisitions, his relationship with CEO Indra Nooyi, the threat of soda tax hikes, the UN conference and, of course, what it's like to be the CFO of a cultural entity and one of the world's most famous food and beverage companies.

TheStreet: Is the rivalry between Pepsi and Coke real or perceived

Johnston: Certainly the fact that we've been the two most successful companies in the world in the beverage industry -- it's logical for people to think about it that way. People love to see a good competition and a direct rivalry's the most interesting way for them to see it, so it's certainly not surprising. But since you go back to the early beverage days, we've become so much broader as a company in so many ways.

Johnston (continued): So when we talk about ourselves to a broader audience, we just like to talk about the things that we do and what we think is important. When we talk about day-to-day beverage rivalry, sure it's fun and interesting to talk about. But that's the way I tend to think about it more than anything else.

TheStreet: It's been suggested that Coke is merely following Pepsi's lead with its Coca-Cola Enterprises acquisition plans. Is there any truth to this view?

Johnston: I'll let you all comment on that! The timing of that would certainly seem to suggest that -- that they followed us. But beyond that as I said, we're really interested in doing mostly what we think is right. We didn't do this with the thought that Coke would follow us. We did it with the thought that this is the most efficient and effective way to operate within the North American space -- predominantly North America since that's what the bottling acquisition primarily was.

Over the course of the coming years, you have a market that isn't growing as quickly as it used to; you have customers that have consolidated and have become clearly interested in a more efficient supply chain. And as a company with a heavy operating legacy, it was something we were quite comfortable with getting more and more involved in. It's not as if these were companies that were unknown to us to begin with.

The management of PBG (Pepsi Bottling Group) and the management of PAS (PepsiAmericas) -- we've all worked extremely closely together for years -- but the conclusion that we drew was the combination of the needs and the opportunities with customers, combined with the opportunities that an integrated supply chain would present us in terms of speed and efficiency and effectiveness -- and then take with that the broader opportunities that we have with our Frito-Lay business in terms of where there might be logical overlaps ... and when I say that I'm not talking about combining trucks and all of that stuff.

You're probably familiar ... we did an alliance with

AB InBev

(BUD) - Get Report

to do some procurement things. We're open to doing those types of things with other companies as well. And frankly I expected there might be ways we can do more things with AB InBev. We've defined a narrow set of procurement categories. We'll probably look at more categories over time, assuming that we're successful with this.

If Coke sees some things, great, that's good for them. You know, obviously they are a different company. They're not nearly as significant an operating company as we are, but I'm sure they see strategic logic in what they've done and we'll see how it all turns out in the marketplace.

TheStreet: It's been suggested that the bottling acquisitions have exposed Pepsi to greater input, commodity and capital costs, on top of concerns that the bottlers are less profitable businesses. Have the acquisitions been a painful, but necessary hit to take?

Johnston: No. I don't think so at all. The construct of PepsiCo's financials are very attractive to most investors. They were, previous to the acquisition and they are still very attractive. Are there certain realities in terms of the asset intensity of this business? Yeah, clearly there are, but if you look at the strategy and ask, 'is this a value creating strategy?' The answer, we very much believe is yes. And does that then enhance the value of Pepsi pre to post? The answer to that we believe is yes. So are there certain realities in terms of the way that our math is going to look for a period of time? Yeah, there absolutely are.

Has our return on invested capital declined as a result of the bottling acquisition? We see ways of improving that year after year. In fact, what we've talked about to investors is we expect to see 50 basis points of ROIC (return on invested capital) improvement for the next couple of years. So do we feel good about the financial aspects of the bottling acquisition? The answer is an unquestionable yes. We feel terrific about where we think this is going to take us, and we felt good about it right from the get go. And we're confident that investors can understand the changes in the numbers and be able to sort it out pretty effectively.

TheStreet: So in some ways you had to bite the bullet?

Johnston: I wouldn't even think about it necessarily that way. I'm pretty well convinced that investors at the end of the day are -- ROIC -- if you use that -- is a metric that they're interested in, but they're also interested in growth; they're interested in fundamental profitability, they're interested in the durability of the financial equation that you present to them. I think when they look at the aggregate of all of the financial metrics by and large, they feel good about this move. As a result, I don't even think about it as biting the bullet.

We really didn't spend any meaningful time talking about that aspect of it. We knew it, we looked at it and we said, 'yeah that's exactly what's going to happen' and we moved on because we knew we were on the right strategic course and we knew what was consistent with being a financially-disciplined company.

One of the interesting facts about PepsiCo is if you compare company-owned to franchise across the entirety of our snacks, beverages and foods business, 85% of our business is company-owned. Only 15% is franchised. And that's why when you ask about comparisons to Coke -- I think you would probably see a very different set of numbers on that particular metric for Coke and why it gave us such a level of confidence going into an operating business with the belief that we have the skills set, mindset and culture in our company -- so it's not going to be something terribly new to us.

TheStreet: How has the integration of the bottlers been going?

Johnston: It's gone extremely smoothly. We had the good fortune from the time that we announced the agreement with the companies to the time we actually closed the deal --- because it had to go through all the necessary approvals -- we had a lot of time to plan it. And with that time, we used it to really get to down to a very low level of detail, planning exactly what it was we were going to start to do from the moment we had approval and could go forth and take it from a planning stage to an action stage. The second big advantage for us was these were management and operating cultures that were familiar to us because of our longstanding working relationship.

I was around when the Quaker business came together with PepsiCo and there you had a wonderful consumer business -- and it's been a wonderful combination, but we clearly had to go through a stage where we needed to learn about that company; and they needed to learn about us. I actually was the CFO out there, one of the first people on the ground once we finally put the businesses together. There was a lot of cultural learning that you had to go through.

Here, we had substantially less of that. I won't call it zero, but there really wasn't a lot because we were so closely intertwined to begin with. So I think the combination of an extended planning time along with the fact that we were very familiar with each other and what each others' roles were has made this go extremely smoothly.

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

Click here for part two

-- Reported by Andrea Tse in New York


>>Pepsi Around the World: Interactive Map

>>Pepsi Maintains Full-Year Growth Target

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