Ruma mukerji

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Professor Joseph L. Badaracco and Case Researcher Matthew Preble (Case Research & Writing Group) prepared this case. This case was developed from published sources. Funding for the development of this case was provided by Harvard Business School and not by the company. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2013, 2014 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545- 7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

J O S E P H L . B A D A R A C C O

M A T T H E W P R E B L E

PepsiCo, Profits, and Food: The Belt Tightens

Indra Nooyi, CEO of the food and beverage company PepsiCo, had emphasized adding healthier offerings to the company’s portfolio since her arrival in 2006. Her goal was to grow the company’s “Good-for-You” product category (with items as oatmeal and fruit juices) to a $30 billion business by

2020.1 “With everyone’s focus on health, products that are nutritiously good, or nutritionally better than anything else out there, are a huge opportunity,” Nooyi explained in 2011.2 With roughly one- third of the U.S. adult population obese, Nooyi’s strategy was also in line with a growing recognition that excess sugar consumption contributed to serious health problems.3

However Nooyi and PepsiCo faced criticism not only for this strategy, but for the company’s financial results—particularly that of its stock price—which lagged its competitors (see Exhibit 1 for stock price comparisons with competitors, and Exhibit 2 for PepsiCo’s and select competitors’ financials). PepsiCo’s U.S. beverages business had struggled and some believed that Nooyi’s strategy drew attention away from PepsiCo’s major brands.4 It appeared at times in the early 2010s that her

job was at risk.5 While PepsiCo’s board publicly vouched for Nooyi and PepsiCo’s strategy, it was also said to be disappointed at the lack of potential successors within PepsiCo’s top management.6

PepsiCo’s efforts to develop healthier foods had won it few friends among health advocates. “The best thing Pepsi could do for worldwide obesity would be to go out of business,” one academic

remarked.7 Others pointed to apparent duplicity as PepsiCo fought, through industry trade groups, against regulations, taxes, and other initiatives aimed at reducing obesity.8 Comparisons were made

between the food and beverage industries and the tobacco industry in their lobbying efforts.9

Fundamental questions remained about how Nooyi would lead PepsiCo. As the company grew in international markets, and as obesity became a larger concern in the developing world, should it sell its high-earning core brands there or focus on designing new, more healthful products? What were PepsiCo’s responsibilities to its consumers? Like tobacco companies in the late 20th century, food and beverage companies could be targeted with health-related lawsuits. How should Nooyi protect against this risk? Nooyi also had to decide what her strategy should be for the coming years. Should Nooyi invest in the core products such as Doritos and Pepsi-Cola that had made it successful in the first place, or push through with her vision of PepsiCo’s future? Was it possible for PepsiCo to succeed with a focus on nutritious foods considering its broad product portfolio and competitors eager to take market share away from the company?

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In response to mounting criticism, Nooyi launched a strategic review to answer some fundamental questions in late 2011. What was the right balance in terms of investments and management focus between PepsiCo’s major brands, such as Pepsi Cola and Doritos, and its healthier offerings? Was it possible to succeed with a focus on nutritious foods considering its broad product portfolio and competitors eager to eat away at its market share? How long could Nooyi accept subpar performance while developing the Good-for-You category?

America’s Obesity Problem

Nearly 36% of adults and 17% of children in the U.S. were obese.10 Obesity occurred when a person developed excess body fat from consuming more calories than he or she used (obesity differed from being overweight, which could come from muscle, water, or bone weight, as well as

body fat).11 Obesity increased a person’s risk of developing serious health conditions including heart disease, type 2 diabetes, high blood pressure, stroke, and certain cancers.12 Medical treatment for

obesity-related diseases cost nearly $150 billion annually.13

Obesity rates had increased in the U.S. from the late 20th century through the early 2000s. In 1990,

no state had more that 15% of its adult population classified as obese.14 By 2010, no state had a population where less than 20% of adults were obese, and many states had rates above 30%.15 Multiple causes were given for this rise, including more sedentary lifestyles, food choices, and portion sizes. The U.S. Centers for Disease Control and Prevention (CDC) dismissed ideas of some individuals having a genetic predisposition towards obesity, as “[g]enetic changes in human populations occur too slowly to be responsible for the obesity epidemic.”16

Drinks high in sugar were correlated to obesity, and as one observer noted, “it’s no surprise that America’s rising thirst for sugar-water has paralleled the epidemic rise of obesity and type 2 diabetes.”17 Approximately half of all U.S. adults drank at least one soda per day, and the average

American drank 50 gallons of soda annually.18 The American Heart Association recommended that women consume no more than 100 calories per day, and men no more than 150 calories per day, from

added sugar—one 12 ounce (oz.) soda had 130 calories.19 The United States Department of Agriculture listed soda as an empty calorie product—a food with little or no nutritional value.20 (See Exhibit 3 for a comparison of the nutritional content of various foods and beverages.)

Scientific evidence increasingly pointed towards drinks with added sugar or artificial sweeteners as contributors to obesity. “It is estimated that sweetened beverages account for at least one-fifth of

the weight gained between 1977 and 2007 in the U.S. population,” one study found.21 Another study conducted on children found that “[f]or each additional serving of sugar-sweetened drink consumed, both body mass index [. . .] and frequency of obesity [. . .] increased after adjustment for anthropometric, demographic, dietary, and lifestyle variables.”22 The study came to the conclusion

that “consumption of sugar-sweetened drinks is associated with obesity in children.”23 Another team of researchers tied sugary drinks to 180,000 deaths globally each year (133,000 from diabetes, 44,000

from cardiovascular disease, and 6,000 from cancer).24

Studies were also conducted on sugar addiction. In one experiment, rats were given cookies and plain rice cakes and then allowed to “self-dose” with cocaine, and the rats who liked the cookies best were also the heaviest cocaine users.25 “It has been found that the criteria for substance dependence are similar to that for food dependence. [. . .] When we looked at our animals, we observed that foods with properties which are more appealing, such as those high in sugars and fats content, are preferred and engender addictive-like responses,” said one academic.26 Another team of researchers

worked with rats on sugar addiction.27 “If bingeing on sugar is really a form of addiction, there

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should be long-lasting effects in the brains of sugar addicts. [. . .] Craving and relapse are critical components of addiction, and we have been able to demonstrate these behaviors in sugar-bingeing

rats in a number of ways,” explained another academic.28

Some blamed the food and beverage industry for contributing to the obesity problem, with one individual describing “a conscious effort—taking place in labs and marketing meetings and grocery

store aisles—to get people hooked on foods that are convenient and inexpensive.”29 For example, one specialized consulting firm was tasked with researching various combinations of a new Dr. Pepper

soda.30 The consultants taste-tested 61 different flavor combinations on almost 4,000 people.31 Each participant was asked a detailed set of questions, and the firm was thus able to create a report on

precisely how the new product should taste and be made to draw in consumers.32

PepsiCo

PepsiCo formed in 1965 via the merger of the Pepsi-Cola Company (which owned the Pepsi and Mountain Dew beverage brands) and Frito-Lay, Inc. (the makers of the Fritos, Lay’s, Cheetos, Ruffles, and Rold Gold brand snack foods).33 Over time, the company introduced and acquired other well- brands including Doritos, Tostitos, Walker’s, and Quaker, Gatorade, Aquafina, and Tropicana. The company had once owned quick-serve restaurants, including the Pizza Hut, Taco Bell, and Kentucky

Fried Chicken restaurant chains, all three of which it sold off in 1997.34

The company had 22 “mega brands” in 2011 that each topped $1 billion in global sales.35 Its leading mega brands, in order of sales, were Pepsi-Cola, Lay’s, Mountain Dew, Gatorade, and Tropicana.36 PepsiCo further segmented its products into the categories of fun-for-you (such as

Doritos); better-for-you (diet sodas); and good-for-you (Quaker oatmeal).37 The company’s net revenues were evenly split between its food and beverage offerings (its beverage products contributed 52%).38 PepsiCo divided its operations into four segments (see Table A). The U.S. was

PepsiCo’s primary market, responsible for half of its total net revenues.39 (See Exhibit 4 for PepsiCo’s historical financials by segment.)

Table A PepsiCo’s Revenues and Operating Profit by Segment

2012 PepsiCo Americas Foods

PepsiCo Americas Beverages

PepsiCo Europe PepsiCo Asia, Middle East, Africa

% of net revenues 35% 34% 20% 11%

% of operating profit 51% 30% 11% 8%

Source: PepsiCo, 2011 Annual Report, p. 7, http://www.pepsico.com/annual11/downloads/PEP_AR11_2011_Annual_Report.pdf, accessed August 2014.

The Making of a Manager

Nooyi was born in Madras, India (modern day Chennai) in 1955 to a family that pushed her to

succeed.40 Her grandfather in particular had a lasting impact: “First [he taught me that] if you are given a job to do, do it really well. You must consistently ask yourself ‘Have I done it to the best of my ability?’ Second, he taught me to be a lifelong student. Don’t ever think you’ve arrived, and

remember that what you don’t know is so much more than what you do.”41 One observer noted that college friends described Nooyi as “a tough and independent team player whose first taste of

business was managing college magazine advertising.”42

http://www.pepsico.com/annual11/downloads/PEP_AR11_2011_Annual_Report.pdf

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Nooyi earned an undergraduate degree and an M.B.A. in India and joined a British textiles company.43 Nooyi left to join Johnson & Johnson as a local area product manager for a sanitary pad

brand.44 One observer described the obstacles she faced in this job: “At that time, not only could such

a product not be advertised in India, but many retailers shied away from stocking sanitary pads.”45

Nooyi wanted to continue her education and attended the Yale School of Management.46 “It was unheard of for a good, conservative, south Indian Brahmin girl to do this. It would make her an absolutely unmarriageable commodity after that,” Nooyi later recalled.47 She graduated with a degree in public and private management and worked for the Boston Consulting Group (BCG) for six years on corporate strategy.48 “I don’t think I could have gotten here without a strategy consultant background because it taught me inductive thinking. It taught me how to think of the problem in micro terms but also to zoom out and put the problem in the context of the broader environment and

then zoom back in to solve the problem,” Nooyi remarked of her time with BCG.49

She then spent four years at Motorola, which she joined as the business development executive responsible for the automotive and industrial electronic group, and left as vice president and director

of corporate strategy and planning.50 Nooyi then moved to the industrials company Asea Brown Boveri (ABB) as senior vice president of strategy and strategic marketing.51 She worked closely with

the CEOs of both companies on corporate strategy.52

Nooyi joined PepsiCo as senior vice president of strategic planning in 1994, and became senior

vice president for corporate strategy and development in 1996.53 “Indra can drive as deep and hard as anyone I’ve ever met [. . .] but she can do it with a sense of heart and fun,” remarked former PepsiCo

CEO Roger Enrico.54 She played a key role in the decisions to sell PepsiCo’s restaurants and bottling operations.55 This was a difficult time for her: “I’d sit in meetings and try to be real macho and dehumanize these decisions. [. . .] Then I’d go into my office and close the door and shed a few tears,

thinking, God, why can’t I just be building.”56 However, Nooyi was also behind decisions to move the company in new directions, and PepsiCo acquired the Tropicana and Quaker (which owned

Gatorade) companies during her time in strategic planning.57 These acquisitions were driven by her understanding that health and nutrition were increasingly important to consumers.58

Nooyi became president and CFO in 2001 under CEO Steve Reinemund.59 Reinemund described Nooyi’s “sharp talent for turning insightful ideas and plans into reality.”60 When Reinemund retired

in 2006, Nooyi was chosen as the new CEO.61 The move was hailed by analysts.62 One observer noted how Nooyi’s background differentiated her from other CEOs: “Unlike people in operations and sales, who have to worry solely about meeting quarterly-earnings targets and expanding existing markets, a corporate strategist must position the company for markets that don’t exist yet, and may not for another 20 years.”63

Commitment to Nutrition

Nooyi’s strategic decisions reflected her belief that consumer demand was shifting towards

healthier foods. She also saw little chance to grow through sodas alone.64 “What’s been happening in this category forever: we, Pepsi, would push like hell to get a program with the [retailer], we’d spend everything, and get a tenth of a point of market share. [. . .] The next period, Coke would come along, push like hell, and gain a tenth. This was a zero-sum game. The cola category was profitable, but didn’t grow profits,” she remarked.65 Instead, Nooyi saw opportunity in both making its existing snack and beverage products healthier through R&D, and in transforming the company’s portfolio to include healthier items: “Reduce the salt level, but don’t give up on taste. Reduce the fat levels. Reduce the sugar levels. Take the zero calorie products and nudge consumers to buy more of that. [. .

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.] Take the Good-for-You products and make them great tasting so people never have to compromise taste for health or health for taste,” Nooyi said.66

Shortly into Nooyi’s tenure as CEO, PepsiCo launched Performance with Purpose, its plan for sustainable growth built on three sustainability “pillars”: human, environmental, and talent (see Exhibit 5).67 Under this plan, PepsiCo would increase the number of products based on healthy foods

such as whole-grains, fruits, and vegetables.68 PepsiCo also planned to cut sodium by 25% and saturated fats by 15% in some foods and markets by 2015, and sugar in some beverages and markets

25% by 2020.69 The company planned to include nutritional information on all packaging by 2012, and to stop selling drinks high in sugar in schools by 2012.70

Nooyi made two significant hires early in her tenure: that of Derek Yach, an epidemiologist and former World Health Organization (WHO) official, as PepsiCo’s director of global health policy, and Dr. Mehmood Khan, who had once served as director of the Mayo Clinic’s diabetes, endocrinology

and nutritional clinical trial unit, as chief scientific officer.71 Yach recalled that in his first meeting with Nooyi, “[s]he said, ‘I want you to do exactly what you were doing at the WHO [developing

dietary guidelines], and do it here for us at PepsiCo.’”72

Nooyi invested heavily in R&D.73 PepsiCo reformulated some products and launched new ones

by identifying a product’s unique taste and then replacing ingredients without changing taste.74 For example, PepsiCo created a salt with less sodium but a similar taste and used it on potato chips in the

U.K.75 PepsiCo also looked to reduce sugar or find replacement sweeteners for beverages.76 Tropicana’s Trop 50 brand fruit juices used a sweetener from the stevia plant and had 50% less sugar

and calories than regular fruit juice.77 PepsiCo launched Pepsi Next in early 2012 claiming it had “real cola taste with 60% less sugar.”78

PepsiCo added to its nutrition portfolio through acquisitions and partnerships. In early 2011, PepsiCo became the majority owner of the Russian food company Wimm-Bill-Dann, a food and beverage company with dairy and juice products, for $3.8 billion.79 In 2012, PepsiCo partnered with the German dairy company Theo Muller Group on a U.S. joint venture called Muller Quaker Dairy. The joint venture’s $206 million yogurt plant was scheduled to open in mid-2013.80

Analysts noted that the market was wary of the nutrition focus.81 However, these same analysts thought that “Pepsi will experience solid payback on nutritional initiative spending, given the large

size and strong growth potential of the nutrition category.”82 The Access to Nutrition Alliance (an initiative partly funded by the Bill and Melinda Gates Foundation) gave PepsiCo good marks for its work: “PepsiCo has a clear focus on nutrition and health in its growth strategy [. . .]. While a significant portion of its product portfolio consists of soft drinks and snacks, the company has undertaken meaningful efforts to diversify its offerings and improve its nutrition practices.”83

The Food and Beverage Industries’ Actions to Address Obesity

PepsiCo’s competitors took similar steps in the face of rising obesity rates and shifting consumer

demands. Soda consumption rates in the U.S. had fallen since 2005.84 In 2006, The Coca-Cola Company (Coca-Cola), the Dr. Pepper Snapple Group (DPS), PepsiCo, and the American Beverage Association (ABA), along with the Alliance for a Healthier Generation (formed through a partnership between the American Heart Association and the William J. Clinton Foundation), agreed to limit the

types of beverages available in schools.85 A progress report issued in early 2010 showed that while carbonated soft drinks accounted for nearly 40% of beverages these firms placed in U.S. schools in 2004, they accounted for just under 7% in the first half of the 2009-2010 school year.86

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Coca-Cola had listed calorie content on its drinks since 2009, and introduced smaller 7.5 ounce cans of its leading sodas.87 Roughly 25% of the company’s beverage portfolio was low- or no-calorie

drinks.88 In 2013, Coca-Cola launched an advertising campaign that touched upon obesity and health. One commercial highlighted the company’s healthier products, R&D, and efforts to educate consumers and support physical education.89 Some observers criticized these efforts. “The idea that Coca-Cola is a force against obesity is ludicrous [. . .]. They sell liquid candy at a time when the last thing people need are calories with no nutrients attached,” one academic remarked.90 “The company needs to get off the idea that Coke is just another source of calories like broccoli, or rice cakes. It’s not. Coke is tasty, refreshing and delivers a little jolt, all of which are wonderful things, but they’re not

nutrition,” an observer noted.91

Major food companies had responded similarly. The fast-food giant McDonald’s included apple slices in all of its Happy Meals (designed for children), and allowed customers to replace the Happy

Meal’s soda with milk or juice.92 McDonald’s also pledged to cut sodium in its U.S. food offerings by an average of 15% by 2015.93 A number of companies including PepsiCo and Mondelēz International

introduced pre-portioned 100 calorie packages of leading snack brands.94

Full Commitment?

Openly discussing obesity was challenging for food and beverage companies: as one advertising professional noted, “[h]eavy drinkers are profitable consumers [. . .] and large servings at convenience stores and movie theaters mean more syrup sales. [. . .] [Coca-Cola] has every right to collect money from any consumer who buys its products, but perhaps there is such a thing as too much of a good thing?”95 Industry executives tended to talk about food and beverage choice as just one of many factors contributing to obesity. Nooyi remarked in one speech that a range of players— from urban planners, to video game manufacturers, to food retailers—all contributed in some way to

obesity.96 “We’ve got to get [children] off their rumps,” remarked DPS’ CEO in reference to children spending too much time watching television and using computers.97

Companies fought against attempts to paint the food and beverage industries as the main cause of obesity. One ABA executive, commenting on advertisements connecting soda and obesity, remarked that “the notion that there is a direct correlation between soda consumption and obesity doesn’t measure up to where the numbers are [. . .]. If consumption is down and obesity is up, it’s hard to find that correlation.”98 One food company executive questioned whether people really wanted more

healthy food options.99 “Consumers say they want to eat healthy, but their behaviour tends to be slightly different,” he noted.100

Legislation and Industry Lobbying

Public officials had also taken action while companies redesigned their portfolios. In Boston, Massachusetts, Mayor Thomas Menino banned junk foods and soft drinks from the city’s public

schools in 2004, and selling drinks high in sugar and calories on city property in 2011.101 In New York City, Mayor Michael Bloomberg tried to ban the sale of sugary drinks in containers bigger than 16 oz.

from certain venues (not including convenience stores and supermarkets).102 The ban was opposed by retailers, trade groups, and food and beverage companies through New Yorkers for Beverage Choices, an organization funded by the ABA.103 The ban was halted in March 2013 before it went into effect when a New York State Supreme Court judge ruled that Bloomberg had to go through the city council and the board of health to institute the ban.104

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That same month, the state of Mississippi introduced a law to prevent local governments from limiting portion sizes.105 “It simply is not the role of the government to microregulate citizens’ dietary decisions. [. . .] The responsibility for one’s personal health depends on individual choices about

proper diet and appropriate exercise,” explained Mississippi’s governor.106

Many states and cities contemplated soda taxes, but met with strong resistance: through early

2012, such efforts had failed in 24 states and five cities.107 “We ran into the machine the way anti- smoking activists did in the early ‘60s [. . .] it’s not a fight you’re going to win right away,” noted

New York’s governor.108 Others compared the food and beverage industry’s resistance to regulation with that of tobacco companies.109 One individual noted that companies were missing economic opportunities by fighting regulations, making the comparison to the U.S. automotive industry’s opposition to seat belts and other safety standards which ultimately caused them to lose market share

to foreign companies more willing to meet consumer demand.110 Lawyers that had previously litigated against major tobacco companies had shifted focus to food and beverage companies over misleading product labeling.111

It was not always clear how the general public wanted the government to address obesity. A 2013 poll of people from across the U.S. indicated that 69% of those surveyed would vote against a law

similar to the one Bloomberg tried to implement in New York City.112 However, a poll conducted in 2012 showed that a full 57% said it was either extremely or very important for the federal

government to work on obesity-related health problems.113

Partnerships with Non-Profits and Professional Associations

Beverage companies were also criticized for providing financial support to and partnering with non-profits, medical professional associations, and other groups that historically supported consumers or health interests. For example, both Coca-Cola and PepsiCo had sponsored the Academy of Nutrition and Dietetics, and supported nutritional and public health fellowships and

programs at universities.114 The American Association of Family Physicians and the American Academy of Pediatrics had both previously partnered with Coca-Cola.115

Some observers questioned beverage companies’ financial support of minority organizations.116 In New York City, the local chapter of the National Association for the Advancement of Colored People

and the Hispanic Federation fought against Mayor Bloomberg’s proposed soda ban.117 Both Coca- Cola and PepsiCo said they did not ask for these groups’ support on such issues, and that the

partnerships had been in place well-before obesity concerns arose.118

Some believed that partnerships with these companies were inappropriate, if not detrimental to making substantive change, as one academic noted:

When the history of the world’s attempt to address obesity is written, the greatest failure may be collaboration with and appeasement of the food industry. I expect history will look back with dismay on the celebration of baby steps industry takes (such as public-private partnerships with health organizations, ‘healthy eating’ campaigns, and corporate social responsibility initiatives) while it fights viciously against meaningful change (such as limits on marketing, taxes on [. . .] sugared beverages, and regulation of

nutritional labeling).119

Another academic echoed these feelings: “There is a basic conflict in working with the snack food sector, since branding snacks as ‘healthy’ only diverts attention from the real issues. In my view it is

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the culture of snacking—the consumption of superfluous calories between meals, or perhaps instead of healthy main meals—which is an unhealthy practice in itself.”120

PepsiCo Struggles and Shareholders Push Back in the 2010s

Nooyi faced an increasingly frustrated shareholder base as she moved forward with her strategy while PepsiCo’s performance lagged its peers. Coca-Cola and PepsiCo had long dominated the U.S.

carbonated soft drink market, but soda consumption had declined since the mid-2000s.121 PepsiCo saw its share of the U.S. carbonated soft drink market fall from 31.2% at the start of Nooyi’s

leadership (2006) to 28.5% for 2011.122 Coca-Cola’s market share dropped from 42.9% to 41.9% during the same timeframe (see Exhibit 6 for market share in carbonated soft drinks).123

Coke Classic and Pepsi-Cola had historically ranked first and second respectively as the U.S.’s leading soda brands but Pepsi-Cola fell to third place behind Diet Coke in 2010.124 PepsiCo

responded with increased marketing for Pepsi-Cola in 2011.125 “I think one of the mistakes Pepsi’s made is that Nooyi has taken her eye off Pepsi and she’s focused on these better-for-you, lower- margin