PepsiCo’s Q1: Promising Signs in a Global Soft Drinks Re-alignment

Yesterday, PepsiCo released its first quarter earnings report. Global company organic revenue grew by 4.4%, with beverages accounting for 1.5% of this top-line figure, trailing an impressive performance for the company’s Frito Lay snacks business. The company continued to enjoy volume growth in key emerging markets, despite weakness in Europe, although suffered from exposure to foreign currency volatility in international markets.

Last year, Euromonitor International put forward four recommendations to keep PepsiCo strong in the changing global environment for non-alcoholic beverages. What progress has the company made in addressing these concerns, based on its start to fiscal 2015?

1.       Work to keep US CSD profitable despite declines

  • Even accounting for a strategic shift to emerging markets for soft drinks and packaged snacks, the US drinks business will remain a significant portion of the overall business. US CSDs remains high margin and high penetration, but consumption declines are likely to continue. The company must continue to innovate in terms of natural (real sugar) and healthy (low calorie sweetener blends), without losing focus on its promising full-flavour non-colas.
  • Volumes in its Americas beverage division declined by 1% in Q1, in line with recent industry performance, although revenue increased 2% on higher unit pricing. The company have focused on smaller, more premium positioned sodas (primarily, non-colas) as well as general price increases. The company pointed to Mountain DEWShine, a Q1 new product in the US, a ‘craft’ soda sweetened with cane sugar and served in glass packaging. Mountain Dew, in general, was a strong US performer again for the company (particularly the Kickstart juice/energy non-cola hybrid) while full-flavour regular colas (excluding diet beverages) were a surprising strong point.

2.       Innovate in RTD tea, juice and HW carbonates

  • Premium RTD tea and juices are expected to drive long-term value growth. Although Lipton Pure Leaf has performed strongly, PepsiCo needs to evaluate its partnership with Unilever to ensure that it is in the most profitable position to benefit from expected growth in the tea segment. PepsiCo also needs to look to accelerate its new product development (NPD) and health and wellness innovation to satisfy its corporate objective of massively boosting nutrition products by 2020.
  • In non-CSD innovation, PepsiCo may have made the boldest and encouraging short term strides. In Q1 the company reported that that carbonated soft drinks now account for less than 25% of their total 2014 revenue, as the shift continues away from CSD, particularly cola. Lipton Sparkling Iced Tea – a US Q1 launch –is indicative of the shift away from the traditional carbonated category in terms of new launches. High value premium juice launches from Naked and Tropicana were identified as opportunity areas in premium juice, with more 2015 launches expected under both brand umbrellas.
  • Most notably, the company announced shortly after Q1 reporting that US Diet Pepsi would no longer be formulated with aspartame as its artificial sweetener, but rather with a combination of Ace-K and sucralose. This unexpected move reflects the changing definition of “Health and Wellness” within carbonates, and soft drinks more generally, with negative consumer perceptions about aspartame (and perhaps high intensity artificial sweeteners in general) limiting the growth potential for lower calorie diet products. These mixed messages from the consumer have been termed as consumer “confusion” by PepsiCo’s CEO, Indra Nooyi. Nevertheless, Pepsi have become the first major brand to take a step away from aspartame in its US Diet portfolio rather than simply innovating around alternative low-cal sweetener options and expanding the portfolio via Pepsi True.

3.       Shift beverages focus to key emerging markets

  • PepsiCo has a weak soft drinks position in major emerging markets such as China, Indonesia and Brazil. The company must work to gain share in these markets in order to drive revenue growth, capitalising on “Power of One” synergies with local retailers. In the company’s more promising high-growth markets (including Russia, the Middle East, and increasingly India) the company must defend its share position, building its brands and increasing penetration among the rising middle class.
  • Volatility in Pepsi’s high market share Russian market has had a negative impact on the company’s profitability, and was identified in the company’s reporting as a trouble spot. Pepsi have engaged in aggressive cost cutting and price adjustments to keep this important aspect of the business profitable, although the prognosis for 2015 remains weak.
  • More generally, Q1 results underscore the truly global nature of the much discussed Power of One strategy. While the US beverages business may seem to lag behind the company’s robust US Frito Lay business, historic 2008-2013 Competitor Analytics data demonstrates the extent to which PepsiCo’s Power of One strategy is a global success: despite recent volatility, PepsiCo have balanced robust growth in Sweet and Savoury Snacks with increasing positions in Cola, Non-Cola, Juice, Sports and Other Soft Drinks:
  • PepsiCo North American Sales Growth by Category 2008-2013: Drinks seem to be a drag at home…
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  • PepsiCo Global Sales Growth by Category 2008-2013: But globally, we see a balanced growth story for the company.
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4.       Strengthen soft drinks brand building and NPD

  • Co-branding strategies (including foodservice partnerships in the US) have had a positive impact on the company’s snacks business. The company should explore more exclusive partnerships, including internationally, ensuring that demand for popular packaged snack brands translates into increased demand for soft drinks products. Retailer- or restaurant- exclusive drinks launches (particularly for higher growth non-cola brands, such as Mountain Dew or 7-Up) can stimulate interest and drive higher sales.
  • Finally, branding building and high profile marketing activity around brand Pepsi cola was another area where the company reported strong gains. The company’s sponsorship of the NFL (National Football League) Super Bowl in February 2015 was linked to a reported 60,000 food and beverage displays in the US. Earlier this week, the company also announced a major sponsorship coup in replacing rival Coca-Cola as the official soft drinks sponsor of the National Basketball Association (NBA). The company also announced a new 2015 partnership with the high growth ‘better-burger’ US fast food chain Umami Burger, involving cane sugar versions of PepsiCo’s CSD portfolio.