PepsiCo's East European Snack Attack

Two years ago, PepsiCo (PEP) paid $4.2 billion for Russian yogurt giant Wimm-Bill-Dann Foods, the company’s biggest-ever foreign acquisition. At the time, Chief Executive Officer Indra Nooyi said she was capitalizing on growing global demand for dairy products—and left it at that.

Turns out that was just Nooyi’s opening move: PepsiCo aims to use the Russian market as a springboard to reach new consumers in former Soviet republics such as Ukraine, Turkmenistan, and Kyrgyzstan. She sees Russia, with its 142 million consumers, as a proving ground where PepsiCo can experiment with drinks and snacks targeted at a growing middle class. The company will then use Wimm-Bill-Dann’s distribution across the region to bring Western-style snacking in all its gluttonous glory to Eastern Europeans. Fritos, Lay’s chips, and Doritos are among the company’s most profitable products, in part because they are light and easy to distribute. And capturing market share early in former Soviet satellites offers the possibility of growth for decades to come. “Russia is just a base,” explains Nooyi. “You’re doing it for the former Soviet Union countries. This is a business that is going to grow substantially. That’s what fires everybody up.”

Nooyi, who’s led the company since 2006, could use a win anywhere on the map. Just a year ago, she headed off a rebellion by investors calling for PepsiCo to split into two companies: snacks and soda. Nooyi mollified shareholders by slashing costs, stepping up marketing, and putting more emphasis on soft drinks in the U.S. to revive sales and regain market share from Coca-Cola (KO). The moves helped the company boost profit by 17 percent in the fiscal fourth quarter that ended Jan. 29.

Success in Europe is far from certain. Campbell Soup (CPB) tried and failed to entice time-pressed Russians to buy its packaged broths instead of making traditional soups, says Ivan Kotov, a Moscow-based principal with Boston Consulting Group. “Changing behavior is expensive,” Kotov says. “You can direct it, but it’s an evolution.”

Pepsi’s Russian chops date back to 1959, when Soviet Premier Nikita Khruschev famously shared a Pepsi-Cola with Richard Nixon. Another 15 years passed before PepsiCo opened its first soda plant in Russia, followed by the debut of Lay’s potato chips in 1992. Since then a large middle class has emerged, and per capita income has surged from about $1,000 in 2000 to almost $7,000 in 2008, according to Euromonitor International.

PepsiCo in 2008 paid almost $2 billion for Lebedyansky, Russia’s largest juice company. With the Wimm-Bill-Dann acquisition two years later, the maker of sodas and snacks became the largest food and beverage maker in Russia and the former Soviet republics, putting it toe-to-toe with Danone (DANOY) in dairy and Coke in beverages. PepsiCo has $5 billion in annual revenue in Russia, its second-largest market after the U.S.

While Americans consume $34 billion worth of snacks each year, according to Euromonitor, Eastern Europeans are only now warming up to packaged snacks and on-the-go munching. The potential—and challenges—are personified by 41-year-old Elena Kuchurnyi, who lives with her college-age daughter, 7-year-old son, and husband, an Aeroflot pilot, in a cramped Moscow apartment. Some mornings her daughter grabs a Nature Valley granola bar made by General Mills (GIS).Hershey’s (HSY) syrup and Heinz (HNZ) ketchup sit in the fridge. Still, Kuchurnyi and her husband mostly eat what they grew up with: compote juice boiled from fresh apples, cabbage soup made from scratch, or a breakfast of buckwheat porridge.

PepsiCo hopes to shift such consumers from lower-margin dairy and juice products to “value-added” beverages such as drinkable yogurts or juices with added vitamins. In thousands of retailers’ drink coolers across Russia, it aims to replace slow-selling soft drinks in winter months with Wimm-Bill-Dann probiotic dairy drinks, which many consumers believe help stave off sickness.

Like many locals, the Kuchurnyis make their own snacks: cubes of stale bread, toasted and sprinkled with salty seasoning. Using equipment designed to make Cheetos, PepsiCo developed its own bread-based snack, Hrusteam. The brand is now Russia’s No. 1 packaged version of the traditional goodie, and PepsiCo plans to roll it out across the region. The company also sells Lay’s chips in culturally attuned flavors such as caviar and crab. A Ruffles-like chip has become Lay’s Strong, aimed at beer-drinking men. In Ukraine, PepsiCo country chief Neil Sturrock’s team has printed temperature dials on Strong’s bags to highlight the power of its chili flavoring—a come-on for the region’s men.

As PepsiCo introduces more product categories in individual markets throughout Eastern Europe, the real payoff of Nooyi’s strategy may kick in: economies gained from shared distribution. In Ukraine, for instance, Sturrock is testing transporting juice and dairy products in the same trucks and then throwing Frito-Lay’s snacks on the top—at almost no additional shipping cost. “They are light and can fill up the truck,” he explains. If Nooyi can garner more such economies, then her quiet advance in the East may yet still her critics.

The bottom line: PepsiCo gets $5 billion in sales a year in Russia, which it’s using as a staging ground for expansion into fast-growing Eastern Europe.

BusinessWeek