February 19 2008: 4:23 AM EST
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The Pepsi Challenge (pg. 2)

By Betsy Morris, senior editor

Nooyi has a hard act to follow - one she played a part in shaping. Insiders attribute PepsiCo's success to the combination of the two cultures that were merged to form the company in 1965: the get-things-done expertise of Frito-Lay and the never-take-anything-for-granted underdog mentality of Pepsi-Cola, which Coke had nearly put out of business. The result was a contrarian, risk-taking big company that prides itself on acting like a small company and has posted an eye-popping compound annual growth rate of 13% over the past 42 years. Since 2000 the company's revenue has nearly doubled. As PepsiCo's strategy and M&A chief, Nooyi created a growth machine, shedding restaurants and bottlers and buying Tropicana and Quaker Oats.

PepsiCo today has a completely different flavor. Old Pepsi: Fritos and Cheetos. New Pepsi: Stacy's Simply Naked (pita chips) and Flat Earth (fruit and veggie chips). Old Pepsi: Diet Pepsi and Mountain Dew. New Pepsi: Naked Juice Pomegranate Blueberry and IZZE Sparkling Clementine. Old Pepsi: ill-fitting acquisitions like North American Van Lines and Wilson Sporting Goods. New Pepsi: joint ventures with compatible partners like Lipton (bottled ice teas) and Starbucks (canned frappuccino).

New Pepsi was so early getting beyond soda pop and into the healthier, faster-growing noncarbonated beverages (bottled water, sports drinks, and teas) that it commands half the U.S. market, about twice Coke's share, according to Beverage Digest. Not that PepsiCo is anywhere near becoming purely a health-food company, mind you. The bulk of its products (upwards of 70%) are still in what it euphemistically calls "fun for you" foods, as opposed to its two other internal categories, "better for you" and "good for you." But its acquisitions and product reformulations, even in fried-food-loving markets like Mexico, indicate the strategic shift is more than just show.

Taking the right side of public opinion, of course, has additional benefits in blunting potential legislation, regulation, and criticism that take aim at junk food and soda pop for obesity rates. It doesn't, however, protect against a sudden change in zeitgeist about products like bottled water - PepsiCo's brand is Aquafina - the most innocent of all beverages but lately under siege as environmentally wasteful. At a time when public opinion and tastes can surprise even a fast-moving company like PepsiCo, the CEO of a consumer products company has to be extraordinarily adaptable.

***

Indra Krishnamurthy Nooyi has one of those incredible, impeccable track records. She grew up in Chennai (formerly Madras), on the southeast coast of India, the daughter of an accountant and a stay-at-home mother who "encouraged us but held us back, told us we could rule the country as long as we kept the home fires burning," she says. Her grandfather, a retired judge, scrutinized report cards, presided over homework, and in his later years prepared her in advance for all the theorems in her geometry book to be sure she'd be able to excel if he were to die before the school year ended. Every night at dinner her mother would present a world problem to Nooyi and her sister and have them compete to solve it as if they were a President or Prime Minister. Though her family is Hindu, Nooyi attended a Catholic school, was an avid debater, played cricket, badgered her parents (and the nuns) until she was allowed to play the guitar, and then formed an all-girl rock band - the first ever at the Holy Angels Convent. Though the band knew only a handful of songs (including "Proud Mary" and "Yummy, Yummy, Yummy"), "we were a sensation," she says exuberantly.

Nooyi collected master's degrees in business from the Indian Institute of Management in Calcutta and the Yale School of Management. She did stints at Boston Consulting Group and then held strategic-planning positions at Motorola (MOT, Fortune 500) and the engineering firm Asea Brown Boveri. She was about to go to work for Jack Welch at General Electric (GE, Fortune 500) when former PepsiCo CEO Wayne Calloway, then a GE board member, lured her to PepsiCo instead. He told her PepsiCo needed her more than GE did, and that was exactly the right button to push.

When Nooyi stepped into her new job as CEO, she had an unusually large council of elders to guide her: three former PepsiCo CEOs who keep in touch with one another almost daily. They have no organizational ties - they're friends. "She gets help if she wants it, but not if she doesn't," says Reinemund. He stays in contact from his home in Dallas, as does his predecessor, Roger Enrico, chairman of DreamWorks Animation, from La Jolla, Calif. Don Kendall, 86-year-old co-founder of the modern PepsiCo, has an office down the hall from Nooyi's and serves as a consultant. Nooyi says Reinemund will e-mail her back in 30 seconds and offer to fly up to her office in Purchase, N.Y., if she needs advice. "They were my bosses and my best, best friends," she says. They call her on special occasions and sometimes show up for birthdays.

***

Not long after Nooyi joined PepsiCo in 1994, its recipe for growth suddenly wasn't working anymore. Its restaurant operations, which included Pizza Hut, Taco Bell, and KFC, stalled. An attempt to catch up to Coke overseas - Coke had 71% of its revenue from international sales, vs. PepsiCo's 29% - was a disaster. Enrico took a painful round of write-downs in 1996. Coca-Cola would soon embark on a trajectory that would dazzle Wall Street and turn up the heat in the PepsiCo boardroom.

As Enrico's strategy chief and head of M&A, Nooyi restructured the company out of the wilderness. She went into suburban America and decided that the fast-food marketplace was saturated and the real estate was a hard investment to maximize - Pizza Hut had no breakfast traffic. So PepsiCo spun off the restaurant business in 1997 - no small step, since it would shrink the $31 billion company by a third. She championed the acquisition of Tropicana for $3.3 billion the following year and later the $14 billion acquisition of Quaker, both of which gave PepsiCo some brand names that could help change its reputation. As she explained later in India's Economic Times: "If you want to make a healthy product, you could not use any other Frito brands. To call them the Lays bar or Ruffles bar and expect to use it for breakfast would be crazy." (That didn't stop PepsiCo from coming up with an equally oxymoronic product, Quaker Breakfast Cookies.)

Nooyi also gave a pivotal presentation to the board in 1998 - just as the heat from Coke was becoming unbearable - that dissected the rival's business model and made a persuasive case that its double-digit growth was not sustainable. "It was a tour de force," says Enrico, who is convinced that "at that moment the PepsiCo board understood Coke's business model better than Coke's board did." Four months after the presentation Coke stock peaked at $88 and began a long downward slide.

In the mid-1990s, Nooyi says, Enrico asked her to devise a strategy that could make PepsiCo the "defining corporation for the 21st century." (He remembers saying he wanted PepsiCo to be more like GE.) She drew up scenarios of what that might look like via path A, B, or C. "We picked a particular path, and Quaker Oats was part of that path," she says, along with three smaller "tuck-in" acquisitions. Enrico made Nooyi his CFO, and to this day, he says, she is "the best negotiator I've ever seen in my entire life." Still, he didn't think she was on track to be CEO because "I constantly felt she needed to go do an operating job." His successor, Reinemund, made Nooyi his president and came to feel differently after she successfully integrated the Quaker acquisition. She proved herself both analytical and visionary. She also shared his conviction that the health movement was for real and demanded true innovation - though when fitness freak Reinemund told her he wanted her to run the New York City marathon with him for PepsiCo, she replied, "Well, Steve, I can run it in over a month: a stop here, some shopping there ..." Very early on she made the right calls on the green issue as well. She so readily loosened the capital expenditure requirements for water- and heat-related conservation projects in a Frito-Lay meeting eight years ago that executives remember being stunned by it. "Was that a yes? Can we do that?" sustainability VP David Haft recalls asking his boss immediately after. Those kinds of projects now save Frito-Lay $55 million annually.

As CEO she's been able to stick to her plans for change, which call for gradually shifting the percentage of "better for you" and "good for you" snacks to 50%, up from 30%, and widening the product portfolio with grains, nuts, and fruits. Nooyi has helped shape a model that enabled PepsiCo to pump out new products. Last year the company offered potato chips in 150 different flavors and 55 different variations on orange juice. In December she recruited Dr. Mehmood Khan from the top R&D job at Takeda Pharmaceuticals to be PepsiCo's first chief scientific officer. That may sound dramatic, but in the area of food research, says Morgan Stanley analyst Bill Pecoriello, U.S. food companies are actually falling behind. Switzerland's Nestlé, for example, outspends PepsiCo on R&D (1.6% of sales to 1%) and is calling itself a nutrition company while trying to figure out whether food can prevent disease. Last year PepsiCo bought or partnered with a Bulgarian nut packager, an Israeli hummus maker, and Naked Juice, which makes nutritional beverages like smoothies. "Is Naked Juice a beverage or is it a snack?" Nooyi muses. "I think we can liquefy snacks or snackify liquids."

***

One of Nooyi's most stunning talents is the art of suasion. She can rouse an audience and rally them around something as mind-numbing as a new companywide software installation. Her new motto, "Performance With Purpose," is both a means of "herding the organization" and of presenting PepsiCo globally. Because these days, she knows, you can't take even an emerging market for granted. Says Zein Abdulla, president of PepsiCo Europe: "People still tend to think of the emerging markets as, Oh, well, just do your core portfolio and then sometime in the future when they catch up with the West, you'll do the rest." Well, guess what? They've already caught up. Fully half of PepsiCo's Russian beverage business is noncarbonated drinks - juice, water, tea, energy drinks. Global brands like Pepsi don't play the way they used to. "They work," Abdulla says, "but they are not monolithic."

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