NESTLE'S BRAND BUILDING MACHINE The Swiss powerhouse is racing across the developing world building brands, roads, farms, factories, and whatever else it needs to capture new markets.
By Carla Rapoport REPORTER ASSOCIATE Thomas J. Martin

(FORTUNE Magazine) – PRICE CHECK, Aisle Four! Frozen squid tentacles and Nescafe Cappuccino." If selling in the developing world sounds like a job for a man and a donkey, it's time to have a look at what's happening at Nestle, the world's biggest branded food company. After decades of plodding along as a multinational purveyor of coffee, chocolate, and milk, Nestle is blossoming into a brand franchise machine, albeit with a difference: It's a global company living mostly on local brands. The Swiss giant's full-court press to create Nestle label fanciers in the developing world should set off alarm bells at any growthaholic company eager to escape the shrinking margins of mature markets like Europe and the U.S. Nestle is certainly eager. In the U.S., the company has been engaged in protracted battles in grocery categories like frozen food (Stouffer's) and pet food (Carnation). Nestle's coffee business has been ground into espresso by the everyday low price tactics of Procter & Gamble's Folgers brand. After losing $100 million over the past three years, the U.S. coffee operation was restructured, and four of seven plants closed. Says Les Pugh, an analyst with Salomon Brothers in New York: "The days of the 15% operating margin for the U.S. food industry are dead and buried. " In Europe, the problem is the sluggishness of key markets such as Germany and France, where, of all places, food consumption actually decreased in 1993. These factors have kept Nestle's operating margins barely simmering at 10.7%, less than the likes of Kellogg, Hershey, and Heinz. Despite these unkind conditions, Nestle has plowed ahead in the developed world with the help of acquisitions such as Perrier, Hills Brothers, and Buitoni. Last year sales increased 5.5%, to $43 billion, while earnings increased 7%, to $2.2 billion. And the performance of the company's American depositary receipts makes the rest of the food group look like chopped liver. Nestle represents a thumping rejection of the one-world, one-brand school of marketing. The company prefers brands to be local and people regional; only technology goes global. Call it the Roman Empire school of marketing: Colonize as much territory as fast as you can, adapting to native conditions, and then work at holding off the advancing hordes. TRUE, Nestle grabs a lot of its growth simply by getting on the plane, and into new markets, first. But then it uses brick and mortar shrewdly to build both a manufacturing and a political presence. And Nestle can be extraordinarily patient -- the company negotiated for more than a decade to get into China. Already the largest branded food company in Mexico, Brazil, Chile, and Thailand, Nestle is on its way to becoming the leader in Vietnam and China as well. Salomon's Pugh gets positively misty-eyed about the company's abilities to establish brand loyalty in new places. Says he: "Nestle is the best- positioned food company in the world."

Already, Nestle nets a quarter of its worldwide sales from the Far East and Latin America -- that portion alone is more than General Mills' worldwide sales last year. Says Watinee Khutrakul, a director of Deemar Survey Research in Thailand, the leading market tracker in Asia: "As long as big competitors remain tentative about this part of the world, Nestle can sweep up the market in any product category it chooses." Even better, sales in less-than-mature markets yield grownup profits. Just about one of every three dollars Nestle earns now comes from products it sells outside Europe and the U.S. Pugh predicts that total operating profits will grow 11% annually over the next four years, the highest rate of growth among the global food goliaths. Sales will increase 7% per year, with most of that growth coming from you know where. Nestle has poured nearly $18 billion into acquisitions over the past decade and now owns nearly 8,000 different brands worldwide -- but don't count on seeing hundreds of them in a store near you, wherever you live. Of those 8,000 worldwide brands, only 750 are registered in more than one country, and only 80 are registered in ten. The reason is that the company has chosen two growth paths, neither of which involves global travel for most brands. In developed markets the company gains economies of scale through big acquisitions -- Carnation, Perrier, and Stouffer's, to name three. In the developing world, it grows by manipulating ingredients, or processing technology for local conditions, and then slaps on the appropriate brand name. Sometimes that's a well-known one like Nescafecoffee; generally a local one works fine -- for instance, Bear Brand condensed milk in Asia. In new markets Nestle alights with a mere handful of labels, selected from a basket of 11 strategic brand groups. The idea is to simplify life, limit risk, and concentrate the attack. The approach also means that brand survival becomes the top priority for managers. Nestle can then pour advertising and marketing money into just two or three brands per country and come up with monster-size market shares. Says Peter Brabeck-Letmathe, 49, an Austrian and the executive vice president in charge of marketing: "We don't believe in life cycles for brands. A well-managed brand will survive us all." According to a recent report by the London stockbrokerage James Capel, Nestle is the market leader in instant coffee in Australia (71%), France (67%), Japan (74%), and Mexico (85%). In powdered milk, it's a similar story: the Philippines (66%) and Brazil (58%). In Chile, Nestle has 73% of the cookie market and 70% of soups and sauces. Just how does a Swiss coffee company sell a hot beverage in the tropics, the marketing equivalent of selling snow to Eskimos? That was Nestle's problem in Thailand in 1987. Coffee sales were growing, but the company had to decide whether to launch other Nestle brands into the market or invest in building more coffee sales. The dilemma fell to Att Senasarn, born in Austria as Alfred Senhauser and now a naturalized Thai and general manager of Nestle Thailand. He's worked there for Nestle for 30 years and is one of about 100 managers worldwide who spend their entire careers in just one region of the globe. Says he: "In ten years we had established coffee for breakfast for people in the cities. Sales were growing by about 7% to 10% a year. The economy was growing so fast, it was overheating." The group gambled that this mounting wealth held more for coffee than for any other product it could push or acquire. Says Senasarn: "Soft drinks lacked the satisfaction or romance of coffee. We took a critical decision. We said, 'Let's forget the idea that Nescafe is a Western drink. Let's look at it as a beverage.' " The locals junked the traditional taste, aroma, and stimulation strategy for advertising coffee on TV. Instead, the new ads played on the new urban stress, showing a man kicking a taxi door in frustration. The campaign promoted coffee as a way to relax from the pressures of the traffic, the office, and even romance. Within Nestle, the switch caused a ruckus. The zone manager for Asia, Rudolf Tschan, stalked out of a screening of the first TV ad of the campaign. But the local group still had authority for Thailand and held firm. Then Senasarn desecrated coffee even further. In one of his regular trips to Switzerland he latched on to a summer coffee promotion from Nestle Greece, a cold coffee concoction called the Nescafe Shake. The Thai group swiftly adapted the idea. It designed plastic containers to mix the drink and invented a dance, the Shake, to popularize the activity. Senasarn dreamed up an old- fashioned "talent" contest for an annual Shake girl in 1988, and the event quickly became as big as the Miss Thailand event. Coffee sales in Thailand jumped from $25 million in 1987 to $100 million this year. Says Deemar's Khutrakul: "They made coffee into a Thai drink. There's no doubt they can continue growing like this for the next three years." Nescafe sales, she forecasts, will climb at three times the economic growth rate of Thailand, or about 25% a year. Nescafe now owns 80% of the market. Easy without competition, right? But in South Korea, Kraft General Foods has dominated the coffee market since the Fifties -- when GIs popularized the drink. Nestle crossed the border in 1987, pouring on the advertising, playing tough on pricing, and later building a sophisticated instant coffee plant. Today, Nestlehas corralled 35% of the Korean market and, according to the Swiss brokerage UBS, should hit 50% in the next few years. Beyond its brands, Nestle boasts a unique advantage in its autonomous regional managers. They circulate constantly between the developed and developing worlds and can pick up new weaponry from Europe or Japan before returning home to Asia or Latin America. Says Andreas Schlpfer, managing director of Nestle Thailand: "Unlike most American companies, managers in Nestle can make their career away from the head office. U.S. managers usually come here on two- to three-year contracts." In Asia and Latin America, managers shuffle around the region at four- to ! five-year intervals. For example, the Filipino manager of technical operations at Nestle's new coffee factory in Bangkok recently left for Indonesia, where he'll supervise a new plant. Helmut Maucher, Nestle's German-born chairman and CEO, believes that deepening the pool of cross-border Asian managers is far more important than sending Americans or Europeans. Says he: "They can never know the culture as well as a local." Listening to the local talent might, in fact, have prevented the dismal start for Twin, a powdered blend of milk and soya milk. Twin, invented in Brazil and Switzerland, is made in Indonesia and Mexico with locally grown soya beans and milk, and sold regionally. The product comes straight from the top -- Maucher is intent on fashioning products for Asians and South Americans made from native ingredients. Soya milk is both more available and more stable than cow's milk in these climes. But, complains Suwimol Kaewkoon, executive vice chairman of Robinson Department Stores, one of the leading retail chains in Thailand, "soya beans to Asians are a cheap thing, a second-grade product."

NESTLE is still pushing Twin, but there have been outright flops. For example: a three-in-one coffee, creamer, and sugar mix that took the fun out of making coffee, and nonfat milk powder -- Thais aren't overweight just yet. Something as simple as milk with honey, a relatively rare ingredient in sugar- mad tropical countries, has proved more popular. In Thailand, Bear Brand With Honey is growing 15% annually. "What we lack in Asia is cow's milk," says Robinson's Kaewkoon, "so that was a hit." A slightly different version is on sale in Taiwan and Hong Kong. By going for big shares with a limited number of brands, Nestle leaves the door open for smaller, wilier competitors who can live nicely in the gaps. Says Howard Schultz, CEO of Starbucks: "Companies like Nestle gave us the opportunity to make it in the U.S. For years they've been bringing the consumer bad-quality coffee." One of America's fastest-growing companies in 1993, Starbucks is still putting on sales growth of 75% per year. And Starbucks's kind of success against Nestle could be repeated in Asia. In Robinson's department store in Bangkok, you'll find the first frozen TV dinners in the country attracting attention. But they are made by local competitors, not Nestle's Stouffer's or Findus brands. The heavyweights are here too. In Malaysia, Unilever is barreling in with a huge advertising push for its Magnum Ice Cream bars. No big deal, responds Nestle's man in Bangkok, Andreas Schlpfer, who believes that bordering markets offer a more exciting prospect than broadening Nestle's product range. Says he: "Vietnam has 70 million people. I can open a new front there without weakening the home front. Unless you start early, you risk losing the chance of being market leader." The group is already selling Milo, a powdered chocolate drink, in Hanoi and Ho Chi Minh City. Sales should hit $10 million this year. Schlpfer is eyeing Laos and Cambodia. Says Graham Catterwell, head of Crosby Research in Bangkok: "If you add in Yunnan Province to the north, this region has as many people as Europe. I can see why Nestle is moving geographically and fast." The company has looked at frozen food, frozen pizza, and a whole range of middle-class products but doesn't think the Thai market is ready. Yet Nestle can lug its basic portfolio -- coffee, chocolate, and powdered milk -- into the most remote areas without fear. Latest map points: a bouillon factory in Guinea-Conakry, in west Africa, and a condensed milk factory in Sripur, Bangladesh. There are still plenty of places where the governments are undependable, raw materials hard to get, and import duties sky high. Consider how Nestle managers handled those problems in the most attractive emerging market in the world, China. After 13 years of talks -- that's right, 13 -- Nestle was finally invited into China in 1987 by the government of Heilongjiang province (formerly Manchuria) to help boost milk production in the region. Says Mike Garret, head of Nestle's Asia/Pacific region: "It took so long to get to this point. We often lost heart. We didn't know if there would be a market for our product, not to mention whether we could assure supply. But when a government asks for help, you're on your way to building up valuable credit within a society." Capitalizing on its experience in Sri Lanka and India, Nestle opened a powdered milk and baby cereal plant in China in 1990. Then it had a choice: use the severely overburdened local trains and roads to collect milk and deliver finished goods, or create its own infrastructure. The latter was a lot more costly but would ultimately be more dependable. So Nestlebegan weaving a distribution network known as "milk roads" between 27 villages in the region and the factory collection points, called chilling centers. The farmers, pushing wheelbarrows, pedaling bicycles, or on foot, ; followed the gravel roads to the centers where their milk was weighed and analyzed. The company started another innovation: paying the farmers promptly, something the government didn't always do. Says Garret: "Suddenly the farmers had an incentive to produce milk." Many of them bought a second cow, increasing the district cow population to 9,000 from 6,000 in 18 months. Then area managers organized a delivery system using vans dedicated to carrying Nestle products. Nestlehired retired teachers and government workers to serve as farm agents, bringing in Swiss experts to train them in rudimentary animal health and hygiene. One retiree is assigned to each village, and each receives a commission on all sales to Nestle. They also serve as culture brokers for the Swiss to the peasant farmers. Once this system was in place, the business took off. In 1990 the factory produced 316 tons of powdered milk and infant formula. This year it will turn out 10,000 tons, and capacity is being tripled. Nestle has exclusive rights to sell the output across China for 15 years. David Sheridan at James Capel in London estimates that Nestle's sales in China, boosted by two additional factories, are now about $200 million and delivering a small profit. He predicts sales will hit $700 million by 2000. Says Sheridan: "I haven't found another company willing to pour resources into China like this. The big payoff is still to come, but you can bet it will be solid and long-lasting." This on-the-ground development creates such good will with governments that it often insulates Nestle from the kind of instability found in developing nations. Take Malaysia: There Nestle still has to import coffee beans, but it is teaching farmers in the north how to grow the important robusta variety of bean. Last year Nestle's import quota on coffee was about to be denied. But before its import license expired, the managing director in Malaysia, Frits Van Dijk, gave government officials a tour of the Nestle-sponsored coffee plantation. Two weeks later the license arrived. Another case of working with the locals to build a business is chocolate. Nestlelags behind its competitors in many Asian markets, mostly because it was slow to conquer the obvious difficulty of distributing rich, meltable chocolate in hot climates. Some makers, like Cadbury Schweppes, have their own display cases in shops. Others, like Toblerone, stick to air-conditioned stores. For Van Dijk in Malaysia, the challenge was whether to break into the market with imports and risk a bruising price war, or consider making chocolate bars there. Malaysia is a leading exporter of cocoa beans, but the quality of the Malay beans wasn't rich enough, says Peter Eichenberger, chairman of Diethelm Holdings, which imports Toblerone from Switzerland. Adds Van Dijk, a Dutchman who has also spent his career with Nestle in Asia: "The Malaysian market wasn't really big enough to justify its own chocolate bar plant, even if we could get the local beans to satisfy our requirements." The solution: produce a slightly different Nestle's KitKat chocolate wafer bar for the entire Asian region from Malaysia, using local cocoa. This plan came with a built-in bonus. Johnny Santos, a Filipino and head of Nestle Singapore, knew that tough import duties among Asean countries (a trade group including Malaysia, Singapore, the Philippines, Indonesia, and Thailand) would be slashed for Nestle if it could produce KitKat and Smarties (an M&Ms competitor) in Malaysia with a local joint-venture partner, and then set up other such ventures around the region. By 1991, Van Dijk had persuaded the Mecca Pilgrim Fund, one of the largest investment funds in Malaysia, to be his partner. His colleagues in other countries set up similar ventures: soya-based products in Indonesia, breakfast cereals in the Philippines because of ample corn and sugar, Coffee-Mate in Thailand, and soy sauce powder in Singapore. THEN Nestle went into the plantations and worked with the farmers. In the case of Smarties and KitKat, Nestle's lab in Singapore devised a formula to raise the candy bar's melting point by reducing the fat content. The factory technicians redesigned their equipment to handle the tougher native beans. Van Dijk is gambling that the new KitKat, launched last November in Malaysia, will appeal to local consumers even though it doesn't taste as rich as the imported kind. (Smarties go on sale this summer.) Instead of the rich, chocolate taste, Van Dijk is offering a tasty price. Nestleintroduced KitKat at one ringgit (39 cents), about 30% cheaper than the imports. Even at this price, however, the company can maintain margins of about 20%. By June, Low Ming Siong, a director in Kuala Lumpur of Crosby Research, reported, "KitKat is one of the fastest-growing products in Malaysia in its category. If it stays cheaper, it will go like a rocket." If local production is the key to boosting sales and profits in the - developing world, why don't more companies do it? Says Nestle's Thailand manager Schlapfer: "One of the great mysteries of my life is, Where is the American competition out here?" Competition, however, is arriving in the form of American-style supermarkets and supercenters now sprouting up in the developing world. Bringing low prices and huge volumes, these retailers are starting to apply the kind of margin pressure that Nestle thought it had left in the U.S. and Europe. In Mexico, joint ventures between Wal-Mart and Cifra, Fleming Cos. and Gigante, and Price/Costco and Comercial Mexicana are starting to concentrate retail power. Makro, the Dutch warehouse club operator, now runs eight stores in Thailand, seven in Taiwan, and two in Malaysia, and is opening in Korea and China next year. Says Ian Hamilton, president of Siam Makro in Bangkok: "The new middle classes, just emerging from poverty -- that's who we are serving." Already, in Taiwan, Makro is reaching sales of $1 billion a year. Joseph Hendricks, 28, a former Wal-Mart manager and a native of Mena, Arkansas, is vice president of business development of Lotus Supercenters, a Thai subsidiary of one of the largest industrial groups in the country. Failing to link up with Wal-Mart directly, Lotus hired three ex-managers of the chain and now aims to build 76 superstores across Thailand in the next decade. Says Hendricks: "The usual deterrent for Western companies looking at the developing world is the lack of an efficient form of distribution throughout the country. Our goal is to correct that. We're doing for Thailand what Wal- Mart did for the U.S." The first Lotus store opens in September. So, can Nestle forget about milk roads and start worrying about margin erosion? The nervousness Nestle managers feel is palpable. Says Schlapfer: "Supermarkets took 8% of our urban business five years ago. Today it's 45% of the business. It's like someone uncorked a genie out of a bottle." Makro, which opened its first store in Thailand five years ago, is now Nestle's biggest customer in Thailand and Taiwan. So Nestleis importing Western brand-management tactics swiftly to hold margins firm. In Thailand, Senasarn launched an overhaul of the sales team, dubbing the new outfit the Red Hot Sales Force. Staffed with college graduates fluent in English, many with MBAs, this group took over the job of selling to supermarkets and superstores. The Red Hot team members routinely jet to Hong Kong, Australia, or the new staff training center in Switzerland for instruction in the latest shelf- management techniques, like Neilsen's Spaceman inventory control system. Nestle is giving this technology, normally used by retailers, to the staff and helping to train its customers, the supermarkets. The hope is to establish solid relationships that will withstand the inevitable competition, when it arrives. ON THE OTHER side of the equation, local manufacturers are stepping up the pressure on big multinationals in Asia. In Malaysia, a local producer is now making store-label tomato ketchup pitched about 25% below Nestle's Maggi brand. Van Dijk is already test-marketing a price cut of 20% in the north of Malaysia. If the lower price boosts sales enough, he'll bring it country-wide. What about margins? Van Dijk responds: "We have the economy of scale and the technical knowledge to streamline production, not just in Malaysia but across the region." Nestle is also adapting loyalty-building programs from England, such as frequent-buyers clubs, to keep the private-label monster at bay. The challenge ahead for Nestle: maintain profit growth as the competition in the developing world intensifies. The pickings still look good. Admits Makro's Ian Hamilton: "The balance of power in emerging economies is still very much in favor of the manufacturer at the moment." For Nestle, that fact still looks as attractive as an ice-cold drink of coffee.F