Gatorade’s Switch to DSD Brings Up Pricing Issue

PepsiCo's recent move from warehouse delivery of Gatorade products in the c-store channel to direct-store delivery through company-owned and independent bottlers has led some industry players to rethink the beverage category and question the channel's decades-old pricing structure.

As 2010 drew to a close, retailers were asking: how will this move affect pricing? Will self-distributing c-store chains be allowed to self distribute and will they get a price break? Will the switch lead to more product diverting? More difficult to answer: Why has the industry “allowed” higher pricing to c-stores, compared to other channels of trade?

"I knew [the switch to DSD] was going to happen sooner or later because that was the original plan when Pepsi purchased Gatorade," said Matt Paduano, vice president of category management, Nice N Easy Grocery Shoppes Inc., an 80-store chain based in Canastota, N.Y. "But it's still kind of took me by surprise. I see this as a competitive reaction to Coke being able to distribute, merchandise, market and control its PowerAde brand."

For its part, PepsiCo said the move to DSD for convenience, up and down the street (UDS) and dollar channels is an example of the company resetting systems to best serve its customers.

"We remain dedicated to the existing warehouse distribution system for some of our beverage products, but the change to direct-store delivery makes sense for Gatorade as we redefine the sports nutrition category through the G Series," Massimo d'Amore , CEO of PepsiCo Beverages Americas, said when the strategy was announced last September. "As a company, we are committed to bringing a wider variety of products to market more quickly and efficiently than ever before."

But Paduano said Pepsi's DSD strategy may mean fewer Gatorade SKUs in Nice N Easy's cold vault. "With Pepsi carrying some Gatorade, as well as the wholesalers, there was competition between the two for share of space," he said. "With one distributor this should go away.

"In addition, I don’t believe Pepsi can handle all of the various SKUs on their trucks, so I expect to see some paring down their offer in other SKUs and not jeopardize the SKU assortment for Gatorade. They also tell me they will consider increased frequency of distribution if warranted. Some of our stores were getting twice-a-week delivery from our wholesaler, and Pepsi is well aware of that."

In the past, it was not unusual for Nice N Easy to put 150 cases of isotonic drinks in a store and sell them down to avoid distribution issues during peak selling season. "My Gatorade and Pepsi rep are on top of the issues and want to make sure this gets off to a good start," Paduano said.

The retail executive is bracing for a large Gatorade cost increase as Pepsi DSD starts delivering, even though this would put the brand at a greater disadvantage to PowerAde, which is being priced very aggressively to retailers. Still, his biggest concern is the beverage giant will try to build minimum share of isotonic space into their retail contracts.

"We have resisted this with Gatorade when it was coming from the wholesalers and will look to be doing the same with Pepsi DSD," Paduano said. "In addition, every time one of the 'big boys' buys out an existing brand and folds it into their portfolio, retailers lose major marketing/merchandising payment that were being earned when those brands were independents."

His latest contract, however, continues to keep Gatorade business separate from other Pepsi products and is tied to cooler space and maintaining a maximum retail price differential between Gatorade products and the competition.

For its part, Pepsi management said the move to DSD is the first large-scale step toward optimizing delivery systems resulting from the company's bottling acquisitions in early 2010. The expected synergies related to these changes are included in the company's target of $400 million in pre-tax annualized synergies from the bottling acquisitions once fully implemented by 2012.

"The distribution of Gatorade in key trade channels of convenience, UDS and dollar is well-suited to the direct-store delivery model due to its high velocity, so the switch will result in better store-level customer service," said Eric Foss, CEO of Pepsi Beverages Co. "By achieving greater speed, simplicity and flexibility, we will be able to better serve the current and future needs of both our retail customers and consumers in the marketplace.”

Other PepsiCo brands that are warehouse-delivered to c-stores, including Tropicana, Quaker and Naked Juice, will not be affected by the change.

More than two months after the announcement, there was still uncertainty about how the move will play out and what it will mean to the c-store industry. One large self-distributing retailer declined to comment on the move, saying the chain's management team hadn't heard much from the beverage company. Another said its strategy in getting Pepsi to the stores would remain confidential so as not to anger anyone.

Gus Olympidis, CEO of Valparaiso, Ind.-based Family Express Corp., a self-distributing operator of 52 stores, said the company occasionally diverts product, buying on deal in areas/channels outside the Northwest, North Central Indiana convenience market.

"We don't know yet how this move will affect pricing to c-stores," Olympidis said. "PepsiCo is exercising its legal rights to place Gatorade on DSD trucks and is looking, I suspect, to manufacture low and sell high. The critical question is not how will this affect pricing in the channel, but how may it affect the extraordinary price differential we see in the beverage category between the convenience channel and the other channels for the exact same product? It could be inconsequential, problematic or even therapeutic. Who knows?"

There is some industry concern, too, that the Gatorade DSD delivery model will be less efficient than the warehouse distribution model was."The warehouse model is remarkably more efficient," Olympidis said. "What will the switch do to price? We don't know. One could argue the [added cost of] the lack of efficiency will have to be passed on to the retailer."

One wholesale industry player who didn't wish to speak on the record predicted a bump in out-of-stocks, at least initially. But Joe Jacuzzi, vice president product and brand communications for Pepsico Americas beverages told CSNews the beverage company's DSD system will allow speed to market, address high velocities in peak months and improve reach to all convenience stores.

"Gatorade, with its high turns and acceleration of consumer demand in the hotter months, is well-suited to this method of delivery," he noted. "We will also be a more tightly linked total beverage partner for our customers and will be able to increase flexibility and responsiveness to the competitive influences in the marketplace."

For Olympidis, industry stock levels were not a huge concern. "The inefficiency and the unfairness of what some may describe as discriminatory pricing are the key issues," he said. "Buying an ounce of one drink and seeing that same ounce of that drink being sold at Sam's for less than half the amount than a c-store would pay via DSD is the real problem."

While the bottler may argue that adding critical mass to the DSD system will boost efficiency, Olympidis said he "doesn't see half-empty Pepsi trucks driving by, so where would the efficiency of [adding SKUs to a truck] come from? Having said all that, should one blame Pepsi for asserting a venue that is ultimately beneficial to its shareholder? Of course not. Pepsi is in the business to make a buck. You can't blame the bottler.”

Calling this channel price differential a "sore subject with us and other c-store retailers for years," Paduano said the team at Nice N Easy believe the big beverage companies are using the channel as a profit generator to subsidize the big box and supermarket pricing structure on take-home packages.

"This gets brought up each year at time of contract negotiations and these big guys will not budge," he said. "We have walked away from contracts in the past because of this but the problem is that some of the bigger c store chains will sign with these beverage companies and then put the rest of us at a disadvantage even with the c-store channel."

In contrast, the beer vendors in upstate New York, he said, "have not played that game," offering straight pricing for all retail channels, and c-stores have benefited by being able to compete with the bigger retailers and in many instances moving more product than their big box neighbors. “One of these days the big beverage companies will see the c-store channel as an opportunity to move cases and not just be the golden goose,” said Paduano.

Butch Fulton, merchandise manager for Plaid Pantry Inc., the 104-store chain based in Beaverton, Ore., believes the move puts the c-store channel at a disadvantage to larger format stores, who will still buy directly. “There are inherent costs in DSD, in fewer efficiencies and the cost of ordering and stocking in the stores, which I don’t consider worth a price increase,” he said. “This year, I know, because of our size, we will be treated fairly and have a deal that is on par with the one we had when we received Gatorade through our wholesaler. But going down the road, in 2012, I think the program will tighten up.”

Fulton, who said he has an “excellent” relationship with his PepsiCo account executive, doesn’t believe the switch to DSD is a good plan long term. “If they did it across all channels -- which I’m told will happen in a year, but I don’t really believe it -- then it would be more fair,” he said.

Regardless, Fulton said he “can’t touch” the retails tagged on Gatorade at large format stores now. “They are definitely getting price advantages, but I’m not sure what our channel can do about it. We’ll get the ‘volume argument.’ And in most markets, there is little competition, since Gatorade dominates share. It’s almost impossible to throw Gatorade out of the stores.”

Fulton, who calls himself a squeaky wheel that always gets the grease, said the price difference has hurt the company’s isotonic business quite a bit over the past 10 years. “One [big box] chain or another has it for 79 cents darn near every week and definitely $1 is a common retail price anymore. But I’m paying $1.34 for the same product,” said Fulton.

The pricing puzzle has lead to isotonics being one of the most diverted products in the channel, Fulton noted. Despite the obstacles, Gatorade is the only isotonic sold in Plaid Pantry stores because the retailer is compensated for giving exclusivity to Gatorade. “I could not go Powerade exclusive, even 90 percent, some Gatorade SKUs would have to keep for my customers,” said Fulton.

He expects to see self-distributing retailers divert a great deal of product. “I’ve also heard that some of the independent bottlers in some markets don’t want to take on Gatorade -- they don’t want to handle it or don’t have space in their warehouses -- and that c-store wholesalers in those regions are being asked to keep distributing Gatorade in those areas.”

Addressing this and the possibility of selling direct to self-distributing retailers, PepsiCo's Jacuzzi said DSD is the company's standard go-to-market system for Gatorade for all c-stores.

"We are working with retailers to maximize this delivery method," he said.