FRITO-LAY UNDER SNACK ATTACK

By John Greenwald

Can it really be bad to be so good? Consider the case of Frito-Lay, which has long been America's king of salty snacks. In recent years the PepsiCo subsidiary, whose bite-size best sellers range from Lay's Potato Chips to Rold Gold Pretzels, has crunched more than one rival that got hungry for its business. Since the late 1980s, Frito-Lay, with $5.5 billion in sales last year, has boosted its industry market share from 38% to a towering 55%.

But despite--or because of--this stellar performance, Washington suspects that something must be rancid at Frito-Lay. In a move that caught even antitrust experts by surprise, the Justice Department confirmed last week that it has begun a probe of the salty-snacks industry; insiders say it is focusing on Frito-Lay. The action was all the more unexpected because other companies have amassed even larger shares of their respective markets without government eyebrows being raised (see chart). But Justice is said to be looking hard at Frito-Lay's use of shelf allowances, a common retailing practice in which manufacturers pay stores up to $100,000 a foot for desirable shelf space. Among other things, investigators want to know if Frito-Lay has been purchasing more space than it needs in order to muscle out competitors.

Certainly, over the past six years, Frito-Lay has beaten the daylights out of big companies and small through a combination of restructuring, new products and lower prices. "That's exactly what a competitor is supposed to do, get more efficient and gain market share; and that's what they did," says August Busch III, president and chairman of Anheuser-Busch Cos. Busch should know, having lost somewhere north of $500 million trying to make Anheuser's Eagle Snacks division a power chip. In February, Eagle gave up; it recently sold four plants to Frito-Lay. A-B launched Eagle in 1979, but the division never turned a profit. "We could never get enough market share," says Busch, who has had far more success in his core business of beer, where A-B commands a 44% share of the market.

Another casualty was Borden, the one-time dairy king, which believed it could develop a highly profitable position as the No. 2 player by assembling a group of regional snack-food companies. Not only did Frito-Lay beat Borden until the cows went home, but the damage was so severe that Borden, once a $5.6 billion independent company, nearly imploded, and was eventually bought by Kohlberg Kravis Roberts. Borden, having sold all its snack units except for its Wise Foods and Moore's Quality lines, now has a market share of 5%, down from a high of 12%.

Dozens of independent regional snack companies have folded in recent years. "Frito-Lay makes no bones about it," says Spencer Hill, vice president of sales and marketing of Clover Club Foods, a $60 million manufacturer of salty snacks in Kaysville, Utah. "They want to be the only salted-snack company in the country." Another food-company executive says Frito-Lay fields marketing "warlords" assigned to ride herd on regional companies. "They are the best-run company in the food business," this executive says, without rancor. "They are terrific at what they are doing--and we don't want anything to do with them."

The Justice Department got interested in Frito-Lay while monitoring the firm's acquisition of the Eagle Snacks factories. The department cleared the Eagle deal in April, but its inquiry raised concerns that spurred the new investigation. Nonetheless, Sean Orr, senior vice president and chief financial officer of Frito-Lay, told Time last week that the company had learned of the probe only through news reports. "We have a very strong market position, and they have a right to investigate us or anybody like us anytime they want," Orr said. "We'll be as cooperative as we can."

Fortress Frito-Lay began to assume its present state in 1991 when Roger Enrico, now CEO of parent PepsiCo, was put in charge of the division. The company's market share had fallen to 38% from 42%, but profits were solid because Frito-Lay kept raising prices. Raising prices while losing share is a recipe for disaster in an era in which value is a driving force in consumer behavior. Worse, when Frito-Lay compared its snacks with those made by Eagle, it concluded that its rival's were better.

Enrico launched a major overhaul, including more than 1,000 layoffs, that slashed half a billion dollars from operating expenses. He used the savings to improve existing products, lower prices and aggressively roll out new items. Recently the company has been adding low-fat varieties that are hits. Aiding that strategy has been a 13,000-strong delivery force armed with hand-held computers that can track buying trends by the day and act accordingly.

Frito-Lay is now a virtually unassailable stronghold that provided a more than bite-size 31% of PepsiCo's $3.5 billion in operating profits last year. Frito-Lay's 1995 profits hit $1.13 billion, up from $617 million in 1991. The company has added some 9,000 jobs since it reorganized, bringing its payroll to 35,000. Sales have been rising 10% to 11% a year, while other big food companies, such as Campbell Soup and Nabisco, have eked out gains of no more than 3%.

News of the Justice investigation puzzled legal experts, who noted that Washington hasn't challenged industry shelf-space practices in more than a decade. Apparently Frito-Lay has become something of a victim of its own clout. "They've driven all their competitors out of business by being too successful," says William Leach, who follows the food industry for the investment firm Donaldson, Lufkin Jenrette. "There's nothing unethical. They're just better at product development, marketing and execution. But there is no law against doing well." That, of course, is something the government is now trying to decide.

--Reported by Viveca Novak/Washington and Stacy Perman and Jane Van Tassel/New York

With reporting by VIVECA NOVAK/WASHINGTON AND STACY PERMAN AND JANE VAN TASSEL/NEW YORK