By mid-2002, it was not quite clear how Janessa Caldwell, recently elected CEO of

Snack Foods International (SFI), should go about growing the company's new product line,

SnackChips, a healthy snack-food product. SFI, a large U.S.-based global manufacturer of

conventional snack foods, acquired SnackChips' parent company, International Brands (IB) in

2001 because Caldwell believed in significant growth opportunities for SnackChips beyond its

primary market in the United States. "We didn't buy International Brands for its current U.S.

sales," she said. "We bought it for its future growth prospects around the world." If she did not

get top line growth, Caldwell would have paid an awful lot for some cost savings.

One of these avenues for growth was clearly China, where, among others, SFI had some

key decisions to make about a range of marketing expenditures in the context of the emerging

Chinese market and a formidable competitive threat from its chief rival, Consolidated Snack

Foods (ConF). Although a version of the Snackchips brand had been developed for the Chinese

marketplace and was available in some Chinese cities, SnackChips was not widely distributed

and had not been aggressively promoted in China. Moreover, ConF had yet to develop a healthy

snack-food brand for the Chinese marketplace. How SFI went about promoting SnackChips in

China now and in the future would almost surely affect its rival's response and SFI's long-term

profitability.

BACKGROUND

SnackChips, a line of popular snack items, was born in the United States in the early

1980s. In response to growing concerns about the lack of nutritional value in conventional snack

foods, dietician and entrepreneur Chris Ratcliffe had developed a chip made from whole grains.

The original chips were promoted as healthy snacks, having low levels of fats, little sugar,

increased fiber, and a full array of vitamins and minerals.

More than 20 years later, SnackChips were available in a variety of flavors, including the

original whole-grain recipe, nacho cheese, barbecue, salt and vinegar, red and green chile, miso,

and Caribbean jerk. Most flavors were available in both regular and organic recipes. The

packaging was distinctive, using tetrahedron-shaped paper containers in bright colors and

highlighting the nutritional value of the chips.

By 2001, SnackChips brand had more than $3 billion in annual sales and 79% of the

"nutritional" (including natural and organic) snack chip market in U.S. supermarkets. That

success made SnackChips a crown jewel in the portfolio of its parent company, IB. Both SFI and

ConF openly articulated their interest in acquiring IB, with SFI finally succeeding with a $13.8

billion bid, after a bid from rival ConF fell apart. ConF responded to this loss with a massive

promotion of its NutriBite brand, which, at least temporarily, slowed the growth of SnackChips

sales in the United States.

Context: Investing in China

The Chinese marketplace had not been kind to either the SnackChips brand (under IB's

management) or SFI's conventional brands. Since coming to Asia in 1990, IB had lost

considerable amounts of money. Its worst loss in Asia was $35 million in 1996, due mostly to

high overhead and lackluster sales in China. Sales of SnackChips that year in China were

reported to be a mere $14 million. In 2000, things were not all that much better for SFI, whose

share of the $3.1 billion Chinese snack-food market (including both conventional and healthy

packaged snack foods) was only 20% compared to ConF's 40% share. Pundits in the business

press pointed out that SFI's 20-year experience in China was a classic example of the need to

look at investment in China as investing for the long haul.

ConF, on the other hand, had been in China on and off since 1950, with some success.

Although Chinese translations of their brand names had occasionally gone awry?one brand had

inadvertently been translated as "cat fur in the mouth"?ConF had for the most part been able to

do reasonable business there.

After China's opening to market-based reform in the late 1970s, ConF's business

improved substantially. By 1994, ConF had established 20 joint venture production plants across

China. But progress was not a foregone conclusion. The government in Beijing generally

preferred to limit growth of foreign brands in China. Moreover, until recently, the economic

development of China's population presented a potential limit to profitable growth. On top of all

this was the question of whether Western flavors could be successfully adapted to Asian tastes.

In 1995, a prominent analyst had suggested that the way forward for SnackChips

depended on whether IB could make SnackChips a global brand. But could SFI succeed in China

with SnackChips where IB had failed? How would China's government, its developing

economy, and its "local tastes" affect SFI's efforts to grow the nascent SnackChips brand there?

The Decisions

In mid-2002, the immediate decision for SFI in China over the next two and a half years

(through 2004) seemed clear?(1) continue the "usual" expansion plan already in place for

SnackChips or (2) supplement this plan with an additional "targeted" campaign aimed at its most

developed packaged snack-food market?Shanghai. (Of course, SFI's third option was to

withdraw SnackChips from the Chinese market, but this alternative did not make much sense

given the sheer power of SFI's distribution system.)

Between mid-2002 and mid-2012, the "usual" 10-year expansion plan for SnackChips

called for advertising and promotional expenditures of $10 million per year, which amounted to

$25 million in the two and a half years between mid-2002 and the end of 2004 (Period 1). Under

the "usual" plan, from 2005 until mid-2012 (Period 2), the company planned to spend another

$75 million for a total of $100 million over 10 years.

If SFI chose a "targeted" campaign for Period 1, however, it would spend $50 million in

advertising and promotional expenditures in Shanghai in addition to the "usual" Period 1

spending of $25 million for a total of $75 million. SFI also had to start thinking about what it

would do down the road in Period 2. It could either continue as "usual" or be more "aggressive"

in Period 2, which depended, in part, on what it did in Period 1.

In particular, if healthy-snack sales in China were strong in Period 1, SFI might

subsequently pursue an "aggressive" nationwide campaign based on a sports star sponsorship

model. This model had been very successful in the United States. Could SFI make a campaign in

China successful with local sports stars? This was a critical question leading up to the 2008

Summer Olympics in Beijing, when sports would clearly be on the minds of Chinese consumers.

SFI's "aggressive" SnackChips campaign in China would need to begin in 2005 to

capitalize on the upcoming Olympics. Because of economies of scale in negotiating media buys,

the "aggressive" campaign would only cost an additional $200 million beyond the usual $75

million already budgeted for Period 2. In addition, if SFI pursued a "targeted" campaign in

Period 1, it would lay some of the groundwork for an "aggressive" campaign in Period 2 and

would need to spend only $190 million in additional "aggressive" ad support, for a savings of

$10 million.

On the other hand, if the sales of healthy snacks were not strong during Period 1, SFI

might want to fall back on the strategy of continuing to expand the sales of SnackChips with the

"usual" level of advertising and promotional support in Period 2.

Complicating matters was the challenge of predicting ConF's reaction to SFI's decisions

and the sales results for healthy snacks in China. It was clear that ConF was already committed

for the next two and a half years to rolling out new conventional snack-food products in China.

Even so, SFI knew that if healthy-snack sales in China were strong during this period, ConF

might decide to enter the healthy-snack market with a competing brand at the beginning of 2005.

Because of supply chain and other product development issues, though, ConF would not be able

to enter the Chinese healthy-snack market before 2005.

In mid-2002, a widely agreed-upon forecast estimated that total sales of packaged healthy

snacks in China during Period 1 under the "usual" campaign would most likely be $240 million

(on average $266.67 million), with a low-end estimate of $160 million and a high-end estimate

of $400 million. Furthermore, it estimated that sales under a "targeted" strategy in Period 1

would be 125% of sales under the "usual" campaign. Without a competing brand from ConF in

the market, SFI thought SnackChips could establish and maintain an 80% market share in China.

But if ConF spent $50 million to introduce a competing brand of healthy snacks at the beginning

of 2005, SnackChips would only keep a 50% market share, and ConF's competing brand would

garner 10% thereafter.

Both SFI and ConF were marketing conventional snack-food brands in China. Each

company's promotional strategies in China for these brands were pretty well played out, and

there was no reason to expect those strategies to change much in the foreseeable future. As a

result, SFI's and ConF's market shares for conventional snack-food brands were expected to

remain at 20% and 40%, respectively.

In addition, each additional dollar of sales of healthy snacks was expected to reduce total

sales of conventional snack foods by $0.40. Gross profit margins on packaged healthy snacks

were 30%, while net margins (net of advertising and promotional expenses) on conventional

packaged snack foods were 5% for both SFI and ConF. Given these figures, it might make sense

for SFI to risk some further erosion of sales of its conventional snack-food brands. Unfortunately

for ConF, whether it entered the healthy-snack market or not, some erosion of its conventional

snack-food sales was unavoidable; it knew SFI was already committed to the healthy-snack

market at some level.

Projections for total sales of healthy snacks in China under the "usual" strategy during

Period 2 were most likely 5.5 times (on average 5.33 times) the sales in Period 1, with a low of

4 and a high of 6.5. Under an "aggressive" strategy without an entry from ConF in the beginning

of 2005, total sales of healthy snacks in Period 2 would be 150% of those under the "usual"

strategy. In any case, with a healthy-snack entry from ConF in the beginning of 2005, total sales

of healthy snacks would be 120% of those absent a ConF entry in Period 2.

Because of long-term uncertainty about the Chinese government's reaction to foreign

food companies dominating the Chinese market, SFI and ConF were both unwilling to look more

than a decade into the future. Thus, the companies evaluated projects based on their expected net

present values of 10-year pretax cash flows, discounted at an annual rate of 10% and evaluated in

U.S. dollars. SFI and ConF both were willing to consider all cash flows in Period 1 as effectively

received/dispersed in mid-2003 (essentially in one year) and all cash flows in Period 2 as

effectively received/dispersed in mid-2007 (essentially in five years).

It seemed reasonable, at least initially, to assume that SFI's and ConF's decisions and

results in all other markets (e.g., packaged foods for meals, baby food, cereals) were independent

of their interactions in the conventional- and healthy-snack markets. For Caldwell, the question

remained: Should SFI go forward now with the "usual" or the "targeted" campaign for

SnackChips in China? To address this question, Caldwell's assistant had already put together the

baseline analysis shown in Exhibit 1. Clearly, what remained was to anticipate ConF's reaction,

check the implications of SFI's possible decisions, and then make a move.

Exhibit 1 SNACKCHIPS IN CHINA Baseline Analysis A B C D 1 Assumptions 2 3 Expenses (in millions) 4 "Usual" ad support per year 10 5 "Usual" ad support in Period 1 (mid-2002 through 2004) 25 6 "Usual" ad support in Period 2 (2005 to mid-2012) 75 7 Additional "targeted" ad support in Period 1 50 Additional "aggressive" ad support in Period 1 200 9 Additional "aggressive" ad support savings in Period 2 10 10 Conf's entry costs and ad support 50 11 12 Market shares 13 ConF conventional-snack share 409% 14 SFI conventional-snack share 209% 16 BFI initial healthy anock chore 16 SFI healthy-smack share if ConF enters 509% 17 Conf potential healthy-smack share 109% 18 19 Discount rate. erosion cale, margins, and base-level sales 20 Annual discount rate 109% 21 Conventional-smack sales erosion rate 04 23 Gross margin healthy snacks 309% 24 Healthy smack sales in Period 1 under "usual" (in millions) 246.67 25 26 Multipliers 27 "Targeted" Period I multiplier 1.25 28 "Aggressive" Period 2 multiplier 1.50 29 Conf entry Period 2 multiplier 1.20 30 Healthy-snack Period 2 multiplier 5.33 31 32 Analysis 33 34 Decisions 35 SFT's decision in Period 1 (1="Targeted," (="Usual") 36 SFT's decision in Period 2 (1-" Aggressive," (-"Usual") 37 ConF's decision in Period 2 (1-"In," 0-"Out") 38 39 Period I sales results 40 Healthy-snack sales in Period 1 S 266.67 41 Conventional-snack sales lost in Period 1 due to erosion 106.67 42 43 Period 2 sales results 44 Healthy-snack sales in Period 2 S 1,421.35 45 Conventional-snack sales lost in Period 2 due to erosion 568.54 46 47 Cash Flow Statements (in millions) NPV Period 1 Period 2 48 (mid-2002) (mid-2003) (mid-2007) 49 Contribution margin 5 64.00 5 341.12 50 Erosion costs 1.07 5.69 51 Ad expenses S 25.00 75.00 52 SEI's payoffs $ 196.20 37.93 $ 260.44 53 54 Contribution margin 55 Erosion costs 2.13 11.37 56 Ad expenses 57 ConF's payoffs 5 (900) 5 (2.13) 5 (11 37)