How PepsiCo Dreams Up New Products in China -- And Outsmarts the Copycats

Chef Links Chen once worked the kitchens at a five-star hotel in Shanghai. Now, still wearing crisp chef's whites, he spends a typical day cooking up new potato-chip flavors at PepsiCo's research center in Shanghai. PepsiCo's Lay's brand has famously funky flavors in China, from cucumber to iced lemon tea to a concoction called "Numb & Spicy Hot Pot." Mr. Chen's latest challenge: Make pizza-seasoned chips more palatable to Chinese taste buds. "Chinese people do like pizza, but they don't like too many herbs," Mr. Chen said, offering up a tray of snacks seasoned with barely any basil or oregano. If local tasters like them, they might go from Mr. Chen's kitchen to a lab for development into a product, then on to a pilot manufacturing plant -- all in the same building in Shanghai. PepsiCo has found success in China by adapting brands including Lay's, Tropicana and Quaker to local tastes. The year-old research-and-development center in Shanghai -- the company's largest outside North America -- is a centerpiece of its ambitions for China and Asia in general. But PepsiCo isn't the only global marketer focusing on R&D in a market where coming up with compelling new products can be tough due to local copycats, pricing and manufacturing challenges. L'Oréal's Shanghai center for research and innovation has developed beauty products using traditional Chinese medicine remedies, including ginseng and white fungus. And in nearby Wuxi, Caterpillar designed a piece of construction equipment, the Cat 986, for China and other growth markets. Coca-Cola, Hershey, Mondelez, DuPont and 3M all have R&D centers in Shanghai or nearby. Copycat brands Fast-moving consumer-goods companies like PepsiCo have a particular product-development challenge in China: Their innovations are especially vulnerable to cheaper copycats. Dara MacCaba, founding partner of innovation consultancy Lucid360, worked with Unilever in China several years ago as it launched a Lipton milk tea in a cup. That offering inspired "hundreds" of copycats nationwide, he said. "Competitors made the cup at a cheaper price point, with less-strict regulatory rules about how you make it," Mr. MacCaba said. While Unilever did painstaking market research and branding work, local competitors simply churned out flavors and put them in supermarkets to see what sold at which prices, he said. Low prices still really matter in China, especially for goods consumed in private that don't confer any status. PepsiCo's solution to the copycatting problem is to add a hard-to-replicate ingredient or other product tweak, often at the research level. One product out of the R&D center is a Quaker dairy drink with oats in it, launched in October. Consumers wanted a high-fiber dairy drink but didn't enjoy the gooey texture of crushed oats. So PepsiCo developed a technique to make roasted oats smooth to drink. Shank Hu, senior director for beverage technical innovation in Asia, the Middle East and Africa, expects local brands to copy it -- but without PepsiCo's know-how their products will be sticky. "We protect our innovations -- there's always a secret ingredient," he said. PepsiCo is doing well here: Snacks volume was up 15% in the third quarter, the company says, while beverage volume also grew in the double digits. PepsiCo has worked hard on snacks in China and has a 4 % share of that market, ahead of Nestlé, General Mills and Kellogg's, according to Euromonitor International. Rival Coca-Cola, which makes Sprite and Minute Maid along with its signature drink, is China's No. 1 beverage maker -- it had a 15.7% share of that market in 2012, compared with PepsiCo's 4.5%. How PepsiCo does it Across the street from PepsiCo's R&D center are farms growing rice and canola. Despite the rural touch, it's a half-hour drive from central Shanghai, since location is key for attracting talent in a competitive market. The center has about 100 employees. Experimentation starts in the massive kitchen (where the chef recently prepared an Indian-Thai fusion vegetarian meal for visiting PepsiCo CEO Indra Nooyi). The chef's creations are sampled by local taste testers who were hired for their discerning palates and then given training. Many are local homemakers, Mr. Hu said. A successful creation might go on to a lab to be turned into a mass-market product. There's a lab to test products for chemicals, and another stocked with microorganisms, including E. coli. "Sometimes we deliberately contaminate products to see whether our processes are good enough to kill it," Mr. Hu said. (That lab is off-limits to visitors.) Elsewhere, there's a 3-D printer for experimenting with packaging shapes and sizes. Sizes vary by market based on customer price expectations -- in China, the company tries to keep its snack prices around 50¢. The last step is a pilot manufacturing plant -- which, during a recent visit, was churning out a mango drink being developed for India. Asia ambitions PepsiCo's R&D plant isn't just for China -- it's also the hub for other Asian markets. A team from India came to Shanghai to develop the mango drink, Mr. Hu said. That product was based on a Tropicana product launched in China and several other Asian markets. "Good ideas will go across to other markets" within Asia and beyond, Mr. Hu said. Another China product development that PepsiCo believes has potential in other markets, possibly including the U.S., involves packaging. In China, Stax potato chips come in the usual cardboard tube, but inside that there's a plastic pull-out tray. The tray stemmed from the insight that Chinese snackers don't like to get their hands dirty when they eat -- and really, does anybody like reaching into a greasy can?

How PepsiCo Dreams Up New Products in China -- And Outsmarts the Copycats

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