BUSINESS

Back to barter

Pepsico signs a major Soviet trade deal

April 23 1990
BUSINESS

Back to barter

Pepsico signs a major Soviet trade deal

April 23 1990

Back to barter

Pepsico signs a major Soviet trade deal

BUSINESS

Vodka, the Russian liquor distilled from grain mash, has often been denounced by Soviet President Mikhail Gorbachev as a prime cause of low productivity among the nation’s workers. Now, it is gaining importance as an ingredient in Gorbachev’s campaign to stimulate the Soviet Union’s economic rebirth. Last week, Pepsico Inc., the soft-drink and food company based in Purchase, N.Y., announced one of the biggest barter agreements in U.S.-Soviet trade history. Doubling an existing vodka-for-Pepsi-Cola trade arrangement, the Soviets agreed to increase shipments of premium Stolichnaya vodka over the next 10 years and transfer title to 10 Soviet-built oceangoing ships to Pepsico. The American company will increase its production of Pepsi-Cola in the Soviet Union to almost two billion bottles annually by the year 2000, from 960 million bottles in 1989. Pepsico will also introduce its Pizza Hut chain of fast-food outlets to the Soviet Union. And last week in Moscow, as he toasted the deal with a glass of

Pepsi-Cola, Pepsico chairman Donald M. Kendall hailed the accord as the culmination of his efforts to develop the Soviet market. Said Kendall: “We are more than doubling our business over the next 10 years.”

Pepsico executives said that the contract, worth an estimated $3.5 billion in revenue over the next 10 years, will enable the company to expand its already firm foothold on the vast

Soviet consumer market of 290 million people. The deal is also a critical test of Gorbachev’s economic reform program of perestroika, which is faltering because of shortages and poor distribution of consumer goods. At the same time, other Western companies are studying the current vodka-for-Pepsi agreement to determine if it will ultimately be profitable. Because the ruble cannot readily be exchanged for Western currencies outside the Soviet Union, the only convenient way that foreign firms can patriate their profits from Soviet investments is by accepting payment in the form of Soviet-produced goods. They then sell them in the West.

Among the interested onlookers are some Canadian companies. So far, few Canadian firms have entered barter arrangements. Since 1987, the year that the Soviets first liberalized joint-venture legislation, 23 Canadian firms have launched commercial joint ventures in the Soviet Union. According to the department of external affairs, another 50 are now considering ventures, and the Pepsico accord will likely signal to other companies that doing business in the Soviet Union is no longer a high-risk venture. Said Kendall, of the Pepsi deal: “I don’t think there’s any risk. Gorbachev has said he wants more consumer goods and he is counting on the West to do that.” After negotiating with the Soviets from 1959, Kendall finally introduced Pepsi into

the Soviet market, with vodka as a form of payment, in 1974. That was at the height of the regime of Leonid Brezhnev, the Soviet leader whom many economists blame for the economic stagnation of the country. Now, under Gorbachev’s expansionist programs, the food and soft-drink conglomerate, which had worldwide sales of $17.6 billion in 1989, has agreed to double its imports to 24 million 22V2-ounce bottles of Stohchnaya vodka over the next 10 years. Pepsico does not distribute the vodka in Canada.

In return, Pepsico agreed to spend more than $1 billion to double the number of bottling plants it operates in the Soviet Union to 50. They will have a total capacity to produce almost two billion eight-ounce containers a year. And within five years, company officials say that they hope to have an efficient nationwide distribution system in place. To do that, Soviet officials have agreed to allow the company to introduce disposable, lightweight alumi-

num cans and plastic containers. Currently, Pepsi is only available in the Soviet Union in heavy llVfe-ounce bottles and, because they are expensive, cumbersome and must be returned, Pepsico’s market has been limited to 20 km around its plants. There is also a severe shortage of trucks, and the Soviet transportation system is underdeveloped.

As well, the deal allows Pepsi to earn revenues by leasing out the 10 Soviet ships that it received in the barter package. The oil tankers and freighters range from 28,600 to 65,000 tons and are worth an estimated $348 million. Pepsico spokesman Stuart Ross says that the ships are simply another form of counter-trade with the Soviets and the 10 vessels taken over by Pepsico will be leased or sold to a third party, and that company will be responsible for the crews and cargoes. In part, the revenue

from the ships will be used by Pepsico to construct the first Pizza Hut restaurant in Moscow later this year. Pepsico owns the Pizza Hut chain, which has 6,200 outlets worldwide.

Although being paid in vodka and ships is a highly unusual way of doing business, analysts say that the deal is the most expedient way that Pepsico could patriate its Soviet earnings, given the Soviets’ chronic shortage of foreign currency. Traditionally, the Soviets have earned the desperately needed foreign cash through the export of commodities, particularly oil. But, as one of the world’s largest petroleum producers, it has been hurt by an international oil surplus that has kept prices more or less stagnant since 1982.

The result has been a crippling shortage of hard currency that it can use to pay foreign investors and companies for their products. Instead, investors have had to accept other forms of payment in kind. George Thompson, an economic analyst with Prudential-Bache

Securities Ltd. in New York City, said that the Soviets need money to rebuild their roads and factories, but “everybody there is broke.”

So far, however, Canadian companies have been particularly reluctant to enter into barter arrangements because of the high risk and complicated nature of barter deals. McDonald’s Restaurants of Canada Ltd., for one, invested $50 million before it opened its first McDonald’s outlet in the Soviet Union in January, in a joint venture with Moscow’s foodservice administration. Much of the money went to construct a huge food-processing plant in Moscow, as well as to establish special farms to raise beef, potatoes and other foodstuffs. Company president George Cohon has repeatedly said that the ruble profits from the Moscow outlet will be used to finance an additional 19 restaurants that McDonald’s plans to open

in Moscow over the next few years. Still, McDonald’s does plan to eam a limited amount of hard currency to help offset its $50-million investment by opening a special restaurant in Moscow that will accept only Western currencies as payment.

One Canadian company that does barter is Canadian Fracmaster Ltd., a Calgary-based resource company that has negotiated a unique method of patriating Soviet profits. Last year, Fracmaster signed a joint venture with the Soviet ministry of oil to recover petroleum that cannot be obtained by conventional methods. In return for the Canadian technology, the Soviets agreed to give the company any extra oil that is produced above a specified amount as a form of payment that can be sold abroad.

But Fracmaster executives said that the risk of costly failures is high. To date, the Alberta firm has invested $25 million in the project and has been promised access to a total of 4,500 wells by the oil ministry. Fracmaster’s president, Ron Bullen, says that if the company cannot produce any extra oil from the wells above the agreed level, the company gets nothing for its efforts. And with an individual investment of $100,000 to $200,000 per well so far, the Siberian venture requires considerable patience and long-term financial planning. Said Bullen: “We don’t expect a profit until 1991.”

But most Canadian firms lack the resources of Pepsico or McDonald’s. For them, according to Lou Naumovski, an expert on U.S.S.R. and Eastern Europe trade with the external affairs department, the inability to convert the ruble is a severe problem.

As a result, Naumovski says g that joint ventures are still i the most practical way for I small and medium-size Cana-

dian firms to enter the Soviet Union, because linking up with a Soviet business reduces the risk involved in doing business in a largely unknown environment. Soviet law was changed in 1987 to permit less restricted foreign participation, and Canadian firms, says Naumovski, can now use their expertise to carve out a market share with their Soviet counterparts.

Indeed, many analysts say that the Pepsico deal indicates that Moscow is willing to bend its rules as far as it can to meet the demand of Soviet citizens for Western-style consumer goods. Kendall, for one, claims that if Western firms wait for opportunities to do business in the Soviet Union in the customary way, or for a fully convertible ruble, they may be too late. Added Kendall: “They had better go now or they will lose the business.”

MICHAEL HARRISON