Frito Lays

An Analysis of the Market forOlestra-Based Potato Chips

Kristin St. RaymondAyala M. SolisEcon 200H, Section 5

Who wouldn’t want to munch on delectable potato chips all day without the

worry of adding extra inches to the waistline? This is the assumption the manufacturers

of Olestra-based potato chips are banking on. Olestra is a “fake-fat”; it is a cooking oil,

made by a combination of sucrose and vegetable oil, whose numerous fatty acid chains

are indigestible by the human body. Therefore, it imbues potato chips with the same

flavor and texture as their full-fat cousins but diminishes the guilt factor substantially:

Olestra chips have zero fat and half the calories of the full-fat varieties (ACSH).

Obviously, this is quite an attractive prospect to chip producers, especially in the current

times where thinness and physical fitness reign supreme. Presently, there appear to be

three major potato chip brands using the fake-fat technology: Frito-Lay’s WOW! Chips,

Procter and Gamble’s Fat Free Pringles, and Utz Brand Yes chips (though Utz is sold

almost exclusively on the eastern half of the country). The market structure is a bit

interesting, considering that the Olestra oil is an innovation of Procter and Gamble alone.

Adding to this interest is the heated controversy surrounding the fake-fat chips, which has

undoubtedly had some effect on pricing and market behavior.

Before examining the market workings of today, it could perhaps be beneficial to

review a brief history of Olestra. Olestra is not a new fat substitute by any means;

Procter and Gamble scientists discovered it in 1968. They esterified eight fatty acid

residues to a molecule of sucrose, reasoning that the increased number of fatty acid

chains would help premature infants to absorb more fat. However, just the opposite

happened: they effectively created a molecule so large and fatty that was indigestible by

the body (CSPInet). This is because so many fatty acid chains are crowded around a

sucrose core that digestive enzymes cannot find a breaking point to separate them (FDA

Backgrounder). Realizing that opportunity was knocking at its door, Procter and Gamble

petitioned the FDA to approve Olestra as a fat substitute for shortening, fast food, chips,

and other products (such as ice cream) in May of 1987. This move garnered criticism by

the Center for Science in the Public Interest (CSPI), who claimed Olestra was

inadequately tested and caused numerous detrimental gastrointestinal side effects (CNN).

When the FDA raised similar concerns in 1990, Procter and Gamble narrowed their

petition to “savory snacks”, which includes crackers, tortilla and corn chips, and, of

course, potato chips (CSPInet).

Procter and Gamble devoted extensive time and financial resources to its new

baby, concentrating on safety testing, product development, and marketing campaigns. It

applied for and received a special patent extension in the early 1990s (effectively

extending the life of its patent until January 25, 1998). It was granted FDA approval on

January 24, 1996 to use Olestra in production of savory snacks, but there was a major

caveat: every bag of Olestra-based snacks had to bear the label

“This product contains Olestra. Olestra may cause abdominalcramping and loose stools. Olestra inhibits the absorption of somevitamins and other nutrients. Vitamins A, D, E, and K have beenadded” (CSPInet).

Nevertheless, Proctor and Gamble and other major snack makers were eager to jump on

the Olestra bandwagon; after all, many stock analysts shared the sentiments of Drexel

Burnham Lambert, Inc.’s Hercules Sagalas, who proclaimed that Olestra was “’the single

most important development in the history of the food industry’” and predicted it would

bring in $1.5 billion in annual sales (CSPInet).

This eagerness gives an interesting structure to the market. Procter and Gamble,

who manufactures Olestra under the brand name Olean, had a virtual monopoly on the

fake-fat until 1998. However, it decided not to be the sole provider of Olestra-based

potato chips. Rather, it licensed out the use of Olean to its competitors Frito-Lay (a

division of Pepsico) and Utz. Why did Procter and Gamble do such a thing? Most likely

it was diminishing its own risk, as there is a “high likelihood that investments in

apparently promising innovations will go down the drain” (Baumol and Blinder, 298).

Procter and Gamble had invested nearly half a billion dollars in the fat-substitute, so it

was exercising justified caution in inviting the competition to participate. By licensing

out the use of Olean to its competitors, it could conceivably have created agreements to

share its competitors’ profits. It also could have engaged in cross-licensing, in which it

allowed Frito-Lay and Utz the use of its product in return for information about any of

their future innovations. Procter and Gamble’s move resulted in an oligopolistic market

structure, as there are only three firms nationwide who market the fake-fat potato chips.

Furthermore, one barrier to entry is quite clear: not just any upstart chip manufacturer

has the available funds to obtain use of Olean or to invest in R&D for a new fat

substitute.

How is this market currently doing? Test markets of Frito-Lay WOW! Chips

(initially called Max Chips) and Pringles Fat Free Chips showed that there was great

interest in the product. This interest came in spite of over a thousand reports of adverse

side effects associated with Olestra, including severe diarrhea, fecal incontinence, and

abdominal cramps (CSPInet). To counter these claims, Procter and Gamble hired

numerous consultants and dietitians to back up the product and spent even more money

on advertising. Nationwide marketing of the WOW! Chips and Fat Free Pringles began

in the spring of 1998, and there was a huge initial boom in sales. This is not hard to

comprehend though, as Olestra-based products had incredible appeal from a variety of

sources: health conscious adults and athletes, senior citizens or people with health

conditions who have to monitor fat intake, mothers concerned with the nutritional value

of their children’s snacks, and people who are dieting. However, sales quickly declined,

and the reasons for this are not hard to comprehend either. There was wide publicity

about alleged adverse side effects of Olestra—the gastrointestinal distress and the limited

absorption of important fat-soluble vitamins. Beyond these, some consumers may have

felt that the prices of these chips were high relative to their full-fat or baked counterparts.

The initial boom in sales in 1998 has never been repeated in the Olestra-based

potato chip market. Furthermore, it seems as if no new competitors have entered the

market since its beginning, even though Procter and Gamble’s patent on the fake-fat ran

out in the same year. This has allowed the market to retain its oligopolistic structure

rather than shifting to one of monopolistic or perfect competition, which often occurs

when patents run out. What possible reason could there be for the enduring oligopoly?

Perhaps it is Olestra’s bad reputation that has prevented other companies from cashing in

on the product. Though the fake fat has been supported by many physicians (such as C.

Wayne Callaway of George Washington University, who equates its gastrointestinal

effects to those caused by bran (www.olean.com)), it is quite possible that many

consumers are turned off by the bad publicity. To make matters worse, Olestra-based

products have been forced to retain their cautionary labels, which list a buffet of

unappealing side effects. These reasons, along with the steadily declining sales, have

perhaps made entry into the market an unfavorable decision for other potential

competitors. As a result, in spite of the opportunity for entry, this market has retained an

oligopolistic structure. This contrasts greatly with the market for regular potato chips,

which appears to have a monopolistic competition structure. Though in the full-fat

market there are several brand-name bigwigs, such as Lay’s and Pringles, lesser known

brands (such as Grandma’s and Poore Brothers) and generic supermarket varieties pack

the store shelves. A quick trip to any supermarket would show that the same could not be

said for the Olestra-based market, which relies solely on three manufacturers.

We have spoken of a boom and decline in this market, but what evidence is there

to support this? Using Pepsico (the owner of Frito-Lay) annual reports1, we can trace the

financial success and subsequent drop-off of their WOW! Chips. In 1998, the year the

WOW! Chips were launched, the Olestra-based snacks accounted for 4% of Frito-Lay’s

$7.5 billion in sales (roughly $300 million). According to the report, this “made WOW!

Frito-Lay’s most successful new product ever” (pepsico.com). The WOW! Chips helped

to advance Frito-Lay’s pound volume by 5%, despite declines in sales of low-fat, baked

style potato chips. In 1999, the story was not as rosy; the WOW! Chips now accounted

for 3% of the $7.9 billion in sales (approximately $240 million). This represents a

decrease of about $60 million from the previous year. These findings are summarized in

the table below:

The 2000 annual report gives no percentage sales of the fake-fat chips, though a graph

depicting sales of snack chip brands in U.S. supermarkets puts the sales of WOW! Snacks 1 Procter and Gamble Annual reports were vague in terms of this market and Utz reports were not found.

Total Sales WOW! Chips % of Total Sales WOW! Chips Sales in $1998 $7.5 billion 4% $300 million

1999 $7.9 billion 3% $240 million

Decrease: $60 million

at approximately $100 million. The financial review, though it gives no quantitative

value, mentions the “continued declines in WOW! Brand products” (pepsico.com) which

offset the 4% pound volume advancement by—interestingly enough—the full-fat

versions of Lay’s chips. In essence, the sales declines of the fake-fat products—chips

which had debuted as Frito-Lay’s most successful product—actually began to eat away at

Frito-Lay’s gains from sales of regular chips.

We have discussed market structure and sales history, but where does pricing fit

into all of this? Unfortunately, past prices (for years 1998-2000) could not be found on

corporate websites for any of the brands. However, present prices were obtained for

three regions in the United States2:

We can see some differentiation amongst the three brands’ prices, especially when the net

weight of the product is a factor. Since net weight among the brands is most similar in

the VA example, we will examine this portion of the market. It appears as if the Lay’s

are the most expensive, which seems to make sense as Lay’s is the largest and most

widely known potato chip manufacturer in the U.S. (Frito-Lay controls 58% of the U.S.

snack chip industry, compared to Procter and Gamble’s 5% and Utz’s portion of Private

Label Brands’ 8% (pepsico.com)). As a result, Lay’s may be the most trusted and

2 Prices for the AZ and OR markets were obtained in Albertsons Supermarkets in Tucson and Portland.Pricing information for the VA market was obtained in a Safeway Supermarket in Sterling.

12 oz. Lay's 6.5 oz. Pringles 5 oz. UtzTucson, AZ $4.29 $2.19 N/A

12 oz. Lay's 6.5 oz. Pringles 5 oz. UtzPortland, OR $4.29 $1.89 N/A

5 oz. Lay's 6.5 oz. Pringles 5 oz. UtzSterling, VA $2.29 $1.99 $1.99

Price Per Oz

12 oz. Lay's 6.5 oz. Pringles 5 oz. UtzTucson, AZ $0.36 $0.34 N/A

12 oz. Lay's 6.5 oz. Pringles 5 oz. UtzPortland, OR $0.36 $0.29 N/A

5 oz. Lay's 6.5 oz. Pringles 5 oz. UtzSterling, VA $0.49 $0.31 $0.40

desirable brand, allowing it to have a higher price. The prices of Fat Free Pringles and

Utz Yes chips (which are almost exclusively sold on the East Coast) appear to be

identical in the VA market, but a slight difference in net weight shows that Utz is actually

the more expensive brand. It is possible that Utz, which has a limited sales region and

has found luck along the East Coast, feels comfortable charging a higher price relative to

Procter and Gamble. Another possibility is that Procter and Gamble has such a diverse

product base that it can afford to charge the lowest price of the three because doing so

poses no real risk to its total profits. Though differentiation amongst prices does exist—a

possible result of brand reputation or the manufacturer’s product diversity—all prices are

fairly comparable.

Does price discrimination exist in the Olesta-based chip market? From examining

the differences in prices with regard to their locations, we can see evidence of some

discrimination. This is particularly apparent with the Fat Free Pringles, whose prices

vary in all three places: Arizona is the most expensive, with a can costing $2.19,

followed by Virginia at $1.99 and Oregon at $1.89. What could account for these

differences, as the product most certainly remains unchanged? Perhaps the relatively

high elderly population of Tucson allows Procter and Gamble to charge a higher price, as

many elderly folks are concerned with fat intake for health reasons. Virginia’s prices

may be a bit lower in comparison as Procter and Gamble is forced to compete with not

only Frito-Lay, but Utz Yes Chips as well. In any of these cases, the prices may be

dependent on the relative luck the food vendors have had in each location; in areas where

there are higher sales of these chips, manufacturers may have found it easier and more

attractive to charge a higher price.

We stated earlier that past pricing information for the years 1998-2000 could not

be obtained. However, due to the oligopolistic structure of the market, it is quite possible

that prices have not fluctuated much since the products’ debut. How is this possible,

given the market’s continuously declining sales? Price stickiness is a common feature of

oligopolies, and it results from simple logic: “if a firm raises its price, it will lose many

customers (because in that case its demand is elastic); if it lowers its price, the sales

increase will be comparatively small (because then its demand is inelastic)” (Baumol and

Blinder, 259). That is, an increase in price will result in lost business as competitors

retain their old prices, but a decrease in price will not dramatically change sales as all

competitors will match the cut. In the case of the Olestra-based potato chip market, a

price decrease would be the most reasonable possible event, as management surely would

not choose to elevate prices in the face of declining sales. Furthermore, any increase to a

seemingly high price would likely drive some of the market to regular or non-fried chips,

as some people would feel the non-fat benefits are not worth the sky-high price tag.

However, as prices of these products have remained high relative to their full-fat and

baked cousins (12 oz. Regular Lay’s potato chips=$2.99, 10 oz. Baked Lay’s=$3.39, 6.5

oz. Regular Pringles=$1.49), it is logical to assume that oligopolistic price stickiness is in

effect—despite the decreasing sales.

A hypothetical shock to the market for snack chips containing Olestra would

begin with increased investment into research and development. This increased R & D

would be aimed at disproving the claims regarding the negative side effects of Olestra. If

this were to happen, the new information could then be advertised to make consumers

aware of the change, particularly those consumers who previously chose not to buy

Olestra-based snack chips in order to avoid the side effects. In addition, the warning

label that currently appears on these products could be removed (with the approval of the

FDA). This would be most noticeable to people who had already bought the snack-chips

despite the warnings stated on the label, and word-of-mouth could serve to increase

awareness about the improvements.

As a result of the improved advertisements, demand for these products would

eventually increase (the demand curve would shift to the right), and more people would

be willing to buy the snack chips at the same price. However, the higher demand would

not affect the price of the product because oligopolies have kinked demand curves.

Neither Frito-Lay nor Pringles would want to raise their prices in response to the outward

shift in demand because the risk of losing business to the other company, if it were to

hold its prices constant, would be too high.

Both consumers and producers would benefit from these changes. Consumers

would have at their disposal fat-free snack chips that they could be confident no longer

caused undesirable side effects, and they would have consumer surplus if the prices

stayed constant. Producers would benefit financially with a more marketable product and

therefore a more successful business.

Demand for Olestra-based snack chips would not shift immediately. It would

require a lot of advertising to simply make people aware of the change. Then, even as

demand began to increase, it most likely would not increase by an enormous amount

simply due to the rocky history Olestra has and the bad reputation it has developed in the

eyes of many consumers. It would require a lot of persuasion to convince some people of

the improvement. The effects of this shock, although visible, would be fairly limited.

The Olestra-based potato chip market has garnered everything from criticism to

praise, controversy to support. Once thought to be one of the snack food industry’s

biggest breakthroughs, touting of the fake-fat chips has seemingly declined along with

market sales. This is most likely due to the horrible publicity Olestra has received over

the years as well as to the less than appetizing label its products are forced to bear. This

controversy has shaped the market into what it is today: an oligopoly with declining

sales, sticky prices, and heavy scrutiny. Perhaps increased R & D, which could disprove

the claims of negative side effects and thus result in a removal of the cautionary label,

would effectively shock the market and alleviate some of its sales problems. However,

the unfavorable reputation that Olestra has earned—whether justified or

unjustified—might still prevent a huge jump in the success of the market. Undoubtedly it

will be interesting to see how this market behaves and changes both in the present and in

years to come.

Works Cited

American Council on Science and Health. “Issues in Focus: Olestra.” 1997 and 1998.http://www.acsh.org/publications/story/olestra

Annual Report: Pepsico Corporation. “1998 Annual Report.” 1998http://www.pepsico.com



Baumol, William J. and Alan S. Blinder. Economics: Principles and Policy. Fort Worth:Harcourt. 2001

Center for Science in the Public Interest. “A Brief History of Olestra.” 2000.http://www.cspinet.org/olestra/history.html

CNN. “FDA Panel Generally Endorses Safety of Olestra.” June 17, 1998.http://www.cnn.com/HEALTH/9806/17/olestra.fda

FDA Backgrounder. “Olestra and Other Fat Substitutes.” November 28, 1995http://www.fda.gov/opacom/backgrounders/olestra.html

Olean. “Answers to Questions about Olean.” Procter and Gamble. 1998http://www.olean.com

Documents

Frito Lays