ITC. Tobacco, right? Er, right and wrong.

Wrong, because it's also been into hotels for three decades (ah yes, you say), but over the last few years, and pretty much under your nose, it's become a huge FMCG and lifestyle brand that, even though you buy it (perhaps unknowingly, unconsciously), still surprises you with the breadth of its spread.

Shirts and skirts. Pasta and paper. Biscuits and candy. Soaps and perfumes. Cigarettes too, of course. All ITC products.

India Tobacco Company? Yes, it still drives the business -- there wouldn't be an ITC without the filter tip that earns the company 87 per cent of its revenue.

But now, three years after it was set up, ITC Foods is nudging up the ladder. It might be a distant fourth (it contributes over 5 per cent of the turnover) in terms of revenue to tobacco, agri-business, and paperboards but it has already surpassed revenues from hotels in the last quarter.

And it is certainly a formidable force in the country's organised food biz.

Ravi Naware is the dapper divisional chief executive of ITC Foods and he doesn't believe in mincing words. "We want to become the number one foods company in India within the next five years" he says.

Wishful thinking? You couldn't be faulted for thinking so -- after all there's tough competition entrenched into the trade by big boys Unilever, Nestle [Get Quote] and Britannia [Get Quote] whose distribution prowess and popularity (some of the key brands are virtually household names) have to be matched, exceeded even, if it's to succeed.

But ITC Foods isn't balking at the challenge. Already, customer loyalty is being built up for its buffet of food products -- from biscuits, pasta, spices, confectionery and ready-to-eat foods to branded commodity products like flour, salt and spices.

The conglomerate has begun to grab slices of the market share from its rivals in the game. Aashirwad atta, for instance, is already the number one flour brand with a 40 per cent market share, virtually forcing Unilever to slow down its Annapurna atta.

Five months after its ready-to-eat pasta under the Sunfeast brand was pitted against kiddie favourite Maggi noodles, it has established its presence with 6 per cent in volumes of the branded noodles market.

Its Sunfeast biscuits are at number three position (after Britannia and Parle) with an overall 10 per cent share of the branded market. And in ready-to-eat foods, it's a close number two behind MTR Foods.

A slow starter in the confectionery segment (at number four position), its Mint-O has managed to grab a 40 per cent market share in its category.

The sales figures reflect this market thrust. This year, ITC Foods hopes to do sales in excess of Rs 800 crore (Rs 8 billion), and analysts reckon this as a growth of over 90 per cent over the previous year.

At this point, it's already 50 per cent of sales for both Hindustan Lever [Get Quote] and Britannia, and a third those of Nestle. And its target for 2006? To double sales once again, to Rs 1,600 crore (Rs 16 billion).

Overall, ITC Foods has managed a 10 per cent market share in segments in which the others are operating -- biscuits {Rs 4,500 crore (Rs 45 billion), confectionery {Rs 2,000 crore (Rs 20 billion), atta and salt {over Rs 1,000 crore (Rs 10 billion) among others.

Says Naware: "For the next year or two, our strategy will be to consolidate and offer a greater range in the existing categories and grow these markets."

Strategically, the company has kept away from those markets where it does not have the back-end or does not see value additions. So it is unlikely to make forays into tea and coffee ("highly commoditised") or dairy products ("needs a very large infrastructure to source milk").

In both cases too, giants in the business (Unilever, Tata Tea [Get Quote], local brands and a huge unbranded tea market on the one hand, Nestle, NDDB and state-owned dairy corporations on the other) would make any headway in the trade extremely difficult.

Juices? Potato chips? Nothing is being ruled out yet, but ITC Foods is all set to invest Rs 450 crore (Rs 4.5 billion) in the next three years {apart from the Rs 150 crore (Rs 1.5 billion) it has already put in} as part of its long-term strategy of ruling the branded food market in India.

Industry analysts are suggesting it has earmarked a hefty 20 per cent of its sales for advertising and sales promotion, which should grab a good deal of media space.

What's ITC doing that's different from its competitors? Well, it is working on a different model from them, but Naware says the market is too big for anyone to worry about competition.

For instance, branded and packaged foods is only 8 per cent of a total food market worth a staggering Rs 5,00,000 crore (Rs 5000 billion). This is expected to increase to 15-20 per cent in the next six years. Should that happen, there's more than enough room, and then some more, for everyone to coexist.

What is different at ITC though is its ability to leverage its e-Choupals as a pragmatic rural supply chain system.

For the uninitiated, ITC's trading arm, the International Business Division, has set up over 5,000 e-Choupals covering 31,000 villages across the country where farmers can sell their produce directly sans middlemen or having to go to a mandi at a fair price, and also get information relevant to farming, weather and prices at other mandis, all on the net.

The "sanchalaks" (supervisors) in some areas also sell products manufactured by the company, and in some cases the company has started hypermarkets (Choupal Sagar) in rural locations to cater to rural needs.

This backward integration is at the heart of the enterprise. For instance, the entire wheat for Aashirwad atta is procured from e-Choupals.

The advantage, says Naware is twofold: by cutting the middlemen out, it saves 2 per cent on cost of wheat, which is significant in a low-margin commodity business; and the company classifies the quality of wheat and stores it separately so it does not mix with any inferior varieties, which is common enough if you were to buy it from a mandi.

The result is an assurance of quality. Using the same route, ITC acquires spices (chilli powder), again with a similar advantage. That it has stayed away from branded rice is because the majority of its e-Choupals are not located in rice farming areas.

The model is simple enough. ITC is looking at creating food verticals to integrate the foods division with that of IBD and the e- Choupals. In the case of wheat, Naware explains: "We do the first value addition by offering branded atta, the second value addition is through biscuits, and the third is pastas."

And points out that it would look at similar verticals for sugar (going up to confectioneries and chocolates) once it can be freely traded.

At the other end the e-Choupal has become an alternative distribution channel for ITC products. About 10-15 per cent salt volumes are sold through this chain; so are 5 per cent of the biscuits and confectionery items. And the numbers will grow once more Choupal Sagars get going.

The other key element ITC is leveraging for the foods business is its tobacco distribution chain. It has over 1.5 million tobacco retailers across the country, larger than Unilever's distribution chain of over 1 million, virtually neutralising the fact that it is a latecomer in the foods game. That's not to say it hasn't had to create a separate distribution system to sell Aashirwad atta and other FMCG products through kinara stores (3,50,000 outlets).

But biscuits and confectioneries are perfect complementary products that can be sold through the tobacco chain. Currently, as much as half the tobacco retailers carry confectionery and about 300,000 stock its biscuits. And as much as 40 per cent of the tobacco retailers are already stacking FMCG products other than just tobacco.

But perhaps the most important factor that has helped ITC sustain its foods business is its healthy financials backed by attractive tobacco margins that can absorb the pressure of losses in the FMCG business.

Says Mohan Krishnaswamy of ABN Amro, who tracks the company: "ITC is leveraging the strength of its cigarette business and does not face any immediate pressure of returns, which is not the case with the multinational food companies. So, it can build scale and wait for 2-3 years to build a viable business."

Analysts point out that operating margins for ITC are around 35 per cent as compared to 15 per cent for Hindustan Lever and 20 per cent for Nestle India.

This despite the fact that in ITC's non-cigarette FMCG business (which primarily includes foods) margins are negative (minus 35 per cent), so it resulted in losses of over Rs 190 crore (Rs 1.9 billion) last year -- but ITC has the strength to absorb the losses without affecting its bottomlines.

Unlike ITC, analysts say companies like HLL, which are trying to get in line with their international goals, are under pressure because they are concentrating on power brands and improvements in margins.

HLL's sales of processed foods have actually come down and ice-cream sales have grown only marginally in the six months ending June this year over last year.

Clearly, part of the foods strategy is prompted by ITC's attempt to reduce its dependence on tobacco, which constitutes over 87 per cent of its operating profits and over 71 per cent of its turnover.

But without excise (because excise duty on cigarettes is high it distorts the turnover in their favour) cigarettes contribute for only 55 per cent of the turnover.

To that extent, the non-cigarette FMCG business (at 5 per cent per cent of the company's turnover) might look small, but its contribution to turnover has already surpassed the company's hospitality business and is closing the gap with its paper business.

And without taking excise into consideration (excise on food items is very low) its contribution to turnover is already a healthy10 per cent.

Also, the FMCG business is growing much faster than others: FMCG revenues in the first quarter were up 90 per cent compared to hotel growth of only 36 per cent and paper of 22 per cent. Of course, the agri-business grew handsomely by 64 per cent and is the second-largest revenue earner after tobacco.

Not everything's hunky-dory though. Losses in ITC's FMCG business went up in the first quarter this year from Rs 39 crore (Rs 390 million) to Rs 54 crore (Rs 540 million), even though turnover went up by 90 per cent.

A Merill Lynch report on the company cautions: "We are a little disappointed by higher losses in the FMCG business on a y-o-y basis." It earmarks two risks: "Cigarette demand may slow down and FMCG losses may exceed expectations."

FMCG analyst Kunal Motishaw is monitorial too: "ITC has the potential to become the number one foods player, but food is not its core competency, hence it will be a tough task.

"Its strategy is totally different from that of HLL, Nestle and Britannia. ITC offers its distributors higher margins (ITC says it offers competitive margins) and also its products are more competitively priced as compared to its competitors, all of which has resulted in it cornering an over 10 per cent market share in a short span of time."

HLL and Britannia have predictably declined to comment on their rival's strategy, but another Mumbai analyst says: "ITC has no existing products so it has to first develop them, which might take them longer. The company right now is very clear about focussing on market share and not profitability."

But that isn't likely to put a brake to ITC's foodie ambitions. It has identified its immediate task to expand its reach into more cities and towns, to garner more retailers. The target is to reach 1.2 million retailers (from 8,00,000) in the next two years and to ensure they stack all ITC products.

More importantly, it is playing up product differentiation to catch the eye of the consumer. In the overcrowded biscuit category, for instance, ITC has introduced the popular Marie biscuit in an orange flavour. Customers used to the salty crackers of Parle's Monaco are being offered an alternative flavoured with chilli flakes.

In confectionery, ITC again changed the rules of the game by introducing flavoured mints in orange and lemon for Mint-O, and as much as 50 per cent of the mint volumes now come from this category.

That apart, it also introduced a format of six rolls (instead of 12) priced at Rs 2, which fits in well in cigarettes stores across the country. Buoyed with the brand's success, it has now extended the brand with the launch of cough lozenges and in a short three months, has already grabbed a 15 per cent share of the market.

As for the ready-to-eat food market, ITC has created two distinct segments -- the upper end catered through the Kitchens of India brand (based on recipes from its restaurants in Welcomgroup hotels) and the mid-market through the Aashirwad series.

ITC executives admit that this is a small market {total size: Rs 80 crore (Rs 800 million)} but it's growing at 35 per cent per annum. And even though a large number of players are packing meals into packets, Aashirwad is spreading the banquet across 15,000 retail stores, while Kitchens of India is available at 7,000 outlets.

Branded foods isn't likely to be a simple market to crack. But if the record up to now is any indication, it might suggest that ITC Foods has been able to understand the culinary palate of Indians much better than many of its competitors.

Tobacco company, did anyone say?