The Kraft Heinz disaster has been on track for years. Anyone paying attention noticed long before the 28% collapse of their share price February 22, 2019, followed since by a slow drift lower.
How could investors have been so surprised? The SEC investigation into accounting policies was a factor; however, as widely reported, 3G Capital, Kraft Heinz’s largest shareholder after Berkshire Hathaway, cut their position by 7%, six months before the deluge. Given the share price had been in a long slow decline, the sale didn’t signal a vote of confidence.
In August, 2018, CNBC quoted 3G’s co-founder, Jorge Paulo Lemann, during the annual Milken Global event, “We bought brands that we thought could last forever. You could just focus on being very efficient…. All of a sudden we are being disrupted.”
Read that again: “last forever…. all of a sudden.” Could this be anything but billions of dollars of naiveté?
Over the past few years, I’ve lamented the Kraft Heinz path in sessions with my students at the Kellogg School of Management, clients of my growth strategy firm, Clareo (including some folks at Kraft Heinz), and really anyone who would listen.
In mid-2018, I spoke for a wonderful billion-dollar family-owned enterprise in the food products industry. (One of those stunning businesses that represents the heart of our economy.) After sharing the “what-not-to-do” story of Kraft Heinz, I felt a pall descend over the room. The CEO explained that they had hired many talented Kraft Heinz refugees. The story hit close to home. It also reinforces his company’s commitment to investing for the future.
The 3G Model: Paths To Easy Profits— And Obsolescence
Defenders of the 3G approach will point to years of performance with other brands, such as AB InBev, Burger King and the early years of the Heinz acquisition. The company built a stellar reputation for driving margins. Their record of organic revenue growth was far less impressive.
As any corporate roll-up expert knows (Kraft Heinz is one big fruit roll-up), acquiring and cutting provides a near-term margin bump, but that’s only half the equation. You must also build paths to growth.
The beginning of the end for their current model was the failure in early 2018 of 3G’s attempted Unilever acquisition. At the time, the Financial Times positioned the failed bid as follows: “Yet the fact that Kraft Heinz was confident enough to target a company with double the sales underscored the vulnerability of even the biggest names in the sector.” The FT was half right. The failed acquisition bid also exposed the Achilles Heel of 3G’s ‘slash and burn’ model.
3G’s maniacal focus on efficiency at the expense of innovation, their practice of “zero based budgeting” and their habit of firing legions of experienced senior and mid-level managers lead to strong margin performance in the near term. Catastrophic loss of talent and lack of investment in innovation lead to future weakness— unless you find another, hopefully larger, acquisition for radical cutting.
Had 3G succeeded in its bid for Unilever, they would have acquired over $60 billion in new revenues, a company over twice the size of Kraft Heinz. This would have provided enormous opportunities to cut, hiding the accelerating slide in Kraft Heinz’s performance and perpetuating 3G’s cost-focused model— at least for a while longer.
In a world that doesn’t much change, this model works. In a world of rapid change, 3G’s model amounts to a cost-cutting pyramid scheme. As revenues slide, you’re compelled to buy new companies to cut. When that eventually fails, you’ve meanwhile destroyed your paths to growth.
Earning The Future: Time For Courage
It’s not too late for Kraft Heinz. I personally know some talented executives still with the company. Their iconic brands haven’t vanished, but even icons need to continually earn relevance. Examples from outside Kraft like Pabst Blue Ribbon beer, now known as PBR, show that even moribund brands can find new life.
Their February 21 investor update underscores leadership’s plans to “rebuild commercial momentum,” partly by re-establishing growth pillars such as breakthrough innovation. The plan seems to recognize that cost obsession has gone too far. To return to growth, Kraft Heinz must turn their cost obsession into prudence and recognize that long-term prosperity requires long-term investment.
It’s frustrating to see this play out, not just at Kraft Heinz but at other formerly venerable companies like Sears. While most companies don’t suffer from a single-minded focus on near-term efficiency, the temptation to succeed near-term at the expense of future growth remains ever-present. All leaders must recognize it is their personal responsibility to protect meaningful resources— capital and the attention of their best people— for creating the future.
Public markets love a great margin story. Valuing long-term growth portfolios in an accelerating world is a lot harder. Beware the easy path to profits.
Since thwarting 3G’s advance, Unilever CEO Paul Polman retired January 1, 2019, after posting a nearly 300% return to shareholders over his 10 years at the helm. During an interview in 2017, Polman noted, “Any CEO can decide to think long term. I think it is courageous leadership that is missing.”
3G and Kraft Heinz, it’s time for courage.