Lean Recipe Fuels Food Deals
Heinz merger with Kraft shows how Brazilian buyout shop is rewriting cost-cutting playbook
The former Pittsburgh headquarters and production plant for H.J. Heinz, which adopted zero-based budgeting after it was acquired by 3G Capital. PHOTO: BLOOMBERG NEWS
A key ingredient in 3G Capital Partners LP’s recipe for reshaping the U.S. food industry—reflected in its roughly $49 billion deal to acquire Kraft Foods Group Inc.—is an arcane-sounding financial tool that slashes costs by focusing on details as minute as how to make photocopies.
On Wednesday, 3G confirmed plans for its H.J. Heinz Co. unit, which it bought two years ago, to buy the maker of Kraft cheese products and Oscar Mayer deli meats. The transaction extends the Brazilian private-equity firm’s acquisition spree in the food industry, where its previous purchases include Burger King Worldwide Inc. and Canadian coffee-and-doughnuts chain Tim Hortons Inc.
The latest deal would unite two of the industry’s biggest names in a company with combined revenue of about $28 billion and a roster of brands that are traditional staples of American kitchens but are struggling to keep pace with shifting consumer tastes.
MORE ON HEINZ, KRAFT DEAL
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- The Deal: By the Numbers
- Buffett Stepped on Some Toes in Long Dance With Kraft
- Buffett, 3G Behind Most Post-Crisis Megadeals
- Analysts React: ‘Elephant Gun’ Aimed at Old Friend
- Berkshire to Be Largest Shareholder
- What’s Missing in Deal: Big Banks
- Other Food Stocks Now Look Tasty
- What Separates 3G
- Kraft’s Long Deal-Making History
- 3G’s Bid Explains Blackstone’s Moves
At Kraft, as it has elsewhere, 3G plans to implement something called zero-based budgeting, an austerity measure that requires managers to justify spending plans from scratch every year. The technique has triggered sweeping cost cuts at 3G-related companies including Heinz—from eliminating hundreds of management jobs to jettisoning corporate jets and requiring employees to get permission to make color photocopies.
Investors have grown increasingly aggressive about second-guessing management’s operational decisions and use of capital. Several activist investors, including Nelson Peltz and William Ackman—himself a personal investor with 3G—have praised the Brazilian firm’s cost-cutting methods. Investors’ enthusiasm was evident in Kraft’s stock price Wednesday, which soared 36% on the merger news.
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WSJ's Dana Mattioli explains the significance of the accounting strategy known as zero-based budgeting to the Kraft Heinz deal. Photo: Getty
Other food and beverage companies are embracing 3G’s financial tool, in part out of fear that they, too, could become targets of activist investors or stronger rivals. Big packaged-food companies have been particularly appealing targets for zero-based budgeting. Steeped in history—Heinz traces its roots to 1869 and Kraft to 1903—many of them are fighting rapid shifts in consumer tastes away from processed foods such as Cheez Whiz and Ore-Ida Bagel Bites toward items deemed fresher or healthier. That’s sapped growth and made the companies ripe for cost cuts.
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“Every board needs to be on notice, that they have to take very similar lessons” from 3G’s cost-cutting or risk being outmaneuvered by leaner rivals, said Bruce Cohen, analyst with consulting firm Kurt Salmon.
Under the deal, Heinz shareholders, including Warren Buffett’s Berkshire Hathaway Inc.in addition to 3G, will hold a 51% stake in the new company, which will trade publicly. Kraft shareholders will hold 49%, and receive a special dividend of $16.50 a share, representing 27% of Kraft’s closing price on Tuesday. The companies didn’t disclose a value for the deal, but based on Kraft’s market capitalization following the announcement, investors pegged it around $49 billion.
The combined company, Kraft Heinz Co., will apply zero-based budgeting at Kraft just as Heinz did after 3G bought the ketchup maker in 2013, 3G managing partner and Heinz Chairman Alex Behring told reporters Wednesday. The tool will be “an integral part of the integration process here,” he said.
Zero-based budgeting requires managers to plan each year’s budget as if no money existed the previous year, rather than using the typical method of adjusting prior-year spending. That forces them to justify the costs and benefits of each dollar every 12 months. So, for example, once-successful divisions that have d can’t keep spending like they did in their heyday. The system, pioneered as a business tool decades ago by a formerTexas Instruments Inc. manager, initially wasn’t used widely in corporate America.
—fizzle
As much as anything, zero-based budgeting is a symbol of the new reality for U.S. business: Activists are pressing at all sides, giving managements little room for slack or bloated budgets. This ethos has seeped into nearly every boardroom, prompting pre-emptive steps that emulate the activists themselves.
The effects of this change are improved shareholder returns and dividends. But on the flip side, it has made the work for employees more rigorous and, some would argue, more ruthless.
At Heinz, which already had undergone years of cost cuts, 3G quickly set out to make deeper changes, paring staff at its Pittsburgh headquarters and gutting individual offices in favor of open floor plans. It slashed Heinz’s overall head count by about 1,480, or 4% of the world-wide workforce, shut several factories and grounded corporate jets.
Similar cutbacks jolted Anheuser-Busch Cos. after it was acquired in 2008 by InBev, in which 3G co-founder Jorge Paulo Lemann was a major shareholder. InBev quickly began retooling the U.S. brewer’s cushy corporate culture, mandating coach flights for Anheuser-Busch managers used to flying first class and curbing freebies like tickets to St. Louis Cardinals games.
“There’s sometimes extravagance that exists at some of these firms, and then there’s just bureaucratic waste,” said former Anheuser-Busch president Dave Peacock. “It’s painful because of the uncertainty and the change, and anytime you have to let people go. But I also would tell people, ‘The team matters more than any of us.’ ”
The rigors of zero-based budgeting can stretch down to the most mundane elements of corporate life. After chicken processor Pilgrim’s Pride Corp. adopted it a few years ago, it scrutinized how much paper it used to print documents, how much soap employees used to wash their hands, and how much Gatorade hourly employees at one processing facility drank during breaks. One Pilgrim’s plant manager said the company’s efforts were so thorough that when another would call saying, “Hey, I need a flashlight,” he responded: “Do you really need that flashlight?”
The ultimate success of 3G’s tactics has yet to be proven. While it has made headway cutting costs, the bigger challenge for companies like Heinz and Kraft will be reigniting growth.
And the approach risks souring morale. Some companies have resorted to tweaking the terminology because of negative perceptions.
Coca-Cola Co. is embracing zero-based budgeting as part of a plan unveiled in October to cut $3 billion in costs by 2019. But it is calling its process “zero-based work,” because of negative perceptions of the technique, Brent Hastie, vice president of strategy, said in a recent interview.
“If any associate Googles zero-based budgeting, you end up getting pointed to 3G and Heinz,” he said, and “there’s lots of negative connotations that come along with that,” including sweeping job cuts. “We wanted to make sure we were setting the right tone with folks.”
Still, other companies have recently taken the plunge, including Mondelez InternationalInc., from which Kraft was spun off in 2012, and Campbell Soup Co., which last month unveiled plans to use the start-from-scratch accounting method.
Zero-based budgeting also is emerging in other sectors, such as the pharmaceutical industry, where spending on research and development of drugs and treatments is a big expense.
Mr. Ackman, the investor, looked to highlight the model last year when his firm andValeant Pharmaceuticals International Inc. teamed up to try to buy Botox maker Allergan Inc., which they accused of spending too much.
Valeant uses a similar zero-based budgeting system for its R&D. “It really forces you to ask yourself, do you need to spend this,” Valeant finance chief Howard Schiller said in a presentation discussing the Allergan bid last April. “And when people have to explain it, and justify it, you often get to a different answer. And the worst answer at Valeant is, ‘Because everyone else does it.’ That’s a bad meeting.”
