The Gut Squeeze Strategy Fails
- By David Aaker Published on February 25, 2019
On Friday, February 22, 2019 the stock of Kraft Heinz, the firm put together in mid-2015 by 3G, a Brazilian private equity group, fell over 25% in a single day to around $35 which was 44% of its initial price and 36% of its highest price in late 2017.
The business plan of 3G Capital to “Buy Squeeze Repeat,” as Fortune once described it, dramatically and visibly failed. By ruthlessly reducing headcount and operational expenses to improve operating margins, profits and, most important, per-share earnings, 3G guts brand-building assets and budgets, and squeezes growth initiatives and investments. The predictable results at Kraft Heinz were short-term financial gains at the expense of long-term health and performance. It was always surprising that Warren Buffet, the very symbol of long-term investing would be involved in this 3G venture.
The 3G methods are extreme. During the first 15 months after buying Kraft, for example, the employee count went from 46,600 to 41,000 and overhead went from 18.1% to 11.1%. Just days after the purchase, ten top executives were fired (presumably replaced with 3G cost cutters), company planes were gone, everyone flew coach–all in the name of creating a cost-reduction-first culture. All programs and people were placed on zero-based budgeting systems with a “justify what you are worth” ongoing evaluation. It is hard for brand-building efforts to sustain programs that yield long-term benefits to withstand this myopic focus on cost.
The sharp stock decline was caused in part by a $16 billion brand evaluation write-off that undoubtedly, when it was created, did not take into account the fact that a cost-first strategy eventually runs out of costs to cut and, in the meantime, damages brands instead of keeping them energized and relevant.
Of course, Kraft Heinz is living in a world where people are turning away from packaged goods to eat “fresh.” However, the other large packaged food firms are not suffering like Kraft Heinz. General Mills during that same period saw its stock fall from 56 to 47 and Mondelez actually had a stock increase from 35 to 48.
The good news is that other firms with strong brands are a bit less threatened by the specter of 3G coming and gutting the brand-building team and effort. Last year 3G made a serious (yet unsuccessful) bid for Unilever, the poster child for building great brands and managing with a higher purpose. Unilever has a vision of addressing environmental and social problems under the Unilever Sustainable Living Plan launched in 2010. And consider Dove (a Unilever brand) and its programs to raise the self-esteem of girls and women and the Lifebuoy program (another Unilever brand) to get one billion people to change their hand washing habits to reduce infant deaths throughout the world (they are halfway toward the goal). It is scary to think what would have happened to Unilever had 3G been successful.
This whole chapter reminds me of the Schlitz story. In 1976 Schlitz was a hair behind the leader Budweiser in the beer category and had a market cap well over a billion dollars (a lot in those days). Two years earlier, they decided to reduce costs to increase profits and solidify their market position. They introduced a new brewing process that reduced fermentation time from 12 days to four and replaced barley malt with corn syrup. Taste tests show no meaningful difference between the old and new Schlitz, but it turned out the tests did not detect the fact that the new beer turned flat after being on the self for six months.
The result was a disaster for Schlitz, with Budweiser happy to capitalize on the failure. Schlitz tried to recover. They went back to old methods. They hired the brewmaster from Budweiser who became the spokesperson for this move. They did five live blind taste tests—one on the Super Bowl with a football referee. But nothing worked. By the 1980s, the value of the Schlitz brand had all but disappeared. Risking the brand to focus on costs did not pay off for Schlitz. It also did not pay off for 3G when they tried it at Kraft Heinz. The verdict is out on the other 3G ventures InBev and Restaurant Brands International, but my guess is that the operating strategy, if continued, will cause brand erosion them there as well.