By David Kesmodel and Annie Gasparro
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.
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 operations 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.
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.
"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 or divisions
that have fizzled can't keep spending like they did in their
heyday. The system, pioneered as a business tool decades ago by a
former Texas Instruments Inc. manager, initially wasn't used widely
in corporate America.
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 International Inc., 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 and Valeant 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."
David Benoit and Mike Esterl contributed to this article.
Write to David Kesmodel at david.kesmodel@wsj.com and Annie
Gasparro at annie.gasparro@wsj.com
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