3G’s Failings At Kraft Heinz: You Reap What You Sow
This is a story that admittedly I’ve wanted to write for several years. With a $15.4 billion write down (one of the largest in corporate history), a freefall of its stock price (more than 50 percent of its value lost over the past year) and an ongoing SEC investigation, Kraft Heinz has become the poster boy of how not to purchase and reorganize a company.
Let’s go back a few years. In 2013, Brazilian private equity company 3G Capital combined with Warren Buffett’s Berkshire Hathaway group to acquire H.J. Heinz for $23 billion. Although Berkshire Hathaway was the bigger investor, it was clear from the outset that 3G’s ridiculous (at least when applied to the food industry) Zero Based Budgeting (ZBB) system would be the driver to reorganize the Pittsburgh-based condiments icon. More on that later.
In 2015, the two PE giants continued their tag-team strategy of acquiring established, mature food companies with well-known brands when it overpaid to purchase Kraft for $40 billion. That’s when it became obvious that the Boys from Brazil and the Oracle of Omaha were beginning to heavily deploy their version of AI (avarice and insensitivity).
The whackin’ and hackin’ accelerated at furious levels. Hundreds of veteran employees were riffed and manufacturing plants were shuttered, shifting a culture that used to be admired in the industry to one of dislike and distrust.
This sea change wasn’t personal (although many former Kraft and Heinz associates would argue that point) – it was so highly impersonal that the zealousness and resulting toxicity of its ZBB methodology also managed to piss off many retail customers who watched in disbelief as Kraft Heinz reduced promotions and raised prices on many of its brands.
Nearly as bad was the fact that it failed to nurture some of America’s most well-known products, even though 3G and Berkshire Hathaway knew those aging brands needed financial resuscitation.
To be fair, most CPG companies are under siege. Whether their portfolios are filled with not so healthy brands – Oscar Mayer, Capri Sun, Kool Aid, Kraft Mac & Cheese, to name a few from the Kraft Heinz roster – or are being threatened by the growth of private label, we’ve seen virtually all manufacturers which have a significant presence in center store reduce staff and make other adjustments to become more efficient.
And even though some other suppliers have tried to emulate parts of the 3G ZBB model, none has been as egregious as Kraft Heinz or suffered the dire consequences of the Chicago-based company whose annual sales last year were $26.3 billion.
While the ZBB approach might be effective with 3G’s foodservice holdings – Burger King, Tim Horton’s and Popeye’s – the concept just isn’t workable in the retail grocery industry where relationships (and trust) still have some traction, especially when discussing budgets and promotions with retail customers.
A snapshot of how ZBB works makes it obvious why this should have been a non-starter from the beginning, even excluding the human and cultural collateral damage that occurred. When 3G buys a company it analyzes all expenses, even including office supplies. Appointed managers oversee specific areas of costs and budgets, which are assigned a financial ceiling every year. Managers are evaluated on how they’ve supervised their areas of responsibility and are rewarded for meeting the targets established under the ZBB model.
The constraints of the system would make it seem much more difficult to sell large customers such as Walmart, Kroger and Albertsons, whose other vendors utilize a more flexible selling model. For medium-sized and smaller merchants it would seem even worse when they are potentially told there’s not much money left in the kitty for you. Perhaps the best current job at Kraft Heinz is VP-paper clips and staples. Bargaining with Office Depot would seem a lot easier (and potentially more productive) than negotiating with Walmart.
Kraft Heinz officials have been quoted as saying they’ve made the adjustments necessary to become more competitive, including expanding their sales force, ramping up promotions and utilizing analytics more effectively.
I’m not impressed. What I see is a company whose stock is trading at $33 per share (down from nearly $68 per share a year ago), an organization that just slashed the value of its portfolio by a whopping $15.4 billion and is currently under SEC investigation for its accounting practices. The perception of Kraft Heinz in the food industry and in the public markets isn’t good, because in this case, the facts are directly proportional to that perception. This is private equity at its worst.
Remember the old Wall Street adage about bulls, bears and pigs: “Bulls make money, bears make money and pigs get slaughtered.”
Amazon Apparently Ready To Put On Big-Boy Pants For Bricks & Mortar Grocery Retailing
You knew Amazon wasn’t going to end its quest into bricks and mortar food retailing with only Whole Foods natural and organic stores and Amazon Go c-stores in its tote sack.
According to the Wall Street Journal, Godzilla is poised to expand its physical store presence by planning to build and open “dozens” of grocery stores, beginning perhaps as soon as the end of this year. The story notes that the Seattle-based monolith has already signed two leases in Los Angeles and is negotiating for sites in DC, Philadelphia, Seattle, Chicago and San Francisco. Amazon is also considering acquiring several regional grocery chains with 12 stores or less, as a vehicle to expand its physical presence as well.
The new stores are not intended to compete with Whole Foods; the Journal notes that these stores would offer a different mix of products at more aggressive retail prices.
Tactically, this is a needed move for Godzilla, which still dominates the e-commerce world (even in food and related items), although walmart.com is catching up slowly. Walmart’s three-year resurgence is clearly evident in the digital world, but what might be less visible to some people (not food industry executives) is that the Behemoth has significantly upped its game on the bricks & mortar side, improving its stores on many levels – cleanliness, staffing, customer service, perishables, etc. – while using its click and collect ability to help both store sales and e-commerce revenue.
Frankly, I’m a bit surprised Amazon hasn’t done more with Whole Foods in the 21 months since it acquired the Austin, TX-based merchant for $13.4 billion.
Sure, they’ve created a powerful link to Prime members and mobilized the nearly 500 WFM stores as delivery hubs. That’s important but not game changing. As for the stores themselves, everyday retails haven’t come down appreciably and there seems to be slightly less labor in the stores than before the acquisition.
And maybe that’s the entire point in a nutshell. Food retailing is hard – there’s no magic bullet that will create instant improvement. Could it be that, as mighty and powerful as Amazon and its dynamic CEO Jeff Bezos are, improving a business that’s so uniquely capital and labor intensive with too many stores operating in diverse styles is more difficult than the company thought?
I’m assuming that Amazon’s new supermarket model will operate under an independent infrastructure, just like many of the company’s other units. That’s still the case with WFM (although Amazon’s influence is obvious) and it’s also the case with Amazon Go, which now has 10 stores, but reportedly plans hundred more.
I visited my first “Go” store earlier this month in San Francisco (one of two it operates in the city). Located in the busy downtown area of California and Battery Streets, the store was clean, moderately busy and priced fairly. However, I wasn’t impressed by the store’s prepared foods quality (not terrible, but certainly no standout) and item mix. Out-of-stocks were also too high.
I also understand that I’m not the customer profile that the store is seeking. The GenYers in the store were clearly comfortable with the store’s layout and cashless checkout system. Still, the store should have been busier at lunchtime on a Friday in the heart of one of America’s largest and most affluent cities.
The not so dirty secret for those who’ve spent their careers in the industry is that food retailing is a beast. Bezos knows it, too. Certainly, it’s a tremendous advantage that a company can “test pilot” an idea and lose billions over several years and still continue to work to improve it (which Amazon is very good at) or cut and run if the rewards aren’t forthcoming (Amazon’s had a few of those examples, too).
From a strategic perspective, this a good time to enter the overstored fray. There are dozens of existing retailers who are struggling, tired, frustrated and who may not have a firm succession plan in place. Some are destined for attrition, while a select few would certainly listen very hard if Amazon offers them a grande satchel of dinero.
I’m certainly not betting against Amazon – he who has the gold rules – but this will be a challenging endeavor. Successful bricks and mortar food retailing isn’t about being smarter or savvier than the next guy. It’s about location, merchandising ability and operational execution. It’s also about tenacity and grit.
Let’s see how Godzilla fares against a different breed of merchant which operates in a silo where Amazon isn’t yet all that dominant – physical spaces.
‘Round The Trade
Wegmans has agreed to build its first store in the First State. The Rochester, NY-based uber-retailer will be the prime tenant in the new Barley Mill Plaza in affluent Greenville, DE. The new store won’t open until 2022 and is part of a 56-acre mixed use project on the site of a former DuPont office complex. The new Wegmans will spell trouble for Janssen’s Market, the nifty single store upscale merchant whose store is less than two miles away from the Wegmans site. Also challenged will be Acme which has three very productive stores within Wegmans’ potential shopping radius. More Wegmans news: while the family-owned company has yet to open its first store in the Research Triangle of North Carolina (it will debut in the area next year with a store in Raleigh), the high-volume merchant has signed its sixth lease in the area, this one in suburban Holly Springs. The next Wegmans ribbon cutting will be on April 28 in Virginia Beach… a tip of the hat to both Giant Food and Safeway for hosting informative vendor meetings during the past month. It’s nice to see the old stalwarts from the B-W market with some spring in their step, and it certainly doesn’t hurt that both chains operate from a decentralized platform, which certainly improves vendor engagement. Also helping both retailers is the continued erosion of Shoppers’ business. I feel badly for the associates of the company, now owned by UNFI. The stores have been on the selling block for months with little announced activity, while the clerks and meatcutters are forced to wait out the clock in lame duck hell. And speaking of UNFI, it posted a $341.7 million loss in Q2 ended January 26, much of that deficit related to the integration of its Supervalu business. The Providence, RI-based distributor is still sticking with its prediction that it will save $185 million in year four of the deal, but I’m not making that bet. And after talking to many of UNFI’s independent customers in the Mid-Atlantic, it’s clear UNFI is not currently exuding a high level of confidence about the postscript of the Supervalu acquisition. UNFI’s operating loss aside, the past quarter saw almost every other retailer post some of the best numbers in recent years. Without providing you with the agate type of financial reports, here’s a summary of same-store sales (ex-gas) of some of the biggest retailers in the country in their most recently completed quarters: Ahold Delhaize USA, +2.7 percent; Kroger, +1.9 percent; Target, +5.3 percent: BJ’s +2.8 percent; Publix, +1.1 percent (with a record profit of $2.4 billion for the year); and Walmart +4.2 percent. A few notes from some of those retailers. At Kroger, two new Ocado automated e-commerce centers – in the Mid-Atlantic and Florida – will be built and should be operational by 2021. In something of a rarity, Walmart will be closing one of its stores – a 41,000 square foot Neighborhood Market on Iron Bridge Road in Chesterfield, VA which opened in 2015. The reason: underperformance. In the Richmond market, this won’t be a game changer for the Behemoth. It operates 19 other units (mostly SuperCenters) in the area, including another Neighborhood Market about two miles away and a SuperCenter about 3.5 miles from the soon-to-be-closed store. Walmart will also be improving its “time off” policy for its associates, giving workers more flexibility to miss time while also rewarding associates who show up more often by providing bonuses ($550-$900 per quarter). Last year, the Behemoth, the country’s largest private employer, raised its minimum wage (to $11 an hour) for all of its 1.1 million hourly employees. As for BJ’s, the club operator not only had a strong fourth quarter it also enjoyed a great fiscal year, posting strongly positive metrics in every category including a record EBITA of $578.4 million. And the timing couldn’t be any better for Leonard Green and Partners and CVC Beacon Capital, the two private equity firms that engineered BJ’s Wholesale Club’s IPO last year, who now want to pull their entire investment from the chain. In a filing, the company said that all 58 million shares held by Green and CVC were put up for sale which could bring the investors more than $1.5 billion in proceeds. Before BJ’s went public last June, the two PE firms received a $735.5 million dividend…kudos to Peter Larkin, CEO of the National Grocers Association (NGA), whose recent trade show was once again successful. The venue move to San Diego (vs. Las Vegas) was a big plus and the presentations and meetings continue to be relevant for the independent retailers and regional chains that attend. Larkin will be retiring at the end of this year after a long and distinguished career in the industry, the last nine spent helping to reshape what is now one of the best trade shows in the industry…and if Amazon has big plans for any form of bricks and mortar retailing, they might have to rethink their plans about entering Philadelphia which officially banned cashless stores within the city limits. It’s non-progressive laws like this as well as its unfair beverage tax that have made the City of Brotherly Love the worst city in America in which to do business…we have several obituaries to report this month. From the world of music, we lost one of the best jazz singers of the past 50 years. Ethel Ennis (who with Billie Holiday) was one of the finest singers ever to come from Baltimore. Starting as a 15 year old while still in high school, Ennis, 86, performed with such musical greats as Benny Goodman, Duke Ellington, Louis Armstrong, Miles Davis and more recently, Wynton Marsalis. Her full-throated bluesy, contralto voice made her popular with audiences around the world as well as her peers in the business and she continued performing until 2016.…also passing on was Peter Tork, whose halcyon days were in the late 60s as the bass player for The Monkees. Actually, Tork was a very good musician, but often didn’t play on the group’s recording sessions because the band’s producers and managers Bob Rafelson and Bert Schneider created the group as a made-for-TV entity. When it came time to record albums, Rafelson and Schneider chose to use a group of extremely talented Los Angeles studio musicians known as The Wrecking Crew (which, by the way, is also the name of a great documentary flick about those studio musicians) to actually play the Monkees songs. Tork was 77 when he passed…pianist, composer and conductor Andre Previn has left us at the age of 89. A Holocaust survivor whose family fled Nazi Germany, Previn was a child prodigy who began working in Hollywood as a teenager. He won four Academy Awards for his orchestrations and, in 1967, left the movie scene to become a classical music conductor. He led such renowned orchestras as the Los Angeles Philharmonic and London’s Royal Philharmonic. The genius of Previn, who was trained as a classical musician, was his unique ability to cross over into other musical genres, recording pop and jazz albums. He was married five times including once to actress Mia Farrow. Together they had six children, three of whom were adopted. One of those adopted children was Soon-Yi, who had an affair with Farrow’s next husband, Woody Allen (Allen would eventually marry her). Asked what he thought of Allen, Previn said, “I would a cheerfully run him over with a steamroller.”…I am sad to report the death of former Dodger’s pitching great Don Newcombe. Newcombe’s story is a heroic one. Beginning his career in the Negro Leagues before becoming one of the first African-American players to play in the majors when he joined the Dodgers in 1949, Newcombe was named National League Rookie of the Year. “Newk” also won the Cy Young Award in 1956 (when only one pitcher for both leagues was recognized), when he posted a 27-7 record with a 3.06 ERA over 268 innings. However, the most courageous part of Newcombe’s life came after his career ended in 1960. During his career, he began drinking and his alcoholic problems only got worse after he retired. He finally quit drinking in 1967 and for the next 50 years helped countless others with substance abuse problems, while also serving as a community service ambassador for the Dodgers. Newcombe was 92…I also want to recognize the passing of Peter Magowan, 76, former CEO of Safeway. After leaving the big chain in 1993, where he started as a teenager (his father, Robert, was also chief executive of the company), Magowan acquired the San Francisco Giants baseball team. From the late 1970s until the early 90s, I met with Peter dozens of times and always enjoyed his intellect and his curiosity. He was actually one of the first of a new breed of supermarket industry executives – analytical, smart and somewhat low key. Even though he came off as a bit shy, he really wasn’t. I can recall several Safeway annual meetings which were often held in Charm City (usually at the somewhat seedy Lord Baltimore Hotel) where Peter displayed leadership, resolve and passion. An all-around good guy, Peter Magowan will be missed.