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Brazilian-American investment firm 3G is particularly ruthless in its approach to private equity. The firm implements a ‘zero-based budgeting’ policy in its portfolio companies, meaning every expense must be justified. These are then analysed, before the budget manager for each category is awarded a cap, which they are incentivised to spend under.
Standard practice usually involves reviewing the previous accounting period before proposing a percentage cut. However, 3G believes this is inefficient and uses their work at Burger King and Budweiser as evidence that their approach works: both became cash machines under 3G’s stewardship, with Burger King’s net income rising 34% over three years.
Like most private equity firms, 3G capital’s business model follows a 4-step process.
In March 2015, 3G, alongside US conglomerate Berkshire Hathaway, announced it was buying American food manufacturing conglomerate Kraft Foods to merge with the H.J.Heinz company ‘Heinz’ . The deal is estimated to have cost around $49 billion and formed North America’s third-largest food company.
Cost-cutting measures were enacted at speed and expansively. Four months into 3G’s management, seven plants had been closed and over 10% (5,100) of Kraft Heinz’s workforce had been made redundant.
Analysts praised these early moves from an investors’ perspective, noting a soaring stock price by February 2017. The measures eliminated more than $1.7 billion in annual spending and allowed Kraft Heinz to hold the highest operating profit margin among its peers in the US food industry.
At this time, for every dollar of sales, the food industry earnt 15 cents; after 18 months of 3G management, 3G earnt 26 cents for every dollar sold.
The company was so focussed on cost-cutting, it lost sight of its business aim: to produce food people wanted to eat.
Analysts have suggested that 3G failed to invest enough in new products that would grow sales in the long haul. Kraft Heinz spent only 0.36% of its 2017 gross sales on R&D (Research and Development). Rivals Kellogg and Unilever spent 1.15% and 1.68% of their 2017 gross sales respectively.
Where rivals caught on to the consumer trend of healthier, organic alternatives, Kraft Heinz was left behind. Hershey’s bought SkinnyPop maker Amplify Snack Brands in 2017 and ConAgra purchased gluten free food brand Udi’s in 2018. Instead of focussing on a smaller, more strategic company to acquire, 3G botched an attempt to buy conglomerate Unilever for $143 billion. Although Kraft Heinz was far smaller than Unilever, the acquisition was proposed to be fuelled by debt.
By February 2019, shares had plunged by more than 60% and the company reported that annual profits would be well below expectations. Furthermore, investors were disappointed as 3G slashed Kraft Heinz’s dividend payments and took a $15.4 billion write-down on its two biggest brands: Kraft and Oscar Mayer.
Whilst Kraft Heinz has, like many of its rivals, enjoyed a sales spurt across the pandemic, the problems facing the company continue to mount. Extreme cost cutting has left the company’s research and development underfunded, and in turn stifled innovation. This is an example of where private equity’s ruthlessness for maximised operating profit does not fit with the longevity and growth of the companies it manages.
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