Okay, that’s a highly tendentious headline for an article full of interest. It furnishes the canny observer with another aspect of the austerity puzzle.
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 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.
Private equity firms undertake to pool select partner capital, as opposed to accepting public shareholders, in order to operate in capital markets based on some management or financial strategy. Many of them focus chiefly on investing in rising enterprises, while they are still privately-held; some aspire to move these privately held enterprises to the stage of a public offering of stock, which, if successful with return enormous profit to the early investors. The downside risk lies in this: most enterprises fail, some fail spectacularly.
Now zero-based budgeting has long been a horizonal desiderata for fiscal conservatives and budget hawks in and outside of government. These sensible folks, with good reason, lament the contrary technique of government accounting that simply subsumes regular annual budget increases into the baseline; thus, by the ready conveyance of a supine media, allowing liberals to treat mere slowing of the rate of growth as harsh budget cuts.
It seems that quite a number of financiers and tycoons have taken in mind the notion that corporate America needs some zero-based austerity. While Warren Buffett, we may surmise, has little use for austerity-minded folks in government (unless their only contribution to austerity is higher taxation), he appears pleased enough with them in business.
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 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.
Now this too is a different aspect of activism from the one we’re used to. These are financiers, moguls, magnates, who have a settled view of business, an aggressive investment posture, and a healthy pile of capital with which to impose that view, via investments, upon companies willing and unwilling.
So a lot is going on here. What strikes me, in view of the concerns of What’s Wrong with the World is the what we might call the plausibility of detachment. It is possible to read of this austerity without forming a strong view one way or the other. This activism does not instantly arose our outrage or kindle our warm admiration. These budget fights do not much concern us, though neither are they exactly trivial or without important implications. It will be interesting — and not in an idle sense — to observe the medium- and long-term results of the activism that is bringing austerity to the consumer food products industry.
I am reminded of Federalist 51, where James Madison speaks of the “policy of supplying, by opposite and rival interests, the defect of better motives,” which “might be traced through the whole system of human affairs, private as well as public.” The connection is, I hope, not too strained. The political science of The Federalist carved out a wide range for public life purposed toward private interests; we sometimes call it the free enterprise system. Tycoons and financiers may maneuver to apply their theories of profit-by-austerity; and other rivals may resist. Brazilian private equity is free to take a run at reshaping, by austere accounting principles, the production and delivery of the food in American pantries. All this can go on while the vast bulk of Americans look on with interest and curiosity, but with little rancor, indignation or partisanship. We may proceed in the assumption that many actors in the free enterprise system do indeed share a “defect of better motives”; but this need not agitate us.
And there is at least a chance that all this activity will supply us — humble pupils at the School of Experience — with useful knowledge by which we might enrich the discussion of public finances, austerity, and the health of our political economy.