This week’s edition of Bloomberg BusinessWeek features a timely but sober update indicating that: Things Are About to Get Ugly at Kraft.
Not only does this report indicate that change is already already underway for Kraft, it provides more sobering indicators of expected erosion in other associated industry business and supply chain capabilities in the months to come.
We are Supply Chain Matters have featured a number of commentaries related to Kraft and its associated supply chain capabilities since our inception in 2008. That includes its split in 2012 into two separate companies, Kraft and Mondelez International. We have done so because of our belief that this global CPG giant was a true barometer of the significant market and industry forces impacting what is increasingly being termed as “Big Food” today.
In 2009, Irene Rosenfeld, the CEO of Kraft at that time, indicated to The Wall Street Journal that “scale is a source of great competitive advantage” in terms of industry growth and innovation. That motivation probably led to the acquisition of Cadbury. Eighteen months later, Ms. Rosenfeld, along with Wall Street partners, orchestrated a massive corporate split, carving out Mondelez as a $30 billion focused snacks company with the most attractive prospects for global growth, particularly in emerging consumer markets.
The $18 billion North America focused grocery brands business was to be Kraft Foods which literally was forced to develop its own separate supply chain and business support systems.
Prior to the split, Kraft corporate had reportedly invested $700 million in a global rollout of a singular SAP ERP system. All of the assumptions that made-up that implementation suddenly changed.
This corporate split further implied two different supply chain business support and distribution models. Snack food and cookie consumers are impulse buyers, with promotions, market timing and inventory deployment strategies requiring sophistication and proper timing. The distribution model is focused on higher touch including direct to store service needs of convenience stores and smaller retail, particularly when emerging consumer markets are considered. Grocery, on the other hand, was a model of conservative sales growth but high scale and distribution volume. Much of the grocery customer base was large supermarkets, with emerging penetration among smaller retail and convenience stores. Grocery implied a high dependency on vendor managed inventory and responsive replenishment business replenishment. We again bring these tenets out, because they provide more context as to what existed and to what is now occurring.
In September of 2013, we praised the positive transformation and new leadership that was underway at split Kraft Foods. Former Procter & Gamble supply chain executive Bob Gorski was recruited to lead a dramatic transformation. In an industry conference presentation we viewed at the time, Gorski described product demand and supply processes touching literally 60 different times with little effect on forecast accuracy. Supply chain wide metrics were at odds with individual plant and functional metrics, some in direct conflict. There was a lack of a fixed execution planning window with 60 percent of plan changes occurring in the execution window. Production lines, on average, were forced to shutdown every 4 minutes because of various maintenance or setup issues due to inconsistent process specifications. Gorski articulated a goal as moving from metrics in isolation to metrics as part of a performance culture. Oh yes, adding to the challenge was a need for Kraft grocery to adopt a new supply chain software support system and more responsive technology enabled decision-making.
In March of this year, the industry was taken back with the news that H.J. Heinz would merge with Kraft Foods in a combined public company that was named Kraft Heinz Company. It creates what is anticipated to be the world’s third largest food and fifth largest beverage company featuring many well-known consumer brands. This deal was backed by infamous private equity firm 3G Capital Partners, and the financing of Warren Buffet’s Berkshire Hathaway, which each contributed $5 billion in financing. Together, bot investors own 51 percent of outstanding equity.
The latest Bloomberg article essentially opines that in the end, the Kraft-Heinz deal has little to do with market growth and a lot to do with cutting costs. That includes targeting an additional $1.5 billion reduction in annual costs before 2018 and according to the article: “The company will lose employees, whole levels of management, and maybe a few brands, too.” It cites as a reference a February 2015 McKinsey report which describes 3G Capital’s strategy as acquiring marquee brands that need operational improvement, and then “purging existing culture and management teams” while employing zero-based budgeting techniques requiring departments to justify every expenditure, and squeezing suppliers for similar cost savings. McKinsey noted that Heinz itself has since its takeover, lost market share in 65 percent of its product categories, yet adjusted earnings have risen nearly 38 percent.
Bloomberg cites data indicating that with the prior Heinz merger, 90 percent of the senior executive team departed within three weeks and more than 7000 jobs, 20 percent of the then existing workforce was cut, along with closing of five factories. Thus far, after closing the Kraft-Heinz deal last month, 2500 job cuts have been announced including more than a third of the existing staffing at Kraft corporate headquarters. Further announced was that Kraft headquarters will be move from a 700,000 square foot complex of a Chicago suburb to a 170,000 square foot office in downtown Chicago. Travel has been restricted, conferences have been put on-hold and employees instructed to print double-sided.
To reinforce an overall industry concern, Bloomberg reminds us that Nestle Chairman Peter Brabeck-Letmathe had indicated earlier this year that Buffet and 3G have: “pulverized the food industry market, particularly in America, with serial acquisitions.” The Nestle executive additionally indicated that 3G’s “ruthless cost-cutting’, to improve profit margins has had a “revolutionary impact” on other food companies.
Parallel Impact- Mondelez
Today’s Business and Finance section of The Wall Street Journal features an updated report on Mondelez’s efforts at expanding market growth while attempting to reduce costs and improve margins. It observes that a second high-profile activist investor, William Ackman and his Pershing Square Capital Management firm revealed that it had built a $5.5 billion, 7.5 percent stake in the company, and cites sources as indicating a Pershing view that the snacks producer must cut costs significantly or sell itself to a rival. Activist Nelson Peltz of Train Fund Management joined the Mondelez Board in 2014 after a six month conflicting public debate on company strategy.
In emerging markets which currently account for 40 percent of existing Mondelez revenues, the company’s margins reportedly trail those of several rivals. The global snacks company has now reportedly engaged Accenture to implement zero-based budgeting techniques and a sweeping reorganization plan that is closing older factories in the U.S. and opening more efficient ones in lower-cost regions such as Mexico and Russia. The WSJ cites other equity analysts as engaging in debate as to whether the Nabisco brand use of direct-store delivery (DSD) in the U.S. should be curtailed or replaced for a lower-cost alternative.
Impact to Industry Supply Chain Capability
A fundamental belief in supply chain management is that supply chains exist to service customer needs and support required business strategic and tactical outcomes.
As activist actions continue to drive “Big Food” into modes of acute efficiency, cost-cutting and continued break-up and consolidation, the impact to supply chains invariable becomes destructive, risking the obliteration of previous gains in service, product quality, sustainability and process responsiveness. Once more, the tenets of supplier based product and process innovation are subsumed by other tactics to wring out additional cost reductions or more onerous payment terms.
While business and other industry media can for-tell of the pending ugliness that is circling Kraft, and perhaps Mondelez in the not too distant future, industry “Big-Food” supply chains risk a significant erosion of prior process, technology and other transformational gains as zero-based budgeting and wholesale cost-reduction efforts sap the energy of survivors. More importantly, the real objective for providing consumers with healthier, more sustainable food choices becomes subservient to an overriding short-term emphasis on increased margins and stockholder returns.
Hence is the legacy of activism, short-term results and the rest being damned. In the analogy of the wild kingdom, the weak in the herd are overtaken by predators, and soon the predators begin to overtake even the strong, as stamina is weakened.
One final editorial note: Our house has switched to French’s Ketchup. It is noted as free from high fructose corn syrup, artificial flavoring and preservatives and has a great taste. Hopefully, brands that have been around from the 1900’s will not succumb to the current madness surrounding “Big Food” and the wonton destruction of previous supply chain transformation initiatives, commitment to quality and commitment to talent and people development.