Unilever eschews hyena feeding frenzy to hunt social symbiosis
• Despite tweaking its business model to stave off a takeover bid, the company aims to grow its business through investment and uplifting communities
It’s been five months since Anglo-Dutch personal goods company Unilever, the global poster child of corporate responsibility, had its “near-death experience”. It fended off a takeover bid from Kraft Heinz, a company about half its size controlled by a private equity firm considered by some to be the modern-day Barbarians at the Gate.
Unilever CEO Paul Polman recently paid a visit to SA, and in an interview, it quickly became apparent that in some ways, the company’s social mission has intensified and broadened.
But it has also changed in unexpected ways.
The discussion took place in a very Unilever-type context — at a school in Alexandra where the company was holding a function to expand a personal hygiene campaign.
Basic Education Minister Angie Motshekga attended, as did representatives from Facebook, Vodacom and Unilever.
It was a quirky place to discuss the character of global capitalism, but totally in character. Under Polman’s leadership, Unilever has embraced the UN Human Development Goals and tried to build them into its business model with the intention of improving the health and hygiene of a billion people.
Polman, a burly Dutchman with a powerful presence, is perhaps the most vocal and articulate spokesman for Capitalism Reloaded.
Unilever is uniquely positioned to attempt to incorporate the human development goals into its business as a fundamental part of its business model. Its huge range of personal hygiene and cleaning products and its large developing market footprint makes blending social development, corporate social responsibility and market penetration a great fit.
But according to the classic rules of capitalism, the idea is contrary to the natural springs of action: companies are primarily there to deliver profit to their shareholders; their “goodness” is a by-product of this function.
This “shareholder value” model and “society” – including employees, suppliers and customers — are systemically opposed. Any gain for one is necessarily a loss for the other.
This is why the proposed bid by Kraft Heinz for Unilever was such an epic moment. The proposed $143bn selling price would have been close to the largest corporate takeover in history. And the bid was made by Kraft Heinz, a company much smaller than Unilever, itself a recent amalgam.
The motivating force behind the bid was Brazilian private equity firm 3G Capital, the modern equivalent of the private equity raider Kohlberg Kravis Roberts, whose wild 1988 takeover of the US’s RJR Nabisco resulted in the firm being compared to “barbarians at the gates of Rome”.
South Africans know 3G Capital well because it was the force behind the takeover of SABMiller by Anheuser-Busch InBev. The same strategy is visible in both cases: take over one company, then another, then another, until you can dominate the sector and maximise scale efficiencies and control input costs, while shedding staff, slashing costs and tapping debt markets at a furious rate. If implemented judiciously, this kind of “roll-up” model works fabulously for shareholders.
Polman seems convinced about Unilever’s fundamental approach and he is full of ideas about new areas where the model should be applied.
The company, he says, is pursuing something he describes as a “long-term compounding model”.
“You know, it’s easy to get 25% return today and do that for two or three years but we prefer a 15% return forever,” he says.
The main argument in favour of Kraft Heinz’s merger was that its returns, by some measures, were substantially better than Unilever’s. But what constitutes “returns” is more complicated than it seems.
One comparative measure is cost of sales and by this measure Kraft Heinz massively outguns the four other elephants in the sector: Unilever, Mondelez, P&G and Reckitt Benckiser. Kraft Heinz has about 14% of revenue while the rest range between 25% and 30%, according to S&P Capital IQ. In a company with a turnover of more than $50bn, that’s mouth-watering.
Another measure would be return on equity (ROE). Here again, Kraft Heinz is strong. But the problem with ROE is that it tends to be boosted by increasing debt because debt might increase a company’s liabilities but it does bump up shareholders’ equity. The difference between the big fast-moving consumer goods companies by this measure is dramatic. Unilever’s debt-to-core earnings ratio is about 1.9; Kraft Heinz is about double that.
According to an assessment in the Financial Times, the two US packaged food companies had combined revenues before the merger of just less than $30bn, a blended operating profit margin of 15% and they employed 55,000 people.
The merger was initiated in early 2013, when 3G Capital and Warren Buffett’s Berkshire Hathaway teamed up to buy Heinz, and the deal was finalised in 2015. Later that year, when Kraft had been part of the merged company for only six months, combined sales were down a bit, yet the margin had risen to 21%. Kraft Heinz also employed about 13,000 fewer people. What red-blooded shareholder could resist?
The more sophisticated critique of the “stakeholder capitalism” approach is that it makes business performance hard to measure. If you are giving away current profit to earn more later by design, the company might end up effectively being run on behalf of customers or staff rather than its owners.
But the “roll-up” business model is a slightly different beast. It’s the mirror image of Unilever’s existing strategy in broad terms, but it made some big changes in response to what Polman called the company’s “near-death experience”.
First, it put out a returns target for 2020. “I always believed it’s better to just deliver and not talk yourself up because the numbers have always worked well for us. But it was pretty clear that some in the financial market wanted a target. So we have put it out there,” he says.
“And then because interest rates are zero, you don’t want to have a situation where someone uses your balance sheet to buy you. So we took on a little bit more debt and that gave us a possibility to share buy-back.”
His “modest” debt was $5bn. These moves resulted in some suggesting that Unilever had avoided the merger by becoming a little bit more like 3G Capital, but Polman is unperturbed. “Some shareholders like those things, but frankly it’s debatable by many people what that does for you.”
The combination of the bid and buy-back have had one extraordinary effect: Unilever’s share price is up dramatically since February. Kraft Heinz, for all its dramatic increase in returns, has been drifting.
It’s easy to hate the 3G Capital business model. Just days after Heinz took over Kraft, 10 top executives were fired, 5,000 people were ousted, office refrigerators were removed and company aircraft sold.
Perhaps the more appropriate analogy is what Financial Times writer Robert Armstrong memorably called “hyena capitalism”. Hyenas are ugly and vicious, but they play a key role in keeping the savannah’s ecosystem in balance and thinning out the herbivores.
One of the problems is the current phase of capitalism in developed countries, which is marked by low productivity growth. “When the number of US workers was increasing and innovation was delivering faster productivity growth, there were lots of reasons to invest. Today, it just makes more sense to focus on cost,” writes Armstrong.
“The result is a lot of rabidlooking hyenas running around at present”.
The problem with hyena capitalism is that it can become a self-reinforcing cycle. A lack of investment affects future productivity, but it also affects immediate demand. That means money piles up on balance sheets and is distributed as dividends and share buy-backs.
Hyena capitalism also undermines trust in institutions and that tendency may be fostered by share-based incentives and shortening executive tenures.
Polman sees all of these problems acutely: he notes that the average life span of a company has dropped from about 65 years in the 1960s to about 17 years today and that corporate trust is at a record low.
Polman says that in the US, companies are distributing more cash in special dividends or share buy-backs than they keep in retained earnings. “So, if people say their economies are not growing, it’s partly because we’re not investing in these companies to grow,” he adds.
He remains strongly opposed to the quarterly culture and something he calls the culture of “shareholder primacy”.
“Everybody can cut costs. If I invest in your training, my payback is in 20 years. Investment in a new IT system might be better — five to 10 years. So, everybody knows how to cut and get away with that.
“Obviously, your share price over a short time would go up and the CEO will get paid more, and that is part of it. And then, after five years, someone else can clean up the mess.”
The root of the problem is historically low interest rates, particularly in the developed world. “Many of these people that have come in and out of shares do so because they see an opportunity that is a function of how much money is being pumped in the global economy. I’m not so sure that serves a big societal function,” Polman says.
Controversially, he suggests that governments should be intervening more. Polman also floats ideas about shareholders only getting a vote after they have held the share for a few years. Or the dividend policy could be changed to grant higher dividends to shareholders who have held their shares for a longer time.
One big problem shareholders have with hyena capitalism is that while managers from this school may be tough and disciplined, they are terrible at brand management. Hyena managers typically find marketing expenditure “wasteful” partly, one suspects, because their skill is financial engineering and they are on financial statistics rather than on products or employees.
In contrast, Polman seems obsessed about brand management and integrating brands into people’s daily lives.
“Surveys show that people want brands to be fighting for causes. They want brands to have a position on climate change and human rights,” he says. “The market of sustainable goods is exploding. Most of the growth in foods is in responsible politics, green organics, biodiversity and healthy products.”
It is fascinating talking to Unilever executives about the difference between toothpaste culture and shampoo culture. Toothpaste is often a lifelong choice, but experimentation with shampoo is huge.
The spending on brands is enormous — about 20% of turnover on luxury goods and about half that on fast-moving consumer goods. The monitoring is obsessive.
This is where the difference between the cost-cutting culture and investment culture really clash. It may necessarily be a never-ending battle, but when money is cheap and growth is slow, the overpopulation of hyenas becomes a problem rather than a solution.
UNILEVER IS UNIQUELY POSITIONED TO … INCORPORATE THE HUMAN DEVELOPMENT GOALS HYENAS ARE UGLY AND VICIOUS, BUT THEY PLAY A KEY ROLE IN KEEPING THE ECOSYSTEM IN BALANCE