Kraft Heinz mess puts spotlight on shifting industry
If anyone was still looking for signs that the power play between food brands and consumers is shifting, they got it last week.
Kraft Heinz Co. — the owner of major brands we’ve all bought for years like Oscar Mayer, Jell-O, Kool-Aid and Kraft Dinner — announced that it is writing off US$15.4 billion worth of intangible assets.
Essentially, buyers overpaid for Kraft a few years ago. As a result, the company lost more than US$12.6 billion in the last fiscal year. To make matters worse, the company is the subject of a U.S. Securities and Exchange Commission investigation.
Essentially, the company’s management expects its portfolio of brands to generate 25 per cent less in future earnings than it did just a few months ago. That’s a big drop in sales — and represents a lot of food.
To put this into perspective, more than US$12.6 billion worth of food at wholesale represents about 20 per cent of all the food bought at retail in Canada over a year.
It’s no secret that much of the business that traditionally went to food multinationals is going elsewhere. And companies like General Mills, Conagra, Hershey and Mondelez have adapted by acquiring health food manufacturers or changing their own products to make them more natural.
But the focus at Kraft Heinz has been on other issues.
Over the past decade or so, Brazilian giant 3G Capital has deployed ruthless cost-cutting measures to raise profits at Anheuser-Busch InBev, Burger King, Tim Hortons and Kraft Heinz. It’s used a method called zerobased budgeting, which requires that each expenditure be justified every year. That’s opposed to the traditional approach of adding a couple of percentage points to the previous year’s line items.
It was drastic but it worked — until now. Since the Kraft Heinz merger in 2015, most of the profits have come from cost-cutting measures. Most spectacular is what happened to the Kraft Heinz marketing budget. The company, controlled by 3G Capital and Warren Buffett’s Berkshire Hathaway, is spending $1 billion less in advertising a year compared to 2015.
Kraft Heinz has also been combatting steep transportation and commodity costs. But some shareholders believe less marketing has led to brand equity erosion.
Over the last two years, Kraft Heinz shares have dropped by 60 per cent and the brand is now worth barely half of what it was in 2015, when Kraft and Heinz were united.
What the company may be realizing is that cutting costs without prejudice is no longer enough. It will need to make a case for its brands through more marketing or by reformulating recipes.
Regardless, Kraft Heinz will need to spend more, which is counterintuitive to management. And the anti-inflationary environment isn’t helping.
Amazon’s Whole Foods, Walmart, Costco and Target in the U.S. are all keeping processed food prices at historically low levels. There’s not much room, then, for Kraft Heinz to increase prices to support margins.
And given that grocers have all the data, they’re calling the shots and putting more pressure on vendors like Kraft Heinz.
Private labels are also a priority for many grocers, making access to shelf space a larger issue. For example, sales of Costco’s private label Kirkland reached US$39 billion last year in a little over 700 retail outlets. That’s 70 per cent more than Kraft Heinz’s total sales during the same period.
As a backdrop to all of this is the moralistic view of today’s public health regulators.
Regulators, including Health Canada, are becoming more vocal and explicit about the perils of processed foods. This is a nightmare for companies like Kraft Heinz that have to navigate through a sea of growing public skepticism about their brands.
For decades, these behemoth companies have made millions by selling us convenient products that became part of our way of life. But today’s consumers — especially younger ones — want something different. Brands don’t mean much unless the company serves a larger, holistic purpose. The environment, health and other societal issues are important to consumers.
So, Kraft Heinz and many other processed food giants are in trouble unless they respond with good strategies.
But perhaps what’s most shocking is the lack of foresight from Buffett, who was involved in the creation of the company. The Kraft Heinz experiment shows that the billionaire’s investment philosophy is vulnerable to sudden shifts in consumer trends.
If Buffett got it wrong, there’s likely not much hope for the rest of us. The North American marketplace’s unpredictability is the new normal.