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Brazilian Magnates Inflict Dreadful Austerity on American Workers

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.

Comments (4)

Paul, it seems to me that the first likely result is short-term planning ousting long term planning / budgeting. Any project that will require 2 or 3 years of work before it pays off is going to have a hard time meeting the process demanded of it. That would seem to go also for new projects whose payoff is not yet determinable because the product (or method of production) has not yet been before so you can't know for sure it will sell, or if the new method will work.

In short, this zero-based budgeting would seem to be fine for "steady as you go" business with minor tweaks here and there, but not for truly entrepreneurial attempts to try something completely different.

Not necessarily, Tony. I have experience with zero-based budgeting that included multi-year development projects. At the manager budget level, however far up it makes sense, you might build out two or three year budgets, understanding that you have to justify your budget request, not on the basis that last year I had $10 million so this year I get $10.5 million, but on the basis that each dollar I am requesting this year has a specific intended purpose and if my project budgets are $10 million this year, but several are being capitalized in Q1 next year, maybe my budget will be only $5 million, or if a new project is added it might be $20 million. The key is every year, every dollar has to be justified on the basis of what makes sense for the business as a whole.

This is also not just an austerity measure for managing older companies. My first experience came when my company was deciding to pour huge resources into our area to spur growth and our SVP was deathly afraid we would be like kids in a candy store. Guilty. By forcing us to plan and budget for every dollar he imposed discipline on the growth (which was very successful). Then came 2008. It works really well for austerity.

"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."

I believe an engineer turned politician implemented zero-based budgeting when he was Governor of Georgia and then President. The next president found it more useful to ignore it and the resulting deficits.

John, I work in a unit that has a certain amount of repeat business over the years, but it isn't a defined repeat, just that a certain percentage of past users are likely to come back in any given year, maybe 15% or 20% or 40%, depending on economic factors, changes in law, etc. And a certain amount of new business is never directly anticipated, which also varies on factors we can neither control nor prescribe in detail. All we know is that from year to year our "ordinary" business is likely to be somewhere between 60% and 140% of last year's, (with a certain amount of prior inventory carrying over to the next year). A scheme of "justifying" next year's budget will INEVITABLY be based on amorphous guesses drawn from prior years' budgets and inventories about, basically, "what we have typically needed over the years". I don't see that being very susceptible to something conceptually new except something even LESS reality based.

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