April 24, 2019

WSJ: What Tops Kraft Heinz’s Menu? Cost Cuts or Mac ‘n’ Cheese?

In three years since Kraft Foods and H.J. Heinz KHC -1.00% joined forces, the combined company has become as closely watched for the way it manages expenses as its ability to peddle foods that we’ve been consuming since kindergarten.

As Kraft Heinz Co.’s new chief executive, Miguel Patricio, prepares to take over at the food giant, he should ponder whether being better known for cost-cutting than for your ketchup or mac ‘n’ cheese is a recipe for failure. Mr. Patricio, a packaged-goods industry veteran, is replacing a CEO who let a culture of cost get in the way of revitalizing a kitchen-full of aging labels.

Mr. Patricio told the Journal on Monday he needs to revive “dusty brands.” He also needs to change the way the company defines success.

Kraft in February marked down its brand portfolio by $15 billion. It also disclosed a Securities and Exchange Commission investigation into accounting practices. At the time, outgoing Chief Executive Bernardo Hees said cost-cutting failed to yield desired results.

Many point to zero-based budgeting as a primary source of Kraft’s headaches. The practice—prized by the company’s financial backer, 3G Capital —calls on managers to begin each fiscal year with a clean-sheet approach to expenses and financial targets. Under this system, a quirky marketing campaign or a whizzbang invention that made so much sense last year can be killed because it doesn’t square with this year’s financial goals.

Many companies have instituted zero-based budgeting in recent years. Walgreens Boots Alliance Inc. has adopted it as a way to achieve better transparency and slash $1 billion in costs. Tobacco giant Philip Morris International Inc. will also plan each year’s budget from scratch to free up capital for new tobacco alternatives.

Zero-based budgeting was popularized in the 1970s by Pete Pyhrr, who used it to prioritize projects at Texas Instruments Inc.

3G practiced it with the same religious fervor that Apple Inc. valued product-design orAmazon.com Inc. pursued putting the customer first. The upside was ready-made margin growth following the $49 billion Kraft/Heinz merger; the downside was disappointing revenue growth and a lack of long-term focus.

The rise of e-commerce, private labels and direct-to-consumer brands has led to recent changes at the top of many packaged-goods companies, including Campbell Soup Co. ,General Mills Inc., Mondelez International and Kellogg Co. Kraft’s strategy eventually turned off investors, with the company’s shares falling around 43% over the past year through Friday.

A company spokesman said “ZBB is a pillar of the Kraft Heinz culture that helps us drive savings so we can increase support for our brands, drive innovation, and invest in our top-tier talent.”

Brian Wieser, head of business intelligence atWPP PLC’s ad-buying agency GroupM, says zero-based budgeting’s rise is well-intentioned, but 3G’s dependence on it was ill-timed given the pronounced change taking place in Kraft’s core business. Customers have shown they are willing to pay for innovative and healthy foods.

“If you are so rigidly focused on what is directly in front of you you’ll miss a lot,” Mr. Wieser said. “It’s critical to optimize against forests rather than trees.” In Mr. Wieser’s view, running around headquarters worried about what everything costs is optimizing against the trees. Running around grocery aisles worrying about the customers and competition is optimizing against the forest.

Bill George, a former CEO who teaches at the Harvard Business School, said some executives have taken things too far. “ZBB is a process, not a strategy,” he said. Keeping a keen eye on costs is important, but pursuing cuts alone is like macaroni without the cheese.

“You have to grow your business,” Mr. George said. He pointed to recent strides made at PepsiCo. Inc. as an example. The soda giant, facing pressure from a cadre of beverage startups, boosted first-quarter organic revenue by 5.2% after ramping up advertising and focusing on new drinks.

Nilly Essaides, a senior research director at Miami-based consulting firm Hackett GroupInc., said when done correctly, zero-based budgeting frees up wasted money to be put to better use. “This is not just cutting and slashing, she said. ”It’s making sure the dollars are put to work where they should be working.”

Recent advances, including analytics and artificial intelligence tools, make it easier to figure out where to save and where to invest, she said.

Kraft’s new CEO, Mr. Patricio, most recently ran marketing at brewer Anheuser-Busch InBev SA, which is another 3G-backed company well-known for its zero-based budgeting. He doesn’t need to show he can slim down Kraft’s procurement budget or keep research-and-development expenses in check.

Instead, he’ll need to show he can take the money saved in one department and reallocate it to brands and product lines badly in need of a lift.

This content was written by John Stoll for the Wall Street Journal, and originally published on WSJ.com on 4/23/2019.