An SEC Ruling Favors Brands
You may have missed an important brand-elevating event this month. On September 3rd , the SEC settled a case of financial finagling with Kraft Heinz. Kraft Heinz, home to some of America’s favorite brands, agreed to pay a fine of US $62 million. This fine is a result of a financial scheme designed to inflate cost savings. The cost savings inflation made the enterprise look really good to analysts. This positively affected stock prices. Shareholders were happy.
Kraft Heinz, a 2015 merger of two iconic companies, engineered by the Brazilian private equity firm 3G Capital, promoted and utilized a severe financial approach called zero-based budgeting leading to massive cost-cutting. This approach denied funds to brands for renovation and innovation as well as for market research and all other strategies and tactics necessary for brand-value-building.
The extreme cost-cutting, along with debt-accumulation and large numbers of employee firings siphoned money into the pockets of investors and executives rather than into brands. 3 G’s financial engineering seemed to have only one goal: satisfy shareholders at the expense of customer satisfaction and brands.
The SEC was aggressively forthcoming in its ruling. Here is some of what the SEC had to say as quoted in The New York Times:
“Kraft and its former executives are charged with engaging in improper expense management practices that spanned many years and involved numerous misleading transactions and a pervasive breakdown in accounting controls. Kraft and its former executives are being held accountable for placing the pursuit of cost savings above compliance with the law.”
There is a marketing principle that says you cannot cost manage your way to high quality revenue growth. Financial engineering that extracts value from brands is a form of brand extortion. Innovation and renovation of products and services dwindle as monies are withheld.
As Kraft Heinz learned, financial engineering at the expense of customer focus and the brands they love is a financial formula for failure.
Kraft Heinz was so focused on cost savings that the organization ignored this principle at its peril. By 2017, there was no more money to cut. Rather than give up on its financial engineering, Kraft Heinz skirted the law. Rather than honestly reporting its financial statements, Kraft Heinz booked a large amount of cost-savings in the year for the year when the cost savings were meant to be spread over three years. The SEC stated that Kraft Heinz actually changed the wording on a procurement agreement in order to create this false scenario for investors in order to make Kraft Heinz’ earnings report look fantastic. The false accounting was also designed to generate further excitement for zero-based budgeting. Kraft Heinz told analysts that the company had cut US $1.75 billion in yearly spending by the close of 2017.
Brands can live forever, but only if properly managed. Kraft Heinz neglected its brands. And, because of the pressured environment to cut costs, Kraft Heinz found itself unable to sustain the value of its brands. In 2019, Kraft Heinz was forced to write down the value of beloved brands like Oscar Mayer and Kraft mac and cheese by more than US $15 billion.
Again, you cannot cost manage your way to enduring profitable growth. The Wall Street Journal reported that former Kraft Heinz employees said “…the company’s heavy cost-cutting after the Kraft Heinz merger diminished its ability to promote new or improved products.”
The goal of effective management is high quality revenue growth. The bottom line of any enterprise is to attract more customers who purchase more frequently who are more loyal generating more revenues and increasing profitability. Quality revenue growth of the top line is the road to enduring profitable growth of the bottom line. Organizations must focus on both customer value and stakeholder value at the same time. Focusing only on shareholder value at the expense of customer value is death-wish management.
Enriching loyal shareholders through financial finagling combined with short-term marketing tactics does not address declines in customer satisfaction and transactions. The financial engineers insist that their behaviors “unlock value.” Not true. Financial engineering does not unlock value; it exploits value for short-term benefit. And, in the end, the brands (as well as, customers and employees) pay the price for these pecuniary shenanigans.
This is not to say that having a short-term focus is completely wrong. If there is no short term there will be no long term. However, managers must manage both the short term and the long term. The in-the-year for-the-year approach to management is a brand destroyer.
The SEC ruling with its accompanying fine and its charging of two of the executives involved may have been buried in the press after September 4th, but it is a boon for brands.
Hopefully, this ruling will put some nails into the coffin of zero-based budgeting and financial engineering. Hopefully, this ruling will persuade companies to start engineering on behalf of customers, all stakeholders and brands. Hopefully, this ruling will usher in a new era of corporate virtue.
In the meantime, Kraft Heinz has acknowledged that brand building must be a priority.