Are Business And Capitalism Facing Their "Marmite Moment"?

Capitalism, globalisation, free trade, the political parties and other institutions are increasingly polarising opinions, to the far-right and far-left. They are all acquiring the characteristics of Marmite, one of the brands caught up in the recent takeover threat by Kraft-Heinz looking to acquire Unilever. What do I mean by the characteristics of Marmite? I mean people are choosing to either love or hate them. 

Among the young, this certainly seems to be the case. A Harvard University poll of young Americans (18-29) discovered more than half do not support capitalism and are concerned with the flaws of the free market. 

The centre-right parties in Europe and the USA were strong supporters of capitalism and its institutions, which are now under attack from the populist parties on both the far-left and far-right. On the far-right the populist agenda is being pushed by the likes of Trump and Farage - a so-called “Bromance” which could soon become a far-right orgy if Marie Le Pen and Geert Wilders join their mob. 

The liberal parties that once dominated from the centre are now in total disarray. Their many years in office have left the middle class in most countries feeling relatively worse off and totally betrayed. At the same time, the poor are also comparatively much poorer as inequality has increased. In addition, uncertain and insecure employment, together with the dismantling of social welfare systems caused by austerity measure are intensifying levels of anxiety among large sections of society.

The results of the failure of neo-liberal economic policies, and the political parties that pursued neo-liberal policies, are very evident in the latest annual Edelman Trust Barometer findings. It concludes, “Trust is in crisis around the world and people now lack full belief that the system works for them”.

So, business and capitalism may be facing their "Marmite Moment". And, it is in this context the battle between Kraft Heinz and Unilever took place. Although takeover talks failed the attempt and the reason it was aborted illustrate what has gone wrong with capitalism and the reason it is being rejected by large sections of society. 

Julian Birkinshaw, Professor and Chair of Strategy and Entrepreneurship at London Business School, in an article for Forbes Magazine said, “I think the bid was actually a contest between two different models of capitalism”. He notes that on the one hand, “Kraft Heinz is managed with ruthless efficiency by a team of mostly Brazilian executives installed by 3G Capital. Plants have been closed, corporate jets sold, everyone now flies economy class” and, as a result, overhead costs in the company dropped from 18.1% to 11.1% in the last two years. On the other hand, “Unilever represents the other end of the capitalist spectrum. It exemplifies the view of a corporation as a force for good in society. Unilever’s mission is to “make sustainable living commonplace”. 

Birkenshaw has described the two companies as “standard-bearers for their respective ideologies”. That of Unilever stems from the values that drove an earlier era of capitalism, akin to those of the Quaker industrialists. Their focus is on long-term value creation and the shared prosperity of all stakeholders. On the other hand, 3G Capital, the private equity company that owns Kraft Heinz, typifies neo-liberal capitalism, a view that says shareholder interests must be given priority over all other stakeholders. It is surprising Warren Buffett, known for being a 'value investor' and a "long-term investor', was a key player in the 3G Capital attempt. Such activity seems to contradict his own philosophy. I will return to this below. 

3G Capital’s approach is to acquire firms from which it believes it can strip out costs to increase profits. Once it acquired Heinz, the company ruthlessly cut costs to increase profit margins by 10%. Additionally, at 30% the Kraft Heinz profit margin is twice that of Unilever. So, it seems clear the same strategy could be applied with great results in the short-term. The question is, at what price to long-term growth and sustainability? And at what price to the workers who lose their jobs? Consider that after 3G and Buffett bought Heinz in 2013, they closed six factories and cut 7,000 jobs in 18 months.

Reuters also questioned the Kraft Heinz strategy from a reputation perspective, noting that, “under the stewardship of 3G, Kraft has developed a reputation for extreme cost cuts that risk hurting a company's top line by sti?ing investment in innovation and marketing. Indeed, Unilever's rejection of Kraft's bid was not just based on price considerations. The company feared that a merger with Kraft risked eroding the value of its brands and could impede its expansion in emerging markets, which requires more investment.” And Reuters added, “Unless Kraft can shed this image as a relentless cost-cutter, it could face similar opposition from other acquisition targets”.

Once costs are stripped out, a company may be more profitable. But, it could well be a shell with no growth potential, like a car without an engine. This seems to have been the result at Heinz where its sales have fallen in four of the six quarters. As Reuters put it, “their winning formula now needs a growth boost. Buffett and 3G built Kraft into the world's ?fth-largest food and beverage company through acquisitions followed by a relentless drive to boost pro?t margins. While this cost cut-driven business model wowed industry observers, it appears to be reaching its limits, with Kraft's sales stagnating and margins ?attening. Kraft's bid for Unilever was aimed at addressing these challenges”. It would use the initial boost in profits to acquire other companies and achieve growth by repeating the same investment formula.

So, cutting costs is the easier and less risky approach to boosting short-term profitability. And, it is the favoured approach of the short-term investor. But, it undermines future growth. Paul Polman, CEO of Unilever made it clear, people should not invest in the company if a short-term strategy is what they want him to follow. Such clear signals to the market have earned him a great deal of respect.

With its long-term strategy, Unilever took the decision to invest in emerging markets, which already generate 58% of its sales. This compares to only 25% from emerging market sales in the case of Kraft Heinz. After the global financial crisis and the Great Recession, Unilever looked to have made a bad move, and its short-term results were impacted, making it a take-over target. But, the company is likely to be well placed in the medium and longer-term. 

Returning to the question I posed earlier, why does Warren Buffett, a long-term value investor, support 3G Capital? He does so because technically 3G Capital are not asset strippers that cut costs, boost profit and sell. It retains its holdings and uses increased profits to acquire other companies to achieve growth as I mentioned above.

Some, including Warren Buffett probably, say this is an efficient way to re-allocate resources. Others might argue it is nothing more than serial asset stripping. The collapse of Unilever takeover attempt may be a sign that Buffet is starting to feel uncomfortable with the strategy. Or perhaps he realises there is a risk to his personal reputation if he continues to pursue it. His strategy was questioned by FT columnist John Gapper in a recent article.

As I have argued in many previous articles, management theory has, for several decades, focused on stripping out costs from the so-called “value chain”. But, whilst controlling costs is important, value creation is the result of growing the nominator (creating value), not just reducing the denominator (reducing costs). 

The challenge is in getting the balance right between the two. As Colin Price, one of the co-authors of Beyond Performance said, “when it comes to achieving sustained excellence in performance, what separates winners from losers, paradoxically, is the very focus on performance. Performance-focused leaders invest heavily in those things that enable targets to be met quarter-by-quarter, year-by-year, but they tend to neglect investment in company health; investments in the organisation that need to be made today in order to survive and thrive tomorrow”.

The challenge is that in investing for the future, short-term results are reduced - a fact that is made worse by current accounting rules which require many investments to be expensed immediately. Drops in short-term earnings do not please shareholders. And among the shareholders are the CEOs who receive stock-based compensation packages - often amounting to very large percentages of their total remuneration. It can also leave companies vulnerable to hostile takeover bids, as Unilever just discovered.

For these reasons, a short-term focus on profit reduction is by far the easiest option, even if it means destroying long-term value. And this is where we find the real problem with the current form of capitalism. It is being driven by speculators (sharetraders), rather than real investors (shareholders). And, by managing and manipulating the expectations of future performance (speculation), rather than any real assessment of, and support for, the fundamental drivers of future performance (investment). 

Another way to distinguish between the two types of capitalism, and between sharetraders and shareholders, is to see that one is focused on value extraction and the other on value creation. We might call value extraction focused capitalism “denominator capitalism” and value creation focused capitalism “nominator capitalism”. 

Only nominator capitalism, focused on value creation, can deliver long-term sustainable growth and prosperity. And I have previously called this Valueism (short for value creation focused capitalism). Unilever pursues a Valueism focused strategy, and Kraft Heinz is driven by the unsustainable extraction model.

Prosperity for the company, its stakeholders and society is the focus of Unilever and of Valueism. It is the way to deal with the challenges that capitalism now faces. Only if Business can generate prosperity that is shared will trust be restored, and will capitalism regain legitimacy. The value extraction and capture approach leads to massive inequality and continues to destroy the legitimacy of capitalism and trust in business. It also puts business and capitalism are in breach of the social contract.

As FT columnist Martin Wolf says, capitalism is finding it far more difficult to generate improvements in prosperity. "The evidence is of growing inequality and slowing productivity growth”. And he adds, "This poisonous brew makes democracy intolerant and capitalism illegitimate”.

This being the case, we must hope more companies follow the strategy of Unilever in pursuit of value creation and shared prosperity. But, as Wolf also notes, and as I have already said, “The marriage of liberal democracy with capitalism needs some nurturing. It must not be taken for granted”. That means looking at public policy, CEO incentives, Governance issues, accounting practices etc. Until it is at least as easy to manage for the long-term as for the short-term we cannot expect to see the real changes that are needed. 

In conclusion, it is good to see that the takeover attempt failed. As one veteran institutional investment expert said to me, the attempt was nothing more than, “a perfect example of shorter-term value extraction capital in chase of short-term / mid-term yield / return, at the expense of long-term innovation, value creation and sustained Returns on Capital”.

While the takeover threat may be over an article in the Economist notes, “some investors are now pushing Unilever to do more” and, “the company announced a wide-ranging review of its business”. However, it is encouraging that in response the firm has said it wants to find ways to “accelerate delivery of value”. By making its strategy clear, Unilever attracts shareholders rather than sharetraders. Seventy percent of its shares are held for more than seven years. This means Unilever should continue to have the strength and support it needs to continue to prove that Valueism is not only a viable option but also a good one.

The case also highlighted the differences in approaches to capitalism, with Unilever illustrating one and 3G Capital illustrating the other. If it can be seen that Unilever's approach represents a far better model as a route to prosperity for all stakeholders, it might also be seen as a model that gives business and capitalism a chance to restore their legitimacy in the eyes of the growing number of people that have learned to hate them.

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