3G acquiring Heinz, Kraft, Anheuser Busch, SAB Miller: the common denominator

What attracts Brazilian takeover specialist 3G to mature companies in low/no growth industries?

Three features are right out of a finance or marketing textbook:

–the target firms are priced at modest multiples of earnings in the stock market, that reflect the consensus assumption that earnings growth will be hard to come by.  So there’s money to be made if 3G knows that assumption is too pessimistic.

–in an industry that has two giant competitors with, say, 25% of the total market each, and then a bunch of firms with no more than 5% each, the two leaders will continually knock heads with one another.  Both have large absolute market shares but no relative market share advantage against one another.  If 3G already owns one (as is the case with Kraft and SAB Miller) and the two combine, even if they are forced to divest assets to avoid antitrust objections , the post-merger industry structure will be something like one 40% giant and a (possibly larger) bunch of 5% midgets.  The one giant will have 8x the market share of its nearest rival–a huge competitive advantage.

–in mergers like Kraft/Heinz and AB InBev/SABMiller, there’s lots of duplication in SG&A that can be eliminated

 

There’s a fourth reason that doesn’t get talked about much, but which I think is much more important than the other three–

–at the end of WWII, victorious troops returned to the US and began fashioning the “modern” American corporation, the structure that most mature publicly traded enterprises still maintain.  A basic building block was the idea of span of control, or the maximum number of people who any manager could effectively supervise directly.  That number was seven.  So if a firm had 7,000 workers performing essential company tasks, they would need 1,000 first-line supervisors.  Those would, in turn, require 70 second-line supervisors, who would be controlled by 10 third-line managers…

Of course, that was in combat.  And that was before copiers, fax machines, television, cheap landlines, personal computers, cellphones or the internet   …and when most workers had far less training/education than today.

In addition, in the army, a lieutenant would be in charge of 30 people, a captain 150, a lieutenant colonel a thousand.  So it was an easy conceptual step to associate importance in the company hierarchy with the number of people under a manager’s purview.  But this means that if a manager opts to run a department more efficiently with fewer people he risks losing status in the firm.  So no one does this.  Instead, managers want to have more subordinates, even if they’re underutilized.

So these companies tend to be bloated with non-productive labor.

 

To address again the question of what 3G does

…it looks for companies that still cling to a seventy five-year old business model that internal bureaucracy keeps in place, and modernizes it.  It looks for the 15% – 20% extra people the target firm employs and lays them off.  It also sells the corporate art collection or the polo club a former chairman persuaded the board to allow him to buy.  It installs zero-based budgeting, meaning managers are required to justify all expenses each year, not just new ones.  By this time, it doubtless has a good idea going in of where to look for fat.

To my mind, the surprising thing is that this pre-technology corporate structure has lasted so long past its sell-by date.  3G is willing to be a catalyst for change because it sees the immense profits that can be made by doing so.

 

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