Cutting cost is good, investment is better

Ten years ago this month, the American stock market, stricken by the global financial crisis, bottomed out and started one of the longest upward market trends in history. Now, a decade on, Rathbone Income fund manager Carl Stick thinks it’s appropriate to talk about change.

24 April 2019

The world has been up-ended dramatically since stocks started their decade-long rebound. Globalisation of trade and liberalisation of politics have now given way to protectionism and populism. Lately, I’m starting to believe that what we regard as cutting-edge business practice should change, too. I want to talk about brands and what they mean, about avoiding complacency and the dangers of getting too comfortable with easy narratives that serve the past better than they do the future.

The last decade was all about efficiencies: stripping out costs and paring back investment – corporate austerity, if you will – or embarking on market domination, buying up fledgling competitors and steamrolling your brand across the world in all its homogenous glory. All zero-based budgeting and marginal gains. Yet these motifs/signals of corporate excellence are losing their lustre. These themes are less about investing in the future and more about using cheap money, easy debt, to amplify returns and send capital back to shareholders. This trend no longer seems sustainable.

Perhaps the most high-profile example of this change is Kraft Heinz, a huge consumer brands company with a grab-bag of products from ketchup and mac ’n’ cheese to pop, soy sauce and pet food. Kraft Heinz was created when Warren Buffett teamed up with 3G Capital, the posterchild of cost-focused investment, to make two of the largest mergers and acquisitions in the history of household brands back in 2013 and 2015. Kraft Heinz’s products used to dominate supermarket aisles around the world, but after implementing “zero-based budgeting” – forcing staff to fight every year to justify every bit of spending – these brands lost their lustre. The investment to stay relevant, to create the next thing to excite and keep customers was lacking.

Jorge Paulo Lemann, the billionaire Brazilian businessman who co-founded 3G Capital, gave an unusually frank interview to Forbes magazine last year. He made this brutal self-assessment: “I’m a terrified dinosaur. I’ve been living in this cosy world of old brands and big volumes … We bought brands that we thought could last forever. You could just focus on being very efficient … all of a sudden we are being disrupted.”

Recently, Kraft Heinz reversed course. Now it will inject substantial sums into its brands through increased marketing and product innovation. However, I wonder whether this ship has already sailed. Kraft needs to hold back the tide on multiple fronts: a general distrust of big food companies, healthier eating trends, and sustainability concerns around supply chains, packaging and buying local. But it may already be too late. Customer behaviour has changed rapidly as the digital age has developed.

Take the situation here in the UK. Not very long ago, discounters were a shameful last resort for UK shoppers. Things are very different now. Now, it’s cool to swipe a bargain and get one over the mainstream supermarkets down the road that are charging over the odds. Increasingly, middle class people are likely to get an Ocado delivery from Waitrose in the morning and pop down to Aldi in the afternoon to rummage round the middle aisle deep-discount specials.

It may seem counterintuitive to my argument to talk about a cut-price retailer beating the purportedly upmarket supermarkets. But the point here is investment. It’s slight mental gymnastics, but companies can invest in prices (this is what the industry calls taking less profit on what you sell and giving it to the customer through cheaper prices). Aldi has been exceedingly strong in this. It has also been investing in everything from its staff to store layout and branding. Its staff are the best paid of any other supermarket and its regional manager internship programme is extremely well-regarded. Meanwhile, the major supermarkets have, in the main, been focused on eking out greater profits through keeping costs low and raising prices in line with inflation. Now, many major supermarkets look tired, with grumpy staff and expensive goods. By contrast, Aldi achieves a vibrancy and relevance by stocking large amounts of a limited number of goods, at very low prices.

The playbook of the last decade was one of scale: become the biggest fish in the pond so you squeeze your suppliers on cost and slash your own expenses through centralising as much as possible. This edition seems inappropriate now. The difficulty is that the correct play-book for the next 10 years has not yet been written.