Radical Cost-Cutting Is Out, Brands Are Back

Marketing budgets became a key target for the frugality drive of companies ever since the last recession. Last year, budgets had decreased from 12.1% of average revenues in to 11.3% the previous year, according to consulting firm Gartner.

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Predictably, with a focus on cost-cutting rather than growth, the financial health of corporate America is deteriorating. According to an analysis of the 2017 Fortune 500, 53% of corporates had experienced an after-tax profit decline, while only 47% saw profit growth. Marketing, once the driving force of America’s consumer society, has been in retreat for over a decade.

Brands were harmed further by 3G Capital, a Brazilian multi-billion dollar private equity firm best-known for partnering up with Warren Buffett’s Berkshire Hathaway. 3G Capital was lauded by Wall Street as a model operation. It bought Kraft and merged it with its privately-owned the Heinz company in 2015, taking the combined business public, as Kraft Heinz.

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The 3G Capital approach to business is ruthless and revolves around cost-cutting. Every employee must justify his existence every single day. Promotions are quick and merit-based, and underperformers get fired with the same alacrity. Budgets are zero based and evaluated unsparingly every year, or even sometimes with more frequency. Expenses are eliminated if they’re no longer judged worth incurring.

In less than two years after merging Kraft with Heinz, its workforce was cut by 20% and overhead by 40%. Critics have long contended that 3G Capital’s cost-cutting went too far and came at the expense of growth. They turned out to be right. The problem with this philosophy is that you can’t cost-cut your way to growth.

Not surprisingly, what followed is sales declined for six quarters in a row. The wheels came off last Friday morning when Kraft Heinz stock dropped 30% at the open and the company lost $16 billion of its market value. The essential problem facing Kraft Heinz is that it stopped investing in its brands at a time when consumer tastes and behaviors are shifting, and the competitive environment is intensifying.

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It is time for companies to refocus on growth by investing in marketing, distribution and continued innovation, not adhere to a strategy of frugality alone. Tellingly, when hedge fund Third Point Capital mounted an activist challenge to Campbell Soup last year, their main criticism was that the company wasn’t investing enough to update its aging soups.

Kraft Heinz’s failure is the canary in the marketing mine shaft. It is simply a confluence of self-destructive actions by many marketers that has had reached a tipping point. The same Gartner survey that I quote above points out that investment in external agencies, 22%, as percentage of marketing budgets is the lowest ever, as is investment in paid media, 23% of average marketing budgets.

At the same time that investment in external agencies is falling, marketers are spending more, about 25% of their budgets, on internal agencies. Most worrisome, perhaps, is that despite the talk about the prominence of data science and optimization, “marcom” acquisition has been cut by 15%.

It was Kraft Heinz’s botched $143 billion bid for Unilever in early 2017 that unleashed the wave of cost cuts at big-name consumer companies, as consumer goods companies became the third-most-targeted for acquisitions of all sectors in 2018.

These companies have under- performing margins and therefore they are still vulnerable, but activist investors will now have a tougher time steering them. They will have to bring fresh ideas to the table on how to grow the business, not just cut costs.

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Brands are more important than ever, as the world has come online and there are many new markets and a growing middle class in places like India, China, Brazil, Russia, South Africa, Nigeria, Indonesia, Turkey or Mexico. These consumers buy brands, not commoditized products. They buy premium brands. And branding is essential to differentiate itself in a world of parity and, in order to create brand preference.

Remember, brands do better in tough times compared to unbranded products and brands outlive product cycles.

McKinsey has shown the importance of brand-value. They found that in almost 90% of categories that they measured recently, consumers are not loyal to their chosen brands, and almost 60% will switch when considering a new purchase. This means that the moment of initial consideration can be decisive in a consumer’s engagement journey – and a strong brand is the key to winning the battle for that initial consideration.

By Avi Dan