Mergers, Margins & Misunderstandings

Mergers, Margins & Misunderstandings – the challenge of culture clash in M&A

Kraft Heinz’s audacious bid to acquire Unilever took everyone by surprise last month, including, it seemed, Unilever’s board and its high-profile CEO Paul Polman, more used to being in the news for his focus on social responsibility and sustainability. The approach prompted an angry rejection by Unilever, leading Kraft Heinz and its backers, the Brazilian private equity (PE) firm 3G Capital and Warren Buffet’s Berkshire Hathaway, into an embarrassing climbdown. As The Economist dryly pointed out, Kraft Heinz “badly misjudged Unilever’s depth of attachment to its culture”, which Mr Polman assessed to be the “opposite” of 3G’s ruthless cost-cutting approach, with its long-term building of brands and focus on sustainable stewardship.

3G is renowned for pursuing margin expansion by ruthlessly cutting costs, epitomised by its ‘zero-based budgeting’ where budgets need to be justified from scratch each year (under the ownership of 3G and Berkshire Hathaway, Kraft Heinz has so far closed seven factories in North America and shed 13,000 jobs). This focused and decisive approach has struck fear into many established (3G might call them complacent) businesses in the food industry and beyond.

The Economist article also provides examples of how some of 3G’s practises are being adopted by mainstream businesses to stay competitive and fend off unwanted suitors. Also, Unilever announced a strategic review in a bid to boost margins, responding to the implicit criticism in Kraft Heinz’s approach, within days of the deal being shelved.

The Hunt for Profit

Deal making is on the rise, highlighted by the announcement over the weekend of the Standard Life getting together with Aberdeen Asset Management. Despite corporate balance sheets being in good health, this increase in M&A reflects current difficulty in finding organic growth, thereby depressing valuations. In addition, acceptance is growing that dividends and share buy-backs, in vogue in recent years, are not a good long-term use of capital (although they are effective at improving a company’s share price in the short-term and consequently boosting management incentive schemes).

There seem to be three main drivers to the current wave of mergers. Firstly, where a merger is designed to consolidate capacity in an industry where competition is high and margins are low (good examples are AB InBev’s acquisition of SABMiller; Nomad Foods’ acquisition of Findus; and Shanks’ reverse take-over of Van Gansewinkel completed last week, creating Renewi plc).

The second reason for a deal is to expand into new markets or capabilities. Softbank’s acquisition of ARM, and more recently of Fortress Investments and the sale of United Biscuits to Turkey’s Yildiz Holding are good examples. Thirdly, acquirers seek growth where their own organic growth is stalling (see Reckitt Benckiser’s acquisition of Mead Johnson, announced last month).

Culture Clash – the hidden pitfall

Whatever the driver, most deals are done to expand margins, generate profit growth and ultimately, create long-term value. Another feature most mergers share is the significant challenge of cultural integration. Creating a single company from two is always a challenge as it involves changing long-held habits on all sides. Whether the divide is predominantly across national styles (as in the Yildiz/United Biscuits deal) or in merging distinctly different corporate cultures (as would have been the challenge with Kraft Heinz and Unilever), culture always ends up being at the heart of whether the grand ambitions of such deals can be realised. Jack Welch, former CEO at GE, captured the challenge nicely when commenting on the proposed Unilever deal on LinkedIn:

“M&A is filled with opportunities – and pitfalls. And when it comes to the latter, none is as dangerous as the clash of two disparate cultures coming together.”

Brave New World

One of the more eye-catching of recent deals is Froneri, created by the merger of Nestle’s ice cream and European frozen food business with R&R Ice cream, backed by PAI Partners, a European private equity house. The attraction of the deal is clear: applying the dynamism, management rigour and financial focus of a PE-owned business to the brands, marketing capabilities and established distribution of the world’s largest food company, combining the ‘best of both’ to boost margins and sustain growth in the longer-term. It is the same principle behind Kraft Heinz’s bid for Unilever, though on a smaller scale. The central question for PAI and Nestle, and number one challenge for the Froneri’s leadership team, is whether they can shape a coherent business from two such disparate cultures.

The years immediately following the financial crisis was a period of major re-structuring, but contained mainly within firms. We are now seeing the next phase emerge, characterised by re-structuring between firms and even between industries, accelerated by the growth in technology-driven disruptive business models. Whilst there are always risks and opportunities in such change, cultural integration will be one of the prime risks and opportunities for many of these deals.

Kraft Heinz’s bid for Unilever felt like the collision of two world views: between that of ‘finance is king’ where growth, profit and balance sheets exclusively guide thinking, and that of the ‘corporate stewards’ where the identity, long-term custodianship and an organisation’s culture is of primary concern. Whilst the likes of 3G challenging established companies to be more focused and decisive is undoubtedly positive, it would be good to see ideas also flowing the other way, educating these modern day ‘barbarians at the gate’ on the benefits and contribution that a positive and aligned culture can make to the top and bottom line of a business.

And just to be clear, we’re not talking about the sort of ‘leadership help’ that Travis Kalanik, Uber’s CEO, recently admitted he needed after an embarrassing video was released of him losing his cool with an Uber driver.

With all this M&A activity, our sincere hope is not that one of these competing world views wins out, but what emerges is an approach that leverages the strengths of both. Now that would feel like a brave new world.

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