As the 50 top executives of the H.J. Heinz Co. walked through the grand entrance to the Four Seasons San Francisco in June, they knew that this year’s Chairman’s Leadership Conference would be like no other. Typically an exercise in team building and strategy setting, the event had a standard agenda: a mix of meetings and market discussions, a wine tasting in Napa Valley, and a motivational talk from the CEO of 15 years, Bill Johnson.
But Johnson’s speech wasn’t a forward-looking call to action — it was more of an emotional farewell to the 144-year-old company he had run. That’s because just 10 days earlier, the owner of such brands as Smart Ones, Ore-Ida frozen foods, Heinz Beanz, and, of course, its market-leading ketchup, had closed the largest food company transaction in history. Heinz, with $11.6 billion in revenue, had sold itself to Warren Buffett’s Berkshire Hathaway and Brazilian-owned private equity firm 3G Capital for $29 billion. Johnson had already handed the CEO crown to Bernardo Hees (pronounced “hess”), who previously ran Burger King, another 3G investment. Now that the deal had closed, the executives wondered whether an offsite even made sense. The Brazilian owner was known for ruthless cost cutting, and the attendees all knew their tenure at Heinz was at risk.
But the meeting went on, and after Hees spoke about his “dream” for the new Heinz — to make it the most efficient company in the food world — many of the executives experienced 3G-style efficiency firsthand. About half of them were summoned, in 15-minute increments, to a conference room where the new CEO informed them whether they had a place at the new company or whether their Heinz career was over. “You couldn’t dream it up, it was that weird,” says one attendee.
When the purge was over, 11 of the top 12 executives were gone, replaced, in many cases, by people they had managed or by executives who had previously worked at other 3G-owned companies. Easing the sting was the fact that they were ushered out with full vesting of their stock options and retirement accounts. Johnson left with a package worth an astounding $212 million.
The newly jobless were invited to hear speakers and tour Alcatraz prison along with their now former colleagues. “The bar was open,” says a Heinz executive who lost his job — and the scene was like a wake, both sad and celebratory at the same time.
The survivors were told a jet would be waiting for them Wednesday morning. They would fly back to Pittsburgh to begin work for the new Heinz, a company with fresh leadership — but also nearly $15 billion in debt, plus $8 billion in preferred stock with a 9% dividend owed quarterly to Buffett. (Although Buffett has typically preserved the management team in other Berkshire acquisitions, this setup is somewhat different. He says through an assistant that he is leaving the operations of the company to 3G and that his job was simply to provide financing. He is, however, a member of the six-person board, as are Greg Abel and Tracy Britt Cool, both Berkshire representatives.)
What is this new Heinz? So far, according to interviews with 21 current and former executives, it’s a place in which every cost, no matter how minor, is attacked and reduced or eradicated. That applies to human costs as well; in August, Heinz announced the layoffs of some 350 of the 1,200 full-time staff at its Pittsburgh headquarters and another 250 across North America, with more to come. The move was expected, given that 3G has implemented a similar approach at the other companies it has controlled, including Burger King, Anheuser-Busch InBev, Brazilian logistics company America Latina Logistica (ALL), and retailer Lojas Americanas. Says Michael Mullen, Heinz’s senior vice president of corporate and government affairs: “The difficult actions we are taking now will better position the company to support and fund our next chapter of growth while further strengthening our world-leading brands.” (Hees declined to be interviewed.)
The layoffs were only the beginning. Heinz’s corporate planes are being sold, and the company’s two headquarters buildings are being combined into one. Individual offices are being done away with altogether. Instead, even top executives now work only inches from one another at white industrial tables with one shared filing cabinet per “pod.” They are encouraged to wear shirts imprinted with the Heinz logo. Execs who once rested up at Ritz-Carltons now stay at Holiday Inns when traveling, and they are expected to work even longer hours than they already did.
On one level, 3G’s rejection of the frippery of the C-suite lifestyle is welcome. Hees and his team adhere to the same spartan rules as everyone else, working at particleboard tables and surviving on non-imperial per diems of $45 when they’re on the road in the U.S. But the significance of what’s happening at Heinz is not really about logos or airplanes. What is being called “the 3G way” is, in fact, a particularly unadulterated form of the private equity philosophy, one that prizes efficiency above all.
There has long been a tension in business over whether people or processes should reign supreme. Both are critical, of course, but which matters more? Some see human capital as the key instrument of corporate success. They believe that great leadership and motivated employees (along with excellent products) create happy customers and an intangible brew that fosters sustainable profitability.
Then there is the 3G way. Here, what matters above all is efficiency. People are relevant, yes, but explicitly as a function of what they contribute to the bottom line. This philosophy holds that employees are motivated by an ownership stake in the company rather than a feeling of purpose. Everything is measured; the leanest, meanest operation is the winner. That method has paid off big so far for Jorge Paolo Lemann, Marcel Herrmann Telles, and Carlos “Beto” Sicupira, the “3” men whose first creation was Brazilian investment bank Banco Guarantia (the “G” in the firm’s name). Just last year Lemann became the richest man in Brazil.
They have developed and refined their approach over the past few decades. The group applies a nearly identical playbook in each of its acquisitions. It slashes nonstrategic costs to the bone and plows some of those savings into marketing and acquisitions. The results have been, for the most part, breathtaking. At AB InBev, the world beer leader with $40 billion in sales, Ebitda margins hit 37%, from 23% when 3G bought it, compared with 24% for rival SABMiller, and the stock has more than doubled since 2009. At Burger King, 2012 profits sizzled, up 33%. “Everyone talks the talk [about efficient management], but 3G really does it,” says activist investor Bill Ackman of Pershing Square Capital Management, which owns 11% of Burger King. “These guys are the best.”
Yet many food industry experts see a major difference between Heinz and 3G’s other purchases, which were flabby and ready for the corporate equivalent of a juice fast. After all, Heinz has been slimmed and trimmed for seven years now by investor (and, until June, board member) Nelson Peltz, no slouch in the efficiency department. Heinz was a relatively lean, hard-working enterprise, a place with a long-standing corporate culture and a commitment to high-quality brands. The company had posted organic growth for 30 straight quarters, and the stock price rose 27% in the two years prior to the deal.
The experiment now under way will determine whether Heinz will become a newly invigorated embodiment of efficiency — or whether 3G will take the cult of cost cutting so far that it chokes off Heinz’s ability to innovate and make the products that have made it a market leader for almost a century and a half. “Right now they’re in the middle of a transplant,” says Gil Schneider, former CFO for North America Consumer Products at Heinz. “It’s a whole new model on top of a living organism, and the question is will they reject it or not?”
For most of its history, the H.J. Heinz Co. has stood not only for ketchup and other comestibles but also for a shining model of corporate paternalism. Its founder, Henry J. Heinz, was an industrious son of German immigrants who got his start by selling his family’s vegetables door to door in Sharpsburg, Pa. By 1869 he was producing his own horseradish, which he sold in clear glass so that customers could see its quality. After some financially rocky years, including a cash squeeze caused by a cucumber glut, the H.J. Heinz company emerged in 1888.
Heinz soon produced everything from baked beans to soup to, of course, ketchup. The company prospered, thanks both to its high-end reputation and the family’s marketing abilities. It was Henry Heinz himself who dreamed up the “57 varieties” tag line. The number of products was in fact much higher, but he seized upon the number 57 as appealing and memorable. Quality, too, was always a hallmark. In fact, the term “quality control” is said to have been invented at Heinz, which was the only major foodmaker to support the 1906 Pure Food and Drug Act.
The company believed that workers would be far more productive if they were part of a community. So Henry Heinz built an auditorium, a gym, a library, and even a swimming pool for his employees. He provided showers and bathrooms at a time when indoor plumbing was scarce, and according to the corporate history In Good Company, “insisted on providing a weekly manicure to those who worked with food. A weekly manicure!” Later the Heinz Foundation’s charitable contributions solidified the company’s reputation as a proud pillar of Pittsburgh.
But venerable companies eventually endure some rot. Heinz stagnated and only fully entered the modern era with the ascent of Anthony O’Reilly to CEO in 1979. A charismatic onetime Irish rugby star, O’Reilly became one of the best-known CEO personalities of the 1980s — and the best paid as well. “Every 25 years some disruptive force breaks in at Heinz,” says Ted Smyth, Heinz’s chief administrative officer until 2006. The share price soared, the company expanded into baby food and Weight Watchers, and earnings increased 15% annually, thanks in part to drastic budget slashing. O’Reilly’s method was decentralized; he handed managers targets and then gave them leeway to meet them in the way that worked best for their business.
O’Reilly would eventually recognize a limit to the corporate scythe. “Over the years the relentless pressure of cost cutting had created within Heinz a mounting feeling of bile,” he told Fortune in 1990. “There was an ever-increasing feeling of hostility among the employees.” The stock price stagnated. In 1997 he stepped aside, replaced by his fiery deputy, Bill Johnson, who had excelled in Heinz’s StarKist and pet foods divisions.
Under Johnson the company expanded heavily into emerging markets, which jumped from single digits to 24% of sales through 40-odd acquisitions. It sold off brands like StarKist and produced innovations such as the now ubiquitous upside-down ketchup bottle. Market share in ketchup remained dominant. Yet shareholder value lagged, leading to multiple restructurings.
Enter an activist. Nelson Peltz saw an opportunity to spark growth and won two seats on Heinz’s board in a 2006 proxy fight. Instead of battling each other, however, Johnson and Peltz became allies. Peltz encouraged Heinz to reduce its discounting. He emphasized the need to grow the business by spending on marketing.
The company revved up once again, delivering stellar results. Convinced that he had whipped Heinz back into shape, Peltz began preparations to leave the board and sold much of his company stock.
Then, out of the blue in January, came the 3G/Buffett offer. Most shareholders, who loved both the 19% takeover premium and the fact that Warren Buffett was involved, welcomed the bid. Few knew 3G, but they knew Buffett’s reputation for buying well-run companies and leaving them alone. They also loved Heinz’s promise that it would keep its headquarters in Pittsburgh and maintain the Heinz Foundation’s level of charitable contributions.
The pledge helped torpedo any resistance to the deal. Meanwhile, Buffett’s aura of folksy financial integrity distracted some observers from the fact that the deal had the DNA of a 1980s-style leveraged buyout. With a total of $23 billion in debt and high-dividend preferred stock, any cost savings that 3G could find would go to paying down obligations — not to nurturing the business.
Although 3G is little known in America, its founders are business stars in Brazil. The legend began with Lemann, a five-time Brazilian tennis champion who worked in finance after graduating from Harvard. In 1971, at the tender age of 32, Lemann founded a small investment bank, Banco Guarantia, along with fellow bankers Telles and Sicupira. It grew to become one of the most influential financial institutions in Brazil. From there the team bought Brazilian beermaker Brahma, which they gradually built into an acquisition vehicle, now known as AB InBev, that today controls some 46% of the U.S. beer market. They founded 3G in New York and Rio de Janeiro in 2004.
Over time the group refined its approach and applied it to companies ranging from banks to retail outfits to consumer products. As Lemann has acknowledged, 3G’s management philosophy is a pastiche of ideas, many of them decades old.
For a preview of what to expect at Heinz, let’s examine an earlier 3G deal, Burger King. 3G bought the fast-food chain in October 2010 from private equity firms Texas Pacific Group, Bain Capital, Goldman Sachs, and public shareholders for $4 billion. It was in sad shape. The perennial second-place burger house had been passed around for years to a motley collection of owners, including Pillsbury and Grand Metropolitan. Burger King had been starved of resources, and it lacked a coherent strategy.
As it did with AB InBev and now Heinz, 3G began by hiring Accenture consultants to analyze every cost, using a process called zero-based budgeting. As the phrase implies, all costs are assessed as if starting from zero. If a process or product or person is no longer justifiable, out it goes. Says Paul Cichocki, head of Bain Consulting’s performance-improvement practice in the Americas (which does not work with 3G): “It is the most radical cost-and capability-changing tool that a senior executive would use.” It is expensive and time-consuming to implement, but — if it succeeds — it can produce radical savings. It can eliminate entrenched departments and methodologies that are there simply because they’ve always been there.
The next step in the process is the culling of leadership — or what 3G considers talent assessment. To hear 3G tell it, its employees work within a true meritocracy. Those who are willing to work very, very hard will be rewarded lavishly; those who don’t will be tossed overboard. The game plan usually begins with the firing of most of the top team and the promotion of younger, less experienced employees. Over time an increasing number of 3G transplants are installed at the top. Indeed, Hees’s replacement at Burger King is 33-year-old Daniel Schwartz, who worked at 3G before becoming CFO at the fast-food chain. Burger King’s new CFO is 26.
At Burger King, virtually every member of the headquarters staff, including administrative assistants, sat through a 15-minute one-on-one interview with Hees. “The 15 minutes of fame,” as one former Burger King executive calls it facetiously, followed the same format for everyone: Arrive with one piece of paper — employees were instructed to write on only one side of it — answering three questions: What have you done for the brand? What can you link to driving sales traffic or relevant financial metrics? What suggestions do you have for the company?
That was it. At the end Hees thanked you and you left, unsure if you’d just extended or ended your career. Adding to the stress, in at least one instance, according to a witness, a round of such meetings was held on a couch at the bottom of a heavily trafficked stairwell in the middle of a convention. (A Burger King spokesperson denies any interviews occurred in public.) “It was nerve-racking,” another former executive says. “People were throwing up in the bathroom because their whole career comes down to this.”
Two months later a massive restructuring followed, and 413 people were removed from Burger King’s Miami headquarters on one day in December 2010. Offices were turned into open workspaces, with one personal item allowed at each seat; Saturday became an expected day at the office. (Burger King denies there was a one-item limit and says employees were asked to work “as necessary to accomplish goals.”)
Then the ubiquitous logo shirts appeared. Like citizens subtly undermining an oppressive authority, some took to wearing them ironically. Says one former executive: “They brought a machine into the cafeteria for people to have their own personal shirts embroidered for free. People were bringing in shirts they hadn’t worn in years. Two days after boxes [of personal items] were going out, garage sale shirts were coming in.”
Cuts at the company sliced deeply into areas that don’t directly contribute to the bottom line, such as human resources, legal, and quality assurance. Burger King’s research and development staff was chopped from some 25 people to about three, and much of the work is now being outsourced. The company has switched to a nearly all-franchise model, paring its ownership to only 51 stores out of a total of 13,000 worldwide. That saves a lot of money at headquarters by moving store and renovation costs to the franchisees.
Suppliers also found themselves squeezed. They were informed they’d need to reduce costs by 20%, according to several former executives, if they wanted to keep Burger King’s business.
For 3G, the results have been outstanding. In June 2012 it took Burger King public again via a shell company called Justice Holdings. 3G collected about $1.4 billion on top of the 70% of Burger King’s equity it retained. Profits continue to rise, with second-quarter 2013 earnings up 31%.
What’s less clear is whether Burger King has any real growth prospects. U.S. same-store sales are projected to fall this year, according to Consensus Metrix, while those of its main rivals are expected to rise. Burger King continues to lag far behind McDonald’s, with average annual store sales of $1.2 million, vs. McDonald’s’ $2.6 million. Indeed, the chain has even ceded its longtime No. 2 position to Wendy’s. Burger King hopes to grow by opening 1,000 restaurants in China. But restaurant consultant John Gordon of Pacific Management Consulting Group says he’s “pessimistic” because the company is relying on partners that have not worked in that part of the world before.
Meanwhile, cutbacks have hampered some functions and reduced institutional memory, says Andy Kerridge, who was head of food safety and quality for Europe until he was laid off in 2012. “What Burger King probably lacks now, and it is across all sectors, is just a baseline of knowledge. The person with the longest experience in quality assurance in Europe was someone I recruited six months before I left.” More than a year after leaving, Kerridge says he still gets calls from people at Burger King asking how to run things.
Despite the company’s recent financial success, there’s another sign of turmoil: churn at headquarters. Turnover hovers above 30% annually — modest, perhaps, for burger flippers, but stratospheric for white-collar executives.
It’s been four months since the Heinz deal closed. Already the 3G model is firmly in place. An internal document obtained by Fortune shows an amazing level of micromanagement — a major difference from the cost-cutting autonomy once granted by O’Reilly. “Monthly tracking of printer use by employee(s) should be implemented,” with a limit of 200 copies per month, it says, and there is to be only one printer per 100 full-time employees. Executives at the director level and above are allowed only 100 business cards per year. “Mini-refrigerators,” it reads, “are not permitted,” and “pre-payment for services is not allowed without prior approval from the CFO.”
Many Heinz executives now have two areas of responsibility instead of one, says former chief people officer Stephen Clark, who calls it “doublehatting.” His replacement, Kristen Clark (no relation), former head of Heinz Canada, has no human resources experience at all; her new second-in-command is from finance. The global leadership-development team has been let go. “They took the H out of HR,” says Randy Keuch, a Heinz HR vice president who retired in September after the company abruptly ended its long-standing practice of offering above-market annuities for employees’ pension money.
Heinz may not need internal talent development as much as it once did, because 3G’s expanding global profile means it now has a SWAT team of loyal executives who jump from company to company, regardless of location or industry. Most are Brazilian, and many of them received scholarships from 3G’s founders. Recipients have included Carlos Brito, the well-regarded CEO of AB InBev, and Hees. The scholarship winners are talented and hungry (many come from low-income families), but their first loyalty is to 3G, not Heinz. The proposition is simple but compelling: Work harder than you’ve ever worked, and — if you are a senior executive, that is — you might receive bonuses or lavish stock options (which vest only after five years).
Holdover Heinz employees feel off-balance. They and others describe an insular management style in which only a small inner circle knows what’s really going on. Both inside the company and publicly, the new management has said little about its strategy. “It’s a bit like God,” says one recently departed executive. “You feel there’s a grand plan, but you aren’t sure what it is.”
As a result of both the cuts and the culture change, Torrey Foster, interim region leader for the Americas at search firm Heidrick & Struggles, says he is seeing more interest from previously loyal Heinz executives. “Heinz is certainly a very solid [item on a] résumé,” he says. Executives there “get high marks for management and general acumen.” Foster says they’re in demand by Heinz competitors.
Those rivals are watching anxiously to see whether 3G can achieve the profitability it has managed elsewhere — or whether, should it stumble, there is an opportunity to make inroads into Heinz’s dominant brands. “Managing brands is like tending a garden,” says Ken Coogan of marketing consultancy Coogan Partners. “If you don’t stay on top of it, it goes to weeds.” Many see the purchase as the base for a massive consolidation of the food industry, much as AB InBev has done with beer. Yet a roll-up is unlikely anytime soon because of the vast restructuring under way — and the massive debt and preferred stock burden (the highest in the industry at nine times operating Ebitda). That high leverage caused Fitch to drop its ratings on Heinz’s debt from BBB+ to BB-, well into junk territory.
So how is Heinz doing so far? It’s hard to tell because the company is now private, and because, like other 3G acquisitions, it seems likely to move its fiscal year-end to December from the end of April. That would allow the current year to be treated as a “stub” and make it harder to compare past and future results. Still, there are clues. In the quarter that ended in July, overall sales dropped 5.2%, which the company attributed primarily to a change in the timing of its promotions but is more likely a result of dramatic reductions in spending on those promotions. Between July and late September, market share, too, dropped in the U.S. for each of Heinz’s main categories (including ketchup, frozen potatoes, and pasta sauces), according to Nielsen consumption data obtained by Fortune.
That may not bother 3G at all; it doesn’t chase sales at all costs. “They win by figuring out how to be more efficient than anybody else,” says former Heinz executive Clark. “The question is how sustainable that is over time if you are not also focused on the top line.” The reduced sales may also have something to do with 3G’s having ended the dubious practice of trade loading, in which products are sold and held by the distributor rather than the manufacturer. Once caught in the trade-loading trap, public companies cannot stop without taking a huge hit to sales. 3G no longer has that worry. (A Heinz spokesperson declined to comment.)
Meanwhile, Heinz’s close connection to Burger King has already cost it major business. Heinz’s CEO Hees remains vice chairman of Burger King, and Alexandre Behring is chairman of Burger King and a director of Heinz. Fortune has learned that McDonald’s, which until now has used Heinz products only abroad and in a few U.S. cities, has decided to stop using Heinz altogether. “As a result of recent management changes at Heinz,” says a McDonald’s spokesperson, “we have decided to transition our business to other suppliers over time.” Buffett confirms he had a “friendly” phone call with McDonald’s CEO Don Thompson to discuss the issue. But he was not able to change Thompson’s mind. (Heinz declined to comment.) McDonald’s wasn’t a huge account for Heinz — but it’s a painful symbolic loss.
The next step for Heinz will undoubtedly prove challenging. The company has hundreds of brands in 200 countries run in a largely decentralized manner. Says a recently departed top company executive: “The challenge with Heinz is it’s a myriad of categories, not one brand. It’s less easy to get these massive synergies. The risk on a business like Heinz is that if you lose market share, you don’t get it back by putting the people back.” To modify an old phrase: You can’t put ketchup back in the bottle.
Additional reporting by Daniel Roberts
This story is from the October 28, 2013 issue of Fortune. (An excerpt of this article was first published on Fortune.com on Sept. 18.)