How Did Cost Cutting Lead Kraft Heinz to Scandal?

Miguel Patricio, the new CEO of Kraft Heinz, faces a wealth of challenges in his new position. He joins the organization as its profits are flagging and its public perception is at perhaps an all-time low. In addition to losing health-conscious customers, the maker of supermarket staples like Jell-O and Heinz 57 has faced months of scrutiny from the SEC.

The SEC probe could not have come at a worse time for the struggling brand. Kraft Heinz broke the news to stakeholders alongside an utterly disastrous earnings report this February. News that the company had engaged in procurement and accounting misconduct quickly took things from bad to worse and drove consumer confidence even lower. Required to re-file its financial statements, the company also conducted an internal investigation of its own.

While they've wrapped up their own inquiry, Kraft Heinz is still contending with SEC investigators and its stock hit a new nadir earlier this month.

Where Did it All Go Wrong?

Kraft and Heinz have seen their problems multiply since the two organizations merged in 2015. Spearheaded by Berkshire Hathaway (Warren Buffet called it "my kind of transaction"), the deal produced a combined entity that quickly set about reducing costs. It's this dogged focus on slashing expenses that led Kraft Heinz to engage in procurement misconduct and attract the attention of investigators. 

Kraft Heinz' internal investigation revealed financial misstatements accounting for around $200 million dollars. "The misstatements," a spokesperson explains, "largely relate to the timing and recognition of supplier contracts in the procurement area." Most likely, this means that employees accelerated the rebates and discounts they negotiated with suppliers to reflect cost savings more quickly. The company also noted that it had reprimanded several dozen employees for these actions.

Citing conversations with current and former employees, CNBC suggests this tricky contracting was just one symptom of a culture dominated by savings targets and annual bonuses. In addition to inspiring "rapid-fire promotions of often inexperienced employees," Kraft Heinz' policies appear to have encouraged bad behavior. As sales declined throughout 2016 and 2017, the pressure to cut costs at all costs grew even more intense. "A large portion of that pressure," writes CNBC, "fell on the procurement and operations teams."

More specifically, it fell on hungry, young employees eager to make an impact and elevate the company's procurement group. They tended to strike suppliers as overly-aggressive, even combative in their pursuit of low-cost contracts. One described the call for savings opportunities as little more than a "blunt instrument." 

What's Next? 

For a company looking to change with the times, Kraft Heinz relied on surprisingly outdated methods. Coming down hard on suppliers and beating the drum for cost savings are the tactics of Procurement's dark, ineffectual past. Patricio acknowledged this in his first earnings call last week. "I believe," he remarked, "that we persisted with integration-minded cost cutting and did not commit to a continuous improvement, productivity-driven mindset soon enough." 

This mindset will prove essential for rebuilding Kraft Heinz' reputation and (hopefully) winning back the consumers it's lost over the last decade. If nothing else, the hard work of rebuilding and rebranding will provide a valuable opportunity for the Kraft Heinz procurement group to evolve in their approach and make the function a force for more than just savings.