The Limits of the Sharp Pencil

Can a company thrive by having a laser-like focus on running a tight ship – reducing headcount and using severe cost controls to maximize productivity and performance? Brazilian private equity firm 3G Capital thinks this is the recipe of success, and its story tells us the answer to the opening question.

3G Capital is universally known in investment banking but less well known outside of it. Odds are, even if you haven’t heard of 3G, you’ve consumed products from their companies.

3G made a name for itself by taking controlling stakes in food and beverage companies like Heinz, Kraft, Burger King, Tim Horton’s and Budweiser, and unrelentingly squeezing costs. 3G uses a zero-based budgeting model which means that, year-to-year, every expense must be justified anew, and every employee has to demonstrate that they are earning their jobs. Warren Buffet and Berkshire Hathaway got on the 3G bandwagon, investing heavily. Buffet lauded 3G’s approach, saying they were doing a “marvelous” job improving the performance of the companies they controlled.

It turns out, though, that 3G’s work has not produced such marvelous results. A few weeks ago, Kraft Heinz (3G’s investment in Kraft and Heinz led to the merger of the two) took a multibillion dollar write-down. Shares plunged, and Berkshire Hathaway lost an estimated $4 billion that day. Now the SEC is investigating 3G.

The media was quick to jump on the company. For example, a recent Forbes article taking 3G to task commented, “It is time for companies to refocus on growth by investing in marketing, distribution and continued innovation.” The New York Times similarly ran an article critiquing 3G’s strategies.

Missing from these reports is what I think the essential message ought to be: A leadership style that cues insecurity and breeds a culture that motivates only by money is not going to get the most out of most employees.

When asked to describe his company’s approach to management, 3G co-founder Jorge Paulo Lemann likened it to running a marathon: “You’re running, you’re always close to a limit, you’re working very hard and being evaluated all the time.” Another leader in the company said, “They do not allow you to hide in a nice room, stay for the whole day. No.”

In organizational psychology, there are rich literatures demonstrating the limits of extrinsic motivation (external rewards such as money), and also showing that excessive cost-cutting and downsizing have detrimental – and enduring – effects on a company’s subsequent financial performance. If people feel their jobs are in jeopardy, you may be able to squeeze short-term productivity out of them, but how long can you sustain that before exhaustion, resentment and turnover result?

The problem with 3G’s approach to leadership is that it creates a culture where people are resources to be consumed and expense items to be reduced to their most efficient state. Nestlé’s CEO Ulf Mark Schneider recently told his shareholders: “Many companies are focusing on radical cost-cutting to deliver higher profits in the short term. This approach is not sustainable.”

A leader who creates the right culture and manages it well has created a durable competitive advantage that sharp pencils, while important, cannot substitute.

Before the 3G meltdown, Buffet told his shareholders, “The 3G people . . . are very good at making a business productive with fewer people than operated before, but we have been doing that in every industry, whether it is steel or cars, you name it, and that’s why we live as well as we do.”

Tell that to Juan Perez, who worked nearly two decades at Kraft’s Oscar Mayer factory in Madison, Wisconsin before the 3G axe fell. “It’s like wasting 18 years.”

As a business school professor, I am all for training anyone who runs a company on the importance of finance. You can’t run a company without it. But there is no substitute for a leadership approach that puts equal emphasis on creating a positive, motivating culture and climate that is founded on trust and respect.

I am sorry for all the workers at Heinz, Kraft and Budweiser that 3G’s approach has harmed. But I am glad the companies – supported by Mr. Buffet all the way – are getting the comeuppance they deserve.