Thursday, August 23, 2012

Mad Men MBA - Heinz (HNZ) Case Study in Competitive Advantage

Doug wanted to get me watching the AMC hit series Mad Men and so proposed a series of case studies on companies featured on the show. He had me at case study. Thus was born the Mad Men MBA, a collection of articles exploring the strengths and weaknesses of the businesses being pitched by the admen at fictional Sterling Cooper Draper Pryce.  We conduct our analysis based on a four-part framework, ("for really understanding companies") outlined here. In the end, we try to make this a practical exercise, estimating a reasonable price for buying the business and deciding whether it's a worthy investment today.

Our first case is H.J. Heinz, Inc. (HNZ), the undisputed champ in today's ketchup market and a key account Don Draper and crew were trying desperately to retain in season five of the show (representing the early-1960's).  In episode five, At the Codfish Ball, Jack Heinz is preparing to take his lucrative Heinz Baked Beanz marketing budget to another ad agency. Draper's young wife catches wind of the defection while powdering her nose with Mrs. Heinz at a dinner meeting, relays the tip to her husband, and sets up a dramatic ad-man pitch to keep Baked Beanz with Sterling Cooper Draper Pryce.

Today baked beans is a big business for Heinz in the UK market but has much less importance globally. The big brand is Heinz Ketchup, providing over $5 billion of its $11.6 billion in 2011 sales and with a global market share close to 60 percent. 

Doug sets up the case study in a recent email:
Heinz's big challenge was defining itself after pure domination in the baked beans market. They were friends to the military and the ease of packaging their product for wartime solidified their position. But they also had the vision to know they needed to branch out into new product territory, especially in times of peace. Ketchup became their big push and more than the product their packaging became signature. Pounding of the glass bottle to get it started and even when it pours out, it is all good. You can never use too much ketchup.
That was the 1960's, let's bring it back to the Heinz of today using our four-part framework for understanding businesses.  

Competitive Advantages: The Heinz Ketchup X-Factor

Competitive advantages serve to protect a company's earnings from attack by other businesses eager to steal their customers and their profits. The best companies are protected by advantages that intertwine around each other, creating greater protection in combination than any one of them could individually. Heinz is a clear beneficiary of the intertwining gestalt effect, distancing it from much cheaper catsup alternatives offered by Hunt's, Del Monte, and countless private labels offered by grocery stores. 

We should start out with what we can only describe as an "X"-factor that protects Heinz's ketchup empire. 

In his excellent 2004 The New Yorker article, "The Ketchup Conundrum"*, Malcolm Gladwell sits down with food-tasting specialists who describe how the human palate possesses some intrinsic attraction to flavors with a specific balance among salty, sweet, sour, bitter, and umami. If a particular food or drink strikes the right harmony - the specialists call it "high amplitude" - it keeps drawing consumers back for more. From Gladwell's article:
When something is high in amplitude, all its constituent elements converge into a single gestalt. You can't isolate the elements of an iconic, high-amplitude flavor like Coca-Cola or Pepsi. But you can with one of those private label colas that you get in the supermarket...Some of the cheaper ketchups are the same way. Ketchup aficionados say that there's a disquieting unevenness to the tomato notes in Del Monte ketchup.
Products with high amplitude resonate so much with consumers that they can eat more and more without ever seeming to grow tired of it. So businesses that somehow stumble upon the right formulation for achieving high amplitude - Coke, Pepsi, Heinz - have some sort of built-in advantage rooted deep in the physiology of the human taste buds.  

This creates such consumer demand for Heinz ketchup that they pick it over the alternatives, pay more for it, and even favor restaurants that allow them to slather their burgers and fries with this particular Heinz condiment. The high amplitude has created a strong consumer preference, giving Heinz an opportunity to combine the flavor preference with an emotional attachment by investing heavily in creating a brand. Heinz has wisely exploited this opportunity, and it's effects are undeniable. It has created a preference so powerful that we can recount multiple experiences of sitting in a restaurant and watching as a waitress picks up one of those iconic glass Heinz bottles (surely a Don Draper recommendation) to refill it with a cheaper alternative like Hunt's. Ketchup counterfeits! The restaurant would only bother to do this if they knew customers had a strong preference for Heinz. It doesn't want to pay extra for carrying the premium brand, but it sure loves the benefits of the Heinz halo effect.  

This high amplitude "X"-factor sounds like a pretty compelling competitive advantage. But it doesn't operate in a vacuum. As we explored in a previous article, Scale Advantage and the Great Coke Scandal (where a secretary at the cola company tried to sell Coke's secrets to Pepsi), the success of even the most delectable of food and drink products are not born solely of taste. It creates demand, but the companies must work tirelessly to build additional advantages to fortify this consumer preference and brand. 

Like Coke, Heinz has developed deep relationships with grocery stores and restaurants to get its ketchup on shelves and tables. That's distribution, a component of customer captivity or the network effect. If Heinz can tie up enough shelf-space with its ketchup, it doesn't leave much room for fresh alternatives to establish a toehold to compete. Heinz invests in this distribution network and guards it jealously. Any new entrant that Heinz deems viable that tries to get into the grocery stores will meet a ferocious counterattack to box it out.  It's very, very hard to break through.

Finally, there's the scale advantage that allows Heinz to practice selective low-cost, low-price tactics. While it charges a premium over other ketchups, Heinz produces such an enormous amount of ketchup that it has all sorts of scale benefits. From buying tomatoes in massive volume, to running more throughput in its manufacturing facilities, to spreading its advertising budget over a much wider base of sales...each of these reduce Heinz's cost per unit of ketchup bottle produced. If push comes to shove and a competitive product tapped into its own "X"-factor (thereby threatening Heinz's market dominance), Heinz could - by virtue of its low-cost scale advantages - undercut the emerging threat. It could push them into a price war, and Heinz's scale advantages would provide it the ability to price its products lower for extended periods of time without threatening the survival of the company.

So we see that Heinz has intertwining advantages to protect those earnings from encroachment by competitors.

Information sources:

* Malcolm Gladwell's excellent 2004 article for the New Yorker, The Ketchup Conundrum, is available on his website:

** Information about Heinz business performance and history is pulled largely from the company websites, and We pulled from the company's strategic overview slides from a 5/24/2012 presentation available on the investor relations website.

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