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H. J. Heinz Chairman & CEO Bill Johnson: The Innovation Playbook

Usually when shareholder activists call on a CEO demanding a slate of new board directors, its time to circle the wagons, but Bill Johnson, 58, is nothing if not a survivor who took the takeover titan at his word that he was more interested in building the brand than advancing a personal agenda. Johnson confesses …

Usually when shareholder activists call on a CEO demanding a slate of new board directors, its time to circle the wagons, but Bill Johnson, 58, is nothing if not a survivor who took the takeover titan at his word that he was more interested in building the brand than advancing a personal agenda. Johnson confesses that when Nelson Peltz de clared that his Trian Group owned 5.4 percent of H.J. Heinz shares and lectured him on having the wrong recipe for Heinz’s growth, it was not an auspicious beginning. Among other things, Peltz criticized the Pittsburgh-based company for too much overhead, over-relying on incentive payments to retailers, and insufficient marketing of its brands. That was 2006. Today, the relationship between the two is more cordial, thanks in part to a strategy, which Johnson argues was still in its early days of implementation when Peltz came calling, that has demonstrated strong results. (See five-year change of MVA and EVA in the graph below)

With almost $10 billion in annual revenue, Heinz has leading brands in some 200 countries. (Its top 15 brands account for 70 percent of sales.) In trying to build a platform for future growth, Johnson and his senior team had one major advantage. Heinz ketchup, according to a Harris poll, was identified along with Coca-Cola as the most familiar brand in the U.S. The company is also a brand leader in beans, soups and infant foods in the U.K. and Australia. But iconic brands are not enough in a competitive world food market dominated by numerous brands and tight margins. The challenge was to grow the core portfolio, accelerate growth in emerging markets, and leverage its brands on a larger global scale.

To do this, the company divested more than $3 billion in disadvantaged categories to focus on three attractive businesses: ketchup and sauces, meals and snacks, and infant nutrition. It also added $1.5 billion in targeted acquisitions.

But Johnson had to do more, much more, if Heinz hoped to pull ahead of giants like ConAgra Foods, Kraft and Sara Lee. He had to step up the pace of innovation.

Johnson doubled R&D spending over the last four years and set up an innovation and quality center in an ultramodern facility formerly owned by Siemens in suburban Pittsburgh. The facility focuses on condiments and sauces, which is 40 percent of its business. (Consumers can order Heinz ketchup online with personalized labels.) New product introductions more than doubled in fiscal 2008, with a significant amount of new innovation taking place in Europe and China. Ten years ago, less than 2 to 3 percent of the company’s annual sales came from new products. Today, that figure is somewhere between 10 and 15 percent. In some markets such as the U.K., Australia and New Zealand, it’s north of 15. Over the next three to five years, new products are expected to represent at least 15 percent of overall business.

“We have more ideas in the pipe line than we can introduce at any one time,” says Johnson. “We are learning how to differentiate small versus big, important versus me-too.”

Despite the fact that Heinz’s founder sold his products to London‘s Fortnum & Mason as early as the 1870s, the extent of the company’s international footprint is not generally appreciated. Johnson, who is the company’s fifth chairman in 138 years, has pushed hard into emerging markets, which now represent more than 10 percent of sales and 30 percent of its sales growth. Today, 60 percent of the company’s overall revenues come from outside the U.S. compared to 45 percent in 1997 when Johnson became CEO.

Despite these trends, analysts worry that worsening economic developments coupled with rising commodity costs might stall future growth. Johnson counters that productivity growth, more value-added products and continued demand in emerging markets will offset these concerns. Organic growth for the last five quarters has exceeded 4 percent. Heinz reckons to have top line organic growth of 5 to 6 percent this year, which in the food industry is in the top tier.

The son of Tiger Johnson, a former coach of NFL teams the last of which was the Cincinnati Bengals, Johnson told CE when we caught up with him at his Pittsburgh headquarters that since the game isn’t over at halftime, he takes little for granted. In fact, the coach for team Heinz himself employs a personal coach to sharpen his skills. “Why not,” he smiles. “Tiger Woods has a coach.” Of course, reality checks aren’t far from the Johnson household. He recalls that in December 1997 when he was appointed CEO of Heinz, he arrived home and said to his wife Susie, “I have some good news. I just got promoted.” She responded with, “I heard, now leave your crown at the door.”

Nelson Peltz’s first encounter with you was reportedly less than cordial. He insisted on coming on the Heinz board bringing with him four other directors. Now the relationship is altogether different. What changed?
That encounter happened when the company was in the final stages of making the changes that we had told the market we would make. Markets often became impatient because it always takes longer than you thought. We have several peers now going through a similar episode, and I can tell them through your magazine that they’re going to face the same issue. My first encounter with Nelson was at a dinner near his home in Palm Beach. Yes, it was a less-than-cordial dinner.

 
 

But interestingly enough, every other encounter I had after that was not that way. It became far more cordial. As he began to understand what we were doing, and I began to understand what he was doing, and despite the disagreement during the proxy contest, a grudging mutual respect emerged. We announced our two-year plan on June 1, 2006, which is basically a continuation of what we’d been doing. We put up very aggressive numbers and have since beaten virtually all those numbers, including the top line, the bottom line and EPS. As it became clear that the process was going to yield a change in the board, and [Peltz] wanted five seats, he got two. That’s two more than we wanted.

At this moment you have two choices. You either recognize the changed circumstances and deal with it and move forward, or you try to live in the past. I’m a forward-looking person. There was no point in going back and reliving that. The market had spoken to us. They put two on the board. We accepted that.

 EVA and Five-Year Change in EVA*

EVA = (ROC) – COC) X capital = operating profit less capital charge

Sometimes earnings don’t tell the whole story. Under economic value added (EVA), which is an alternative way to measure profit, a charge is placed on all the capital used in running a business as management is simply renting the money employed. Since 2002, Heinz trails only General Mills in its peer group in generating economic profit.

Nelson and I had dinner in Pittsburgh in August or September-I don’t recall the exact date. It was cordial. We agreed that we would work together going forward. The company reported a barnburner first quarter. Since then, we’ve had six or seven outstanding quarters. We knew the results would show. My concern was whether we had time to show people, and we did. There was no point in looking back and recriminating about who said what to whom. Nelson has been an enthusiastic, value-added director because he brings a couple of things that are unique. One, a consumer mind-set, and two, a shareholder mind set, both of which I can relate to. In fact, I find myself more aligned with him as we go forward.

He’s got infectious enthusiasm and has been extremely supportive of management. Nelson likes what we’re doing. He’s got ideas, I’ve got ideas, we talk about them. But I had a choice. I had a choice of not going forward and trying to stay in the past, which proved unacceptable, or moving forward. I moved forward.

How much of the transformation was already underway versus that which Peltz instigated?
You don’t turn the Titanic in a bathtub. You don’t make fundamental changes in two weeks. This was a result of plans and diligent execution over the prior four years. People are going to believe what they’re going to believe. And frankly, it doesn’t bother me one iota what they believe because I know what the truth is. Nelson helped us build on our progress by contributing, by being a supportive director, and by asking the right questions.

 MVA and Five – Year Change in MVA*

 MVA = market value – capital = wealth created = NPV of all investments

Since 2002, Heinz has created more wealth than its peer group and is catching up in total MVA with some of its rivals.

I said to another CEO, who I won’t name who had called me and inquired about Nelson, that if I were to form the board today, Nelson would be one of the first directors I’d ask to serve because he is an insightful, communicative, enthusiastic, energetic and available director. I have never called him when he hasn’t called me right back. I’ve never called him when he wasn’t prepared to talk about something. We disagree on a few things, but we are more aligned than not. Sometimes you find that who you thought was an adversary turns out to be an ally. I don’t get terribly hung up on it. Nelson and I both have a good understanding of what the other wants. 

What advice would you offer a good CEO friend who is about to face an activist in his face?
One, make sure the business is going well. Second, be open-minded and talk. Also, be transparent. You have to listen to what activists have to say. Activism takes two forms. Some, like Nelson, want to make the business better and grow the share price. Others have governance issues that may or may not be relevant to anything other than somebody’s personal agenda. The key thing when you have disagreements is to present facts. Don’t present an opinion. One of the things I’ve learned about activists is that they respond well to facts. They do not respond well to opinion. Sometimes they misperceive facts, which is why you lay out all the facts in an effort to work with them. The difficulty is that this is not easy to go through.

For example, when Nelson first joined the board but before he’d come to his first board meeting, he requested some information. Not only did I send him literally a truckload of information-P&Ls, balance sheets, product data, market information-I sent three of my key people to walk his people through it for almost a day. There’s no point in not sharing the information with him. He’s now on the board. You might as well bring him up to date and get him involved. His team had good questions and some good suggestions. There was a lot of interaction. This episode said to him, “I’m not going to play games with you. I will treat you as a valued member of this board, and I will address your needs and concerns.”

I’m a football coach’s son. I learned a long time ago that the game’s not over at halftime. You see the game through. Much of this comes down strictly to the integrity and tenacity that an individual possesses. Believe me, they’re not easy things. It’s no fun for the families involved, but I believed and was able to convince Nelson of what we were doing. Today I like having Nelson on our board. If you had ask ed me that 18 months ago, I would not have said that. But life changes and you move on.

Over what did the two of you disagree, and when you pointed out facts, did he accept your conclusion?

There were a lot of things on both sides. Clearly, our international business, particularly our emerging markets business, was not well understood. Part of this is the result of our not explaining this adequately to the market. CEOs sometimes take for granted that the market understands more than it really does. When you meet portfolio managers, you think, well, my business is really important to them.

Then you recognize they’re managing 1,000 different stocks and see you once every blue moon. Nelson made a very interesting point during this process, which is that people on the outside-activists- are operating on less-than-perfect information. My advice to CEOs is, if you’ve got the information, share it with them. It doesn’t cost you anything. There are certain rules you must follow-Reg FD obviously, confidentiality agreements- but it is amazing how fast transparency can speak to the situation.

So is it fair to say that as a result of Nelson Peltz’s intervention, Heinz operates more like a private equity play without actually having gone private?

You’re right. We think like private equity people because Nelson forces us to think like private equity. There’s no one more aligned with Nelson than me because, other than Nelson, I am by far the largest owner of Heinz shares on the board. I have every incentive to continue to create shareholder value.

Which innovative products have yielded the best returns?
There are so many, but let me discuss a few of them. Clearly, the topdown ketchup bottle has been a home run. Baked Bean Snap Pots in the U.K. are early in the process, but the reaction has been extraordinary. We have prebiotic baby food products in China that have given us great bang for the buck. These are products that use DHA, or docosahexaenoic acid, that basically mimic the benefits of mother’s milk and share similar benefits.

We’ve introduced lower sodium soup in the U.K. We did this by working with the Food Standards Agency in the U.K., the counterpart to the FDA in the U.S. Reducing sodium in our food is a global issue, one we’re addressing around the world.

Also in China, we’ve adapted advances in our frozen food business by introducing regional ethnic items such as frozen dumplings and dim sum. It’s the fastest growing business in the company now. Complan, an easy-to-prepare food drink in India, has historically been a powdered mix. We’re now looking at liquefying it and making it ready-to-serve. The returns on all these have been pretty striking.

What about acquisitions?
We went in Indonesia in 1999 with a lot of teeth gnashing from the board at the time because Indonesia was a risk. That business has, over the last eight years, been one of the fastest growing businesses in the company, returning our investment some four to five times.

The Classico acquisition has been a home run. We bought the brand, recognizing our tomato expertise would help us improve the product-which it did. We’ve gotten a great return out of that. Some of the businesses we’ve purchased in Canada, such as food services and Renee’s [Gourmet], a maker of chilled salad dressings, has been nothing short of a home run.

What have you learned from your stepped-up innovation process?
We’re less concerned whether a new product is an exact fit in our core business. We’ve launched a beverage in the Netherlands, throughout the Benelux and Spain, called “Sunshine.” This is a tomato-based beverage that leverages what we do better than anybody, which is tomato technology. It’s a functional drink loaded with lycopene and extra vitamins. Initially, some were concerned that this didn’t fit the core. But it does if you think our core is tomato expertise and technology. As we become more innovative, our learning curve grows, our confidence builds, and our willingness to take risks that beforehand we wouldn’t have considered prudent also increases.

Bill, a number of your direct reports give you high marks for transparency and candor.I am, sometimes, probably, at risk to myself.

So let’s put it to the test. Every company doesn’t do everything well. What, within Heinz, still defies your efforts to put it right, and what are your plans for addressing it?

We need to do a better job of aligning our processes globally. One of the differentiating strengths of this company is our local autonomy and the way we execute strategy locally. One of the downsides of this is that sometimes we don’t have all our global processes aligned. That’s being addressed. The second is that when you run a business this way, it requires a lot more effort by senior management to know its talent and its people. We address this through a number of initiatives such as our CEO Academy, surveys and interactions with my visits to improve our ability to reach into the talent of the organization so that we understand who’s there.

Although we have wiped out the not-invented-here attitude, there are occasionally pockets where we want to do something, and somebody is resistant. There are two ways to convince those individuals. One is with facts and logic, and the other is to tell them to do it anyway. We’ve upgraded our capabilities dramatically, but we are nowhere near perfect. That’s what makes this job challenging.

About JP Donlon

JP Donlon is the Editor-in-Chief of Chief Executive magazine.