by Merlin Hernandez

The closing of Hostess Brands due to a Bakers’ Union strike says less about the state of industrial relations in the country than it does about a lack of strategic focus in relation to contemporary business needs, failed risk management, and a company that has existed on the brink of bankruptcy for many years. To be fair, the company did inherit a labyrinth of labor agreements from the smaller companies acquired in its growth to become a national brand. The company cites resulting difficulties in streamlining systems to increase productivity as major barriers to efficiency. But the Union issue is not new and after two trips to bankruptcy court in the past eight years, one wonders at the kind of risk management protocol that was put in place in order to secure the additional financing needed for the restructuring that kept the company alive.

The Unions have not been intractable, making concessions and accepting wage cuts to the tune of $80M a year, but balked at additional sacrifice. Even with the injection of some $160M in new investment capital last year, the revenue outlook remained dim. With over $700M in debt (some say closer to $1Bn), the revenue picture would not have supported further debt restructuring or meaningful investment funding. Hostess’s strong asset base might have presented acceptable debt-asset ratios which could have raised some debt financing to make investing more attractive. But further investment would have been tied to some kind of divestment strategy to cover the likelihood of default. No such contingency is evident.

Compared to Canada’s George Weston Limited, a direct competitor of Hostess Brands and one of the largest baked goods suppliers in North America, which maintained steady revenue growth over the last five years, the November 16 announcement begs questions of what went wrong. With 18,500 workers to hit the unemployment lines in a stalled recovery, blame is being directed at the Union but persistent debt, declining revenues and repeated net loss on the part of market leader, Hostess, over the past ten years tell a different story. Taking the comparison further, a common thread between the two companies is declining net earnings due to increasing operating costs. But while both companies have a history of diversification and acquisition to steer growth, Weston has an active divestment history to liquidate problematic assets as part of a broad-based strategy to improve earnings.

Another interesting facet to the comparison is that diversification at George Weston Limited took the product platform into many different directions – baked goods, grocery chain (Loblaws), general merchandise, financial products and services – which provide an active cushion in case of revenue contraction in one industry. Hostess Brands mainly confined itself to the domestic market with a wide product mix within the baked goods platform, leaving the business vulnerable to environmental threats, with no fail safe mechanism. Kellogg’s basic breakfast cereal staple is boosted by snacks and cookies but the company also has a strong international presence that drives revenues. Kraft, as part of the new Mondelez International is branded in the global marketplace with its cookies, crackers, chocolates etc.

The Hostess situation appears to be a classic case of failure to apply business strategies that would win the competitive game. The shift to healthier eating and more nutritious snacks for children was an external threat to which there should have been some response or, at the very least, it should have sounded a warning that a new culture of innovation to satisfy a more discerning consumer might be indicated. Increased globalization of the baked goods industry brought new cost efficiencies and wider markets to insulate against the full effects of the recession. Hostess did not change with the times. Because a business model or product mix has always worked is no guarantee that it would continue to work when market forces are moving in a different direction. The failure of Hostess Brands to strategize for the changing business environment and new types of consumer demand are the main underlying causes of the company’s woes.

Furthermore, however difficult the labor situation might have been, the expansive brand mix of Hostess would have compounded it. Masterbrands like Hostess have traditionally relied on brand recognition as a primary marketing tool. There has also been the tendency to see brand equity as the most important leveraging force in positioning the company against competition. It is a risky strategy within the dynamics of the contemporary marketspace where priorities are constantly shifting. The strength of a brand has become its capacity to evolve and change with the market while maintaining its basic integrity. The companies that best survive the challenges of size, multiple product silos, and rising costs have been those that pursue internationalization of the brand and/or its brand stable. Companies like Sara Lee/Hillshire (US), Grupo Bimbo (Mexico), and Nestle (Switzerland) have long operated at various levels in the international trade whether through direct sales, franchising, retail outlets, private labeling, or operating manufacturing facilities in emerging markets.

In the present Hostess situation, time would be an important factor if there is any way to keep the workforce from facing unemployment. Decisions have to be made in the very short term. But any plans devised by company officials to show a commitment to turn the company around will need to be concerned with cost reductions that are not primarily centered on reduction of the workforce, new strategies for improving net earnings, the divestment of business units that contribute to losses, and debt reduction. The company’s risk management profile will be of heightened interest at this point.

But something tells me that there is really nothing to salvage here and all that’s left is to sell off assets, including brands, to the highest bidder. Call me paranoid but something is very amiss about the way business has been conducted since the 2009 emergence from Chapter 11.