Kraft-Heinz cost-cutting impact likely will be limited

Packages of Kraft Foods' Singles cheese slices are displayed at a supermarket in New York.
Scott Eells | Bloomberg | Getty Images
Packages of Kraft Foods' Singles cheese slices are displayed at a supermarket in New York.

Private equity firm 3G Capital, the Brazilian-based backer of the Kraft-Heinz merger announced Wednesday, instills fear in the companies it acquires with its reputation for fierce cost-cutting.

But while the acquirers have already promised to reduce costs by as much as $1.5 billion, the local economic impact may not warrant such anxiety.

The combined company will create a food colossus, merging the Pittsburgh-based maker of ketchup, Ore-Ida french fries and Lea & Perrins Worcestershire sauce with Kraft Foods Group of Northfield, Illinois, which makes A1, Cheez Whiz, Cool Whip, Jell-O, Kool Aid, Maxwell House, Oscar Mayer and Velveeta, among other product lines.

The deal will produce the third-largest food and beverage company in North America and the fifth-largest such business in the world, the companies said, with revenue of some $28 billion. The new entity will be call the Kraft Heinz Co. and continue to keep its headquarters in Pittsburgh and the Chicago area.

Warren Buffett's Berkshire Hathaway and 3G Capital will put about another $10 billion into the new company; Heinz shareholders will hold a 51 percent stake.

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The new company will create an "unparalleled portfolio of powerful and iconic brands," according to the companies' press release.

But sales of the formidable lineup have been flat in recent years, and the companies' fortunes have suffered.

Heinz last month reported net income for 2014 dropped to $269.5 million from $284.7 million the previous year. And revenue inched up to $2.93 billion from $2.91 billion—short of the $2.99 billion company analysts had expected.

Kraft, meanwhile, has also been struggling to squeeze more profit from its product lines. In December, the company announced a shake-up, naming Chairman John Cahill to succeed Chief Executive Tony Vernon, who stepped down. Last month, its chief financial officer left and two other senior executives announced they were leaving.

The company said the moves were aimed at boosting growth. Kraft reported a net loss of $398 million for last year's fourth quarter, compared with a profit of $931 million a year earlier. Revenue rose just 2.2 percent to $4.69 billion.

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The new owners, 3G Capital, have been investing heavily in food and beverage companies with an eye to boosting profits by cutting costs. In August 2013, Heinz announced layoffs of about 350 workers at its Pittsburgh headquarters, with additional job cuts coming worldwide. 3G Capital has applied a similar strategy in acquisitions of fast food giant Burger King and beverage conglomerate Anheuser-Busch InBev.

In announcing the Heinz-Kraft deal, the companies said they see "significant synergy potential" of as much as $1.5 billion in annual cost savings by the end of 2017.

"Synergies will come from the increased scale of the new organization, the sharing of best practices and cost reductions," the companies said.

"This is just a reflection of the bigger structural changes in the U.S. food industry at the moment," said Alexia Howard, an analyst at Sanford Bernstein & Co. "It really shows that 3G sees a lot of cost coming out of the whole area of U.S. food."

Based on 3G Capital's cost-cutting moves at other companies it controls, some of those synergies will come from shrinking a combined worldwide payroll of some 24,500 Heinz workers and about 22,100 Kraft employees.

But while the threat of layoffs could be devastating for company workers and their families, the impact on the headquarters cities of Chicago and Pittsburgh will be minimal as only a handful of those employees—less than 5 percent—work in those locations. That will mean little economic impact for the economies those two cities.

For company workers elsewhere, the outlook will depend heavily on whether the new owners can revive sales of existing brands or develop new ones with higher growth potential.

"[The merger] is not a magic wand that can wave away the underlying problems of either company," said Neil Saunders, managing director of Conlumino, a retail research and consulting firm. "Heinz, and especially Kraft, both need to invest in brands, in marketing and, most critically, in product innovation if they are to remain relevant to consumers around the world. Unlike cost savings, this is not something that a merger automatically delivers. "