Hostess is being bought down by in part by unfunded defined benefit pensions forced on the company by its unions over the last 50 years. In a previous post, I explained how, as a company’s products age, its profit margins decline and pension costs consume an ever increasing percentage of revenue.
Defined benefit pensions are especially destructive:
In economics, a defined benefit pension plan is a major type of pension plan in which an employer promises a specified monthly benefit on retirement that is predetermined by a formula based on the employee’s earnings history, tenure of service and age, rather than depending on investment returns.
The most common type of formula used is based on the employee’s terminal earnings (final salary). Under this formula, benefits are based on a percentage of average earnings during a specified number of years at the end of a worker’s career.
Obviously, if the pension payout is based not on the success of investments or current company revenues but instead on the particular worker’s performance years or decades ago, a company has to make up any difference between investments and pension cost with current revenue. Revenue diverted to pensions contributes nothing to value for the current customers who provide the revenue. The current customer literally doesn’t get what they paid for. If they had instead bought the product from another company identical in all respects to the first except for the defined benefit pension cost, they would have paid less and/or gotten a higher value.
The value delivered to the customer is the single determiner of business success. High pension costs undermine delivered value and thereby harm both the customer and the company.
It was Taiichi Ohno most often credited with formalizing the business folk wisdom that all business profit arises from value delivered to the customer. In the Toyota Production System (“Lean” in the US,) he defined a wasteful business process as a process of any scale, complexity or origin, that did not add value for the customer. The customer has no significant knowledge of the production process. The customer knows only if the value they receive from the completed and delivered product justifies the price they pay for it. They communicate their net assessment of the product by the price they will pay to purchase it and by whether they purchase a product repeatedly.
To ensure high customer value, Ohno asked managers and workers to look at the production process through the eyes of the customer and to evaluate processes as if a customer was actively present and making comments like, “I’ll pay for making the graphics on the label easier to read but I won’t pay for labor cost incurred while a worker wastes time looking for tools in a disorganized toolbox.”
Since customers aren’t actually present during production, managers and workers must act as the customer’s proxy and reduce waste and enhance value on the customer’s behalf.
Defined benefit pensions paid out of current revenue or capital are a waste from the customer’s perspective because the customer can’t distinguish pension cost from any other form of production waste that gives them no value. The customer just knows they pay more for less value and eventually they seek alternatives.
Companies like Hostess with multi-billion dollar unfunded defined benefit pension obligations are stuck with a massive and inescapable chunk of waste lodged in their system like a cat with a hairball bigger than its esophagus. No amount of skillful process improvements from workers and management can reduce that big lump of waste and its drag on the value customers receive. The best a company can do is optimize everything else and hope their competitors are inept or equally burdened.
The inability to reduce the waste caused by defined pension benefits and other union imposed waste means that unionized companies are on an inevitable death spiral. As their industry ages, their profit margins shrink but those profits have to pay for more pension costs which customers interpret as production waste and reduction of the value they receive from the company. Customers leave, which reduces overall revenue while pension cost remain the same or increase. Less revenue must support more pension meaning less revenue left to provide customer value. Customer value decreases… and the feedback loops through again.
Someone once described GM as retiree pension and healthcare system that funds itself by selling cars. That’s not far from the truth and is likely true of Hostess as well. Progressively over the last decades, the price you pay for a Twinkie related less and less to the value provided by the Twinkie and instead paid for the “waste” of an ill conceived pension system doomed to fail from inception.
Don’t despair though. Some other company, most likely a younger, non-union and probably foreign company will buy the Twinkie brand and recipe and start churning out Twinkies at a lower cost and higher customer value. Instead of paying for stupid and ill conceived pensions through pastry, you can pay for them through increased taxes and/or reduced government services whether you ever had a Twinkie or not.
It’s the first rule of unions: They get paid, everyone else gets screwed.