Berkshire Hathaway: Contagious Behaviour & Long-Dated Human Assets via '15 - '20 Letters
"Betting on people can sometimes be more certain than betting on physical assets.”
The following is an investing article for OMD Journal. Keep in mind I may own or have owned the company discussed. None of this is investment advice, do your own due diligence.
Find the archive of companies and people explored here
This is Part Ten of my exploration of Warren Buffett’s shareholder letters. While most letters and questions focus on his financial analysis and investment advice, I wanted to pull out elements that showed his analysis of people—something he doesn’t get enough credit for.
Here are articles on preceding letters:
Pre-Berkshire Hathaway: Buffett Partnership Letters 1957 - 1969
Berkshire Hathaway: Acquiring People it Deserves via 1971 - 1980 Letters
Berkshire Hathaway: Financially Sub-Optimal Yet Optimally Human via 1981-1986 Letters
Berkshire Hathaway: Families of the Sainted Seven via 1987-1991 Letters
Berkshire Hathaway: Ordinary Things by Exceptional People via 1992-1996 Letters
Berkshire Hathaway: Think for Yourself & The Compass to Decentralization via 1997 - 2001
Berkshire Hathaway: Owner Capitalism via 2002 to 2005 Letters
Berkshire Hathaway: The Self-Aware Organization via 2006 - 2010 Letters
Berkshire Hathaway: The Berkshire System & Imperfect Cultures via 2010-2014 Letters
We’ve caught up! If you stayed on this journey with me since Part 1, we’ve gone through all the Buffett letters from 1957 to 2020. What a journey!
Observed from the 2015-2020 period was Berkshire’s continued evolution with a switch among its businesses. Apple became a new entrant to its Big 4—included are the insurance, Berkshire Hathaway Energy (BHE), and Burlington Northern Santa Fe (BNSF) operations. It came a long way from its textile roots in the 60s.
Berkshire transformed without a master plan. It was an organic process akin to that of any living organism. It shed off deficiencies and emphasized what worked. But all this wouldn’t have been possible without the foundation of admirable values and behaviour set by Buffett. It attracted like-minded leaders and started a virtuous cycle that thrived over 60+ years.
An examination of human behaviour became the crux of the Berkshire letters. While Buffett praised the actions of his team, a fair amount of effort was placed in sharing the misbehaviours that often formed the foundation of many companies. Considering the Mungerism of inversion, we will start by looking at what not to do.
Contagious Misbehaviour
People can’t be forced to change. Any parent, coach, mentor, manager, or lover will have felt the frustration of attempts to change another’s behaviour.
"If you want to guarantee yourself a lifetime of misery, be sure to marry someone with the intent of changing their behavior.” - Charlie Munger
Change must come from within. However, the environment they are in is bound to influence what is acceptable, even if it’s not admirable behaviour. Often, the managers who misbehave aren’t evil, stupid, or ill-intentioned. Misbehaviour hurts another for the benefit of someone else and the root is the incentive structure that awards such actions.
Meeting Targets
Consider the incentive to appease Wall Street. The Street looks at quarterly results—it would look at daily ones if it could. Managers who want to pump up stock prices in the short term may obsess over hitting targets set by these “analysts.”
Why appease them? Oh, it could be reasons from greed for more money, the envy of others who do, pride of the position, lust for power, to all the deadly sins.
Whatever the internal motivation might be, most managers will obsess over “hitting” targets as they seek the reward for pleasing the Street. Some might actively engage and share targets themselves as a means to control the narrative and their future.
I think the sharing of goals is admirable. But that requires the goals to be well selected, meaning they should at the very least be within the company’s control.
That would make a revenue target an absolutely stupid thing to share to investors. How would they have any control over this? Are they going to control the customer’s wallets? No. They can’t do that. But they can control their financials and how they report the numbers.
"Charlie and I cringe when we hear analysts talk admiringly about managements who always “make the numbers.” In truth, business is too unpredictable for the numbers always to be met. Inevitably, surprises occur. When they do, a CEO whose focus is centered on Wall Street will be tempted to make up the numbers."
What gets measured gets done. The existence of quarterly targets is a slippery slope towards obsessing over the short term. What slope is this? A slope of exceptions.
"Berkshire has no company-wide budget (though many of our subsidiaries find one useful). Our lack of such an instrument means that the parent company has never had a quarterly “number” to hit. Shunning the use of this bogey sends an important message to our many managers, reinforcing the culture we prize.
Over the years, Charlie and I have seen all sorts of bad corporate behavior, both accounting and operational, induced by the desire of management to meet Wall Street expectations. What starts as an “innocent” fudge in order to not disappoint “the Street” – say, trade-loading at quarter-end, turning a blind eye to rising insurance losses, or drawing down a “cookie-jar” reserve – can become the first step toward full-fledged fraud.”
We know it’s easier to stick to a rule 100% of the time than 97% of the time. The moment we start making exceptions, we will rationalize our way to more exceptions.