Berkshire Hathaway: Owner Capitalism via 2002 to 2005 Letters
"When a problem exists, whether in personnel or in business operations, the time to act is now.” - Warren Buffett
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 Seven of my exploration of Warren Buffett’s shareholder letters and annual meetings (as of 1994). 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
The 2002 to 2005 period was a time of peace. This five-year period hid between the preceding 9/11 and Dotcom crisis and lived in ignorance of the Great Financial Crisis to come in a few years. A core lesson of Buffett’s during this period was that of Owner Capitalism.
Amidst the lessons to be learned and those to prepare for in the future, this foreshadowed the hindsight predictor of most crises: incentives. Buffett brought the idea of owner capitalism to life when highlighting the alignment of interest Berkshire’s board of directors had with its owners (i.e. shareholders).
None of the above should be unique. Yet, they were—and still are—for most public companies. Though Buffett used an example of director incentives to denote owner capitalism, it’s an idea that played throughout the letters during this time of peace.
Berkshire went through its own evolution as the U.S. economy picked itself back up. The insurance operations continued growing, learning from various mishaps in its reinsurance lines. Mid-American energy, which would become Berkshire Energy, built out a foundation with acquisitions of other utility businesses and pipelines.
Such evolution might appear normal. I might even call it an expectation for most outsiders. But that’s because the intricacies are so far away that we forget about the dynamism of business.
"Every day, in countless ways, the competitive position of each of our businesses grows either weaker or stronger.
If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength. But if we treat customers with indifference or tolerate bloat, our businesses will wither. On a daily basis, the effects of our actions are imperceptible; cumulatively, though, their consequences are enormous.
When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as 'widening the moat.’"
It’s easy to forget that companies are working every day to make a difference. People show up to work every day to build something. When shit doesn’t get done—or the wrong shit is done for too long without correction—companies fall behind.
Some businesses have more leeway than others. But all have to execute in the tiring world of capitalism. That is no exception at Berkshire Hathaway and Buffett relies on great managers to make all the difference in leading the daily execution of each business.
It was in his letters that he shared lessons on the need for great people, how they are a necessity at Berkshire, the incentives that bring forth better capital allocation, and the human tendencies for short-term optimism in business.
No Exceptions for People
Owner Capitalism embraced the managers leading the business as a priority. A good business with a great manager was preferred to a great business run by a mediocre one. No exceptions.
"Berkshire acquired some important new businesses – with economic characteristics ranging from good to great, run by managers ranging from great to great. Those attributes are two legs of our “entrance” strategy, the third being a sensible purchase price.”
No quarters were to be given for people who didn’t fit Buffett’s standards. Success was reliant on aligning oneself with the best group of players. After all, aren’t all institutional success reliant on the culture created by the individuals within?
Here’s one of Buffett’s many stories that highlight this idea:
A side note. I want to point out how Buffett equates himself to the example of a batboy instead of the manager of a team. Some might think it’s fake humility. But I think it’s a genuine depiction of how he views his role as supporting those who execute day in and day out.
This function of aligning with the best team at Berkshire was critical given the range of businesses that had economic characteristics that ranged from mediocre to great. Buffett was willing to invest in mediocre businesses. But not mediocre managers.
“...directors must get rid of a manager who is mediocre or worse, no matter how likable he may be.”