“So you do get an occasional opportunity to get into a wonderful business that’s being run by a wonderful manager. And, of course, that’s hog heaven day. If you don’t load up when you get those opportunities, it’s a big mistake. … Averaged out, betting on the quality of business is better than betting on the quality of management. In other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager. But, very rarely, you find a manager who’s so good that you’re wise to follow him into what looks like a mediocre business.”
The Only Duty of Management is to “Widen” the Moat:
In typical fashion Charlie gets right to the point here:
“The only duty of corporate executive is to widen the moat. We must make it wider. Every day is to widen the moat. We gave you a competitive advantage, and you must leave us the moat. There are times when it is too tough. But duty should be to widen the moat. I can see instance after instance where that isn’t what people do in business. One must keep their eye on ball of widening the moat, to be a steward of the competitive advantage that came to you. A General in England said, ‘Get you the sons your fathers got, and God will save the Queen.’ At Hewlett Packard, your responsibility is to train and deliver a subordinate who can succeed you.
Munger wants managers of the business who have “an ownership mentality” toward the business, not just the attitude of manager.
“Carnegie was always proud that he took very little salary. Rockefeller, Vanderbilt were the same. It was a common culture in a different era. All of these people thought of themselves as the founder. I was delighted to get rid of the pressure of getting fees based on performance. If you are highly conscientious and you hate to disappoint, you will feel the pressure to live up to your incentive fee.
Munger and Buffet want managers with what Nassim Taleb calls “skin in the game.” They hate situations in which the result is: “heads managers win and tails managers do not lose.” They want risk and benefits to be symmetrical. For Munger the presence of the right incentives for manager is critical. Buffett adds that he wants to see managers have: “a major portion of their net worth invested in the company. We eat our own cooking.”
Management Already In Place with Integrity
Munger has made it clear that integrity is just as significant an investment filter as talent. When Munger buys a company or makes an investment he wants both:
“We would vastly prefer a management in place with a lot of integrity and talent.”
“Remember that reputation and integrity are your most valuable assets – and can be lost in a heartbeat.”
“I think track records are very important. If you start early trying to have a perfect one in some simple thing like honesty, you’re well on your way to success in this world.” http://12valuestocks.com/2012/06/best-value-investment-quotes/
“When you mix raisins with turds, they are still turds.”
“All investment evaluations should start by measuring risk, especially reputational.” Poor Charlie’s Almanack (p. 61)
“Avoid dealing with people of questionable character.” Poor Charlie’s Almanack (p. 61)
It is harder to spot a lack of integrity than many people imagine. Munger:
Munger has said that if you think this sort of thing is easily explainable, you do not understand the problem. Complexity, risk, uncertainty and ignorance are impossible to avoid.
The Rare Exceptions to the Moat Rule
Occasionally Munger and Buffett find a person who they can bet on who has such superior talent that they really don’t need much of a moat (regarding moats see my previous post). This situation is rare, but it does happen.
“Occasionally, you’ll find a human being who’s so talented that he can do things that ordinary skilled mortals can’t. I would argue that Simon Marks – who was second generation in Marks & Spencer of England – was such a man. Patterson was such a man at National Cash Register. And Sam Walton was such a man. These people do come along – and in many cases, they’re not all that hard to identity. If they’ve got a reasonable hand – with the fanaticism and intelligence and so on that these people generally bring to the party – then management can matter much. However, averaged out, betting on the quality of a business is better than betting on the quality of management. In other words, if you have to choose one, bet on the business momentum, not the brilliance of the manager. But, very rarely, you find a manager who’s so good that you’re wise to follow him into what looks like a mediocre business.”
“There are people- very few- worth paying up to get in with for a long term advantage’.
Buffett has pointed out that the talents of Ajit Jain in the reinsurance business are just such a case. Buffett said at the most recent Berkshire meeting: “Ajit Jain has created tens of billions of dollars in value for this company out of nothing but brain and hard work. “ That is high praise indeed since there is no mention of any moat in that business. Wells Fargo as has previously been mentioned is also described by Munger and Buffett as a company that relies mostly on management instead of a moat. I would disagree since I think being “too big to fail” like Wells Fargo is a form of moat since it gives them an artificially low cost of capital. The CEO of Wells thinks his business is all about execution:
“We always say we could leave our strategic plan on an airplane, somebody could pick it up, and it wouldn’t matter. It’s all about execution.”
I think it’s dangerous to rely on special talents — it’s better to own lots of monopolistic businesses with unregulated prices. But that’s not the world today. We have made money exercising our talents and will continue to do so. I’m glad we have insurance, though it’s not a no-brainer, I’m warning you. We have to be smart to make this work.”
“I find it quite useful to think of a free-market economy – or partly free market economy – as sort of the equivalent of an ecosystem. Just as animals flourish in niches, people who specialize in some narrow niche can do very well.”
This strategy is similar to what Professor Michael Porter calls “differentiation.” It can be workable, but is inherently riskier to find a haven from competition in a niche than to have a moat (it is better to have both). An example of a niche market where Munger and Buffett find a gem of a management team is Iscar:
“Judging the management at a company like Iscar is easy—those people are enormously talented and wonderful. But, there aren’t many managements like that and few people with the incentive of such intensity.”
“The reason I got so high on it so fast was that the people are so outstandingly talented. The idea of being in business with them just struck me worth straining for. We didn’t know when we were young which things to stretch for, but by the time we reached Iscar, which we never would have bought when we were young, we knew to stretch for the right people. It’s a hell of a business. Everything is right there. Isn’t it good that we keep learning? Better late than never.”
This post is getting beyond my self-imposed limit so I will let Bill Gates summarize the Munger/Buffett management philosophy:
“[Warren’s] penchant for long-term investments is reflected in another aphorism: “You should invest in a business that even a fool can run, because someday a fool will.” He doesn’t believe in businesses that rely for their success on every employee being excellent. Nor does he believe that great people help all that much when the fundamentals of a business are bad. He says that when good management is brought into a fundamentally bad business, it’s the reputation of the business that remains intact. Warren installs strong managers in the companies Berkshire owns, and tends to leave them pretty much alone. His basic proposition to managers is that to the degree that a company spins off cash, which good businesses do,my new blog.www.jokenshayari.com .the managers can trust Warren to invest it wisely. He doesn’t encourage managers to diversify. Managers are expected to concentrate on the businesses they know well so that Warren is free to concentrate on what he does well: invest.”