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Book - Warren Buffett Management Secrets

nfwyt, quest-for-wealth19 min read

Buffett's managerial record surpasses even his amazing investment record with Bershire Hathaway where company's operational net annual income grew from $18/share in 1979 to $4093/share in 2007 this equates compounding annual growth rate of 21.39% a record that indicates warren and his managers are doing fantastic job of minding the store. In the same time period warrens personal investment portfolio grew at an annual compounding rate of 19.78% as a manager he has outperformed himself.

Warren found dale carnegie's book on public speaking which changed his life till then warren had fear of public speaking. Warren has read How to win and influence friends dozens of times.

LEADERSHIP is really what a good manager is about, letters of the word is qualitites what a good manager should have L is for loyalty, E is for Enthusiasm, A-attitude, D-discipline, E-example, R-respect, S-Scholarliness, H-honesty, I & P stands for integrity and pride. Thing about WB is he posseses all these qualities.

We will examine warrens leadership qualities and how warren synthesized what he learned into a winning management forumla. To facilitate learning process we have broken down warrens management philosophy into following 5 segments or steps.


1. Pick the right business

  • Not all business are created equal, first step to success is to own manage or work for the right business with the right economics working in its favor thats how to get ahead of the game right from the start whether you are owner, manager or employee.

  • Certain companies have business economics so great even a bad manager will look good in working for them these are the companies he wants to own and these are the companies we want to work for.

  • Warren has identified a number of characteristics to help us identify wonderful businesses. There is a huge difference in business that grows and require lots of capital to do so and the business that grows and doesn't require capital. Businesses with superior economics tend to burn considerablly less capital than they earn this is usually because of the brand, product that never has to change or they provide key services that allows them to charge higher prices which gives them better profit margins. Company with these qualities have product that never has to change, doesn't have to spend large money on research and development, it doesn't have to retool plan and equipment to implement new design changes. All the money it saves can be used to expand the business without having to burden of additional debt or selling of new shares. Good example is Coke and Bad example is General motors.

  • Companies with durable competitive advantage have near lockdown on their entire market. They have product that never change or easy to sell and own a piece of consumers mind this equates to higher profit margins and inventory turnover. These companies come in 3 categories

  1. Sell unique product
  • Coke, Pepsi, Wrigley, Hershey, Coor, Guinnes, J&J, P&G and philip morris. They have established themselves though the process of customer need, experience and promotion by advertising. When a company owns piece of consumers mind, it doesn't have to change its product which is a good thing and can charge higher prices and sell more of it products which means bigger profit margins and higher inventory turnover and they have little or no debt in their balance sheets. Here opportunities in career growth are high.
  1. Sell unique service
  • Moodys, HR Block, American Express, Wells Fargo. Companies like this can even earn better margins than firms selling products. These are institutions don't have to spend on redesigning its products or building production plan and warehousing. These are firms selling unique services. IF you compare HR Block(Tax servies) and GM, even during recessions people have to file their taxes. Here management doesn't have to worry about recession or unions they can sleep and go to work next day without tensions.
  1. low-cost buyer and seller of a product or service that public consistently in need of
  • Walmart, Costco, Nebraska Furniture Mart, Borsheim's fine jewelry.
  • Here big margins are traded for volume with increase in volume more than making up for the decrease in profit margins. Key here is to be low-cost buyer which allows you to get your margins higher than your competitors and still be low-cost seller of the product or service. Here being best price in town lures consumers. Here opportunities are lower for career advancement as continued stress of keeping costs low put great pressure on management and tends to keep salaries low.

2. Delegate authority

  • This step is warrens unique view on delegating authority which has allowed him to grow BRK from a small failing textile company into a gaint multinational conglomerage.

  • We delegate almost to the point of abdication - Micromanaging too many tasks or businesses leads to too many balls in the air at once and if you drop one ball, you drop them all.

  • Delegating to one manager who is focussed on just one job means more thorough understanding of task and more careful execution of the job. Warrens CEO has complete control over their businesses and warren has told CEOs not to expect to hear from him more than once a year. Once McLane company CEO(Grady Rozier) phoned warren to request approval of buying new Jets. Warren replied thats your decision, its your company to run.

Rules of delegation
  1. Every business culture is unique from smallest of firms to largest of corporations, workers and managers have developed highly specialized skill sets that allow them to accomplish their tasks as a manager warren has learned that cannot perform these highly specialized skillsets even remotely as well as they can. He feels his employees are the experts and should be allowed to do what they are good at doing without his interference he also feels that if he has any job as a manager it is to inspire his employee ot greatness at their jobs think cheerleader not slave driver.

  2. Competent managers like to be left alone to run their businesses as they see fit. Warren encourages managers to think of their businesses as their own result is they work harder and make sure that business does well for them its a matter of pride.

  3. In order for complete delegate of authority to work it is necessary not only that the manager be hard working, passionate and intelligent about their businesses thy must also have a great deal of integrity in other words they must be as honest as day is long.


3. Find a manager with right qualities

  • Warren looks for integrity, intelligence and passion for the business which also happen to be qualities that we need to cultivate in ourselves to be successful managers.

  • Management changes like marital changes are painful, time-consuming and chancy. This is a lesson warren learned by experience by businesses at bargain price that were poorly run. Eg-Demster Mills.

  • If we think that business is losing money not due to economic but due to management then its time to change the management.

Warren buys business with competent managers in-place. Warren every year asks managers to write him a letter telling him who in the company would succeed them if they were to die tomorrow these letters are updated each year, this way if something does happen to one of his managers time won't be wasted in trying to find a replacement. Warren gets a manager who is already familiar with the business and was hand chosen by the person who best understood the company its people, products and customers.

Warren bought dempster mills manufacting when stock was selling 25% of its bookvalue. It is a windmill and water irrigation company in nebraska and warren understood once he has taken board of directors of the company is it was poorly managed, so he conviced board members to bring in new manager whom they chose and he was bigger disaster than earlier manager and he asked Charlie for recommendation of any person he knew to save the day. Charlie recommended Harry Bottle, Harry is a turnaround artist, a manager remarkably skilled at fixing failing businesses. First thing harry did was reprice the inventory of spare and replacement parts. Dempsters products need constant upkeep as company did big business in replacement parts. Some products can be bought at any hardware store and some are unique to dempster and couldn't be bought anywhere else. One of the errors harry discovered was Dempster was pricing all products at standard 40%, harry tripled the price of unique parts and cut the inventory of common parts thereby increasing revenue and freeing capital.

Lesson here is this change managers only when necessary, promote from within if possible and if you can't look for talen with a proven track record when all else fails call in Remarkable Harry Bottle.

Would you rather be the world’s greatest lover, but have everyone think you’re the world’s worst lover? Or would you rather be the world’s worst lover but have everyone think you’re the world’s greatest lover?

All people have inner or outer scorecard. We are true to ourselves or we conform to what we think the world wishes us to be. A true leader follows the beat of his or her own drummer while a bureaucrat bends to the perceived wishes of others.

In discussing the differene between victor and victim mentality psychologists talk about the Locus of Control.

  • If you have internal locus of control, you will blame yourself when something goes wrong as you believe you are in control of your fate and you have control of outcome and if you fail, its because of your own actions and no one elses.
  • If you have external locus of control, you will blame everyone else but yourself.

Young man warren was deeply influenced by his father Howard who has strong interal LoC, when depression hit Howard started a successful new business and when he disagreed with what was going on in government he got himself elected to congress. This taught warrent that he not the world was in control of his life and he not the world would determine what his life would look like.

Failures can bring a person with internal LoC down as there is no scrapegoat. Have to remember not dwell on failures for too long.

Work at a job you love and delude yourself into believing that a day will come when we will finally do what we dream of doing, in meantime we spend life in misery which we bring home with us each day to share with our loved ones. This usually happens at early stage in life due to need but when we continue to do it, its for greed.

Warren believes when we employ people to work for us we must try to find people who are going to love what we hired them to do these are the people who will take pride in their work and inspire their fellow workers to greatness and become the driving force behind the business they are also the people who have made men like warren look like geniuses.

In management of our lives, the rule is love what you do, in the management of business, the rule is hire people who love what they do. Both will lead you to gold.

Warren says "Perfect manager is someone who gets up in the morning think about business and in the night dreaming about business" as he says obsession is the price for perfection. Warrens obsession led him to memorize moody's stock manual starting at A working his way through Z.

Warren could ask his interviewees for a job at Berkshire a question and it would be

  • How obsessed they are with what they do ?

And second question he would ask himself, is, do they love money ? If they love the money, there is no reason to do business with them.

  • CEO who misleads in public will often mislead himself in private

  • When a manager or an employee who is truthful with others about their mistakes is more likely to learn from them. This especially true in all matters of accounting, when one has willingness to fuddle with one set of numbers will lead to a willingness to misrepresent all the numbers.

Managers who always promised to make the numbers will be tempted to make up the numbers -- WB

Profit is the life blood of business and lack of profit is the death of business. The only way to make a profit in business is to have lower costs than the prices you are charging for the products you sell. Difference between the two is called profit margin.

Managers of business have two main goals,

  1. Inspire our sales force to sell as much of the product as possible at the highest possible price
  2. Inspire our manufacturing and buying teams to produce or acquire the products we sell at the lowest possible prices.
  • Task of keeping costs low is very important, it determines the pricing of the product.
  • If managers aren't disciplined on little things, they will probably be undisciplined on the large things as well.

Being a manager has made me better investor and being a investor has made be better manager. -- WB

Most managers of businesses tend to have a time horizon of under a year. They live in a world defined by quarterly and yearly results. If they surpass quarterly or yearly projections they get bonuses otherwise heads start to roll. This tend to keep management focused on short term, this short-term almost kills any long-term planning part of management.

One of the things warrens asks his managers to do is to stop worrying about the short-term ups and downs of the business and focus on making the business strong and viable for the long term.

Any mangements intense focus on the short term tends to make those managers poor allocators of capital. This creates two big problems.

  1. Management may keep throwing good money after a mediocre business long after its time to put that capital to use elsewhere
  2. Management tries to allocate capital outside its core business it almost always ends up buying a short-sighted promise of prosperity at an inflated price.
  • Eg 1 -Coke failed movie business as a perfect example of great business throwing money after a bad one.
  • Eg 2 -Bershire is a mediocre business, it was spending more money than it was earning as it was competing with foregin texttile manufacturers and warren understood it was dying business from the industry insights which he had analyzed over the years. So he stopped spending Bershires working capital on the textile business and used to acquire insurance company which is better business in a long term perspective.

Ultimately, when warren looking for a great manager, he is also looking for a great investor whose responsibility is to invest firms money in people, products and new businesses always with long-term perspective in mind.

If you have a great manager you want to pay them very well. --WB

Not all businesses are the same, some have mediocre economics and others have exceptional economics those with exceptional economics will make even the lousy managers look good and its reverse in mediocre economic business and spectacular manager.

Managers performance is compared with the others in his industry. For example if a company is earing 20% on shareholders equity and when comparing with others in the industry its in the lower-end then you don't want to give exceptional bonuses to ma nagers for mediocre result. On the other hand if a business is earning 5% on equity and its in the high end in the industry then manager should be handsomely rewarded for keeping us ahead of the pack.

Warren is big believer in performance based pay as long as it is based on the value added by the manager and not the inherent economics of the business.


4. Motivate your workforce

Once you have found the right business and right manager in place. Warrens job is to motivate his managers and employees to be productive as possible. Below are some management styles that warren has learned from Carnegie and others are first impression, to using praise, to understading the dangers of using criticism, to subtle use of suggestion.

  • First impression - Begin in a friendly way, be light, funny, friendly and eager to put at ease.

  • Power of Praise - We all have a deep and honest need to be appreciated. Schwab said "way to develop best in a person is by appreciation and encouragement, there is nothing that kills the ambitions of a person as much as criticisms from superiors, i never critize anyone". Warren learned from schwab, if he praised people of little things they give even bigger things to praise them for down the line.

  • Power reputation - Give your employee fine reputation to live up to. Let people know about their expertise and skills. Give a nation or person a fine reputation to live up to and they will live up to it and make them feel guilty and shame they will dissapoint you. Using guilt is not productive. Appealing to the greatness of others is what works for warren and it will work for you.

  • Dangers of Critism - Using critisim to motivate is futile because it puts person on the definsive and wounds his precious pride and hurts his sense of importantce and arouses resentment. Thing to understand is "we all make mistakes, message is to learn from the error and not to dwell on it".

Praise by name, critize by category --WB

Work is not just a place to earn a buck, its also becomes a place to boost self-esteem.

When a manager comes to warren to ask his opinion of a business, warren never critizes directly. He will make suble suggestion, leaving manager to draw his own conclusion. A classic warren response would be acknowlege the managers idea to say that it is enticing and then to offer a story where warren or another businessman had a similar idea that led to disaster. Warren applies same theory when talking about the world, he is quick to praise a banker about his/her integrity but when he is unhappy with the banker he will only critize the banking professional as a whole.

If you must critize people personally, praise/complement them first.

  • How to win an argument - To win an argument, sometimes you have to lose. Way to win an argument is to not to have one in the first place. When you listen to people and respect their opinions even when they are contrary to his own. This allows other person to relax and listen to yours and getting other person to listen to you is first step to winning the argument.

  • Speak to other persons wants and needs - In case of Nebraska Furniture Mart owner Rose Blumkin was offered $80M by German business man, she wanted the money but she didn't want to giveup running the business she built and loved. Instead of selling to germans, she sold 90% of business to Warren for $40 millions dollars. This is a great deal for warren as he took care of her needs. Now her family takes cares of the business.

  • Encouraging other person to come up with the right idea - Inducing other person to come up with the right idea is a far more powerful motivational tool and telling them the right idea. Warren is famous for hiring the right people and not telling them what to do instead he lets them set their own goals and standards. Invariably they set the bar higher than he would have. Warrens managers say even though the never tells them what he expects from them they know he expects a great deal. His silence induces his managers to imagine that he expects a lot and this becomes the reality that drives their performance.

If order somebody to do something, they resist but if it our idea we treat it as gospel and act on it with purpose and conviction.

Insteading of ordering something illustrate the negative consequences of doing it.

Examples

Order : dont swim in the lake

Explain consequences : There are crocodiles in the lake and they like to eat little children

Child start imagine crocodiles eating them which compels them not to swim in the lake.

You can illustrate positive consequenes as well.

Order : i want sales production to increase

Explain consequences : If sales and production increases it will make me happy and i'll be able to pay bigger bonues at christmas

Workers will realizes that increase in sales will make happy manager and bigger christmas bonuses.

Below are some examples of order converted to suggestions,

  • It would be great if we get that job done by monday, do you think you can come up with a way to do that ?
  • You know the roads are rather slick do you think that if we slowed down that would make it safer
  • can you think of better way to do that
  • do you think we do did it this way, it would turn out better.
  • When we go to zoo can you think of any reason to stay by my side.

When we are wrong we should admit it quickly and emphatically. There are always error in judgement.


5. Managerial Axioms for different problems

  • Buffett has different methods on dealing with managing leverage to handling dishonest employees to keeping costs low.
Borrowing too much money

The roads of business are riddled with potholes, a plan that requires dodging them all is a plan for disaster. --WB

Banks are king of leverage, they have to borrow all the money they lend out and most of the money is borrowed short term and loaned out long term.

Economic change can offer lots of opportunity provided we have cash to take advantage of it, economic change can also mean disaster if we have taken on too much debt to survive it.

Good idea gone astray

You can get into way more trouble with a good idea than a bad one --WB

Subprime mortgages were originally a good idea they allowed good people with marginal credit to buy homes and mortgage to make money but eventually people with poor credit histories were qualifying for subprime mortgages more people got homes and more mortgage brokers got even more money then one day we woke up to a recession and people started losing their jobs and they didn't have money to make their subprime mortgage payments. Suddenly great idea become a disaster.

Employee breaking the law

There are plenty of money to be made in the center of the court, there is no need to play in the edges --WB

While it is important to be aggressive in making money. You can make money you need by staying within the boundaries of the law. When manages break the law in the name of making a quick buck they risk losing their entire business with one single action in solomon's case the bond trader bet the entire company for a slightly larger piece of the US Government bond market as managers we have to keep a watchful eye on our employees to make sure that they don't bet the store in an attempt to further their careers and when we can catch employees doing something illegal the first call we make is to the authorities and not to make call is to become an accessory after the fact which is also a crime, its a hard lesson that no one wants to learn first hand.

Making mistakes

I make plenty of mistakes and i'll make plenty more mistakes too thats part of the game you just have to make sure that right things overcome the wrong ones. -- WB

Trick to remember is that our successes in life must outweigh our mistakes reverse the equation we end up in trouble.

Warrens Mistakes,

  • Paying too much for a business - conocco philips, US Air
  • Buying into sinking business - Blue chip stamps
  • Not buying into the right business - Capital citys broadcasting
  • Himself ran companies- Insurance company
  • Hired wrong manager - Hired first manager for dempster mills, second was a winner.

Learn from mistakes and dont dwell on them, those who dwell on their mistakes waste an enormous amount of time and energy that could be spent on developing new ways to make money and enjoy life.

Mistakes are part of the past and short of remembering their lessons and they should stay there since all the money to be made are in the future.

Managing sycophants

Sycophants are they an asset or liability. One thing to be certain if a CEO is enthused about a particularly foolish acquisition both his internal staff and outside advisors will come up with whatever projections are needed to justify his stance.

Leaders love to be loved and in the process they are surrounded by YES people.

  • YES people job is to say yes to the boss for that they are handsomely rewarded
  • they suck up to the boss
  • reinventing the truth
  • Hire an advisor and his job likely becomes to advise you to do what you wanted to do in the first place. If they say anything else they will be soon out of job.

Warren's solution is to surround himself with few people as possible and his idea of group decision is to look himself in the mirror. He seeks council from Charlie and he often says NO ten times than yes.

Missing opportunities

Since mistakes of omission doesn't appear in financial statements, most people don't pay attention to them. We rub our noses in mistakes of omission --WB

Seeing road ahead

Bank on the tried and true

Best ideas in life and business are the ones that tried and true where the chance of failure is almost NIL. Where do these proven ideas come from they come from other people and businesses that have successfully put them to work by studying successful businesses we can get dozen of great ideas about how to do something right and from studying unsuccessful businesses, we can learn how easy it is to do something wrong.

Lesser artists borrow and great artists steal -- Miles davis, Jazz Musician

Same can be said of great business managers, if we see a great idea we should steal it and put it to use and where do we find these ideas by studying the competition, what they are doing right and what they did that was wrong.

Jacks Ringwalt's philosophy of National indemnity is "He would only write insurance if he knew it would make him money". If rates dropped he simply stopped writing policy even if it meant his staff sit around doing nothing. Warren followed this philosophy in all the insurance companies he invested in that "there is a proper rate for every legitimate risk"

There is not such thing as bad risk, there are only bad rates Jacks Ringwalt, CEO, National indemnity


Its better to hangout with people who are better than you and pick out associates whose behaviour is better than yours and you'll drift in that direction --WB

We are who we hangout with. Warren at young age he was at race tracks instead of falling into a life of gambling however he was able to put his knowlegdge of calculating probability to use college and graduate school.

He found mentors who are older and wiser than he,

  • Nick newman - He used warehousing techniques developed in WWII and used them to create modern supermarket
  • Jack ringwalt - Founder of National Indemnity who introduced warren the concept of disciplied underwriting.

Aim high in your associations you will get to the top.

Best asset during inflation is your own earning power, any thing you do to improve your talents and make yourself more valuable will get paid off in appropriate real purchasing power. You are your best asset.


Modern retailing has gone from selling you a product to selling you the money to buy a product, the modern merchant makes money loaning consumers the money to make purchases. Here you are cashing in twice

  1. When consumer borrow the money
  2. When he spends it

Three Economic tests to determine if a company has Durable Competitive Advantage
  1. Check Per share earnings for a 10yr period this should show consistency and upward trend meaning they don't have to go through the expensive process of change and company's economics are strong enough to allow strategic expenditures to increase market share, advertising or increase per share earnings by use of stock buybacks.

When companies earnings are erractic means they are in competitive market and prone to booms and busts, boom increases demand which increases prices to meet demand company increases production which increases supply which increases costs and eventually leads to an excess supply in the industry and to falling prices. Company once profitable starts to lose money until it has to cut production and costs there are thousands of companies like this and in the boom year they give illusion that the company is a winner.

  1. Debt test - Companies should have absense or low levels of long-term debt. Low, no-debt companies are companies that can give good salaries and survive recession with flying colors. In general, debt load in excess of 5x its net earnings is a good indication that it is not company with Durable Competitive Advantage.

  2. Gross profit margin test - Take companies revenue and subract cost of goods sold, we get gross profit and if we divide gross profit by revenue we get GPM. Companies with DCA have higher GPM like Coke-60%, Moodys-73%, Burlington Northern Railroad-61%. Companies with poor economics such as United Airlines-14%, GM-21%, US Steel-17%, GoodYear-20%. In tech MS-79% and Apple-33%

More tests are available in book Warren Buffett and Interpretation of financial statements.


# References

  • Wealth Education