When one thinks of the brightest minds of investment over the last 50 years, Warren Buffett's name invariably tops the list. And well it should — as his leadership of Berkshire Hathaway has shown, his strategies, guidance and direction have brought little but success to all involved — from account managers to the "owner-partners" (customers) who entrust their investment dollars to Berkshire. Indeed, Buffett's prevailing philosophy — that investors should act and think like owners — informs everything he does as a manager, and forms the overarching premise for telling his story in The Real Warren Buffett . When Buffett makes a capital management decision, he makes a move only after considering what he would do if it were his own money. When he makes a people management decision, he does so in the context of how the move will affect owner-partners. Buffett truly acts like an owner in all he does as a leader — a philosophy any good manager or executive would do well to consider.
In the early 1960s (after spending nearly 20 years as a successful stock picker), Warren Buffett developed a vision of his future role — as the manager of an enterprise — that was unique when he had it, and remains unique today. The vision was this: In the management of the enterprise, he would act as its owner.
To accomplish this vision, Buffett recognized that he would have to redefine the role of a manager as one who would choose, from the mass of opportunities that lay within his core competence, the application of capital that would both earn its highest return and incorporate the least risk — just as shareholders would if the money was in their hands. If he could not achieve a return in excess of what they could earn on it elsewhere, he would return it to them. He called this role the "allocator of capital." Those who work for him must fall in with this philosophy.
At Berkshire Hathaway, Buffett is both owner and manager, which means that his interests as one are perfectly aligned with his interests as the other. He treats even the smallest of Berkshire's shareholders as an equal partner in the enterprise, so that he manages the company on their behalf as much as his. This runs counter to the typical misalignment of corporation and customer, and was, initially, a problem for Buffett the manager — until he discovered a negative force he termed the "institutional imperative."
Buffett's discovery in the early 1960s was as momentous for his future management of Berkshire Hathaway as that of Jack Welch's seminal revelation at GE, which was to make the company the number one or number two player in every industry in which it was active. "Institutional dynamics," said Buffett, "not venality or stupidity, set businesses on these courses, which are too often misguided."
In order for Buffett (and Berkshire Hathaway) to gain and maintain a competitive advantage and continue to outperform both the Dow Jones Index and his competitors, he realized he would have to change his approach. It would be a different one from GE's, however; the institutional imperative has no respect for size or market position.
To attain sustainable advantage, Buffett had to acknowledge the institutional imperative in himself. Specifically, he had to open his eyes to the concept of value creation on an ongoing basis, and see that the imperative was an obstacle to this — in all aspects of the management of, acquisition of, and investiture in companies.
Buffett recognized the imperative and specified its mechanism as a problem of human nature. He also put himself in a position where he could bridge the void between the manager of an enterprise and its owner, and act like the capital allocator that all owners want their managers to be.
Warren Buffett's predilection toward introspection could help him spot and resolve some issues (dissolving the Partnership, for instance), but not all of them. He lacked a framework for his introspection — a system of analysis that would link one to the other and make sense of the totality of his behavior.
Enter Charlie Munger, a lawyer friend from the West Coast who preached that value could be found in a company's enduring earnings potential, which included management's ability to create value. Eight years Buffett's senior and possessing a legendarily abrasive personality, Munger encouraged Buffett to recognize that companies create value by dint of things like their ingenuity, service, brand, marketing managerial competence, and so forth. Above all, Munger encouraged Buffett to look for value in each company's capacity to act like owners, then to invest in these good businesses.
By necessity, Munger's approach meant analyzing the factors shaping the future economics of a company — the orientation of management with respect to the company's shareholders, their quality and corporate culture, and the competitive characteristics of their industry.
Munger's insights on psychology and the institutional imperative infused Warren Buffett's vision of capital allocation. Buffett had already had the facts:
As a manager, you cannot tell people what to do and expect them to do it. They must be motivated personally. Commitments to businesses manifest their own dynamics, divorced from their original conception, aggregated around self-interest. The psychological needs of managers' managers can threaten to change the way companies are managed on their behalf. The companies in which Buffet would henceforth invest also faced the same problems he himself had experienced, most importantly in dealing with the expectation of shareholders whose motivation was subject to imperatives of their own. Thanks to Munger, however, these facts now spoke to Buffett with one voice. At last, he had them in usable form.
In order to emulate Warren Buffett, the first thing CEOs must do is adopt the right mind-set. Although they might have come through the ranks as an operational manager, if they are predisposed to manage as an executive, the institutional imperative will color any "rational" debate about the conduct of the firm.
Battling the institutional imperative includes refusing to pursue pre-ordained strategies; indeed, Buffett's leadership at Berkshire Hathaway follows his maxim, "In order to act like an owner, first you must think like an owner."
Buffett explicitly embeds this philosophy into the deliberation process he follows when managing capital. The intellectual framework to which he adheres in this respect centers on whether to pay the capital out to the shareholders or keep it within the company. If the decision is made to pay it out, what is the best method (via repurchases or dividend)? On the other, if you retain the capital, how do you use it to create value with the least risk?
In managing the enterprise, Buffett defers to mental models and essential elements contained in his Circle of Competence — truths, the equation for value, the patience to wait for value, and an intimate knowledge of how his cognitive apparatus functions. The lesson for any who would seek to emulate Buffett's capital management is to do the same. Copyright © 2003 Soundview Executive Book Summaries
Soundview Executive Book Summaries
