(if not posted already)
The Financial Times
How Warren Buffett broke American capitalism:
The investor tells Berkshire Hathaway managers to widen their moat or cut competition
by Robin Harding
September 12, 2017
Growing up, I admired nobody more than Warren Buffett, the greatest investor ever. His
achievement is towering. The market is an implacable opponent but here was a man
who beat it year after year, making $75bn out of nothing but wisdom and charm. There
was moral purity in his modesty, his ethics and his quiet attachment to home in Omaha,
Nebraska. What footballer, politician or thinker could compare?
Now 87, Mr Buffett wields huge influence over US business and finance, usually
positive. He pushed companies to expense stock options, warned of danger in
derivatives and taught the public to invest long term in low-cost index funds.
But how ever much you admire the man, his influence has a dark side because the
beating heart of Buffettism, celebrated in a thousand investment books, is to avoid
competition and minimise capital investment in the real economy.
A torrent of recent studies show how exactly those forces — diminished competition,
rising profits and lower investment — afflict the US. Economists Jan de Loecker and
Jan Eeckhout chart a rise in corporate mark-ups, a measure linked to profit margins,
from 18 per cent in 1980 to 67 per cent today. In a paper presented at the Brookings
Institution last week, Germán Gutiérrez and Thomas Philippon show how investment
has fallen relative to profitability. Mr Buffett did not cause these trends. However, they
are central to his fortune. When you celebrate him, you celebrate them.
If he had found a few truly unusual companies and bought them on the cheap there
would be no issue. But acolytes are taking his methods economy-wide
Mr Buffett is completely honest about his desire to reduce competition. He just calls it by
a folksy name — “widening the moat”. “I don’t want a business that’s easy for
competitors. I want a business with a moat around it with a very valuable castle in the
middle,” he said in 2007.
He tells Berkshire Hathaway managers to widen their moat every year. The Buffett
definition of good management is therefore clear. If you have effective competitors, you
are doing it wrong.
As with many aspects of his career, Mr Buffett used to act more visibly. An example is
his 1977 purchase of the Buffalo Evening News. He bought this newspaper for $32.5m,
a high multiple of its $1.7m operating profit, then launched a Sunday edition and drove
the competing Buffalo Courier-Express out of business. By 1986, the renamed Buffalo
News was a local monopoly making $35m in pre-tax profit. At the time, it was Mr
Buffett’s largest single investment.
His concept of a moat is linked to his views on capital investment: the beauty of one is
you do not need the other. One of his most celebrated purchases is See’s Candies, a
company he bought for $25m in 1972. Every year, Mr Buffett raised prices. So strong
was its brand that despite sales growing little, profits grew mightily, with barely any need
for capital investment. “The ideal business is one that takes no capital, and yet grows,”
he said last year.
His statement is unquestionably true for an investor. For an economy, it produces the
pattern above: low investment relative to higher profits. A line attributed to business
partner Charlie Munger in Alice Schroeder’s biography of Mr Buffett, The Snowball, is
revealing: “Munger had always kidded Buffett that his management technique was to
take out all the cash from a company and raise prices.” That does sum it up.
If Mr Buffett in his brilliance had found a few truly unusual companies and bought them
on the cheap there would be no issue. But acolytes are taking his methods economywide.
These days, Mr Buffett has two main ways of putting his money to work. On one hand,
he is finally investing in physical assets, although only in regulated industries such as
electricity and railroads where returns are largely guaranteed. On the other, he is
working with Brazilian private equity firm 3G as it slashes costs to the bone and drives
up margins at Burger King and food company Kraft Heinz.
Kraft now makes a 23 per cent operating margin and an enormous return on tangible
capital. In a competitive market, those high margins ought to present an opportunity for
rivals to invest and steal market share. Instead, Kraft competitors such as Unilever and
Nestlé are under pressure from their owners — a mixture of index funds and Buffett-like
activists — to match those sky-high margins. If rivals also cut, rather than invest and
compete, Kraft can cut even more. A kind of Buffett equilibrium is taking hold.
To be clear, this is not the only reason for declining investment and higher profits in the
US. Nor is there a simple solution. Better antitrust enforcement would help, but recent
proposals for a complete revamp of competition policy are not well founded. Although
research linking lack of competition to cross-ownership by institutional funds is
interesting, it does not capture the reality of private equity operators such as 3G.
We can decide who to admire. Mr Buffett is brilliant at buying into monopoly profits, but
he does not start companies or gamble on new ideas. America is full of entrepreneurs
who do. Elon Musk is investing in two wildly risky and competitive sectors: automobiles
and space. Even the much-reviled Koch brothers built most of their fortune on
investment in the real economy. Celebrate that kind of business. It is the kind America
needs.
Comments
"take out all the cash from a company and raise prices”
as a matter of rote and the extent to which WB does it.
But money managers--and I've spoken to a ton--generally hate investing in such commoditized businesses. When they and Warren Buffett speak of a "wide moat" they speak of companies that have what they call "defensible business models"--some form of monopolistic or oligopolistic power that competitors can't assail and eat away at their profit margins. It's the reason why a pharmaceutical company with a patent on a drug that other companies have no legal power to manufacture trades at a premium valuation to a coal mining company. Ensuring that such monopolistic control of the manufacture, sale and pricing of such drugs continues--including pharma companies lobbying Congress to prevent the import of lower priced copies of those drugs from overseas--is not a net benefit to society. It's one of the reasons the U.S. has some of the highest drug prices on earth. Yet generally speaking drug companies have been great investments long-term for this very reason. Their monopolistic profits are protected by law.