Berkshire Beyond Buffett

The Enduring Value of Values

Lawrence A. Cunningham

• Publisher: Columbia Business School Publishing
• Year: 2014
• ISBN:
  9780231538695
• Topic: Commerce
• Subtopic: Histoire des affaires

A profile of Berkshire Hathaway, the keys to its success, and how it can survive beyond its iconic chairman and CEO, Warren Buffett. In a comprehensive portrait of the corporate culture that unites Berkshire's subsidiaries, Lawrence Cunningham unearths the traits that assure the conglomerate's perpetual prosperity. Riveting stories of each subsidiary's origins, triumphs, and journey to Berkshire reveal how managers generate economic value from intangibles like thrift, integrity, entrepreneurship, autonomy, and a sense of permanence. Berkshire Beyond Buffett explores not only what will happen to Berkshire after Buffett, but presents all of Berkshire behind Buffett, the inspiring managerial luminaries, innovative entrepreneurs, and devotees of deep values that define this esteemed organization. Whether or not you are convinced that Berkshire can endure without Buffett, the book is full of management lessons for small and large businesses, entrepreneurs, family firms, and Fortune 500 CEOs. Enjoy entertaining tales from Berkshire's 50 main subsidiaries, including Dairy Queen, GEICO, Benjamin Moore, Fruit of the Loom, BNSF, Justin, Pampered Chef, Marmon, Clayton Homes, FlightSafety, and more.

"An invaluable read for entrepreneurs, business leaders, investors, managers and anyone wanting to learn more about corporate stewardship."— The Economist

"How did Warren Buffett build such a great firm as Berkshire Hathaway? To unravel this mystery, Lawrence Cunningham takes a deep dive inside the cultures of Berkshire's subsidiaries, highlighting the value of integrity, kinship, and autonomy—and revealing how building moats around the castles may help the firm outlast its visionary founder."—Adam Grant, Wharton professor and author of Give and Take

II

4

Budget-conscious and Earnest

1936, San Antonio, Texas. Leo Goodwin, a fifty-year-old insurance manager, was working closely with U.S. military personnel at USAA, an insurer that catered to the military.¹ He was concerned that his customers were paying too much for car insurance and calculated that by putting the least risky drivers into an insurance pool and selling policies without agents, a company could discount prices by up to 20 percent and still turn a profit. This simple idea blossomed into GEICO, a car insurance company that is one of the cornerstones of Berkshire’s business, epitomizing the first of the Berkshire values I’ll explore—budget consciousness, in the strict sense of frugality and thrift.

GEICO’s start came when Goodwin persuaded a local banker, Cleaves Rhea, to stake $75,000, which, along with his own $25,000, provided the seed capital to implement his idea.² For the pool, Goodwin targeted U.S. military officers as well as other federal government employees, perceiving them to be among the least risky drivers. Since such workers are concentrated in the nation’s capital, Goodwin and his wife, Lillian, moved to Washington, D.C., to launch the new company, called the Government Employees Insurance Company—GEICO for short. Toiling twelve-hour days, six days per week, the Goodwins built GEICO with sheer grit. They marketed by direct mail, handled underwriting details, and managed claims. On weekends, Leo Goodwin drove to military bases and made his sales pitch door to door.

To complement the commitment to low-cost insurance, GEICO stressed customer service. For instance, in 1941, after a hailstorm damaged cars across town, Goodwin arranged with local shops to work overtime on repairs and got suppliers to expedite shipping of roof tops and window glass.³ GEICO customers appreciated getting their cars back in service before neighbors insured with competitors.⁴

Goodwin’s business model was simple: low-cost insurance, sold without agents, to targeted risk pools that were given quality customer service. First-year results were promising: 3,754 policies written, $103,700 in premiums, and a staff of twelve.⁵ Underwriting results (the difference between premiums written and policy claims paid) were negative early on but soon swung to a small underwriting profit. Despite the adversity of the Great Depression and the displacement of World War II, the “thrifty” business model was vindicated as GEICO grew steadily in policies, premiums, and profits.

In 1948, Rhea’s family sold its stake in GEICO to several private investors. Helping the Goodwins to locate these new investors was their friend, banker and GEICO senior officer Lorimer (“Davy”) Davidson. Among others, Davidson placed a large block of stock with Graham-Newman, whose named partner, Benjamin Graham, became GEICO’s chairman.

Graham-Newman’s GEICO position represented a large portion of the firm’s assets. The investment concentration departed from Graham’s usual preference to diversify. But then, federal authorities ruled that an investment company such as Graham-Newman could not own such a large stake in an insurance company. So the firm distributed its GECIO shares to its partners to hold directly. At that point, the shares were held by so many people that federal law required them to be registered with the Securities and Exchange Commission, which made GEICO a public company.⁶

A few years later, Buffett was enrolled in Graham’s investment class at Columbia Business School, located on the university’s main campus in the Morningside Heights neighborhood of Manhattan. Graham’s biography listed his position as chairman of GEICO, a company Buffett had never heard of in an industry he knew nothing about. Eager to learn more, Buffett decided to visit the company’s Washington headquarters.

On a cold Saturday in January 1951, Buffett boarded the 6:30 A.M. “Morning Congressional” train of the Pennsylvania Railroad from New York.⁷ Arriving in Washington four hours later, he found the GEICO building, then at 14th and L Streets Northwest, was closed.⁸ But the young Buffett caught the attention of a custodian, who indicated there was someone working on the top floor. It was Davidson. Buffett told Davidson he was Graham’s student, and Davidson went on to spend four hours explaining the company and the industry to Buffett.

Buffett’s key takeaway: “GEICO’s method of selling—direct marketing—gave it a wide cost advantage over competitors that sold through agents, a form of distribution so ingrained in the business of these insurers that it was impossible for them to give it up.”⁹ Inspired by his chat with Davidson, Buffett studied GEICO and the insurance industry carefully. He then wrote a report about GEICO for “The Security I Like Best” column in the Commercial and Financial Chronicle, a widely read trade publication.¹⁰ Putting his money where his writing was, Buffett bought 350 shares of GEICO stock during 1951 at a cost of $10,282, representing half his net worth. (The next year, Buffett sold his GEICO shares for $15,259. That taught a lesson about buy-and-hold: by 1995, that stake was worth more than $1 million.)

Throughout the 1950s, Leo Goodwin continued to build GEICO, emphasizing its goal to keep costs at an absolute minimum. However, the goal of low costs was not merely to increase profits. In fact, Goodwin insisted on passing along most of the savings to customers in the form of lower premiums. That, in turn, attracted more customers. Greater total premium volume and, ultimately, profit, resulted, as did deepening customer loyalty across a widening base.

By the end of the decade, GEICO had more than seven hundred thousand policies and wrote $65 million in premiums.¹¹ Goodwin retired in 1958, handing the reins to Davidson, who sustained GEICO’s unique business model, continuing its tradition of thrift, increasing volume by keeping premiums low. By 1965, insurance premiums tallied $150 million and earnings doubled to $13 million.¹²

In the 1970s, after Davidson retired and the Goodwins passed away, the GEICO story took a different turn. Growth in premium volume became more important than cost management or underwriting quality, and policies were written or renewed with little regard to relevant information such as policyholder accident histories.¹³ In 1973, the company opened eligibility to all, regardless of employment, believing that technology and statistical modeling enabled screening more effectively than occupational groupings. Yet the company lacked the requisite computer systems to aggregate or analyze the data.¹⁴ Policies and premium volume soared.

Also during this time, many states adopted no-fault insurance laws. Previously, insurers of culpable drivers paid claims. Since GEICO’s good drivers were rarely at fault, GEICO rarely owed claims. No-fault switched the emphasis from who was at fault to how much damage occurred. GEICO’s management failed to appreciate how such changes would affect the company. For several years, it underestimated losses and thus underpriced insurance, an error that drove the company to near-bankruptcy in the mid-1970s.¹⁵

In 1976, a GEICO director, Samuel C. Butler, senior partner of Cravath, Swaine & Moore, recruited John J. (“Jack”) Byrne, a forty-three-year-old prodigy of the insurance industry, as chief executive. Byrne promptly improved the company’s approach to estimating losses and restored the company’s traditional underwriting discipline. He took other steps to control costs, including refusing to renew policies of high-risk drivers, and increased revenues by raising premiums. To relieve pressure and maintain public confidence, Butler and Byrne arranged for a consortium of insurers to assume a large book of GEICO’s policies. To raise capital to meet claims, GEICO made a secondary offering of its stock. In that offering, Berkshire bought a 15 percent stake.

GEICO escaped a doomed fate, thanks to Byrne’s leadership and Berkshire’s capital infusion. It emerged a much smaller company, with a market share of less than 2 percent, where it would remain for more than a decade. Byrne, along with his colleague and successor, William B. Snyder, adhered to the business model Goodwin had established: being the low-cost seller in a large market in which competitors were wedded to the costly practice of marketing through agents.¹⁶ In 1980, Berkshire more than doubled its stake in GEICO, soon owning half the stock.

Budget consciousness was, above all, GEICO’s secret sauce. In 1986, GEICO’s total underwriting expenses and loss adjustment expense accounted for just 23.5 percent of premiums.¹⁷ Rivals’ costs were fifteen percentage points above that. It sported a combined ratio—expenses plus claims as a percent of premiums—of 96 in a year (1983) when the industry’s was 111. The difference was GEICO’s moat that thus protected a business castle.¹⁸ Buffett explained:

GEICO’s growth has generated an ever-larger amount of funds for investment that have an effective cost of considerably less than zero. Essentially, GEICO’s policyholders, in aggregate, pay the company interest on the float rather than the other way around. (But handsome is as handsome does: GEICO’s unusual profitability results from its extraordinary operating efficiency and its careful classification of risks, a package that in turn allows rock-bottom prices for policyholders.)¹⁹

In 1995, Berkshire paid $2.3 billion for the other half of GEICO (princely, compared to the total of $46 million it laid out for its first half begun nineteen years earlier). Buffett noted the importance of attracting and keeping good customers and accurate reserving and pricing. But he stressed the vital key was the rock-bottom costs that permitted low premiums:

The economies of scale we enjoy should allow us to maintain or even widen the protective moat surrounding our economic castle. We do best on costs in geographical areas in which we enjoy high market penetration. As our policy count grows, concurrently delivering gains in penetration, we expect to drive costs materially lower.²⁰

Buffett attributes the prosperity GEICO enjoys today to Olza M. (“Tony”) Nicely, who joined GEICO in 1961 at age eighteen and has been CEO since 1992—one of several Berkshire executives who have been with their company more than fifty years. Buffett stresses that Nicely inherited a company commanding merely 2 percent of the market without significant growth and turned it into a powerful industry force—while maintaining underwriting discipline and keeping costs low.²¹ Under Nicely, GEICO clocked many productivity gains. As one example, during a three-year period in the early 2000s, policy volume rose by 42 percent (from 5.7 million to 8.1 million), whereas the employee base fell by 3.5 percent, contributing to a productivity growth (in policies per employee) of 47 percent.²²

While Nicely exemplifies managerial quality at Berkshire subsidiaries, his colleague Louis (“Lou”) Simpson, GEICO’s chief i...