Lawrence Cunningham first stumbled upon Berkshire Hathaway when he was researching a paper on corporate governance. Warren Buffett’s hands-off management style fascinated him and Cunningham ended up getting advice from the Oracle himself after he put together his first book, The Essays of Warren Buffett. It was a compilation of Buffett’s letters to shareholders arranged by topic and Buffett advised Cunningham to self-publish. Since then, he has attended 15 annual meetings and a good part of that was spent lugging his self-published book around with his nephew Justin. Cunningham’s latest book, titled Berkshire Beyond Buffett, delves into the sustainability of Berkshire’s unique culture.
Warren Buffett and Charlie Munger believe that the Berkshire system is firmly in place. Is there anything that could spoil this party, if at all?
There is no organisational blind spot; the only thing that could go wrong is the people. That is the inherent risk of any social institution. What could go wrong is if the new CEO turns out to be something other than what he is perceived to be, that is, a micro manager or someone interested in the short term or someone who wants to get rid of businesses; that is the thing you worry about, the wrong people getting the wrong positions, because otherwise the basic structure is all there: thrift, autonomy, the board, the managers. You always have the risk of the person departing from the elements of the Berkshire system. It showed up in the case of David Sokol, who was running the energy company and who ran the trade at Lubrizol.
Sokol was a front-runner for succession and let’s say it was 2012 and if Warren and Charlie had checked out and David was in charge, everyone thought here is a great successor. If you had the wrong person in there and they did something terrible, that could really hurt Berkshire. That said, I think the culture and the structure is as strong as possible to protect against that. I don’t think anyone has the thermostat or the exact dial of how much trust and how much diligence. What’s been true of Berkshire is that it has basically succeeded with an enormous amount of trust, with occasional problems like Sokol but nothing catastrophic.
Do you see any external risks?
I don’t know. One context of that question would be a recent piece in the Financial Times. London banking authorities questioned how the US Federal Reserve failed to designate Berkshire as a significant financial institution. After the 2008 crisis, Dodd-Frank legislation requires the Fed to identify large financial institutions and subject them to special regulation. MetLife, AIG, Prudential and Allianz are on the provisional list and the Bank of England asked why not Berkshire’s reinsurance operations? My answer to that is Berkshire generates enormous cash, has vast assets and virtually no debt. The other companies I mentioned, their balance sheet is as much about liability management as asset management. Berkshire doesn’t have that kind of problem. In a crisis, those companies may need some help. So, pre-stabilisation is wise.
Berkshire is the opposite. If there is a crisis, it will have to pay some insurance claims probably, especially if it is a natural crisis. In a financial crisis, it may even have some derivatives to settle. But, just as in 2008, it is going to be supplying capital and not sucking it out. This self-reliance is a fortress. Buffett has said: if you have an insurance crisis, terrorist destruction on an unimaginable scale or a huge earthquake or flood and all large insurance and reinsurance companies had to step up, a few rivals might disappear. But if Berkshire might have to pay out $3 billion or $5 billion or $10 billion, it would still make a profit for the year. That is the way this thing is set up. So, I think they have managed those kinds of external risks pretty well. I think the thing to worry about in this trust-based model is some particular subsidiary not living up to the standards. That would hurt Berkshire but I don’t think it will shake it that much. It is hard to imagine problems but that is my only concern.
Buffett’s leadership is iconic. But in this year’s letter, with respect to the conglomerate accounting that was in vogue, he wrote, ‘Never forget that 2+2 will always equal 4’. In Berkshire, with respect to his role, does 1+1 equal more than 2?
With Buffett and Munger, it is 2+2 equals 5. No one, no matter what their bandwidth, will have their experience to take over. They could handle it because they put it all together and know all the people. Buffett says, and we all know that, Munger has played a vital role throughout. With Munger as consigliere, Warren can run things by and get the truth. Any CEO would need somebody like that. But the CEOs in Berkshire know that and tend to have those people. So whoever is picked will probably have somebody already but they might not want to bring that person up there with them. The whole point of having that person is to run that subsidiary. So, there are all these number twos across Berkshire. Warren has had a good run at picking people. The CEOs have generally turned out to be faithful and successful, with some exceptions. 10 years ago, all the CEOs at Berkshire were people that Warren picked. But now there are a bunch of them that he didn’t pick initially — they were chosen by predecessors. In 10 years, it is going to be even more different.
Both Buffett and Munger write in the latest letter that Ajit Jain and Greg Abel are better business executives than Buffett. Were they being simply generous? What aspects were they referring to?
Maybe. Generosity is not to be overlooked, specially with Warren. He is a very generous guy. Charlie is not so automatically generous. He does not suffer fools gladly and is willing to call people out, too. Warren has got a philosophy of criticise by category and praise by name. But I think they both mean it when they say it and there is some evidence for it.
Both those guys have run businesses for a very long time. Greg has been in charge of acquisitions and putting the energy business together. Ajit, too, has run a business in his own way. They are directly involved in their product lines and capacity, what the pricing is, the payroll, etc. They have run pretty complicated businesses for a long period of time, through a lot of different economic cycles. They have been vetted. Warren has not done that. He has a staff of 24. He has been an investor for most of his life and he sort of stumbled into this conglomerate. His management is much more intellectual and analytical. So, that could be the basis of their observation.
I think the flip side to that is the skill sets that are most important to run Berkshire are probably what Warren has. You don’t need to meet a payroll or economic cycles. You have to think about capital allocation at a really high level. They may be better businessmen but the question is: are they going to be good at capital allocation? I think the answer is, defensively, yes. I wouldn’t compare them to Warren, especially Abel. He has made acquisitions. He has allocated $10 or $15 billion of Berkshire’s capital or something like that, or maybe even more. His track record has been pretty good — picking assets, negotiating them, integrating them and putting people in place. He has a good track record of one thing Buffett has done.
Ajit hasn’t put businesses together but he has done the underwriting and built float of $60 billion, which is a big part of Berkshire’s business. He has got a skill set that is really useful, maybe even more useful than some of Warren’s. But up there at the top, there are obvious trade-offs. Greg has not written insurance, he is going to have to learn that. Ajit hasn’t made acquisitions, so he would have to learn that. But I think both of them can do it. They are both supremely talented people.
But I wouldn’t say that they are going to be like Warren or need to be like Warren. Charlie and Warren built this whole thing, put these guys into place, showed how they work and collected a large number of people around them. For the people taking over, you have the playbook all written out. You don’t have to make it up. You just have to get in and sustain it. I think it will be a bit easier to maintain and build. So, there is a small edge their successors will have. I acknowledge that size can be an anchor in terms of being able to find opportunities to generate outsized returns. But the Berkshire system is unique and the elements of it that have been put in place are scalable. It is already massive and if there was a breakpoint, I think we ran past it.
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