Below are notes taken across three lectures by Warren Buffett to the Notre Dame Faculty in 1991 on the topic of pricing power, and what makes a good business.
The first set of notes is a comparison between two companies, a capital-intensive telecoms business and a capital-light newspaper business:
“Now I’ll tell you a little bit about these companies (we’re leading up to the question of whether the business makes a difference). Company A had thousands of MBAs working for it. Company E had none. I wanted to get your attention. Company A had all kinds of employee benefit programs, stock options, pensions, the works. Company E never had stock options. Company A had thousands of patents – they probably held more patents than just about any company in the United States. Company E never invented anything. Company A’s product improved dramatically in this period, Company E’s product just sat.”
“Well, I’ll tell you a little more about it. Company A is known as company A because it was in agony, and Company E, as Company E, because it was in ecstasy. Company A is American Telephone and Telegraph. I’ve omitted eight zeros on the left hand side, and the American Telephone and Telegraph Company, at the end of 1979, was selling for $10 billion less than the shareholders had either put in or left in the business. In other words, if shareholder’s equity was “X” the market value was X minus $10 billion. So the money that shareholders had put in, or left in, the business had shrunk by $10 billion in terms of market value.
Company E, the excellent company, I left off only six zeros. And that happens to be a company called Thompson Newspapers. Thomson Newspapers, which most of you have probably never heard of, actually owns about 5% of the newspapers in the United States. But they’re all small ones. And, as I said, it has no MBAs, no stock options – still doesn’t – and it made its owner, Lord Thompson. He wasn’t Lord Thompson when he started – he started with 1,500 bucks in North Bay, Ontario buying a little radio station but, when he got to be one of the five richest men, he became Lord Thompson.”
“…The telephone company, with the patents, the MBAs, the stock options, and everything else, had one problem, and that problem is illustrated by those figures on that lower left hand column. And those figures show the plant investment in the telephone business. That’s $47 billion, starting off with, growing to $99 billion over an eight or nine year period. More and more and more money had to be tossed in, in order to make these increased earnings, going from $2.2 billion to $5.6 billion.
So, they got more money, but you can get more money from a savings account if you keep adding money to it every year. The progress in earnings that the telephone company made was only achievable because they kept on shoving more money into the savings account and the truth was, under the conditions of the ‘70s, they were not getting paid commensurate with the amount of money that they had to shove into the pot…”“Lord Thompson, once he bought the paper in Council Bluffs, never put another dime in. They just mailed money every year. And as they got more money, he bought more newspapers. And, in fact, he said it was going to say on his tombstone that he bought newspapers in order to make more money in order to buy more newspapers [and so on].”
“One is a marvelous, absolutely sensational business, the other one is a terrible business. If you have a choice between going to work for a wonderful business that is not capital intensive, and one that is capital intensive, I suggest that you look at the one that is not capital intensive. I took 25 years to figure that out, incidentally.”
The second two businesses Buffett compares were real-world examples in Berkshire Hathaway’s portfolio at the time of the lectures and have become important landmarks in the Berkshire Hathaway story.
“Company E is the ecstasy on the left. You can see earnings went up nicely: they went from $4 million to $27 million. They only employed assets of $17 million, so that is a wonderful business. On $17 million they earned $27 million, 150% on invested capital. That is a good business. The one on the right, Company A, the agony, had $11 or $12 million tied up, and some years made a few bucks, and in some years lost a few bucks.
The company E is our candy business, See’s Candies out in California. I don’t know how many of you come from the west, but it dominates the boxed chocolate business out there, and the earnings went from $4 million to $27 million, and in the year that just ended they were about $38 million. In other words, they mail us all the money they make every year, and they keep growing and making more money, and everybody’s very happy.
Company A was our textile business. That’s a business that took me 22 years to figure out it wasn’t very good. Well, in the textile business, we made over half of the men’s suit linings in the United States. If you wore a men’s suit, chances were that it had a Hathaway lining. And we made them during World War II when customers couldn’t get their linings from other people. Sears Roebuck voted us “Supplier of the Year.” They were wild about us.
The thing was, they wouldn’t give us another half a cent a yard because nobody had ever gone into a men’s clothing store and asked for a pinstriped suit with a Hathaway lining. You just don’t see that.
As a practical matter, if some guy’s going to offer them a lining for 79 cents, [it makes no difference] who’s going to take them fishing, and supplied them during World War II, and was personal friends with the Chairman of Sears. Because we charged 79½ cents a yard, it was ‘no dice.’
See’s Candies, on the other hand, made something that people had an emotional attraction to, and a physical attraction you might say. We’re almost to Valentine’s Day, so can you imagine going to your wife or sweetheart, handing her a box of candy and saying ‘Honey, I took the low bid.’
Essentially, every year for 19 years I’ve raised the price of candy on December 26. And 19 years go by, and everyone keeps buying candy. Every ten years I tried to raise the price of linings a fraction of a cent, and they’d throw the linings back at me. Our linings were just as good as our candies. It was much harder to run the linings factory than it was to run the candy company.”
You really want something where, if they don’t have it in stock, you want to go across the street to get it. Nobody cares what kind of steel goes into a car. Have you ever gone to a car dealership to buy a Cadillac and said ‘I’d like a Cadillac with steel that came from the South Works of US Steel.’ It just doesn’t work that way, so that when General Motors buys they call in all the steel companies and say ‘here’s the best price we’ve got so far, and you’ve got to decide if you want to beat their price, or have your plant sit idle.'”