Your “Circle of Competence” is the area that you understand well. For investors and business owners, it is wise to keep your business activities within your Circle of Competence. This should not be a limiting concept — once you focus on something, you begin to see more opportunities in that area. In fact, most people have a lifetime of business opportunities staying within their Circle of Competence. One great thing about business and investing is that you can increase your Circle of Competence over time. Furthermore, everyone can be helped by spending time assessing what business activities you truly understand.
For me, the most interesting question at the 2011 Berkshire Hathaway meeting was the question, “If Warren and Charlie were young and starting out, what new area would they most want to learn and include in their Circle of Competence?” I immediately guessed that they would say health care because it is such a huge and increasing segment of the American economy and sort of fits the Berkshire preference for stable, reliable segments (reminds me of energy, or home products). As far as I know, Berkshire has not made a big investment in health care.
To my surprise, Warren responded that he would want to understand “technology” because there are such outsize investment gains to be had in technology. And then I was even more surprised when Charlie also seconded the notion with even more enthusiasm. This was particularly surprising because Warren had spent so many years saying how he “doesn’t understand technology” and this seemed to imply a disdain for something where the future cash flows could not be predicted.
I suppose I should have been able to guess that something like the investment in IBM would happen after last year’s meeting.
What is your Circle of Competence? And, what would you most like to add to your Circle of Competence?
First, a little extraneous caveat about this prediction. I have not spoken to anyone at Berkshire about this. Frankly, I do not know anyone who works at Berkshire. And, I have no special knowledge about this at all. It is just a pure guess (maybe a slightly educated guess) and an attempt to have some fun.
I predict that Berkshire Hathaway Board Member Stephen Burke, CEO of NBCUniversal and COO of Comcast, will succeed Warren Buffett as the Berkshire Hathaway CEO. To me, it is a very straightforward prediction because:
- He is a Board Member which means he has inside knowledge of Berkshire and would have less to learn.
- He understands the Berkshire culture — he has knowledge and exposure to the company over several decades. His family has been friendly with Warren Buffett since the 1980’s (1985 investment in Capital Cities Communications and the American Broadcasting Company) and probably since the 1970’s as Cap Cities was listed as a Berkshire investment in the 1977 annual letter. Stephen Burke’s father, Dan Burke, was the long-time business partner of Thomas Murphy, a long-time friend of Buffett’s and Berkshire Board Member since 2003, who ran Cap Cities and ABC together. Buffett has referred to Murphy and Burke glowingly numerous times throughout the years and he wrote in the 1985 annual letter, “Tom Murphy and Dan Burke are not only great managers, they are precisely the sort of fellows that you would want your daughter to marry.”
- Burke understands the Berkshire way of being hands-off with the business unit managers. Burke has the track record and business reputation that he will not feel like he has to prove himself by making big moves or getting overly involved in the business units.
- Burke seems to be about the broader purpose or meaning of being in business — something he will find in spades at Berkshire. He will appreciate and understand the nuance of the role, and revel in the fact that the Berkshire job is being part of a legacy. Berkshire prides itself on having strong values, doing things differently than most companies, having deeply rooted norms and ethics — things that I suspect Burke would enjoy supporting because these things have always been important to him and his family. Burke will not strain against that unique culture.
- He has the stature to gain immediate respect. Comcast has $55 billion in annual revenue and NBCUniversal has about $20 billion in revenue. Burke is also on the Board of JPMorgan Chase & Co. He has reportedly been offered the CEO role at Coca-Cola, Nike, DirectTV and others.
Anyone else want to make a guess that is not the usual suspects?
Related post about how Buffett will make his slection: Berkshire CEO after Warren Buffett – May 2, 2012.
I believe the next CEO of Berkshire Hathaway is hiding in plain site. There is a person that is very obvious, but no one (as far as I have read) has mentioned him as a potential candidate. Tomorrow, I make my prediction. Today, I have fun thinking through the decision as a mini case study in the culture of Berkshire Hathaway.
Most of the time, we only know of a decision that Buffett faced after the fact. We can then analyze the decision, but it is sort of impossible to think in an unbiased way about whether we would have bought the Washington Post or See’s Candies or Burlington Northern because we know how the story unfolds. For the CEO decision, however, we all know that Buffett is thinking about it and we can make a prediction without the bias of knowing what happens. It is more fun to try and match our thinking with Buffett’s in this circumstance — it is the power of the case study.
As Buffett and the Berkshire board considers whom should be the next CEO, I think it is the ultimate statement about the culture of Berkshire Hathaway. Here are some things about the Berkshire culture that I think are particularly relevant to the decision:
- The culture is not one where the business unit managers aspire to Buffett’s CEO position, so looking at internal managers is looking in the wrong place. When asked about Berkshire’s history of retaining talented managers even when they are very wealthy or could easily gets jobs elsewhere, Buffett has often said that they are happiest in their current positions and furthermore, they are not looking to get the Berkshire corner office. It is my guess that this description fits Ajit Jain perfectly (I don’t know him and am just guessing) — probably the manager having the most similar mental outlook on allocating capital to Buffett. I don’t imagine that he would ever want the Berkshire CEO job. He has probably built his small team in Connecticut to be exactly how he wants it. He probably could have had his pick of a number of financial services positions throughout the years. The Berkshire CEO position would be much less fun and interesting for him. On the other hand, would Jain do it if the Berkshire Board asked him to? My guess is absolutely yes.
- Buffett likes best a situation where you can judge the track record of the company and of the management together. He knows that picking a great CEO for a particular business out of a list of great CEO’s is still a decision that is very difficult — better to assess someone with a track record in the same position. So, I would guess that Buffett would prefer to not pick a great manager of an existing Berkshire business (Jain, Tony Nicely, or Matt Rose) and place him in a new situation as Berkshire CEO. By the way, this is also why he is basically trying out Todd Combs and Ted Weschler as Berkshire money managers before giving them an even bigger portfolio of money. And, the David Sokol situation, in my opinion, turned out great for Berkshire because he was tested in the limelight of Berkshire for a couple of years before cracking (better that he stumbled now than later). So, how does he find someone with a track record running something similar to Berkshire? He can get close (find a CEO of a large conglomerate) and someone who knows Berkshire well, but this will be the most difficult characteristic for Buffett to find.
- The new CEO needs to understand the seriousness of Berkshire’s prior commitments to acquired companies not to re-sell, dipose, or “surprise” those companies — he needs someone strong enough to know this is non-negotiable. In the 1985 annual report, Buffett wrote “I have told [our managers] that there will be no surprises, and these agreements put Berkshire’s signature where my mouth is. That signature also means the managers have a corporate commitment and therefore need not worry if my personal participation in Berkshire’s affairs ends prematurely (a term I define as any age short of three digits).” Still, a new CEO may be tempted to sell some of the businesses if he didn’t know better.
- The culture of Berkshire is one with a “rather extreme delegation of operating authority to a number of key managers at the individual company or business unit level” as Buffett wrote in his 1979 annual letter. The new CEO will have to be very comfortable supporting his managers when needed, but basically leaving them alone to run their businesses. This will take an unusual degree of self-restraint for most normal people. To do it, it will take a person with a deep appreciation and understanding of the intelligence and effectiveness of this strategy for Berkshire. Although most of the Berkshire business managers are probably very stable individuals, they will be hyper-sensitive to any meddling or extra questions that signal more Berkshire corporate involvement in their affairs. Furthermore, this new CEO may also need the self-restraint to begin a dividend or stock repurchase program rather than try and match Buffett’s track record in allocating the mountains of capital that will be generated by Berkshire. This restraint will be easier for someone who doesn’t yet have to prove himself as a manager, an international CEO, or business thinker.
- Buffett’s ultimate statement is that the Berkshire business and culture thrive after he is gone and that Berkshire maintains its reputation as being better than a typical company on many fronts. Buffett does not want the public’s reaction to be a grudging or unremarkable acceptance of the new CEO — a possible risk if the new CEO were unknown or merely a manager of a Berkshire business unit (no offense intended to those talented individuals). I think Buffett will want us to be impressed with the quality and the unexpectedness of the selection — sort of how Buffett made the thoughtful decision to give his wealth to the Gates Foundation. It seemed totally novel (give your money to a different foundation) but makes imminent sense once we all thought about the decision.
- Buffett wants the earnings to continue, so he won’t disrupt the internal companies. To make that happen, he wants his business unit managers in placing and working.
- For Berkshire to succeed after the initial shock and stock price drop with Buffett’s departure, the person also needs to have enough business stature, character, and business intelligence for the broader community, the media, and potential new acquisitions to trust him.
So, where can we find someone who deeply understand the Berkshire culture, has a track record in a job big enough and similar enough to overseeing Berkshire’s collection of businesses, is confident enough to maintain the Berkshire culture of restraint and “extreme delegation”, and will not create a large management hole in one of the Berkshire operating companies? Stayed tuned tomorrow for my best guess . . . . . . .
Related Post: –Predict Stephen Burke as next Berkshire CEO May 3, 2012.
Obtaining alignment among the various parts of a company, particularly between company founders and investors, is a never-ending topic. Two items have caught my eye this month that relate to this issue and may help spread some enlightened thinking about investor alignment.
First, Fred Wilson, a venture capitalist at Union Square Ventures and the king of venture-bloggers, wrote a post on April 11 that begins, “Possibly the most interesting conversation I’ve been having with entrepreneurs lately is how they can keep their companies independent without having to go public and turn their cap tables into a casino”. He is wrestling with the idea of how to support founders that don’t want to exit their company as required by their professional investors. Check out his post here. Below, I have some tips for business owners and entrepreneurs on how to avoid some of these problems and achieve a higher state of investor alignment.
Also, an article in the April 2012 issue of Wired titled “For High Tech Companies, Going Public Sucks” by Felix Salmon. Salmon writes, “From the time that VCs invest in a company, they have five years—10 at the most—to sell their entire position, hopefully for many times more than their original investment. After that, it doesn’t matter to them whether the company survives a year or a century. To put it another way, the VC model is based on creating wealth for investors, not on building successful businesses. You buy into a company early on and sell out a few years later; if you pick well, you can make lots of money. But your profits don’t accrue to the company itself, which could implode after your exit for all you care. Silicon Valley is full of venture capitalists who have become dynastically wealthy off the backs of companies that no longer exist.”
This is a very basic, but effective, tool to brainstorm growth initiatives — just a simple reminder for us all. On one axis, put a list of all your products or services. On the other axis, put a list of all your customers. Then, fill-in the matrix for which customers buy which products. The white spaces represent the easier to execute opportunities of selling your existing products to your existing customers. It is one of the most effective tools available — sell new products to your customers. Obviously, not every customer can buy every product, but you will find some very high probability opportunities.
This will also prompt you to think about other things in your business. Is there a product that has very large potential for most of my customers and we should prioritize our investment in that product? Should we eliminate a product that is very expensive to execute that only a few customers care about? There are some businesses where the customers turn over every year or so where this exercise isn’t as helpful. But even in these circumstances, it may prompt you to think of other services that you may offer those existing customers to strengthen the overall foundation of your company.
Be careful to whom you sell your company, said the founder of Jimmy Choo footwear, Tamara Mellon. In the Financial Times, Mellon was quoted, “What happens in private equity is they come in and they say we’re going to be a great partner. We want to hold this long term and we’re going to help build this brand. But the day after signing, they talked about selling the business.” This is true — often because the private equity fund structures leave the private equity investors no other options.
In retrospect, she wishes that she hadn’t sold a majority of her company to a private equity firm in 2001, even though the financial results were outstanding. In fact, her firm was sold a total of four times among private equity firms before being sold for £500m to Labelux, a private German luxury goods group in 2011.
For each unique company and unique situation, I believe they should utilize business structures, financing strategies, and all other tools that help them keep their company unique. For this reason, I cheer on Mark Zuckerberg and Facebook for their ability to utilize unique investment terms and corporate structures to suit their purposes. I applaud them for being able to garner these terms and to recognize the importantance of doing things differently when the circumstances demand or allow it. Some of these differences include:
- Zuckerberg being able to maintain voting rights for many shares held by others
- Utilizing restricted stock to compensate employees rather than the traditional stock options used by Silicon Valley companies
- Being able to alter significant, standard terms from the venture capitalists who invested in Facebook
- Utilizing the dual class structure also utilized by Google, Zynga and other older companies like the Washington Post and the New York Times Continue reading
Designing the financial model (in a real-world sense, not a spreadsheet sense) of your business is worth every minute that you can dedicate to it. We should craft the financial model of our business with as much care as a fine architect and craftsman would spend on their own house. Too often, we settle for models of how the business was run before or how other people in our industry do things rather than proactively designing our business to maximize its potential.
To help you think about the financial model of your business, I want to try an experiment that I call “The Perfect Financial Business” — this business is so perfect that it does not exist in the real world. However, the idea is to compare your business with perfection to identify the areas where your business is very strong and those areas where it is weak compared to The Perfect Financial Business. It does not necessarily follow that you should work to improve your weakness or deepen your strength. It may be that a weakness of your industry/company compared to the Perfect Financial Business is helping you because you can handle that weakness better than other firms. More on this later. For now, here is an overview of the areas that I want to cover in describing the Perfect Financial Business.
To grow faster, I have found it is better to focus on growth initiatives that are singles and doubles — counter-intuitive but effective. Some people prefer to attempt the big, home-run initiatives. Large companies, in particular, can feel they need a growth initiative to provide $x million of profit or “it just won’t be big enough.” When you find the huge opportunities, they can be wonderful. But home-run initiatives are often very difficult to find, difficult to execute, and may even put the core business at risk. I much prefer growth initiatives that build on something a business already does and are incremental efforts with a very high probability of success. Each incremental addition of profitable growth makes the company stronger and better able to take-on larger growth opportunities when they arise. And, it is easier to get started on smaller projects. Begin the small inititives, show profits and success, and look to build on them. Before you know it, the small successes add up to larger profits.
An author who makes this point particularly well is Ram Charan in his book Profitable Growth Is Everyone’s Business: 10 Tools You Can Use Monday Morning.