Stephanie Cuba’s books include “The Warren Buffett Shareholder: Stories from the Berkshire Hathaway Annual Meeting” (2018) and “Margin of Trust: The Berkshire Business Model” (forthcoming 2019), both with Lawrence A. Cunningham.
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Pop quiz: What’s Berkshire Hathaway’s secret sauce, the most important source of its unique prosperity and longevity? Choose one:
A. Warren Buffett’s investment savvy.
B. Charlie Munger’s worldly wisdom.
C. Insurance float’s low-cost capital.
D. Deferred taxes on long-term capital gains.
E. None of the above.
Choices A through D all contribute greatly to Berkshire’s success. However, E is the best answer. Berkshire’s sustained success does not depend so much on the continuity of any of those but on something else: the company’s deeply embedded culture of trust.
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Trust, Buffett says, is the glue that holds Berkshire together. It pervades every aspect of Berkshire and the nexus of relationships that constitute it, among shareholders, directors, managers, employees and business associates.
Buffett has always viewed Berkshire’s shareholders not merely as owners of corporate equity but as partners. The first tenet of Berkshire’s operating principles: “While our form is corporate, our attitude is partnership.” Despite Berkshire’s huge scale, Buffett has kept the partnership spirit alive through practices such as a candid annual letter he writes himself and forthright answers to tough business questions at each annual meeting. These practices have earned Buffett the trust of nearly 1 million people worldwide who can call themselves Berkshire partners.
Trust is a two-way street in this Berkshire partnership, as the company’s shareholders reciprocate: They are engaged and informed; concentrate heavily in Berkshire stock and hold it for long periods; and otherwise behave like owners and partners. To a far greater degree than among other large companies, Berkshire shareholders study the chairman’s letters, join the annual meeting and embrace a business philosophy that focuses on a long-term horizon.
Buffett has never committed Berkshire’s shareholder capital to any business without firmly believing in the trustworthiness of those running it. With the assurance of such integrity, the Berkshire model puts unbridled trust in those managers. The power of this trust is attested repeatedly by many Berkshire managers over the years:
» Jim Weber, CEO of Brooks Running Co., who will host Sunday’s 5K Race as part of the Berkshire annual meeting, says: “I’ve never been trusted so much in my career, and never felt more accountable.”
» The late Bruce Whitman, long-time CEO of FlightSafety, who passed away in 2018, put it this way: “Buffett trusts me so much with Berkshire’s money that I am even more careful in handling Berkshire capital than in handling my own.”
Buffett leads from the front by entrusting his managers and offering them complete autonomy. In turn, the managers radiate that virtue throughout their companies, and across Berkshire. To quote Tom Manenti, the retired CEO of MiTek: “Being trusted so much by Buffett enables me to trust my team members with enormous delegated responsibility.”
Berkshire’s trust-based culture creates a competitive advantage: corporate dexterity to respond quickly to opportunities and threats alike. Most large corporations feature layers of hierarchy and heavy reliance on internal controls. These features may promote compliance and deter error, but at the expense of swiftness. As Buffett wrote in his 2009 letter:
“We would rather suffer the visible costs of a few bad decisions than incur the many invisible costs that come from decisions made too slowly — or not at all — because of a stifling bureaucracy.”
The Berkshire team has made notably few bad decisions.
Berkshire’s board protects Berkshire’s culture. The directors share Buffett’s view that managers are stewards of shareholder capital. They have won the trust of fellow shareholders by acquiring sizable stakes themselves — most in extraordinary portions, all with their own cash. As a tribute to trust, they all serve without the security of director liability insurance, which is essentially unheard of in corporate America.
In rare cases when bad decisions are made, the board is prepared to swing into action to reassert the primacy of trust to Berkshire culture.
But if trust is pervasive inside the company, looking outside, the opposite is true. Berkshire avoids, as much as possible, retaining intermediaries such as bankers, brokers, consultants or lawyers in the routine way of most large corporations. Apart from the direct expense of fees, conflicts of interest often impair independent judgment.
Such skepticism explains Berkshire’s preference to finance operations and acquisitions through retained earnings and cash, not debt. It explains why it prefers to develop acquisitions through an informal network of friends and colleagues rather than engage brokers in the hunt. Such methods are a huge benefit to subsidiary managers: When they need funds, they rarely turn to outside financial institutions but to headquarters, where Buffett is the world’s friendliest banker, staking funds without conventional contracts, conditions or covenants.
If Buffett has any doubt about the trustworthiness of a prospective business colleague — seller, manager or otherwise — he usually politely declines interest. Call this the margin of trust: It’s not enough to be an excellent judge of business, business methods or character — though Buffett has honed those skills. It is, above all, a disciplined aversion to misplaced trust that rules at Berkshire.
Since the 1980s, Berkshire has promised to provide not only autonomy to all of its managers but also a permanent home for all of its businesses. Buffett has always wanted to make Berkshire the buyer of choice for business sellers who prize such features. Buffett has earned trust in the marketplace by always honoring those commitments. As he wrote in his 2008 letter:
“Our long-avowed goal is to be the ‘buyer of choice’ for businesses — particularly those built and owned by families. The way to achieve this goal is to deserve it. That means we must keep our promises; avoid leveraging up acquired businesses; grant unusual autonomy to our managers; and hold the purchased companies through thick and thin (though we prefer thick and thicker).”
Trust may be a moral virtue but it is also an economic advantage. Berkshire avoids overpaying in acquisitions, insisting on a margin of safety between the price it pays and the expected value it gains. More than that, Berkshire often makes acquisitions at a discounted price because sellers prize its culture of trust and commitments to autonomy and permanence.
“Trust takes years to build, seconds to break and forever to repair.” Many associate this anonymous saying with personal relationships. But after more than a decade of Berkshire in my orbit, I believe it aptly applies to this company as well. Trust is among Berkshire’s most valuable assets, one whose loss would be permanent.
Those choosing incorrectly on this column’s quiz can take solace in knowing that all four listed choices have been valuable — another tempting answer might have been “all of the above.” But Berkshire would continue in its current form even without such peerless figures as Buffett and Munger or such capital advantages as insurance float and deferred taxes. It cannot endure without its trust-based culture.