The Secret Behind Berkshire Hathaway's Success

At this year’s annual meeting Buffett and his longtime business partner, Charlie Munger, revealed “the secret” to their success.

May 7, 2014 at 9:46AM

Buffettfs

Berkshire Hathaway (NYSE:BRK-B)(NYSE:BRK-A) is widely regarded as one of the most successful companies in the world. If you look at Warren Buffett's 49 year track record with Berkshire, it almost looks easy in hindsight. Yet it wasn't easy, and he didn't do it alone.

At this year's annual meeting Buffett and his longtime business partner, Charlie Munger, revealed "the secret" to their success. Only, it's not really a secret and, of course, extraordinary success is typically a combination of many things working together.

Here are three underrated factors that carried the bulk of the weight to creating Berkshire's success. Oddly, I don't think you'll find them on any business school curriculum.

1. Hire good people and let them run their own mini-company.
2. Quickly admit mistakes and scramble out of them. 
3. Remove your ignorance by always learning. This formula is simple but not easy.

Let's explore these a little. 

1. Get Out of The Way

"Yeah, by the standards of the rest of the world, we over-trust. And so far, our results have been far better, because we carefully selected people who should be over-trusted." 
— Charlie Munger

In answering one question on Berkshire-subsidiaries this year, Buffett admitted that he was sometimes too slow to act on certain things like personnel changes.

Buffett is famous for his hands-off management style. He lets the CEOs of the companies run their show; he only asks that they send him the money they can't use.

Good people want to work with him, and this is important because most of the people running Berkshire subsidiaries are already wealthy. They don't have to come to work; they want to come to work. And there is a huge difference. The only time you can get away with a crappy bureaucracy and a culture of distrust is when people have to come to work.

Brands

Buffett leaves these guys alone.

Every now and then something happens at a Berkshire company that calls into question his near abdication of responsibility to a subsidiary. "If only he had been paying attention," the critics chirp, "this wouldn't have happened." Those critics are idiots. The alternative approaches are worse, not better.

There are many positives to the approach Buffett takes.

If Buffett closely managed each of his subsidiary CEOs to the point where most bosses manage their subordinates, they'd probably quit. If he sent out memos telling them all to use a new corporate HR system, they'd stop wanting to come to work. If he peppered them with relentless emails from "headquarters" on some new policy, they'd ... well how do you feel about all of this stuff?

With Berkshire, Buffett wanted to do things his way. He wanted to paint his own canvas. He didn't want other people telling him to add a little more blue here and take away a little red there. Most people want to run their own show. And the best part? This system gets more out of people than micromanaging.

Sure sometimes things go wrong, but for the most part, the outcome is positively skewed. Things go wrong in other corporate cultures too, they are not immune.

When things go wrong in bureaucratic cultures, however, it's nearly impossible to hold anyone accountable because no one is really responsible for anything. And it's hard to hold people accountable when they are not responsible. It's a seductive illusion to think we can create a system where people can't mess up. Buffett's hand's off approach makes it clear who is responsible for what. And this approach, not stock options, creates a real ownership culture.

This system also frees up Buffett's time. He doesn't have to chase management details, read power-points, etc. He can sit and read and think — that means he does what he does best. And judging by the results, this has worked out well. Hiring the right people and largely staying out of the way is incredibly underrated and yet nearly impossible to find in large established bureaucratic organizations. Yet as Buffett shows, it's a much better approach.

2. (Quickly) Scramble Out of Your Mistakes

"It's a learning process, and mistakes made in one year often contribute to competence and success in succeeding years.
— Warren Buffett

You know the old adage, when you find yourself in trouble, the first thing to do is stop digging. That applies to business as well as life.

In the late 1960s, Buffett acquired a department store, Hochschild-Kohn, through company called Diversified Retailing, which later merged with Berkshire.

The people running the company were, in Buffett's words, "first class." Retailing, however, is a difficult industry, even with a first class management team. They were, in Buffett's words, "running in quicksand." Realizing this quickly after the ink dried on the contract, Berkshire "scrambled" out of it, selling Hochschild-Kohn as quickly as they could — 3 years.

Business schools don't generally teach this either. What they teach and reinforce, in so many ways, is that you can be the hero. You can be the exception to the base rate.

But in life and business, you don't need to be the hero. There are no points for difficulty, so as Munger alluded to, smart people will play where competition is weak.

You can have the best management team that money can buy and still fail big in retailing — a recent example being J.C. Penney.

Buffett learned quickly that, in his words, "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

3. Remove Ignorance

"See's has provided us with lots of cash for acquisitions and opened my eyes to the power of brands. We made a lot in Coke partly because of See's. There's something about owning one to educate yourself about things you might do in the future. I wouldn't be at all surprised if we hadn't owned Sees we wouldn't have bought Coke." 
— Warren Buffett

Diversified Retailing also owned shares in a better business: Blue Chip Stamps, which provided supermarkets and other retailing outlets trading stamps to give their customers that could be exchanged for merchandise.

The contrast between running a good business and a poor one stuck with Munger and Buffett and they decided to pay up for a real quality business. On January 3, 1972, Blue Chip Stamps bought See's Candies, a West Coast Manufacturer and retailer of boxed-chocolates. See's is an extraordinary business.

Sees

Most people think that See's main contribution to Berkshire was its overwhelming financial success. It wasn't. According to Munger, See's main contribution was "ignorance removal."

"We were barely smart enough to buy it." See's taught them a powerful lesson, the value of strong brand names.

Without See's, they never would have purchased Coke shares in the 80s. And without Coke, Berkshire would be a lot less prosperous today as that investment has been one of their best.

"If there's any secret we have, it's ignorance removal. And the nice thing is we still have a lot of ignorance left to remove," Munger said at the 2014 Shareholders meeting this past weekend. Removing ignorance is about continuously getting smarter.

Be a copycat
I don't know why more people don't copy these three underrated factors to Berkshire's success. I spend my time trying to master the best of what other people have figured out, so clearly, I think they are on to something.

Buffett and Berkshire own this stock. Learn more here.
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Shane Parrish has a position in Berkshire Hathaway and recommends you do your own thinking. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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