Boring Portfolio

<THE BORING PORTFOLIO>
Thanksgiving Thoughts
The "War Munger" Lecture

by Alex Schay (TMF Nexus6)

ALEXANDRIA, VA (Nov. 25, 1998) -- During the course of performing some research on Borders Group (NYSE: BGP) in recent days, I was suddenly struck by the curious origins of an analytical technique that I often use. The technique itself entails thinking about problems in reverse, that is, a kind of qualitative discounted cash flow model. After much digging, I finally struck something hard in my brain, and realized that this "method" of ruminating about problems (though aligned with common sense) had been formally introduced to my thought process by Charlie Munger -- vice chairman of one of our favorite businesses.

No, he didn't talk to me personally (he only speaks with Dale), but the transcript of a lecture he gave in 1996 certainly did. Considering that it's the time of year where we ought to give thanks, this Boring Port column offers a summary of that lecture, along with Munger's five keys to "better thinking." We tend to believe there's something for everyone in this piece.

The Lecture...

The argument is often made that Coca Cola Co. (NYSE: KO) is the greatest global franchise in the world, but perhaps no one has articulated the case for Coke more clearly than Charles T. Munger, vice chairman of Berkshire Hathaway. In a talk given mid-year 1996, Munger laments the fact that, "Our civilization now keeps in place a great many educators who can't satisfactorily explain Coca Cola." The solution to this abhorrent state of affairs comes in the form of an informal talk conducted by Munger, ostensibly on the subject of "better methods of thought."

Munger's Coke manifesto, as it would have been written in 1884, springs from five "problem solving" notions that serve as aids for clear thinking. Munger's first helpful notion is that it is usually best to simplify problems by deciding big "no brainer questions first." To this end, it is decided that Coca-Cola must be a strong legally protected trademark, and the growth of its brand equity must begin with local awareness and spread organically from there. In turn, the product must have universal appeal. This can be achieved by harnessing many powerful forces simultaneously, the most important of which is the understanding that the beverage business is about "creating and maintaining conditioned reflexes." This can only be successfully accomplished if the product is available everywhere, discouraging alternative competing products.

The second helpful notion is to cultivate numerical fluency as a means of perceiving scientific reality (which in some instances actually approximates what's really going on). Without this, no plans can be laid. Here is Coke's formula for success going forward from 1884 as analyzed by Munger (the actual formula for Coke is in the footnotes): By 2034 there will be about 8 billion beverage consumers, each of which will be more affluent in real terms than the average consumer in 1884. Each consumer is composed of mostly water and must ingest 64 ounces of it per day (eight 8-ounce servings). If the beverage market as a whole can account for 25% of the water consumption through "value-added" water products, and if Coke can occupy the role of providing half of these products, Coke can sell 2.92 trillion eight-ounce servings in 2034. If Coke can net $0.04 per serving, it has the potential to earn $117 billion.

The third helpful notion is to think about problems in reverse, for it is not enough to just think them through going forward. Take the example of Coke and its position in 2034 and then work backward, revealing as many potential stumbling blocks as possible. Presently (1996), Coke is worth well over $100 billion and will have to increase its value at only 8% per year until 2034 to reach a value of two trillion dollars. If servings grow at a healthy 6% per year until 2034, Coke can hit the annual physical volume target of 2.92 trillion servings.

The fourth notion is multi-disciplinary thinking that avoids "extreme balkanization" into specialties. An approach that derives its strength from elemental truths from many fields contributes greatly to "out of the box" thinking, crucial for adaptation and problem solving. The fabric of reality is not composed of one material. Coke, above all else, draws upon behavioral conditioning classified and studied by psychologists. "Operant conditioning" is the easiest to manipulate: (1) maximize rewards created by the beverage's ingestion by providing an alluring flavor, texture and aroma (combined with suitable stimuli known as sugar and caffeine); (2) minimize the chance that the desired reflex, once created, will be wooed away and find an outlet in other products. "Classical conditioning" utilizes the power of pleasant associations, cultivated in advertising. As Munger notes, "The brain of man yearns for the type of beverage held by the pretty woman he can't have." (Applying equally to the beefcake male construction worker that chugs Diet Coke.)

The fifth and final notion is that the really big effects act in a synergistic fashion and an awareness of this is essential. All the elements combine to propel a whirlwind force that is greater than the sum of its parts. By combining Pavlovian conditioning, powerful "social-proof" effects, and a wonderful tasting, energy-giving, stimulating and desirably cold beverage that causes "much operant conditioning," the end result is accelerating sales over a long period of time. The boundaries of success are set; they are only limited by the logistics of distribution and the degree to which the operators stay on track (and avoid derailments with lame-brained endeavors like New Coke).

Have a great Thanksgiving and we hope to hear from you on our Boring message board.


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11/25/98 Close

Stock  Change    Bid
ANDW  +  7/8   16.88
BGP   +1 3/8   23.38
CSL   +1 1/4   46.06
CSCO  +  7/8   77.06
FCH   +  1/4   23.75
PNR   -  1/2   37.88
TBY   +  1/16  7.25

                   Day   Month    Year  History
        BORING   +1.97%   7.71%  -1.47%  23.97%
        S&P:     +0.33%   8.03%  22.30%  90.93%
        NASDAQ:  +0.98%  12.07%  26.42%  90.71%

    Rec'd   #  Security     In At       Now    Change
  6/26/96  225 Cisco Syst    23.96     77.06   221.69%
  2/28/96  400 Borders Gr    11.26     23.38   107.66%
  8/13/96  200 Carlisle C    26.32     46.06    74.98%
  4/14/98  100 Pentair       43.74     37.88   -13.41%
  5/20/98  400 TCBY Enter    10.05      7.25   -27.82%
  1/21/98  200 Andrew Cor    26.09     16.88   -35.32%
  11/6/97  200 FelCor Sui    37.59     23.75   -36.82%

    Rec'd   #  Security     In At     Value    Change
  6/26/96  225 Cisco Syst  5389.99  17339.06 $11949.07
  2/28/96  400 Borders Gr  4502.49   9350.00  $4847.51
  8/13/96  200 Carlisle C  5264.99   9212.50  $3947.51
  4/14/98  100 Pentair     4374.25   3787.50  -$586.75
  5/20/98  400 TCBY Enter  4018.00   2900.00 -$1118.00
  1/21/98  200 Andrew Cor  5218.00   3375.00 -$1843.00
  11/6/97  200 FelCor Sui  7518.00   4750.00 -$2768.00

                             CASH  $11273.22
                            TOTAL  $61987.28

</THE BORING PORTFOLIO>

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