What do GEICO, a car insurance company, and Costco (NASDAQ:COST), the massive retailer, have in common?
According to Warren Buffett and Charlie Munger, a lot more than you think.
The Berkshire Hathaway annual meeting is highlighted by a six-hour question and answer session with Buffett and Munger, the conglomerate's CEO and vice chairman.
They were asked whether GEICO -- which Berkshire Hathaway owns -- will overtake State Farm as the largest auto-insurance company in the U.S. The long and optimistic response came from Buffett:
No one knows for sure ... we will gain share, in my view. Month after month, year after year, as long as we never forget our job is to take care of the customer, and keep rating risk well. ... It won't come fast, but I do think it'll come.
After all, as of last December GEICO had surpassed Allstate (NYSE:ALL) to take second place in the market. Since 2010, Allstate's annual premiums written have stood flat at $18 billion, while GEICO has seen its rise by more than $4 billion.
Since Berkshire Hathaway took complete control of the insurer in 1995, it has taken GEICO less than 20 years to grow its share of policies in the U.S. market from 2.5% to over 10%. Total policies have increased by nearly $16 billion, from $2.8 billion to $18.6 billion.
So the natural question then becomes, how did it achieve such great growth and what does this have to do with Costco?
The fascinating answer
Following up on Buffett's remarks, Munger said:
GEICO to me is very much like Costco. One of the reasons that they succeed is because they're really committed to offering a really great product. A lot of people talk that game, but few live it. GEICO does and that will help it over time.
That makes sense. Both companies are known for their low costs and remarkable customer satisfaction. In fact, GEICO and Costco in 2013 topped the American Customer Satisfaction index for their respective industries.
Like GEICO, Costco has also experienced rapid growth. Since 2009, Costco sales have risen nearly 50%, from $70 billion to more than $100 billion, and its membership base has grown 35%, from 21.4 million to 28.9 million.
Costco is unbelievable...Talking the game is one thing, but living the game is something else. It's against human nature to offer prices like that.
The key takeaway
Buffett regularly speaks to the reality that successful businesses must have "moats" that distance and insulate them from the competition and provide years, if not decades, of success. In Berkshire's latest annual letter, he said:
GEICO's cost advantage is the factor that has enabled the company to gobble up market share year after year. Its low costs create a moat -- an enduring one -- that competitors are unable to cross.
And although he said "no one likes to buy auto insurance," Buffett noted that it's a necessity, and as a result, "savings matter to [families] -- and only a low-cost operation can deliver these."
The same is true of Costco, which provides the necessities consumers need at prices competitors cannot match. While at first glance the two businesses couldn't be more different, it turns out the root of their immense success is the same. Perhaps that explains why Berkshire Hathaway owns more than $500 million of Costco stock.