One of Warren Buffett's most well-known principles is the power of a business that is run efficiently and profitably. Yet, surprisingly, one Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B) business spends more than $1 billion in advertising each year. Some people think dollars dropped on advertising are a waste of money for far too many companies.
In true Berkshire Hathaway fashion, however, the dollars invested in advertising are those well spent. The business? None other than GEICO.
The increased investment
In his letter to shareholders following 2005, Buffett revealed:
When Berkshire acquired control of GEICO in 1996, its annual advertising expenditures were $31 million. Last year we were up to $502 million. And I can't wait to spend more.
And "spend more" he has, as the latest information reveals GEICO spent $1.2 billion on advertising in 2013. But a recent study reveals GEICO is doing a phenomenal job at putting those dollars to work.
The impressive success of advertising
Bain & Company, a consultancy, recently released its 2014 review of customer loyalty in the insurance industry. It explored the various ways to succeed, and discovered there are really two critical keys to success.
Insurers can either excel at retaining the customers they already have, or acquiring new ones. And the survey of more than 26,500 individuals revealed it is very unlikely an insurer can do both well.
The critical thing to learn from the study is its admission:
Acquisition leaders tend to attract customers who are highly price-sensitive -- and thus more likely to defect when they are presented with a lower-priced offer. Their customers tend to be younger, lower-income and have fewer insurance needs.
As shown in the figures below, the study revealed the insurance agencies that excelled at getting new customers found those individuals who were the most sensitive to the prices, thanks to age and income differences:
And this is the very key to the remarkably successful business model at GEICO. GEICO is seeking to gain customers by offering its insurance policies at the lowest price possible. And providing customers the product they want (or in this instance, need) at the lowest price is a ticket to success.
But the thing is, the only true way to alert customers to this benefit is by telling them via advertising it.
Remember, we learned that GEICO not only saw the biggest gain in its insurance premiums written -- 11% compared to 4% for the industry as a whole -- but it moved into second place in terms of market share. It also was the most well-run and profitable company with the lowest combined ratio, which measures how much of its premiums it pays out.
Clearly, the billions spent on advertising by GEICO through the years are worthwhile investments. The dollars spent help explain why it has seen its market share grow from 2.5% to 10.2%.
Warren Buffett is full of wisdom from sitting atop Berkshire Hathaway, but it's critical to remember that, when you're investing in the company, you're buying into the businesses that make it up. And this provides one more example of why Buffett isn't the only thing that's worth being excited about at Berkshire -- it's the businesses, as well.