“Buy commodities, sell brands” has long been a formula for business success. It has produced enormous and sustained profits for Coca-Cola since 1886 and Wrigley since 1891. On a smaller scale, we have enjoyed good fortune with this approach at See’s Candy since we purchased it 40 years ago.
Warren Buffett wants us to see that the formula for a business's success isn't difficult to understand. But it's mighty hard to do.
Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B) invested in Coca-Cola (NYSE:KO) in the late 1980s and finally stopped buying shares in 1994. Since then the value of Coca-Cola has more than tripled, as Buffett saw his position -- which cost $1.3 billion -- grow from being worth $5.1 billion at the end of 1994 to $16.5 billion today.
Coca-Cola has made Berkshire Hathaway a lot of money, but Buffett's "dream business" of See's Candy has been wildly more profitable. Not surprisingly, the "formula for business success" mentioned above -- which Buffett said in 2011 -- has been the same for both.
The little business that could
Berkshire Hathaway bought See's Candy for $25 million in 1972, the year it had roughly $30 million in sales and brought in $4.2 million of profit. As a result of its small size, we can't track its results over the decades, but 35 years later, in 2007, Buffett noted sales had risen nearly 13 times to stand at $383 million.
Even more impressive, Buffett revealed profits were up nearly 20 times and stood at $82 million. That means Berkshire now earns nearly three times the cost of its original investment each year.
But perhaps what is even more remarkable is that, in 2011, Buffett said See's had brought in a staggering $1.65 billion in total profits since he bought it 40 years ago.
So how has See's been so successful? Let's see what Buffett has to say.
In 1972, See's sold 16 million pounds of candy, and 35 years later, it stood at 32 million, meaning it gained just 2% a year, but it's profit rose by 9% a year:
So how'd See's do it?
It's easy to think it made massive investments to boost sales. But Buffett revealed, in that 35-year period, only $32 million worth of money had been put back into See's. Instead, Berkshire Hathaway benefited as Buffett "used the rest to buy other attractive businesses."
The reason behind this is simple. At its core, See's is a commodities business. It sells products made from peanuts, sugar, chocolate, and more, and it can raise its prices little by little with each passing year. While what it costs to buy the ingredients used to make the candy will rise, it has the ability to continuously raise its prices too.
In 1972, it sold 17 million pounds of candy, and by 1984, that number had grown to 25 million pounds, a gain of roughly 50%. Yet it went from having $31 million in revenue to $136 million, an increase of 333%. How did it do it? Little by little, it raised its price per pound:
Of course, these 12 years saw major inflation, but the thing is, even after factoring that in, if prices had stayed the same, the $1.85 per pound of See's Candy in 1972 should've cost $4.60 by 1984. Yet instead it stood at $5.49 per pound, showing how much of an advantage operating in a commodity business can be.
As a result, the growth in profits was the most impressive result, jumping by 540%, from $2 million to nearly $13.5 million.
Operating in a commodity business can be treacherous if that's the only thing going for it. But See's not only had favorable underlying business dynamics, but it had a powerful brand that allowed it to slowly raise its prices and boost its profitability year after year.
In Buffett's own words, when they bought it in 1972:
What we did know was that they had share of mind in California. There was something special. Every person in California has something in mind about See's Candy and overwhelmingly it was favorable...If we can get that in the minds of people, we can raise prices.
Investing in an industry that has favorable dynamics can seem like the key to success. But in the case of See's Candy, countless other candy firms have fallen by the wayside.
Buffett wants us to know the key to success for any business -- whether it's one we've started or one we're investing in -- isn't just the opportunity for profits, but a strong brand to ensure they're realized.
Patrick Morris owns shares of Berkshire Hathaway and Coca-Cola. The Motley Fool recommends Berkshire Hathaway and Coca-Cola. The Motley Fool owns shares of Berkshire Hathaway and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. 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.