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Lessons from Warren Buffett - XXXIII

Mar 27, 2008

In our previous article in the series, we came across few of the advantages that Warren Buffett has vis-a-vis acquisitions over other firms and managers. Let us go further down the same letter and have a look at some of the other nuggets on investment wisdom the master has to offer.

It is often said that if investing all about building a few statistical models and taking positions based upon the output from the same, then all the quants and statisticians would have been billionaires. But fortunately, investing is as much about qualitative aspects as it is about quantitative ones. And no one epitomizes it better than Warren Buffett. Right from the first letter, the master has come up with some unique ways in describing the economic characteristics of a lot of industries and businesses. And in the letter for the year 1995 too, which we are currently discussing, the master pulls out few more arrows from his quiver. Although funny and humorous at first sight, his descriptions often contain a lot of insights for the person who properly chews upon them.

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Since 1995 was the year where his investment vehicle, Berkshire Hathaway made a couple of acquisitions in the retail space, the master has devoted a few lines towards explaining his views on the sector and why with a few exceptions, he generally tends to sidestep investments in retail firms. This is what he has to say on the general characteristics of any retail business.

"Retailing is a tough business. During my investment career, I have watched a large number of retailers enjoy terrific growth and superb returns on equity for a period, and then suddenly nosedive, often all the way into bankruptcy. This shooting-star phenomenon is far more common in retailing than it is in manufacturing or service businesses. In part, this is because a retailer must stay smart, day after day. Your competitor is always copying and then topping whatever you do. Shoppers are meanwhile beckoned in every conceivable way to try a stream of new merchants. In retailing, to coast is to fail."

Indeed, anyone with a few bucks in his pocket is allowed to enter a retail outlet. And when this happens, the trade secrets are nothing but an open book, thus letting some key competitive advantages slip into oblivion. Soon, competitors would be employing the same tricks and eventually might even lure the customers from under the nose of the successful retailer. Thus, the management of a retail firm in order to periodically bring out new tricks from the bag has to be on its foot all the time and not focus too much on expansion that may eat into a lot of its day-to-day management time. Further, with profit margins for most the players being wafer-thin, cost control is of the essence, which again calls for increased involvement in the day-to-day management.

Contrast this with a manufacturing business, be it a value added product like the automobile or a commodity, where technology and price contracts are a closely guarded secret, thus giving the management enough headroom to further expand the business and tap into newer markets. Thus, as is rightly said by the master, in the retail business, to coast is to fail.

To conclude, the master has given a very interesting name to the retail business, which he calls 'have-to-be-smart-everyday-business'. And he compares it to another kind of business, which he calls 'have-to-be-smart-once' business. Laid out below is a small paragraph on how he brings out the contrast in these two businesses in his own inimitable style.

"In contrast to this have-to-be-smart-every-day business, there is what I call the have-to-be-smart-once business. For example, if you were smart enough to buy a network TV station very early in the game, you could put in a shiftless and backward nephew to run things, and the business would still do well for decades. For a retailer, hiring that nephew would be an express ticket to bankruptcy."

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