What is Warren Buffett’s business strategy? How did his strategy make him rich?
In The Snowball, Alice Schroeder explains how Warren Buffett’s business strategy made him a billionaire. The secret to his success: Always acting responsibly.
Let’s look at how he succeeded in business thanks to his effective plan of action.
Accumulating Businesses: Stewardship in Action
As the 1960s came to an end, Warren Buffet’s business strategy began to change while the market itself entered a period of transition. However, Buffett’s core value of acting as a responsible steward of wealth never budged. Through the downturn of the ’70s and the fiscal heyday of the ’80s, Buffett shifted his focus from buying cheap stocks to buying great businesses, protecting them from corporate raiders.
Just as Buffett was dissolving his partnerships, the financial world entered a period of turmoil. The bull market of the ’60s went into a downturn, which created an opportunity for Buffett to expand his portfolio. However, the beginning of the ’70s saw the creation of the NASDAQ, the first computerized stock exchange, which did away with the paper-trail trading that had been Buffett’s bread and butter. Technology stocks also took off, but Schroeder writes that Buffett wanted no part, setting a personal rule not to invest in tech he didn’t understand.
(Shortform note: Launched in 1971, the NASDAQ allowed brokers to trade stocks electronically and eliminated much of the inefficiency of the older, in-person trading system. The NASDAQ traded many more companies’ stocks than were commonly found on the New York Stock Exchange, and beginning in 1975 it listed the Initial Public Offerings of companies going public.)
As Buffett took more of a controlling interest in the companies he bought, stewardship became the name of the game—of the companies themselves, and of the interests of their shareholders. Buffett grew willing to pass up opportunities in the name of limiting risk, and he became more comfortable accepting lower returns. Instead of hunting for cheap stocks to buy, Buffett began to search for high-profile, well-run businesses where he could invest at a reasonable price. Buffett also bought his local paper, The Omaha Sun, to get his hands back in the newspaper game, going back to his childhood paper route days. Though he bought it for mainly emotional reasons, the Omaha paper would later play a major role in his life.
(Shortform note: The Omaha Sun was only the beginning of Buffett’s foray into the world of publishing. In addition to a stake in The Washington Post and the Gannett media company, in 2012 he bought 63 newspapers that were struggling to stay in print because of the impact of the Internet. However, he drew criticism for not working harder to keep those papers afloat. In 2020, Berkshire Hathaway sold all of its newspaper holdings to Lee Enterprises, in which Buffett expressed confidence to manage the papers through the shifting media landscape.)
By the mid-1970s, Buffett was managing a network of companies owned by Berkshire Hathaway and his long-time friend Charlie Munger’s Blue Chip Stamps, neither of which were worth much as actual businesses. Their value was as holding companies that invested the liquid assets from their subsidiaries into other businesses. Schroeder says the best source of cash for this system came from insurance companies such as GEICO, which Buffett purchased when its stock was going down. In fact, the sheer clout that came with Buffett’s investment helped GEICO survive a difficult time, while a stream of cash from GEICO fueled Buffett’s other endeavors.
Insurance as a Source of Capital
Buffett describes this process in detail in his 2010 letter to Berkshire Hathaway shareholders. In it, he explains that between the time when an insurance company collects its premiums and the time when it pays out its claims, that money is available for use in investing. During a year in which the total collected in premiums is greater than the total paid out in claims, the excess value is free income that the insurance company’s owners—in this case, Berkshire Hathaway itself—can use to finance other endeavors.
Buffett is careful to state that the insurance industry on a whole doesn’t produce a steady stream of free cash. Berkshire Hathaway’s position is unusual, which he attributes to the excellent managers of the companies in its portfolio. The excess cash funneled into Berkshire Hathaway from its insurance companies grew from $16 million in 1967 to $62 billion in 2009. In Poor Charlie’s Almanack, Buffett’s partner Charles T. Munger points out that Berkshire Hathaway’s stellar returns become harder to repeat as their insurance capital grows—it’s easier to invest millions than it is to find companies where you can invest billions.
Buffett in the ’80s
In 1980, the dismal market of the ’70s finally turned around, and the bets Buffett made with his investments paid off in spades. To simplify the many joint holdings he had with Charlie Munger, Blue Chip Stamps merged with Berkshire Hathaway, so that Buffett and Munger became partners. Schroeder says that neither was interested in liquidating assets for quick gains. In a report to shareholders, Buffett and Munger declared that they wouldn’t sell off any business so long as it made even a little bit of money. The only notable casualty was Berkshire Hathaway’s original textile business, which Buffett eventually had to shut down.
The ’80s were the era of the hostile takeover, with unscrupulous corporate raiders buying up ailing companies, carving them into pieces, and selling off the scraps for easy money. Schroeder writes that Buffett was appalled at the way this process transferred wealth from shareholders (where it belonged) into the hands of greedy managers, brokers, and bankers.
(Shortform note: In The Essays of Warren Buffett, Buffett lambasts the practice of “leveraged buyouts” in which raiders weaken and dismantle corporations for easy gain. He raises the issue of corporate social responsibility—that one of a corporation’s moral functions is to remain fiscally robust enough to protect its employees and stakeholders in times of volatility.)
Buffett’s sense of stewardship was clear in how he shepherded companies through difficult times. He was now a billionaire, and in the ’80s he used his wealth to buy up businesses in order to protect them. He invested huge sums into struggling companies like Coca-Cola, ABC, and the Wall Street investment firm Salomon Brothers. (The latter was Buffett’s first financial stake in Wall Street itself, which Schroeder says he would later regret.) The way Buffett cut deals to save embattled corporations gave him a reputation as a backroom insider, but at least that was better than being seen as a corporate shark.
(Shortform note: Among the well-known corporate raiders of the ’80s were Carl Icahn and Ronald Perelman. Icahn is remembered for his hostile takeover of the airline TWA, from which he made nearly $500 million while saddling the airline with a staggering amount of debt. Perelman, who competed with Buffett for ownership of Salomon Brothers, is best known for his takeover of Revlon. The negative public image of the “hostile takeover king” was solidified by Michael Douglas’s portrayal of the fictional Gordon Gekko in the 1987 movie Wall Street.)