And of course, virtually everybody starts out with their initial models being their parents. So they are the ones that are going to have a huge effect on 'em. And if that parent turns out to be a great model, I think it's going to be a huge plus for the child. I think it beats a whole lot of other things in life to have the right models around...
But you've got to start early. It's very tough to change behavior later on. I tell the students
in classes, "Just pick out the person you admire the most in the class, and sit down and write the reasons why you admire him and then try and figure out why you can't have the same qualities." After all, they're not like the ability to throw a football 60 yards or run the 100 in ten seconds flat or something like that. They're qualities of personality, character and temperament that can be emulated.
And you can apply the reverse ofit following Charlie's theory: You can find the people you don't like and say, "What don't I like about these people?" It takes a little strength of character, but you can look inwards and say, "Have I got some of that in me?"
It's not complicated. Ben Graham did it, Ben Franklin did it. And nothing could be more simple than to try and figure out what you find admirable and then decide that the person you really would like to admire is yourself And the only way you're going to do it is to take on the qualities of other people you admire.
Munger: Also, there is no reason to look only for living models. The eminent dead are in the nature of things some of the best models around. And if a model is all you want, you're really better off not limiting yourself to the living. Some of the very best models have been dead for a long time. (Berkshire Hathaway annual meeting, 2000, Outstanding Investor Digest, Year End 2000 Edition, pp.62-63.)
On overconfidence
About 99% of American management thinks that if they're wonderful at doing one thing that they'll be wonderful at doing something else. They're like a duck on a pond when it's raining
- they're going up in the world. They start thinking that they're the ones that are causing themselves to rise. So they go over to some place where it isn't raining and they just sit there on the ground. But nothing happens. Then they usually fire their number rwo in command or hire a consultant. They very seldom see what really happens is that they have left their circle of competence ...
If you take the CEOs of America's largest corporations, they do not know what their circle of competence is. That's one of the reasons they make so many dumb acquisitions. They rise to the top of the business because they're great salesmen, great production people or whatever. All of a sudden, they're running a multi-billion dollar business and their job is to allocate capital and to buy businesses. They've never bought a business in their life. They don't know what it's all about.
So they usually do one or rwo things. Either they set up an internal department, hire a
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bunch of guys and have them tell him something to do. Of course, the guys know if they don't tell him something to do, then there will be no jobs. So you can imagine what activity takes place then. Or they go out and hire investment bankers who get paid by the transaction. (Warren Buffett, lecture at Stanford Law School, March 23, 1990, Outstanding Investor Digest, April 18, 1990, pp.13-14.)
On some reasons to why bad lending happen so often
Granting the presence of perverse incentives, what are the operating mechanics that cause widespread bad loans (where the higher interest rates do not adequately cover increased risk ofloss) under our present system? After all, the bad lending, while it has a surface plausibility to bankers under cost pressure, is, by definition, not rational, at least for the lending banks and the wider civilization. How then does bad lending occur so often?
It occurs (partly) because there are predictable irrationalities among people as social animals. It is now pretty clear (in experimental social psychology) that people on the horns of a dilemma, which is where our system has placed our bankers, are extra likely to react unwisely to the example of other people's conduct, now widely called "social proo£" So, once some banker has apparently (but not really) solved his cost-pressure problem by unwise lending, a considerable amount of imitative "crowd folly," relying on the "social proof," is the natural consequence. Additional massive irrational lending is caused by "reinforcement" of foolish behavior, caused by unwise accounting convention in a manner discussed later in this letter. It is hard to be wise when the messages which drive you are wrong messages provided by a mal-designed system ...
Many eminent "experts" would not agree with our notions about systemic irresponsibility from combining (1) "free-market" pricing of interest rates with (2) government guarantees of payment. If many eminent "experts" are wrong, how could this happen? Our explanation is that the "experts" are over-charmed with an admirable, powerful, predictive model, coming down from Adam Smith. Those discretionary interest rates on deposits have a "free-market"
image, making it easy to conclude, automatically, that the discretionary rates, like other free market processes, must be good. Indeed, they are appraised as remaining good even when combined with governmental deposit insurance, a radical non-free-market element.
Such illogical thinking displays the standard folly bedeviling the "expert" role in any soft science: one tends to use only models from one's own segment of a discipline, ignoring or underweighing others. Furthermore, the more powerful and useful is any model, the more error it tends to produce through overconfident misuse.
This brings to mind Ben Graham's paradoxical observation that good ideas cause more investment mischief than bad ideas. He had it right. It is so easy for us all to push a really good idea to wretched excess, as in the case of the Florida land bubble or the "nifty fifty" corporate stocks. Then mix in a little "social proof" (from other experts), and brains (including ours) often turn to mush. It would be nice if great old models never tricked us, but, alas, "some dreams are not to be." Even Einstein got tricked in his later years...
We think current accounting for many high-interest-rate loans has terrible consequences in the banking system. In essence, it "front ends" into reported income revenues that would have been deferred until much later, after risky bets were more clearly won, if more
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conservative accounting had been employed. This practice turns many a banker into a human version of one of B.F. Skinner's pigeons, since he is "reinforced" into continuing and expanding bad lending through the pleasure of seeing good figures in the short term. The good figures substitute nicely in the mind for nonexistent underlying institutional good, partly through the process, originally demonstrated by Pavlov, wherein we respond to a mere association because it has usually portended a reality that would make the response correct. (Charles Munger, Wesco Financial Inc., 1990 Annual Report. Berkshire Hathaway Inc., Letters to Shareholders, 1987-1995, pp.205-208.)
On the value of math
53% of the world's stock market value is in the U.S. Well, if U.S. GDP [gross domestic product] grows at 4-5% a year with 1-2% inflation - which would be a pretty good, in fact it would be a very good result - then I think it's very unlikely that corporate profits are going to grow at a greater rate than that. Corporate profits as a percent of GDP are on the high side already- and corporate profits can't constantly grow at a faster rate than GDP. Obviously, in the end, they'd be greater than GDP.
It's like somebody said about New York - that it has more lawyers than people. You run into certain conflicts as you go along if you say profits can get bigger than GDP. So if you have a situation where the best you can hope for in corporate profit growth over the years is 4-5%, how can it be reasonable to think that equities - which, after all, are a capitalization of those corporate profits - can grow at 15% a year? It's nonsense, frankly...
The other day, I looked at the Fortune 500. And the companies on that list earned $334 billion and had a market capitalization of $9.9 trillion at year end - which would probably be up to at least $10.5 trillion now. Well, the only money inves
tors are going to make in the long run is what the businesses make. There's nothing added. The government doesn't throw in anything. Nobody's adding to the pot. People take out from the pot in terms of frictional costs - investment management fees, brokerage commissions and all of that. But $334 billion is all that the investment earns.
If you own a farm, what the farm produces is all you're going to get from the farm. If it produces $50 an acre of net profit, you'll get $50 an acre of net profit. And there's nothing about it that transforms that in some miraculous form. If you owned all of the Fortune 500
- if you owned 100% ofit -you'd be making $334 billion. And if you paid $10.5 trillion for that, well, that's not a great return on investment.
Then you might say, "Can that $334 billion double in five years?" Well, it can't double in five years with GDP growing at 4% a year or some number like that. It would just produce things so out of whack in terms of experience in the American economy that it won't happen. Any time you get involved in these things where if you trace out the mathematics of it, you bump into absurdities, then you better change your expectations somewhat. (Warren Buffett, Berkshire Hathaway annual meeting, 1999, Outstanding Investor Digest, December 10, 1999, p.52.)
On advantages of scale
In terms of which businesses succeed and which businesses fail, advantages of scale are
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ungodly important. For example, one great advantage of scale taught in all of the business schools of the world is cost reductions along the so-called experience curve. Just doing something complicated in more and more volume enables human beings, who are trying to improve and are motivated by the incentives of capitalism, to do it more and more efficiently. The very nature of things is that if you get a whole lot of volume through your joint, you get better at processing that volume. That's an enormous advantage. And it has a lot to do
with which businesses succeed and fail....
Let's go through a list - albeit an incomplete one of possible advantages of scale. Some come from simple geometry. If you're building a great spherical tank, obviously as you build it bigger, the amount of steel you use in the surface goes up with the square and the cubic volume goes up with the cube. So as you increase the dimensions, you can hold a lot more volume per unit area of steel. And there are all kinds of things like that where the simple geometry - the simple reality- gives you an advantage of scale.
For example, you can get advantages of scale from TV advertising. When TV advertising first arrived - when talking color pictures first came into our living rooms - it was an unbelievably powerful thing. And in the early days, we had three networks that had whatever it was - say 90% of the audience.
Well, if you were Proctor & Gamble, you could afford to use this new method of
advertising. You could afford the very expensive cost of network television because you were selling so damn many cans and bottles. Some little guy couldn't. And there was no way of buying it in part. Therefore, he couldn't use it. In effect, if you didn't have a big volume, you couldn't use network TV advertising - which was the most effective technique.
So when TV came in, the branded companies that were already big got a huge tail wind.
Indeed, they prospered and prospered and prospered until some of them got fat and foolish, which happens with prosperity- at least to some people....
And your advantage of scale can be an informational advantage. If I go to some remote
place, I may see Wrigley chewing gum alongside Glotz's chewing gum. Well, I know that Wrigley is a satisfactory product, whereas I don't know anything about Glotz's. So if one is
$.40 and the other is $.30, am I going to take something I don't know and put it in my mouth
which is a pretty personal place, after all - for a lousy dime?
Another advantage of scale comes from psychology We are all influenced - subconsciously
and to some extent consciously- by what we see others do and approve. Therefore, if everybody's buying something, we think it's better. We don't like to be the one guy who's out of step.
Again, some of this is at a subconscious level and some of it isn't. Sometimes, we consciously and rationally think, "Gee, I don't know much about this. They know more than I do. Therefore, why shouldn't I follow them?"
The social proof phenomenon which comes right out of psychology gives huge advantages to scale - for example, with very wide distribution, which of course is hard to get. One advantage of Coca-Cola is that it's available almost everywhere in the world.
Well, suppose you have a little soft drink. Exactly how do you make it available all over the Earth? The worldwide distribution setup - which is slowly won by a big enterprise - gets to be a huge advantage And if you think about it, once you get enough advantages of that
type, it can become very hard for anybody to dislodge you. 270
There's another kind of advantage to scale. In some businesses, the very nature of things is to sort of cascade toward the overwhelming dominance of one firm.
The most obvious one is daily newspapers. There's practically no city left in the U.S., aside from a few very big ones, where there's more than one daily newspaper.
And again, that's a scale thing. Once I get most of the circulation, I get most of the advertising. And once I get most of the advertising and circulation, why would anyone want the thinner paper with less information in it? So it tends to cascade to a winner-take-all situation. And chat's a separate form of the advantages of scale phenomenon.
Similarly, all these huge advantages of scale allow greater specialization within the firm. Therefore, each person can be better at what he does...
On the subject of advantages of economies of scale, I find chain stores quite interesting. Just think about it. The concept of a chain store was a fascinating invention. You get this huge purchasing power - which means chat you have lower merchandise costs. You get a whole bunch oflittle laboratories out there in which you can conduct experiments. And you get specialization. If one little guy is trying to buy across 27 different merchandise categories influenced by traveling salesmen, he's going to make a lot of dumb decisions. But if your buying is done in headquarters for a huge bunch of stores, you can get very bright people chat know a lot about
refrigerators and so forth to do the buying.
The reverse is demonstrated by the little store where one guy is doing all the buying. It's like the old story about the little store with salt all over its walls. And a stranger comes in and says to the store owner, "You must sell a lot of salt." And he replies, "No, I don't. But you should see the guy who sells me salt." (Lecture by Charles T. Munger to the students of Professor Guilford Babcock at the University of Southern California School of Business on April 14, 1994, Outstanding Investor Digest, May 5, 1995, pp.52-54.)
On disadvantages of scale
For example, we - by which I mean Berkshire Hathaway - are the largest shareholder in Capital Cities/ABC. And we had trade publications there that got murdered - where our competitors beat us. And the way they beat us was by going to a narrower specialization.
We'd have a travel magazine for business travel. So somebody would create one which was addressed solely at corporate travel departments. Like an ecosystem, you're getting a narrower and narrower specialization.
Well, they got much more efficient. They could tell more to the guys who ran corporate travel departments. Plus, they didn't have to waste the ink and paper mailing out stuff that corporate travel departments weren't interested in reading. It was a more efficient system. And they beat our brains out as we relied on our broader magazine.
That's what happened to The Saturday Evening Post and all chose things. They're gone. What we have now is Motorcross- which is read by a bunch of nuts who like to participate in tournaments where they turn somersaults on their motorcycles. But they care about it. For them, it's the principal purpose of life. A magazine called Motorcross is a total necessity to those people. And its profit margins would make you s
alivate. Just think of how narrowcast chat kind of publishing is. So occasionally, scaling down and intensifying gives you the big advantage. Bigger is not always better.
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The great defect of scale, of course, which makes the game interesting - so that the big people don't always win - is that as you get big, you get the bureaucracy. And with the bureaucracy comes the territoriality- which is again grounded in human nature.
And the incentives are perverse. For example, if you worked for AT&T in my day, it was a great bureaucracy. Who in the hell was really thinking about the shareholder or anything else? And in a bureaucracy, you think the work is done when it goes out of your in-basket into somebody's else's in-basket. But, of course, it isn't. It's not done until AT&T delivers what it's supposed to deliver. So you get big, fat, dumb, unmotivated bureaucracies.
They also tend to become somewhat corrupt. In other words, ifl've got a department and you've got a department and we kind of share power running this thing, there's sort of an unwritten rule: "If you won't bother me, I won't bother you and we're both happy." So you get layers of management and associated costs that nobody needs. Then, while people are justifying all these layers. It takes forever to get anything done. They're too slow to make decisions and nimbler people run circles around them.
The constant curse of scale is that it leads to big, dumb bureaucracy - which, of course, reaches its highest and worst form in government where the incentives are really awful. That doesn't mean we don't need governments - because we do. But it's a terrible problem to get big bureaucracies to behave. (Lecture by Charles T. Munger to the students of Professor Guilford Babcock at the University of Southern California School of Business on April 14, 1994, Outstanding Investor Digest, May 5, 1995, p.53.)
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