Warren Buffett - “Buying Berkshire was a mistake”. Lessons from this “bargain” purchase: Part 2

Key takeaways at the end

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My most surprising discovery: the overwhelming importance in business of an unseen force that we might call "the institutional imperative." 

In business school, I was given no hint of the imperative's existence and I did not intuitively understand it when I entered the business world. 

I thought then that decent, intelligent, and experienced manager would automatically make rational business decisions. But I learned over time that isn't so. Instead, rationality frequently wilts when the institutional imperative comes into play.  For example: 

(1) As if governed by Newton's First Law of Motion, an institution will resist any change in its current direction; 

(2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; 

(3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and 

(4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.

Institutional dynamics, not venality or stupidity, set businesses on these courses, which are too often misguided. After making some expensive mistakes because I ignored the power of the imperative, I have tried to organize and manage Berkshire in ways that minimize its influence. Furthermore, Charlie and I have attempted to concentrate our investments in companies that appear alert to the problem.

After some other mistakes, I learned to go into business only with people whom I like, trust, and admire. As I noted before, this policy of itself will not ensure success: A second-class textile or department-store company won't prosper simply because its managers are men that you would be pleased to see your daughter marry.

However, an owner – or investor – can accomplish wonders if he manages to associate himself with such people in businesses that possess decent economic characteristics. Conversely, we do not wish to join with managers who lack admirable qualities, no matter how attractive the prospects of their business. We've never succeeded in making a good deal with a bad person.

1989 Shareholder Letter

* Bold emphasis added

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Key concepts and takeaways:

• Importance of the institutional imperative: Although a soft factor and difficult to measure precisely, it is still important to consider. Every business will have their own culture and you should beware of businesses that exhibit at least the following: (1) an institution that resists any change (meaning innovation); (2) bad capital allocations driven by imitation of peer companies in their industry or by top management’s / CEO’s egos. 

• Importance of management: There is a subtle but big difference in having vs. depending on a good management. When you look to invest in a company, focus firstly on the underlying business economics. Eliminate businesses whose success depends on having a great manager. Of course, a terrific CEO is a huge asset for any enterprise, but if a business requires a superstar to produce great results, the business itself cannot be deemed great. Even the best management will typically not be able to turn around a business with bad underlying economics.