If you can find a business which is investing in building relationships that are based on seamless web of deserved with its customers, suppliers, vendors, shareholders, and employees, you’ve found a business with a strong moat. A moat which is hard to identify with numbers and hence not visible to Mr. Market.
On January 3, 1972, Warren Buffett acquired See’s Candy business for $25 million. This acquisition has an interesting backstory. The first time when an investment advisor approached Buffett for See’s Candy, he showed no interest. Buffett was in Nebraska. See’s Candy was in California.
“The candy business?”, Buffett squirmed, “I don’t think we want to be in the candy business.”
Fortunately, Buffett’s partner Charlie Munger lived in California and he was familiar with See’s Candy brand. On Munger’s advice, Buffett agreed to negotiate. Coming from the Benjamin Graham school of thought, Buffett was reluctant to buy See’s at the asking price. But Munger nudged him in the direction of paying up for quality.
In 2015, Buffett wrote –
The family controlling See’s wanted $30 million for the business, and Charlie rightly said it was worth that much. But I didn’t want to pay more than $25 million and wasn’t all that enthusiastic even at that figure. (A price that was three times net tangible assets made me gulp.) My misguided caution could have scuttled a terrific purchase. But, luckily, the sellers decided to take our $ 25 million bid.
To date, See’s has earned $1.9 billion pre-tax for Berkshire Hathaway. Moreover, in the same period, it has required only $40 million of added investment for growth. Not only that, acquisition of See’s dissolved the mental block that Buffett’s had for fairly priced businesses which later resulted in Berkshire acquiring many other high-quality companies. Not a year goes by when Buffett forgets to talk about how wonderful See’s business is.
So, Munger played a seminal role in See’s Candy transaction. For that matter, it wasn’t even Munger who first identified See’s candy as a business worth acquiring. Al Marshal, Munger’s long time business partner, was the one who first started pursuing Munger for See’s purchase.
The point I am trying to make is that while reading about Warren Buffett, most people miss out on a crucial aspect of his business life. Many of the investment ideas were brought to Buffett’s doorstep by his friends and business associates. Of course, Warren didn’t buy everything that was recommended to him, but he clearly had an advantage by getting quality ideas from people he trusted.
We know how Munger and Buffett have learned by reading and thinking. However, this vital ingredient of their learning process – their interaction with other equally smart people – is rarely discussed.
Talking to a knowledgeable person for 30 minutes can make up for dozens of books that one would have to read to gain the similar insights. Learning from other smart people is one of the most underrated learning tools. And there’s a reason why this mode of learning isn’t popular. Getting access to smart people isn’t easy. Buffett and Munger have access to a network of wise people all over the world. They didn’t have this advantage at the beginning of their career but over several decades, by being learning machines themselves, they have attracted similar people in their life. By deserving those people, they have become magnets for more learning opportunities.
This is what Charlie Munger says about Warren Buffett (emphasis is mine) –
…if you take Warren Buffett and watched him with a time clock, I would say half of all the time he spends is sitting on his ass and reading. And a big chunk of the rest of the time is spent talking one on one either on the telephone or personally with highly gifted people whom he trusts and who trust him.
An important piece of Buffett’s journey, another of his moat if you will, is the gains (investment ideas, knowledge, etc.) he made with the help of a network of incredibly intelligent and trustworthy people. And it’s a two-way street. The people in Buffett’s network trust him as much and benefit equally from that connection.
Charlie Munger says –
The highest form which civilization can reach is a seamless web of deserved trust. Not much procedure, just totally reliable people correctly trusting one another. That’s the way an operating room works at the Mayo Clinic. In your own life what you want is a seamless web of deserved trust. And if your proposed marriage contract has 47 pages, my suggestion is do not enter.
How do you build trust? Let’s look at the Munger’s life again.
Charlie and Rick Guerin were 50-50 partners in a company called K&W Products. Guerin once needed money and wanted to cash out his partnership. So he offered his share to Charlie. Charlie asked how much Guerin wanted for his part. Guerin figured that he would sell his stake to Charlie for $200,000. Charlie said, ‘No, you’re wrong about that. It’s worth $300,000.’ And he pulled out a check and wrote it.
This anecdote comes from Janet Lowe’s book Damn Right. Buffett wrote the foreword. He writes –
I have never seen Charlie try to take advantage of anyone, nor have I seen him claim the least bit of credit for anything that he didn’t do. In fact, I’ve witnessed exactly the opposite: He has knowingly let me and others have the better end of a deal, and he has also always shouldered more than his share of the blame when things go wrong and accepted less than his share of credit when the reverse has been true. He is generous in the deepest sense and never lets ego interfere with rationality.
There you go. That’s how you build trust. By being transparent, honest and ‘more than fair’ in all your dealings.
When Benjamin Franklin said honesty is the best policy, he chose his words very carefully. He could have called it a moral policy but he didn’t say that. Being rational is the biggest edge an investor can have. I say honesty is the best policy because it’s a rational policy.
If you tell the truth, goes the adage, “you don’t have to remember your lies.” Well, what could be more logical than this?
Honesty will do two things for you. First, it will keep you away from troubles. In 2004 Wesco meeting, Charlie said this artfully –
We think there should be a huge area between what you’re willing to do and what you can do without significant risk of suffering criminal penalty or causing losses. We believe you shouldn’t go anywhere near that line. You ought to have an internal compass. So there should be all kinds of things you won’t do even though, they’re perfectly legal.”
In business and in life there are many instances where there’s a fine line between what’s ethical and what’s legal. In such situations, honesty is a great decision-making tool.
In the words of Wendy Munger, Charlie’s daughter, “The lesson of his [Charlie’s] business life is that you don’t want to do business with people you can’t trust. The economics are irrelevant if you don’t have trust. Most people are just thinking about the economics, thinking that the contract will save you when entering into a transaction with someone you can’t trust. You must do business with high-grade people – that’s all he will deal with.
The second unseen benefit of being honest is that it will bring opportunities as it did for Buffett and Munger. But it takes time for those opportunities to transpire for the game of building trust is a very long-term proposition. It’s like compounding money. On one occasion Munger advised –
I think track records are very important. If you start early trying to have a perfect one in some simple thing like honesty, you’re well on your way to success in the world.
Every incremental act of honest and transparent behaviour accumulates slowly and compounds – first gradually and then crazily. Unfortunately, the snowball of trust is extremely sensitive to dishonesty and unfairness. It takes a lifetime to build reputation, observed Buffett, “and a second to lose it all.”
You earn trust by deserving it. The safest way to get what you want, says Munger, “is to try and deserve what you want.”
Want a good business partner? Be a good business partner yourself and sooner or later you’ll find a partner you deserve. And this holds true for life partners as well. For friendship too.
Munger again –
It’s such a simple idea. It’s the golden rule so to speak: You want to deliver to the world what you would buy if you were on the other end. There is no ethos, in my opinion, that is better for any lawyer or any other person to have. By and large the people who have this ethos win in life and they don’t win just money, not just honors. They win the respect, the deserved trust of the people they deal with, and there is huge pleasure in life to be obtained from getting deserved trust.
Dealing with honest people is easy and highly efficient. Lengthy legal contracts don’t take away the stress associated with being unsure of other party’s conduct in future? An environment of mutual trust takes away a lot of friction – the friction created by second-guessing and doubting.
Over long term, honesty turns out to be a very profitable strategy. If you can find a business which is investing in building relationships that are based on seamless web of deserved with its customers, suppliers, vendors, shareholders, and employees, you’ve found a business with a strong moat. A moat which is hard to identify with numbers and hence not visible to Mr. Market.
The world believes that most negotiations are zero-sum games and the side with better leverage should shoehorn the last bit of value from the transaction. This worldview is dangerous, argues Craig Shapiro in his recent article on the topic of negotiation.
I see a connection between Shapiro’s insights on negotiation and Charlie’s seamless web of deserved trust. Shapiro writes (emphasis mine) –
The winds shift so quickly in the business world that even when you feel invincible, you are still vulnerable – you just don’t know it. If you spend your life extracting as much value from people when you can, do not be surprised when people don’t want to help you when you get knocked down. Some of the most successful people are also the most generous. They always leave something on the table for the other side. They do this even when they have maximum leverage. They do this because they know what it is like to be on the other side of the table. They do this because they believe in fairness more than winning. The key is realizing that in a world where most projects are not zero sum, how things are negotiated upfront sets the stage for how the relationship will play out in the long term.
The next time you find yourself negotiating, and you have a lot of leverage, consider finding middle ground. Not just to be a nice person. But because it will ultimately produce a better long-term outcome.
Peter Kaufman, the author of Poor Charlie’s Almanack, runs Glenair Inc., a manufacturer and supplier of military and commercial connectors. In his business, there are times where he doesn’t need to place orders to his suppliers for extended periods of time. However, many vendors find it hard to stay afloat without regular income. In spite of it being uneconomical, Kaufman ensures a steady pipeline of order for his vendors. He looks at it as an investment for building a long-term relationship with its channel partners. He’s willing to leave money on the table.
Now to leave something on the table it’s important to know what you’re leaving on the table is of value to the other party. It’s easy to win a poker game if you know the hands of the other players, argues Kaufman, “The same goes for the game of business. If you take the time to understand the needs of the other players – such as customers, employees, and regulators – you will have a winning advantage, said Kaufman. The real work in business is not learning spreadsheets or terms. The real work in business is seeing through the eyes of your counterparty groups.”
The lesson: Treat partners well at all times and they will reciprocate.
Reciprocity, the tendency to return the favour, is a strong psychological force in human nature. Robert Cialdini, in his wildly popular book Influence, has classified reciprocity as one of the most powerful weapons of persuasion.
Whether it’s business, investing or personal relationships, the biggest and most enduring moat one can aim to build is the seamless web of deserved trust.[/show_to] [hide_from accesslevel=’almanack’]
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