And itâs also an interesting model on the other sideâhow with all its great advantages, the disadvantages of bureaucracy did such terrible damage to Sears, Roebuck. Sears had layers and layers of people it didnât need. It was very bureaucratic. It was slow to think. And there was an established way of thinking. If you poked your head up with a new thought, the system kind of turned against you. It was everything in the way of a dysfunctional big bureaucracy that you would expect.
In all fairness, there was also much that was good about it. But it just wasnât as lean and mean and shrewd and effective as Sam Walton. And, in due time, all its advantages of scale were not enough to prevent Sears from losing heavily to Wal-Mart and other similar retailers.
Hereâs a model that weâve had trouble with. Maybe youâll be able to figure it out better. Many markets get down to two or three big competitorsâor five or six. And in some of those markets, nobody makes any money to speak of. But in others, everybody does very well.
Over the years, weâve tried to figure out why the competition in some markets gets sort of rational from the investorâs point of view so that the shareholders do well, and in other markets, thereâs destructive competition that destroys shareholder wealth.
If itâs a pure commodity like airline seats, you can understand why no one makes any money. As we sit here, just think of what airlines have given to the worldâsafe travel, greater experience, time with your loved ones, you name it.
Yet, the net amount of money thatâs been made by the shareholders of airlines since Kitty Hawk, is now a negative figureâa substantial negative figure. Competition was so intense that, once it was unleashed by deregulation, it ravaged shareholder wealth in the airline business. Yet, in other fieldsâlike cereals, for exampleâalmost all the big boys make out. If youâre some kind of a medium grade cereal maker, you might make 15% on your capital. And if youâre really good, you might make 40%. But why are cereals so profitableâdespite the fact that it looks to me like theyâre competing like crazy with promotions, coupons and everything else? I donât fully understand it.
Obviously, thereâs a brand identity factor in cereals that doesnât exist in airlines. That must be the main factor that accounts for it.
And maybe the cereal makers by and large have learned to be less crazy about fighting for market shareâbecause if you get even one person whoâs hell-bent on gaining market shareâŚ.For example, if I were Kellogg and I decided that I had to have 60% of the market, I think I could take most of the profit out of cereals. Iâd ruin Kellogg in the process. But I think I could do it.
In some businesses, the participants behave like a demented Kellogg. In other businesses, they donât. Unfortunately, I do not have a perfect model for predicting how thatâs going to happen.
For example, if you look around at bottler markets, youâll find many markets where bottlers of Pepsi and Coke both make a lot of money and many others where they destroy most of the profitability of the two franchises. That must get down to the peculiarities of individual adjustment to market capitalism. I think youâd have to know the people involved to fully understand what was happening.
In microeconomics, of course, youâve got the concept of patents, trademarks, exclusive franchises and so forth. Patents are quite interesting. When I was young, I think more money went into patents than came out. Judges tended to throw them outâbased on arguments about what was really invented and what relied on prior art. That isnât altogether clear.
But they changed that. They didnât change the laws. They just changed the administrationâ so that it all goes to one patent court. And that court is now very much more pro-patent. So Ithink people are now starting to make a lot of money out of owning patents.
Trademarks, of course, have always made people a lot of money. A trademark system is a wonderful thing for a big operation if itâs well known.
The exclusive franchise can also be wonderful. If there were only three television channels awarded in a big city and you owned one of them, there were only so many hours a day that you could be on. So you had a natural position in an oligopoly in the pre-cable days.
And if you get the franchise for the only food stand in an airport, you have a captive clientele and you have a small monopoly of a sort.
The great lesson in microeconomics is to discriminate between when technology is going to help you and when itâs going to kill you. And most people do not get this straight in their heads. But a fellow like Buffett does.
For example, when we were in the textile business, which is a terrible commodity business, we were making low-end textilesâwhich are a real commodity product. And one day, the people came to Warren and said, âTheyâve invented a new loom that we think will do twice as much work as our old ones.â
And Warren said, âGee, I hope this doesnât work because if it does, Iâm going to close the mill.â And he meant it.
What was he thinking? He was thinking, âItâs a lousy business. Weâre earning substandard returns and keeping it open just to be nice to the elderly workers. But weâre not going to put huge amounts of new capital into a lousy business.â
And he knew that the huge productivity increases that would come from a better machine introduced into the production of a commodity product would all go to the benefit of the buyers of the textiles. Nothing was going to stick to our ribs as owners.
Thatâs such an obvious conceptâthat there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business thatâs still going to be lousy. The money still wonât come to you. All of the advantages from great improvements are going to flow through to the customers.
Conversely, if you own the only newspaper in Oshkosh and they were to invent more efficient ways of composing the whole newspaper, then when you got rid of the old technology and got new fancy computers and so forth, all of the savings would come right through to the bottom line.
In all cases, the people who sell the machineryâand, by and large, even the internal bureaucrats urging you to buy the equipmentâshow you projections with the amount youâll save at current prices with the new technology. However, they donât do the second step of theanalysis which is to determine how much is going stay home and how much is just going to flow through to the customer. Iâve never seen a single projection incorporating that second step in my life. And I see them all the time. Rather, they always read: âThis capital outlay will save you so much money that it will pay for itself in three years.â
So you keep buying things that will pay for themselves in three years. And after 20 years of doing it, somehow youâve earned a return of only about 4% per annum. Thatâs the textile business.
And it isnât that the machines werenât better. Itâs just that the savings didnât go to you. The cost reductions came through all right. But the benefit of the cost reductions didnât go to the guy who bought the equipment. Itâs such a simple idea. Itâs so basic.
And yet itâs so often forgotten. Then thereâs another model from microeconomics which I find very interesting. When technology moves as fast as it does in a civilization like ours, you get a phenomenon which I call competitive destruction. You know, you have the finest buggy whip factory and all of a sudden in comes this little horseless carriage. And before too many years go by, your buggy whip business is dead. You either get into a different business or youâre deadâyouâre destroyed. It happens again and again and again.