Sunday, May 04, 2008

Pilgrimage, Part X: On The Cheap

Unexpired Time, Blinking Screens and What Might Have Been

Warren Buffett takes pride in his cheapness.

“My suits are expensive, they only look cheap on me,” he likes to say, being as self-deprecating as he is tight-fisted.

Cheapness defines more than his personal proclivities, however; it also defines his investment style. For not only is Buffett cheap, but, as the CEO of a deep-pocketed insurance giant named Berkshire-Hathaway, he buys entire companies cheap.

And those companies, once in the Berkshire fold, adopt his personal and professional proclivities: they spend cheap—the better to generate excess cash for the great Warren Buffett to invest…cheap.

How cheap is Warren Buffett?

In his 2006 letter to shareholders—which runs 24 pages, so seriously does he take his own advice that a CEO should communicate directly to “the people who gave him the money”—Buffett re-tells the story of Berkshire-Hathaway’s $8.6 million purchase of National Indemnity from Jack Ringwalt, 40 years ago;

“Jack was a life-time friend of mine and an excellent, but somewhat eccentric, businessman… When we were due to close the purchase at Charlie’s office, Jack was late. Finally arriving, he explained that he had been driving around looking for a parking meter with unexpired time.”

Far from being annoyed at the delay, says Buffett, he was delighted:

“That was a magic moment for me. I knew then that Jack was going to be my kind of manager.”

I suspect the “magic moments” of most public company CEOs run more towards the thrill of a successful initial public offering, or a blockbuster major mega-merger announcement, or the first time they were served a dry martini on the corporate jet—not from hearing about the search for unused time on a parking meter.

But that’s Warren Buffett. And, hey, it’s worked: he is, after all, the most successful investor in the world.

Still, is penny-pinching for the sake of penny-pinching always a good thing when it comes to running a business?

Is the CEO in the story, who drove around the block looking for unexpired time on a parking meter (and the story must be true, because from what we have seen, the streets of Omaha do have a lot of parking meters on them), the kind of CEO who’s going to maximize the value of a business not just in the short-term, but also in the very, very long term?

Some readers will, no doubt, answer with an emphatic “Yes” and quickly name a relevant example.

My own personal favorite is probably Great Lakes Chemical, the Indiana-based bromine producer that expanded and adapted over the years into a large, yet still notoriously tight-fisted specialty chemicals company.

I recall the CEO of a Great Lakes competitor telling me, with awe, about a visit to Great Lakes’ bare-bones corporate office, where the lights in the conference room were operated by an old-fashioned light timer, like the timers that control heating lamps in hotel bathrooms.

Not only did Great Lakes save money on their lighting bills, he pointed out, but “the meetings were real short,” what with executives having to get up to turn the lights back on every ten minutes or so.

Now, if you’re thinking the Great Lakes Chemical people sound like Warren Buffett’s kind of managers, you’re right. Berkshire-Hathaway bought 7% of the company in 1999—a move that paid off six years later, when Great Lakes sold out to a competitor.

Still, while the Great Lakes Chemical stock provided Warren Buffett and others with an excellent return on their investment, the Great Lakes Chemical company didn’t survive.

Could both the company and its stock have done even better if there’d been less focus on the utility bill and more focus on new growth opportunities? In the long run, is running a business on the cheap—cheapness for cheapness’ sake—a good thing or a bad thing?

That question pops into my head as we follow a long line of cars snaking into the Nebraska Furniture Mart parking lot, which is actually many parking lots of various sizes and shapes connecting the huge buildings—and by “huge” I mean airplane hanger size-huge—that comprise the Midwest’s largest home furnishings store.

The buildings are scattered in such a random fashion across 77 acres of what used to be prairie that it feels as if each time they outgrew a building, somebody decided to put up the next building right here, without much forethought as to how it all fit with any of the others.

It reminds me of nothing so much as an old-fashioned lumberyard.

We park in the general vicinity of the electronics store, which Nebraska Furniture Mart opened in 1995. Large flags on the nearby lamp-posts display various electronics brand names, simultaneously enticing shoppers into the store, as well as reminding them where they parked.

The entirely unintended effect of these flags, however, is to plainly age the place, for there is not a single new or even semi-new brands that electronics shoppers care about these days—Garmin, for example, or LG or even iPod.

Instead they are older, stodgy brands such as IBM and Hewlett Packard and Maytag and Whirlpool. Some of the brands no longer even exist in any meaningful fashion. The one near our car, for example, reads “Compaq.”

They might as well advertise Underwood Typewriters.

That out-of-dateness sets the tone for the entire place, which, while every bit as big and eye-popping as Buffett’s fond mentions in his annual shareholder letters, is fraying around the edges—like a Wal-Mart Super Center three or four years after the grand opening.

And we haven’t even gone inside yet.

Not helping matters, I will admit, is our having to go through the clumsy manual door-locking sequence of this GM rental car, nor is it a plus that when we start walking towards the main entrance we witness the oddest sight of the entire day: a middle-aged couple changing their clothes in the dubious privacy of Nebraska’s Largest Parking Lot.

I am not making that up.

The husband and wife have obviously come a long way to attend the shareholder’s meeting—their minivan is packed with gear—and they appear to be changing into more formal attire for a shareholder reception being readied under a big white tent that rises on a far corner of the Furniture Mart property.

Yet they are doing it—at least the husband is, muscle shirt and all—while standing under the flipped-up hatch of the minivan. We move on quickly, before we can see what the wife might be planning.

Once inside, the electronics store seems like an extremely huge, but extremely basic, electronics store. The prices on a few familiar items appear to be nothing very special, although we are not here to conduct an in-depth price check.

Nevertheless, the place does project a deep-discount feel that gives a shopper the impression they could do no better, and probably a whole lot worse, elsewhere.

The cash registers are busy, and easily one-third of the adult shoppers are wearing their plastic Berkshire-Hathaway “shareholder” badges. They wear the badges not out of mere habit, but because they will get a steep discount on their shopping here this weekend.

As Buffett noted in his shareholder letter with pride, Nebraska Furniture Mart generated $30 million of revenue during the 2005 shareholder meeting weekend—almost 10% of this location’s annual total sales (there are two other Marts: one in Kansas City, and another in Des Moines).

Which, I suspect, makes Berkshire-Hathaway the only public company to routinely earn a profit on its annual meeting.

Nevertheless, the merchandizing is familiar to anyone who has shopped in a Best Buy or a Frye’s—aisles of CDs, DVDs, telephone products, boom-boxes, stuff. There is a small but crowded iPod display and an empty Microsoft Zune display.

Then we reach the heart of the store, which consists of two giant, crowded aisles along which big screen televisions are displayed, floor to near-ceiling level. Given Buffett’s own innate, er, cheapness, it makes sense that Berkshire-Hathaway's own shareholders would be savvy enough to cash in their discount on the biggest dollar value item in the joint.

After all, why waste it on a DVD?

We squeeze through browsers, customers and clerks to the far end of the store and make our way back down an adjacent aisle with the computer displays—a relatively bare-bones but decent offering that includes Macs. This strikes me as fairly impressive, since Best Buy only recently got authorization from Cupertino to roll them out.

Still, the general warehouse-type aura of the store feels out-of-date, particularly now that most electronics stores are downsizing, not upsizing.

After all, an aisle or two of music CDs can be carried on an iPod these days, and Volkswagen-sized stereo systems have shrunk to the approximate width and length of a beer can.

It’s not merely that big is no longer better: big is no longer necessary at all.

Even Best Buy, which helped drive the supersizing of American electronics retailing, is cutting its prototype store size by one-third.

It is while contemplating this that I come upon something else far more unsettling at a nearby register. The Nebraska Furniture Mart computer monitor on which one of the sales people is checking something for a potential customer is an ancient, pre-Windows type of screen—the kind with block white letters and a blinking white cursor.

I haven’t seen this kind of ancient point-of-sales software in a large chain in so long I can’t remember where I last saw it. Dollar General, maybe?

Of course, not having the latest and greatest software isn’t necessarily a sign of back-office chaos. For all I know, the Nebraska Furniture Mart computer systems might offer every piece of vital information a sales person or an accounts payable staffer needs, at a keystroke.

But I doubt it.

And I doubt it even less when we move on and I see an open door to a small room, which contains a bunch of less-than-cutting-edge servers stacked on cluttered shelving. Makes me wonder not only how up-to-date this place really is, but how secure the systems might be.

Retailing has, after all, come a long way since 1983 when Buffett bought Nebraska Furniture Mart on a handshake from Rose Blumkin, the late Russian immigrant whose motto—“Sell Cheap and Tell the Truth”—could, with a minor adjustment (replace the “Sell” with “Buy”) be Buffett’s own.

And electronics retailing has come even further, what with the constant downward spiral in prices, fickle consumer tastes, accelerating product cycles and the rise in online shopping.

Disappointed and not having spent a dime, we head outside and cross a busy driveway to the Main Event—the furniture store.

It is big, cavernous and long. Very long. The longest store I have ever walked through.

Fully loaded showrooms meld into one after another—a seemingly endless display of sofas, recliners, tables, and chairs. And that’s before we even get to the lighting area, which appears to offer every fixture ever created since Thomas Edison patented the thing.

Which reminds me: here we see even more of those old-fashioned computer screens with blinking white cursors at the customer service desks.

There is no doubt the shoppers are here—whether they are University of Nebraska students getting ready for summer school or Berkshire-Hathaway shareholders loading up on discounted La-Z-Boys.

And there is no doubt the place has grown from the single-store brainchild of Rose Blumkin—“Mrs. B,” as she is reverently known—to a three-store Midwest home furnishings powerhouse.

But why, I wonder, is the Nebraska Furniture Mart not a national phenomenon?

Why, 74 years after its modest beginnings, are there only three stores in the entire United States?

"Well," you might say, "this was a family-owned Nebraska retailer in the middle of nowhere, with a limited product line and no Wall Street big shots pulling the strings—so what’s wrong with three stores and a half-billion or so in very profitable sales?"

Not a thing, certainly—except that another family-owned Nebraska retailer in the middle of nowhere, with a limited product line and no Wall Street big shots pulling the strings managed to rack up over $2 billion in very profitable sales last year, its 45th year in business.

Like Nebraska Furniture Mart, this retailer operates huge stores in out-of-the-way places (ever hear of Hamburg, Pennsylvania?) and puts the customer first.

Unlike the Mart, however, this company's stores are modern, lively and fun to shop, even if you couldn’t care less about hunting or fishing gear—which is what they sell. There's even an ice-fishing department, if you can believe it.

That company is Cabela’s.

And if a retailer of hunting and fishing gear (U.S. market size: $30 billion) could grow into a $2 billion enterprise, why—with a little more capital investment over the years—couldn’t Nebraska Furniture Mart, which sells home furnishings, for goodness sake (U.S. market size: $250 billion), be a whole lot bigger than a mere half billion or so by now?

Lest readers think I am picking unfairly on Nebraska Furniture Mart, the question also holds for See’s Candies, I think.

In 1994, See’s sold $216 million worth of chocolates and sweets, mostly in the western half of the U.S., earning $28 million after-tax.

Of that, See's spent a modest $4 million on expansion and turned in the $24 million balance to Berkshire-Hathaway for Warren Buffett to invest as he saw fit.

That same year, another west-coast company sold $284 million worth of consumables in shops mostly on the west coast, on which it earned $10 million after taxes.

Unlike See’s, however, this company was growing: it spent $136 million on expansion and didn’t pay a penny of dividends to its shareholders.

Today, See’s is still a west-coast business, with about 200 shops and, I am guessing, perhaps $500 million in sales generating as much as $75 million in cash for Berkshire-Hathaway.

That other west-coast firm, however, now has over 13,000 shops around the world, sold nearly $8 billion worth of coffee last year and generated almost $1 billion in pre-tax profits.

I am talking, of course, about Starbucks.

Both Starbucks and See's make an excellent product, have an excellent brand name and earn excellent returns on capital. The biggest difference, as far as I can see, is that one invested their capital to grow; the other invested it, well, in other companies.

I am reminded of Charlie Munger’s remark earlier today, when he said, “If a business is good, it will carry a lousy management.”

How long, I wonder, can a good business carry an owner who does not reinvest in that business?

It is a question that, until our walk through the cavernous halls of the Nebraska Furniture Mart, had not occurred to me.

Time to go. It has been a long day.

The air outside the Mart is cooling down thanks to threatening dark clouds rising up in the southern sky. We drive out of the parking lot and head back downtown. I haven’t seen or heard a thing about the outside world all day, and I’m hoping whatever those clouds are going to bring, it won't happen early tomorrow morning when my flight is scheduled to take off.

After the crowds at Mart, the hotel feels almost empty. There are some people in the bar, and a few more waiting near the main door, dressed for dinner and clearly waiting for friends or acquaintances.

I head up to my room. It’s straight out of the 1970’s—polyester bed spread with a dark, stain-hiding motif; a basic alarm clock on the night table and a shower that somehow leaks a flood into one corner of the bathroom floor unless the shower curtain is sealed with duct tape, which I don’t have.

The view out the window is to the north side of town, overlooking some construction, an office building, and, a few blocks away, a giant sign for Sol’s Pawnshop that for reasons I haven’t bothered to analyze vaguely calls to mind the giant eye in The Great Gatsby.

I suppose it has to do with the irony that such a literal sign of economic need could exist in city limits that are also home to the accumulated wealth of the greatest investor the world has, literally, ever known.

I had planned to take a walk towards Sol's with my camera after our excursion to the furniture mart, but parts of the city center do not have a particularly safe feel, and when I had asked a cop outside the Qwest Center if there was any area I particularly would not want to walk, he had nodded in the direction of Sol’s, and said, “Don’t go north.”

Instead, I pack for the morning flight and head downstairs for dinner.

We intend to walk the five or six blocks to Old Town, but after half a block, those clouds really look ready to break, so we decide to drive, even if it means the convoluted door-opening routine, which is getting tedious.

Three blocks into the drive, the clouds get purple and then black. They open up just as we find a parking spot and run inside the restaurant, feeling vindicated, having sized up the situation and, as Buffett had advised, tried to “look ahead to see danger where others don’t,” even if it merely applies to a little rain.

The restaurant is packed with shareholders, and getting a table will take too long, so we eat at the bar and review the day.

It has been far more than I bargained for.

To be concluded…

Jeff Matthews
I Am Not Making This Up

© 2007 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


matt said...

This has been an interesting series of observations on Berkshire, but I do have to pick a nit.

Compaq isn't an independent company anymore, but there are still Compaq-branded computers being sold. So having a Compaq sign isn't such a sign of being out of it as you might think.

Brian said...

Great posts Jeff. One comment about reinvestment in NFM and See's... Would the performance of BRK as a whole have been better off if instead of purchasing the remaining interest in GEICO they had reinvested in NFM or See's? I think its all about opportunity cost. Then again, he has been sitting on plenty of cash for a long time.

Brian said...

Great posts Jeff. One comment about reinvestment in NFM and See's... Would the performance of BRK as a whole have been better off if instead of purchasing the remaining interest in GEICO they had reinvested in NFM or See's? I think its all about opportunity cost. Then again, he has been sitting on plenty of cash for a long time.

AltaJoe said...

The highway is littered with retail expansion that started with a bang and ended with a thud. Cabela's expansion is in its infancy. I'd give it a few years before I ordain it the model of modern strategy..

David said...

Thank you Jeff. You have managed to articulate some of my nagging, unformed and half-concious thoughts about Berkshire and Buffett. I am a shareholder, and have been for about 10 years. My wife and I went to our first meeting several years ago. My wife didn't know who Buffett was. I just wanted to see the show at least once. Now my wife insists we go see "Uncle Warren" every year. She likes the shopping and the good steaks. I am finding the meetings repetetive, with many of the same inane questions every year. To me, Buffett always stops short of explaining how he invests. "Good companies at a fair price" as a mantra only goes so far. Even my wife, who knows nothing about business and investing has noted the lack of specificity in his answers.

As far as the agglomeration of businesses go, I suspect you are right. Buffett has said that the managers are to run the businesses as they see fit, but to send the money to Omaha. I'm sure "as they see fit" includes running any investment idea past Buffett. That may put a damper on any enthusiasm managment might have for acquisitions or expansion. Who really knows how well they could fly on their own, or conversely, how fast they would fall without BH's cash behind them. It will be interesting to see what happens after WEB passes. Will there be some pruning? I know Buffett believes that the culture is ingrained. I have a more dubious outlook on human nature, and the perversities can wear any culture down like water on rocks. As much as I love BH and have learned from Buffett, I profess to being quite nervous about BH's future, despite Buffett's protestations to the contrary.

Shook said...

Thank you very much for the BRK AGM stories (and insights) Jeff. It was also great to learn a tidy bit on your works from Herb's WSJ story (actually inspired some ideas how to formulate potential turnaround candidates basic screen).

Thanks again,
Oded, Israel

Matthew M said...

For a retail experience that is the polar opposite of a tired warehouse, visit the Dehner Company's factory, headquarters and shop the next you are in Omaha. They make a wide range of boots and a few styles of shoes, and it is heartening to see such high quality products made in the USA--or at all, for that matter.

Shook said...

I was thinking about your comments re NFM and See's size (or lack of it). Some grow, some don't. My question is, analyzing the ones that do grow exponentially, how many of them do it taking excessive risks (unacceptable to Buffett) and how many do it without risking their existence. How many are 'natural growers' (say, with wide moats) and how many are 'unnatural growers' (no moat, lots of risks).

Thinking of NFM - it would be interesting to compare it to Jordan's and ask similar questions, or to IKEA.

When IKEA came to Israel about 7 years ago, it was the first and only 'big' furniture store in Israel and so had huge advantage over the moms and pops (to this day they only have one big store in Israel (covering the north and center) and are in the process of building a second one for the south - Israel is about the same size as New Jersey, with population of about 7M ).

I wonder how would IKEA do in a NFM environment, or Jordan's. Could it achieve the same success? Do you think furniture stores are 'natural growers'?

Oded, Israel

PT said...

This has been one of the more interesting reports on Mr Buffet and his acolytes that I have ever had the pleasure to read. Thank you for some very keen observations. Keep up the good work, it's appreciated.

yolanda said...

mr. matthews, i too have enjoyed your berkshire hathaway meeting comments.

the anecdote about rose blumkin was interesting. too bad other sell cheap retailers don't always tell the truth.

Liz said...

Your description of the Furniture Mart sent shivers down my spine, I would never go somewhere like that, it sucks up too much time. Check out Room & Board, great product, impressive computers, etc.

Jim said...


Thanks for all the write-ups. Great stuff, and the comments on managing risk are also well considered. Three thoughts:

1. CEOs who are cheap by nature are likely to correlate negatively with the prodigal overspenders we see in the CEO suite of many corporations.

2. Are the businesses that Berkshire in growth businesses or value businesses? Is it possible that, by the very nature of the buffett-munger problem solving approach (ie avoid hard problems, at least ones that aren't in insurance), they lock into a very limited growth model, or at least one that requires external acquisitions.

3. I hope the BRK managers are reading your blog, and asking themselves "What could we do with some of our retained earnings? Are there new, internal ventures worth investing in."

Dave said...

Indeed an interesting series. Recall the mantra - pick a business you understand with defendable value, good management and longevity. All well and good but difficult - and the discussion of how much the people part is important to Buffett is invaluable. But consider Coke which passed all the litmus tests and was a poster child until it's basic product reached the saturation point and int'l expansions didn't fill in the growth. Now they're struggling mightily with product innovation and development.
It seems to me that the challenge in Warren's style is to find that level of appropriate re-investment to organically grow the value and maintain the position over time. It might be an interesting exercise to ask are any of the current portfolio growing their businesses appropriately ?
Or the even deeper question of what would a modified Buffet approach look like for moving beyond the basic value story ? In other words is there a Grahm-Buffett model that would maintain the virtues but also see leveraging, say, a NFM larger. Or at least considering it ?

Bill said...

You're right about the computer terminals. Straight out of the 80's. I've seen them while buying furniture there.

Your sample size is too small to draw conclusions about the entire family of Berkshire companies. Just yesterday a subsidiary of NFM, Homemakers of Des Moines, Iowa, announced a $30 million renovation and expansion. That's $30 million that won't be shipped over to Omaha for Warren to allocate.

Steve said...

enough already

Michael said...

Between yesterday and today, I have gone through all nine of your posts on the BH annual gala and enjoyed every minute of the reading.

I've been a BK owner for 12 years or so now and have been fascinated with WB for an even longer time. For example, what other CEO of a multi-billion dollar company takes home a salary of only $100,000?

I've read everything I can lay my hands on about BH and WB and I am particularly glad that I found your posts here. You've raised some interesting questions which I will have to mull over and investigate further. I thank you for that and for your observations on the meeting itself. I've always wanted to go, but have never made the time to do so. Now, at least, I have some idea of what attending would be like.