BERKSHIRE MAY BE UNIQUE, but its model is often emulated. Companies that share the model’s practices and policies likewise draw on trust. The comparisons in this chapter illustrate, and further the contrast with private equity (PE).
To classify a company as closer to the Berkshire model or to PE, compare it on two dimensions: acquisitions and operations. Regarding acquisitions, chief differences involve leverage, intervention, and time horizon. Berkshire prefers no debt, limited intervention, and a permanent time horizon. In contrast, PE borrows heavily, intervenes intensively, and looks for the earliest possible opportunity to flip.
Concerning operations, PE exerts strong control with heavy oversight and a view toward reselling; Berkshire is highly decentralized with managerial autonomy and a commitment to holding. And Berkshire is fiercely guarded in promoting and protecting a reputation for ethical elevation, an aspiration not generally recognized as a high priority in PE.
Many boards and managers developing strategy debate where their policy mix should reside on this continuum, some consciously thinking of the poles as the Berkshire model versus the PE model. This chapter provides some examples of companies closest to the Berkshire model.
Insurance
The insurance sector is particularly well suited to the Berkshire model—after all, insurance is Berkshire’s backbone. The industry attracts skilled managers of capital who think long-term and for whom the Berkshire model is inherently congenial. To boot, insurance is a trust-based industry, where policyholders pay premiums based on their faith in the insurer to honor promises in the distant future.
Consider Markel Corporation, a holding company for global insurance, reinsurance, and diverse noninsurance businesses. Founded in 1930, as a family firm, the public face of the company since the early 2000s has been Tom Gayner. Dating to at least 1985, Markel has consciously modeled the company on Berkshire.
In addition to substantial insurance and reinsurance operations, the company is an opportunistic buyer of operating companies in various sectors, from manufacturing baking equipment to merchandising ornamental houseplants. It has impressively outperformed peers and the overall market on a regular basis for many decades. Highlights from its website illustrate company principles:
The Markel approach is one of spontaneity and flexibility. This requires a respect for authority but a disdain of bureaucracy. At Markel we hold the individual’s right to self-determination in the highest light, providing an atmosphere in which people can reach their personal potential.
Our companies are leaders in their respective industries. Our management teams are the leaders of those companies. We provide corporate governance and other related services to our companies but refrain from affecting management’s day-to-day activities. Therefore, our companies can focus on what they do best. From providing healthcare solutions, affordable housing, or retail price solutions across the US to manufacturing capital equipment around the world, each of our companies strives to achieve long-term success for its customers, employees, and communities.
The company’s 2012 letter to shareholders is explicit about the role of trust at Markel:
One key reason why things have worked out so well for Markel over time is the environment of TRUST that exists at your company. We appreciate that you as shareholders have entrusted us with your capital to build the value of your investment over time. You’ve given us great latitude to pursue this goal without artificial constraints, and we’ve validated your faith in us by producing excellent results over time.
We work hard every day to maintain and build a level of trust around Markel because we think that makes our business better. It is almost magical to live in this environment and enjoy the mutual commitment that the people of this company feel towards each other and towards the company.
Or consider Alleghany Corporation, another reliably successful insurance company. Alleghany, which was founded in 1929, owns and operates important insurance businesses, including Transatlantic Holdings (TransRe), a venerable company founded in 1977 by Maurice R. (“Hank”) Greenberg of AIG (American International Group) and acquired by Alleghany in 2012.
Led since 2004 by Weston Hicks, Alleghany also owns a variety of autonomous decentralized operating companies in a wide range of businesses. These include manufacturing toys (including Peppa Pig), fabricating steel for massive industrial projects (from sports stadiums to office building complexes), and producing funeral parlor products.
In its annual reports, Alleghany attaches a brief set of operating principles. It is akin to Berkshire’s Owner’s Manual and contains some assertions that parallel the Berkshire model. Following are a few selections:
As the owner of insurance and reinsurance companies, Alleghany Corporation itself is, to a significant degree, an asset management company. Like a closed-end fund, the corporation retains most of its profits and reinvests those profits on behalf of its stockholders.
Alleghany Capital Corporation is our investment subsidiary that acquires and oversees primarily non-financial companies with durable businesses. Unlike a private equity firm, we do not acquire companies with the intention to sell them in the future. Rather, we believe that we provide a stable ownership structure when the founders or other control owners need to effect a capital transition. We believe that our ownership allows our owner-manager partners to grow their company and to improve each company’s results over time.
Our primary function in overseeing operating businesses is to provide strategic guidance, to set risk parameters, and to ensure that management incentives are appropriate. We don’t “run” our subsidiaries—their executive teams do.
A final example is Fairfax Financial Holdings, a diversified insurance company led since 1985 by Prem Watsa. The company, which has outperformed peers and the overall market by substantial margins, was formed after Watsa acquired the Canadian truck insurance business of Markel.
Over ensuing decades, Watsa steadily grew the business into an insurance giant, today composed of dozens of major separately operated insurance companies along with a variety of noninsurance businesses, including restaurant chains and retail shops as well as significant investments in assorted public companies. The company’s guiding principles have been in place from those early years. They include the following, from the company’s website:
We expect to compound our mark-to-market book value per share over the long term by [15 percent to 20 percent] annually by running Fairfax and its subsidiaries for the long-term benefit of customers, employees, shareholders and the communities where we operate—at the expense of short term profits if necessary. We always want to be soundly financed. We provide complete disclosure annually to our shareholders.
Our companies are decentralized and run by the presidents except for performance evaluation, succession planning, acquisitions, financing and investments, which are done by or with Fairfax. Investing will always be conducted based on a long-term value-oriented philosophy. Cooperation among companies is encouraged to the benefit of Fairfax in total.
Complete and open communication between Fairfax and subsidiaries is an essential requirement at Fairfax. Honesty and integrity are essential in all our relationships and will never be compromised. We value loyalty—to Fairfax and our colleagues.
In his 2012 letter to Fairfax shareholders, Watsa also stressed the central role of trust at his company:
Fairfax benefits greatly from our “fair and friendly” culture that we have developed over the past 27 years. Our small holding company team, with great integrity, team spirit and no egos, keeps the whole company going forward, protecting us from unexpected downside risks and taking advantage of opportunities when they arise. The glue that keeps our company together is trust and a long-term focus. From our Board of Directors through our officers and all our employees, you can count on them to do the right thing, always taking a long-term view.
So at Fairfax you will not see a huge holding company that checks every move our companies make, companies being sold to maximize short term profits, excessive compensation among our management, mass layoffs, management turnover or promotion of our stock. Our officers almost never sell our stock, and are a pleasure to work with. We have never lost a President or officer whom we wanted to keep. Our Presidents, officers and investment principals, who have been with Fairfax for an average of 13-1/2 years, are ultimately the strength of our company and the reason I am so excited about our future.
The Berkshire model—or call it the Alleghany, Fairfax, or Markel model—is followed in other industries as well. Exemplars operate with a high degree of trust, although all with variations in exact practices and their execution, as illustrated next.
General Businesses
Illinois Tool Works (ITW) is a global Chicago-based manufacturer formed by Byron L. Smith in 1912. Built by diverse industrial acquisitions funded mainly with internally generated capital, the company always strived to maintain managerial autonomy, although as it grew, it also tended to centralize.
From the late 1970s, the leadership eventually organized into eight separate divisions composed of eight hundred different businesses. The founder’s son, Howard Smith, president from 1972–1981, explained: “The key to it is the realization that if you’re going to have an organization like we had, if you’re going to have that spread of very capable people involved in all these businesses, you had better show them that the avenue of really running their own business is open.”1
The ITW approach assumed the status of the ITW business model during the tenure of CEO John Nichols (1982–1995). He explained:
We set up separate entities and gave autonomy to the people by getting decision-making out to these operating entities. I learned everything about what not to do when I worked at Ford and ITT.
You learn that you can’t run everything and you have to get good people to do it and let them do it. All of a sudden people had a chance to do their own product development and build their own organization.
During the Nichols’ era, ITW grew at an average of nearly thirty acquisitions annually, to a total of 365. One reason for ITW’s commitment to autonomy was practical: any given manager can only handle so much oversight.
The chief change after ITW acquired a company was to segment the business into manageable units. A parallel practice was for group executive vice presidents to invest in training programs to prepare personnel for management roles.
ITW executives say the greatest difficulties they face are around integration of new businesses; ITW business unit managers, having been integrated, say the same thing. As one ITW group president put it: “Once you acquire the company, the hard part is integrating the business and getting them to be ITW-ized. Even though it is common sense and practical, not everybody gets it. Some get it more quickly than others.”2
Nichols’s successors embraced most of the model, but they also tried to simplify by combining units rather than continuing to segment them. Jim Farrell, CEO from 1995–2005, also pursued larger, pricier acquisitions. Despite shifts, Farrell maintained the core philosophy:
We believe it is necessary to split a company. The larger a company is, the more bureaucratic and slow it gets, and the more expensive it gets. Our units have their own operations, sales, marketing, and finance. There are no traditional functional heads in the corporate office. Individual operating units are much faster to market, to get problems resolved, and have opportunities realized—and we do it with less cost than a centralized operation.
Although ITW continued to prosper in the post-Nichols era, it never quite achieved the same results. The cautionary note is clear—sustained segmentation can be more effective than combination. Indeed, each business unit is unique and evolves in its own way, based on its particular history and practices, and segmentation is more likely to enable creating the most value out of that uniqueness.
Despite these points, ITW drew criticism from shareholder activists amid the contemporary wave of anticonglomerate sentiment. In response to activist pressure from Relational Investors LLC, the company, under the leadership of CEO Scott Santi, appointed one of its nominees to the board, and from 2012 to 2016 ran a divestiture and consolidation program.
Yet throughout this period, Santi stated and restated the longstanding core elements of the ITW business model, including decentralization and a unit-level focus on efficiency and customer-based innovation. Santi’s 2014 letter explained this approach in a succinct statement, repeated in subsequent annual reports. It includes these points:
Our decentralized, entrepreneurial culture allows us to be fast, focused, and responsive. Our people are clear about what is expected of them with regard to our business model, our strategy, and our values. Within the confines of this framework, we empower our business teams to make decisions and customize their approach in order to maximize the relevance and impact of the ITW Business Model for their specific customers and end markets.
In every market in which we operate, our businesses work hard to position themselves as the “go-to” problem solver for their key customers. Inventing solutions for our customers to help them address difficult technical challenges or improve their business performance has been the central focus of ITW’s approach to innovation all the way back to the founding of our company over 100 years ago.
Another cousin of the Berkshire model, and the ITW model, is Marmon Group (introduced in chapter 3).3 Begun in the 1960s by Jay and Robert Pritzker through acquisitions and organic growth, the Pritzker brothers invariably retained existing management and followed a hands-off policy that gave managers autonomy to make operating decisions. They built an industrial conglomerate in diverse manufacturing businesses: agricultural equipment, apparel accessories, automotive products, cable and wire, piping and tubing, musical instruments, and retailing equipment as well as services involving mining and metals trading.
Through the 1980s and 1990s, the acquisition rate was high, although many deals were of modest size: thirty acquisitions in 1998; thirty-five in 1999; and twenty in 2000. Assimilation was not a problem, as the company operated in a decentralized manner. After Jay died and Bob retired, the Pritzker family drew ITW’s John Nichols out of retirement.
Nichols promptly divided Marmon into ten business sectors, each with a president reporting to him. That enabled him to oversee the sprawling organization while facilitating growth and acquisitions at divisional and product levels. As the company grew, Nichols added divisions to accommodate that. Nichols then handed the reins to a former senior ITW colleague, Frank Ptak, whose explanation echoed the ITW approach. Ptak included the following sentence in a callout box in the letter he included in Marmon’s annual reports from 2015 to 2017:
The Marmon business model employs the time-tested lessons of 80/20 statistical analysis as part of a comprehensive, continuous thinking process. Key elements include decentralized management of small, homogenous, segmented businesses, continuous improvement in operating efficiency and productivity, [and] selective bolt-on acquisitions to enhance strategic direction.
Marmon’s decentralization was created rigorously, using the 80/20 principle. This thought process is based on a common statistical distribution: 80 percent of given outcomes are contributed by 20 percent of the inputs. Marmon executives found, for example, that 80 percent of sales came from 20 percent of the product mix, and 80 percent of profits were due to 20 percent of customers.
Armed with such insights, Marmon generates highly segmented profit and loss statements to zero in on what specific parts of every business contribute most and least to overall performance. With laser focus, managers allocate time and resources to the divisions, products, and customers that drive the greatest profits. This approach enables pinpointing parts of the business that warrant reinvestment to foster innovation and growth.
The process entails endless pursuit of greater segmentation and decentralization that yields product breakthroughs. Recent examples include cables used in subway systems and high-rise buildings that can withstand two-thousand-degree flames for two hours; copper fittings for refrigeration equipment that can be connected by pressing, without need for an open flame; greaseless “fifth wheels,” the plate that couples trucks to trailers; and kink-free extension cords. Marmon’s 80/20 model of decentralization is an innovative way to take advantage of size.
Ptak made a further refinement: creating three autonomous divisions. Each divisional president oversaw three or four units whose presidents reported to them, and each divisional president reported to Ptak. Ptak continued the relentless segmentation, ultimately forming four autonomous groups, fifteen separate divisions, and two hundred business units (an organizational chart reflecting these changes appears in chapter 3).
In 2008, Berkshire acquired Marmon. Since then, it has continued to operate as it always had, now like a Russian nesting doll as a subsidiary within a like-minded parent. Within Berkshire, several other successful industrial conglomerates follow similar organizational principles, including Berkshire Hathaway Energy, MiTek, and Scott Fetzer. These examples illustrate Berkshire’s practice of bucking the trend.
In recent years, the industrial conglomerate has been dying off—with long-gone names such as Gulf & Western Industries; ITT Corporation; and Textron. The call for business focus is so strong that it even catches companies that are diversified but far from the conglomerates of old. Examples include DuPont, which was pressured into first merging with Dow Chemical and then splitting the combination in three, and United Technologies, first merging with Collins and then spinning off its Carrier air conditioning and Otis elevator units before merging with Raytheon.
Despite intense pressure, the principles—especially autonomy and decentralization—often endure, at a wide range of diverse businesses today, such as Danaher, Dover, Roper Technologies, and TransDigm Group. All use slightly different approaches to managing scale and justifying it, some aligned more with the Berkshire approach than others.
Consider Danaher, a conglomerate operating in several industries and across multiple platforms. Danaher was founded in 1983 by the brothers Mitchell and Steven Rales, who still own a large stake, although they withdrew from management roles long ago. At Danaher, the Rales brothers began a system that is both similar to and different from the Berkshire business model.
Called the Danaher Business System, it has been relentlessly refined under the stewardship of three successive world-class CEOs. They have built a mighty industrial conglomerate, while along the way spinning off several divisions into freestanding businesses that have achieved great scale in their own right.
Danaher is similar to Berkshire in at least three key ways: an acquisitive, autonomous, decentralized organization. It differs in at least two primary ways: Danaher uses a rigorous company-wide system of management recruitment and training around a set of shared fundamental operating principles stressing leanness in every step.
Differences aside, trust remains an important element of the Danaher Business System, a feature that helps make any such training and best practices program work. For a glimpse at the culture and the record, start with this from George Sherman, Danaher CEO from 1990 to 2001:
When I joined Danaher eleven years ago, sales totaled less than $750 million, and the company sold a fragmented assortment of products. Over the next decade, we evolved Danaher into a global corporation with leading positions in higher growth multi-billion dollar markets. Over the last ten years, our sales and earnings per share have grown, respectively, at a 15 percent and 21 percent compounded annual growth rate. Danaher stock has appreciated over the past ten years at a 33 percent compounded annual growth rate While we were developing a stronger business mix and a clearly articulated operating philosophy and culture around our powerful [Danaher Business System], we also grew our organizational capability.
Sherman’s successor was among the first executives he had hired at Danaher: H. Lawrence Culp, Jr.. After an impressive decade-plus tenure at Danaher, Culp in 2018 was tapped to head the beleaguered General Electric. The first Danaher annual report he issued, in 2002, elaborated on the history:
In the mid-1980s, a Danaher division faced with intensifying competition launched an improvement effort based on the then-new principles of lean manufacturing. The initiative succeeded beyond anyone’s expectations—reinforcing the division’s industry leadership as well as spawning the Danaher Business System (DBS). Since this modest beginning, DBS has evolved from a collection of manufacturing improvement tools into a philosophy, set of values, and series of management processes that collectively define who we are and how we do what we do.
As a final contemporary example, take Constellation Software Inc. (CSI, where Lawrence Cunningham is a director). CSI buys, improves, and operates vertical market software companies worldwide. Now numbering more than three hundred separate business units, each is operated autonomously in a highly decentralized structure. What holds the culture together is trust. In his 2011 letter to CSI shareholders, CEO Mark Leonard explained:
A long-term orientation requires a high degree of mutual trust between the company and all of its constituents. We trust our managers and employees and hence try to encumber them with as little bureaucracy as possible. We encourage our managers to launch initiatives, which in our industry, often require 5 to 10 years to generate payback. We are comfortable providing them with capital to purchase businesses that won’t be immediately accretive, but that have the potential to be long-term franchises for CSI.
We nearly always promote from within because mutual trust and loyalty take years to build, and conversely, newly hired smart and/or manipulative mercenaries can take years to identify and root out. We incent managers and employees with shares (escrowed for 3–5 years) so that they are economically aligned with shareholders. In return we need and want loyal employees: if they aren’t planning to be around for 5 years, then they aren’t going to care much about the outcome of multi-year initiatives, and they certainly aren’t going to forego short-term bonuses for long-term profits.
At CSI, as with Berkshire, structure is a salient organizational motif. In both cases, however, structure was not the cause of success but a consequence of the real cause: a culture of trust. When managers encourage employees to produce, innovate, and excel, they tend to rise to the occasion. When trust is central in a business organization, decentralization and autonomy result. Success follows.
So it was interesting when in 2015 the founders of Google created a new holding company structure, called Alphabet, to house not only the legacy Internet search business but some twenty-six other separate autonomous business units operating in a decentralized structure. The move prompted speculation that Alphabet wanted to become the twenty-first-century version of Berkshire. We share their enthusiasm.4 But we’d stress that this will not occur by virtue of the structure alone. It can succeed only if the structure is embedded in a culture of trust.
• • • •
In recent years, business people increasingly dream of creating businesses in Berkshire’s image, much as proverbial literary types aspire to write the great American novel. It is achievable, if on a smaller scale, but not formulaically.
A key lesson from the Berkshire business model is the margin of trust. Being suitably skeptical of most, especially financial intermediaries, proponents seek out special managers and partners who are trustworthy. They win the trust of shareholders and employees alike by honoring promises.
Neither decentralization nor autonomy are the primary reasons for Berkshire’s success or durability. Trust is. Autonomy is a manifestation of trust; decentralization is a consequence of it. The model is based on values, not formulas.