FEW COMPANIES will ever reach Berkshire’s vast scale, but many face the rising challenges that accompany corporate growth. These challenges range from finding new ways to “move the needle,” to providing oversight of a sprawling organization, to maintaining focus in the conglomerate form of business organization. Ultimately, they all face a general mistrust of bigness in business that is a part of the U.S. political landscape.
Huge corporations have appalled Americans from Woodrow Wilson and Louis Brandeis to Bernie Sanders and Elizabeth Warren. Financial institutions seen as “too big to fail” are the latest repugnant targets, now governmentally regulated when classified as systemically important. Demonization of the conglomerate form, dating to the 1980s, is a private sector pastime, continuing today to challenge some Goliaths as “too big to succeed.”
President Wilson stressed that employees’ individuality is lost in large corporations to organizational mission, especially for companies that grow by acquisition rather than organically. Employee morale may suffer when workers see themselves as pawns of an empire, not as human members of a team. Justice Brandeis warned against corporate agglomerations as a threat to social welfare, to the spirit of the nation. Concern went all the way to the top: when one company acquires another, the latter’s CEO almost always surrenders the role of ship captain for a mere seat in a crew of corporate bureaucracy.
Today’s critics of corporate giants claim they facilitate the transfer of wealth from the workforce to the executive staff. The flow appears in mushrooming executive compensation, often paid using stock that rises in value with more regard to size than performance. As Senators Warren and Sanders view it, all these features drive pernicious wedges along the socioeconomic ladder. Worse, large corporations wield political power proportional to scale, contradicting democratic values.
On the surface, Berkshire might seem to be an easy target for such rebuke. It is among America’s largest corporations by any measure, whether assets, capital, or employees. If Berkshire were a country, and its revenue its gross domestic product, it would rank among the top-fifty world economies, rivaling Ireland, Kuwait, and New Zealand. Much of its recent growth is due to an energetic acquisition program. It has acquired nine wholly-owned subsidiaries that, if standing alone, would be Fortune 500 companies.
But Berkshire has avoided the sins that populist antagonists deplore, mainly a result of its distinct corporate culture, starting with its practice of autonomy. In a Berkshire acquisition, incumbent CEOs remain captain of their ship; there is no bureaucratic crew to join. There’s even a book devoted to the phenomenon—The Warren Buffett CEO: Secrets from the Berkshire Hathaway Managers by Robert Miles.1 The CEOs report that this autonomy and trust stimulate them to immaculate stewardship.
Although Berkshire executives are highly paid, compensation is not as lavish as with peers at public companies. Pay is explicitly tied to performance metrics under their control, in cash not stock. In addition, Buffett’s pay is trivial compared with other U.S. chief executives.
If critics perceive Berkshire to exercise outsize political influence, there is scant evidence that the corporation, as opposed to specific individuals or units, does so. Through 2004, Berkshire spent little on lobbying, perhaps $300,000 in a typical year, whereas other large companies from Boeing to Verizon doled out closer to $10 million.
Since then, as Berkshire’s energy business quadrupled and it acquired BNSF Railway in 2009, lobbying by those two regulated units raised yearly costs to some $6 million. That figure is still a fraction of what like-size companies spend. Berkshire is no political patsy, yet its comparatively modest disbursements defy any accusation of undemocratic crony capitalism.
Too Big to Fail
Sheer size has become vexing for banks, thanks to the 2008 financial crisis. Several financial institutions had grown so large and important that their failure compelled extraordinary government exertion. During 2008, authorities seized control of companies, such as Berkshire insurance rival AIG and one-time investee Freddie Mac; arranged for the sale of others, such as Countrywide and Wachovia; and intervened across the sector, allowing the collapse of Lehman Brothers.
All such institutions became stringently regulated under the Dodd-Frank Act of 2010 to maintain minimum asset levels and caps on debt. In addition to large banks, authorities named large insurance companies to be systematically significant financial institutions (SIFIs), subject to considerable regulation and oversight.
Skeptics of bigness suggested tagging Berkshire with the SIFI label, even resulting in a formal inquiry by the Bank of England to U.S. authorities about why it was omitted. Several reasons explain this decision. For one, in the 2008 crisis, while all such financial institutions, and many other corporations, hemorrhaged capital, Berkshire commanded an abundant supply.
In contrast to many rivals whose operations remain primarily financial, Berkshire’s insurance and finance businesses, once central pistons, have become less so as Berkshire has diversified. Berkshire’s evolution from an insurance-driven investment vehicle to a vast industrial conglomerate manifested around 1990—just when the conglomerate form of business organization withered under scathing criticism.
Conglomerates
Berkshire has avoided the major pitfalls of its form of business organization—the conglomerate. While fashionable when Buffett began running Berkshire in 1965, it gradually went out of style.
In the 1960s and 1970s, the conglomerate form flourished in corporate America, in part due to enactment in 1950 of the Celler-Kefauver Act, which discouraged mergers among rivals, stimulating acquisitions of unrelated businesses.2 Massive companies were built through numerous diverse acquisitions by powerful chief executives.
Prominent examples include ITT Corporation, which, under the leadership of Harold Geneen and later Rand Araskog, boasted three hundred fifty different companies, including car rentals, baking, hotels, and insurance; and Teledyne Technologies, assembled by Henry Singleton as nearly one hundred different businesses ranging from acoustic speakers, aeronautics, banking, computers, engines, and insurance. By 1980, the majority of Fortune 500 companies were conglomerates.3 Rationales included exploiting scale, seizing synergies, spreading managerial acumen, and diversifying investments.
Critics accused imperious executives of indulgent empire building, however. They stressed that many of these businesses struggled, incurred significant losses for sustained periods, misallocated capital internally, or otherwise proved difficult to manage. Under pressure from hostile corporate takeover artists seeking to maximize shareholder value, as well as academics urging greater focus, the conglomerate model began to unravel.
Corporate raiders, such as Carl Ichan and Ronald Perelman, and buyout firms, such as Kohlberg Kravis Roberts, targeted or acquired conglomerates and proceeded to break them up. Others, like ITT and Teledyne, simply succumbed to the changing times and divided their conglomerates into multiple discrete corporations.4
By 1990, the era of the conglomerates was over and widely viewed as a systemic mistake. Top executives prone to conglomerate-wide systems and micromanagement ultimately undermined operational success. Subsidiary managers could execute more effectively when permitted to apply systems tailored to the needs of their business and focused on areas within their unique expertise.
Boards of directors, increasingly called on as active monitors of managers rather than loyal advisors, could not oversee sprawling empires. Shareholders could diversify more efficiently themselves than conglomerate executives who proved inept at allocating capital. And U.S. antitrust policy had swung back in the direction of solicitude toward mergers among rivals.5
During this same period, however, Berkshire transformed itself from a small investment partnership in the 1960s, into a diversified conglomerate with vast stock holdings by 1995. Today, it is a conglomerate more sprawling than ITT or Teledyne or any of the other colossuses of the 1980s, such as Beatrice Companies, Gulf & Western Industries, Litton Industries, or Textron. And its performance is impressive.
One broad reason for this success is that Berkshire recognized and avoided all the pitfalls: Buffett, as chief executive, is the opposite of a micromanager; Berkshire’s decentralization and principle of managerial autonomy enable managerial focus; Buffett’s investment acumen made Berkshire’s practice of diversification valuable to investors; and Berkshire’s internal capital allocation saved stockholders sizable transaction costs and taxes.
Berkshire may be in a class by itself. Yet plenty of others share many practices and much of the prosperity. As noted in chapter 8, these include numerous insurance companies (such as Alleghany Corporation, Fairfax Financial, and Markel Corporation) and numerous noninsurance firms with refined business models (such as Constellation Software, Danaher Corporation, and Illinois Tool Works).
Too Big to Succeed
Today’s strain of anticonglomerate fervor inverts regulatory concern about “too big to fail” to probe “too big to succeed.” Evidence suggests that large corporations often underperform smaller rivals over long periods of time. Critics say that size, frequently achieved by acquisition, indicates hidden problems impairing organic growth. They say accumulations, especially through acquisition, spell conflicting and therefore self-defeating internal strategies. As the early populists warned, contemporary critics contend that size can lead executives to stress short-term profits at the expense of the human element.
Others acknowledge uncertainty in the relationship between size and success or failure. These contrarians say size can enable scaling up while controlling its downside using small teams, instilling a trust-based culture, and ensuring that everyone has a sense of purpose. They could point to Berkshire as a model of leadership that fostered a galactic organization formed of units that are often quite small.
Buffett has repeatedly stressed that Berkshire’s size is incidental. As early as 1982, Buffett stressed in an annual shareholders’ letter, “We will not equate corporate size with owner-wealth.” Munger has expressed his socioeconomic aversion to vast concentrations of corporate power when addressing issues from merger activity to income taxation.6 For these two Berkshire builders, it is as if Berkshire’s size is accidental, more consequence than conquest.
One’s greatest strengths are often one’s greatest weaknesses. The same can be said of the Berkshire model. Its valuable business methods—self-reliance, autonomy, decentralization, and opportunistic acquisitions—all promote entrepreneurial executives. At the same time, however, they risk error from independence, wayward souls, and periodic reputational damage.
But size is not a problem. The only real cost of size at Berkshire might be as an anchor against sustained outsize returns on capital. Buffett has been ruing that for decades, as far back as 1994 warning in his annual shareholder letter: “A fat wallet is the enemy of superior investment results. And Berkshire now has a net worth of $11.9 billion compared to about $22 million when Charlie and I began to manage the company.”
Times have changed. In seven of the past ten years, Berkshire’s annual gain in net worth exceeded in seven of the past ten years. As net worth approaches $300 billion, that is some twenty-five times the 1994 level. Berkshire’s corporate culture has enormous value that is invariant to its scale. It is a company that even Brandeis and Wilson might have loved.