Warren Buffett on reputation: the economic value of values, integrity and corporate culture
Warren Buffett is commonly hailed as the world’s greatest investor, and for good reason. As the chairman and CEO of Berkshire Hathaway, Buffett has a net worth of more than sixty-six billion dollars—one of the largest of anyone in the world.
How exactly does someone become so financially successful? In his book Berkshire Beyond Buffett: The Enduring Value of Values, Lawrence Cunningham argues that one of Berkshire Hathaway’s greatest assets is something we talk about all the time on this blog: reputation.
1. Warren Buffett understands that reputation and integrity have economic value
In past blogs, we have pointed to research that shows that a good reputation is worth real money — in fact, some research indicates that a good reputation might replace a line of credit at the bank.
Like few other CEOs, Buffett understands this, and will happily pay a premium for something as intangible as a reputation.
Surprisingly, Buffett did not start his career that way. In fact, Buffett was something of a bargain hunter initially, says Cunningham. It was Charlie Munger (Buffett’s longtime friend and co-investor) who convinced him otherwise:
Munger (...) encouraged Buffett to adopt a long-term view of business opportunities, rather than the approach of bargain hunting Buffett had practiced in his early career. Munger [factored] in not only statistical analysis of balance sheet quantities and earnings, but soft factors like entrepreneurship, integrity, and reputation.
Buffett is not only willing to pay a premium for companies he sees as having more integrity, but also to maintain his own good reputation in the business community, as a takeover bid from the 1970s shows.
Case: Wesco (1972)
In 1972, Buffett wanted to acquire a financial company called Wesco. At the time, though, Wesco was about to merge with another company. Buffett deemed Wesco’s other suitor to be overvalued, and tried to convince the Wesco’s CEO to abort the merger. The CEO followed Buffett’s advice and pulled the plug on the merger.
What happened next was extraordinary:
Wesco’s stock price dropped, as typically happens in such a scenario, from a high of $18 to $11. [Buffett] could have begun acquiring shares at the low market price that Buffett and Munger’s scuttling of the merger had engendered. lthough they wished to acquire Wesco, they did not think it would be fair to pay the low market price after their interference with the merger caused it to drop. So they ordered their brokers to acquire the stock at prices as high as $17 and subsequently made a formal tender offer at $15.
"Integrity is a reputational advantage that others will weigh in subsequent dealings" - Warren Buffett
Many people were baffled by Buffett’s strategy. Why would a businessman ever pay more than he had to? The market watchdog, the Securities and Exchange Commission (SEC) actually started a yearlong probe into the deal, suspecting foul play:
It was hard for people to understand what Buffett…spent a year explaining: they paid a higher price to show integrity. Moreover, such a premium had economic value, because integrity is a reputational advantage that others would weigh in subsequent dealings. Buffett and Munger stressed both the immediate value of winning Vincenti’s respect and the longer-term value of ‘general business reputation’ The authorities were finally persuaded.
2. How much value? Quite a lot, actually
Buffett shows that he understands that reputation is, as the academic definition goes, an impression of past behavior that is used to predict future behavior.
Berkshire Hathaway’s reputation is what attracts entrepreneurs when they go looking for an acquirer, resulting in a great number of opportunities for Berkshire Hathaway:
So valuable is Berkshire’s culture—especially the values of permanence and autonomy—that business sellers undeniably treat it as a valuable part of what they receive on the sale. It is its culture that enables Berkshire to acquire companies at lower prices than rival bidders.
You might find that hard to believe, but here’s one deal where there’s tangible proof.
Case: RC Willley (1995)
In 1995 a home furnishings company named RC Willey sold to Berkshire Hathaway for only $175 million, even though they had received several other offers for more than $200 million. In other words, RC Willey effectively paid Berkshire $25 million (one eighth of the total transaction value!) in exchange for the Berkshire Hathaway’s reputation.
In some Berkshire Hathaway subsidiaries — notably the insurance and reinsurance businesses — this long-term view of reputation is actually part of the business model.
It was partly what insulated Berkshire Hathaway from the worst impacts of the financial crisis:
Buffett noted when discussing the industry in 2008, a year that battered insurers amid a roiling financial crisis: ‘Reinsurance is a business of long-term promises, sometimes extending for fifty years or more. This past year has retaught clients a crucial principle: A promise is no better than the person or institution making it.’
It wasn’t only Berkshire’s insurance businesses that came out better than competitors during the crisis. In the overheated real estate market between 2001 and 2007, many financial and real estate companies sold mortgages to people who could not afford them. When the financial crisis broke loose, these companies suffered huge losses, and many of them went bankrupt.
"A promise is no better than the person or institution making it." - Warren Buffett
Clayton Homes was the only player in the industry that didn’t suffer huge losses. According to CEO Jim Clayton, it was a direct consequence of a business decision to maintain high ethical standards:
Clayton attributed the difference to his company’s maintenance of a “sacred wall” between sales and credit that competitors failed to maintain. (...) no purchaser of the loans it originated or had repackaged for sale ever lost a dime of principal or interest.
Once again, Berkshire came out on top because of its culture of integrity and long-term vision.
3. Buffett guards his reputation by keeping the stakeholder’s perspective in mind at all times
Another instance that shows how intuitively Buffett grasps reputation is an episode from the early 1990s, when the investment bank Salomon Brothers was in the midst of a scandal.