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Poor Charlie's Almanack

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On Business Strategy

Even though Charlie Munger and Warren Buffett don’t operate businesses themselves (they are famously hands-off and leave management to their business leaders), they do base their investment decisions on the strength of a company. They therefore have strong opinions on what makes companies successful over the long term.

What Makes Companies Successful?

According to Munger, outlier business success often results from the combination of some of these factors:

• Extreme focus on maximizing or minimizing one or two variables. For example, Costco focuses on driving volume and lowering prices, to the exclusion of many other factors obsessed over by typical retailers.
• Positive feedback loops, so that success begets further success. These often produce nonlinear results as the combination of multiple multiplicative factors.
• Strong, consistent execution over many factors. For example, Toyota executes well on many aspects of manufacturing, marketing, and capital allocation.
• Riding a rising wave that adds tailwinds even to an otherwise strong company. For example, Oracle rode a wave of improving technology and adoption of technology by businesses.

Moats and Competitive Advantage

Munger and Buffett consider the primary factor of a great business to be an enduring competitive advantage—what they call a “moat.” Like a moat protecting a castle, the competitive advantage allows a business to resist being made obsolete by competitors or changing markets.

To highlight the frenzy of competition, Munger points out that of the 50 most actively traded stocks in 1911, only one company—General Electric—survived as an independent, meaningful company. The forces of new technology, fierce new competitors, and shifting management are formidable and can drive companies out of business.

Berkshire Hathaway thus counsels its companies to widen their moats every year. This doesn’t necessarily mean earning more profits each year, but rather growing a company’s strategic position to weather the long term.

Under certain conditions, businesses with large moats can increase prices dramatically without cutting volume, and thus increase earnings dramatically. This happened with Disney in the 20th century. For decades Disneyland priced its tickets very affordably. Then the managers realized it was underpriced—it was a unique experience unlike any on Earth; people don’t consume it that frequently, so they’re not as worried about racking up high costs. So Disneyland raised its prices, and attendance maintained steady levels, leading to sudden profits.

(Shortform note: The ideas of competitive advantage were formalized by Harvard Business School professor Michael Porter. For more details, read our guide to Understanding Michael Porter.)