RSS feedI hope you’ve all taken the time to check out Buffett and Lampert’s letters for this year. Maybe they’ve even piqued your interest and you’ve started reading more in the archives. But, if you haven’t, I thought I would write a few posts summarizing some of the best lessons to take away from these two most recent letters. I’ll be breaking it up into two portions - business analysis and investment lessons.
An enduring “moat”
The “moat” is one of Buffett’s favorite principles. It’s not any sort of special concept, it’s just a metaphor for a business’ competitive advantage. More importantly, an unassailable competitive advantage. Why is this important? Let’s let Buffett describe:
A truly great business must have an enduring “moat” that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore a formidable barrier such as a company’s being the lowcost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success. Business history is filled with “Roman Candles,” companies whose moats proved illusory and were soon crossed.
Our criterion of “enduring” causes us to rule out companies in industries prone to rapid and continuous change. Though capitalism’s “creative destruction” is highly beneficial for society, it precludes investment certainty. A moat that must be continuously rebuilt will eventually be no moat at all.
Additionally, this criterion eliminates the business whose success depends on having a great manager. Of course, a terrific CEO is a huge asset for any enterprise, and at Berkshire we have an abundance of these managers. Their abilities have created billions of dollars of value that would never have materialized if typical CEOs had been running their businesses.
Is this an idea shared by Eddie Lampert? Well, he doesn’t come out and say it, but his Sears operation is an enduring example of how important it is to have a “moat” around your business. Otherwise, he wouldn’t have been finding as hard a time figuring out just how to manage his KMart and Sears franchises to better compete against the full range of big box retailers - Best Buy, Home Depot, Walmart, JC Penney, etc.
Importance of Great Management
While Buffett and Lampert are great investors and show great prowess in managing their respective company’s lush cash flows, the credit for the operational success of their businesses goes to the managers that each has brought on board.
With the departure of Aylwin Lewis at Sears Holdings and with the cost cutting initiatives seemingly having done all they can to improve Sears’ and Kmart’s profitability, Lampert describes the next step of his company’s turnaround:
The idea behind the reorganization is to drive decision-making down into the organization and to harness free-market forces to convert a centrally planned company into a more decentralized company. In effect, Sears Holdings will operate as a holding company that owns five types of businesses… In the case of the operating and support business categories, there will be a number of business units that fall into those categories, each run by a single leader accountable for its results.
Our hope is that the new structure will bring much more focus, clarity, and accountability to the process of analyzing the performance of our company’s various business units. In turn, the hope is that greater visibility and accountability will help us identify, monitor, and accelerate the improvements we require to be more competitive.
Sound like the Buffett strategy? Oh yes. The best way for a conglomerate to work is to allow individual business groups to operate competitively within themselves. Yes, cost cutting and synergies involved in integrated companies are important, but managerial decisions ought to stay with those with the core competencies to run them.
Capital Allocation is Key
No business grows forever. In fact, Warren Buffett doesn’t even invest looking for growth. Eddie Lampert is similar as well. Looking at his history in retail investing from Autozone to Kmart to Sears, he’s never pushed for aggressive square footage expansions or focused on same store sales numbers. For both Buffett and Lampert, a business is successful if it provides consistent cash flows and profitability particularly with minimal capital expenditure.
What do you do with all the money the business makes? The trap that most companies and management teams fall into is the desire to continue to grow their core business past the point where it generates acceptable return on its investments. These businesses would be better off taking the money and giving it back to shareholders. In the case of Sears Holdings and Berkshire Hathaway, they act as the clearing house for all capital expenditure decisions. Lampert and Buffett decide where the money goes and they don’t spend money indiscriminately. When return cannot be found through acquisition or business unit investments, cash generated is better left in the corporate coffers or returned to shareholders in the form of dividends.
March 6th, 2008 at 6:07 pm
[…] up yesterday’s piece on lessons in business analysis that could be gleaned from this year’s Warren Buffett and Eddie Lampert shareholder letters, […]
June 29th, 2008 at 1:48 pm
Tuesday, June 24, 2008
John Marcenek
PO Box 942, Cocoa, Florida 32923
Telephone: (321) 890-6565 E-mail: jmarcenek@yahoo.com
RE:
Sears Holdings Corporation
3333 Beverly Road
Hoffman Estates, IL 60179
(847) 286-2500
To whom it may concern:
As of yesterday, I worked in Sears store 1175 in Merritt Island, Florida. I have been employed by Sears for about a year and a half. Last year, I was given an award for the most protection agreements sold for Home Improvement (including tools, hardware, lawn/garden and patio, and sporting goods). I put division six (sporting goods) into the number one spot for protection agreement sales for the first time ever in this store’s history. About two weeks ago, I was wondering how two salespeople in the tool department managed to raise their protection agreement sales numbers seemingly within a few weeks. One night, while closing solo in the tool department, I noticed about a half-inch stack of coupons stacked on the side of registers 531 and 532. Registers automatically print three to four coupons on each sale. Most customers leave them on the counter and tell us to give them to someone who might need one.
Up until this point, I was just crumpling them up and throwing them in the trash can. I realized the sales people in tools were doing the opposite; they were saving them and using them to get sales. I asked Frank King about it the next day and he said that was in fact what he was doing, he gives them to customers and others that are hesitant about buying a protection agreement. I thought this was brilliant. I started saving ones that customers did not want for sporting goods and lawn/garden. Over the next week, I used two that I can remember. Both were similar sales, one a tractor, and one a treadmill. Both customers were hesitant about buying the product AND a protection agreement. For example, on the tractor sale, I offered him a $25 coupon that another customer left if he bought both the tractor and the $300 protection agreement. He instantly came onto the YES side of the fence; he was no longer hesitant and said yes. Therefore, in effect, I got the company and myself a protection agreement sale that no one would have had if a previous customer did not leave the coupon on the counter and I offered it to this customer. It helped close the sale, close the package deal. For illustration purposes, say half the coupon came off the tractor and half off the protection agreement, we (the company and myself) got 287.50 from a coupon discounted $300 protection agreement. We would not have gotten that sale, that money, if a previous customer did not leave the coupon on the counter and I offered it to this customer.
Yesterday… Monday June 24, 2008, Anthony, the store’s loss prevention manager, called me into his office asking me if I liked my job, how long I had been working there. I stated yes and a year and a half. He said let’s talk coupons. He asked why I was offering customer’s coupons. I told him because the register prints them on every sale. He said it was against company policy and I was violating company policy. I must admit, I was thoroughly confused about this as 1) The company’s own registers printed the coupons with every sale and 2) It helped increase revenue for the store, the company, and me by increasing sales. 3) If the customer was not offered the coupon, they WOULD NOT BUY the protection agreement; if they were offered the coupon, they WOULD BUY the protection agreement. 4) If offered the coupon, everyone wins… the customer, the store, the company, and me. How could this be wrong? Nothing appeared underhanded about it to me. Anthony stated I was offering unauthorized discounts and that it was a violation of company policy. He made me sign a statement that I understood this and would not do it again. I was not aware this was a violation of company policy and I agreed to what he wanted and signed the statement.
After going home, I called a Sears Human Resources consultant at the associate service center for advice on this (888-88S-ears, case number 6067037). The woman told me while she understands both points of view… Anthony’s and mine; it is actually a violation of company policy and I should not offer the coupons to customers again. I agreed.
Today I came into work at 1:00 PM. At about 3:30, I was called to Claudia’s office, the store manager. Anthony and Claudia were in the office. Anthony told me that he escalated his report on me to the associate service center and it has been decided that I would be terminated because I offered unauthorized discounts to customers.
I went home and called a Sears Human Resources consultant at the associate service center for advice again. I told her how this is wrong from so many angles as 1) Anthony violated company policy by only allowing 4 hours work time between warning me about the violation and terminating me. I offered no coupons to customers in that four-hour time span. 2) No opportunity was given to show that I stopped any company violation. I was warned then terminated, a violation of company policy. 3) Anthony could not provide me anything in writing showing this was a company policy violation. 4) This all opens the company up to possible wrongful termination lawsuits. 5) None of the other sales people in the tool department also using the coupons in the same way, the sales people I learned this from, were terminated. 6) As previously explained above, this results in loss of sales and revenue for the company (I am sure company stockholders would not like any of this). She replied that it is still a violation of company policy to offer these coupons to customers because I am not authorized to give them and that my termination would stand. I told her how flabbergasted I was that the company was willing to lose sales and employees over this.
Later, after speaking with a paralegal friend, I called a Sears Human Resources consultant at the associate service center for advice on this (888-88S-ears, case number 6067037) again. This time, I received an answering machine at which point I stated that it is not true I am not authorized to give these coupons. If it were true what she said that only management were authorized to use the coupons, the coupons would not print out at the register; they would be e-mailed or faxed to managers. The mere fact that the company has them set to automatically print with every sale at the register authorizes me to use them. If the sales people are not authorized to use them, then why do they print at the register with each sale? I looked through ALL the Sears employee paperwork given to me, there is nothing regarding how these coupons are to be used, and I do not recall any paperwork I was asked to sign over my time there stating the same. As of June 25th at 11:30 AM when I am writing this, I have received no reply to the issues or points I raised above.
I believe in this company. I would like to see it survive. But policies and decisions like the above leave you wondering and your head spinning. In conclusion, I am almost sure that Sears’ investors, stockholders, and executive management would not be happy with any issues raised here.
Respectfully,
John Marcenek
Terminated Sears Store Employee
June 30th, 2008 at 1:43 pm
A very interesting letter, John. I feel for your termination and think it’s a pretty interesting question of whether or not the use of coupons is a good idea for your company. I’m not sure that posting comments like this on my blog are going to advance your case against Sears, but thanks for sharing!
July 13th, 2008 at 11:26 am
[…] received a very interesting comment on my post “Lessons in Business Analysis” a few weeks ago and just wanted to comment on […]