Buffett's Five Minute Decisions
And my month to monk review, Troubled, and more
Warren Buffett can be kind of infuriating. On my path to a self-study MBA, I’ve been reading a collection of Berkshire’s Shareholder Letters from 1965 to 2012 which functions as a textbook (and for context I’m on year 2005 which is page 1296 and 77% way through the book…)
One thing I’m discovering is how Buffett effortlessly demystifies the enormity of Berkshire’s accomplishments with phrases like, “It took me five minutes to buy this billion dollar company.”
There are some passages where he delves deeper into his thought process on how he sets up these arrangements. For example, in the 1994 letter, Buffett talks about the management bonus structure deal with Ralph Schey who managed Scott Fetzer, a conglomerate holding company of businesses Berkshire bought in 1986.
I can’t resist mentioning that our compensation arrangement with Ralph Schey was worked out in about five minutes, immediately upon our purchase of Scott Fetzer and without the “help” of lawyers or compensation consultants. This arrangement embodies a few very simple ideas—not the kind of terms favored by consultants who cannot easily send a large bill unless they have established that you have a large problem (and one, of course, that requires an annual review)….
In setting compensation, we like to hold out the promise of large carrots, but make sure their delivery is tied directly to results in the area that a manager controls. When capital invested in an operation is significant, we also both charge managers a high rate for incremental capital they employ and credit them at an equally high rate for capital they release.
The product of this money’s-not-free approach is definitely visible at Scott Fetzer. If Ralph can employ incremental funds at good returns, it pays him to do so: His bonus increases when earnings on additional capital exceed a meaningful hurdle charge. But our bonus calculation is symmetrical: If incremental investment yields sub-standard returns, the shortfall is costly to Ralph as well as to Berkshire. The consequence of this two-way arrangement is that it pays Ralph—and pays him well—to send to Omaha any cash he can’t advantageously use in his business.
It’s a great incentive scheme. Fundamentally, Buffett views businesses as capital-generating machines. His framework gives managers significant leverage and the ability to make capital allocation decisions, especially since he owns 100% of these subsidiaries.
For example, let’s assume we’re running a business and have to evaluate the investment of running something like paid ads. We decide to invest $10K into Google ads every month with an expectation that we are to get a positive return back in terms of revenue generated. We can set our gross profit numbers are 90% to make it simple. So if we invested $10K into Google ads and it returns $15K of revenue, we would generate $15K revenue x 90% margin - $10K spend = $3.5K in free cash flow. For anyone, this investment would be worth scaling until our free cash flow levels decline (also assuming that as you scale paid ads, the cost of running those ads is fixed).
But it’s the second part of Buffett’s quote on determining hurdle rates that sets his incentive plan apart. Maybe a 35% return on capital invested is good enough for any normal business. But if Buffet himself could take that initial $10K of investment and generate a higher return of let’s say 60%, then it wouldn’t make sense for his manager to invest it in their business, because he could turn an investment of $10K and generate $16K from it at Berkshire, through acquisitions or other companies having higher returns.
It’s a great framework to use for making capital allocation decisions but also hand waves away so much complexity that makes you appreciate how well Buffett can run his businesses. And what I struggle with is not just finding these sorts of capital returns, but also executing on it in a mildly comparable manner.
For example, if we dive back into the paid ads scenario, I could not just take my existing manager and tell them, “hey, deliver me over a 1.35 return on ad spend and I’ll give you a bonus”. Building this framework comes with the upfront work of interviewing agencies, evaluating marketers past performance, and even making judgement calls on if Google ads could even work for a data science ed-tech business.
And let’s say after a month we get sub-optimal returns. Is that because my ace marketer is dealing with a slow engineering team? Or what if the marketing agency that hire actually spends more time on the sales pitch than the ads implementation?
What I realize is that there are a series of playing levels to even get to the point of making the sort of judgement calls that Buffett himself can make. If I look at the first few years of my career, it took time to understand what “good work” even looked like when writing code and delivering on projects. Then another few years to strategically come up with my own ideas and execute on them successfully. Then the last few years have been hiring team members and getting them to understand what good looks like when executing strategy. And I’m sure I’ll spend some more years, maybe a lifetime, understanding the differences between a strong manager / CEO / operations person that can take an idea or strategy, distill it, and then execute against it.
Then you have someone like Buffett who in almost every shareholder letter talk about meeting someone over golf and hiring them or buying their company by the 9th hole. Clearly Buffett works hard and has an intellectual, memetic, and emotional ability that he does test people with in meetings. And realistically I’m reading an entire years worth of accomplishments in an hour. But I think his experience in forming mental models, leveraging opportunities, and maintaining focus allow him to make it look effortless.
TLDR - business is hard. Buffett has had 90+ years to make it look easy.
Month to Monk Review
Last April / May I finished up my experiment of “Month to Monk” where I stayed “mostly sober” for around five plus weeks. Besides giving up on abstaining from daily coffee after a week, everything else was pretty easy (with one or two exceptions here and there). But my social media break proved to really open up better habits.
I hadn’t ever been off social media for more than month before. And while I wouldn’t say I’m addicted to Tiktok or Instagram, I did notice on screen time that I would browse Reddit, Twitter, and Youtube for over half an hour a day.
So it wasn’t too surprising that inhibiting access to these dopamine generators did actually create new daily behaviors for myself. Usually after a long work day I would throw myself on the couch and pull out my phone ready for mindless scrolling. And for the first few days I would repeatedly scroll sideways through home screens searching for these apps. But eventually I’d throw down my phone in disgust, look around, see a book on the coffee table, and then pick it up instead to read.
Reading way more books is probably a good enough argument to quit social media all together. But I’m hesitant on deleting Instagram forever given how much I use it to keep up with my friends lives. But since then, I’ve deleted everything but Youtube and Instagram, though I’m pondering my usage here still.
Overall - I’m confident in using most social media on my desktop if I really need it. TikTok I can delete forever and why not given it’s probably going to get banned in the US anyway. But everything else - I’m still figuring out what the right balance really looks like.
Things to Share
Troubled by Rob Henderson describes the author’s tough life growing up as an orphan. I was a little disappointed by the book because I like the author’s Substack where I find interesting social psychology stats here and there. What I thought was going to be memoir paired with facts and analysis about the poor social class was instead just a memoir with a bit of background on why he cares about luxury beliefs so much at the end (spoiler: he went to Yale and then realized everyone else that goes to Yale is rich).
Two articles that give insight into what I think about on a daily basis is How to Fund Growth and Deciding whether an investment is worthwhile. I don’t have more to add than the fact that they’re both great articles for the active entrepreneur.