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We’ve all heard of today’s Titans; those business moguls that possess incredible net worth that rivals almost all others. Bezos, Musk, Gates, even Buffett and Munger. These are household names to both investors and businesspeople the world over. But there was one Titan that could rival them all, and indeed is regarded as the richest American to ever live. Who was it?

John D Rockefeller.

With an estimated net worth of $400b today, how did he earn that title? How did one man find himself literally crushed by money and yet was still able to retire in his mid 50’s?

He did it by owning a great business - which is key to long term investment success. The very best businesses aren’t just slightly better than their competition, they’re orders of magnitude better. Businesses which can grow their earnings and compound their investor’s capital can underwrite their share price performance for years to come - making them one of the safest and surefire ways to investment success.

At the foundation of history’s greatest businesses is usually a powerful business model. In the case of Rockefeller’s Standard Oil, it was ‘Owning the Choke-Point,’ the narrow part of an hour glass separating suppliers and consumers; the centre of the ecosystem. It’s an enduring business model that has delivered windfall profits to company shareholders for centuries.

“Rockefeller had an annual untaxed income of $58m in 1902 - or about a billion dollars in tax-free income per annum in today’s money.”

If the names Chevron, Conoco, Exxon, Mobil or Amoco ring a bell, you’re already familiar with the legacy of Rockefeller’s business, The Standard Oil Trust. An indomitable energy company whose activities spanned production, storage, transport, infrastructure, distribution and retailing that touched consumers and businesses the world over. Standard Oil has long been considered the greatest monopoly of all time.

There are a myriad of lessons for today’s investor in the history of John D Rockefeller and Standard Oil; owning the choke-point, keeping prices low, leveraging and sharing scale, embracing technology, continuously innovating, empowering employees, decentralising, aligning management, growing the market, spurning debt, encouraging internal competition and harnessing tailwinds are as relevant today as they were over a hundred years ago.

Standard Oil’s ability to consistently increase profitability and defy the notoriously boom-bust nature of its industry descended from its ownership of the choke-point; the point where oil supply was transformed into commercial products and distributed for sale.

Rockefeller started out in refining, recognising the benefits of scale, he amalgamated capacity to extract favourable terms from the railways. As refining competitors buckled, Rockefeller drove further consolidation; taking partial stakes, retaining management, and using scrip based funding ensured interests were aligned - creating emergent effects.

Rockefeller recognised the benefits in keeping prices low; the pool of potential buyers was expanded while new competition was deterred from entering the industry. Ever frugal, Rockefeller focused on costs and looked for ways to increase efficiencies; embracing new technologies, constantly innovating and leveraging economies of scale ensured competition was muted. By 1907, the Standard Oil leviathan refined 87% of the kerosene market and was more than twenty times the size of its most serious competitor.

Having come of age in an era of emerging corporate dominance and nascent regulatory oversight, Standard Oil’s anti-competitive tactics [there were many!] eventually attracted Government attention. In 1911, after forty-one years of existence, the Supreme Court ordered the Trust be dismembered into thirty-seven subsidiary companies [including those five companies mentioned above]. The post split performance of Standard Oil Trust might prove a useful guidepost given the regulatory concerns overhanging some of today’s tech titans.

By his mid-fifties, Rockefeller had retired, yet the enormous tailwind of the automotive generation would make him far richer in retirement than in his working life. An abiding self-belief that he was fulfilling God’s wish to earn and share wealth had created a predilection for charity from an early age. At the time of Rockefeller’s death, a few weeks short of his 98th birthday, his career would be defined as much by his philanthropic endeavours as it was by his business success.

Rockefeller’s incredible story has been told in the wonderful book, ‘Titan’, by Ron Chernow.

“Another book that I liked very much was ‘Titan’, the biography of the original John D. Rockefeller. That’s one of the best business biographies I have ever read. And it’s a very interesting family story, too. That was just a wonderful, wonderful book. And I don’t know anybody who’s read it who hasn’t enjoyed it. So I would certainly recommend that latest biography of John D. Rockefeller the first.” Charlie Munger

‘Titan’ is a fantastic journey into the highly complex and contradictory mind of one of the world’s shrewdest businessmen. While not an easy read (bring a dictionary!) it’s worth the effort. While barely scratching the surface of this epic biography, I’ve included some favourite extracts below.

Education and Smarts

“‘I was not an easy student, and I had to apply myself diligently to prepare my lessons.’ said Rockefeller, who described himself accurately as ‘reliable’ but not ‘brilliant.’”

“[When playing childhood games] to ensure that he won, he submitted to games only where he could dictate the rules.”

“‘I was trained from the beginning to work and save,’ Rockefeller explained. ‘I have always regarded it as a religious duty to get all I could honourably and give all I could.’”

“Once Rockefeller spent three days helping a local farmer dig potatoes for 37 cents per day. This set up an instructive contrast for the frugal boy when, soon afterward, he loaned one farmer $50 at 7 percent interest and collected $3.50 at year’s end - without a stitch of work. He was thunderstruck by the happy math, which hit him with the force of a revelation. ‘The impression was gaining ground on me that it was a good thing to let the money be my slave and not make myself a slave to money.’”

Optimism

“[Rockefeller] was a confirmed exponent of positive thinking.”

“Like other Gilded Age moguls, Rockefeller was shaped by his faith in economic progress, the beneficial application of science to industry, and America’s destiny as an economic leader.”

“[After the 1929 market crash, Rockefeller was encouraged to make a calming statement] Rockefeller issued a press release, ‘These are days when many are discouraged. In the ninety years of my life, depressions have come and gone. Prosperity has always returned, and will again.’ In his peroration, he said, ‘Believing that the fundamental conditions of the country are sound, my son and I have been purchasing sound common stocks for some days.’”

Embrace Technology

“The firm relied upon the railroad and the telegraph, the two technologies then revolutionising the American economy.”

“Standard Oil also profited immeasurably from the revolution in oil transport as barrels gave way to tank cars.”

“The railroads balked at investing in rolling stock that couldn’t also transport general freight, So Rockefeller stepped boldly into the breach… As the owner of almost all the Erie and NY Central tank cars, Standard Oil’s position grew unassailable.”

“Only belatedly did Rockefeller discern the full potential of pipelines… [Ultimately] gaining uncontested control of all major pipeline systems connecting oil wells to railroad trunk lines. ‘Practically not a barrel of oil could get to a railroad without Rockefeller’s consent… ‘Rockefeller’s firm had now advanced far beyond the railroads to more efficient pipelines.’”

Understand the Business

“For Rockefeller, ledgers were sacred books that guided decisions and saved one from fallible emotion. They gauged performance, exposed fraud, and ferreted out hidden inefficiencies. In an imprecise world, they rooted things in solid empirical reality. As he chided slipshod rivals, ‘Many of the brightest kept their books in such a way that they did not actually know when they were making money on a certain operation and when they were losing.’”

Efficiency and Scale Advantages

“The proliferation of railroads enabled Rockefeller to extract discounts from them by playing one off against the other.”

“Rockefeller’s ceaseless search for even minor improvements meant that within a year refining had overtaken produce as the most profitable side of the business. Despite the unceasing vicissitudes of the oil industry, prone to cataclysmic booms and busts, he would never experience a single year of loss.”

“His tight-fisted control of details and advocacy of unbridled expansion. Daring in design, cautious in execution - it was a formula he made his own throughout his career.”

“[Rockefeller] was a mastermind of many negotiations with the railroads.. Since oil was a relatively cheap, standardised commodity, transportation costs inevitably figured as a critical factor in the competitive struggle.”

“Rockefeller had built gigantic plants so he could drastically slash his unit costs. Even his first partner remembered that ‘the volume of trade was what he always regarded as of paramount importance.’ Early on, Rockefeller realised in the capital-intensive refining business, sheer size mattered greatly because it translated into economies of scale.”

“Once describing the ‘foundation principle’ of Standard Oil, Rockefeller said it was the ‘theory of the originators’ .. that the larger volume the better the opportunities for the economies, and consequently the better opportunities for giving the public a cheaper product without .. the dreadful competition of the late ‘60’s ruining the business. During his career, Rockefeller cut the unit costs of refined oil almost in half, and he never deviated from this gospel of industrial efficiency.”

Emerging Effects

“Rockefeller activated a self-sustaining movement as his new allies agreed to consolidate business in their localities and supervise the purchase of remaining independent refiners. A massive chain reaction was thus set in motion that rippled through both refining centres, with local businessmen acting as Rockefeller’s agents.”

Owning the Choke-Point

“The spot chosen for the new refinery tells much in miniature about Rockefeller’s approach to business… Able to ship by water or land, Rockefeller gained the critical leverage he needed to secure preferential rates on transportation - which was why he agonised over plant locations throughout his career.”

“[Rockefeller’s] overriding reason for his attachment to Cleveland: It was the hub of so many transportation networks that he had tremendous room to manoeuvre in freight negotiations.”

“Rockefeller’s first visit to Pennsylvania must have persuaded him that he had picked the right entry point to the business. Searching for oil was wildly unpredictable, whereas refining seemed safe and methodical by comparison. Before too long, he realised that refining was the critical point where he could exert maximum leverage over the industry.”

“Rampant speculation had so overbuilt the industry that total refining capacity in 1870 was triple the amount of crude oil being pumped. By then, Rockefeller estimated 90 percent of all refiners were operating in the red. Producers and refiners didn’t shut down operations in the expected numbers causing Rockefeller to doubt the workings of Adam Smith’s invisible hands: ‘So many wells were flowing that the price of oil kept falling, yet they went right on drilling.’ The industry was trapped in a full blown crisis of overproduction with no relief.’ Thus in 1869, Rockefeller feared his wealth might be snatched away from him. As someone who tended toward optimism, ‘seeing opportunity in every disaster’, he studied the situation exhaustively instead of bemoaning his luck. He saw that his individual success as a refiner was now menaced by industrywide failure and that it therefore demanded a systematic solution. This was a momentous insight, pregnant with consequence. Instead of just tending to his own business, he began to conceive of the industry as gigantic, interrelated mechanism and thought in terms of strategic alliances and long term planning. Rockefeller cited the years 1869 and 1870 as the start of his campaign to replace competition with cooperation in the industry. The culprit, he decided, was ‘the over-development of the refining industry,’ which had created ‘ruinous competition.’ If this fractious industry was to be made profitable and enduring, he would have to tame and discipline it. A trailblazer who improvised solutions without any guidance from economic texts, he began to envision a giant cartel that would reduce overcapacity, stabilise prices, and rationalise the industry.”

“Between February 17 and March 28 1972 - between the first rumours of the SIC [proposed agreement between Standard Oil and the railways] and the time it was scuttled - Rockefeller swallowed up twenty-two of his twenty-six Cleveland competitors… Another businessman might have started with small, vulnerable firms, building on easy victories, but Rockefeller started at the top, believing that if he could crack his strongest competitor first, it would have tremendous psychological impact.”

“In retrospect, it seems peculiar that Standard Oil - omnipotent in refining, transportation, and distribution - owned just four production properties in the early 1880’s… He had long profited from the juxtaposition of cooperation in refining and competition in production.”

“Rockefeller applied to iron ore [interests] lessons he had learned in oil, such as controlling an industry through transportation and demoralising competitors with prices too low for them to match.”

“The unity of Standard Oil partners was especially impressive given the organisation’s byzantine structure, a far-flung patchwork of firms, each nominally independent but in reality taking orders from 26 Broadway [Standard Oil head office].”

Innovation

“Scarcely dreaming that oil would ever supersede their main [agricultural produce] commodity business, they [Rockefeller & partner] considered it ‘a little side issue.’”

“Rockefeller wasn’t stultified by precedent or tradition, which made it easier for him to innovate. He continued to value autonomy from outside suppliers. At first, he paid small coopers up to $2.50 for white oak barrels before he showed, in an early demonstration of scale, that he could manufacture dry, tight casks.. for less than a dollar a barrel. The Cleveland coopers bought and shipped green timber to their shops, whereas Rockefeller had the oak sawed in the woods and dried in kilns, reducing its weight and slicing transportation costs in half.”

“Regarding each plant as infinitely perfectible, Rockefeller created an atmosphere of ceaseless improvements.”

“Below the executive committee came a battery of specialised committees dedicated to transportation, pipelines, domestic trade, export trade, manufacturing, purchasing and so on. These committees standardised the quality of subsidiaries engaged in similar work, enabling managers to swap insights and align their operations… These were chosen experts who had daily sessions and study of the problems, new as well as old, constantly arising. The benefit of their research, their study, was available for each of the different concerns.”

“Rockefeller created the model for the vertically integrated oil giants that would straddle the globe in the twentieth century.. By 1891 Rockefeller had gained control of a quarter of American oil production.”

Tailwinds

“The [civil] war had stimulated growth in the use of kerosene by cutting the supply of southern turpentine .. kerosene emerged as an economic staple and was primed for a furious postwar boom.”

“The [civil] war markedly accelerated the timetable of economic development, promoting the growth of factories, mills, and railroads. By stimulating technological innovation and standardised products, it ushered in a more regimented economy. The world of small farmers and businessmen began to fade, upstaged by a gargantuan new world of mass consumption and production.”

“Europe emerged rapidly as the foremost market for American kerosene, importing hundreds of thousands of barrels yearly during the civil war. Perhaps no other American industry had such an export outlook from its inception. By 1866, fully two-thirds of Cleveland kerosene was flowing overseas.”

Low Prices

“Rockefeller’s goal was to forestall potential competitors through low prices and thus minimise risk and chance disruptions.”

“Standard Oil had not kept prices low out of altruism but to deter competition and ‘keep our profits on such a basis that others would not be stimulated to enter the field of competition with us.’ This belied Rockefeller’s frequent claim that his motive was to bequeath cheap oil to the working people.”

“Rockefeller was obsessed with high-volume, low cost production to maintain market share, even if he temporarily sacrificed profit margins. As he noted, ‘This fact the Standard Oil Company always kept in mind: that they must render the best service and be content with largely increasing volume of business, rather than increase the profit so as to tempt others to compete with them.’ When discussing prices with subordinates, he frequently reminded them, ‘We want to continue, in reason, that policy which will give us the largest percentage of business.’”

“In general, Standard Oil did an excellent job at providing kerosene at affordable prices. It boasted far lower unit costs than competitors and relentlessly drove down costs over the years.’ Between 1880 and 1885, its average cost of processing a gallon of crude oil went from 2.5 to 1.5 cents. [In the 20 years to 1890] the retail prices of kerosene had plunged from 23.5 cents to 7.5 cents per gallon.”

“But Standard Oil never sought a perfect monopoly because Rockefeller realised that it was politically prudent to allow some feeble competition.. A very smart monopolist, Rockefeller kept prices low enough to retain control of the market but not so low as to wipe out all lingering competition.”

“Rockefeller new that if he got greedy, other products could be substituted for kerosene, and this, too, curbed his appetite for excess profits.”

“Rockefeller keenly felt a need to freeze the industry’s size, stymie new entrants, and create an island of stability in which expansion and innovation could then occur unimpeded.”

John D Rockefeller’s NY Residence

Empowering People

“Rockefeller wanted to be surrounded by trustworthy people who could inspire confidence in customers and bankers alike.”

“In the early days, Rockefeller knew the name and face of each employee.”

“Rockefeller generally received excellent reviews from employees who regarded him as fair and benevolent, free of petty temper and dictatorial airs.”

“So highly did Rockefeller value personnel that during the first years of Standard Oil he personally attended to routine hiring matters.”

“‘The ability to deal with people is as purchasable a commodity as sugar or coffee,’ Rockefeller once said, ‘and I pay more for that ability than for any other under the sun.”

“Employees were invited to send complaints or suggestions directly to Rockefeller, and he always took an interest in their affairs. His correspondence is replete about sick or retired employees. Reasonably generous in wages, salaries, and pensions, he paid somewhat above the industry average.”

“His employees tended to revere Rockefeller and vied to please him. As one said, ‘I have never heard of his equal in getting together a lot of the very best men in one team and inspiring each man to do his best for the enterprise.”

“At first, Rockefeller tested employees exhaustively, yet once he trusted them, he bestowed enormous power upon them and didn’t intrude unless something radically misfired.”

“People who worked for Rockefeller usually found him a model of propriety and paternalistic concern.”

“Rockefeller’s decided the leading men [management co-owners] would receive no salary but would profit solely from the appreciation of their shares and rising dividends - which Rockefeller thought a more potent stimulus to work.”

“When it came to mergers, Rockefeller didn’t fight for the last dollar and tried to conclude matters cordially. Since he aimed to convert competitors into members of his cartel and often retained the original owners.”

“The creation of Standard Oil was often less a matter of stamping out competitors than of seducing them into co-operation. In general, Rockefeller was so eager to retain original management that he accumulated expensive deadwood on the payroll and, for the sake of intra-empire harmony, preferred to be conciliatory.”

“One of Rockefeller’s greatest talents was to manage and motivate his diverse associates. As he said, ‘It is chiefly to my confidence in men and my ability to inspire their confidence in me that I owe my success in life.”

“Free of an autocratic temperament, Rockefeller was quick to delegate authority and presided lightly, genially, over his empire, exerting his will in unseen ways.”

“The Trust’s formation created negotiable securities, and this profoundly affected the Standard Oil culture. Not only did Rockefeller urge underlings to take stock but made money abundantly available to do so. As such shareholding became widespread, it welded the organisation more tightly together, creating an esprit de corps that helped in steamrolling competitors and government investigators alike. With employees receiving huge capital gains and dividends, they converted Standard Oil into a holy crusade.”

“Rockefeller hoped the Trust would serve as a model for a new populist capitalism, marked by employee share ownership. ‘I would have every man a capitalist, every man, women and child,’ he said, ‘I would have everyone save his earnings, not squander it; own the industries, own the railroads, own the telegraph lines.”

“[Rockefeller’s] committee system was an ingenious adaption, integrating the policy of constituent companies without stripping them of all autonomy. We must remember that Standard Oil remained a co-federation and most of its subsidiaries were only partially owned. A top down hierarchical structure might have hampered local owners whom Rockefeller had promised a measure of autonomy in running their plants. The committee system galvanised their energies while providing them with general guidance. The committee encouraged rivalry among local units by circulating performance figures and encouraging them to compete for records and prizes. The point is vitally important, for monopolies spared the rod of competition, can easily lapse into sluggish giants.”

Walk The Floors

“In the first years of Standard Oil, Rockefeller regularly toured his facilities and was extremely inquisitive and observant, soaking up information and assiduously quizzing plant superintendents. In his pocket, he carried a little red notebook in which he jotted suggestions for improvements and always followed up on them.”

Financial Strength

“[Rockefeller] always moved into battle backed by abundant cash. Whether riding out downturns or coasting on booms, he kept plentiful reserves and won many bidding contests simply because his war chest was deeper.”

“Standard Oil weathered the six-year depression magnificently, a fact Rockefeller attributed to its conservative financial policy and unparalleled access to bank credit and investor cash.”

“The Standard Oil Trust’s resilience during the depression of the 1890’s, its tested immunity from market fluctuations, cheered Rockefeller, who attributed this to Standard’s large cash reserves and conservative dividend policy.”

“Since the early 1880’s, Standard Oil had been self-financing, very liquid at all times, and free from the thrall of Wall Street bankers.”

Grow the Market

“To inflate demand, Rockefeller sold hundred of thousands of cheap lamps and wicks and sometimes distributed them gratis with the first kerosene purchase.”

“Rockefeller also sold, almost at cost, heaters, stoves, lamps, and lanterns to widen the market. In the manner of a modern corporation, Standard Oil created demand as well as satisfied it.”

“Rockefeller continually extended the market for petroleum by-products, selling benzine and paraffin, and petroleum jelly in addition to kerosene.”

Fanaticism & Obliquity

“Rockefeller derived a glandular pleasure from work and never found it cheerless drudgery. In fact, the business world entranced him as a fount of inexhaustible wonders. ‘It is by no means from money alone that these active-minded men labor - they are engaged in a fascinating occupation.’ he wrote in his memoirs. ‘The zest of the work is maintained by something better than mere accumulation of money.”

“Rockefeller seemed destined to succeed as much from his fastidious work habits as from innate intelligence.”

“Even in as a young man, Rockefeller was extremely composed in crisis. In this respect, he was a natural leader; The more agitated others became, the calmer he grew.”

“The passion for excellence originated with Rockefeller and radiated throughout the organisation. The ethos of Standard Oil’s operations around the world was John D Rockefeller’s personality writ large.”

“Rockefeller inspired subordinates with his fanatic perfectionism.”

Humility

“Aside from the occasional courtesy call from other moguls, he hobnobbed with the same family members, old friends, and Baptist clergy who had always formed his social circle.”

“When someone expressed surprise to Rockefeller that he had not gotten a big head, he replied, ‘Only fools get swelled up over money.’ Comfortable with himself, he needed no outward validation of what he had accomplished.”

“Rockefeller preferred outspoken colleagues to weak-kneed sycophants and welcomed differences of opinion so long as they weren’t personalised.”

Frugality

“From his mother he learned economy, order, thrift, and other bourgeois virtues that figured so largely in his success at Standard Oil.’”

“Rockefeller engaged in strenuous rituals of austerity, and grimly sought to simplify his life and reduce his wants. He liked to say that ‘a man’s wealth must be determined by the relation of his desires and expenditures to his income. If he feels rich on ten dollars, and has everything else he desires, he really is rich.’”

“Rockefeller spent a ridiculous amount of time protesting bills both large and small.”

“[Rockefeller would say,] save when you can and not when you have to.”

“The world’s richest man never lost the thrifty boyhood habits that had made him the nonpareil of American business.”

Secrets

“Rockefeller trained himself to reveal as little as possible.”

“He learnt to cultivate a secretive style and a defiant attitude toward strangers.”

“Rockefeller never allowed his office decor to flaunt the prosperity of his business, lest it arouse unwanted curiosity.”

“Rockefeller was concerned that if he advertised his own wealth through fancy houses, he might attract investors into the refining business and only worsen the excess capacity problem.”

“Ever alert against industrial espionage, Rockefeller never wanted people to know more than was required and warned one colleague, “I would be very careful about putting someone into a position where he could learn about our business, and be troublesome to us.”

“Rockefeller equated silence with strength. Weak men had loose tongues and blabbed to reporters, while prudent businessmen kept their own counsel.”

Anti-Competitive Tactics

“Since the rules of the game had not yet been encoded into law, Rockefeller and his fellow industrialists had forged them in the heat of combat. With his customary thoroughness, Rockefeller had devised an encyclopaedic stock of anti-competitive weapons. Since he had figured out every conceivable way to restrain trade, rig markets, and suppress competition, all reform-minded legislators had to do was study his career to draw up a comprehensive antitrust agenda.”

“Rockefeller perfected a monopoly that indisputably demonstrated the efficiency of large scale-business.”

Post Split

“During the ten years after Standard Oil’s 1911 dismantling, the assets of its constituent companies quintupled in value.”

“Those who had seen the Standard Oil dissolution as a condign punishment for Rockefeller were in for a sad surprise: It proved to be the luckiest stroke of his career. Precisely because he lost the antitrust suit, Rockefeller was converted from a mere millionaire, with an estimated net worth of $300 million in 1911, into something just short of history’s first billionaire.”

“What quickly grew apparent, however, was that Rockefeller had been extremely conservative in capitalising Standard Oil and that the split-off companies were chock full of hidden assets. Two other factors encouraged a veritable feeding frenzy in the stocks. For years, the shares of Standard Oil of New Jersey had been depressed by the antitrust litigation, but with the litigation ended, they bounced back to more normal levels. And the explosion of the automobile industry created euphoria about the endless growth prospects of the petroleum industry.”

“Many of the newly independent companies were powerful enough to inspire fear as freestanding entities. Standard Oil of New Jersey remained the world’s largest oil company, second only to US Steel in size among American enterprises and retaining 43% of the value of the old trust.”

Philanthropy

“During his first year on the job, the young [Rockefeller] donated about 6 percent of his wages to charity, some weeks much more. ‘I have my earliest ledger and when I was only making a dollar a day I was giving five, ten, or twenty-five cents.”

“Even as a teenager, he took palpable pleasure in distributing money for charitable purposes, and he insisted that from an early date he discerned the intimate spiritual link between earning and dispensing money.”

“Since his adolescence, charity had been interwoven with the fabric of his life.”

“Rockefeller argued that the rich should donate large sums to worthy causes during their lifetimes, less their money be frittered away by idle heirs.”

“Rockefeller regarded his fortune as a public trust, not as a private indulgence, and pressure to dispose of it grew imperative in the 1900’s as his Standard Oil stock and other investments appreciated fantastically.”

“Rockefeller believed that certain universal principles of businesslike efficiency should apply to non-profit ventures no less than to profit-making ones.”

“Never before had a rich benefactor spent his money in this area.. ‘It marked the first large public recognition of medical education and research as a rewarding subject of philanthropy.’”

“Rockefeller Foundation played an integral part in the rise of American medicine to the pinnacle of world leadership.”

“Rockefeller’s philanthropy was more orientated toward the creation of knowledge, and if it seemed more impersonal, it was also far more pervasive in its effect.”

“The fiercest robber baron had turned out to be the foremost philanthropist.”

“Rockefeller established the promotion of knowledge, especially scientific knowledge, as a task no less important than giving alms to the poor or building schools, hospitals, and museums.”

Summary

Studying history’s great businesses and managers can enlighten us to factors that characterise success and help shed light on new investment opportunities. While technologies change and economies evolve, the business models that define these great companies can endure for decades, even centuries.

Since the days of Standard Oil, many businesses have achieved effective ownership of the choke-point. Even the Mafia recognised the significant benefits accruing to such a position when they controlled New York’s concrete industry in the 1980’s. Collecting a tax of 1-2 percent on every new skyscraper - if you wanted to build you had to talk to the Mob.

More recently we’ve witnessed a multitude of companies monopolising industry choke-points. The capital-light nature of some of these technology businesses with their first mover advantages, network effects, increasing returns and winner-take-all dynamics may mean even longer life cycles.

Businesses which can compound capital for decades are the holy grail of investing. Charlie Munger likes to remind us, "There are certain fundamental models out there that do not take the kind of ability that quantum mechanics requires. You just have to know a few simple things and really know them.” The choke-point is one of them.

“There was only one John D Rockefeller,” concludes Chernow’s epic biography. Indeed, there was.

Reference:
‘Titan - The Life of John D Rockefeller, Sr,’ Ron Chernow, 1998, Random House.

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The great investors never stop learning. Warren Buffett, Charlie Munger and John Templeton all continued to learn well past the age of most people’s retirement, and despite decades of investment success, they all had the humility to recognise there was so much more to learn. More recently, the eminently successful practitioners, Howard Marks and Dan Loeb have each acknowledged their continued evolution as investors.

And the information they absorb can come from a multitude of sources. At MastersInvest we have looked at what can be learned from a variety of areas, many of which upon first reflection you would consider to be only tenuously related to investing at best. Interestingly though, often the better learning is to be found in the most unlikely of places.

“Camel's nostrils are miracles of heat exchange and water recovery engineering. We are currently looking at cuttlebone and bird skulls to help design more efficient concrete structures for office buildings. The combustion chamber in the abdomen of a bombardier beetle mixes two high explosives from fuel tanks with valves that open and close 200 times a second—it is being studied in order to develop needle-free medical injections, more efficient fuel injection systems and more effective fire extinguishers.” Michael Pawlyn

This field is called biomimicry; a discipline that looks at nature's best ideas to inspire solutions to human problems. When it comes to continuous innovation and devising strategies for success, nature has a three billion year head start on us humans. While we’ve barely scratched the surface when it comes to understanding the world we live in, it’s no reason to be despondent. The world is just far too complex and ever changing. There’s much to learn and everyday those learnings can help in all facets of life.

A recent article in The Economist titled, ‘The nose knows - Flies, worms and bees could help detect illness’ provides an enlightening example. While everybody knows dogs have a much better sense of smell than us, few would realise they can smell things at concentrations of one part in a trillion. That’s equivalent to a single drop in a pond the size of 20 Olympic swimming pools! While trials have shown that dogs can detect human disease - cancer, diabetes, tuberculosis, and malaria - recent research shows bees have senses just as good. Imagine such an expendable resource providing an economical, easy and non-invasive way of detecting cancer.

“The imagination of nature is far, far greater than the imagination of man. No one who did not have some inkling of this through observations could ever have imagined such a marvel as nature is.” Richard Feynman

Many great investors have found lessons in life within nature itself. The learnings that she can offer us are many and varied, and so upon recommendation by both Michael Mauboussin and James Anderson, I recently delved into an interesting book called, ‘Honeybee Democracy.’

In this fascinating treatise, the world-renowned animal behaviourist Thomas Seeley delves into the life of a honey bee swarm. These tiny creatures face a life-or-death problem when choosing a new home, effectively ‘staking everything on a process that includes collective fact-finding, vigorous debate, and consensus building.’

It all starts with the honey bee colony’s reproduction process. In the late spring and early summer, as a bee colony becomes overcrowded, a third of the hive stays behind and rears a new queen, while a swarm of thousands departs with the old queen to produce a daughter colony. As part of this process, a small percentage [c2%] of the hive’s worker bees, referred to as scouts, will independently search for a new nest site.

Experimental studies have found these scout bees to have an innate sense of what comprises the ideal location; a small entrance, plentiful volume for honey storage to survive winter, a suitable height above the ground, etc. Each scout bee’s job is to independently search for new locations and report them back to the hive. This communication process is achieved through a form of ‘ritual dance’ which signals both the location of the sites and the scout bee’s relative keenness on it.

Upon witnessing the dances, other scout bees will then visit the advertised sites and make their own independent assessment of the location’s merits and once again communicate this to the colony. Over time, each scout gradually reduces their marketing efforts regardless of how suitable the site is. The most keenly marketed sites attract more scouts who then inspect and, if appropriate advertise the site, creating a positive feedback loop. In contrast, lower quality sites are abandoned. When a quorum of bees is reached at the optimum site, the swarm will depart and take up residence in its new home.

An intelligent decision making process emerges from a group of less sophisticated beings; the wisdom of the hive is greater than that of any individual bee. This decision making process, honed over millions of years, almost always leads to the optimal site selection. There is no central decision maker; the queen bee plays no role in the process.

There are lessons in this decision making process that can help improve group decision making. Thomas Seeley recommended four things:

1) make sure the group is sufficiently large for the challenges it faces
2) make sure the group consists of people with diverse backgrounds and perspective
3) foster independent exploratory work by the group’s members
4) create a social environment in which the group’s members feel comfortable about proposing solutions

Every bee in the hive starts with a common purpose. The individuals and the hive’s interests are aligned - to the point where it is a life or death decision. When it comes to human decision making, ensuring a group understands the entities goals, have alignment and are incentivised appropriately, is fundamental.

The scout bees possessed an innate sense of what constitutes an optimal nest site. Extrapolating this to an investment group requires agreement on the attributes of a ‘good investment.’ Defining qualities such as a businesses’ purpose, a good culture, enduring competitive advantages, high returns on capital, management alignment and capability are perhaps, pre-requisites to consider. Filtering out unsuitable opportunities is an important part of the process.

Just as each bee doesn’t compare and contrast every site, but investigates a diverse range of sites, investment analysts should search widely for potential opportunities. Each analyst however, must be discerning in their selection process before reporting back to the group. Other analysts can then independently investigate those companies and a debate can be held about the merits of each.

While it might sound like common sense, collective groups of people have a tendency to make poor decisions. It’s uncanny the extent to which Thomas Seeley’s findings and recommendations parallel with those that the renowned Yale psychologist, Irving Janus described in his famous book, ‘Groupthink.’

Summary

One recurring trait of the great investors is their dedication to continuous learning. And its astounding from how many diverse fields they can draw life’s lessons from. At Mastersinvest we’ve drawn on teachings from great Investors, Businesses, CEO’s, Navy Captains, Psychologists, Physicists, Artists - and now - Honey Bees!

As humans, we understand just a fraction of what there is to know, which should make one optimistic about the amazing things we will achieve in the future. I’ll leave you with one of my all time favourite quotes from Ray Dalio, it connects the concept of nature and humility far better than I ever could.

“While I spend the most time studying how the realities that affect me most work—i.e., those that drive the markets and the people I deal with — I also love to study nature to try to figure out how it works because, to me, nature is both beautiful and practical. Its perfection and brilliance staggers me. When I think about all the flying machines, swimming machines, and billions of other systems that nature created, from the microscopic level to the cosmic level, and how they interact with one another to make a workable whole that evolves through time and through multi-dimensions, my breath is taken away. It seems to me that, in relation to nature, man has the intelligence of a mould growing on an apple—man can’t even make a mosquito, let alone scratch the surface of understanding the universe.” Ray Dalio, Principles 2011.

Source:
‘Honeybee Democracy,' Thomas Seeley, 2010, Princeton University Press.

Further Reading:
‘Avoiding Groupthink,’ Investment Masters Class, 2016.

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I recently had the pleasure of chatting to Sean Murray from ‘The Good Life.’ We talked about all things investing including quality companies, powerful business models, developing a multi-disciplinary mindset and the common threads evident amongst the very best investors, CEOs and businesses.

I’m a big fan of Sean’s work, be sure to check out his other interviews with the likes of Robert Cialdini, Annie Duke, Michael Abrashoff, Morgan Housel and William Green.

I hope you enjoy the episode…

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There are many companies in the world across a range of quite diverse industries. Some are simple by nature while others are infinitely more complicated, and you would have to think that with such a diverse spread that some businesses would be easier to compete with than others. And if you thought that, you wouldn’t be wrong.

In the next few years, the world’s leading semiconductor company will release a chip with almost 300 million transistors per square millimetre! Hard to copy? Unquestionably. How about a fast food outlet selling chicken sandwiches? On the face of it, not that hard to compete with. You can replicate the ingredients, the store fit-outs, the locations, the marketing and the packaging - but the one secret ingredient you might struggle to copy is the culture.

Consider Chick-fil-A, the fast food business that’s taken over America. A private company, Chick-fil-A is now the third largest chain behind McDonalds and Starbucks. In 2019, it generated more than $US11 billion in revenue, signifying 52 consecutive years of sales growth. When it comes to sales-per-store, no major US fast food chain comes close; the average store turns over more than a Burger King, KFC, Dominoes and Subway combined. And the stores are closed on Sunday!

On the basis of sales per store you’d expect Chick-fil-A could achieve a premium for the franchises it sells. It costs more than $US1 million to open a McDonald’s, a Burger King, or a KFC restaurant, and yet opening a Chick-fil-A restaurant costs just $US10,000.

Charlie Munger’s counsel to understand Chick-fil-A and it’s incredible success would be to ask his favourite question, ‘What in hell is going on here?’

Luckily for us, Chick-fil-A’s founder, S. Truett Cathy, addressed just such a question in his book, ‘How did you do it, Truett?' The answer aligns with another of Charlie’s mental models, ‘businesses that go ridiculously far in maximising and/or minimising one or a few variables tend to have the winning systems.’

“I’d recommend a book by S. Truett Cathy who started Chick-fil-A, the chicken burger chain. The book, ‘How did you do it Truett?,’ was really good. I've been hoping that Chick-fil-A becomes a public company since then.” Francois Rochon

Legendary customer service lies at the heart of Chick-fil-A’s success. There’s even such a thing as Chick-fil-A memes; Parodies of the lengths employees will go to delight their customers. A few years ago a video of a 20-year-old Chick-fil-A worker went viral, ‘The way you interact with people really matters, it transforms their day,’ the eager employee later explained. Termed ‘second-mile-service,’ staff have been known to change a customer’s tyre or drop their lost keys or cell phone home, earning the company the top spot amongst fast food chains in the American Customer Satisfaction Index in each of the last seven years.

Source: QSR 2020 Ranking the Top 50 Fast-Food Chains

The late S. Truett Cathy understood that a business has a higher purpose than just making money. From the humble beginnings of a single restaurant, S. Truett Cathy rode the tailwind of America’s urbanisation, living his religious values, empowering his franchisees, listening to his customers, encouraging innovation, embracing crises, exceeding his patron’s expectations and taking a long term view. In the process he created a multi-billion dollar fast food enterprise.

S. Truett Cathy has shared his experiences and wisdom in a collection of short business books. Highly engaging, the lessons of ‘servant leadership,’ managing growth, selecting and valuing employees, delivering quality and setting the tone from the top are but a few of the mental models to be gleaned. Chick-fil-A’s unconventional approach to franchising provides a bounty of lessons in itself.

I’ve include some of my favourite S. Truett Cathy quotes below.

Education and Smarts

“As a young boy I had a speech impediment so severe I could not pronounce my own name.”

“When I was in school, I never was an achiever. I wasn’t able to make the chorus, I could never play a musical instrument, I didn’t excel in sports, and I certainly didn’t excel academically. But I had established some good work habits and had an attitude that has been very beneficial to me.”

Keep it Simple

“Every day, we remember the Chick-fil-A Chicken Sandwich is really a simple concept. We take advantage of our biggest opportunities when we keep it simple, focusing on serving great tasting food in a clean, wholesome environment with great customer service. That hasn’t changed in the sixty-one years I’ve been in the restaurant business.”

Customers

“Be kind to your customers. It’s the key to success… You can’t beat the Golden Rule as a business philosophy: Do unto others as you would have them do unto you.”

“The customer is always king. He or she is always right. You know the kind of service you like to have from people behind the counter. That’s the kind of service we want you to offer the customers.”

“Listening to my customers - One of the first things I learned in the restaurant business was to find out what my customers wanted then provide it to them.”

“The key to succeeding with a paper route - and the restaurant business, I would learn later on - is to take care of the customer.”

“Ever since I was a teenager delivering newspapers, I have tried not to lose a single customer. I treated each one like the most important person in the world, and delivered each paper as if I was delivering it to the front door of the Governor’s Mansion.”

“The customer is always right, and I always oblige the customer.”

“Courtesy is cheap to provide, and it pays great dividends.”

“The bottom line is, the customer standing right in front of you is funding your paycheck, and perhaps your future. Treat that one person right. Give him or her all of your attention for the moment. Have a servant’s attitude. The customer is always right, even when he or she is wrong.”

“We are building success one loyal customer at a time, and we make sure that everyone who comes in leaves with the intention of coming back.”

“We outperform other quick-service restaurant chains because of the courtesy and kindness we offer our customers. We advertise on radio, television, and in newspapers, but none of that takes the place of having customers as our cheerleaders.”

Servant Spirit

S Truett Cathy [Source: Chick-fil-A]

“To often these days, especially in retail situations, when I say, ‘Thank you,’ the response is ‘No problem.' Or worse, just a grunt. It seems the best I can hope for is, ‘You’re welcome’. I asked our Operators, team members, and corporate headquarters to say, ‘My pleasure’ whenever someone thanked them. The purpose was not just to change the words we say, but to remind those we serve, as well as ourselves, of the ‘servant spirit’ and ‘second-mile’ orientation we are continually building into our business.”

“Second-Mile service is about the heart, and it goes above and beyond the requirements, making sure customers not only get what they expect, but something more that makes them say, ‘Wow!’ Almost everyday we hear about a team member helping change a customer’s tire or making an extra effort to return lost keys or a cell phone that was left behind.”

“You can do a lot of things short of giving away food to express hospitality, but the most important thing is to feel in your heart the desire to serve.”

Competitive Advantages

“Chick-fil-A is what it is today because of its product, people, and purpose.”

“Businesses don’t succeed or fail. People do.”

“I believe the reason Chick-fil-A is so successful is simple - we care much more than our competitors. Being successful requires more than just unlocking the doors every day. Our philosophy of ‘doing the right thing and doing things right’ is hardly ever the easiest solution. It is, however, always the best solution.'“

Source: Chick-fil-A

“Because almost all Chick-fil-A franchised Operators have only one restaurant, they’re in the store virtually every day and have the best interest of their particular restaurant in mind. They care about the quality of people on their team and the quality of the food they serve. Better people and better food means higher sales and higher profits for the Operator.”

“Two things set our people apart: We’re happy to be here, and we have the spirit of a servant. In our restaurant, both of those feelings must come from me, the Operator.” Charles Gibson, Chick-fil-A Operator

“Today we go out of our way to keep people from being able to figure out our product. Our company makes our seasonings, and another makes the breading.”

“Raising prices for me has always been the absolute last resort - after we squeeze out every bit of waste we can.”

“Although we’ve been closing my places of business on Sunday for more than forty years [in deference to S. Truett Cathy’s religious beliefs], I keep hearing the same comments and questions. I don’t believe we’ve lost any sales in the long run. In the shopping malls we usually generate more sales per square foot in six days than many others do in seven. We also believe that by giving employees that free day, we attract the kind of people who want Sunday off because of their own convictions.”

Associate with Quality People

“Associate yourselves only with those people you can be proud of whether they work for you or you work for them.”

“You’ll be the same person five years from now as you are today except for the books you read and the people you associate yourself with. I hope I’m not the same person today that I was five years ago.”

Hiring & Firing

“If you really aren’t interested in serving others, you don’t need to be in the restaurant business in the first place. We like to say we recruit smiles. You can’t teach a sour person to be joyful.”

Source: Chick-fil-A

“A good attitude is one of the best guarantees of success. A less qualified individual with a good attitude would be more welcomed at my company than a highly talented individual with a bad attitude.”

“From the beginning, and until only recently, I interviewed every new candidate. I knew all the Operators by name, and most of their spouses and children.”

“I never want to fire someone simply to save money. I want everyone who works at Chick-fil-A to feel secure that we will not resort to layoffs because we have overextended.”

“We don’t hire people because they need a job. We hire people because we need them. We must be very selective... The wrong person working just ten hours a week can run off a lot of customers.”

“The biggest impact on service is our people.”

“Motivation expert Zig Zigler has said that among the top twenty-five attributes companies look for in an executive, not one of them deals with experience. Character traits are most important. Everything else can be learned.”

Hire Better People

“When you get to this size, you grow through the talent of others - people I have attracted through the years who make my job look easy. I divided the tasks among other people more skilled in their areas than I am, and I trust them to do the job well.”

Trust

“Loyalty begins with trust. My policy has always been to select trustworthy people - then trust them!”

“Success in any relationship or endeavour begins with trust. It’s amazing how much you can accomplish when you trust the people around you and they trust you.”

“A lot of what we do is trust. The Chick-fil-A franchise Operator Agreement is based on trust. It’s the biggest key to our success.”

“We trust our Operators to make good decisions - and they do.”

Obliquity

“It’s an axiom of business that if you help people get what they want, you’ll get what you want.”

“Profits should be the score of the game, not the name of the game.”

“What counts in this business is not how much money we make or how much chicken we sell. What counts is the difference we make in the lives of others.”

Reciprocation

“We would be loyal to [the Operators], treating them as we wished to be treated, and they would reciprocate. They did. Fewer than five percent of our Operators leave the chain in any given year. Other chains tout their ‘knowledge management’ with their computer and communications systems; we manage knowledge by keeping people - and their knowledge - in the organisation.”

“I look for ways to do special things for customers. Like when I see a customer three or four times in the same week, I go to their table and give them a ‘Be Our Guest’ card. I figure if they’re spending fifteen or twenty dollars a week, I’ll give them a free sandwich. All of this fits into the Chick-fil-A philosophy that I first experienced when I went to work for the company.” Chick-fil-A Employee

Value Employees

“The most important people in this business are our employees. Some people will say customers are most important, but if we create the right atmosphere where our employees enjoy their jobs and have opportunities for growth, they will get a kick out of their work. Then that feeling will spill right over to the customer.”

“Studies show that between 65% and 80% of working people do not like what they are doing for a living. That’s a sad fact because a person spends one-third of his life on the job.”

Operators

“We do all we can to make our Operators successful because if they’re successful, so is the company.”

“The most important decision we make at Chick-fil-A is selecting restaurant Operators who care about others, who can motivate their team, and who understand how to run a business. Our franchise Operators determine the success of the chain. They’re the ones meeting customers and selling chicken sandwiches.”

“The Operator selection process can be lengthy, sometimes as long as a year, because we want to be certain before we make a franchise commitment that we believe the relationship will last.”

“Our relationship with our Operators begins with the assumption that we have the same goals and we all plan to succeed. Our operators own their own business, but our relationship is extremely close.”

“It’s easy to apply for a position as an Operator of a Chick-fil-A Unit, but hard to qualify... We don’t select or even seriously consider an Operator or a member of staff unless we want the individual to be with us until one of us retires or dies. Because of that, Chick-fil-A has one of the lowest turnover rates in the restaurant industry.”

“Two requirements of being an Operator are that the Operator run only one restaurant and must be on-site to manage it.”

“We supply the initial capital for the restaurant, so we don’t have to limit our search for Operators to people with high personal net worth. The only money required is $5,000 refundable initial capital commitment. To fuel the kind of growth we desire, we need eager, talented, honest, dependable, people-orientated Operators who are hungry to succeed in the restaurant business.”

“The first question most people ask about our [Operator] agreement is, ‘How could you afford such a generous arrangement with Operators?’ The answer is obvious. We love it when an Operator earns a lot of money because that means we are also earning a lot of money from the restaurant. The more successful we make the Operator, the more successful we are.”

“We are placing our reputation and our future in the hands of one individual. Because we build the Unit and then lease it to the Operator, the ability and the character of the individual are more important than his money.”

“The more we can foster the feeling that we are a group of people working together, depending on each other, and not just bound by a franchise agreement, the more likely we are to be loyal to each other.”

“In my first meeting with a potential Operator, I explain that our commitment is going to be like a marriage, with no consideration given to divorce. We’re much more careful about selecting Operators when we know we cant easily get rid of them.”

“Our lifelong commitment to the success and well-being of Operators has resulted in loyal Operators who then experience tremendous loyalty from their team members - and, in turn, their customers - especially when compared to the rest of the quick-service restaurant business.”

“We have created this ‘loyalty effect’ at Chick-fil-A through a unique relationship with our Operators.”

“The Operator is the CEO, manager, president, and treasurer of his or her own business. I haven’t changed the basic agreement with Operators since my first Chick-fil-A restaurant opened in 1967.”

“Our Operators work closely with us, but they are the owners of their own business.”

Chick-fil-A - Closed Sunday

“Another key to Operator loyalty lies in our decision to allow each Operator to have only one restaurant… A few Operators believe that because they have trained their staff well, their presence isn’t needed. But I’ve found that team members will always perform better when the Operator is on site.”

“We have a saying around the office, ‘An Operator gets the people he or she deserves to have.’ Good people attract good people.”

“We had our design people spend a lot of time in the field talking with Operators and seeing how they ran their business. Experienced operators know better than anybody how to serve people quickly and efficiently.”

“We screen very carefully our Unit Operators. Therefore, we assign our unit realising that this is the most important decision we make. We can decorate it beautifully and out the best equipment in there are prepare the very best food, but if we don’t have the very best Operator, we have blown the whole thing.”

“Another question we often hear is, ‘Why don’t you offer typical franchises where the franchisee makes a substantial investment?’ The answer is similar to my answer regarding a public offering, and can be found in our needs. A restaurant company needs two things to succeed, capital and talent. Franchise restaurant corporations raise capital by selling the rights - usually for hundreds of thousands of dollars - to open a restaurant to people who have already succeeded in business and are looking for a good investment. Sometimes the franchise owner will work directly in the restaurant, but most of the ones I have met are looking to own several units from which they draw income. They aren’t interested in actually wearing a uniform and serving customers. Restaurant magazines are full of articles discussing franchisees blaming franchisers for their lack of success, when the problem is their own lack of time in the restaurant.”

Commitment

“I want everyone at Chick-fil-A to know that we don’t build and open restaurants just so we can close them if they don’t work out. We must be careful about how we build them, where we put them, and who we put in there to run them. Anybody can open a restaurant. All it takes is money. But keeping one open is what makes the difference.”

Family

“We felt like a family, and in many cases we actually had family members working together.”

“When we have team members working together like a family, they extend that feeling to their customers.”

“When Paul Richards was a manager of the Dwarf House [S Truett Cathy’s first restaurant], he mailed out about four hundred birthday cards with handwritten notes to customers every year. He visited them when they were sick and sent food when there was an illness or death. Customers knew we cared. That’s really the key: caring.”

Take Risks & Accept Contrarian Views

“We don’t want to scare people into thinking they can’t take any risk or push limits of their responsibility, or we’ll end up with a bunch of timid Operators. We encourage people to think and to experiment under reasonable circumstances.”

“I want people who work with me to feel completely relaxed when they take a viewpoint opposite mine. I respect their opinions - I would not have hired them if I didn’t - and I want them to feel my acceptance and appreciation for them when we disagree. When you have a dynamic atmosphere, you never know where great ideas will come from. They just come.”

“We prosper by debating ideas and voicing our opinions.”

“Ideas for new products come from Operators, staff members, and customer surveys… We introduce new products only after letting our customers try it out in test conditions in a few restaurants throughout the change.”

Appearances

Source: Chick-fil-A

“Customers can choose from many places to eat. They are quick to pick the most appealing restaurant, the the appearance of the people who work in it can affect such decisions favourable or unfavourably.”

“We concentrate on making sure the back of the restaurant is manicured nicely. Our drive-thru customers spend a lot of time back there, and if they see that area is clean and pleasant, they can be assured that everything is clean inside as well.”

Humility & Tone from the Top

“Everyone from the Operator to the newest hire must be willing to do any job in the restaurant: prepare food, wash dishes, mop floors, clean restrooms. I was the janitor at the Dwarf House, and it’s still my job to pick up paper on the floor, or whatever else needs attention.”

“When top executives demonstrate that they don’t mind doing the dirty jobs, team members understand that every job is important.”

Incentives

“Each year Chick-fil-A brings all our Operators and their spouses together for a business seminar in an exotic resort complex. Through Chick-fil-A’s ‘Symbol of Success’ program we give a new car to an Operator to use for one year if sales in his or her unit increase by 40% or more in one year. If that Operator shows at least a 40% increase the second year, he or she gets the title to the car. We awarded forty-six in 1984 alone. Other incentive awards for Operators include trips, merchandise and cash bonuses.”

Consistency

“I tell our Operators at Chick-fil-A Units today: Consistency is one of the most important aspects of the food business. You can even build your business on bad coffee as long as your’e consistent. Customers are very sensitive to change.”

“We hope customers visiting anywhere in the country know the Chick-fil-A Chicken Sandwich they order will taste just like the ones they eat back home. Few things are more important that consistency in the food business.”

Word of Mouth & Retaining Customers

“Word of mouth in the food business is more important than any other source of advertising. It’s better to maintain your present customers than to spend a lot of time and expense replacing them with new ones.”

Imitate

“Business often remained on my front burner even when we were traveling on family trips… We made lots of stops along the way. Whenever I saw a fast-food restaurant I hadn’t visited, I stopped, went in, and observed their operations, taking away ideas on what was or wasn’t working.”

Evolve & Adapt

“Many successful people I know set magnificent goals for themselves, then let nothing stand in the way of their achievement. I don’t engage in that kind of long-range planning. Instead, I leave myself and our company available to take advantage of opportunities as they arise.”

Frugal

“Some people think I’m a penny pincher today, but when you grow up in a family and in a time where every dollar must be stretched as far as it will go, you learn to watch where your money goes.”

Managing Growth

“To succeed we knew we had to start small and grow slowly. This is where so many start-up companies today make their mistake. Dreamers dream big, and they want to reach their goals quickly. There’s nothing wrong with big dreams. But my experience tells me that we’re more likely to reach our dreams if we climb with care and caution, putting one foot in front of the other.”

Source: Chick-fil-A

“In all my years in the restaurant business, I have tried never to overextend. I’m satisfied stepping from one plateau to the next, making sure we’re doing every thing right before moving on. Financial experts tell me our strength would allow us to open restaurants at a much more aggressive pace than our current seventy per year. But I’d rather have seventy restaurants operating efficiently and professionally than 500 restaurants where half are run well and the others are not.”

“The most common reason companies fail, I believe, is their desire to grow faster than they can manage. This can be particularly true with companies that make a public offering and find themselves staring at a pile of money. All they want to do is grow. But you have to digest growth as you go.”

Debt

“New units are built from the profits of Chick-fil-A. We try not to go into debt to expand.”

“Companies may set goals, and if all goes according to plan everything works out well. But if they have extended themselves to the limits of their finances and their talent, even a slight economic downturn can force them to lay off employees to salvage the company. You don’t build a good reputation by discharging people, but rather by developing people.”

“I am conservative in the amount of money I will borrow to build a new restaurant. I also prefer to own the real estate under our restaurants rather than to lease. The initial investment is greater, but when the loan is repaid, the advantage is clear.”

Private Company

“Chick-fil-A is now one of the largest privately owned restaurant companies in the country. Many others have achieved our size by offering ownership in their companies to the public. We have resisted and will continue to resist that status.”

“In the early years we did not offer stock for sale because I could not predict how fast the company might grow or what dividends we might pay to anyone who might invest. Additionally, I’m afraid the directors, if we had a bad year, might tell me I’m old fashioned and fire me. Too often, Wall Street analysts are more interested in profits than they are in principles and people.”

“Our system puts the cash in the hands of the Operators today, instead of sometime down the road with a lump sum, and encourages them to earn all they can, save all they can, and give all they can right now. Their focus is on today’s customer.”

“Stanley Marcus, retired chairman of Neiman Marcus, said, ‘A public corporation concentrates on profits while a private company concentrates on its people’. By operating one of the country’s largest privately held restaurant chains, Chick-fil-A has been able to do a lot of things that would not be allowed by others in the industry. For example, as a public company, we could not easily give away brand-new Lincoln automobiles, sponsor annual business seminars in posh resorts, offer $1,000 scholarships to our young people, or help support Winshape Centre and Berry College, to name a few projects.”

Letter from Warren Buffett

Community Engagement & Ecosystem

“Our people contribute to their community in ways they could not if they were associated with any other company. They feel a sense of significance.”

“Another key to success in our little corner of the world is community involvement. If somebody calls and asks for something, we give them something. And if churches and schools don’t call us, we call them, and make the offer.”

“It seems the more we give to our community, the more customers support us.”

“The pure and simple bottom line at Chick-fil-A is a commitment to people, and that’s the staff, operators, crew, and the public. From the outset we wanted to have a positive influence on all who came in contact with Chick-fil-A.”

Summary

Today’s business landscape is changing at the fastest rate in history. Technology advancements have disrupted businesses and competitive moats have been filled like never before. Yet, there are some things that haven’t changed and likely won’t. Customers will always enjoy exceptional service and they’ll reciprocate, it’s human nature.

Almost forty years ago, the research underlying Tom Peters’ book, ‘In Search of Excellence’ found, ‘The intensity of customer orientation that exists within top performing companies seems to be one of the best kept secrets in American business.’ Warren Buffett’s exposure to countless businesses across a multitude of different industries has made him conscious of the value in delighting customers, “Don’t just satisfy your customers – delight them .. Anybody who has happy customers is likely to have a pretty good future.” It’s little surprise Buffett expressed an interest in acquiring Chick-fil-A [see letter above].

When it comes to finding great businesses, being able to filter out the noise and identify the key variables that won’t change is hugely valuable. The same ingredients that have delivered Chick-fil-A success for more than 70 years, are likely to deliver success in the future. When ‘delighting the customer’ defines a business’ culture, the results can be extraordinary. That’s how S. Cathy Truett did it.

Sources:
“How did you do it Truett?” S Truett Cathy, 2007.
“Eat Mor' Chikin - Doing Business the Chick-fil-A Way,’ S.Truett Cathy, 2002.
“It’s Easier to Succeed Than to Fail,” S.Truett Cathy, 1989.

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MastersInvest has spent a lot of time studying businesses and business leaders that have been successful, some remarkably so. Those companies that have forged not only stellar reputations in their fields, but also those who have succeeded in industries where success is not a common commodity. And whilst a solid working knowledge of these success stories is vital for any investor to know, its also incredibly valuable to look at the other side of the coin - those businesses that have failed.

Warren Buffett and Charlie Munger have long espoused the benefits of studying failure. Armed with the foresight of what not to do can help an investor avoid the key risk to any investment program - the permanent loss of capital. With this insight in mind, and having read a short synopsis in Bill Gates Summer Reading List, I looked forward to reading the book, ‘Lights Out - Pride, Delusion and the Fall of General Electric’ by Ted Mann and Thomas Gryta. An easy read, the book details the multitude of problems which beset GE coupled with a cornucopia of red flags to look out for in your own investments.

“I like to study failure… we want to see what has caused businesses to go bad." Warren Buffett

Once a storied industrial leader, the last few decades have been nothing short of brutal for GE. While a toxic culture of ‘making the numbers’ seemed ingrained at the time Jack Welch handed the reigns to Jeff Immelt, Immelt’s sixteen year term atop GE earned him a scathing review. Characterised with an incessant focus on the share price, always coveting Wall Street’s admiration, ignorant of tail risks, obstructive to feedback, turning a blind eye to questionable accounting and an absence of humility were the hallmarks of a failed leadership tenure. If the expression, ‘an institution is the lengthened shadow of one man’ rings true, this isn’t a book for Immelt’s trophy cabinet.

Gates Notes - ‘5 Ideas for Summer Reading’ 2021

Perhaps unsurprisingly, the company’s travails were strikingly at odds with the traits that have defined the great businesses we’ve reviewed in the past. Below I’ve called out some red flags and accompanying lessons from GE. Notwithstanding the accounting misconduct, most of the tell-tale signs of trouble are qualitative and behavioural in nature.

S&P500 [grey] vs General Electric [blue] Normalised - 2000 - 2021 [Source: Bloomberg]

Financials Above Purpose

In the superb book, ‘In Search of Excellence,’ Tom Peters noted, “We found that companies whose only articulated goals were financial did not do nearly as well financially as companies that had broader sets of values.”

“The Growth Playbook [was] a grueling annual examination of GE’s eight major business leaders. It was here that GE hammered out targets for sales and profits, setting the underlying assumptions for the financial estimates it would give investors. Under Immelt, the point of the exercise was determining how his executives would get to their financial targets - though not how they would determine what output the business would produce as a starting point. This practice had been ingrained at GE from the days of Welch.” Lights Out

“The problems stemmed not from any single action but from the practices of accountants on staff at the dozen or so plants in the division. They’d reported their numbers by working backward: starting with a profit target and then working out what their sales figures would have to show to get there, rather than simply running the business and reporting their results to headquarters every three months.” Lights Out

The best business leaders have long recognised a company’s share price is a function of long term business performance. Solve for the latter, and in time, the share price will look after itself. At GE the financials dictated strategy.

“Investors and executives need to realise that the creation of shareholder value is an outcome — not an objective.” Terry Smith

“Stock price is an outcome. You can’t manage the outcome. You manage the inputs.” James Gorman

“We want corporate management to solve for value creation, not security price.” Dan Loeb

“Companies that focus on their stock price will eventually lose their customers. Companies that focus on their customers will eventually boost their stock price. This is simple, but forgotten by countless managers.” Morgan Housel

“When it comes to discussing a company’s strategy, it is alarming how frequently one finds confusion about what a strategy actually is. Often a CEO mistakes a short-term target, say an earnings per share target or a return on capital threshold, with a strategy.” Marathon Asset Management

“Some would claim that maximising profits is a business’s ultimate purpose. Yet it is often when companies become exclusively profit orientated – and explicitly define this as their objective - that things go wrong. The end result of what investors seek, good shareholder returns, is invariably better achieved obliquely.” Nick Train

“An annual report with a numbers obsession speaks volumes about what’s important.” Marianne Jennings

Jeff Immelt’s strategy was directed with reference to the share price; providing guidance, smoothing earnings, setting optimistic long term EPS targets, undertaking acquisitions and divestments to appease Wall Street, appealing to big investors and ‘making the numbers’ regardless of cost. All are misguided short cuts.

Focus on Share Price

Of all the books on great businesses I’ve read, I can’t recall one where a company’s share price featured so prominently. Great businesses are all about empowering people, innovating, delighting customers, tolerating mistakes, focusing on the long term, upholding values, embracing change and remaining humble, to name but a few - none of which rated barely a mention.

“The stock market didn’t appreciate what GE was really worth. And it was driving Jeff Immelt crazy. His handlers claimed that he didn’t watch the daily movement in the shares, but his actions betrayed him. The stock market was the ultimate scoreboard tracking his performance.” Lights Out

“‘The stock is currently trading at one of the lowest earnings multiples in a decade,’ Immelt wrote in his annual letter to investors in early 2006. ‘Investors decide the stock price, but we love the way GE is positioned. We know it is time to go big!’ he wrote.” Lights Out

“Always aware of the stock’s reflection on his leadership, Immelt was trapped in a waking nightmare.” Lights Out

“GE’s stock price and its miserable performance were a constant cloud over Immelt’s head.” Lights Out

A management’s obsession with their share price is often a tell for investors; as recognised by some of the world’s best.

“Today, it seems to be regarded as the duty of CEOs to make the stock go up. This leads to all sorts of foolish behaviour.” Charlie Munger

“[The managers we have owned] don’t have a screen in their office showing them the price of their stock. And lots of them do. Sometimes you find it in the lobby of a company and sometimes you find it on the CEO’s desk. That doesn’t interest us. Their focus is on the wrong thing, in our judgement.” Chuck Akre

“We’ve been suspicious of companies that place a whole lot of emphasis on the price of their stock. When we see the price of a stock posted in the lobby of the headquarters or something, things like that make us nervous.” Warren Buffett

“A worrying sign is a CEO with a subscription to Bloomberg as this may indicate an unhealthy interest in stock prices and short-term news flow to the detriment of long-term thinking.” Marathon Asset Management

Quarterly Earnings

The best investors have a long-term orientation, focused on where a business might be in three to five years or more, rather than next quarter’s result. GE spent their time trying to please short-term investors.

“We do not worry about the stock price in the short run, and we do not worry about quarterly earnings. Our mindset is that we consistently build the company — if you do the right things, the stock price will take care of itself.” Jamie Dimon

“The investor wanting maximum results should favour companies with a truly long-range outlook concerning profits.” Phil Fisher

“We really think that an undue focus on quarterly earnings, not only is probably a bad idea for investors, but we think it’s a terrible idea for managers. If I had told our managers that we would earn three dollars and 17 1/2 cents for the quarter, you know, they might do a little fudging in order to make sure that we actually came out at that number.” Warren Buffett

Business Results Aren’t Linear

Smart investors recognise the business environment and economy are not conducive to a perfect earnings trajectory. GE failed to understand this, deploying unethical and in some case illegal short cuts to deliver.

“GE executives have acknowledged that they worked to make sure earnings were growing in a nice smooth trajectory.” Lights Out

“When Fortune’s Carol Loomis once told Welch that the smoothing practice was terrible, he vehemently disagreed with her. ‘What investor would want to buy a conglomerate like GE unless its earnings were predictable?” Lights Out

“The concept of managing earnings, another wonderful numbers term that infiltrates the numbers-pressure culture that leads to ethical collapse. It’s not cooking the books, it is managing earnings. A numbers obsession finds employees and officers not managing strategically but manipulating numbers for results.” Marianne Jennings

“Be suspicious of companies that trumpet earnings projections and growth expectations. Businesses seldom operate in a tranquil, no surprise environment, and earnings simply don't advance smoothly. Charlie and I not only don't know today what our businesses will earn next year we don't even know what they will earn next quarter. We are suspicious of those CEOs who regularly claim they do know the future and we become downright incredulous if they consistently reach their declared targets, Managers that always promise to ‘make the numbers’ will at some point be tempted to make up the numbers.” Warren Buffett

“Businesses do not meet expectations quarter after quarter and year after year. It just isn’t in the nature of running businesses. And, in our view, people that predict precisely what the future will be are either kidding investors, or they’re kidding themselves, or they’re kidding both.” Warren Buffett

Promoting the Stock

“In the [2015] annual letter, Immelt wrapped up his lecture on the limitless superlatives of GE with an awkward plea to major institutional investors.. ‘We have delivered for you in the last five years. But we are still under-owned by big investors. In this time of uncertainty, why not GE?’ he wrote, like a heartbroken lover begging for reconciliation. ‘We have a ton of cash that can protect you,’ he added.” Lights Out

“[At the annual Electrical Products Group conference for industrial investors and executives] Immelt, as he had done before, argued that investors had GE all wrong and were mispricing a stock that should have been above $30 a share.” Lights Out

“We suspect that business leaders who are busy promoting themselves or their stock are not properly focused on running their companies. We go out of our way to look for management that cares about shareholder value but doesn't hype its stock.” Marathon Asset Management

“People who have a proclivity for announcing how valuable their stock is, are I think, people who you ought to be very cautious of.” Warren Buffett

Fancy Predictions

“As the [2016] year came to an end, Immelt planted a flag that would define the rest of his career: he declared that GE would produce at least $2 of profit per share in 2018. It was an unusually long-term projection, and its meaning was undeniable to Immelt.” Lights Out

“It was wishful thinking at best that GE could deliver the $2 of earnings Immelt had promised.” Lights Out

“Charlie and I tend to be leery of companies run by CEOs who woo investors with fancy predictions. A few of these managers will prove prophetic – but others will turn out to be congenital optimists, or even charlatans. Unfortunately, it’s not easy for investors to know in advance which species they are dealing with.” Warren Buffett

Candor and Bad News

“Faced with the prospect of telling their tempestuous CEO that the new product was a disaster, the managers chose another route. They massaged the numbers.” Lights Out

“There was no market for hard truths or bad news. Not as far as the guy at the top was concerned.” Lights Out

“It was better to figure out a better way to deliver the bad news, or make it go away somehow, than to present it to Immelt straight.” Lights Out

Great businesses are tolerant of mistakes. Great Leadership recognises businesses grow through trial and error. When problems aren’t addressed they fester and the eventual impact on a business can be disastrous.

“Almost every business has problems, and we’d just as soon the manager would tell us about them. We would like that in the businesses we run. In fact, one of the things, we give very little advice to our managers, but one thing we always do say is to tell us the bad news immediately. And I don’t see why that isn’t good advice for the manager of a public company. Over time, you know, I’m positive it’s the best policy.” Warren Buffett

“Bad news concealed over time doesn’t get any better. See those studies again: companies with the most candid disclosures in their financial statements perform better over the long term and have higher share prices.Companies that put their current positions and performance right out there for investors and analysts to study are the companies to put your money in.” Marianne Jennings

A Culture of Making the Numbers

“The pressure to perform inside GE is omnipresent, and missed goals can be fatal, a tradition true at all levels of the company.” Lights Out

“Management expectation about the sales growth and profit they should be able to hit didn’t reflect the dim reality of the market, team members told Steve Bolze [CEO GE Power] and Paul McElhinney, the head of the unit that administers the service contracts. Vocal complaints about management’s view diverging from the reality of the market, or from basic math, were common among lower level Power executives. When the concerns were raised to leaders like McElhinney, they were stopped cold... ‘Get on board,’ McElhinney said. ‘We have to make the numbers.’” Lights Out

“When Immelt took over the Plastics operation, the previous management hadn’t been playing it straight. Under pressure from Welch, the division had stretched to make the numbers, including misreporting inventory figures to reduce the cost of goods sold.” Lights Out

“Welch would argue that he pushed his underlings to produce results, not fraud. But even if the CEO didn’t bend the rules himself, Welch cultivated an environment of pressure that incentivised people to do just that.” Lights Out

“If you couldn’t do the job and hit your targets, they all knew, Jack Welch would get someone else who could.” Lights Out

“Jeff Immelt’s assignment was clear: keep the earnings machine of GE humming steadily along, as it had under Welch.” Lights Out

“GE regularly leaned on [GE Capital] to make sure that profits stayed steady.” Lights Out

“Few fates were worse than missing your numbers at GE. Executives assigned targets to underlings, rather than lower-rung workers passing information up the ladder, so projections were based on market realities.” Lights Out

“Salespeople relied on financing provided by the stub of GE capital to prop up customer demand.” Lights Out

Marianne Jennings wonderful book, ‘The Seven Signs of Ethical Collapse - How to Spot Moral Meltdowns in Companies... Before It's Too Late’ cites ‘Pressure to Maintain Those Numbers’ as the number one sign of ethical collapse; “All companies experience pressure to maintain solid performance. The tension between ethics and the bottom line will al-ways be present. Indeed, such pressure motivates us and keeps us working and striving. But in this first sign of a culture at risk for ethical collapse, there is not just a focus on numbers and results but an unreasonable and unrealistic obsession with meeting quantitative goals. ‘Meet those numbers!’ is the mantra.”

“Charlie and I have been around the culture, sometimes on the board, where the ego of the CEO became very involved in meeting predictions which were impossible and everybody in the organisation knew, because they were very public about it, what these predictions were and they knew that their CEO was going to look bad if they weren’t met. And that can lead to a lot of bad things. You get enough bad things, anyway, but setting up a system that either exerts financial or psychological pressure on the people around you to do things that they probably really don’t even want to do, in order to avoid disappointing you, that’s a terrible mistake. And, you know, we’ll try to avoid it.” Warren Buffett

“We really believe in the power of incentives. And there’s these hidden incentives that we try to avoid. One we have seen more than once, is when really decent people misbehave because they felt that there was a loyalty to their CEO to present certain numbers, to deliver certain numbers, because the CEO went out and made a lot of forecasts about what the company would earn. I’ve seen a lot of misbehaviour that actually doesn’t profit anybody financially, but it’s been done merely because they don’t want to make the CEO look bad, in terms of his forecast.” Warren Buffett

“You really have to be very careful in the messages you send as a CEO. If you tell your managers you never want to disappoint Wall Street, and you want to report X per share, you may find that they start fudging figures to protect your predictions. And we try to avoid all that kind of behaviour at Berkshire. We’ve just seen too much trouble with it.” Warren Buffett

If a culture is broken and toxic the best advice is to steer clear. It’s almost impossible to turn around a poor culture.

“You can’t buy a company that’s got a dishonest culture and turn it into an honest culture." Bradley Jacobs

Cost Cutting

“The Corporate cost cutting program [was'] called ‘Simplification.’ That program had zeroed in on worker pensions and retiree health insurance as a good place to tighten the company belt.” Lights Out

'Whenever I read about some company undertaking a cost-cutting program, I know it's not a company that really knows what costs are all about. Spurts don't work in this area. The really good manager does not wake up in the morning and say, 'This is the day I'm going to cut costs,' any more than he wakes up and decides to practice breathing.'' Warren Buffett 

“You can’t cut a company to greatness.” Charles Schwab

“Almost every firm engages in bouts of cost cutting. Exceptional firms, however are involved in a permanent revolution against unnecessary expenses.” Marathon Asset Management

Losing Your Competitive Position

“If a management makes bad decisions in order to hit short-term earnings targets, and consequently gets behind the eight-ball in terms of costs, customer satisfaction or brand strength, no amount of subsequent brilliance will overcome the damage that has been inflicted. Take a look at the dilemmas of managers in the auto and airline industries today as they struggle with the huge problems handed them by their predecessors. Charlie is fond of quoting Ben Franklin’s ‘An ounce of prevention is worth a pound of cure.’ But sometimes no amount of cure will overcome the mistakes of the past.” Warren Buffett

“Companies which underinvest in their franchise in order to meet short term targets are not good candidates for compounding wealth.” Terry Smith

Accounting Irregularities

Pressure from the top to hit numbers coupled with an unwarranted focus on the share price, can tempt employees to fudge the numbers. Once again, Marianne Jennings observed, ‘A declining stock price can cause bizarre accounting behaviour. The drive for numbers, number, numbers can take us right to the slippery slope and into ethical collapse.”

“GE Power had sold service guarantees to many of its customers that extended out for decades. By tweaking its estimate of the future cost of fulfilling those contracts, it could boost its profits as needed.” Lights Out

“These reviews [of GE’s service contracts] produced profits that GE could use to hit targets for Wall Street, but they were really future profits, produced by accounting adjustments alone. There was no actual cash coming in… [They] can be red flags to investors… To pad the hole, GE now began selling its receivables - bills its customers owed over time - to GE Capital in order to generate short-term cashflow, making it appear that those newfound profits were matched by cash flowing in the door.” Lights Out

“The SEC concluded its investigations into GE accounting practices, having found multiple instances of misbehaviour in the pursuit of financial targets. The company had overstated its earnings by hundreds of millions of dollars and stretched the accounting rules to their breaking point.” Lights Out

“The SEC described [GE as] a company that lied to investors in its regulatory filings and in its public statements, that ignored growing risks, and that worked to keep those risks hidden.” Lights Out

“Over the years, Charlie and I have seen all sorts of bad corporate behaviour, both accounting and operational, induced by the desire of management to meet Wall Street expectations.” Warren Buffett

Hitting Guidance

“What starts as an ‘innocent’ fudge in order to not disappoint “the Street” – say, trade-loading at quarter-end, turning a blind eye to rising insurance losses, or drawing down a “cookie-jar” reserve – can become the first step toward full-fledged fraud. Playing with the numbers ‘just this once’ may well be the CEO’s intent; it’s seldom the end result. And if it’s okay for the boss to cheat a little, it’s easy for subordinates to rationalise similar behaviour.” Warren Buffett

Acquisitions & Divestments

Immelt wanted to appease Wall Street and convince them to place a higher multiple on the stock. Historically GE had enjoyed a premium valuation providing the currency for accretive acquisitions. As GE Capital grew, a complex finance business within an industrial company, Wall Street applied a lower multiple. Immelt believed shrinking GE Capital would fix the problem.

“GE could use its unusually high price-to-earnings ratio for an industrial company as high-value currency to pay for deals. By acquiring companies with a lower price-to-earnings ratio, GE was getting an automatic earnings boost.” Lights Out

“Immelt needed to make moves that would finally impress upon Wall Street that he had found a way to lead the old GE into a new economic paradigm.” Lights Out

Capital Management

“GE had been sending cash out the door to repurchase its stock but wasn’t bringing in enough cash from its regular operations to cover its dividend.” Lights Out

“Buybacks were a regular fixture under Immelt, who spent more than $108 billion on them after 2004. At the end of 2018, GE’s entire market value was $67 billion.” Lights Out

Group Think

“The oversight role of the board was minimal.” Lights Out

“The board, made up of current and retired business executives and academics, as a group, liked Immelt and didn’t want to challenge him.” Lights Out

“Top GE executives, including Immelt, would say that they never heard any serious dissent about the Alstom deal.” Lights Out

“The absence of robust opposition [to the Alstom deal] also pointed to the broader problem, long cultivated and growing into a quiet crisis within the company of real candor and self-awareness. When it had come time for lower levels of management to stand up to the ultimate boss and tell him that his legacy play wasn’t going to work - and in fact, had been a clumsy mistake all along - no-one was willing to do so.” Lights Out

“Vice Chair John Krenecki, insiders said, had been forced out by Immelt, in part because he had already seemed a little too prone to disagreeing with the CEO or telling him no.” Lights Out

“GE’s board of directors was unquestionably weakened from having the CEO as the chairman of the Board.” Lights Out

“While Immelt said he encouraged debate, [Board] meetings often lacked critical questioning.” Lights Out

“The seventeen independent directors got a mix of cash, stock, and other perks worth more than $300,000 a year.” Lights Out

“[Board] directors rarely challenged Immelt.” Lights Out

“The [Board] directors had amassed impressive titles in their own career and in many cases undeniable achievement. They had resumes a yard long, most of them had personal fortunes, and they were presumed in all company to have unusually astute minds for business - not least because each one was a highly compensated director of GE. And yet, on their fiduciary watch, with whatever caveats about individual misjudgement and macroeconomic trends, they had done nothing to stop one of the world’s most solid industrial companies from lunging off a commercial cliff.” Lights Out

“Sycophants are the enablers of ethical collapse. Fear and silence are the enemies of an ethical culture.” Marianne Jennings

“If you arrange your organisation so that you basically have a bunch of sycophants who are cloaked in titles, you are going to leave your prior conclusions intact, and you’re going to get whatever you go in with your biases wanting. And the board is not going to be much of a check on that. I’ve seen very, very few boards that can stand up to the CEO on something that’s important to the CEO and just say, you know, ‘You’re not going to get it.’” Warren Buffett

Complexity

“Inside GE’s legendary management machine was a complex mechanism that used [GE Capital’s] deals to help the company meet its profit goals.” Lights Out

“GE Capital was always a problem. It was utterly complex and filled with risk, and its tentacles reached everywhere in the company.” Lights Out

“[The financial services] balance sheets were treacherously complex, and deep risks lurked there and were not always easily spotted in the quarterly profits and losses.” Lights Out

“[GE Capital was] essentially operating a high-powered hedge fund.” Lights Out

“Where you have complexity, by nature you can have fraud and mistakes.. This will always be true of financial companies. If you want accurate numbers from financial companies, you’re in the wrong world.” Charlie Munger

Cyclical Industries

GE ventured into the highly cyclical oil business with optimistic forecasts, little experience and no margin of safety.

“GE was going big into the oil business.” Lights Out

“Now GE became, in a series of high-dollar acquisitions, a player in the oil and gas equipment market virtually overnight.” Lights Out

“While Immelt heard, and was annoyed by, the chirping of some analysts who felt he’d paid a premium to leap into the oil and gas industry several years after his competitors, the company’s leadership was sure that the ensuing years would show the bet payoff.” Lights Out

“GE’s ‘base case’ assumption for all of the rosy pictures it was painting about its oil unit was $100 for a barrel of oil. Brent crude had closed out the previous month at more than $105 a barrel, only a little off its summer peak.” Lights Out

“Afloat on fracking profits during an oil boom, Lufkin had caught GE’s eye and been swallowed up at an expensive price, only to become a casualty when the conglomerate couldn’t abide the hit to earnings that a prolonged dip in the price of oil represented.” Lights Out

Insurance Tail Risks

“Everyone - reporters, analysts, investors - thought that the company had sold the insurance business long ago, significantly de-risking GE Capital. In often highlighting this point, Immelt and his top executives hadn’t minced words: GE was out of insurance.” Lights Out

“The core problem was that GE had made some bad decisions in reinsuring the long-term care policies.” Lights Out

“GE needed $15 billion to cover its liability.” Lights Out

"Virtually all surprises in insurance are unpleasant ones." Warren Buffett

“You can make big mistakes in insurance… You can make mistakes in something like insurance reserving, big time.” Warren Buffett

Bigger than Life CEO

Jeff Immelt almost personified the ‘bigger-than-life’ CEO. It’s a characterisation Marianne Jennings identified as another red flag for investors.

“Immelt knew the power of his influence, and he wasn’t above calling these subordinates [below the divisional heads] to make sure they knew the stakes and urge them to hit their targets.” Lights Out

“The structural component that fuels fear and silence and numbers pressure is the presence of an iconic CEO who is adored by the community, media, and just about anyone at a distance.” Marianne Jennings

Humility & Tone from the Top

“Immelt was required by the board to use only the company’s planes and was barred from flying commercial.” Lights Out

“Immelt, his good cheer notwithstanding, was not interested in hearing his judgement questioned. ‘My job is to make the company perform,’ Immelt told a newspaper reporter, ‘and my job is to make sure that nobody defines this company other than me.” Lights Out

“[Owning GE Capital meant] Immelt enjoyed having the accompanying seat at the table with Wall Street power players.” Lights Out

“Owning NBC gave Immelt and Welch access to red carpets.” Lights Out

“It had taken two corporate jets to take Jeff Immelt around the world. For much of his career [Immelt] often had an empty jet follow his GE-owned Bombardier or Gulfstream to far-flung destinations, just in case there was a mechanical issue that could lead to delays.” Lights Out

“No effort was spared by the staff to ensure that meeting venues were cooled to meat-locker temperatures to accommodate Immelt’s preference, irrespective of whether anyone had ever heard him make such a demand out loud.” Lights Out

“Was a CEO supposed to object that the temperature was not to his liking, or demand that elevators were always open and waiting for him? Or that the cold diet sodas he liked were always present on a sideboard when he entered a room, no matter how far-flung the visit or conference room he walked into?” Lights Out

“But GE has stood for well-bred hubris as well. Under Immelt, the company believed that the will to hit a target could supersede the math, even when hundred of thousands of livelihoods - those of investors, customers, and suppliers, to say nothing of workers, retirees, and their families - hung in the balance." Lights Out

Smart Investors

The emergence of a smart investor on the register is no panacea for investment success. Activist investor Nelson Peltz’s fund emerged with a $2.5 billion stake in 2015. Even the great investors make mistakes.

“Trian’s endorsement was the stamp of approval that Immelt thought would help others realise the full legitimacy of GE’s expected turnaround.” Lights Out

“In every great stock market disaster or fraud, there is always one or two great investors invested in the thing all the way down. Enron, dot-com, banks, always ‘smart guys’ involved all the way down.” Jim Chanos

Summary

The ‘pressure to maintain those numbers’, a culture of ‘fear and silence’, a bigger-than-life CEO, and a weak board conspired against the investors of General Electric; red flags that stand firmly in the qualitative camp, not to be found in a spreadsheet.

These misdeeds aren’t unique or new to investing. After more than two decades of research and observation, Marianne Jennings identified each of them in her book, ‘The Seven Signs of Ethical Collapse.’ They didn’t go amiss at Berkshire either, given Munger and Buffett’s astute understanding of human behaviour.

History is littered with similar corporate disasters to GE. They serve as a warning for analysts, investors, portfolio managers, boards and CEO’s alike; Forewarned is forearmed. Understanding those qualitative tools that may suggest not all’s right with a company might help you ‘keep the lights on,’ when the next GE turns up.

“I think that many CEOs get carried away into folly. They haven’t studied the past models of disaster enough and they’re not risk-averse enough.” Charlie Munger

Source:
“Lights Out - Pride, Delusion and the Fall of General Electric,” by Ted Mann and Thomas Gryta, Mariner Books, 2020.

Further Suggested Reading:
“The Ten Commandments of Business Failure,” Investment Masters Class, 2016.
“The Seven Signs of Ethical Collapse - How to Spot Moral Meltdowns in Companies... Before It's Too Late,” Marianne Jennings, MacMillan, 2006.
“Avoiding Group Think,” Investment Masters Class, 2016.

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