Berkshire Hathaway manages Capital for its Business Units
Every year, Warren Buffett and Charlie Munger include an Owner’s Mannual in their annual report. It rarely changes from year to year.
Near the bottom of the report, they discuss their philosophy on autonomous business units and on the role of the parent in managing capitalization. Here is an excerpt:
Most of these managers are happiest when they are left alone to run their businesses, and that is customarily just how we leave them. That puts them in charge of all operating decisions and of dispatching the excess cash they generate to headquarters. By sending it to us, they don’t get diverted by the various enticements that would come their way were they responsible for deploying the cash their businesses throw off.
If this sounds similar to my preachings on stand-alone business units, I’ll clue you into why: I shamelessly steal my ideas from the Oracle of Omaha.
Elsewhere in the Owner’s Manual, Warrant Buffett writes:
Charlie and I mainly attend to capital allocation… Charlie and I are exposed to a much wider range of possibilities for investing these funds than any of our managers could find in his or her own industry.
Berkshire Hathaway’s ongoing success depends in large part on finding great new acquisitions. Though I couldn’t find it in my quick review, part of Warren Buffett’s pitch is that the manager, once part of Berkshire Hathaway, need not waste time on raising capital or managing their investor base. They can focus on running their business.
So there you have it. Warren Buffett and Charlie Munger don’t mess around with separately capitalized business units. They leave the responsibility of running the business to the business unit leaders. Corporate handles raising capital and allocating it among units.
Does this give you a clue where I come out?
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Dan – I am a bit confused – and of course anxious to take the contrarian view. Berkshire absolutely capitalizes its companies with debt – in fact I bet there is debt at both the entity BH owns and debt at subsidiaries in order to write the interest off for state income tax purposes. Buffet’s comments relate to who makes the decision how to capitalize a company – which he is saying he does. Therefore, I take it that yes, different businesses are capitalized differently – just not by the management team. But the intersting thing I took away is that you’re view is that nearly all functions down to the bank accounts should be at the subsidiary level. yet you are saying just the opposite for capital efficiencies. If someone is smart enough at the corporate level with regards to capital, why wouldn’t legal, HR, accounting, finance, etc have that some level of knowledge at the corporate level? Why wouldn’t the premiere cash management person at a company manage cash for all the subs just as Buffet is the premier allocator of capital?
great response…it is forcing me to think through this a bit more…
As I understand it:
first, the capital allocation that Buffett does is simply an agreement with the management of business units as to the extent that they should deliver cash back to corporate or whether they should invest excess cash back into their busienss. In some cases, corporate provides them additional cash, for example to fund acquisitions.
Individual busienss units do not raise their own equity, other than through the parent.
However, I think you are right. The business units do (presumably) manage certain aspects of their debt structure. They probably have bank lines-of-credit, equipment financing, capital leases, postive working capital (which is huge source of cash in many of Buffett’s companies). In this regard, the business units to varying degrees to manage aspects of their capitalization.
I don’t think Buffett would gain efficiencies by having an army of corporate folks managing HR, legal, etc. for his dozens of companies. He would make each entity less accountable and more bureaucratic, and he and Charlie would have long since hung up the spikes for needing to be involved in the execution of all their businesses.
None of this is black and white of course, and taking decentralization too far is always a risk. Telecom companies, in my opinion, tend to be way to centralized and have little visibility on where they are creating or destroying value.
Dan – I think both of us focused on BH, in whom we both have great respect. However bringing it back to the original question I was more focused on generally unique subsidiries of an operating company (for Zayo – bandwidth, voice services and managed services; Level 3 – content vs. network; Comcast – newtork/cable versus content/programming/espn.) The original reason I asked the question was your view (which I agree with) that many key decisisons should be made by those closest to the business. I recently met with a former fortune ~50 CFO who has long since retired to summit county. He told me he is astounded that in many CFO orgnaizations today means looking in the rear view mirror (heavy accounting/controller experience). While Sar-box is the primary driver of this it has lead to a degredation of focus on managing a balance sheet create to value as opposed to the view that only the P&L creates value. His view is that the optimal alignment of assets and liabilities (effectively how you capitalize an entity) can increase enterprise value in the 10-20% – in some cases it may be de-risking which lowers overall cost of capital – again increasing value. A good example I think is the very old article I sent you on Disney whereby the sold of the revenue streams from Tokyo Disneyland – which gave them immediate access to low cost capital and hedged all currency risk.
So my question to you, if you don’t feel business units should be individually capitalized to optimize assets and libialites – do you feel you are leaving value on the table?
Here is what I say, and this I have huge conviction about. If a business units isn’t responsible for its balance sheet, it isn’t a business unit. Nor is it a P&L. Nor does it have any real abilty to know whether or not it is creating value or not.
I have a whole series of posts in my head to write on this topic. One snipit: at Zayo, each of our business units has a balance sheet and checking account. Moreover, our bonus incentive scheme is migrating to cash balance, which will emphasize that each business unit better understand its working capital, capital leases, etc. AND then manage each of these accounts. Use other people’s money to fund your business and less cash is consumed/more is delivered–and bonuses will be higher.
I love when people declare they run a P&L. “How does your balance sheet look?”, I ask. They don’t even understand the question.
These are great discussions/debates and my guess is we are not that far apart in our views. I think there is great value to really understanding these types of principles, though principles alone won’t make a company successful. I remember reading a quote by the infamous Fischer Black from your stomping grounds (Univ of Chicago). When asked about the application of Black-Scholes he said it was a lot like shooting pool. In a pool match if you have the chance to take a Ph D. in math who knows every principle around the angles of incidence and refraction or Lenny the pool shark who dropped out of high school… you got to take Lenny every time.