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Why Warren Buffett is worth US$72bn and other people are not

One of the most successful companies of the past 50 years has achieved its success by becoming a not so ‘awfully inefficient’ multinational conglomerate

By Neil Irwin  /  NY Times News Service

Academics who study corporate finance overwhelmingly believe that conglomerates — giant companies that operate in a wide range of industries, often built through acquisitions — are an awfully inefficient way to organize businesses.

One of the most successful US companies of the past 50 years is a conglomerate called Berkshire Hathaway, run by the renowned investor Warren Buffett, which is the fourth-most valuable firm in the US, behind Apple, Google and Exxon Mobil. It employs 340,000 people, roughly the population of Honolulu.

Buffett gave his best go at explaining this seeming contradiction in his latest letter to shareholders, released on Feb. 28, which was in effect a guide to why he has been able to build such a vast corporate empire and a US$72 billion personal net worth.

It lays out two theories of why Berkshire has been so successful.

However, those two theories have radically different implications for how the company might fare after the 84-year-old chairman’s retirement or death.

It helps to understand why finance economists do not much like the idea of conglomerates in the first place.

Back in the 1960s, a popular strategy was to buy up random industrial companies and use accounting tricks to create the illusion of growth even when the underlying performance of the acquired companies was no better, and often worse, than it had been when they were run separately.

It is easy to look at Berkshire Hathaway over the past couple of generations and see a version of the same thing.

Buffett has bought enough seemingly random companies over the years that the combined entity defies any simple description (In short: A giant insurance company, a giant railroad, a giant electric utility and a giant stock portfolio along with various and sundry investments, including in private jet travel, mobile homes, men’s and women’s underwear and dairy-based desserts. Oh, and half of Heinz ketchup).

Finance theory would say that there is no real reason for all those unrelated businesses to be underneath the same corporate umbrella.

The company is an extreme example of decentralization, with Berkshire Hathaway’s corporate headquarters in Omaha, Nebraska, employing only 25 people to oversee this vast empire.

All meaningful operational responsibility remains with executives who run all those portfolio companies.

Why should they not each exist on their own, or as part of a larger company with a narrower focus?

Here is Buffett’s explanation:

“One of the heralded virtues of capitalism is that it efficiently allocates funds,” he wrote. “Nevertheless, there are often obstacles to the rational movement of capital,” for example, the reluctance of a chief executive officer in a declining business to shut down factories and return capital to shareholders to be reinvested elsewhere, or the tax and transaction costs for investors who wish to shift money from one sector to another.

“At Berkshire, we can — without incurring taxes or much in the way of other costs — move huge sums from businesses that have limited opportunities for incremental investment to other sectors with greater promise. Moreover, we are free of historical biases created by lifelong association with a given industry and are not subject to pressures from colleagues having a vested interest in maintaining the ‘status quo.’ That is important: If horses had controlled investment decisions, there would have been no auto industry,” Buffet added.

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