Margin of Trust: The Berkshire Business Model
Lawrence Cunningham and Stephanie Cuba
Columbia Business School Publishing (January 2020)
Value investing depends on “margin of safety”; organizational health depends on “margin of trust”
In my review of The Essays of Warren Buffett: Lessons for Corporate America, Second Edition (2008), I quoted this passage from Lawrence Cunningham’s Introduction to one of several volumes he has edited:
“The CEOs of Berkshire’s various operating companies enjoy a unique position in corporate America. They are given a simple set of commands: to run their business as if (1) they are its sole owner, (2) it is the only asset they hold, and (3) they can never sell or merge it for a hundred years.” With regard to investment thinking, “one must guard against what Buffett calls the `institutional imperative.’ It is a pervasive force in which institutional dynamics produce resistance to change, absorption of available corporate funds, and reflexive approval of suboptimal CEO strategies by subordinates. Contrary to what is often taught in business and law schools, this powerful force often interferes with rational business decision-making. The ultimate result of the institutional imperative is a follow-the-pack mentality producing industry imitators, rather than industry leaders – what Buffett calls a lemming-like approach to business.”
In the Prologue to Margin of Trust, Cunningham and Stephanie Cuba assert that trust — then and now — “is the essence of the business model Warren Buffett developed at Berkshire Hathaway. This simple idea has profound implications for corporate life” but the unique features of Berkshire’s organizational structure — one that has evolved since 1965 — has only recently begun to attract significant attention. Although they acknowledge that in some ways Berkshire Hathaway is complex, they suggest that “just as the vast field of value investing can be boiled down usefully to three words, ‘margin of safety,’ we believe that this vast management philosophy can be distilled to ‘margin of trust.’ We also think that this simple idea, animated by the discussion that follows, offers useful insights for every manager and shareholder in corporate America.”
I have read most of Buffett’s essays. He calls his annual letters “missives” to shareholders. On countless occasions, when explaining why he has invested in some companies and passed on most others, he stresses the importance of the integrity of management. Consider this widely quoted observation:
“Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you. You think about it; it’s true. If you hire somebody without [integrity], you really want them to be dumb and lazy.”
None of the CEOs of Berkshire Hathaway’s operating companies is dumb or lazy; for more than sixty years, few have been accused of insufficient integrity.
Cunningham and Cuba note that Buffett’s best friend and business partner, Charlie Munger, “has contributed enormous value — many billions of dollars’ worth — over the years [since the 1960s] and central to their prosperous relationship is their shared belief in trust as the essential element in business and corporate life.”
Indeed, a leadership duo such as theirs “with a joint belief in values like integrity and keeping promises” is highly regarded throughout the Berkshire Hathaway enterprise. Elsewhere, other examples of the “1 + 1 = 3” equation include Thomas S. Murphy and Daniel B. Burke at Capital Cities/ABC and Michael D. Eisner and Franklin B. Wells at the Walt Disney Company.
With all due respect to Berkshire Hathaway’s extraordinary success, Cunningham and Cuba emphasize that it would not have been possible without a business model whose foundation is mutual respect and mutual trust. I think the same can be said of John Wooden’s “Pyramid of Success” which, the U.C.L.A. coach claimed, was key to the success of men’s basketball teams that won ten national champions within a 12-year period.Value investing may depend on a “margin of safety” but organizational health depends on a “margin of trust.” That really has been true of Berkshire Hathaway throughout Warren Buffett’s years of stewardship.
In fact, the lessons to be learned from Buffett’s essays and, more importantly, from his behavior will be of much greater to leaders in small companies than to C-level executives in Fortune 100 companies. Why? Because applying those lessons effectively will have proportionately much greater impact, and add proportionately much greater value.
That is why I think Margin of Trust is the most important book that Lawrence Cunningham has written or co-authored…thus far. And be sure to give Stephanie Cuba her fair share of the credit for that. Bravo!