In early 1986, Berkshire Hathaway held an auction in New Bedford, Massachusetts, to get rid of its textile machinery. The equipment filled about 750,000 square feet of factory space and, by Warren Buffett’s account, was “eminently usable.” It had cost about $13 million. Bought new, it might have cost $30 million to $50 million.
Gross proceeds from the equipment, counting some sold in the months before the auction, came to $163,122. After costs, Berkshire netted less than zero. “Relatively modern looms that we bought for $5,000 apiece in 1981 found no takers at $50,” Buffett wrote. “We finally sold them for scrap at $26 each, a sum less than removal costs.”
The textile business was where Berkshire began. When Buffett’s investment partnership bought control, 21 years before he wrote about the auction, all $22 million of the company’s accounting net worth was in textiles. He put a long-time employee, Ken Chace, in charge, and later Garry Morrison succeeded him. Buffett called both “excellent managers, every bit the equal of managers at our more profitable businesses.” They reworked product lines, machinery configurations and distribution. In July 1985, Berkshire decided to close the mill anyway.
In his letter to shareholders, Buffett explained why good management hadn’t been enough. Over the years, Berkshire could have spent heavily on equipment that would somewhat reduce its variable costs. “Each proposal to do so looked like an immediate winner,” he wrote. By standard return-on-investment tests, they often promised more than comparable spending in Berkshire’s candy and newspaper businesses.
“But the promised benefits from these textile investments were illusory. Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industrywide.”
Each company’s decision looked rational on its own, he wrote. Together, they cancelled each other out, “just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes.” After each round, everyone had more money in the game, and returns stayed anemic.
Buffett did not blame the cost-cutting race alone. Much of the trouble, he wrote, came from foreign mills whose workers earned a small fraction of the U.S. minimum wage, in a commodity business with substantial excess capacity worldwide. Refusing to invest would have made Berkshire less competitive. Investing would have meant terrible returns on ever more capital.
He pointed to Burlington Industries, the largest U.S. textile company. Between 1964 and 1985 it spent about $3 billion on capital, far more than any other American textile maker, much of it, Buffett was sure, on cost improvement and expansion. He surmised that those decisions were quite rational. Yet Burlington’s sales volume had fallen in real terms, its returns were far lower than 20 years earlier, and by his arithmetic each share commanded about a third of the purchasing power it had at the end of 1964.
“A textile company that allocates capital brilliantly within its industry is a remarkable textile company,” Buffett wrote, “but not a remarkable business.”
The machinery that went for scrap, he added, had not many years earlier, under different competitive conditions, been able to employ more than 1,000 people.