On May 2, 2020, Warren Buffett told Berkshire Hathaway’s shareholders, at an annual meeting held virtually that year, that Berkshire had sold every share it owned in America’s airlines: American, Delta, Southwest and United.
According to Reuters, he said Berkshire had put around $7 billion or $8 billion into the four. “We did not take out anything like $7 or $8 billion and that was my mistake,” he said. “I am the one who made the decision.”
A mistake, from him of all people. Twelve years earlier, in his letter to shareholders, Buffett had written a sentence about the industry that reporters were still quoting: “if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.” In the same letter he admitted to an earlier bet. In 1989, “to my shame,” he had bought into U.S. Air. Berkshire sold in 1998 for a hefty gain, by luck, he wrote. In the following decade the company went bankrupt twice.
This time he blamed no one in the executive suites. “It turned out I was wrong about that business,” he said, according to CNBC, “because of something that was not in any way the fault of four excellent CEOs.”
Five hands on the same fare
Before asking how well a company is run, look at the five forces squeezing its industry.
Michael Porter laid them out in Harvard Business Review in 1979, his first article for the magazine, and updated the argument in January 2008, a month before Buffett’s letter. Most managers watch their direct rivals. Porter counted four more claims on the same money: customers, suppliers, companies that might enter, and substitutes that do the job another way. “If the forces are intense, as they are in such industries as airlines, textiles, and hotels,” he wrote, “almost no company earns attractive returns on investment.”
Airlines show up in his article again and again. Seats on rival flights are nearly identical and passengers can switch at little cost, so price cuts spread; “years of airline price wars,” he called it. Pilots’ unions hold considerable supplier power because there is no good alternative to a well-trained pilot in the cockpit. Aircraft have a high resale value, so financing is available to new carriers, one reason he gave for “numerous new airlines in almost every region.” And videoconferencing is a substitute for travel.
Porter’s chart put a number on it. From 1992 to 2006, US airlines earned an average return on invested capital of 5.9 percent, the bottom row of the industries he showed. The average US industry earned 14.9 percent.
A food truck’s profit isn’t set by its cooking alone. The landlord, the trucks parked beside it, customers who walk ten meters for a cheaper lunch, anyone who can buy a truck, and the lunchbox from home all take a share. A great cook in a crowded lot can still earn very little.
Buffett had put the same trap in one sentence. Investors, he wrote, had been “attracted by growth when they should have been repelled by it.” Porter calls it a common mistake to assume fast-growing industries are always attractive: growth can hand suppliers power and, when entry is easy, draw in new rivals.
When the forces shift
The forces aren’t fixed, and the airlines’ good decade shows it. Through the 2010s, as CNBC described it, consolidation through post-bankruptcy mergers and lower fuel prices helped the airlines to record profits. In 2019 they posted their tenth straight year of profit. In Porter’s terms, fewer and larger rivals is a change in one of the five forces. That was the market Berkshire bought into.
Porter is also clear about what his framework doesn’t cover. Weather and the business cycle, he wrote, can swing profits in the short run; the forces set profitability over the medium and long run. By that reading, a pandemic is a shock, not a sixth force. And the forces describe an industry’s average, not the fate of each company in it. A company can find the spot where the pressure is weakest, as the truck maker Paccar did, in Porter’s example, by building for drivers who own their own trucks rather than for fleets that bargain hard. Southwest built a very different airline inside the same industry; its story is on the page about trade-offs.
A careful repairer in a crowded mall
Imagine your friend has saved enough to open a phone-repair kiosk in a mall. She is fast and careful, and her plan is all about doing the repairs well.
Run the five forces on her plan. The mall can raise her rent at renewal. Two other kiosks sit within sight. Customers can check her price against theirs on the phone they’re holding. Anyone with a few thousand dollars can open a fourth kiosk next spring. And each time new phones get cheaper, a cracked screen looks more like a reason to upgrade.
None of that says she’ll fail. It says that how good she is at repairs settles less than she thinks, and that the question worth an evening is where in that mall, or for which customers, the squeeze is lightest.
Too many planes
Porter’s article names one more thing that keeps a hard industry hard. Bankruptcy rules that let failing companies reorganize rather than exit, he wrote, can lead to excess capacity and intense rivalry. The seats stay on sale even after the company selling them has gone broke.
At the meeting in May 2020, Buffett said he wasn’t sure people would fly as many passenger miles three or four years later as they had the year before. Then he said it in five words. “You’ve got too many planes.”