In early 1986, Berkshire Hathaway held an auction in New Bedford, Massachusetts, to get rid of its textile machinery. By Warren Buffett’s account the equipment was “eminently usable.” It had cost about $13 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.”
It would be easy to blame the people running the mill. Buffett didn’t. He called Ken Chace and his successor, Garry Morrison, “excellent managers, every bit the equal of managers at our more profitable businesses.” They reworked product lines, machinery configurations and distribution. Over the years, Berkshire could have spent heavily on equipment that would somewhat reduce its variable costs, and “each proposal to do so looked like an immediate winner.”
The managers were good, and so were the machines on offer. That was the trap.
Everyone on tiptoe
“Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures,” Buffett wrote in his letter to shareholders for 1985, “and, once enough companies did so, their reduced costs became the baseline for reduced prices industrywide.” Each company’s decision made sense on its own. Together they cancelled out, “just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes.”
Doing what rivals do, only better, is necessary but rarely lasts. They catch up.
A decade later, Michael Porter drew the line sharply in the Harvard Business Review. In “What Is Strategy?” he argued that managers kept failing to tell two things apart. Operational effectiveness means “performing similar activities better than rivals perform them”: fewer defects, faster development, less waste. Strategic positioning means “performing different activities from rivals’ or performing similar activities in different ways.”
The first kind of advantage is real, Porter wrote, but it leaks. Competitors “can quickly imitate management techniques, new technologies, input improvements, and superior ways of meeting customers’ needs.” When everyone improves, the bar rises for all of them. Such competition “produces absolute improvement in operational effectiveness,” he wrote, but “it leads to relative improvement for no one.”
His example was American commercial printing. The major players, as he described them, served all kinds of customers with the same printing technologies, invested heavily in the same new equipment, ran their presses faster and cut crew sizes. The productivity gains went to customers and equipment suppliers. By Porter’s figures, the industry leader, R.R. Donnelley, had a profit margin consistently above 7 percent in the 1980s, and below 4.6 percent in 1995.
There is a second, slower cost. “The more benchmarking companies do, the more they look alike,” Porter wrote. Rivals copy each other’s improvements until competition becomes “a series of races down identical paths that no one can win.”
A race you can’t sit out
None of this makes improvement optional. Porter called it “necessary to achieve superior profitability,” just “not usually sufficient.” Japanese manufacturers in the 1970s and 1980s, he wrote, were so far ahead in operational effectiveness that they offered lower cost and better quality at once, for many years. The trouble came as the gap narrowed. Most Japanese companies, in his view, imitated one another, offering every variety and matching one another’s plants. Sony, Canon and Sega were “the exception rather than the rule.”
Buffett’s mill also shows the limits of the idea. He did not blame the race alone. Much of the trouble, he wrote, came from foreign mills whose workers earned a small fraction of the U.S. minimum wage. And staying out wasn’t free: refusing to invest would have made Berkshire “increasingly non-competitive, even measured against domestic textile manufacturers.” The race could not be won, and it could not simply be skipped.
He also described the company that ran hardest. Burlington Industries, the largest U.S. textile company, spent about $3 billion on capital between 1964 and 1985, 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. By his arithmetic, each Burlington share in 1985 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,” he wrote, “but not a remarkable business.”
The two-hour sofa
Imagine you run a small moving company in a city with five rivals. Two years ago you bought hydraulic lift trucks and route-planning software. A two-bedroom move that took your crew six hours now takes four. You priced the saving into your bids to win more jobs.
So did the other five. They bought the same trucks from the same dealer and the same software from the same vendor. This spring the going quote for a two-bedroom move is lower than when you started, and your margin is where it was. The dealer and the vendor are doing well.
Your crew is genuinely better than it was. Nothing in your price shows it. They carry the same sofa down the same stairs two hours faster, and the invoice is two hours smaller.