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The vast majority of managers who come into the Berkshire Hathaway fold never leave, except through illness or retirement (often long delayed). These people are usually multimillionaires and so do not need to work. However, they feel valued by Buffett and Munger. They feel part of a larger family of likeminded people. They feel that they are doing something worthwhile – tap-dancing to work they put in an enormous effort to build something of importance. They want to make their friends, Warren and Charlie, proud of them.
Think like an owner
The case of GEICO illustrates well the approach Buffett takes toward his managers. Tony Nicely says that he thinks of GEICO as his company, as though he owns it, and accordingly takes long-term focused decisions.
Logically, he knows full well that all the shares are owned by Berkshire; but emotionally he has been encouraged to think of it as his. This attitude is aided by Buffett’s instruction to all key executives to behave as though the businesses they run are theirs, and will be forever.
It is also helped by the enormous amount of freedom each key person is given to run the business the way he/she thinks fit. It is his/her canvas on which to paint; where they can be creative, be a builder of something great with very little, if any, operational input from Berkshire head office, which anyway has only a handful of staff.
Efficient use of time
Being under the Buffett umbrella means that Tony Nicely does not have to do what so many CEO’s have to spend vast amounts of time on, such as meeting with Wall Street analysts or equity and bond fund managers. Nor does he need to think about “smoothing earnings” to give the impression (usually false) of a gentle upward rise in profits per share.
Buffett explained the advantages of being off-market in his 1998 Letter to BH shareholders: “I believe the GEICO story demonstrates the benefits of Berkshire’s approach. Charlie and I haven’t taught Tony a thing — and never will — but we have created an environment that allows him to apply all of his talents to what’s important. He does not have to devote his time or energy to board meetings, press interviews, presentations by investment bankers or talks with financial analysts. Furthermore, he need never spend a moment thinking about financing, credit ratings or “Street” expectations for earnings per share. Because of our ownership structure, he also knows that this operational framework will endure for decades to come. In this environment of freedom, both Tony and his company can convert their almost limitless potential into matching achievements.”
A meeting of minds
Nicely told author Robert Miles in 2001, when preparing for his book The Warren Buffett CEO, that the greatest thing about becoming part of Berkshire Hathaway “is being able to talk with Warren even more frequently. We have, in Warren, an owner, a manager, who takes the same outlook on insurance as he does on all of his other investments. And that is: ‘Where are we going to be, and where is the world going to be, 30 years from now?’ Not ‘Where is it going to be tomorrow?’ So he not only encourages us to take a long-term perspective on the business, but also gives us freedom to act on the basis of that perspective. That has enabled us to create, renew, and expand our management team to make sure that the company will be strong not only next year but 30 years from now.” (p37)
He said Buffett is “the best boss in the world. Period. He’s absolutely the best person that you can report to in terms of support, in terms of wisdom, in terms of encouragement. So, I’m a mighty lucky person. I sincerely want to make him proud” (The Warren Buffett CEO p 38)
Having spoken with fellow executives in the Berkshire tribe Nicely said “I think that most people who work for Berkshire do it because they love the work, not because of anything else.” (The Warren Buffett CEO p 40)
The respect is mutual, illustrated by what Buffett wrote in his 1998 letter “Quite simply, there is no one in the business world who could run GEICO better than Tony does. His instincts are unerring, his energy is boundless, and his execution is flawless. While maintaining underwriting discipline, Tony is building an organization that is gaining market share at an accelerating rate.”
Be motivated by the right things
Buffett encourages decency in business, integrity and service to others. Nicely gains great satisfaction from doing right by the customer, saving them money and giving an excellent service, as well as serving BH shareholders. He says, “It’s not material possessions, or wealth, or those type of things that give you satisfaction. It’s being part of creating something that is truly worthwhile.” (The Warren Buffett CEO p 40)
Nicely on the key ingredients for a successful operating manager: “I think, certainly, honesty and integrity have to be at the top of the list…the ability to communicate well…to work with people for a common cause.” (The Warren Buffett CEO p 39)
But financial incentives are also important
Buffett regards one of his most important tasks is to select the incentive plan for managers. The targets vary from one subsidiary to another depending on what factors the managers have under their direct control. In the case GEICO Buffett focuses on two key variables:
- Growth in number of policies. Insurance is generally unprofitable in the first year under the direct marketing approach, even though it results in longer term customers who do bring profits, and therefore GEICO employees should not be penalised by an incentive scheme requiring immediate profits. Thus only volume is looked at regarding first year policies.
- Underwriting profitability on “seasoned” (on the books for more than one year) auto business.
Each of these factors contributes 50% to bonuses.
Buffett thought it wise to reward all the GEICO staff on the basis of the same criteria through the company’s profit-sharing plan.
“Everyone at GEICO knows what counts.” He wrote in his 1996 letter to BH shareholders. “The GEICO plan exemplifies Berkshire’s incentive compensation principles: Goals should be (1) tailored to the economics of the specific operating business; (2) simple in character so that the degree to which they are being realized can be easily measured; and (3) directly related to the daily activities of plan participants. As a corollary, we shun “lottery ticket” arrangements, such as options on Berkshire shares, whose ultimate value – which could range from zero to huge – is totally out of the control of the person whose behavior we would like to affect. In our view, a system that produces quixotic payoffs will not only be wasteful for owners but may actually discourage the focused behavior we value in managers.” (1996 Letter)
We have some figures for the extent to which bonuses boosted GEICO employees take-home pay: in the first year under BH’s full ownership, 1996, the equivalent of 16.9% ($40m) of salary was handed out in incentive pay. Two years later it was 32.3%, or $103m, and in 2004 24.3% ($191m). With that amount of extra pay on offer it’s no wonder that staff went the extra mile and the number of policies and the profitability went up.
The table shows that the GEICO team kept underwriting costs in the range of merely 14% – 20% of premium taken from customers, which was often 15 percentage points less than competitors, (we’ve have already seen the growth in market share and operating profits of GEICO).
| YEAR | Underwriting expense, % of premiums |
| 1995 | 15.8 |
| 1996 | 15.8 |
| 1997 | 16.4 |
| 1998 | 19.5 |
| 1999 | 19.3 |
| 2000 | 18.3 |
| 2001 | 16.5 |
| 2002 | 16.8 |
| 2003 | 17.7 |
| 2004 | 17.8 |
| 2005 | 17.3 |
| 2006 | 18.0 |
| 2007 | 18.4 |
| 2008 | …….. |
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