Is the Cost Truly a Benefit?
September 5, 2011 5:53 PM Subscribe
Charles Munger mentions in his USC speech the danger of harnessing technology and to recognize when it can hurt you. Are there any articles or books I can read that go in to depth on this concept? (Speech excerpt after the jump.)
The great lesson in microeconomics is to discriminate between when technology is going to help you and when it's going to kill you. And most people do not get this straight in their heads. But a fellow like Buffett does.
For example, when we were in the textile business, which is a terrible commodity business, we were making low-end textiles—which are a real commodity product. And one day, the people came to Warren and said, "They've invented a new loom that we think will do twice as much work as our old ones."
And Warren said, "Gee, I hope this doesn't work because if it does, I'm going to close the mill." And he meant it.
What was he thinking? He was thinking, "It's a lousy business. We're earning substandard returns and keeping it open just to be nice to the elderly workers. But we're not going to put huge amounts of new capital into a lousy business."
And he knew that the huge productivity increases that would come from a better machine introduced into the production of a commodity product would all go to the benefit of the buyers of the textiles. Nothing was going to stick to our ribs as owners.
That's such an obvious concept—that there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that's still going to be lousy. The money still won't come to you. All of the advantages from great improvements are going to flow through to the customers.
Conversely, if you own the only newspaper in Oshkosh and they were to invent more efficient ways of composing the whole newspaper, then when you got rid of the old technology and got new fancy computers and so forth, all of the savings would come right through to the bottom line.
In all cases, the people who sell the machinery—and, by and large, even the internal bureaucrats urging you to buy the equipment—show you projections with the amount you'll save at current prices with the new technology. However, they don't do the second step of the analysis which is to determine how much is going stay home and how much is just going to flow through to the customer. I've never seen a single projection incorporating that second step in my life. And I see them all the time. Rather, they always read: "This capital outlay will save you so much money that it will pay for itself in three years."
--Charles Munger
The great lesson in microeconomics is to discriminate between when technology is going to help you and when it's going to kill you. And most people do not get this straight in their heads. But a fellow like Buffett does.
For example, when we were in the textile business, which is a terrible commodity business, we were making low-end textiles—which are a real commodity product. And one day, the people came to Warren and said, "They've invented a new loom that we think will do twice as much work as our old ones."
And Warren said, "Gee, I hope this doesn't work because if it does, I'm going to close the mill." And he meant it.
What was he thinking? He was thinking, "It's a lousy business. We're earning substandard returns and keeping it open just to be nice to the elderly workers. But we're not going to put huge amounts of new capital into a lousy business."
And he knew that the huge productivity increases that would come from a better machine introduced into the production of a commodity product would all go to the benefit of the buyers of the textiles. Nothing was going to stick to our ribs as owners.
That's such an obvious concept—that there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that's still going to be lousy. The money still won't come to you. All of the advantages from great improvements are going to flow through to the customers.
Conversely, if you own the only newspaper in Oshkosh and they were to invent more efficient ways of composing the whole newspaper, then when you got rid of the old technology and got new fancy computers and so forth, all of the savings would come right through to the bottom line.
In all cases, the people who sell the machinery—and, by and large, even the internal bureaucrats urging you to buy the equipment—show you projections with the amount you'll save at current prices with the new technology. However, they don't do the second step of the analysis which is to determine how much is going stay home and how much is just going to flow through to the customer. I've never seen a single projection incorporating that second step in my life. And I see them all the time. Rather, they always read: "This capital outlay will save you so much money that it will pay for itself in three years."
--Charles Munger
I've been meaning to read the free e-book here for a while, because I assume it addresses the issues you ask about.
posted by ropeladder at 8:40 PM on September 5, 2011
posted by ropeladder at 8:40 PM on September 5, 2011
Best answer: I like Berkshire, and I like Buffet, but nothing about what they do is necessarily based on fundamental economic analysis. This seems to be about competition: when everyone buys newer, better equipment, they can all bid down prices. The hole with Charlie's analysis here is that if you don't buy that loom and your competitor does, you'll be priced out of the market. So it makes sense to me that this capital outlay benefits you more when you have fewer competitors, competitors with less access to capital, with less existing cash flow. Conversely in a perfectly competitive market we'd expect prices to fall to the costs of the looms and financing them. No idea how anyone's supposed to measure it, but fortunately I'm arguing it doesn't matter. Either you do it or lose business to people who do.
The cost of financing Which is where Charlie Munger wins. He can find large amounts of money internally and externally that few of their competitors can. Hell, they get to borrow from their insurance customers for free! If you can finance the loom at half the price of your competitors, that translates into a much faster growth rate etc. If Charlie's right that investments mainly benefit the consumers, then there's likely few textile companies with spare cash to buy extra machinery.
posted by pwnguin at 8:52 PM on September 5, 2011 [1 favorite]
The cost of financing Which is where Charlie Munger wins. He can find large amounts of money internally and externally that few of their competitors can. Hell, they get to borrow from their insurance customers for free! If you can finance the loom at half the price of your competitors, that translates into a much faster growth rate etc. If Charlie's right that investments mainly benefit the consumers, then there's likely few textile companies with spare cash to buy extra machinery.
posted by pwnguin at 8:52 PM on September 5, 2011 [1 favorite]
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What Munger is describing would be a (positive) supply shock, where the supply curve changes. The analsysi Munger says is lacking is a close examination of how the supply curve interacts with the demand curve; the people promoting the capital outlay are only looking at the supply curve.
posted by chengjih at 6:36 PM on September 5, 2011 [1 favorite]