Excerpt from the Warren Buffett Biography, ''Of Permanent Value: the Story of Warren Buffett / 2008 Cosmic Edition'' by Andrew Kilpatrick of AKPE

The following is an excerpt from Andrew Kilpatrick's biography on Warren Buffett entitled, "Of Permanent Value: The Story of Warren Buffett/2008 Cosmic Edition/2 volumes." The two-volume set can be purchased from Amazon.com by following this link.

BIRMINGHAM, Ala. (Business Wire EON) April 15, 2008 -- The following is an excerpt from Andrew Kilpatrick’s biography on Warren Buffett entitled, “Of Permanent Value: The Story of Warren Buffett/2008 Cosmic Edition/2 volumes.” The two-volume set can be purchased from Amazon.com by following this link.

But if somebody wants to sell a generic box of chocolates in California against See's Chocolates, that's obviously somewhat of a threat. And I just hope that they take them home on Valentine's Day and say, 'Here, Honey, I took the low bid.'

Generics – Business School in an electrifying Two Minutes

The Berkshire Annual Meeting in 1993 occurred just weeks after “Marlboro Friday” when retail prices of Marlboro cigarettes came tumbling down to compete with “generic” brand cigarettes. Brand managers as well as their ad agencies were shaken badly and many businessmen were wrestling with the question of just how many inroads generic brands were making on the long-standing, famous brand names.

Sitting before a crowd of more than 2,000 people, with no notes, no aides, and no idea a question about generics was coming, Warren Buffett stunned the audience with his mastery of the business scene.

Here’s how, over a couple of minutes, Buffett answered the question:

“Will developments in the generic brand area hurt Coca-Cola? That’s a terribly important question.

“Generic brands have been with us a long time. But lately they’ve attracted a great deal of attention—partly because they’re doing better and in particular because of Philip Morris’s actions a few weeks ago—when, in reaction to the threat and the inroads of generics, they cut the price dramatically on Marlboro.

“I wouldn’t say Marlboro is the most valuable brand name in the world. Coca-Cola is more valuable—and I think that’s been proven by subsequent events. But Marlboro earned more money than any brand name in the world.

“And all of a sudden, Philip Morris took some actions which dramatically reduced the earnings of that brand and changed the pricing dynamic that had existed in the cigarette business for many decades. And since then, Philip Morris has had $16 billion lopped off its market value and RJR’s suffered accordingly.

“It’s a terribly interesting case study and it illustrates one of the dangers of generic competition. Philip Morris cigarettes got to where they were selling for $2.00 a pack. The average cigarette consumer uses something close to ten packs a week. Meanwhile, the generic was at about $1 or thereabouts. So you really have a $500 a year differential in cost per year to a ten-pack-a-week smoker. And that is a big annual cost differential. You better have something that people think is dramatically better than the generic for the average consumer to shell out an extra $500 a year. It’s happening in other areas, too—whether it’s corn flakes or diapers or a lot of things...

“In our case, I think the Gillette brand name, for example, is far better protected against generic competition than the main product of Philip Morris—although there always has been generic competition in blades and there always will be.

“The average male purchases something like 30 blades a year. He pays 70 cents each if he buys the best—which is the Sensor. That’s $21 a year. The best he can do if he wants something that leaves him Band-Aids on his face and an uncomfortable experience costs him $10 a year. So you’re talking $11 for a 365-day experience...

“I think there’s a generic threat of some sort in any industry where the leaders are earning high returns on equity. It just stands to reason that that’s going to encourage competition.

“And the threat may be accelerating in many industries. But I think that brand names with the right ingredients are enormously valuable. Sometimes infrastructure is a problem for the generics. The worldwide infrastructure for Coca-Cola, for example, is very impressive and very hard for a generic provider to duplicate.

“But if somebody wants to sell a generic box of chocolates in California against See’s Chocolates, that’s obviously somewhat of a threat. And I just hope that they take them home on Valentine’s Day and say, ‘Here, Honey, I took the low bid.’ ”

Then Buffett addressed the question of Coca-Cola point blank:

“Wal-Mart’s selling Sam’s Cola. And Wal-Mart is a very, very potent force. One thing that’s helpful is that they were selling it as cheap as $4 a case here. And I don’t believe that’s sustainable. That’s 162/3 cents a can.

“It’s been a while since I looked at aluminum—and it’s down. But I think the can is close to a six-cent item by itself. The can is far more expensive than the ingredients... Distribution costs, trucking, stocking and all that sort of thing have to be fairly similar. In a 12-ounce can, there’s 1.3 ounces of sugar—which at the domestic price, would be around 13/4 cents per can. And that’s got to be the same whether it’s Sam’s Cola or Coca-Cola.

“The Coca-Cola Company sells about 700 million 8-ounce servings—largely of Coca-Cola, but also of other soft drinks—worldwide every day. If you take 700 million and multiply it by 365 days, you come up with 250 billion or so 8-ounce servings of Coke or its products in the world each year.

“The Coca-Cola Company made about $21/2 billion pretax last year. That’s one penny per serving. One penny per serving does not leave a huge umbrella. The generic is not going to buy the can any cheaper. And they’re not going to buy the sugar any cheaper and so on. Their trucks aren’t going to be any cheaper.”

Buffett, in an electrifying two minutes, just took you through business school. “Better than business school, awesome,” says shareholder Michael Assael. “Buffett’s the best professor ever.”

A Ph.D. in Global Economics in One Minute

In an interview (CNBC, September 7, 2007), Becky Quick asked Buffett about the effects of an $80 oil price. Just winging it, Buffett replied: “Anything that you import, and we import maybe 11 million barrels a day of oil, so everytime it goes up a dollar that’s $11 million that goes out of the American economy and goes to somebody else around the world. And so, it’s a tax on... in effect, a higher oil price is a tax on the American economy. And that tax is not paid to the American government, it’s paid to various entities around the world. So, it’s always a negative. But, I’ll take a negative. We had higher prices than this adjusted (for inflation) 25 years ago. So, the economy can take it but it is a tax, and it comes right out of the American consumer’s pocket and goes into the purchasing power of somebody in the Middle East.”

Perhaps Becky was stunned. She didn’t ask another question after that one.

For more information

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