Video Link: https://youtu.be/q842zpKcXoQ
In this episode, Warren Buffett was asked does he view American Express as the "Inevitable"?
In this episode, you’ll learn:
What does "Inevitable" businesses mean?
Why did Warren Buffett invest in American Express?
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~ Please visit the site above for full video of Berkshire Hathaway Annual Meeting.
AUDIENCE MEMBER 00:08
Mr. Buffett, Mr. Munger, good morning. My name is Pete Banner (PH), and I’m from Boulder, Colorado.
In the 1996 annual report, Mr. Buffett, you stated companies such as Coca-Cola and Gillette might well be labeled “The Inevitables,” and you just reaffirmed your view of Coca-Cola and Gillette.
My question to you is, do you have the same view of American Express? That is, do you view American Express as, quote, “The Inevitable”?
WARREN BUFFETT 00:39
Yeah. I would like to clarify one point, too. I didn’t really say I regard the companies as “Inevitables.” I regarded the businesses, their dominance of soft drinks, or their competitive strength in soft drinks and in razors and blades.
And as a matter of fact, I actually pointed out in talking about that — a few paragraphs later, I pointed out the danger of having a wonderful business is the temptation to go into less wonderful businesses.
And to some extent, for example, Gillette’s stumble in the last year or two has not been the product of their razor and blade business, but it has been some other businesses, which are not at all inevitable.
And that, you know, that is always a risk. And it’s a risk I pointed out, that when a company with a wonderful business gets into a mediocre business, that usually the reputation of the mediocre business prevails over the supposed invincibility of the management of the wonderful business.
American Express, an interesting case study, because it does have a — we always think in terms of share of mind versus share of market because, if share of mind is there, market will follow.
People — virtually — probably 75 percent of the people in the world — have something in their mind about Coca-Cola. And overwhelmingly it’s favorable. Everybody in California has something in their mind about See’s Candy, and overwhelmingly it’s favorable.
The job is to have it in a few more California minds — or world minds in the case of Coke — over the years, and have it even be a little more favorable as the years go by. If we have that, everything else follows. And consumer product organizations understand that.
American Express was — had a very special position in people’s mind about financial integrity over the years, and ubiquity of acceptance. When the banks closed in the early ’30s, American Express traveler’s checks actually substituted, to some extent, for bank activity during that period.
The worldwide acceptance of this name meant that when American Express sold traveler’s checks — for many years, their two primary competitors were what are now Citicorp — First National City — and the Bank of America.
And, despite the fact that American Express charged you one percent when you bought your traveler’s checks, and you had two other premier organizations, Citicorp, imagine, and BofA, and — actually, Barclays had one and Thomas Cook had one.
And American Express still had two-thirds of the market after 60 or 70 years — two-thirds of the worldwide market — while charging more for the product than these other very well-known competitors charged.
Anytime you can charge more for a product and maintain or increase market share against well-entrenched, well-known competitors, you have something very special in people’s minds. Same thing came about when the credit card came around.
Originally, American Express wanted the credit card because they thought they were going to get killed on traveler’s checks. And they thought it was going to be a substitute, and therefore, they had to go into — it was a defensive move.
It came about because a fellow named Ralph Schneider, and Al Bloomingdale, and a couple people came up with the Diners Club idea. And the Diners Club idea was sweeping, well, initially New York, and then the country in the mid-’50s.
And American Express got very worried because they thought, you know, people are going to use these cards. Nobody had ever heard of Visa at that point, or anything of the sort.
But people were going to use these cards instead of traveler’s checks. So they backed into the traveler’s check business — I mean, it backed into the credit card business.
Immediately, despite the jump the Diners Club had on the — on this business — because Diners Club had the restaurants signed up already, and they already had the high rollers carrying around their card, and nobody had an American Express card.
But American Express went in and they started charging more than Diners Club for the card, and they kept taking market share away.
Well, that is a great position to be in people’s minds where they are willing to — when faced with a choice — they’re willing to go with the newer product, at a higher price, and leave behind the entrenched product.
And it just showed the power of American Express. American Express had a special cache. It identified you as something special.
When you pulled out your American Express, as opposed to your Diners Club card, and as opposed to the Carte Blanche card, which was the third main competitor at the time. Visa still did not exist. And you could see this dominance prevail.
That told you what was in people’s minds. It’s why I bought into the stock in 1964. We bought 5 percent of the company for — a huge investment at the time for us. I was only managing $20 million at the time.
But you could see that this share of mind, this consumer franchise had not been lost.
In the — considerable period of time, American Express got into other businesses, they got into — Fireman’s Fund Insurance was a very big acquisition. And, to some extent, they let the Visas of the world and all of those get established. They still had this preeminent cache position, but it was eroding.
But I would say that Harvey Golub, along with a lot of other people in the management, have done an extremely good job of reaffirming — intensifying — the cache. There will be probably $300 billion worth of charges, something in that area, put on American Express this year.
The — 300 billion, those are big numbers, even in today’s world. The average discount fee is about 2.73 percent. If you look at the average discount fee on Visa, MasterCharge, you know, it’s going to be a —probably, a full percentage point beneath that.
So you’ve got a percentage point on $300 billion, which is $3 billion of revenue that your competitor doesn’t get. You can do a lot of things for your clientele.
And they’ve segmented the card, as you know. They’ve even recently gone to this black card, and — which sells for a thousand dollars. It’s got a very special cache.
I would say that — I wouldn’t use the word “inevitable,” but I would say that nourished properly, that the American Express name has had — excuse me — has huge value and is very, very likely to get stronger and stronger as the years go by.
But I don’t — I think that what they went through showed that it could take quite a beating and come back. But I don’t want to — I don’t think you’d want to test it that way indefinitely.
Incidentally, that’s one of the things we look for in businesses, is how — you know, if you see a business take a lot of adversity and still do well, that tells you something about the underlying strength of the business.
The classic case was on that was — to me, is AOL. Four or five years ago — you know, I’m no expert on this, but I got the impression there for a period of time when they were having a lot of problems, that a very significant percentage of AOL’s customers were mad at them.
But the number of customers went up every month. And that’s a terrific business. I mean, if you have a business where your customers are mad at you and you’re growing, you know, that has met a certain test, in my mind, of utility.
And you might argue that American Express had that, to some degree. It wasn’t that bad. But they had a lot of merchant unrest and all of that. So, occasionally, you will find that an interesting test of the strength of a business.
Coca-Cola had some problems, you know, in Europe. But it comes back stronger than ever. They certainly had problems with New Coke, and they came back stronger than ever.
So you do see that underlying strength. And that’s very impressive as a way of evaluating the depth and impenetrability of the moat that we talked about earlier.
CHARLIE MUNGER 08:50
Well, I think it would be easier to screw up American Express than it would Coke or Gillette. But it’s an immensely strong business, and it’s wonderful to have it.
WARREN BUFFETT 09:07
We own about 11 percent of American Express. So when there are 300 billion of charges, we’re getting 33 billion of those for the account of Berkshire, and it’s growing at a pretty good clip. The first quarter, it grew very substantially in both cardholders and charges.
My guess is that our 11 percent becomes more valuable over time. It’s hard to think of anything that would destroy it.
CHARLIE MUNGER 09:33
The business is very interesting. They made a deal to put American Express cards into Costco. I think that is a very intelligent thing for American Express to have done. And it’s a very aggressive place that does a lot of interesting things.
WARREN BUFFETT 09:53
Charlie is a director of Costco, so he’s a — Costco is an absolutely fabulous organization. We should have owned a lot of Costco over the years and we — I blew it. Charlie was for it, but I blew it.
OK, we’ll go to number 1 again.