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Berkshire Hathaway New Strategy (McKinsey Case Championship)

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A new strategy for Berkshire Hathaway presented on a McKinsey Case Championship in Moscow

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Berkshire Hathaway New Strategy (McKinsey Case Championship)

  1. 1. McKinsey Case Competition Berkshire Hathaway 30 May 2009, Moscow
  2. 2. Why we are here today? Task, our work, executive summary Task Pick a company from the Fortune 100 and explain how it should respond to one of 5 major issues facing corporations today to dramatically improve their profitability over the next 5 years What have we done? 1. We analyzed Berkshire Hathaway (BH) business and concluded it is highly dependent on Mr. Buffet. For the sake of sustainable development in the future this dependence should be decreased. 2. We found how that dependence could be minimized – by investing in businesses which BH fully controls. We called them MUFI businesses (Manufacturing, Utilities, Finance and Insurance). 3. We created a matrix showing influence of each of 5 major issues on MUFI businesses. Then points of greatest influence were chosen. 4. Detailed strategy for each MUFI-business was developed targeting points of influence. Strategy allows 58-88% EBT increase by 2014. Executive summary 1. Maximize profitability by targeting the issues of greatest influence. 2. Decrease BH dependence on Buffet by developing MUFI businesses and slowing down equity investments (investments in blue chips with less than 20% stake) “I can't change the direction of the wind, but I can adjust my sails to always reach my destination” 2 (Jimmy Dean)
  3. 3. Who is mister Buffet? BH is a top investment fund with 40-year history 60 BH growth S&P growth 40 20 0 1965 1970 1975 1980 1985 1990 1995 2000 2005 -20 ELITE FUND TARGETED INVESTMENTS LONG-TERM PHILOSOPHY • Total equity – $109B • Thorough research • BH evaluates its performance by book value • CAGR – 20,3% • Invest in companies with strong economy • Performance inside the • Continuously over- company measured by EBT performed S&P by 10% • Find companies with perfect management • Makes only long-term investment BH is a top fund with great principles and high dependence on Warren Buffet 3
  4. 4. Business Lines (1/2) Financial highlights, Investment, Insurance Share of each business line in total assets Net income distribution Investments 10% 15% 35% Insurance 2007 8% 18% 16% 53% 13 Manufacturing 19% Utilities 2008 -22% 33% 45% 35% 5 21% Finance EBT Main assets Key features Growth Investments • Equity – 57% • Few accurate investments (15 • Past • Derivatives - 38% shares account for 90% of New purchases, Cash flow • Bonds (top corps) – 5% portfolio) increase in value N/A Crisis Weak • Long-term investments • Future • Derivatives - Only short Increase in value contracts (no counterparty 38,40 risk) Insurance 27,90 • GEICO • Keeps money for free • Past: 15,50 • General Re • Auto insurance (GEICO) in a Organic growth of Cash flow • BH Reinsurance very good condition auto insurance Crisis Soso • BH Primary Group • Opportunities for reinsurance • Future: -4,10 business New contracts for 02 04 06 08 reinsurance 2008 was a bad year for BH: earnings dropped 66% 4
  5. 5. Business Lines (2/2) Manufacturing, Financial products, Utilities EBT Main assets Key features Growth 3,95 4,02 Manufacturing 3,53 • Marmon • Diversified set of industries, • Past: 2,62 • Mc Lane many companies hit by the M&A Cash flow (wholesale, groc) recession • Future: • Shaw Industries • Fastest growing business line Efficiency Crisis Soso (carpets) improvements 02 04 06 08 Financial 1,16 • Clayton (home • Strong financial discipline • Past 1,02 loans) • True assessment of clints ability products 0,79 to pay M&A 0,58 • Furniture and • Future • Companies use BH to get cheap Cash flow transport leasing M&A companies capital market financing Crisis Weak • BHF –proprietary 02 04 06 08 trading Utilities 2,20 • MidAm energy • Great management of holding • Past 1,72 • Pacific power company M&A Cash flow • HomeServices • Focus on customer service and • Future 0,88 Crisis Soso 0,61 • Yorkshire electric renewable energy M&A • Ability to turn around acquired companies 02 04 06 08 M&A was primary source of company growth 5
  6. 6. BH Business Model BH plays a role of cash flow regulator Insurance • Insurance premiums fund investment activities $ • BH distributes funds among attractive companies • Performs assessment of available opportunities • Currently portfolio includes: • Utilities, manufacturing Utilities Finance companies and financial • Predictable • Needed cash is organizations investment needs volatile • Bonds, shares and Manufacturing Investments derivatives • Predictable investment • Needed cash is volatile needs Insurance is a main BH business and the only source of FCF 6
  7. 7. BH Investment activities Displace focus from investments to other sources of profitability Ideas and implications Graphs to prove ideas Situation with equity investments in 00-08 Equity inv. portfolio performance Equity investments in BH terminology are investments in companies where BH controls less that 20% of shares. S&P BH Equity accounts for 40% of the total BH assets 200% Purchases on the case by case basis 150% 100% Problems of equity investments in 00-08 50% High dependence on Warren Buffett (all equity investments are made solely 00 01 02 03 04 05 06 07 08 by him) Not very outstanding performance compared with S&P (see graph on the New equity investments/total assets right) Share of equity investments in total assets displays stable growth over the last 10 years (see graph on the right) 8% What to do? 6% We recommend to diminish rate of growth of new investments in portfolio 4% Forward cash to other segments of BH business 2% By 2014 BH can invest to MUFI $17B 0% 01 02 03 04 05 06 07 08 09 10 11 12 13 14 Source: annual reports ; team analysis By 2014 cumulative savings will be about 30% of current BH equity – $17B 7 Proposed strategy decreases company’s dependence on Mr. Buffet
  8. 8. Overall BH strength and weaknesses STRENGTHS WEAKNESSES • Financial discipline • Dependence on Buffet • Pile of cash • Buffet is old • Can buy companies • Equity investments are not cheaper than anyone else so efficient in 2000-2008 • MUFI businesses in crisis usually outran competitors • MUFI businesses are very decentralized GOALS • Primarily develop MUFI businesses which do not require Buffet to be profitable • Reach greater financial synergy between MUFI • Pay less attention to new equity investment purchases (but retain previous) BH strengths far outreach weaknesses. However dependence on Warren Buffet’s name is risky. To 8 reduce risk BH should invest in MUFI.
  9. 9. Issues Matrix Issue Insurance Utilities Manufact Finance Comments >We consider Climate change 5/ +5 3/ -1 0/ 0 0/ 0 opportunities: +2. +1. +1. 0 +1. 0. -1. -1 0. 0. 0. 0 0. 0. 0. 0 > Growth Emerging 4/ 0 3/ -1 2/ +0 5/ +1 > Buy/Sell consumer markets +2. 0. -1. -1 -1. 0. -1. -1 +1. 0. 0. -1 +2. 0. +1. -2 > Profitability > Cash flow Financial markets instability 5/ +3 4/ +4 6/ 0 5/ +1 >Special +2. +2. -1. 0 +1. +2. +1. 0 -1. +2. -2. +1 +1. +2. -1. -1 considerations: >Sustainability Constraints on supply of natural 3/ +3 5/ -5 3/ -3 0/ 0 >Independence resources +1. 0. +1. +1 -1. 0. -2. -2 0. 0. -2. -1 0. 0. 0. 0 >Ability to grow Ease of obtaining information/ 3/ +3 4/0 3/ -1 0/ 0 knowledge +2. 0. 0. +1 ±2. 0. ±2. 0 0. +1. -1. -1 0. 0. 0. 0 3/ -1 – Overall Influence / favorability Insurance is our top priority, stop investing in manufacturing 9 Invest in utilities, good opportunities in Finance
  10. 10. BH Business Model Transition Proposed model will sustain BH and give sources for future growth Insurance Manufacturing Transition to a new model • Volatility goes up • Steady and will be finished • Returns go up predictable cash flow Plusses of a3 years in new model • Increasing predictability of cash flows • Terrific growth opportunities • Easy to manage Utilities Finance • Employs all BH strengths • Predictable • Needed cash is investment needs volatile and reduces weakness Investments • Invest on the case-by-case basis • Eliminate all new investments by ‘14 10
  11. 11. Strategies Insurance 2009-2014 action plan relating Points of attention, risks and mitigating Financial highlights, 2014, $B factors of importance strategy Past based growth excluding M&A Beginning and final Past Financial instability based growth Climate change GEICO is growing via Inappropriate growth strategy attracting new clients Float substantially increases due to GEICO past based Risks: likelihood / impact 4/1 growth and new reinsurance contracts GEICO offers products Risk mitigating strategy: Sensible choice in allied lines 89-103 of markets and price policy Go on developing on emerging 58 3-7 12-18 markets 16-20 Financial market instability New reinsurance contracts Bad contracts Risk calculation is affected by climate change General Re has competitive Risks: likelihood / impact 3/2 advantage of reliability Companies preferable with government Insurance market back-up Insurers capital level P(losses) Climate change shift (25%) Natural calamity in USA Changes in risk calculation models (fat RE market add reinsuring tail, tail correlation) Initial RE market Hotels and cities reinsuring Risks: likelihood / impact 2/2 (Venice, provinces of losses Setting higher prices; using climate Netherlands) against losses analytics caused by sea level rise Source: annual reports ; team analysis; Reinsurance Association of America Insurance is to retain its source of cheap cash position as float can be significantly increased x1,5- 11 1,8 times or by $ 31-45B.
  12. 12. Strategies Utilities & Energy 2009-2014 action plan relating Points of attention, risks and mitigating Financial highlights, 2014, $B factors of importance strategy Industry-based growth Beginning and final result Financial instability Organic Growth Constraints on natural supply • Growth on home markets is Target commercial segments about 2% Assets will increase mainly due to aggressive renewable • Price will be stable in 2009- Responsible for 50% of expansion and acquisition 201 growth 68 Customer service improvement 42 9 Launch 99,9999% initiative 4 13 Financial market instability • One big acquisition in next Carefully assess regions: 5 years Revenue will increase mainly due to aggressive renewable • Ability in win off the High population , economy, expansion and acquisition market due to stable consumption growth rate 8 financial position Segments composition 5 0 Turn around acquired company 1 2 Constraints of natural resources supply • Growth in wind generation Invest in wind and biomass EBT will increase mainly due to aggressive renewable • Enter local gas generation generation expansion and acquisition fast-growing segment 4x growth rate in 2009-2030 3,3 due to regulation and 2,2 decreasing costs 0,3 0,2 0,6 Lowers dependence on fossil Source: team analysis, BH reports fuel Efficiency, Customer service, Strong positions in renewable energy Use synergies with gas Strong financial standing enable us to grow fast distribution 12
  13. 13. Strategies Financial products 2009-2014 action plan relating Points of attention, risks and mitigating Financial highlights, 2014, $B factors of importance strategy Past based growth excluding M&A Beginning and final result Emerging markets Past based growth Financial instability Clayton, XTRA and COST Pay continuous attention to financial strengthen their leading positions discipline and customer attraction Assets will increase mainly due to entering auto loans on market Risks: Clayton/s market shrink market and expanding BHAC operations (likelihood: 4/5, impact: 3/5) 49,-73,0 Risk mitigating strategy: Clayton conservatively waits others to go bankrupt 23,9 Emerging consumer markets 3,1 3,8-4,2 18,2-41,8 Clayton enters Mexican, Financial discipline and costs Brazilian and Argentinean markets Risks: bad welcome on new markets Revenue will increase mainly due to expanding of BHAC through acquisition and strong (likelihood: 3/5, impact: 3/5) operations and entering auto credit market marketing campaign Risk mitigating strategy: careful study 11,7-18,7 Financial market instability and attention to cultural differences Clayton through M&A gets 45- Auto loans market is very diversified, big 4,9 1,1-1,2 5,0-7,9 55% of the US market players have small efficiency. Thus look on 0,7-1,7 BH buys on-captive issuers of small players. auto loans with combined market Risks: auto market shrink (likelihood: EBT will increase mainly due to entering auto loans share 1-2% 2/5, impact: 3/5), BHAC underestimates market and buying Clayton’s competitors BHAC further widens second- risk (likelihood: 3/5, impact: 4/5) 2,0-2,7 and more-to-pay insurance Risk mitigating strategy: do not hurry with auto loans and second-to-pay 0,8 insurance 0,1-0,2 1,0-1,4 0,1-0,3 Source: team analysis, National automobile lenders association, BH reports Financial products business is a new point of growth: x2,5 in assets and x3,0 in revenues. Main growth driver is the financial market instability. 13
  14. 14. Strategies Manufacturing 2009-2014 action plan relating Points of attention, risks and mitigating Financial highlights, 2014, $B factors of importance strategy Organic Growth Beginning and final result Cost reduction Organic Growth Financial instability Manufacturing displays stable Because of the crisis we assume that growth based both on M&A and industry growth in 2009-2010 will be 0% Revenue will increase mainly due to industry growth industry growth of about 3% After recovery in 2011-2014 growth will annually till 2008 be about 3% 84 66 11 1 Risks: Recession in industry may remain 6 longer with deeper contraction in consumer demand (likelihood: 3/5, impact: 3/5) Cost reduction Reduce osts by 6% annually Pay attention to improving logistics and EBT will increase mainly due to cost reduction Improve operational efficiency data sharing, conservation of energy and raw materials 5,13 4 0,08 Risks: due to relatively higher operating 0,7 0,35 costs reduction may not give competitive Financial market instability advantage (likelihood: 2/5, impact: 1/5) Lower raw material costs of Improve consumer service and relations about 2% for ‘09-’10 EBT margin increases to get back to 2004 result Risks: increasing price competition No margin growth in ‘08-’09 (likelihood: 3/5, impact: 4/5) 0,1 due to increased price competition 0,08 Contraction in consumer 0,06 spending => decreasing plant 0,04 operating levels 03 04 05 06 07 08 09 10 11 12 Source: team analysis, BH reports Manufacturing business focus on efficiency and post-merger integration to gain 50% increase in EBT in 5 years 14
  15. 15. Conclusions Secrets of success MUFI EBT 2009, 2014 and growth sources 1. Maximize profitability by targeting the issues of greatest influence. 2009 7,6 2. Decrease BH dependence on Buffet by developing MUFI businesses and slowing down equity investments Insurance 1,4-2,5 MUFI Mission Utilities and 0,8-1,2 • Insurance Be a source of low-cost long-term energy money supply for Utilities • Utilities Capitalize long-term money from Manufacturing 1,13 insurance business • Manufacturing Gain substantial profit and provide Finance and 1,2-1,9 cash flow for Finance financial products • Finance Capitalize cash from Manufacturing and provide excellent returns 2014 12,14,3 No need for external borrowings “Price is what you pay. Value is what you get. ” 15 Warren Buffet

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