(via Motley Fool Newsletter) By Seth Jayson
The starting gun
Imagine you’re a sprinter, looking for an edge in your race. Imagine Nike designs a miracle shoe that can shave a full second off your 400-meter time. And it’s a bargain at $150 a pair! How many races will you win next year owing to this great technological advance? Five? Ten? As many as you enter?
How about zero?
That’s the correct answer, because if this shoe can shave a second off your time, it can do the same for your competitors. And you can bet that everyone will pony up the $150.
Warren Buffett, track star? What’s that got to do with the Oracle of Omaha? Well, as Jeremy Siegel explained in The Future for Investors, the Berkshire Hathaway we know today owes its existence to Buffett’s recognition of this important concept, which economists might call the “fallacy of composition” or “the paradox of thrift.”
Early on at Berkshire — which was a fabric mill, for those who aren’t familiar with ancient history — Buffett’s managers would bring him well-conceived plans for upgrading processes, machinery, you name it. These would, on paper at least, save the plant a lot of money, meaning bigger potential profits for the firm.
But Buffett soon realized that such capital expenditures were wasted: These advances were also available to every other fabric mill out there. That meant investing in such upgrades would benefit none of the manufacturers; with everyone generating similar cost savings and passing them onto the customers to try to boost sales, the only likely beneficiaries would be … the customers!
To make the most of a tight situation, Buffett morphed Berkshire into an investment-driven holding company, and the rest, as we say, is history.