Buffett 1972 Letter to See's Candies and Notes on an Underfollowed Tollroad
I recently came across a letter that Buffett sent to Chuck Huggins, the CEO of See's Candies in 1972. See's is a case study that has been dissected from every angle, but this was a letter I hadn’t seen before, so I thought some notes I wrote while reading it. In the letter, Buffett attempts to give some general advice on the distribution, merchandising, and marketing of the chocolates.
The two main takeaways I took from the letter:
Buffett was extremely concerned about protecting the See’s Candy brand
He recognized that the key to protecting the brand was to tell a good story about the product
Buffett knew that the brand was the company’s main asset and the only real reason for the attractive economics (lots of cash came out of the business and very little had to go back in). And of course, this high return on capital was the key ingredient that Munger used to convince Buffett that the business was worth paying a large premium over tangible capital - something Buffett was very reluctant to do up to that point.
2 Main Paths to High ROIC
Generally speaking, companies that produce high returns on capital do so in one of two ways: by earning above average profit margins, or by turning over its capital quickly. This is basically the crux of the DuPont Analysis: ROIC = Earnings/Sales x Sales/Capital. Firms generally derive their high returns on capital through either having an advantage on the consumer side (high profit margins) or on the production side (high capital turnover). See’s great profitability stemmed from the former.
Where High Margins Come From
When Blue Chip Stamps (the Berkshire subsidiary) bought See’s in 1972, the chocolate maker had 13.4% pre-tax margins. Just five years later in 1977, margins rose to 20%, and are likely much higher today. There are numerous reasons why companies are able to consistently achieve high markups over their cost. Some products are expensive, complex to change, and critically important to a customer’s business operations. Not every user loves SAP’s software, but the company’s tentacles are so entangled in most of its customers’ finance departments that it would be too disruptive and costly to switch vendors.
Some companies have built valuable two-sided networks that have very low costs for each new user, allowing the companies to extract significant value from those users directly (e.g. Visa) or indirectly (e.g. Facebook, Google, and Tencent don’t charge users, but collect high-margin revenue from companies that want to sell something to those users). Some companies have a product that is the only game in town. Costar’s Loopnet is a commercial real website that acts as a property information gatekeeper for the commercial brokerage industry.
Brokers have to list their properties on Loopnet because it’s the only real platform that has all of the buyers and all of the sellers. It’s basically the commercial real estate MLS, and it has given Costar massive (commercial brokers might say abusive) pricing power. Some companies have a product that customers have difficulty avoiding, the so-called “toll road”. Buffett famously talks about his love for toll roads, sometimes literally (Detroit’s Ambassador Bridge) but usually figuratively (e.g. newspapers in one-newspaper towns - in fact the Berkshire-owned Buffalo News was once sued by a competitor, who used Buffett’s liking of toll roads against him (unsuccessfully) in court).
These toll roads are some of my favorite businesses — those that generate residual income with little to no additional investment. The money just shows up at your mailbox (a royalty company I follow actually calls their mineral rights cash flow “mailbox money”).
There are a few businesses that exhibit characteristics of Buffett’s Detroit business. One example: