Article Authored by Razorsight CEO Featured in Pipeline Magazine   http://www.pipelinepub.com/Innovation

By: Charlie Thomas

The pressures facing communications service providers (CSPs) in the face of exponential data growth, from smartphones and increasingly connected devices to market saturation,    declining average revenue per user (ARPU), and new competitors with significant economic advantages, have created a classic case of “Is the glass half full or half empty?”

The market opportunity has never looked better, and CSPs stand to profit handsomely from the mobile explosion and the monetization of “all things connected.” At the same time, the threats    have never been greater, with innovative new technologies, including over-the-top (OTT) services and social apps that disrupt traditional telecom and cable models, putting CSPs at risk of being relegated to mere “dumb pipes” in the same way that Uber has upended the taxicab industry’s long-standing service model.

The winners in this new mobile world will be CSPs that quickly jettison old business models and rethink how they serve customers, both in terms of network architecture and a new economic  model based on mass personalization. To execute this vision, they’ll need to leverage a major breakthrough in Big Data called predictive analytics, the brainchild of a new generation of data  scientists. CSPs that follow this promising new path will redefine the industry and gain a significant competitive advantage in the same way that the Oakland Athletics  redefined their 112-year-old “business,” baseball, using rigorous statistical analysis, as documented by journalist Michael Lewis in his 2003  book Moneyball(and the 2011 movie starring Brad Pitt).

Recognizing that the classic silo approach to products, markets and customers, not to mention the associated business intelligence (BI) models, is obsolete, CSPs are taking action, embracing a new approach to analytics that looks at those three main areas of interest through a 360-degree lens. These innovators represent a new wave in the telecommunications industry that will dominate the market from 2015 to 2020: by making predictive analytics their number one Big Data priority and capitalizing on new insights into customer wants, consumption and service challenges, they’ll be empowered to swiftly deliver premium services and mass customization on demand.

In the meantime the CSP “all-stars” are preparing for a whole new ball game on a much bigger field, one chalked by the next generation of smartphone and tablet users, who by 2020 will    each generate and consume a zettabyte¹ of information. Using predictive analytics, the market leaders in telecommunications will step up to the plate with the power to sift through data volumes at a level not previously witnessed.

As the first in the industry to apply the expertise of world-class data scientists to the challenges of the Zettabyte Age, Razorsight has been active since day one in  helping CSPs find and leverage the long-sought ability to grow their businesses through the application of precise BI by customer, product and location. What we’ve learned and  how we’ve applied this knowledge has set a new standard in the way that CSPs assess customer value, pricing, marketing, and retention as well as network investment. Carriers now have  the power to measure any single customer’s direct contribution and to base business decisions on the current and projected value of said customer, the requirements for product  development and the impact on network infrastructure costs.

The result: a true game changer that will positively transform the business of forward-looking CSPs. While their competitors sit on the bench, the industry’s “A” teams will consistently score home runs, an unprecedented batting average made possible by the ability to analyze off-the-chart data volumes and glean, with laser precision, the exact data required to monetize key, profit-laden insights into customers.

Big Data: the carrier’s perspective

Razorsight’s interest in predictive analytics for CSPs was prompted by daily interactions with industry leaders. Time and again we encountered a common thread of issues that troubled them:

• How much is a customer worth, and what drives each customer’s profitability?
• Which customers are likely to churn, and why?
• Which products is a customer likely to buy, and how will his or her decision impact the products’ lifetime value?
• How is my company’s network impacting customer satisfaction, and which customers should it address as priorities?
• Where will my company have capacity or configuration issues in the network, and how will they impact my top and bottom lines?
• How can my company best communicate with customers to drive response rates and lifetime value?

In theory, Big Data solutions should have addressed these issues all along, but the answers never emerged because old-school BI platforms weren’t designed to handle the complex needs of today’s Big Data. Unlike advanced analytics, which thrives on the massive amounts of data that are generated in the new “all things connected” mobile universe, BI    can only partially supply the answers that CSPs need to know.

The irony is that some CSPs still aren’t aware of how they’re being shortchanged by their own Big Data platforms. Ask them if they have a Big Data analytics solution and    they respond with an emphatic “Yes!” But when you take a close look at their platforms a different picture emerges, one with some obvious problems.

Because these CSPs still house their Big Data solutions in their IT departments, they’re forced to wait days, weeks or even months for answers to their questions, which are often based on hunches rather than facts, while siloed Big Data platforms are plagued by contradictory definitions of metrics that make it impossible to answer even the simplest question, e.g., “What is a customer?” Perhaps most frustrating of all, the personnel in charge of operating the siloed Big Data platforms are forced to manually link sources within the Big Data platform to gain a consolidated view of the customer, leading to long delays, abundant errors and multiple versions of the truth.

The clock is ticking. Under intense pressure from growing volumes of data on one side and profit erosion driven by plateauing revenue and increasing costs on the other, many    CSPs continue to lose ground because the answers to their most fundamental business questions remain a mystery.

Where predictive analytics delivers results

After a decade of BI platforms that promised results but didn’t always deliver, CSPs have every reason to demand better performance. Thankfully, predictive analytics meets their  expectations, and companies that use it can expect:

• Enterprise-wide value. Predictive analytics organizes complex operations and customer data into a multidimensional model to facilitate sophisticated analysis so that users in any of a CSP’s departments can directly and easily consume data.
• Deep analysis. It also incorporates intuitive, three-dimensional data      visualization, granting CSPs the power to drill down for rapid-fire analysis and problem identification.
• Data integration. By pulling from hundreds of sources, including billing,      accounting, network feeds, inventory, customer relationship management (CRM), customer care and activation, enterprise resource planning (ERP), and pricing, predictive analytics reveals what a customer is worth at any given moment in time, whether now or in the future, thus completing the current “mission: impossible” of Big Data.

With these insights CSPs can make informed decisions that precisely determine the lifetime value of a customer, the likelihood of churn, when (or whether) to invest in    product development and loyalty programs, and how much to invest by segment and individual customer, as well as the impact on the network, the expected return on investment (ROI) and profit potential.

Finding the perfect predictive-analytics opportunity

The challenge of where to start can slow a CSP down even when it recognizes the need to take action on its Big Data issues. Unfortunately, this inertia is exacerbated by vendors that flood the marketplace with inflated promises of analytics capabilities that generally fall short of what a true predictive-analytics application can and should do. To guide your selection process and avoid potential pitfalls, you need to know what to look for right off the bat:

• Flexibility and scalability. Insist on a cloud-based approach, as it provides maximum flexibility, meaning you can start small and expand, or contract as      your needs change, without the risk of upfront capital requirements or licensing costs.
• Industry experts. It is essential that your predictive-analytics application be backed by business experts with deep experience in the telecommunications      industry and data experts who understand not only how to properly normalize data from the full array of data sources but also how to optimally leverage      predictive-analytics engines.
• The right questions. The application’s system and design must allow you to ask the right questions and perform specific analyses for your business via multivariate statistical capabilities.
• Operationalization. It must also be capable of becoming an integral part of your everyday business, and it’s imperative that such an application be fully      operationalized to capture the full value needed by all teams across your organization.

The top analytics priorities for your chosen application should include:

• Statistical analysis. The application must use mathematical algorithms to identify hidden relationships between events, people or actions. This can take the form of root-cause identification, social-network analysis, behavioral segmentation, or semantic analyses.
• Propensity analysis. Statistical algorithms are essential for showing what will happen to an entity in the short term (e.g., within 90 days of today). In      addition, propensity analysis can aid in the understanding of the behavioral drivers of such predictions.
• Forecasting. This capability uses econometric and statistical algorithms to forecast what will happen next week, next month or next year. It also enables “what if?” analyses to help with scenario planning.
• Optimization. This one leverages advanced statistical algorithms to identify the best possible outcomes when given a specific set of constraints.

The ideal predictive-analytics application will take your company to its endgame through crucial insights and data analyses that enable value-based decisions honed to customers with the greatest current, and forward-looking, profit potential. The solution you select should be able to define organizational goals and monitor them via key performance    indicators (KPIs) and scorecards, visualize and aggregate metrics into an overall score and make it possible for anyuser in any department to review the data by using the application’s dashboards.

Ease of access across the organization is a must. Predictive analytics empowers managers and line organization users, whatever their specialty or interest, with near-real-time    actionable intelligence that provides a laser focus on a company’s most valuable customers—by name, by the products they use and where they use them. Moreover, the application goes one step further by applying capabilities that predict what these customers will want to buy “down the road,” what that will cost in terms of personalized product development to meet their needs and what the impact will be on the network.

With this pinpoint-accurate data at hand, everyone sees the full picture and is in a better position to contribute to value-based decisions on which actions to pursue—at the appropriate level of investment, of course—in order to fuel savings and accelerate profits.

The ideal predictive-analytics application will take your company to its endgame through crucial insights and data analyses that enable value-based decisions honed to customers with the greatest current, and forward-looking, profit potential. The solution you select should be able to define organizational goals and monitor them via key performance    indicators (KPIs) and scorecards, visualize and aggregate metrics into an overall score and make it possible for any user in any department to review the data by using the application’s dashboards.

Ease of access across the organization is a must. Predictive analytics empowers managers and line organization users, whatever their specialty or interest, with near-real-time actionable intelligence that provides a laser focus on a company’s most valuable customers—by name, by the products they use and where they use them. Moreover, the application goes one step further by applying capabilities that predict what these customers will want to buy “down the road,” what that will cost in terms of personalized product development to meet their needs and what the impact will be on the network.

With this pinpoint-accurate data at hand, everyone sees the full picture and is in a better position to contribute to value-based decisions on which actions to pursue—at the appropriate level of investment, of course—in order to fuel savings and accelerate profits.

Predictive analytics at work

Early movers have been quick to embrace predictive analytics, including a large tier 1 provider with a solution now in production that’s already realized significant gains in operations and its bottom line.

Before adopting predictive analytics, this CSP had faced issues common to all in the industry: it needed to leverage Big Data to drive profits but was swamped by growing volumes of data, plus it was held back by stovepiped systems and multiple tactical-analytics capabilities limited to a single perspective. Data gathering proved to be time-consuming and resource intensive, and the company faced numerous internal obstacles in its analyses of the results, including high-level allocations that didn’t represent actual activities or metrics.

The output of old-school analytics was too fractured to indicate a clear path of action. So, after years of relying on a platform that failed to provide the most essential data—profit value by customer, product and location—the CSP opted for a new approach to meet its objectives: Razorsight Predictive Analytics.

Razorsight’s team of data scientists deployed predictive analytics as an overlay hosted on a secure, private cloud, and today its application is helping the CSP rack up achievements it once thought were impossible, successfully integrating over 100 data feeds from a variety of source systems (CRM, ERP, etc.) to present a single view of each targeted customer by product and exact location. The overlay deployment allows data transmission and ingestion in a loosely coupled model, eliminating the risks typically associated with tightly coupled integration models. All workflow is hands-free automated: data reception, tracking, ingestion, and processing are centralized in the Razorsight Predictive Analytics platform to ensure faster profiling, analysis and deployment. The cloud-based model of the application has also completely wiped out previous costs related to hardware, software and IT.

The CSP can now immediately access an exact view of its highest-value customers based on near-real-time data, leading to millions of dollars in savings and improved EBITDA (earnings before interest, taxes, depreciation, and amortization) profitability. With predictive analytics at its disposal, the company is setting new records in efficiency that positively impact legacy-product sunset, targeted promotions, pricing refactoring for certain product lines by market, and network consolidation. The payoff is measured in:

• improved management across periods of product growth, harvest and sunset;
• faster response times to customer needs that might be unleashed by an advance in technology or a demand for new services;
• an established lead, fueled by actionable insights into customer profitability and price sensitivity, in an intensively competitive market;
• an improved financial performance triggered by new profits from the CSP’s highest-value customers, products and markets;
• the added value of an aggregate view across its organization.

 

Is predictive analytics the future?

Looking ahead, many in the telecom industry believe that predictive analytics focused on customer, product and location data will become the new norm, a capability that all CSPs will demand. And to understand why it will put smart carriers in the Zettabyte Age’s big leagues, one need look no further than the customer.

In a market saturated with look-alike competitors and me-too products, customers seek true differentiation between their service providers. Increasingly, “meaningful separation” from competing products rests on a CSP’s ability to create personalized offers that deliver exactly what each customer demands. Predictive analytics arms that company with the precise data it needs to craft tailored products that match and serve its customers’ needs. Just as important, this “harbinger” application informs the company of the best ways to market products, ensuring rapid acceptance and a loyalty-boosting, positive experience for customers at the right investment threshold, which is critical for establishing profit optimization.

Predictive analytics achieve what Big Data was meant to do all along, quickly simplifying massive volumes of data into usable bytes that put CSPs in sync with the individual who matters most when it comes to financial performance—the customer.

Full Article: http://www.pipelinepub.com/Innovation/big_data_analytics

 

Published by Tim Watsonon May 16, 2013|0 Comment

Rajesh Sabari, Razorsight

Comcast ranks first among providers of hosted IP telephony suppliers in the latest Infonetics Research ranking of the top providers in the hosted VoIP, unified communications (UC) and IP connectivity service markets. 8×8 follows closely behind Comcast.

Verizon and West also are among the top hosted VoIP providers in North America, Infonetics Research says. Other firms include AT&T, Bandwidth.com, Broadview Networks, Broadvox, Cbeyond, Cox, Level 3, Megapath, RingCentral, ShoreTel, Sprint, Thinking Phone Networks, West, Windstream, and XO.

What seems to stand out is the extreme fragmentation of the market. Of the roughly 20 firms tracked by Infonetics, less than 10 sell a minimum of 100,000 seats.

Only the several providers at the top of the rankings had at least 200,000 seats in service.

At the end of 2012, the top hosted VoIP providers had over 200,000 seats each while the cutoff to the top 10 was still slightly below 100,000 seat counts, Infonetics says.

Assume the top-10 providers each had 175,000 seats each. Assume the next 10 providers had about 75,000 seats each. That would imply a total of about 1.75 million seats for the top 10, then an additional 750,000 for the next 10 providers, for a total of 2.5 million seats. At $50 a seat per month, that would imply annual revenue of $600 per seat.

You can make your own assessments of “average revenue” per seat. Some might argue fully loaded revenue is less than $50 a seat, per month.

But $50 a month implies  revenue of about $1.5 billion annually. That’s possibly on the high side, but gives you some idea of market size. In a fragmented market, that suggests the opportunity for any single provider is relatively small, by tier one carrier standards.

On the other hand, for smaller and independent firms, a revenue stream of $120 million (200,000 seats) would be highly relevant.

For a tier one service provider it probably is not so important, unless the provider thought the business could grow far bigger, perhaps a minimum of an order of magnitude bigger.

And that is one reason why a cable company and an independent hosted IP telephony company lead the market. For providers that specialize in the small or medium-sized business market, hosted IP telephony can be a significant revenue source.

On the other hand, the SMB market always has been fragmented, which might explain why the hosted IP telephony market, which mostly caters to SMBs, likewise is fragmented.

In the United States,  around 500,000 small or medium businesses used a hosted PBX service, representing an $800 million market, according to Parallels, which made that estimate in 2011.

But it might be reasonable to expect the total market could grow to as much as $4 billion annually, if virtually all current users of business phone systems migrated to hosted IP telephony. Some might argue that is unlikely to happen.

Optimists might argue that there are about 60 million U.S. business lines, and that is the addressable market for hosted IP telephony. Others might argue the potential market for IP telephony is about 25 percent of the market, or about 15 million lines.

Either way, current adoption of about 2.5 seats suggests most of the market, however large, remains untapped.

“Realists” might argue that economics will prevent hosted solutions from displacing virtually all business lines. The reason is simply that, at some level of volume, an enterprise spends less money by buying its own premises systems.

That would explain why new sales still tend to favor premises systems over hosted solutions about four to one, by some estimates.

Some might argue that the best analogy for hosted PBX is the older Centrex service, to some fairly significant extent.

The total market generated revenue of $1.9 billion in 1989, and Centrex revenue was forecast to grow to $4.8 billion market by 1994.

Centrex might have gotten to be about $6 billion market in the early 2000s, although some estimates might have suggested a Centrex market as small as $2.5 billion.

Assuming annual shipments of about six million to seven million new lines of PBX service, you can do the math on additional revenue if some of that demand was to shift to a hosted alternative.

Still, the future market is likely to remain fragmented, as the SMB market always is.

Published on May 8th, 2013 | by Douglas C. Eby

For forty eight years the first Saturday in May, Omaha, Nebraska has been home to the Berkshire Hathaway shareholders annual meeting, better known as “Woodstock for Capitalists.” Think Jesus Christ returning to planet earth and meeting with tens of thousands of Christians, in order to gain a sense of the order of magnitude, which is the Berkshire gathering. I have made the annual trek to the “Cradle of Capitalism”, as the “Oracle of Omaha” defines his hometown in this year’s letter to shareholders, dating back to the mid 1990′s. Always the business highlight of the year, the “show” never fails to deliver an astonishing experience. One of my favorite words, unique, simply meaning, being one of a kind, without an equal, unparalleled, without compare, sadly butchered and tortured by centuries of misuse, should serve as the logo for both Berkshire and the company’s legendary Chief Executive Officer, Warren Buffett. Neither the business nor the investment worlds have ever seen a man like him and in all likelihood they never will. From scratch, Warren Buffett has built Berkshire into the fifth largest company in the world with a market capitalization in excess of $250 billion. Only Apple, Exxon, Microsoft, and Google are larger.

Mr Buffett, 82 years of age, fresh off of successful treatment for prostate cancer in 2012, and Charlie Munger, 89, held court in front of 35,000 shareholders in the CenturyLink Center for seven hours, with only an hour lunch break. Buffett and Munger sitting behind a desk on the stage in an auditorium packed to the rafters with people crammed into standing room only sections like sardines, creates a sensation of a rock concert sans the music. The opening act is a thirty minute movie featuring Buffett doing just about everything from trying out for a part in the upcoming Terminator 5 to testifying in front of a Congressional Committee in his capacity as interim CEO of Salomon brothers in 1991. In one scene, he approaches a trailer in the Arizona desert where he finds chemistry teacher turned drug dealer, Walter White and his son Walter White Jr. from the television show Breaking Bad. However, instead of manufacturing crack cocaine, the pair are busy cooking up peanut brittle, which according to the “street” is better than Berkshire’s own Sees Candies product. Fearing competition, Buffett negotiates a buyout, after which he phones his partner Charlie Munger with the news, “It is done.” Munger, responds, “Good” after hanging up, he defiantly exclaims “Brittle bitches” a reference to his new partners. The mosh pit is filled with brilliant CEOs who run the Berkshire portfolio companies, the drum solo is replaced by discussions of intrinsic value, the smart phone waving induced encore is substituted by more admonishments about the virtues of value over growth and the air will make you rich but do nothing for a glaucoma sufferer.

So what is so special about Berkshire which enables the company to draw the investment world to relatively obscure Omaha? And by the way, Omaha is an excellent city, which besides Berkshire, is home to Union Pacific Railroad, Conagra, Kiewit, one of the largest privately held construction companies in the world, the College World Series, The University of Nebraska at Omaha and Creighton University, the beautifully restored stockyards section of downtown and the Joslyn Art Museum. Well for starters consider this. Berkshire’s annualized growth in book value per share, the defining performance metric according to Buffett, over the past forty eight years has been 19.7%, trouncing the S & P 500 Index’s total return of 9.4% over the same period of time. Placing Berkshire’s performance in proper perspective, dollars must be assigned. If one had the foresight and good fortune to invest $1 in Berkshire forty eight years ago on January 1, 1964, the value of the holding as of December 31, 2012 would be $586,817. An investment in the S & P 500 Index would only have grown to $7,433. Imagine throwing $100 Buffett’s way in 1964 and now having over $58 million. Warren Buffett, the original investor in Berkshire, holds 350,000 Class A shares worth a tidy sum of $55 billion, making him one of the richest men in the world. Buffett’s fortune would be significantly larger if not for his commitment to a multi year charitable program, whereby he is gifting Berkshire stock to the Bill and Melinda Gates Foundation. To date, Buffett has transferred approximately 89 million class B shares, which today have a market value of slightly more that $9 billion. It is widely thought that upon Mr Buffett’s death, the majority of his holdings will be gifted to the Foundation. Buffett neither having sold a share of Berkshire in his lifetime nor never receiving a dividend from Berkshire, as of course the company’s philosophy precludes such a transaction (Buffett’s reasoning here is well articulated in this year’s letter to shareholders which appears latter) , the Internal Revenue Service has see no tax revenues from him personally as a result of his ownership. And if indeed he ultimately transfers the balance of his holdings to the Gates Foundation, the IRS will never see a penny from Buffett, other than an infinitesimal amount from his modest $100,000 annual salary.

From Buffett’s letter to Bill and Melinda Gates, dated June 26, 2006, announcing the gift program;

“I greatly admire what the Bill & Melinda Gates Foundation (BMG) is accomplishing and want to materially expand its future capabilities. I hope that the expansion of BMG’s giving is one of depth, rather than breadth. You have committed yourselves to a few extraordinarily important but underfunded issues, a policy that I believe offers the highest probability of your achieving goals of great consequence. The doubling of BMG’s present spending can increase the Foundation’s already impressive effectiveness in addressing the societal problems upon which it now focuses. Working through the Foundation, both of you have applied truly unusual intelligence, energy and heart to improving the lives of millions of fellow humans who have not been as lucky as the three of us. You have done this without regard to color, gender, religion or geography. I am delighted to add to the resources with which you carry on this work.”

The Bill and Melinda Gates Foundation’s primary emphasis is on global healthcare, specifically the development of vaccines for Malaria, HIV/Aids and Tuberculosis.

For many, Buffett’s matriculation to a philanthropist has come too late. The Sunday World – Herald, Omaha’s leading newspaper, which by the way is owned by Berkshire, ran a front page article the day after the annual meeting with the following opening paragraph, “For decades, Warren Buffett rarely kicked in when his hometown raised money for buildings or good causes, and he’s still not an automatic go-to-guy for local donations. If Buffett says he has more money than he can use for himself, why doesn’t he just write a check for every worthy cause around Omaha?”

Indirectly, Omaha has benefitted tremendously as a result of donations from local investors in Berkshire. People like Dick Holland, the main donor for the $90 million Holland Performing Arts Center, and Fred and Pamela Buffett who are the lead donors for the $370 million Fred & Pamela Cancer Center, would never have been able to provide such funding without the huge profits they realized by being early Berkshire investors. Susie Buffett, Warren’s daughter, defends her father’s spending habits, by claiming that his value creation at Berkshire has enormously helped Omaha over the years. The Oracle himself believes that waiting to gift shares in Berkshire has been a net positive, “I know people may have criticized some of the people who were associated with Berkshire and say, Why are you not doing more? When the truth is, they ended up being able to do 10 or 100 times as much. The interesting thing is, unless they waited a long time, they would not have had those sums.”

While acknowledging that some local Omaha “feathers” may have been ruffled over the years, in observing the totality of Warren Buffett’s contribution to Nebraska and the rest of the world, we at If You Please have a hard time taking an issue with the outcome, which has been nothing short of spectacular. In addition to the $9 billion donated to the Gates Foundation, Buffett has donated $4 billion to other charities, according to the World – Herald article.

Charlie Munger has taken an opposite approach by giving away the bulk of his Berkshire holdings during his lifetime. Interestingly, the partners, who have been so successful, have many differences. Besides their philanthropic approaches, Charlie is a conservative republican, while Warren is a very liberal democrat, who spouts off about inequities in the tax code at the drop of a hat. Buffett is a vociferous President Obama supporter. Buffett loves the limelight, Charlie shuns it. Warren stayed in Omaha, while his partner moved to Los Angeles. One thing the two agree upon is how to invest. Neither well known, nor discussed much, is the fact that Warren credits Charlie for the investment epiphany, which he experienced decades ago. In the early days, Warren was a deep value investor who prided himself in investing in “cigar butts”, stocks which had been discarded by others. His portfolios were filled with bad businesses, which he was able to buy at extremely attractive prices. While this strategy worked beautifully for many years, it no longer fit with the global economy which began in the 1980′s. If one listens very closely they can hear Buffett admit that without this critical modification to his investment strategy, the spectacular returns achieved by Berkshire would simply never have happened.

2013 Berkshire Annual Meeting – CenturyLink Center

After listening to Warren Buffett and his longtime partner Charlie Munger this year, my conclusion can be summed up by these lyrics from the eponymous song of the Floaters, Float, Float, Float on. As the old saying goes, “Question; What is the definition of a secret? Answer; Something you tell one person at a time!” Well, Mr Buffett has a business secret, which he has been telling to anyone who will listen for decades. If you don’t know what it is, read carefully and I will whisper it to you, but remember only tell one person at a time.

“Float”

From Warren Buffett’s letter to shareholders in the 2012 Berkshire Annual Report;

“Property-casualty (“P/C”) insurers receive premiums upfront and pay claims later. In extreme cases, such as those arising from certain workers’ compensation accidents, payments can stretch over decades. This collect now, pay-later model leaves us holding large sums – money we call “float” – that will eventually go to others. Meanwhile, we get to invest this float for Berkshire’s benefit. Though individual policies and claims come and go, the amount of float we hold remains quite stable in relation to premium volume. Consequently, as our business grows, so does our float. If our premiums exceed the total of our expenses and eventual losses, we register an underwriting profit that adds to the investment income our float produces. When such a profit is earned, we enjoy the use of free money and, better yet, get paid for holding it. That’s like your taking out a loan and having the bank pay you interest. Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous in most years that it causes the P/C industry as a whole to operate at a significant underwriting loss. This loss, in effect, is what the industry pays to hold its float. For example, State Farm, by far the country’s largest insurer and a well-managed company besides, incurred an underwriting loss in eight of the eleven years ending in 2011. (Their financials for 2012 are not yet available.) There are a lot of ways to lose money in insurance, and the industry never ceases searching for new ones. Let me emphasize once again that cost-free float is not an outcome to be expected for the P/C industry as a whole: There is very little “Berkshire-quality” float existing in the insurance world. In 37 of the 45 years ending in 2011, the industry’s premiums have been inadequate to cover claims plus expenses. Consequently, the industry’s overall return on tangible equity has for many decades fallen far short of the average return realized by American industry, a sorry performance almost certain to continue.”

As of December 31, 2012, Berkshire held $73 billion of float in their three major insurance companies, GEICO, Gen Re, Berkshire Re as well as some smaller companies. This is capital that can be invested into public equities, fixed income and private equity, significantly leveraging the company’s return on equity. Let us examine the impact float has on the overall financial results of Berkshire. The current equity of Berkshire stands at $191 billion, which generated comprehensive income of $25 billion in 2012. Since the float is money that will go to others as claims roll in over the years, the balance sheet shows offsetting reserves against the $73 billion. However, in the meantime the money falls into the hands of one of the greatest investors in the world. If Buffett can earn his longterm 19.7% return on equity, a feat he says is not likely given the size of the company, the additive return from the $73 of float would have been approximately $14 billion in 2012 or greater than half of the reported comprehensive income of $25 billion. Now since float is not a new concept, Berkshire’s since inception return of 19.7% includes the historic benefit of float. Making some assumptions, I calculate that approximately a third of Berkshire’s historical performance has come from float. If I could ask Mr Buffett one question, it would be on this critical subject, “How much of the return has come from float?” Several years ago at a small dinner after the annual meeting, I had the opportunity to briefly chat with Mr Buffett. Unfortunately, in the presence of the master, I was only able to come up with, “Long day Mr Buffett.” To which he said, “No where near as tough as when I was on my feet all day selling shirts.” As a matter of fact someone did ask the float question at the annual meeting five years ago, to which he responded, “That is an excellent question, Charlie and I have never really calculated that figure, but if I had to guess I would say a third.” As so often, Mr Buffett plays his cards extremely closely to the vest at critical moments. It is inconceivable to me that he does not know the exact answer to this question. Of course, float alone is useless unless you know how to invest as Buffett does in an extraordinaire fashion. Float of $73 billion, representing over a third of Berkshire’s equity in the hands of a skilled practicioner like Buffett is a powerful combination. This is Buffett’s secret. Shhhh.

All joking aside, this is a secret to neither anyone in the investment industry nor the insurance business. So another interesting question is, “Why do other insurance companies not follow this proven successful financial model?” And after all, despite Berkshire’s diversified investments which include; control positions in Mid American Energy, Burlington Northern Railroad and Heinz, a $50 billion portfolio of minority positions in public companies such as American Express, IBM and Coca Cola, $30 billion in debt securities mainly US Treasuries and $42 billion in cash, Buffett’s baby is really an insurance company. Despite his diversified talents, at the end of the day, Buffett is an insurance man as well. In 1951 at the young age of 21, Buffett knocked on the door of GEICO. CEO Lorimer Davidson answered the door and ever since, Buffett has commanded a deeply burning passion for the insurance business. Pure speculation, however, the prospect of receiving cash up front for assuming a risk that may or may not occur, would be our guess as to what attracted a young Warren Buffett to the insurance industry. With assets of $278 billion and liabilities of $$120 billion, the combined insurance companies of Berkshire have a book value of $158 billion equal to 83% of the entire company’s $191 billion book value at year end of 2012. The latter is net of a $44 billion deferred tax liability, the temporary difference between tax and accounting books. Money that will go out the door, but not currently. Unclear as to how much of the liability is associated with the insurance companies, however, if you assign two thirds of the $44 billion, the insurance companies still have a book value of $90 billion. As a standalone company Berkshire’s insurance entities would easily receive a hefty premium in the market. A modest 50% premium would result in a price per share of $82,000 for the Berkshire’s stock. Approximately 50% of the current price. Insurance company dominance looks even more profound when earnings are analyzed. Flush with $72 billion of float and powerful market positions, Berkshire’s insurance earnings exceed $10 billion or $6 thousand per share. So back to the question, the answer speaks volumes about the state of management in corporate America and the institutional investment business.

The average holding period for a stock by investors is measured in months. Long term strategy falls on deaf ears to the majority in the institutional investment community, where traditional investing has been usurped by speculation manifesting in the form of short term trading. Corporate leaders, channelling the famous Washington Redskin coach of the 1970′s George Allen, deploy a “the future is now” operating philosophy. Not having the luxury of a long term oriented shareholder base so richly deserved by the management of Berkshire, CEOs of most public insurance companies ditch the proven “owner mentality” and opt for short term financial performance in the hopes of pleasing the transitory capital, which dominates their shareholder base. Of course cashing in stock options and restricted stock grants is never too far from thought. When pricing in the insurance market is poor, creating an unfavorable risk – return profile, Berkshire puts down the pen, while their competitors write away. Sadly this mentality is not limited to the insurance industry.

Questions about succession planning abounded at this year’s annual meeting, like they do every year. Buffett takes it all in stride, which is impressive considering his mortality is at question. Few people like to discuss their own death, especially when it is in front of an audience of tens of thousands. My favorite Buffett response to this line of questioning is as follows;

“When you ask who will succeed me as the CEO of Berkshire, what you are really talking about is my death. Naturally this is a subject of grave importance to me personally. Therefore, I have tackled the issue the veracity and intensity, which I do on all matters of importance. I have interviewed doctors, healthcare experts, nutritionists, actuaries and have visited the top medical facilities around the world. I have even taken a spin or two with psychics and fortunetellers. After years of studying the issue of mortality, I have come away with the inescapable conclusion that the number one factor that affects one’s longevity is how long your parents lived. In other words, genes are the most important determinant in how long you will live. Consequently, I never visit the doctor, leave both my high blood pressure and cholesterol untreated, never exercise, smoke cigars, eat a steady diet of red meat, ice cream and candy. I drink alcohol along with sugary drinks like my favorite Coke. But every single morning, I call my mother and ask her if she has exercised on the treadmill yet today.”

Charlie Munger weighs in on the subject of mortality when asked, what is the one piece of information that you do not know that you wish you did? Munger responds, “Where I am going to die.” When asked why, Buffett’s alter ego says, “Because I would never go there!”

Buffett announced that he has selected the individual whom will succeed him as CEO of Berkshire. The board of directors is unanimously in agreement on the choice. Certainly not new news, however, this year’s announcement sounded more definitive than it has in past years. Debate about Buffett’s successor has picked up of late, ever since his prodigy David Sok0l abruptly resigned from the company in 2011. Sokol was a rising star at Berkshire who had managed Mid American Energy and led a dramatic turnaround at money losing NetJets. His dramatic fall from grace shocked the investment community whom widely believed that Sokol would ultimately succeed the man who had become his mentor. Buffett and Sokol enjoyed a special relationship, which was evident during public appearances, where the Oracle was fighting back tears in discussing his prodigy’s departure. Sokol had recommended to Buffett the purchase of Lubrizol, which at first was rejected. After further due diligence Buffett concurred with Sokol and Berkshire announced a deal to acquire Lubrizol in a transaction valued at $9 billion. It would later surface that Sokol was a shareholder of Lubrizol, at the time he recommended the company to Buffett. This fact came to light in the period between the announcement and closing of the transaction. While not breaking any laws, Sokol’s personal ownership in Lubrizol gave the appearance of a conflict of interest, something that is simply not tolerated in the Berkshire organization. Sokol had to go and the one time front runner to succeed Buffett quickly resigned and slipped out of town. Coming to Buffett’s side were the shareholders, who unconditionally threw their support behind Berkshire’s leader, as he faced governance questions regarding policies and procedures, or the lack thereof.

In our opinion there really are realistically five logical choices for the next Berkshire CEO; Ajit Jain CEO of Berkshire Insurance, Tony Nicely CEO of GEICO, Matthew K. Rose CEO of Burlington Northern Santa Fe, Tad Montross CEO of Gen Re and Gregory Abel Chairman & CEO of Mid American Energy. Well I guess you could make it six and throw in Bill Gates, who is on the Berkshire board and one of Warren’s closest friends. And while you are at it, the list should probably include Todd Combs and Ted Weschler, both recently hired by Buffett to help manage part of the investment portfolio. Off to a great start the pair manage a combined $10 billion. In If You Please’s opinion the person who has been selected to succeed Buffett is without question Ajit Jain.

Ajit Jain and Warren Buffett

A graduate of the prestigious Indian Institute of Technology Kharagpur (IIT), Jain went on to earn his MBA from Harvard Business School and work for the consulting powerhouse McKinsey & Co. before joining Berkshire in the mid 1980′s. Jain, age 61, from zero has built the world’s most powerful reinsurance company considered the crown jewel of the Berkshire empire. Buffett has long indicated that his successor must follow the unique culture and investment philosophy, which is so deeply embedded in Berkshire. Jain, who has worked side by side with Buffett for twenty seven years, clearly embodies the Berkshire DNA and “bleeds” value.

From Buffett’s letter to shareholders,

“Ajit insures risks that no one else has the desire or the capital to take on. His operation combines capacity, speed, decisiveness and, most important, brains in a manner unique in the insurance business. Yet he never exposes Berkshire to risks that are inappropriate in relation to our resources. Indeed, we are far more conservative in avoiding risk than most large insurers. For example, if the insurance industry should experience a $250 billion loss from some mega-catastrophe – a loss about triple anything it has ever experienced – Berkshire as a whole would likely record a significant profit for the year because it has so many streams of earnings. All other major insurers and reinsurers would meanwhile be far in the red, with some facing insolvency. From a standing start in 1985, Ajit has created an insurance business with float of $35 billion and a significant cumulative underwriting profit, a feat that no other insurance CEO has come close to matching. He has thus added a great many billions of dollars to the value of Berkshire. If you meet Ajit at the annual meeting, bow deeply.”

“If Ajit is ever not with Berkshire, we won’t look as good,” Warren Buffett said during the Annual Meeting.

Buffett has detailed his investment and business philosophy in excruciating detail in Berkshire’s Owners Manuel. A disciple of the the Columbia Business School professors, Benjamin Graham and David Dodd, Buffett formed his value investment philosophy around a “margin of safety”, a concept developed by Graham & Dodd in their book Security Analysis and later in The Intelligent Investor.

If You Please’s Top Ten Warren Buffett quotes;

10) When the tide goes out, you can see who has been swimming naked.

9) Managements get the shareholders they deserve.

We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.

7) Berkshire is the 800 number during times of crisis. I love it when the phone rings, especially on the weekend, because the pricing is always better then.

6) Our $5 billion 10% Goldman Sachs convertible preferred pays us $500 million a year or $15.85 per second. Tick, Tick, Tick…..

5) Someone is sitting in the shade today, because someone planted a tree a long time ago.

4) Risk comes from not knowing what you are doing.

3) In the business world, the rearview mirror is always clearer than the windshield.

2) Price is what you pay. Value is what you get.

1) Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1

A large part of Berkshire’s business strategy focuses on acquisitions to fuel growth. Buffett and Munger have been telling anyone who will listen for years now that the past returns of Berkshire are simply not repeatable. To quote Buffett at this year’s meeting, “Size matters.” In their opinion, the company has become so large that it forces them to look at acquisition candidates in the tens of billions of dollars. Finding mispriced securities of this size is significantly more difficult than fishing in a pond filled with small companies. According to Buffett, “Too many eyes are focused on the Fortune 500 companies.” Heinz, the most recent transaction, is a good example of the compression in expected returns.Partnering with the Brazilian private equity firm 3g, run by Jorge Paulo Lemann, Berkshire invested $4.4 billion in equity and $8 billion in a preferred stock which yields 9%. Given the slow growth nature of Heinz’s underlying businesses and the price paid (20 x earnings) even Buffett was hard pressed at the meeting to outline a case for double digit returns. Low risk for sure, however, certainly not the type of investment that generated historically annualized returns approximating 20%.

As always, this year’s Shareholder Letter from Warren Buffett includes the company’s acquisition guidelines;

“We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:

(1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units),
(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),
(3) Businesses earning good returns on equity while employing little or no debt,
(4) Management in place (we can’t supply it),
(5) Simple businesses (if there’s lots of technology, we won’t understand it),
(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown)

The larger the company, the greater will be our interest: We would like to make an acquisition in the $5-20 billion range. We are not interested, however, in receiving suggestions about purchases we might make in the general stock market. We will not engage in unfriendly takeovers. We can promise complete confidentiality and a very fast answer – customarily within five minutes – as to whether we’re interested. We prefer to buy for cash, but will consider issuing stock when we receive as much in intrinsic business value as we give. We don’t participate in auctions. Charlie and I frequently get approached about acquisitions that don’t come close to meeting our tests: We’ve found that if you advertise an interest in buying collies, a lot of people will call hoping to sell you their cocker spaniels. A line from a country song expresses our feeling about new ventures, turnarounds, or auction-like sales: “When the phone don’t ring, you’ll know it’s me.”

Other than hostile takeovers, which Berkshire avoids religiously, transactions involving large publicly traded companies only occur when managements want to sell. As the market continues to recover from the financial crisis of 2008, opportunities should surface. Look for Berkshire to announce their largest transaction in history in 2013.

Charlie Munger and Warren Buffett

As America’s number one bull, Buffett spent considerable time during the meeting articulating his well documented view that America’s best days lie ahead. “The dynamics which made this country successful are still working and will continue to work in the future, despite questionable political policies at times. I don’t think 535 people in Washington can overtake 325 million.” Shortly before the meeting, Buffett joined the social media giant Twitter. From his @WarrenBuffett pulpit, the Oracle has registered two tweets. The first, “Warren is in the house” and the second was a link to his recent Fortune Magazine Article in which he outlines the importance of utilizing women in the workplace in order to maximize America’s potential. From the article;

“Fellow males, get onboard. The closer that America comes to fully employing the talents of all its citizens, the greater its output of goods and services will be. We’ve seen what can be accomplished when we use 50% of our human capacity. If you visualize what 100% can do, you’ll join me as an unbridled optimist about America’s future.”

Berkshire’s success defies all logic. How can a team of twenty individuals based in Omaha manage the fifth largest company in the world? An organization with over one hundred subsidiary companies, all of which operate completely autonomously and an investment portfolio exceeding $75 billion. Like a salmon swimming upstream, Berkshire proudly ignores all conventional style and thinking in their unwavering quest to create long term shareholder value. As implausible as this sounds, the “proof is in the pudding” as they say. As Munger indicated, “On paper it should not work, but it does.” On paper, a mirage looks real. Only after one jumps in, does reality emerge. Buffett and Munger have redefined success in the business world and have made it look easy. By opening their “secret” formula and inviting everyone to “jump in” , the legendary duo have provided an invaluable financial roadmap, one which will endure forever. In response to a shareholder question about economic policy in the 1990′s, Charlie Munger interjected, “Just because Warren thinks something, it does not make it part of human nature.” Utopian minds struggle with the urge to wonder how much stronger America would be if Buffett’s musings became dogma. After all it is never too late

Tags: Berkshire, Business, Warren Buffett.

About the Author

Douglas C. Eby Douglas C. Eby is a lifelong resident of the Washington DC metropolitan area. Click here to read more.