“There is a wide difference between completing an invention and putting the manufactured article on the market.” – Thomas Alva Edison

In this week’s New Yorker, Malcolm Gladwell writes about innovation and how Xerox PARC failed to profit from the many incredible inventions that came out of its lab. (You can read the summary here.)

PARC (Palo Alto Research Center), located on the Stanford University campus, was founded in 1970 as a division of Xerox Corporation. They were an R&D lab that Xerox planned to use to both create new products and augment their current ones. They were tasked with creating “the office of the future.” In the mid-1970s, almost half of the world’s top 100 computer scientists were working at PARC. Within five years of its founding, PARC had developed a wide array of important computer technologies, including the following:

• Xerox “Alto”– the first personal computer with a mouse and graphical user interface (GUI) that included windows, icons, and pull-down menus.
• A WYSIWYG (what you see is what you get) text editor.
• Computer generated graphics.
• An Ethernet local-area-network.
• Laser printing.

In Everett Roger’s book Diffusion of Innovations, he uses Xerox PARC as a case study in the “commercialization” phase of the innovation-development process. What led the engineers and scientists at PARC to such an amazing track record? Rogers breaks it down as follows:

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Here is Warren Buffett’s 2010 Letter to Shareholders if you haven’t seen it already.

It was a very good letter overall, with Buffett providing his usual wisdom and wit. This year, he didn’t have to review the basics as he did in 2009 for the new Burlington Northern shareholders, so there was even more wisdom about Buffett’s methodologies and Berkshire’s businesses than usual.

He spends some time in the letter talking about Berkshire’s culture, which is an extremely important yet overlooked part of their past and future success. It is this culture that will allow Buffett to continue to “run” the company for many years after his death. That’s what Berkshire shareholders and the media should focus on instead of worrying so much about succession.

One thing is clear: Buffett may not run the companies that Berkshire owns, but he knows the numbers cold. Of course, that’s always been the case. For every kind of business, he knows the metrics that matter most and the determinants that drive success over time. Sometimes, he even knows it better than the managers themselves (and he’s a much better manager than he’d like to admit in his letters).

For investors, one of the most insightful parts of both Buffett’s letters and annual meetings is how he thinks about and evaluates businesses. In this letter, he didn’t disappoint by providing more insight on how he evaluates Berkshire’s holdings. GEICO was one specific example. The value of policyholders for many insurance companies is zero or even less than zero — these companies are worth tangible book value and no more. But GEICO, according to Buffett’s evaluation, has an extremely valuable base of policyholders: worth about $14 billion, or 97% of annual premium volume.

Number-wise, Buffett provided his estimate of the normalized earnings power of Berkshire’s operations — which at $17 billion, is higher than the reported amount in 2010. These earnings alone would give Berkshire a current pre-tax yield of over 8%, and that doesn’t include any new investments or future gains on their $158 billion in investments.

This valuation compares very favorably to many large-caps in the S&P 500. I think Berkshire is worth at least $100 per “B” share, if not more if Buffett can continue to deploy capital into good, growing businesses.

You can see the above comments in addition to commentary from other Berkshire shareholders in this WSJ blog post: “Here is What People Are Saying About Buffett’s Letter“

Braewick Holdings LP owns shares in Berkshire Hathaway. We reserve the right to buy or sell them at any time.

Some fun facts about Apple’s turnaround:

• +8,524% (37.7% annualized): Stock performance since Steve Jobs’ return to Apple in 1997.
• +821% (18.6% annualized): Revenue growth since Jobs’ return.
• +5,093% (66.4% annualized): Stock performance since the launch of the iTunes Store in April, 2003. (A disruptive innovation.)
• +951% (39.9% annualized): Revenue growth since iTunes Store launch.
• In the last 8 years, revenue has grown by $60 billion (1,000%). 73% of that growth came from newly launched products.
• In the last 3 years, revenue has grown by $40 billion (165%). 60% of that growth came from iPhone sales.
• $220 billion: Amount of products sold since the release of the first iPod.
• $19 billion: Apple’s cut of all sales through the iTunes Store, plus Apple iPod accessories (currently $5 billion a year).
• 298 million: Total number of iPod units sold.
• 90 million: Total number of iPhone units sold.
• If the cash and securities on Apple’s balance sheet (~$60 billion) was turned into a hedge fund, it would be the biggest in the world.

Apple Sales/Income Timeline

Apple’s unit volume for non-Mac products:

The following is a writeup I did for Wal-Mart on Sum Zero, included in its entirety below. Also at the end of the post are some charts that show how Wal-Mart has evolved over time. There is no doubt that Sam Walton and Wal-Mart are one of the, if not the greatest success story over the past 50 years. So it’s a great case study to take a look at. (I believe Warren Buffett once said that his greatest error of omission was not investing in Wal-Mart, a business he could understand very well, in its early days–which is clearly seen in the charts below.)

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Wal-Mart is often listed as a cheap large-cap, but is owned by surprisingly few value investors. One reason is that it’s big and well scrutinized and hence its price is more “efficient.”  This is partly true, and you won’t get stellar returns investing in Wal-Mart. But it is a cheap, well-managed company that returns cash to shareholders and should fare well under a number of different macro scenarios.

Competitive Advantages

The U.S. stores division of Wal-Mart (about 3/4 of pre-tax profit) has significant competitive advantages. To consumers, Wal-Mart’s brand represents one thing: low prices. Customers in the vicinity of a Wal-Mart remain loyal because they can be certain that they will have the lowest prices. And as long as Wal-Mart doesn’t slack off in the service and facility departments, there will be no good reason for customers to switch.

Wal-Mart can have the lowest prices because of their (1) efficient operations and (2) economies of scale. Operationally, expenses are lower because of their non-unionized workforce and other shrewd cost management (shrinkage, inbound logistics, etc.). This penny-pinching mentality has been ingrained in the company since it was founded by Sam Walton. The biggest cost advantages are from Wal-Mart’s economies of scale. The most obvious consequence is purchasing power—Wal-Mart can buy products at lower prices because they can purchase in such enormous quantities. But the biggest and most un-replicable scale advantage is geographic concentration. Wal-Mart has a “hub and spoke” system of a distribution centers with 100-150 stores around them, all within about a day’s drive. Because of this concentration, costs can be distributed over a larger base of potential customers: distribution, advertising, regional management, etc. Wal-Mart also has some of the most technologically advanced merchandise and logistics systems in the world. This is something that smaller or more spread-out retailers can’t match.

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As many have already seen, Google just posted some great third quarter figures. Both revenue and operating income were each up 23%, and Traffic Acquisition Costs (the revenue paid to AdSense partners) were at an all-time low of 25.7% of ad revenue. They also broke out some never-before-released sales figures: $2.5 billion a year for non-text display ads, and $1 billion for Google’s mobile search (driven mostly by use of their Android OS). But one part of the conference call caught my attention:

This is why we’re incredibly proud of Google Instant. Many of you guys speculated that we launched Instant to make more money. Well, let me tell you, that’s simply not the case. We launched Instant because it’s so much better for the user. In fact, from a revenue standpoint, its impact has been very minimal. And from a resource standpoint, it’s actually pretty expensive. So why did we do it? Well, we believe from a user standpoint, Instant is outstanding—and the data that we’re seeing actually bears this out.

The above was from Jonathan Rosenberg, Google’s SVP of Product Management. So, Google Instant was an expensive, non-revenue-producing upgrade to their lucrative search product. They did it, said Rosenberg, because it’s a huge improvement to the user experience. But how can that be measured? This got me thinking about what kind of metrics are truly important to Google in a broader economic sense. In Google’s financial reports they tout improvement in metrics like Traffic Acquisition Costs, Cost-Per-Click, and total number of Paid Clicks. All important to their business, but none that really capture Google’s overall business model. The most important metric to Google, I believe, is Revenue per Unit of User’s Time (or RUUT, for short).

Translating Time into Profit

Time is the ultimate scarce resource. Most businesses capture a portion of their customer’s wallets in exchange for a good or service. But businesses like Google (and TV networks, and most new media/web-based companies) capture a portion of customer’s time first, then translate that time into revenue.

Because time is scarce, when consumers choose to devote their time to a product or service, they are doing it at the exclusion of something else. So that company is literally capturing their customer’s time.  Before Google and other search engines, when people wanted to “find” something, they went about it a multitude of ways: white & yellow pages, classifieds, a library or bookstore, or just plain leaving your house and searching (hard to believe, I know). These things took up a lot of people’s time.

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In November of last year, I wrote “The Restaurant Investor” about Steak n Shake, Sardar Biglari, and what it takes for a restaurant to succeed. In the article, I mentioned that Steak n Shake (now Biglari Holdings) was on solid financial footing and that Biglari would likely start pursuing a holding-company strategy by investing excess cash flow into better opportunities. While this did happen, a few other “revelations” came up over the past six months that changed my view on the company. Anyone who follows BH already knows what I’m talking about, but below I’ve included my thoughts on the situation from my most recent letter to investors:

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Most everyone has heard of the “Type A” and “Type B” personality classifications. In Dan Pink’s book Drive, he adapts MIT management professor Douglas McGregor’s ideas to put forth two more classifications: Type X and Type I. Type X behavior is fueled by extrinsic motivation—external rewards like money and recognition. Type I behavior is fueled by intrinsic motivation—the inherent satisfaction of the activity itself. “I don’t mean to say that Type X people always neglect the inherent enjoyment of what they do, or that Type I people resist any outside goodies of any kind,” Pink says. “But for Type X’s, the main motivator is external rewards. Any deeper satisfaction is welcome, but secondary. For Type I’s, the main motivator is the freedom, challenge, and purpose of the undertaking itself. Any other gains are welcome, but mainly as a bonus.”

Pink lists some well-known examples of both types: Warren Buffett, Oprah Winfrey, and Bruce Springsteen are Type I’s. Donald Trump, Jack Welch, and Simon Cowell are Type X’s. So it’s clear that both personalities can be successful. People can also change over time. But Type I’s almost always outperform in the long run. They’re also the people you want working for you.

On April 30, Biglari Holdings announced that its new compensation agreement with CEO Sardar Biglari would provide him with 25% of the gain in Book Value over an annual hurdle rate of 5%. So if the Book Value of the company went up 13%, Biglari would receive 2% of the company’s equity. At its current size, that amounts to around $7 million, including his regular salary.

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