I am getting Buffett flashbacks reading this letter.
In general, our experience with a commodity business that has virtually no pricing power is to be
cautious when management talks about investing in new equipment or upgrades that would
significantly lower the cost structure compared to its competitors. That may be true for six
months to a couple of years, but in time, competitors will have a new cost structure that is as
competitive if not superior to the company. It is the same treadmill where hardly anyone in the
industry can make a decent return on the assets invested in the company.
Chou
Over the years, we had the option of making large capital
expenditures in the textile operation that would have allowed us
to somewhat reduce variable costs. Each proposal to do so looked
like an immediate winner. Measured by standard return-on-
investment tests, in fact, these proposals usually promised
greater economic benefits than would have resulted from
comparable expenditures in our highly-profitable candy and
newspaper businesses.
But the promised benefits from these textile investments
were illusory. Many of our competitors, both domestic and
foreign, were stepping up to the same kind of expenditures and,
once enough companies did so, their reduced costs became the
baseline for reduced prices industrywide. Viewed individually,
each company’s capital investment decision appeared cost-
effective and rational; viewed collectively, the decisions
neutralized each other and were irrational (just as happens when
each person watching a parade decides he can see a little better
if he stands on tiptoes). After each round of investment, all
the players had more money in the game and returns remained
anemic. -Berkshire, 1985 Annual Letter
