Try to find the simplest businesses.

One of Warren Buffett’s better-known sayings is: I try to buy shares in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will!

Finding a business that passes Buffett’s “idiot test” is exceptionally difficult; the trick is to find one that comes close. Of course, when you find such a business its shares are unlikely to be cheap.

The Idiot-Proof Business
Does Not Exist, But…

Ideally the business has to be able to operate in all economic circumstances and suffers minimal political interference (political interference has ruined many a good business). It would help if it was protected from competition by other barriers to entry, thus permitting other firms to enter its market only at great risk to themselves. Furthermore, the idiot-proof business should be able to grow its earnings on a reasonably consistent basis.

The inherent strengths of the idiot-proof business would overcome the idiot’s tendency to damage the business in the short-term. This protection cannot apply in the long-term since, as recent events have all too well demonstrated, any business can be ruined if an idiot piles too much debt onto it. In recent times many investors have been ruined by the idiotic behaviour of management in businesses which clearly don’t pass the idiot test.

In practice, just like the perfectly competitive market beloved of economic theory, the idiot-proof business does not exist. But some come close…

Destroying Your Flagship Product Isn’t A Good Idea

Coca-Cola clearly passed Buffett’s test back in 1985 when it tried to replace Coca-Cola with New Coke. Mark Pendegrast, in For God, Country and Coca-Cola (The Definitive History of the World’s Most Popular Soft Drink), called New Coke “The marketing blunder of the century.” Pepsi-Cola had recently overtaken Coca-Cola in the US market and for years Pepsi had consistently beaten Coke in blind taste tests. Coca-Cola management’s response to this threat was New Coke which had convincingly beaten both products in similar tests. All the evidence showed that New Coke was the superior product. New Coke’s introduction turned out to be a public relations disaster with lacukustre advertising and a terrible press conference launching where executives were ridiculed for claiming that New Coke wasn’t a response to Pepsi’s success.

Don’t Tread On Me (And My Coke)

The big mistake was that during product testing no-one ever mentioned to the testers that New Coke would replace the old formula. Thus Coca-Cola was completely unprepared for the extreme adverse reaction of consumer who did not want them to take away their Coke. The effect was startling; there were protests all over America, callers jammed the headquarters’ switchboard and there was panic buying of “Classic Coke.” New Coke adverts were even booed when they appeared on the Houston Astrodome’s TV screen.

Coca-Cola had become so strongly ingrained in the culture and daily lives of an extremely large proportion of Americans that the attempt to change it produced a massive adverse psychological reaction. The company’s was bombarded with letters and phone calls, all which could be summed up as saying the company had betrayed them. Yet this outpouring of customer loyalty contradicted taste test evidence which said that people preferred the New Coke to Coca-Cola. That’s what you call brand loyalty!

New Coke was withdrawn less than three months after its launch and by the end of 1985 Coca-Cola retook the No.1 spot from Pepsi (which it retains to this day).

As Donald Keough, the then President of Coca-Cola, commented “Some cynics will say that we planned the whole thing. The truth is that we are not that dumb and we are not that smart.” Coca-Cola clearly passed the idiot test — the New Coke disaster did not harm the brand and even increased its sales!

Failing the Idiot Test

The flipside is that most businesses clearly fail the idiot test but this doesn’t make them investments to avoid. But if you can’t understand how a business makes its money then don’t invest in it; there are plenty of alternatives. However, those businesses which fail the idiot test due to their opaque practices are often a cover for extremely dodgy accounting and/or fraud. Enron’s accounting policies should have put investors off because they made it extremely difficult to determine exactly where the profits came from. That this masked a whole level of fraud was no surprise to many people when Enron collapsed. The idiot test doesn’t mean that you have to understand the details of every aspect of the business, just the basics. It’s easy to understand how Intel makes money (designing and selling microprocessors); but if you don’t understand how a microprocessor works that shouldn’t put you off Intel shares. However, the nature of Intel’s business means that clever people are needed to run it.

Keep looking for those idiot-proof businesses, and let us know if you find one!