In Charles Munger’s famous speech at USC Business School in 1994 entitled A Lesson on Elementary Worldly Wisdom, he discussed the cost cutting phenomenon. Here’s an excerpt from the speech:
Munger: In all cases, the people who sell the machinery—and, by and large, even the internal bureaucrats urging you to buy the equipment—show you projections with the amount you’ll save at current prices with the new technology.
However, they don’t do the second step of the analysis which is to determine how much is going to stay home and how much is just going to flow through to the customer.
I’ve never seen a single projection incorporating that second step in my life. And I see them all the time. Rather, they always read: “This capital outlay will save you so much money that it will pay for itself in three years.”
So you keep buying things that will pay for themselves in three years. And after 20 years of doing it, somehow you’ve earned a return of only about 4% per annum. That’s the textile business.
And it isn’t that the machines weren’t better. It’s just that the savings didn’t go to you. The cost reductions came through all right. But the benefit of the cost reductions didn’t go to the guy who bought the equipment. It’s such a simple idea. It’s so basic. And yet it’s so often forgotten.
You can find the entire transcript of the speech here:
For all the latest news and podcasts, join our free newsletter here.
Don’t forget to check out our FREE Large Cap 1000 – Stock Screener, here at The Acquirer’s Multiple: