2004: What are the benefits of GEICO's direct marketing strategy?

AUDIENCE MEMBER: Good afternoon. My name is J.P., as in justice of peace, or Jell-O pudding.

My last name is Tan, as in suntan. I flew in from the suntan city of Orlando, Florida where an elderly man told me, “J.P. Tan stands for ‘just perfect tan.’”

Mr. Buffett, allow me to give you a big thank you before I ask my question. Some time ago I sent you my business analysis of your investment in Scott Fetzer Company.

I was not sure if you even bothered to read it. Yet you were very kind to write me that my analysis of Scott Fetzer Company is very much on the money.

You also invited me to my first annual meeting where I had the privilege of meeting Mr. Andrew Kilpatrick, who was kind enough to include my analysis of Scott Fetzer Company in his book, “Of Permanent Value: The Story of Warren Buffett.” I want to thank you for making this possible.

Here comes my question. Mr. Buffett, you have said that the nine most important words ever written about investing are these nine words: “Investment is most intelligent when it is most businesslike.”

Mary Buffett said that you have built your entire business success upon these nine words. Investment is most intelligent when it is most businesslike.

For this reason, I started businesslike.com, looking up to guide GEICO and Dell as direct marketing models, since they have the lowest cost structure.

Please kindly share with us in elaborate details the direct marketing methods of GEICO and your friend, Michael Dell? (Laughter)

WARREN BUFFETT (to Munger): What?

CHARLIE MUNGER: He wants you to analyze the marketing methods of GEICO — the direct-marketing methods of GEICO — and Dell.

WARREN BUFFETT: Yeah, well, I’m not as familiar with Dell as I am with GEICO.

The idea of direct marketing in auto insurance at GEICO came from Leo Goodwin, who — and his wife Lillian — who had come from USAA.

And USAA was set up some years — and GEICO was set up in 1936 — USAA was set up, I believe, in the early ’20s, because military personnel moved around a lot, and they had trouble getting auto insurance. And a great organization was established.

Leo Goodwin took that idea, and decided to broaden it beyond the officer ranks of the military. And first went to government employees generally, and now that’s been extended dramatically over the years to the American public as a whole. It’s a better system.

You know, if you go back a hundred years, auto insurance when the auto first came in, was sold by the casualty affiliates of the big fire companies. That’s where — that — in the 1800s, the major insurance companies were fire companies, and casualty insurance was something that came along later.

And it was sold through a system whereby the agent got large commissions, where there was sort of cartel-like rates established through something called a “bureau.” And that system prevailed for several decades.

And then State Farm came along, formed in the early 1920s. A farmer from Merna, Illinois in his 40s. No background in insurance, no capital, but he came in with the idea of having a captive insurance — agency force. And that brought down costs somewhat.

And State Farm, in time, became the largest auto insurer in the country. And Allstate, which followed that system, became the second largest. And that was a better system, a better mouse trap.

And then USAA, followed by Leo Goodwin at GEICO, came along what a direct-marketing operation that bypassed the agent and brought down costs further.

Now, every American family, virtually, wants to have a car. They don’t want to have insurance, but they can’t drive their car without insurance. So they’re a buying a product they really don’t like very well. It cost them a significant part of their family budget. And cost, therefore, becomes very important.

It’s not a luxury item, it’s a mandatory item, virtually. And saving significant money makes a real difference in a lot of household budgets. So the low cost is going to win.

And our direct operation — Progressive has a wonderful direct operation competing with us — we’re the two that will be slugging it out over the years — is a better system, and better systems win over time.

Now, I — again, I’m not that familiar with Dell, but I have the impression that Dell is a very low-cost operation, enormously efficient. You know, very low amounts of inventory.

And, you know, I would hate to compete with them. The — if they can — if they turn out a decent competitive product at the best price, you know, that system will win.

You know, Charlie is a director of Costco, and Costco and Walmart figured out ways to do things at lesser costs that people needed — where people spent money in big quantity. And those two companies are winning.

So, we have a terrific marketing operation, and a terrific insurance operation in GEICO. And in my view it will grow very, very substantially.

And we have a very tough competitor in Progressive, because they’ve seen how well our model works, and they, in effect, have shifted over. I mean, they’re not totally shifted over, but they’ve moved towards a direct operation, and away from an agency operation.

It’s always a good idea to go with a low-cost producer over time. I mean, you could mess it up in other ways, but being a low-cost producer of something that’s essential to people, it’s going to be a very good business usually.

Charlie?

CHARLIE MUNGER: Yeah, you’ve chosen a wonderful field. And if you fail in it, it’s your own fault. (Laughter)

WARREN BUFFETT: I should say also that that — those nine words, they came from Ben Graham, they didn’t come from me. But Ben said those, and they are very important words, although they tie in with some others that he said. But they are very important words.

CHARLIE MUNGER: Warren, I want make an apology, too, because last night I said that some of our modern business tycoons — and I remembered particularly Armand Hammer — were the type that, when they were talking, they were lying. And when they were quiet they were stealing. (Laughter)

And some people got the impression that that was my witticism. That was said a great many decades ago about one of the robber barons.

WARREN BUFFETT: Well, if we start confessing here to the number of quotations we’ve stolen, we’ll be here all afternoon. (Laughter)