What a Worsted Is

Omaha • 1966–1967

Buffett ran a $50 million partnership that owned a textile business, yet he had never stopped looking like the Raggedy Man.¹ He never varied his skinny striped ties and white shirt, though the shirt’s collar had grown tighter, and the jacket of the old gray suit he wore day after day bunched around his shoulders and gapped at the neckline. He refused to part with his favorite camel-colored V-neck sweater, although its elbows had grown thin. His shoes had holes in the soles. His only concession to the sideburns and long hair that other men wore was a little patch of fine dark hairs that he occasionally let sprout from his crew cut like baby grass over his domed forehead. When Chuck Peterson tried to introduce him to a potential investor at a party, the man’s reaction had been “You’re kidding!” He didn’t even want to talk to Buffett, based purely on the way Warren dressed.² Susie had no influence; her husband’s taste had formed back in 1949 when he was selling suits at JC Penney’s, and Mr. Lanford told him that “nobody knows what a worsted is.”

He now bought his suits at Parsow’s, downstairs in the lobby of Kiewit Plaza, where Sol Parsow was always trying to upgrade his taste. Buffett considered Parsow a “very wild dresser” and paid no attention to his suggestions. Warren’s idea of a proper suit was one “that you could bury a ninety-year-old banker from a small town in western Nebraska in.”³ Parsow prided himself on giving Buffett good advice about stocks, however. He had steered Buffett away from hatter Byer-Rolnick, warning that hats were going out of style. He had also kept him from investing in Oxxford Clothes, delivering the news that suits were not a growth business in the 1960s.⁴ Buffett had ignored Parsow’s warning not to buy suit-lining maker Berkshire Hathaway.⁵

Since he knew nothing about clothing, why the next episode of his career would consist of buying a department store remains somewhat mysterious. It took a whopper of an idea to crack open his wallet these days. But in 1966 he was having trouble finding things to buy for the partnership.

It was one of his newer friends, David “Sandy” Gottesman, who brought him this latest idea. The ever-handy Ruane had connected them at a lunch in New York City. Gottesman, a fellow Harvard graduate from a different year, worked for a small investment bank and sometimes found the odd cigar butt or two.⁶ The quintessential New Yorker, Gottesman valued his time with Buffett so highly, he traveled to Omaha often. He stayed up late talking stocks with Buffett every Sunday evening for about ninety minutes. “I was looking forward to that conversation all week,” says Gottesman. “No matter what I talked to him about, he knew as much as I did about them, most of the time. After I hung up, I couldn’t go to sleep for a couple of hours, I was so charged up.” Buffett considered him a shrewd, disciplined, hard-nosed, opinionated, unabashed capitalist. Naturally, they hit it off.

“From then on,” says Gottesman, “every time I had a good idea, I would call Warren. It was like vetting. If you could get Warren interested in something, you knew that you had the right idea.”

In January 1966, Gottesman brought Buffett an idea: Hochschild-Kohn, a venerable department store headquartered in a building a city block in size that sat at an intersection in downtown Baltimore.

Martin Kohn, the company’s CEO, had called Gottesman to tell him that several branches of the family were thinking of selling and would probably accept a discount price. Buffet and Munger flew into Baltimore, and liked the Kohns immediately. Louis Kohn, who had a financial background, was going to run the business for them. Buffett had become confident of his ability to assess people quickly after experience bringing in three hundred partners and meeting countless business executives over the years. He and Munger looked at the balance sheet and made a $12 million bid on the spot.

On January 30, 1966, Buffett, Munger, and Gottesman formed a holding company, Diversified Retailing Company, Inc., to “acquire diversified businesses, especially in the retail field.”⁷ Buffett owned eighty percent of DRC. Gottesman and Munger each took ten percent. Buffett and Munger then went to the Maryland National Bank and asked for a loan to make the purchase. The lending officer looked at them goggle-eyed and exclaimed, “Six million dollars for little old Hochschild-Kohn?”⁸ Even after hearing this, Buffett and Munger—characteristically—did not question their own judgment and run screaming out the door.

“We thought we were buying a second-class department store at a third-class price” is how Buffett describes little old Hochschild-Kohn.

He had never borrowed any significant money to buy a company. But they figured the margin of safety reduced their risk, and interest rates were cheap at the time. Profits in department stores were thin, but as those profits grew over the years, the interest on the debt would stay the same and any increase in the profits would flow to themselves. If the profits grew over the years.

“Buying Hochschild-Kohn was like the story of a man who buys a yacht,” says Munger. “The two happy days are the day he buys it and the day he sells it.”⁹

Buffett began to grow concerned on his next trip to Baltimore, when Kohn showed him a plan the company had been developing for some time to build two new stores, one in York, Pennsylvania, the other in Maryland. The idea was to capitalize on the exodus from city to suburb that was sending people to suburban shopping malls.

“They’d been planning those two stores for a couple of years. The guy that had the men’s furnishings department had his section laid out. He knew exactly how he was going to decorate it. The woman who ran the high-priced dress department had hers all planned too.” Buffett didn’t like confrontation and dreaded disappointing people, but he and Munger agreed that neither of these locations made sense. He spiked the York store and the Hochschild-Kohn employees and management resisted. Lacking the stomach for a fight, Buffett gave in. But he drew the line at the Columbia, Maryland, store. “I ended up killing that. And everybody died. They just died.”

Still, for the first time, Buffett and Munger had found something they could partner on. Through Diversified Retailing, they and Gottesman had, in effect, created a separate company specifically to own retailers. But Hochschild-Kohn was the beginning of a pattern that would recur more than once in frothy markets: Buffett had lowered his standards to justify an investment. That he had done it at a time when he was having more and more trouble finding what he considered to be good investments in the stock market was no coincidence.

In this case, “we were enough influenced by the Graham ethos,” says Munger, “that we thought if you just got enough assets for your dollars, somehow you could make it work out. And we didn’t weigh heavily enough the intense competition between four different department stores in Baltimore at a time when department stores no longer had an automatic edge.”

Within the first couple of years at Hochschild-Kohn, Buffett had figured out that the essential skill in retailing was merchandising, not finance. He and his partners also had learned enough about retailing to understand that it was a lot like the restaurant business: a wearying marathon in which, every mile, fresh, aggressive competition could leap in and race ahead of you. When the three had the opportunity to acquire another retailer through DRC—this one very different and run by a true merchandiser—they went ahead, however. This retailer came to them through Will Felstiner, the lawyer who had also worked on the Hochschild-Kohn deal, who called to say, “If you’re interested in retailing, here’s the numbers on Associated Cotton Shops.” The Cotton Shops sold women’s dresses. Here Buffett was headed even further afield from his basic “circle of competence,” although this next episode would bring into his fold one of the all-time greatest managers and characters he would ever meet in his life.

“A cheap little scroungey” is how Munger described Associated Retail Stores, the parent of the Cotton Shops.¹⁰ Seeing a set of third-class stores for a fourth-class price, he and Buffett were immediately interested. Associated owned eighty stores with $44 million of sales and earned a couple of million dollars a year. Benjamin Rosner, its sixty-three-year-old proprietor, ran discount dress shops, in tough neighborhoods in cities such as Chicago, Buffalo, New York, and Gary, Indiana, under names like Fashion Outlet, Gaytime, and York. Sometimes he installed several tiny stores carrying the same goods under different names on the same city block. Rosner kept the overhead microscopic and sold only for cash. Running these outlets required unusual skills. In Chicago, a manager at the Milwaukee Avenue store, a big, hard-boiled woman, “blew a whistle every time she saw somebody come in that she knew was a shoplifter type. All the employees would look over and watch the guy from then on. She knew them all and had the lowest ‘shrinkage’ rate of practically any store you could ever find in the toughest neighborhood you could imagine.”^*

Born in 1904 to Austro-Hungarian immigrants, Ben Rosner dropped out of school in the fourth grade. In 1931, the downdraft of the Great Depression, he started with one little store on the North Side of Chicago, $3,200 in capital, a partner, Leo Simon, and a batch of dresses they sold for $2.88 apiece.¹¹ When Simon died in the mid-1960s, more than three decades later, Rosner continued to pay his widow, Aye Simon^* (daughter of communications mogul Moses Annenberg), Leo’s salary in exchange for the nominal task of signing the rent checks for their eighty stores.

“This went on for about six months, and then she started complaining and second-guessing and criticizing. And that really got to Ben. She was a spoiled, spoiled, spoiled woman. Now, Ben was a guy whose principle, as he later explained to me, was to screw everybody except his partner. And in his mind, she’s no longer his partner. So he decided that he had to end this whole thing.

“So as the switch flips in his mind, he’s going to screw her. He decided that he was going to sell the business to me too cheap, even though he owns half of it, because it’ll show her. When we met with him, he started talking and I got the picture very quickly.”

Buffett had been there before with people who were talking themselves into thinking they were better off without something, and he knew not to do anything that would interfere. “He’s talking about selling his business that he’s built up all his life, and he’s going crazy because he can’t stand it and he can’t stand her. He’s just a total mess. So Charlie goes back in the room with me. And after about half an hour, Ben was jumping up and down, and he said, ‘They told me you were the fastest gun in the West! Draw!’ And I said, ‘I’ll draw on you before I leave this afternoon.’ ”

Buffett needed a manager, but Rosner told him that he would stay only until the end of the year. Buffett could see, however, that, just as the business couldn’t carry on without Rosner, fortunately, Rosner couldn’t carry on without the business.

“He loved it too much to quit. He kept a duplicate set of store records in the bathroom so that he could look at them while he was sitting on the can. He had this rival, Milton Petrie of Petrie Stores. One time, Ben went to a big bash at the Waldorf. Milton’s there. They immediately started talking business. Ben said, ‘How much do you pay for lightbulbs? How much do you mark up …?’ And that’s all Ben could talk about. Finally, he said to Milton, ‘How much are you paying for toilet paper?’ And Milton said so much. Ben was buying his quite a bit cheaper, and he knew that you want to be not just cheaper but right. Milton said, ‘Yeah, that’s the best I can get.’ And Ben said, ‘Excuse me,’ and he got up, left the black-tie benefit, drove out to his warehouse in Long Island, and started tearing open cartons of toilet paper and counting the sheets, because he was suspicious. He knew that Milton could not be paying too much by that wide a margin, and therefore that he must be getting screwed himself somehow on toilet paper.

“And, sure enough, the vendors were saying there were five hundred sheets per roll in one of these things. And there weren’t. He was getting screwed on toilet paper.”

Buffett knew that he wanted to be in business with the kind of guy who would leave a black-tie party to count sheets of toilet paper; a guy who might screw the guy across the table but never his own partner. He made a deal with Rosner for $6 million. To make sure that Rosner would stay on the job after he bought the business, he flattered Rosner, made certain he got the numbers to evaluate its performance, and otherwise left him alone.¹²

Buffett felt at one with the Ben Rosners of the world—he saw in their relentlessness the spirit of success. He was sick of problem companies like Hochschild-Kohn and was looking for more Ben Rosners, people who had built excellent businesses that he could buy. He and Rosner shared a mutual obsession. As Buffett liked to put it, “Intensity is the price of excellence.”