Question

Legendary for his business and investment acumen, Warren Buffett is frequently called the “Oracle of Omaha” after his birthplace in Omaha, Nebraska. As one of the world’s wealthiest business owner-investors, business executives are always interested in any insight or opinion Mr. Buffett might wish to share.

Explain each one of the following statements made by Warren Buffett. (Quotations from The Wall Street Journal, September 23, 2002.)

“You cannot be the high-cost producer in a commodity business.”

“Sometimes it’s not even any good to be the low-cost producer.”

Answer 1

a) You cannot be the high-cost producer in a commodity business.

The producer using high cost to produce a good will be the first to be removed from the market if there is any other producer who can produce the same good at a cheaper rate. The low-cost producer will simply undercut the price and put the high-cost producer out of business or even if the high-cost producer decided to stay in the market in the short run he will be facing a loss.

Second, a high-cost producer can't be the market leader in case of an oligopoly or he can't reduce the price of his product to keep the competition out of the business. He will be losing his market share sooner or later.

b) A low-cost producer: A low-cost producer earns a very thin margin of profit. In case of a new technology introduction or making an investment the low-cost producer will have to face capital crunch. If he doesn't increase its price its margin is low but if he does he will be attracting more firms in the market which will erode his market share.

He will have to compromise on its quality or the product and this will be harmful in the long run.