A Dozen Things I’ve Learned from Tom Murphy About Capital Allocation and Management

Some people, particularly those that are in the early stages of their career, may ask: who was Tom Murphy? He is the sort of person that industry hall of fames write about in this way: “He began his broadcasting career as the first employee of a bankrupt television station in Albany, New York. Acquisition by acquisition, he built the company.” “Tom, who became President of Cap Cities, gradually built the company into a telecommunications empire. In 1985 he engineered the purchase of ABC with the backing of his long-time friend Warren Buffett, and the company became Cap Cities/ABC. He describes it as ‘the minnow that ate the whale’. Ten years later, Tom sold Cap Cities/ABC to Disney for approximately $19 billion.”

In 1985, Fortune wrote: “Under Murphy and Burke, Capital Cities has turned in an exceptional performance in its principal businesses: broadcasting, which produced 51% of the company’s 1984 operating profits, and publishing (48%). Without much show of effort, Capital Cities’ per-share earnings growth since 1974 has averaged 22% annually, compounded. Return on shareholders’ equity, a key measure of performance, averaged a splendid 19.2% during the period.”

Warren Buffett is one of Tom Murphy’s biggest admirers. For Warren Buffett to say this is high praise indeed: “Tom Murphy and Dan Burke were probably the greatest two-person combination in management that the world has ever seen, or maybe ever will see.” Similarly, Warren Buffett once told Lawrence Cunningham, the author of the book Berkshire Beyond Buffett: “Most of what I learned about management, I learned from Murph. I kick myself, because I should have applied it much earlier.” He has also said it as directly as possible: “I think (Murphy) is the top manager in the U.S.”

When you study what Warren Buffet has said and written about managing a business, in many cases you are learning indirectly from Tom Murphy. That is a good thing since Tom Murphy did not say or write very much in comparison to Buffett. Like many great operators and managers Tom Murphy mostly let his business results speak for themselves, and did not spend any significant time seeking to be noticed by the public.

1. “There’s no substitute for being a good business, and there are not many of them.” “There are not many great businesses that come along in a lifetime.” Warren Buffett and Tom Murphy see eye-to-eye on this point, with the Berkshire chairman famously saying: “When a management team with a reputation for brilliance joins a business with poor fundamental economics, it is the reputation of the business that remains intact.” Without a moat, any business will inevitably see the price of their company’s products reduced to a point equal to the opportunity cost of capital – even if the business has managers who have great operational skills. Yes, you definitely want great managers and occasionally you might find one as talented as Tom Murphy or Ajit Jain. But that does not mean you should invest in a business without a moat if you think it has great management.

The forces of competition are relentless, and the ability to copy the operational effectiveness of a competitor is a constant problem for businesses that do not have a moat. Tom Murphy is making the point above that businesses which have a moat are rarer than most people imagine. In other words, a good moat is truly hard to find. And contrary to what Peter Thiel would have you believe, moats come in all sizes with varying strengths and weaknesses.

The width and depth of a given moat shifts constantly. There is no binary phase transition between moat and no moat. I do find it a bit ironic given the Buffett/Berkshire connection that Tom Murphy once said: “I loved the business I was in, and I loved going to work every morning. If it had been the railroad business, it would not have been as much fun.”

2. “The goal is not to have the longest train, but to arrive at the station first using the least fuel.” This quote is a great setup to contrast the management style of Tom Murphy with William Paley, who ran the competing CBS television network. Tom Murphy was not a fan of a business getting bigger for its own sake or diversifying into unrelated businesses to achieve “synergy” or diversification. Unlike William Paley, Tom Murphy did not buy businesses like a baseball team or a toy company. When Tom Murphy bought a business it was to generate additional benefits for the core media business.

As we discussed, Tom Murphy thought that a business with a moat is very hard to find and for this reason alone he preferred to put capital to work in the business where he had the greatest advantage. When Tom Murphy allocated capital he preferred a focused approach rather than diversification, since he was investing in a business he knew very well and that had very attractive characteristics.

3. “We just kept opportunistically buying assets, intelligently leveraging the company, improving operations and then we’d … take a bite of something else.” One of the great skills that any investor or businessperson can have is a talent for capital allocation. And Tom Murphy, like Warren Buffett, was a master at capital allocation. When Tom Murphy bought a business he used debt or cash generated by the business rather that diluting equity by issuing stock. In this way, he acted a lot like John Malone or Craig McCaw as they rolled up business after business so as to benefit from demand and supply-side economies of scale.

William Thorndike, the author of the popular business book The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success, believes that the best CEOs have an “investor’s mind set.” When they consider a business decision like an acquisition or the purchase of capital equipment, “they viewed it as investment and when it had attractive returns they did a lot of it.”

4. “The business of business is a lot of little decisions every day mixed up with a few big decisions.” A great business is built brick-by-brick on a daily basis. The job of a CEO is to make a few really important decisions that set strategic direction, and then find ways to enable the rest of the company to achieve their goals. Dan Burke, Murphy’s long-time business partner, said in an interview that the process is simpler than people imagine. You gather the facts and then you make decisions based on good judgment. Of course, having good judgment is easier said than done. It is certainly easier if your business itself is sound.

On Warren Buffett’s company, Tom Murphy wrote in the forward to Berkshire Beyond Buffett: “From afar, it may look like Berkshire’s wide-ranging businesses are very different from one another. In fact … while they span industries, they are united by certain key values, like managerial autonomy, entrepreneurship, frugality and integrity.” Dan Burke was fond of a quotation attributed to a Chinese philosopher: ”A leader is best when people barely know he exists, not so good when people obey and acclaim him — worse when they despise him. But of a good leader who talks little when his work is done and his aim is fulfilled, they will say: We did it ourselves.”

5. ”Decentralization is the cornerstone of our management philosophy.” “[Warren Buffett and I] are both proponents of a decentralized management philosophy: of hiring key people carefully; of pushing decisions down the organization; and of setting overall principles and resisting temptation to be involved with details. In other words, don’t hire a dog and try to do the barking.”

“Decentralization, though, is not a magic bullet…. In the wrong environment, chaos and anarchy sit side-by-side with decentralization.” Warren Buffett has said his strength is his weakness: delegation to the point of anarchy. What Tom Murphy taught him was that if you (1) hire the very best people and (2) don’t delegate the critical job of capital allocation, you can create what Buffett’s partner Charlie Munger calls a ‘seamless web of deserved trust’. It is tremendously cost efficient to have a culture that is based on trust, since you don’t have the cost or the inefficiency associated with layers of management that try to act as a substitute. When Tom Murphy bought the ABC Television network, the Capital Cites headquarters consisted of only 36 people. Of course, this seamless web of deserved trust system does not work if you do not hire great people, allocate capital wisely, and delegate authority. Fortune magazine pointed out: “The great exception to the local-autonomy principle is a rigorous annual budgeting process that Burke personally oversees.”

6. “We expect a great deal from our managers.” The flip side to Tom Murphy’s aggressive delegation of authority was that he held his managers accountable for performance. If you have delegation without accountability it is an absolute recipe for disaster. For example, accountability for sales targets was not something that was casually considered at Capital Cities. As another example, in the television broadcast industry feedback is quick. Someone once quoted Murphy as saying: “Every day you wake up and get a report card on how you’re doing.”

In the Berkshire context, Jim Weber, the CEO of Brooks Running, has pointed out that Buffett and Munger “fall in love with a business that has great management in place, so that they don’t have to run it [but] I’ve never felt more responsible and accountable.” Murphy’s #2 Dan Burke put the process at Capital Cities this way: ”We sit everybody down in the dark once a year and show them what they said they were going to do for the year and what they actually did. Then we look at what they say they’re going to do next year. It’s sort of compelling to know that a year from now you’re going to be back in that same slot.”

7. “Cost control was the baseline of our company culture.” “We worked to make cost-consciousness a part of our company’s DNA. Budgets, which are set yearly and reviewed quarterly, originate with the operating units that are responsible for them.” Tom Murphy was famously frugal. One story often told is about Tom Murphy only painting the two sides of a building Capital Cities owned that faced the road. But when it came to buying assets that produced excellent financial returns, Tom Murphy did not hesitate to spend money. If he was cheap, it was on expenditures that he felt did not produce an adequate financial return.

A producer for ABC said once that if your programs went over budget “you would be invited to seek employment elsewhere.” In The Outsiders William Thorndike wrote: “Murphy, however, was a cab man and from very early on showed up to all ABC meetings in cabs. Before long, this practice rippled through the ABC executive ranks, and the broader Capital Cities ethos slowly began to permeate the ABC culture. When asked whether this was a case of leading by example, Murphy responded, “Is there any other way?” Focus on cost control meant “that Murphy’s stations had the highest margins in the business, north of 50% compared to an average of 30%.”

8. “Gauge performance over the long haul.” Tom Murphy was famously patient when it came to acquisitions and he adopted the same view when it came to the performance of his managers. Like Warren Buffett, he was willing to accept results that could be lumpy if that higher volatility improved long-term overall performance. The process was rigorous: “Murphy’s method of deal sourcing … involved staying out of the public eye, and spending years developing relationships with potential prospects. He never financed with equity, either generating cash internally, or using debt which was nearly always paid off within three years. All his major deals were through direct contact with sellers; they were never hostile, and never through an auction. He had strict return requirements: a double-digit after-tax return over 10 years, without leverage.”

9. “There’s no substitute for people with brains who are willing to work hard.” “One wrong hiring decision at a senior level can really hurt hiring decisions down the line.” “If you hire mediocre people, they will hire mediocre people.”

“In terms of culture, we told our employees that we hire the smartest people we can find and that we have no more of them around than necessary.” For Murphy, no partner was more important than Dan Burke who “shaped the culture of the company, with an emphasis on accountability, directness, irreverence and community service.” [Dan Burke had] a “wicked sense of humor that made every day more fun.” Tom Murphy and Dan Burke preferred to hire someone with brains rather than experience. Tom Murphy once said that his company “doesn’t like to have more personnel than it needs. Too many people with too little to do leads to office politicking and other behavior that’s destructive for an organization.”

10. “One of the most uncommon things in life is common sense. It’s very hard to notice whether people have common sense.” Judgment and common sense are among the hardest things to teach. I think everyone can get better at making decisions, but some people have more common sense than others it seems. In many respects, making better decisions and having more common sense is a trained response. In my view, the first rule on this point is to read as much about Charlie Munger’s views on the psychology of human misjudgment and worldly wisdom as you possibly can. The second rule is to not forget the first rule.

11. “As an entrepreneur you don’t want to run out of cash. You don’t want to borrow any more money than you absolutely need.” This point is so obvious, and yet some people forget it and seal their doom. Running out of cash is an unforgivable sin in business. If you have enough cash, you can even go through bankruptcy and survive as a business. Holding the right amount of cash is an art, especially if you are being financed with debt. I plan to write a post on Michael Milken at some point which will deal with this set of issues.

12. “Don’t spend your time on things you can’t control. Instead, spend your time thinking about what you can.” Carl Richards has a wonderful graphic that makes this same point on a napkin-like sketch.