Why Warren Buffett's betting big on American ExpressNovember 21, 2012: 11:30 AM ET
Though losing market share, the company - and its famous green card - has one thing still going for it: the brand.
By Linda Grant
This story is from the October 30, 1995 issue of Fortune. It is the full text of an article excerpted in Tap Dancing to Work: Warren Buffett on Practically Everything, 1966-2012, a Fortune Magazine book, collected and expanded by Carol Loomis.
FORTUNE -- Warren Buffett loves to tell a parable about the stock market's irrationality. It was 1963, and a scandal involving fake inventories of salad oil at a small subsidiary of American Express drove down the price of Amex shares. How bad a problem was this? To find out, Buffett spent an evening with the cashier at Ross's Steak House in Omaha seeing if people would stop using their green cards. The scandal didn't seem to give any of the diners indigestion, so Buffett seized the opportunity to buy 5% of the company for $13 million. He later sold his holding for a $20 million profit.
Now Buffett hopes to relive the story -- with much larger numbers. Over the past few years the CEO of Berkshire Hathaway (BRKA) has accumulated more than 49 million shares of American Express (AXP), a 10.1% stake. Its value, about $2.2 billion, makes it one of Buffett's largest investments, along with Coca-Cola (KO), Gillette, and Capital Cities/ABC. Once again he thinks Wall Street is irrationally down on Amex stock. The trouble this time is not salad oil but a long and well-publicized catalogue of strife: A nearly dysfunctional management team led by James Robinson III damaged the brand in the early 1990s; his grand strategy to build a financial supermarket fell like a house of cards, with Amex's Shearson Lehman brokerage subsidiary eating up $4 billion in capital before being sold last year. More recently the tarnished American Express card has been losing market share to Visa (V) and MasterCard (MA) as Amex's principal consumer benefit -- prestige -- becomes a tougher sell. And the company's international business, say analysts, is in the doldrums.
Always the patient investor, Buffett -- worth $14.2 billion at last count -- believes the latest troubles are little more than a distraction. What he likes is exactly what has made him rich before: a mighty brand coupled with a healthy cash flow. After all, American Express, according to London marketing group Interbrand, is still one of the ten most-recognized brands in the world. Buffett believes the name remains "synonymous with financial integrity and money substitutes around the world." As he explained to Berkshire Hathaway shareholders at last spring's annual meeting: "By far the most important factor in [Amex's] future for a great many years to come will be the credit card. We think American Express's management thinks well about ... how to keep the card special." Buffett probably isn't particularly concerned about the company's loss of market share. More likely, he's gambling that Amex, even if it fails to grow dramatically, will become a very profitable niche player in the card market.
But if American Express is to fulfill Buffett's expectations, it will have to breathe new life into its brand -- no easy task. The big question is whether Harvey Golub, who became CEO in 1993 after the board booted Robinson, is up to the job. He came to Amex from McKinsey & Co. and has done a sterling job doing what consultants do -- cutting costs and shedding money-losing divisions like Shearson Lehman. He imposed discipline on Amex's free-spending ways by cutting a draconian $1.6 billion out of gross operating costs. Amex, with 1994 revenues of $15.6 billion (No. 55 on the Fortune 500), saw operating profits grow 18% last year. Since Buffett started heavily buying the stock over the past year, it has risen -- thanks mostly to the cost cutting -- from $25 a share to a recent $44. (For more on Buffett's investing style, see "How Buffett Rated Amex a Buy," p. 129, Tap Dancing to Work.)
"American Express has the best and most loaded-up battleships," says Salomon Brothers analyst Thomas Facciola: "Now it's a question of whether the company can hit its targets." The answer is not at all clear. In the highly competitive credit card market, which includes Visa and MasterCard, American Express is launching salvos of new cards like Optima True Grace as well as ones aimed at students. But so far critics find Amex's new credit cards ho-hum, modest successes that seem too little too late. The company, they say, needs to wow the market with a sizzling hit like AT&T's Universal card or GM's (GM) 5% rebate card. Argues H. Eugene Lockhart, MasterCard CEO and one of Golub's biggest rivals: "Will Golub ever achieve the growth rates that we and Visa are achieving now? I really doubt it because of the basic core proposition. We offer better value to the customer than they do."
Seated behind a gleaming cherry-wood conference table on the 51st floor of his company's baronial headquarters in Manhattan's World Financial Center, Golub puffs on a Benson & Hedges cigarette and sips coffee from a mug promoting his company's PARTNERSHIPS WITH SUPERMARKETS. This day he comes off as a taciturn man, given to monosyllabic answers and long pauses. During this interview with Fortune he displayed no excitement about his campaign to resuscitate Amex.
Golub is a classic McKinsey consultant, a brilliant analyst who, as he has proved, knows how to restructure a broken business. But that doesn't mean he knows how to inspire, revitalize, and grow one profitably. At IBM (IBM), CEO Louis Gerstner, also a McKinsey alumnus (and former Amex president), has done a skilled job cutting costs but now faces a similar dilemma in making Big Blue grow. At Westinghouse, yet another McKinseyite, Michael Jordan, has so far failed to get a troubled company rolling.
And that could be a problem. Golub needs to transform a slow-moving, arrogant American Express culture into one that more closely resembles those of its competitors: gung-ho, innovative, and fast moving. Over the years, Amex acquired a reputation for being a bear to work with. You may recall the Boston Fee Party, when one restaurateur, upset about the high fees Amex was charging, stuck a chef's knife through an Amex green card, an event that made national TV. In another instance, AT&T (T), American Airlines, and others approached the company with offers to issue joint cards with nifty perks for customers, but Amex management haughtily turned them down. Says Golub: "We should have seen what was happening, but we let success blind us. We were inflexible. We were arrogant. We were dreaming."
Yet Golub can't readily explain his antidote. When asked whether arrogance is still a problem at Amex, the portly 56-year-old with blue eyes blazing behind wire-rim glasses responded as follows: "You want to have an organization that is humble and proud, that is confident but not arrogant, is confident but not self-delusional. So it's a fine line, and I'm sure that to some people what may be viewed as confidence comes across as arrogance. To others it comes across as humility. If we had everybody saying we're not arrogant, my guess is we would be servile."
Even if his strategy is on target, little in Golub's past suggests he has the charisma to rally the troops. In 1967 he joined McKinsey, where he stayed for 14 years, save for a three-year stint running a New Jersey trucking firm. His attempt to grow that company never got off the ground. Golub left, he says, over a strategy disagreement. The business later went bust.
Golub's entree to Amex was through his work at McKinsey, which included advising Amex's Travel Related Services business. He championed quality programs like replacing lost cards within 24 hours. In 1984 he took a job at IDS, American Express's personal finance division, where he gets much credit for improving the sales force and customer service.
But even Golub's fans wonder whether he has the right stuff to take on as big a challenge as Amex. Colleagues admire his blunt, direct style, feeling he's not afraid to face the truth, no matter how bad -- a rare quality in a CEO. At the same time, he is not seen as what anyone would call a forceful leader. Says a former Amex manager who wished not to be named: "Harvey is regarded as very tough. I've never heard anyone say that they like him. Never heard anyone say they would lay down their life for him. No one at Amex waxes about what a great guy he is. He's basically 'In Your Face Harvey,' just like those awful pictures of him where he's always leaning forward in his suspenders looking like he's about to bite your face off."
Inside the company, Golub is both feared and respected. Basically, he has three different styles:
The Brooder. In the first he becomes silent and angry looking, and doesn't say anything. He just conveys unhappiness.
The Attacker. In the second he gets angry. Says a former top executive who has left the company: "I was in a budget review with him where he attacked people at the most basic level. He yelled at them, 'Why the hell should we pay all this money when nothing happens? All you do is cause problems, you aren't even trying, this is the first area I should cut.' "
The Consultant. His third is the highly analytical consultant who cross-examines people. It's an acceptable style that can work, but only when accompanied with reinforcing actions like recognizing people and thanking them. Says the ex-employee: "I have no knowledge of his ever doing that."
Vice chairman Kenneth Chenault, on the other hand, is well liked and trusted by employees. Before coming to Amex, he worked for two years as a consultant at Bain & Co. His sunny personality and marketer's savvy are welcome contrasts to Golub's gloomy persona. But when Golub's friend George "Chuck" Farr left McKinsey last May to join the CEO's office as another vice chairman, employees wondered why. They questioned whether another consultant was what Amex needed.
No matter what kind of leader Golub turns out to be, most everyone in the industry agrees that his strategy to revive the brand basically makes sense. Says one consultant: "What I've picked up working there is that compared with the old regime, people now have a clear sense of where they are going."
Golub is convinced that Amex can clamber back to its former preeminence by adhering to a starkly simple statement of strategy: "To become the world's most respected service brand." Whether that turns out to be a rallying cry or just hubris, it has so far provided Golub & Co. with a road map for revival. Says Farr: "The brand is the engine that will drive the business. If we can't use the brand, we won't be in the business." Clearly words that would comfort Buffett.
If the brand is the strategy, the heart of the brand remains the American Express card. Amex today consists of two main parts: Travel Related Services, including cards, traveler's checks, and a travel agency business, which last year contributed 72% of revenues and 65% of pretax earnings, and American Express Financial Advisors (formerly IDS), which sells mutual funds and other financial products and accounted for 23% of revenues and 29% of earnings.
The good news for Golub is that the card market is booming. Credit cards -- think of them as a pawnshop for yuppies -- have been a hugely profitable business. Last year Americans tallied up $611 billion in card charges; that's $2,336 for every man, woman, and child, and 23% more than the year before. This $611 billion represents only 10% of total consumer spending, so the industry still has room to grow.
But American Express has mostly missed out on the best part, the business of financing credit card loans. Its most obvious difference from such competitors as Visa and MasterCard is that you must pay the entire balance each month. The competition's business is astonishingly lucrative because of an equally astonishing spread; issuers today borrow at about 7%, then lend those funds to cardholders at around 17%. Various bells and whistles like below-market teaser rates, insurance, frequent-flier miles, and cash rebates eat into some of that lucre. Issuers must also invest substantial sums in technology to keep track of all that business.
Why are consumers willing to pay an ungodly 17% to borrow money for things like White Sox tickets and a night out at a Sizzler? This anomaly so mystifies University of Maryland economist Lawrence Ausubel that he recently presented a paper on the subject to the National Bureau of Economic Research. His conclusion: Issuers can get away with charging such steep interest rates because consumers underestimate the amount they'll borrow. And once cardholders do borrow, rose-colored glasses of denial prevent them from acknowledging how much debt they've assumed. In a 1992 study, Ausubel reports, borrowers claimed to owe cumulatively $70 billion in debt when in truth they owed $156 billion.
The bizarre consumer behavior doesn't stop there. Some people, not wanting to hassle with the paperwork, don't bother to trade in their high-interest credit card for one with a lower rate. Others just don't think about the financial ramifications. A woman in Westchester County, New York, chalked up $4,000 on her Visa last month. Though she could afford to pay off the whole thing, she cut a check for only $1,000. As she explains, "I wanted to keep a high balance so I wouldn't be tempted to run up my card again." Understand? In any case, lucky Visa collects a handsome 17% annual interest on her balance.
This has been one great party that Amex came late to -- and now the party looks to be ending. Michael Auriemma, a credit card consultant at a Westbury, New York, firm that bears his name, thinks commoditization in the card business is only a matter of time, irrational cardholders notwithstanding. The industry is shifting to a buyer's market as the 5,000 financial institutions that issue Visas, MasterCards, and others scramble to grab customers by eliminating annual fees and offering attractive initial interest rates. In the U.S. an incomprehensible 2.4 billion preapproved credit card solicitations were mailed last year, enough for every family to receive two a month.
The landscape is becoming so treacherous that among the fastest-growing issuers today are four barely known low-cost Visa/ MasterCard credit card companies: Advanta, Capital One, First USA, and MBNA (For more, click here).
Commoditization is bad news for Amex because the American Express card has always been marketed as a high-fee, high-prestige item -- $55 a year for a green card, $300 for a top-end platinum. Although its corporate card business remains strong, many individuals are beginning to doubt whether this privilege still merits a premium. Amex's share of the U.S. card market, measured by dollar volume, has dropped from nearly 25% in 1990 to 16% this year, behind Visa (49%) and MasterCard (27%). Explains MasterCard's Lockhart: "The consumer today simply doesn't see the need to pay fees for a card that gives them no greater functionality than anything we or Visa would give them."
Golub's challenge, then, is one of the trickiest in management -- to make his brand all things to all people. "The company thinks of its brand as homogeneous," says Thomas O. Jones, a former Amex executive: "But it's not. It is one brand internationally for the business traveler, one for the general public that remembers Karl Malden and 'Don't leave home without it,' and one for the merchants who accept it. It is a huge asset that needs to be watered properly, but I think the company could be doing a much better job."
Priority No. 1 is hanging on to its high-profit, high-rolling customers. Amex cardholders charge on average $4,000 a year, vs. $1,500 for Visa and MasterCard, and Golub wants to offer them more value through special services. American Express Platinum Card members, for instance, now can get calls reminding them to buy a present for their mother's birthday -- which they can, by the way, charge. He also wants to capitalize on the company's vast database of information about customer purchases and retailers' sales. The company's goal is to glean from these records individual tastes such as, say, a customer's predilection for Italian food. Armed with the knowledge, Amex might run a promotion that offers the cardholder a free bottle of wine at a new Italian restaurant opening in his neighborhood. Such customized rewards won't be widely available until next year.
When it comes to polishing the card's carriage trade image, Golub also needs to work on what marketers call "the experience." This is the strategy that has helped companies like Disney (DIS) and McDonald's (MCD) flourish. Disneyland, for example, is more than a theme park. It provides a certain type of enjoyable and predictable experience for its little Mouseketeers. Similarly, McDonald's is not just any fast-food restaurant. Diners know what to expect under the golden arches. Ask a McDonald's executive what the company provides, and he'll give you the official answer: "a consistent, family-oriented, convenient hamburger experience." Or as a Coke (KO) exec would say: "a simple moment of refreshment."
In American Express's world, the card is supposed to offer a sense of financial security and cachet -- an announcement that when you use this card, you've made it in the world. For years that's what has made American Express cards and traveler's checks successful -- both products projected the comforting image of Amex taking care of its members whether at home or traveling abroad. Studies show that some 70% of cardholders feel that emotion is as important as price when choosing a card. Some people believe that whipping out an American Express card will impress a client -- will announce they've arrived.
To his credit, Golub is working hard to improve the Amex experience by making sure members aren't treated like lepers when they pull out their platinum cards. By lowering merchants' fees and making payments to restaurants and stores more promptly, Golub has multiplied the number of places that accept his cards. In addition to the usual four-star restaurants and resorts, consumers can now use American Express cards to buy plebeian items such as stamps at the post office, eggs at ShopRite, socks at Kmart, a cup of coffee at Starbucks, and a movie at Blockbuster. But the company still has a long way to go to build up the Amex experience overseas, especially in Europe, where the card is not nearly as widely accepted for shopping as Visa and MasterCard.
Just rebuilding the traditional Amex aura will be tough enough, but Golub must do it while moving downscale to find more cardholders. Observes David Aaker, a U.C. Berkeley marketing professor and author of the soon-to-be-published book Building Strong Brands: "When you move down-market you run the risk of losing what you had, and then you don't have anything." Adds Atlanta credit card consultant Bruce Brittain: "Can you maintain an upscale image while you go after a downscale market?"
Amex plans to capture the downscale market by going mano a mano against Visa and MasterCard with its Optima card. As with Visa and MasterCard, you must pay your Optima balance each month or pay interest. Optima is what is known in marketing circles as a subbrand, which means it capitalizes on the brand name but has a distinct identity of its own. That's why the Optima card is blue, not green, and has a different name, though American Express is printed prominently on the card. Says Aaker: "You use a subbrand to represent the mass market, while still keeping your prestige brand. The problem is not losing the overall distinction of the brand." It could happen. If the green-, gold-, and platinum-card members sense the brand is being debased with Optima, they'll flee. Conversely, a brand with a history of snob appeal isn't necessarily an easy sell to the masses in an increasingly egalitarian age.
Amex knows it is plunging into a competitive inferno and is working hard to boost its appeal with new services. Last year, for example, Amex successfully introduced a variation on Optima called Optima True Grace. This card starts running the interest meter only after a grace period of 25 days has passed from the date of a purchase. True Grace was snatched up by an estimated 1.4 million users, about twice as many as the company says it predicted, in part because of an effective $40 million ad campaign featuring that purveyor of Waspy lifestyles, magazine publisher-cover model Martha Stewart. This summer Amex sewed up an important deal by winning the right to issue a new Optima credit card jointly with Delta Air Lines (DAL), the last big airline without its own card. The launch of Delta SkyMiles Optima is a coup for Amex, says Card News editor Lurdes Abruscato, because at least 13 other competitors, including Chemical Bank and Wachovia, lobbied hard for it.
Today, Amex is testing all manner of combinations -- cards with rebates, low rates, no fees, and a card targeted at students. Among them is a so-called stored-value card, a handy plastic substitute for quarters and dollar bills in various denominations, say, $25, $50, and $100. Armed with this plastic, college students can call home, buy meals at their cafeteria, or purchase books, and New Yorkers can pay for washing clothes in apartment laundry facilities. It's a great niche for Amex since the company plans to invest the float, i.e., funds paid for the card but not yet spent. Traveler's checks are such a stored-value product, and currently Amex carries a hefty $6.7 billion of these free funds on its balance sheet.
Is Golub up to bringing all this together? He thinks so. As he made clear in a recent talk to students at New York University's Stern School: "To succeed, I believe an organization has to change and adjust before it is forced to do so by external forces. It must reinvent itself and become the very company that could put it out of business before somebody else does."
No matter how tough the challenges that lie ahead for Amex, it's rarely wise to bet against Warren Buffett. After all, he has wagered on strong brands like Coke and Gillette and made a bundle. He also invested successfully in auto insurer Geico, which, like Amex, has a strong cash flow. When Buffett comes up aces, it's usually because he's backing a strong management hand. What's hard to see this time around is how a bunch of consultants can rake in the pot in a truly cutthroat game.