Potential Successor to Buffett Has Tough Task
By GERALDINE FABRIKANT
Published: December 3, 2009
Maybe Warren E. Buffett should have stuck with railroads.
“We are instilling a culture of cost discipline and planning,” said David L. Sokol, who took over as chief of NetJets this year.
Warren E. Buffett, a NetJets user, has posed with his friend Bill Gates in NetJets ads and has endorsed private jet travel.
He once declared after an ill-fated bet on US Airways that he would resist any further urges to invest in airlines. But he ventured anyway into a high-end business that is an airline competitor of sorts — NetJets.
Right about now, he may wish that he had simply bought more of the railways he has accumulated over the years.
At NetJets, the returns have been disappointing — and lately the losses severe. Through his investment company, Berkshire Hathaway, he bought the private jet travel business, which caters to the affluent, for $725 million in 1998. Even though Berkshire does not provide detailed results for this small piece of its empire, insiders confirm that Mr. Buffett has yet to recover his investment.
With problems mounting at the unit — heavy losses and allegations of business improprieties — Mr. Buffett dispatched David L. Sokol to straighten out NetJets in July.
Mr. Sokol’s effort to turn the company around is being watched closely, in part because it provides a glimpse into the management style of a man considered a possible heir apparent to Mr. Buffett at Berkshire.
Mr. Sokol, who previously ran a utility company, has his work cut out for him. NetJets is a luxury business, but its revenue is shrinking, its management is in upheaval and its problems include accusations of improper workplace behavior.
While some former NetJets executives describe his management approach as overly aggressive, Mr. Sokol counters that he merely has “high expectations” for planning and execution and conveys them to employees.
Mr. Sokol describes his mission succinctly. “We are instilling a culture of cost discipline and planning.” In an e-mail message to the staff, he wrote that he had never seen a company of NetJets’ size that operated “without an integrated business plan” and with a budget that was “often ignored.”
Within a week of his arrival in July, Richard T. Santulli, the founder and chief executive of NetJets, resigned. According to several people close to the company, Mr. Santulli was unhappy that a Berkshire executive was brought in to provide oversight.
Mr. Santulli, who declined to comment for this article, is widely considered a visionary for creating a time-share business model for air travel, and a number of current and former executives fondly describe how he treated employees as family, perhaps a shortcoming when the business turned sour and cuts were called for. Initially, Mr. Sokol, 53, had been looking into allegations of excess spending and a consultant who was paid by both NetJets and a supplier. Those issues had been described in several letters to Berkshire from company employees, although the company has not identified the writers.
In a recent phone interview, Mr. Sokol said he had “documented the issues and gotten them fixed.”
After Mr. Santulli resigned, Mr. Sokol became chairman and chief executive, this time with a mandate to rein in costs. That decision was interpreted as a strong Buffett endorsement of Mr. Sokol, who he had no previous experience in airlines or luxury goods.
At MidAmerican Energy Holdings Company, Mr. Sokol turned a small energy company into a leading utility company supplying electricity and natural gas. From his post at the utility, now a subsidiary of Berkshire Hathaway, which acquired the company in 2000, he notably supported the idea of lowering greenhouse gas emissions but rejected a complicated cap and trade system to achieve the goal. The Iowa company, where he still serves as chairman, posted $13.9 billion in revenue last year.
“If there is something prized at Berkshire, it is the ability to commit capital,” said Thomas A. Russo, a partner at Gardner Russo & Gardner, whose clients own Berkshire Hathaway stock. “Mr. Sokol has over the years committed substantial amounts of capital both within the U.S. and overseas, and the returns on those investments have been strong.”
But if Mr. Sokol is to succeed at NetJets, a company a fraction the size of MidAmerican, he needs to lower its costs while maintaining a luxury image.
Delivering a pleasant experience is crucial to the company’s marketing efforts. None other than Mr. Buffett has said so. A NetJets user, he has posed with his pal Bill Gates in NetJets ads and endorsed private jet travel as a life enhancer. By owning stakes in jets that they share with other owners, customers get private flights for far less than the cost of owning their own plane.
The recession has taken a toll on the business, though. NetJets lost $531 million in the first nine months of 2009, and revenue fell 42 percent from a year earlier, to $2 billion. And that was not its first loss. Although NetJets had pretax profits between 2006 and 2008 of more than $550 million, according to one person knowledgeable about the company who spoke only under condition of anonymity, its record has been spotty.
“I call it the Scooby-Doo profitability rationale,” said Robert Aboulafia, an aviation consultant with the Teal Group, a consulting firm. “They were always close to achieving profitability, but there was always one thing that stood in the way, and it was usually related to expansion.”
As sales fell off in 2008 and 2009, Mr. Santulli had begun selling some planes, but he resisted more drastic steps. To avoid layoffs, he favored voluntary measures like asking pilots to forgo holiday pay and to take additional time off. His reluctance to take more aggressive action may have been part of his downfall, Brian Foley, an aviation consultant, suggested.
Could NetJets have been tougher on costs earlier? “Sure they could,” said a former company executive because he did not want to speak publicly about NetJets after leaving. “But clients know that customer service really matters. Without it, air travel is just a commodity product and you can’t compete.”
Mr. Sokol is cutting more deeply. He has begun a program to reduce NetJet’s 7,800-employee work force by up to 11 percent, including 495 of its 3,100 pilots, and has accelerated plans to sell as many as 10 percent of the company’s 800 planes. Some of the high-end perks, including an annual poker tournament in Las Vegas and Loro Piana sweaters for jet owners, are going away, too. Over all, he expects to take $200 million, or 22 percent, out of the company’s operating costs.
Some former executives have complained about his management methods. A onetime NetJets executive, echoing the views of several others, said that Mr. Sokol was intimidating and put people on the defensive. “When he first came in, he got on the phone with a group of us and said: ‘I expect complete candor. I am taking notes and I expect full disclosure’ “ or their jobs could be at stake, this person recalled.
Mr. Sokol said he simply read from a script and did not make threats. He recalled the script thusly: “If you answer deceptively, that will not be looked upon favorably by the board.”
One thing that has changed is the top management, with some bumpy transitions.
Soon after Mr. Santulli left, Mr. Sokol promoted Ben Murray, who had overseen executive charters. Just weeks later, Mr. Murray was demoted to head of global asset management, where he oversaw the buying and selling of aircraft. Mr. Sokol said that Mr. Murray requested the change to “deal with family issues.” Mr. Murray declined to comment.
Meanwhile, Jim Jacobs, who had been Mr. Santulli’s No. 2, was made an adviser. The transition, according to Mr. Sokol, was part of a longstanding plan by Mr. Jacobs to leave the company at the end of January. Mr. Jacobs, too, declined to comment.
Then in October, the European chairman, Mark Booth, and that unit’s chief executive, Bill Kelly, abruptly resigned. Both of those men also declined to comment for this article, but several people close to the men said they were frustrated at being treated the same as their United States counterparts, even though the overseas business had been profitable for several years. They cited an e-mail message to the entire management team describing cost-control measures, in which Mr. Sokol wrote that any attempt to circumvent them would be dealt with “harshly and swiftly.”
The company had operated on some false assumptions, Mr. Sokol said in a recent interview. “I think there was a view that you could make a good return given who your customers were,” he said. Mr. Foley, the aviation consultant, estimates that NetJets’ customers, fractional jet owners, spend an average of $250,000 a year.
But Mr. Sokol says “there was not as much pricing power as one would have thought.” Though NetJets dominates the field with about 70 percent of the market, rivals like Flight Options provide intense price competition.
Now Mr. Sokol must prove that he can make the business hum without damaging one of the best-known luxury brands in travel. With the cost cuts, he expects the company to be profitable next year, but gone are the suites at the Ohio State University football games and North Face jackets for employees.
Mr. Sokol “had to do something dramatic,” said Bruce C. Greenwald, a professor at Columbia University Business School. “But changing a culture is very difficult, and it is not therefore clear that things will work.”