Price is what you pay; value is what you get.

That quote appeared in the Warren Buffett’s letter to shareholders in Berkshire Hathaway’s annual report. Buffett attributes the principle to his mentor, Ben Graham. Buying stocks at a discount to what their market value should theoretically be is one of the pillars of Buffett’s value investment model. Discount to value is one of three principles that our partnership uses in pricing its offerings, along with two other principles that borrow from Buffett’s philosophy – margin of safety being one of them.

In “discounting to value” we attempt to price 15% below the market prices for comparably delivered value. Why 15%? Because we believe that, in a competitive market like ours, buyers will negotiate price down to secure a margin of safety (more on that) for themselves. Pricing this way saves the time and difficulty that accompanies negotiations. As it is extraordinarily difficult to gauge market price in our business at any given time, we must use anecdotal evidence, as imperfect as that is.

I have explained margin of safety before in these blogs. Here is Buffett’s description in his own words: If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you’d need. If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay, but if it’s over the Grand Canyon, you may feel you want a little larger margin of safety…

The margin of safety we seek when pricing a bid stems from the fact that we never know for certain how well a business is functioning until we get inside it. None of us believes in factoring in a “discovery phase” in which the client pays for us to do our homework. Instead, we use information available to us to assess the opportunity and the risk, and typically propose a dual fee structure (a fixed component and a performance-based component) that we believe will return us a satisfactory margin while providing the client with an equally satisfactory risk-return result. Only when we “ink a deal” are we then able to drive the truck across the bridge and determine if it can travel safely.

The third principle? Adherence – the discipline to stick to those principles. Mr. Buffett allocates his precious resource – capital – using two rules. Rule No. 1: never lose money. Rule No. 2: never forget Rule No. 1. Similarly, our partnership allocates a precious resource – time. Spending our time on an engagement that yields a poor return denies us the opportunity to devote that time to an engagement that yields a satisfactory return. It is time lost forever. As a result we say “no” far more often than “yes” to a counter-proposal from a prospective client.

Our partnership has a twofold goal: to deliver superior value to our clients, and to achieve a superior return in doing so. We are wise enough now to never choose one at the expense of the other. For the cost of a little shoe leather, it is easier and better to walk.