How an Investor Can Evaluate Managers: The Gary Friedman Playbook

10 Lessons from RH's Gary Friedman

Warren Buffett often talks about the importance of moats in a business, to the point that you can be forgiven for thinking that he doesn’t value management as much. He is often misquoted as saying “I want a business so good a ham sandwich can run it”. While these aren’t actually his words, the sentiment still stands: he wants a business with such strong moats that it minimizes the importance of decisions management makes (or doesn’t make). However, wanting a business with a wide moat doesn’t imply management doesn’t matter—Buffett will quickly screen out a mismanaged business. 

In fact, Buffett has pointed out that one of the most important roles of a CEO is to allocate capital. We know that the CEO of a company with a 20% ROIC  will be responsible for deploying over half all capital employed in that business in just ~5 years. As Buffett’s partner Charlie Munger has noted, over the very long term the investor basically earns the business’ ROIC. This means that having a good manager is very important. 

On finding quality managers, Buffett remarks: “You’re looking for three things, generally, in a person: Intelligence, energy, and integrity. And if they don’t have the last one, don’t even bother with the first two”. 

Many investors assume that given his fame and Berkshire Hathaway’s size, Buffett can get any CEO on the phone, which gives him a leg up in judging managerial talent. While this is probably true, he notes that he judges a manager on the basis of what they have actually done and dismisses the notion that an investor needs private meetings to assess management. 

And it is this insistence on management having a track record that has steered him away from investing in IPOs (limited financial history), startups, and turnarounds… 

This is where RH comes in. RH is a business that was in technical default for violating a debt covenant and mere weeks away from bankruptcy when Gary Friedman took over in 2001. 

Two decades later, Friedman has grown sales 40x and improved profitability enough to have it rank at the high end of retailers with 25%+ operating margins. Berkshire Hathaway first took a position in RH in 2019, steadily increased their stake, and now holds about ~10% of the company¹. 

What Buffett saw in Gary didn’t come from a private 1 on 1 meeting, but rather from looking at his actual performance in how he engineered an incredible turnaround.

We have studied Gary Friedman too, and below we share 10 lessons from Friedman’s time at RH so far. These ideas and actions speak louder than any 1 on 1 interview. 

1) Untraditional advertising isn’t as experimental as you think.

Ultimately, the point of advertising is to get a message to a consumer, and there is no reason why you must rely on traditional channels like TV ads and magazines. Rather than spend on these traditional ad venues, RH got creative, throwing an RH-branded concert, opening an RH Art Gallery, and designing RH-branded private jets and yachts. 

All of these efforts drove brand awareness, increased consumers’ conversations about RH, and were actually cheaper than traditional ads. 

2) Boring retail is dead. 

If your retail experience is nothing special, then consumers will just go to Amazon. However, just because people love convenience doesn’t mean they aren’t willing to go out: you just have to give them a reason to go to your store. 

RH has taken this ethos to an extreme by elevating their store experience with gargantuan and ornate buildings that have hospitality experiences like restaurants, Barista Bars, Wine Vaults, and more. 

Make your store something special so it can’t get “Amazoned”. 

3) Be channel agnostic. 

It doesn’t make sense to only look at one sales channel of your business such as stores versus online.  

The stores and their design books drive traffic for sales that may later be placed online. Gary Friedman sounds almost like Bezos when he says to not focus on ecommerce mix, but rather the overall experience, and serve your customer where they want to be served. 

4) Promotions are problematic. 

Your employees will be overworked and that will lead to poor customer experience. 

Higher-impulsive purchasing to get the sale means returns will be higher, which clogs up the reverse logistics network. 

Managers will spend 3/4th of their time inventory planning and rearranging the store to adjust for sold out inventory. 

It hurts your brand and ability to get a premium price as you teach consumers you will reward them for deferring purchasing and steep discounts are associated with your products, making them seem low quality.

5) Be opportunistic with stock buybacks. 

Friedman only embarked on one aggressive buyback – and that was when the stock dropped ~70%. 

He knew that the business issues were temporary and misunderstood by the market. 

He quoted Buffett, sharing that he studies Buffett at the time: “I study Warren Buffett all the time… those with capital in difficult times are the ones who capitalize”. 

They repurchased 40% of shares outstanding. 

6) Move up in the value chain. 

Most furniture buyers ask a designer for help.

This makes the designer the decision maker.

RH rolled out free design services for members, so RH locks in the customer earlier in the purchase journey. Last disclosed (a few years ago), 65% of customers use their designers. 

7) Know the difference between horizontal and vertical inventory. 

Horizontal inventory is a company's SKU count. Vertical inventory is how much stock of each SKU they have. 

Too much horizontal growth leads to operational issues as you have to source, stock, and present a growing number of products. 

Friedman also figured out that vertical inventory doesn’t need to be that high because customers will wait for quality furniture pieces. 

8) Be a selective acquirer.

There are very few quality assets in the home furnishing space. . 

Waterworks was one. 

When the opportunity arose, they bought it despite the fact that they were in the midst of rearchitecting RH’s operating platform.

Friedman knew he had to act then or risk losing it forever. 

So they purchased it, and then left it completely alone. They’re still waiting for the right time to incorporate it into the RH platform. 

9) Raise money when you can. 

When markets were frothy in 2021, RH raised a $2bn note just to have the extra cash. 

They then raised another $500mn just because they liked the terms. 

Now, they have $2bn of cash on hand to continue to grow their luxury brand through unfavorable macro conditions. In contrast, some of their competitors raised money this year, with very unfavorable terms. 

10) Set a vision for the company. 

Friedman knows that no one is going to work hard for a quarterly margin target or to beat consensus estimates.

Instead, he tries to inspire them and give them autonomy to create something unique.

Bonus/ Drive traffic with a hamburger. 

To give shoppers an experience worth coming into the store for, RH opened high-end restaurants in their Galleries to drive more traffic.

The first month their restaurant was opened, lines for it were literally out the door and around the block. Their success can be attributed to great food, great services, and incredible ambiance. 

Their restaurants are now among the most profitable in the world, each doing ~$10mn annually. That means just their *restaurants* now generate more than the entire stores used to before Gary Friedman took over. 

The full RH turnaround story is fascinating, and Gary Friedman may be one of the all-time greatest turnaround CEOs who is worth further study. For those that want the full RH turnaround story, we spent ~30 pages on it in our latest RH Research report (you can sign up for a membership here or purchase the report here).   

Follow us on twitter at Speedwell_LLC and our Substack for more RH and business content. 

1. Since the writing of this piece Berkshire has sold their stake. That does not change the spirit of our argument though.