The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.
Table of Contents
Understanding the circle of competence
It is useful to think of the circle of competence as a small circle within a much larger circle.
The larger circle represents what an individual thinks they know but are far from an expert in.
Conversely, the smaller circle represents what they actually know and could be considered an expert in.
Buffet’s strategy for success in life using the circle of competence relatively simple.
Firstly, it is important that individuals know where the boundary of their inner circle is. Once the boundary has been established, it must not be crossed.
Buffet’s business partner Charlie Munger took the circle of competence one step further.
He argues that a person must clarify their individual strengths and then play to them to have a competitive advantage.
If a person not playing to their strengths comes up against a person who is, they will most likely lose.
However, it is a natural tendency for many individuals to deliberately step outside of their circles or attempt to broaden them.
The circle can be expanded to an extent, but skills are usually industry-specific and non-transferable to other industries.
In business, this is why some organizations divest or outsource operations that don’t align with their core business.
Examples of the circle of competence
In a 1991 lecture to university students, Buffet reflects on the circle of competence of a Russian immigrant who built the largest furniture store in Nebraska.
Buffet noted that this woman understood cash and furniture selling. Therefore, her circle of competence was furniture and specifically a talent for buying large amounts of furniture to turn a profit.
Despite also being a business partner of his, Buffet noted that this woman had no interest in the stock market.
The circle of competence explains why. She was disinterested because she did not understand how it worked.
Indeed, Buffet would later exclaim that “she wouldn’t buy 100 shares of General Motors if it was 50 cents a share.”
Furthermore, consider the Olympic athletes Michael Phelps and Hicham El Guerrouj.
The first is a gold medal-winning swimmer, the second a gold medal-winning runner.
Despite the athletes differing in height by 7 inches, the length of their legs is almost identical. Phelps with relatively short legs and a long torso that is perfect for moving through water.
El Guerrouj has relatively long legs and a short torso that is perfect for long-distance running.
Each man operates within his circle of competence, and each has been highly successful.
If the two were to switch sports and move beyond their circles, it would be highly unlikely that either would succeed to the extent they have.
Key takeaways
The circle of competence describes the skills that a person has mastered throughout their careers or lives. Outside of this circle are interests, skills, or abilities that they do not competently understand.
To be successful, individuals must know the boundaries of their circle of competence and stick within these boundaries at all times.
Depending on the context, a circle of competence can encompass very broad or very specialized skills and abilities in a certain field or industry.
Key Highlights:
Circle of Competence Overview: The circle of competence refers to an individual’s area of natural competence, where their skills and abilities match the subject matter. This concept, popularized by Warren Buffett, suggests that individuals should focus on what they understand well and avoid areas outside their expertise.
Understanding the Circle of Competence:
Imagine a larger circle representing what an individual thinks they know but aren’t experts in, and a smaller circle representing what they truly know and are experts in.
Buffett’s strategy involves identifying and respecting the boundary of their inner circle, not crossing it.
Charlie Munger extended the concept by emphasizing playing to one’s strengths for a competitive advantage.
While skills can be expanded to some extent, they’re often industry-specific and not easily transferable.
Examples of the Circle of Competence:
Russian immigrant example: Buffett highlighted a furniture store owner who excelled in cash and furniture selling but had no interest in the stock market due to lack of understanding.
Athlete examples: Michael Phelps (swimmer) and Hicham El Guerrouj (runner) excel within their respective sports due to their physical attributes that match their circle of competence. Switching sports would likely result in lower success.
Key Takeaways:
The circle of competence defines an individual’s mastered skills.
Staying within this circle is crucial for success.
The circle’s size and specialization vary based on the context.
Understanding and respecting one’s circle of competence is key to making informed decisions and achieving success.
Warren Buffett is an American investor, business tycoon, and philanthropist. Known as the “Oracle of Omaha”, Buffett is best known for his strict adherence to value investing and frugality despite his immense wealth. He is among the wealthiest people in the world. Most of his wealth is tied up in Berkshire-Hathaway and its 65 subsidiaries.
Economic or market moats represent long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.
The Golden Circle attempts to explain how certain businesses can inspire others and differentiate themselves in the market. Originally developed by author Simon Sinek, the concept helps businesses identify their purpose and then communicate that purpose to consumers in a meaningful way so that the brand can be highly differentiated in the marketplace.
Value investing is a strategy advocating the purchase of stocks that are underappreciated by other investors or the broader market. Value investing was popularised by investor Warren Buffett, but the approach was pioneered by Benjamin Graham and David Dodd at Columbia Business School in the early 1920s. Graham would later go on to release the seminal book The Intelligent Investor in 1949.
The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.
The 5 Whys method is an interrogative problem-solving technique that seeks to understand cause-and-effect relationships. At its core, the technique is used to identify the root cause of a problem by asking the question of why five times. This might unlock new ways to think about a problem and therefore devise a creative solution to solve it.
First-principles thinking – sometimes called reasoning from first principles – is used to reverse-engineer complex problems and encourage creativity. It involves breaking down problems into basic elements and reassembling them from the ground up. Elon Musk is among the strongest proponents of this way of thinking.
Second-order thinking is a means of assessing the implications of our decisions by considering future consequences. Second-order thinking is a mental model that considers all future possibilities. It encourages individuals to think outside of the box so that they can prepare for every and any eventuality. It also discourages the tendency for individuals to default to the most obvious choice.
Andy Grove, helped Intel become among the most valuable companies by 1997. In his years at Intel, he conceived a management and goal-setting system, called OKR, standing for “objectives and key results.” Venture capitalist and early investor in Google, John Doerr, systematized in the book “Measure What Matters.”
A SMART goal is any goal with a carefully planned, concise, and trackable objective. To be such a goalneeds to be specific, measurable, achievable, relevant, and time-based. Bringing structure and trackability to goal setting increases the chances goals will be achieved, and it helps align the organization around those goals.
Micromanagement is about tightly controlling or observing employees’ work. Although this management style might be understood in some cases, especially for small-scale projects, generally speaking, micromanagement has a negative connotation mainly because it shows a lack of trust and freedom in the workplace, which leads to adverse outcomes.
Developed by business consultants Kenneth Blanchard and Paul Hersey in the 1960s, delegative leadership is a leadership style where authority figures empower subordinates to exercise autonomy. For this reason, it is also called laissez-faire leadership. In some cases, this leadership type can lead to increased work quality and decision-making. In a few other cases, this type of leadershipneeds to be balanced out to prevent a lack of direction and cohesiveness in the team.
Agile leadership is the embodiment of agile manifesto principles by a manager or management team. Agile leadership impacts two important levels of a business. The structural level defines the roles, responsibilities, and key performance indicators. The behavioral level describes the actions leaders exhibit to others based on agile principles.
Active listening is the process of listening attentively while someone speaks and displaying understanding through verbal and non-verbal techniques. Active listening is a fundamental part of good communication, fostering a positive connection and building trust between individuals.
Adaptive leadership is a model used by leaders to help individuals adapt to complex or rapidly changing environments. Adaptive leadership is defined by three core components (precious or expendable, experimentation and smart risks, disciplined assessment). Growth occurs when an organization discards ineffective ways of operating. Then, active leaders implement new initiatives and monitor their impact.
A RASCI matrix is used to assign and then display the various roles and responsibilities in a project, service, or process. It is sometimes called a RASCI Responsibility Matrix. The RASCI matrix is essentially a project management tool that provides important clarification for organizations involved in complex projects.
In a flat organizational structure, there is little to no middle management between employees and executives. Therefore it reduces the space between employees and executives to enable an effective communication flow within the organization, thus being faster and leaner.
Tactical management involves choosing an appropriate course of action to achieve a strategic plan or objective. Therefore, tactical management comprises the set of daily operations that support long strategy delivery. It may involve risk management, regular meetings, conflict resolution, and problem-solving.
High-performance management involves the implementation of HR practices that are internally consistent and aligned with organizational strategy. Importantly, high-performance management is a continual process where several different but integrated activities create a performancemanagement cycle. It is not a process that should be performed once a year and then hidden in a filing cabinet.
Scientific Management Theory was created by Frederick Winslow Taylor in 1911 to encourage industrial companies to switch to mass production. With a background in mechanical engineering, he applied engineering principles to workplace productivity on the factory floor. Scientific Management Theory seeks to find the most efficient way to perform a workplace job.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
