Circle of Competence: How Warren Buffett Avoids Problems

Legendary investor Warren Buffett summarized the concept as: “Know your circle of competence, and stick within it. The size of that circle is not very important; knowing its boundaries, however, is vital.”

In other words: know what you know and know what you don’t know.

Your circle of competence is a combination of what you’re born with and what you slowly develop through work. Skills or expertise you’ve obtained in an area of interest or with your occupation, for example.

Remaining within your circle provides a number of benefits:

• You make fewer poor decisions.
• You can avoid most problems in life.
• You can identify and grasp more opportunities in life (that fall within your circle).
• You can have an edge over others.
• Improvement within your circle of competence comes easier than outside your circle of competence.
• You can more easily learn from others operating inside your circle.

Most problems and mistakes in life come from doing things you know nothing or little about as you cannot properly assess the risk and reward of your actions, i.e. the likelihood and degree of success and failure.

Circle of Competence also applies to business and is known in management theory as Core Competency. According to Prahalad and Hamel, a core competency needs to fulfill three criteria:

1. Provides potential access to a wide variety of markets.
2. Should make a significant contribution to the perceived customer benefits of the end product.
3. Difficult to imitate by competitors.

In short, success in life comes most easily when you define your circle of competence, stay within it, work to expand your circle and your edge, don’t fool yourself thinking you know more than you actually do and don’t be afraid to say “I don’t know.”

Realize that there are more than enough opportunities to which you can say confidently: “I do know”.

How to use Circle of Competence

In business, ask: in which area or aspect do (or can) our clients perceive us as being number 1 in the industry?

Then ask: does improving this edge lead to more sales, higher retention, more referrals, reduced costs or higher customer satisfaction AND will this be difficult for competitors to imitate?

If the answer is yes to both, dedicating as many resources as possible to maximizing this edge almost certainly leads to outsized returns and a stronger competitive advantage (moat).

If the answer is yes to the first one, but no to the second one, it’s better to find another area or aspect that does produce positive returns.

If the answer is none to the first one, ask yourself if it makes sense to continue the business. Being unable to be number 1 in any area of value for clients will lead to margin reductions and ultimately unprofitability as clients switch to other companies providing a superior solution.

On a personal level, ask yourself: in which areas or skills can I safely say I belong to the top 10% in the world?

If none come to mind, reframe the question: which areas or skills give me energy and for which I could safely say I would happily spend more time on improvement than 90% of the world?

These questions help you identify one or more areas in which you have (or can have) an edge over others – as you’re more skilled or willing to dedicate more time than others to hone the craft.

Finding the overlap between your skills – which give you an edge – and interests – which give you energy – and investing as much time and effort into to further developing that overlap is a proven way to success in life. It will lead not only to more opportunities, but also fewer mistakes. 

You owe it to yourself to, at least, explore this and, preferably, dedicate yourself to it.