Summary -The Science Of Success

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The “science of human action” and “market-based management” (MBM) form the core
ideas of the libertarian business philosophy and the successful commercial operating
principles of Charles G. Koch, chairman and CEO of Koch Industries Inc. (KII).
Following these principles, Koch has enjoyed astounding success: A $1,000 investment
in KII in 1960 would now be worth $2 million (with a reinvestment of dividends). During
most of this period, Koch himself planned KII’s strategy and ran the company. Here, with
a few jargon pitfalls, he details his business methods and operating practices. Koch is
known for his heavy financial support of conservative political causes and candidates,
but this is not a political book. It is, in fact, more a work of business philosophy than a
hands-on manual for Koch’s MBM system, which he describes as an approach and attitude based on a selection of “mental models” and not as a linear path.

I recommend Koch’s thoughtful exposition to all 80,000 KII employees and to business executives who want some clues about emulating KII’s success.

Published in: Business

Summary -The Science Of Success

  1. 1. Some Impressionistic takes from the book Charles G.Koch’s “The Science of Success” by Ramakrishnan ( Ramki) ramaddster@gmail.com
  2. 2. About the Author Charles G. Koch is Chairman of the Board and CEO of Koch Industries, Inc., a position he has held since 1967. Since then, the company has been transformed into a dynamic and diverse group of companies in refining and chemicals, fibres and polymers, commodity and financial trading, and forest and consumer products. Familiar Koch company brands include STAINMASTER carpet, LYCRA spandex, Quilted Northern tissue, and Dixie cups. Koch has continuously supported academic and public policy research (including numerous Nobel Prize winners) for more than 40 years, and has helped build a number of market-based organizations. Koch received a bachelor's degree in general engineering and two master's degrees—in mechanical and chemical engineering—from the Massachusetts Institute of Technology
  3. 3. Backdrop Today, Koch is chairman and CEO of the largest privately-held company in the world, with 80,000 employees in 60 countries and annual revenues greater than Microsoft. It is still in the oil business, but has added pipelines, refineries, jet fuel, and asphalt to its capabilities…along with fertilizer, chemical technology, commodities trading, municipal finance, ranching, carpet, spandex, and toilet paper. How did Koch achieve such phenomenal success—multiplying its book value 2,000-fold in the course of 45 years, outpacing even the S&P 500 index by orders of magnitude—with what seems to be an irrational hodge-podge of businesses? He took the analytical mind-set he developed as an engineer, dedicated himself to intense study of some of history’s greatest free-market economists, crafted his own system of Market-Based Management, and set out to drill that philosophy into all of his employees. Forty years ago, Charles Koch returned home to Wichita, Kansas to take the reins of the oil and gas company that his father had established and was threatening to sell.
  4. 4. Prelude What is behind the success of Koch companies? It is Charles Koch’s unique and transformative management philosophy Market-Based Management. Developed by Charles Koch, chairman and chief executive officer of Koch Industries, Inc., MBM ( Market based Management) is defined as a philosophy that enables organizations to succeed long term by applying the principles that allow free societies to prosper. As MBM became the foundation upon which Koch companies grew, the challenge of sharing it internally and externally led to the creation of "The Science of Success." In the book, Mr Koch presents the evolution of Koch Industries and the "Science of Human Action" upon which MBM is based. He also provides a systematic view of MBM at work within Koch companies by outlining five dimensions:  Vision,  Virtue & Talent  Knowledge process  Decision rights  Incentives.
  5. 5. “ The solution of the economic problem is a voyage of exploration into the unknown, an attempt to discover new ways of doings things better” by F.A.Hayek
  6. 6. Market Based Management What is MBM  MBM is a holistic approach to management which integrates theory & practice  It prepares organizations to deal successfully with challenges of growth & change  It is rooted in the Science of human action How ?  Best achieved through purposeful behaviour  It draws on the disciplines of Economics, Ethics, Social Philosophy, Psychology, Sociology, Biology, Anthropology ( study of humanity), Management, Epistemology ( means of acquiring the knowledge) and Philosophy of science  Draws lessons learned from successes & failures of humans to achieve peace, prosperity & social progress.
  7. 7. MBM- Through five dimensions Vision Virtue & Talents Knowledge Processes Decision Rights Incentives M B M
  8. 8. Vision Vision is about “ determining when & how your organization can create the greatest long-term value “ Creative destruction  Destruction of existing structures is a need to promote innovation & economic growth  Drive the creative destruction internally which will enable constructive change, if not you are out of business Is your vision based on your competitive advantages? Will it generate significant value for customers and society?
  9. 9. Virtue & Talent Virtue & Talent— Helping ensure that people with the right values, skills, and capabilities are hired, retained and developed Here, Koch embraces Friedrich Hayek’s rules of just conduct, which include both the rule of law and norms of behaviour. One of the guiding principles of MBM is 10,000% compliance—100% of employees complying 100% of the time Do your people possess the virtue & talents necessary to advance your vision ?
  10. 10. Virtue & Talent  KII’s core capabilities are “market-based management, innovation, operations excellence, trading, transaction excellence and public sector” participation.  KII’s core values parallel economist F. A. Hayek’s proposed societal “rules of just conduct,” which the company incorporates in its “MBM guiding principles.”  They are:  “Integrity” – KII staff must honor all laws and regulations and operate honorably.  “Compliance” – KII’s goal is “10,000% compliance,” which means 100% of the company’s employees comply with all rules and regulations 100% of the time.
  11. 11. Virtue & Talent  “Value creation” – KII is in the value-creation business.  “Principled entrepreneurship” – Workers at KII need to be moral risk-takers. They should exhibit these traits and characteristics: “urgency, discipline, accountability, judgment, initiative,” and “economic and critical thinking skills.”  “Customer focus” – KII’s customers determine its success, and KII employees must satisfy customers at all times.  “Knowledge” – KII’s people should always strive to learn and share information.  “Change” – KII staff members must embrace constant flux.  “Humility”– KII workers must be modest.  “Respect” – Regardless of rank or position, KII employees treat others with respect.  “Fulfillment” – When KII staffers create superior value, they gain gratification as valued members of the company.
  12. 12. Knowledge & Processes Knowledge Processes — Creating, acquiring, sharing, and applying relevant knowledge, and measuring and tracking profitability In one case, a failing Koch company discovered that 60 % of the volume of one product sold to a few large customers generated only 20% of the profit. With this knowledge, the sales force switched its focus away from these large customers to the smaller, more profitable customers. What systems do you have to discover how your employees and practices can become more profitable?
  13. 13. Decision Rights Decision Rights — Ensuring the right people are in the right roles with the right authority to make decisions and holding them accountable Koch makes a compelling case for private property rights, pointing out that when people own a resource, they both realize the benefits and reap the costs of consuming it. Where there is no ownership (e.g., the oceans), the consumers realize the short-term benefit without paying the cost, and thus the resource is often depleted. Do you base authorities on a job title or on an employee's comparative advantage and proven ability to create long- term value?
  14. 14. Incentives Incentives—Rewarding people according to the value that they create for the organization Koch stresses the importance of aligning each employee’s individual interests with the overall interests of the company. He also labels conventional compensation systems—with their automatic raises and pay classification scales— as “destructive.” At Koch, employees are compensated based on the value they add to the company. Is employee compensation based on time in the organization and job title, or is it based on evidence of long as well as short-term value creation ?
  15. 15. Incentives Knowledge Processes Decision Right Ease of comparison affects cost of monitoring & providing Incentives Decentralization enables use of local knowledge , but may inhibit coordination Motivated workers generate more knowledge With more knowledge , monitoring is easier, and incentives are provided more effectively Interaction between Incentives , Knowledge & Decision right
  16. 16. Points which really hit home  Opportunity Cost – Surely everyone knows that an opportunity cost is “the cost of the best alternative forgone to do something.” Koch stresses how this simple principle is under- utilized in most companies, and that by paying close attention to the opportunity cost of EVERY action, companies can be sure to work on the most valuable thing.
  17. 17. Points which really hit home  Comparative Advantage – Here, Koch reiterates the idea that each person should do what adds the most value. This builds on the idea of opportunity cost saying that appropriate distribution of tasks causes people, teams, divisions, and companies to work on what they do best and not forgo their comparative advantage. Doing this all the time at all levels ensures minimal waste.
  18. 18. Points which really hit home  Decision Rights – This term is used as an analogue to “property rights.” By distributing the “ownership” of decision making privileges in the same way that property might be distributed, decision makers have clear responsibility for decisions they make. This means that they will reap all of the benefits for good decisions as well as the repercussions of bad decisions. Allowing a person’s decision rights to grow based on how well they use them makes more sense than allowing them to grow based solely on seniority or rank.  Appropriate Incentives – Finally, Koch describes how incentives are put in place to encourage long-term growth and value creation. A quote I particularly liked was that a company should, “take from each according to their ability and give to each according to their contribution.” Thus, incentives are firmly rooted in how much an employee actually contributes rather than being fixed to seniority, rank, or title.
  19. 19. Points which really hit home  Principled Entrepreneurship – Koch suggests rating performance not just on contributions but also on missed contributions. Hence, if an employee misses an opportunity to make $1 million, that should be judged as if the employee lost $1 million by failing in any other way. This encourages employees to take prudent risks and remain entrepreneurial at all times.
  20. 20. Can MBM work for you  For-profit, nonprofit and governmental organizations can apply the MBM system to achieve their objectives and to operate more efficiently. MBM will not work if you do not apply it properly.  Success depends on understanding MBM, something that is not always easy for busy executives because much of it is theoretical and because it draws from a wide selection of mental models. Such understanding depends, in part, on self-directed change – which is always difficult.  Executives who approach MBM as a series of specific steps to follow misunderstand the system. MBM is a conceptual framework that relies first on strong self-knowledge and then on a menu of mental models.  If you correctly apply its helpful tools, MBM can perform brilliantly. Think of MBM as a holistic collection of general rules that help employees effectively challenge standard or bureaucratic operating procedures.  Well deployed, MBM functions as a robust innovation machine. It spurs discoveries that result in creating new value
  21. 21. Take Away  Koch Industries Inc. (KII) is a profitable corporation in energy, paper goods manufacturing, retailing and other industries.  CEO Charles G. Koch’s “market-based management” (MBM) drives KII’s success.  MBM is a conceptual system using “mental models,” not a series of rules or procedures.  MBM is based on the “science of human action”: how people achieve goals through purposeful behavior.  Koch applied knowledge from science, history, philosophy, economics and psychology to create MBM.  MBM’s core aspects are: “Vision, Virtue & Talents, Knowledge processes, Decision rights, and incentives.”  KII considers opportunity costs – profits forgone due to failure to seize a prospective investment – as actual book losses.  KII employees use MBM mental models to organize and interpret information.  For MBM to work, companies and employees must embrace constant change.  MBM accepts and manages change and so it will always be a work in progress.
  22. 22. Happy Reading, Learning & Application Mail your comments to ramaddster@gmail.com

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