Executive Summary of the book

Charles G.Koch’s
“The Science of Success”
by Ramakrishnan ( Ramki)
ramaddster@gmail.com
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
Backdrop

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.

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.
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.
 “ 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
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.
MBM- Through five dimensions

Vision

Virtue & Talents

M
B Knowledge Processes

M Decision Rights

Incentives
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?
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 ?
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?
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?
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 ?
Interaction between Incentives , Knowledge & Decision right

Motivated workers generate more knowledge

With more
Incentives knowledge , Knowledge
monitoring is easier, Processes
and incentives are
provided more
effectively

Decision Right
Ease of comparison Decentralization
affects cost of enables use of local
monitoring & knowledge , but may
providing Incentives inhibit coordination
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.
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.
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.
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.
Happy Reading, Learning & Application
Mail your comments to
ramakrishnan@gmrgroup.in