If you believe in the free market and are interested in learning how to apply its principles to your working life, Charles G. Koch’s The Science of Success is a must-read.
As chairman and CEO of Koch Industries since 1967, the author built the largest and most profitable privately held company in the world, a firm that is an industry leader in sectors as diverse as oil refining, chemicals, fibers and polymers, financial trading, ranching, and forest products. Koch also has supported a wide variety of prominent market-oriented research and advocacy groups, including the Cato Institute, the Institute for Humane Studies, the Mercatus Center, and the Citizens for a Sound Economy Foundation, which later became the Americans for Prosperity Foundation.
In The Science of Success, this giant of both the for-profit and nonprofit worlds shares the management philosophy behind his many successes, an ingenious application of free-market principles to the internal functioning of organizations. He calls his approach market-based management (MBM).
With the support of excellent research in the fields of science, philosophy, and economics, Koch describes in clear terms how the principal insights of free-market economics can be applied, through MBM, within organizations of all sizes. While he focuses primarily on his own company, and therefore on the for-profit sector, there are lessons here that are highly valuable for the public and non-profit sectors as well.
The whole of MBM, according to Koch, ultimately rests on one simple question: “Is this creating value?” The five dimensions of MBM, all of which relate back to value creation, are vision, virtue and talents, knowledge processes, decision rights, and incentives.
Vision is about how an organization can best create value. Koch argues that value creation is essential to the long-term success of any organization, and for companies operating in a free-market the best gauge of value creation is profitability. Koch writes, “in a true market economy we can only prosper by providing others with what they value.” The vision in MBM reflects an organization’s core competencies and how these can best be used to maximize value creation.
Virtue and talents are about maximizing human resources, which means retaining and recruiting the best workers in an industry, creating an environment in which they can succeed, and either helping below-average workers improve or letting them go. Koch also stresses the centrality of virtue, including integrity and full compliance. The bottom line for talent is results — that is, creating value. Koch puts it starkly: “any employee who is not creating value does not have a real job in the MBM sense of the word.”
Knowledge processes are about replicating market-information mechanisms within the organization. Koch says, “In a truly free economy, profit and loss is the market’s objective measure of the value a business is creating in society.” Within an organization, “measurables” are critical to creating accountability and a form of internal market discipline. He therefore argues that it is critical to use market prices for internal transactions, rather than cost-based pricing, to ensure that the profitability of units within the organization is properly assessed.
Decision rights are a method of introducing something like property rights within the organization. The idea is to confer responsibility and authority on members of the organization commensurate with proven accomplishments, giving members deserved ownership over their projects. Expectations for employees should be open-ended and aimed toward maximizing value rather than meeting fixed targets.
Incentives are used to properly encourage and reward value creation and entrepreneurial risk-taking. For example, Koch pays sales commissions not as a small percentage of the total sales price but as a large percentage of the price above the product’s opportunity cost — a great incentive. And to encourage more entrepreneurial risk-taking, Koch suggests counting foregone opportunities on a par with failed ventures. Koch cleverly refashions Marx’s famous rule: “From each according to his ability, to each according to his contribution.”
Free-market conservatism provides the concepts that we know work in formulating government policies: individual responsibility, free trade, profit-maximization, etc. But the concepts also can inform business and the way we perform our jobs. Charles Koch, a true hero to the free-market movement and a proven expert in the science of success, has provided us with an excellent template for putting these ideas into action.