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The Science of Success: How Market-Based Management Built the World's Largest Private Company

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The Science of Success is a rare opportunity to learn how Charles Koch built one of the most successful companies in history. Think about it. This company:

1. Didn't have a sexy product or build a national image
2. Didn't get jump-started with a technological breakthrough, or create a new industry
3. Didn't rely on political connections or Wall Street gurus to help sell its products
4. Didn't, as a privately held company, have access to expansion capital from stock sales, and
5. DID face stiff competition from some of the largest and most competitive companies in the world.

Yet under the guidance of Charles Koch, Koch Industries grew from a relatively small company to the largest privately held firm in the country, along the way building a record of profitability that leaves most companies you thought were successful in the dust.

If you haven't heard of Koch Industries, you're not alone. This story really hasn't been available to the public until now. How did Koch do it? With Market-Based Management, the business philosophy he lays out in this book. The book includes a thorough discussion of what MBM is and how it was used to create phenomenal value for the owners, employees and customers of Koch Industries.

I'm usually highly skeptical of books "written" by successful businessmen. How many truly successful people are really willing to share their secrets? How many really take the time to write a book? But I have some experience with Koch Industries (I'm a former employee and still do some consulting for the company), and I can verify that these are the same concepts Charles Koch has been teaching his employees, from top management on down, for at least 20 years.

Obviously Charles Koch, as a billionaire, doesn't need money from book sales. He truly believes in the principles and applications in this book, and he's genuinely interested in sharing them with anyone who will take the time to read and learn.

Again, a rare opportunity to learn from a master.

Charles Koch's core premise is universal and elemental, one that should prompt any reader to have a "V-8 moment," like the characters in the old television commercials. That premise is this: We know what makes an economy successful -- private property; the rule of law; individualism; risk and incentive; innovation; entrepreneurship; profit and loss; competition; and Schumpeter's "creative destruction." In other words, a market economy. Why shouldn't those very principles be the foundation of an organization's success? The challenge, as Koch puts it, is to "develop the mechanisms" that allow a firm (or any organization) "to harness the power of the market economy within the company."

Koch's book is more than a management guide. It's a refresher on the critical pillars of market economics. The reader is reminded of concepts he might have either forgotten or never learned -- opportunity costs, sunk costs, marginal utility, subjective value, comparative advantage, imperfect knowledge and numerous others. The author admits to being greatly influenced by some of the giants of economic scholarship, from F.A. Hayek and Joseph Schumpeter to Milton Friedman. He attributes the success of Koch Industries to the leadership's concerted effort to meld management principles with the principles of the market economy, and much of the book explains how that translated into real-world decisions, strategies and directions that built the company over the years.

Koch drives home that even in the for-profit business world, where markets exert a great deal of discipline, plenty of firms really still don't understand the power that market principles can have in their own operations. For instance, in looking at a private business, how many times have you noticed excessive bureaucracy, short-term thinking, ossified decision-making and reward structures that pay for tenure rather than entrepreneurship? How many times have you witnessed supervisors afraid to bestow real authority on those they supervise? And how many times have you observed a corporate culture beset from the top down with corner-cutting on both quality and integrity?

In most cases, what poor managers need is a reality check. If they don't comprehend the miraculous workings of a market economy, don't expect them to be diligently implementing its principles within their organization's operation. If they're managing as if they were Soviet central planners, they're probably reaping Soviet results.

Nonprofits sometimes behave more like unresponsive, unaccountable and nonentrepreneurial government outfits than they do for-profit firms. MBM can work well here, too, with the right leadership that knows how to implement the spirit (and not just the letter) of MBM principles. I'm proud to say that as I read Koch's book, I realized that my nonprofit organization, the Mackinac Center for Public Policy, has succeeded in great measure because of MBM-like ideas, though that wasn't fully apparent to me until I read the book.

The answer to what ails poorly-led organizations is Koch's principles of "Market-Based Management," or MBM, spelled out in very readable fashion in this new book.

Koch knows what he's talking about. He is CEO of Koch Industries Inc., a star performer of a company that boasts $90 billion in annual sales and 80,000 employees. Since the late 1960s, Charles, his brother David and their business associates have taken the oil firm that Koch's father started more than half a century ago and fashioned it into a privately held global conglomerate. It produces more "stuff" than I could describe if I had your attention for an afternoon, including things you eat, walk on, drink from or put in your car -- oil, beef, carpet, asphalt, disposable cups and paper towels, to name a few.

[...]

Charles Koch has quietly and humbly built one of the most successful companies on the planet, in industries that most entrepreneurs would find challenging, to say the least.

Market Based Management distills the ideas and beliefs that have made America the strongest, richest and most virtuous country in history into a set of principles that can be applied to business.

You won't find any "One Minute Manager" type advice in this book, which may disappoint people who are used to chasing the latest business fads. It's more like reading Peter Drucker or Jim Collins...you know it's true, but wish someone could transplant all of the ideas neatly into your business. Unfortunately, that's what great leaders do, and even Charles Koch can't be expected to reduce that sort of magic to a simple set of recipes for a management cookbook.

The privately held Koch companies have compounded their book value by about 20 percent a year since 1967, an enviable record that's made even more impressive by realizing the diversified nature of the enterprises the companies include. At the time of the writing, the combined firms account for $90 billion in annual revenues and employ 80,000 people in 60 countries. That's big-league success. What's more remarkable is that the author, Charles G. Koch, has headed these operations for 40 years while this success was accomplished. When Mr. Koch speaks, wise people should listen.

In The Science of Success, Mr. Koch describes the management philosophy and methods he has employed to direct his organizations. A well-read and thoughtful engineer, Mr. Koch's methods are not unique to him, nor are they originated by him. Rather the philosophies and methods are ones that he has combined in a novel way that few companies pursue.

Mr. Koch is a bigger thinker than that, seeing his methods (Market-Based Management) as a stepping stone between how individual performance can be improved and how liberty can free societies to accomplish more.

In focusing on Market-Based Management, Mr. Koch describes five key elements that need to be combined with one another for full effectiveness:

1. Vision (using experimentation to improve value delivered for customers based on a sense of what the best opportunities are and what the organization can most effectively accomplish)

2. Virtue and Talents (attract and retain people who want to follow the right principles with appropriate talents for the tasks)

3. Knowledge Processes (systematically add to, disseminate, and apply knowledge related to profitability)

4. Decision Rights (encourage people to become better decision makers after they have developed their skills and to be accountable for the decisions they make)

5. Incentives (reward employees as much as possible by the long-term value they have helped deliver for the organization)

Several things are noteworthy about the book that will interest you. Today, many organizations have "vision statements" which encourage everyone to do good while doing well. Mr. Koch finds that statements inadequate: He encourages instead that employees find out what improvements will expand sales and profits the most and focus on those . . . that's what he means by vision. Back when strategic planning was being formulated, that was the original meaning of vision . . . a meaning that's mostly been lost since then. I endorse Mr. Koch's view as an important one.

Another of Mr. Koch's valuable perspectives is to measure by opportunity cost: When you picked up a dime while a $5 bill rolled by, you didn't gain a dime . . . you lost $4.90. In today's quarter-by-quarter drive for profits among public companies, opportunity cost is all but ignored. That's a major mistake.

Mr. Koch is also a believer in being sure that the message is heard and understood. He points out how often when introducing new practices that no improvements followed because people didn't understand the purposes of the initiatives.

I found his concern about how success hobbles organizations matches my own research on the stalls (bad mental models and habits) that plague successful organizations . . . and turn them into unsuccessful organizations.

If you decide to read only one book about how to be an effective business leader this year, I encourage you to make it this one.

I also suggest you go further and visit Mr. Koch's company. You won't really understand what he's talking about until you see people applying this management philosophy.

Bravo, Mr. Koch!

The Science of Success is the most important book about governance, leadership and management since Drucker's magnum opus in 1974. This statement is not a casual claim but is the result of my close study of Charles Koch's Market Based Management during the past six years. MBM ® was an integral part of my course, Managing in a Market Economy at the Columbia Business School and has been the focus of my academic research as well as my service as a consultant and director of several public corporations. The book is short and seems deceptively simple but that is also true of the United States Constitution. Every sentence in the Constitution and every concept in The Science of Success evokes profound thought: it is based on principles rather than prescriptions - not "how to do" but rather "how to decide".

The age-old arguments about decentralization, delegation, incentives, acquisitions, divestitures, sunk costs, opportunity costs, vision - indeed almost every quandary a manager faces - are cast in a bright new light. Make no mistake, however. Even though Charles Koch might seem short on prescriptions he is strong on principle. He has synthesized his study of history, political science, psychology, philosophy and economics (augmented by his 40 years leading Koch Industries, the world's largest and one of its most successful private companies) into a clearly articulated applied science. He draws heavily on the work of the "Austrian School" economists - Menger, von Mises, Hayek, as well as Schumpeter and Drucker. These were the men who most clearly articulated the immutable laws of markets based on their observation of humans in action rather than esoteric mathematical models. Their articulation of marginal utility put the human being at the center of economics which, in turn, established the concept of free and open markets and provided a foundation for individual liberty rather than autonomous authority.

My admiration for Charles Koch's book is not based solely on my academic experience. I was a lecturer, course chairman and Associate Dean at the Harvard Business School, and for 18 years was Professor of Management Practice at the Columbia Business School. However, half of my professional career has been in the business world as COO, CEO and Chairman of start-ups and turnarounds, public and private, large and small. I am convinced that if, early in my career, I had read, understood and applied the principles in The Science of Success I, too, would be in Fortune Magazine's list of the world's richest men.

As Charles G. Koch explains in the Preface to this book, Market-Based Management® (MBR®) has enabled Koch Industries, Inc. (KII) to become one of the largest and most successful companies in the world, with a 2,000 fold growth since 1967, now employing 80,000 people in 60 countries, with $90-billion in revenue in 2006. MBR consists of five dimensions: vision, virtue and talents, knowledge processes, decision rights, and incentives. No surprises there, nor are there any head-snapping revelations throughout Koch's narrative. The great value of the material, rather, is derived from the clarity with which Koch explains each of the interdependent, mutually reinforcing core concepts, and, by how skillfully he illustrates them in real-world situations while examining the evolution of KII. Based on the Science of Human Action, these core concepts are relevant to any organization, regardless of size or nature.

According to Koch, these are the questions that must constantly be asked?

1. Where and how can the organization create the greatest long-term value?

2. Are we hiring, developing, and retaining the people who have the right skills?

3. Are we creating or acquiring, then sharing and applying relevant knowledge, and measuring and tracking profitability?

4. Do we ensure that the right people are in the right roles with the right authorities to make decisions? Do we then hold them accountable for their performance?

5. Are we rewarding people according to the value they create for our organization?

As indicated earlier, there are no head-snapping revelations in this book, nor does Koch claim to offer any, and these questions offer a case in point. Of course, these are questions which decision-makers in all organizations should ask every day. In fact, few do...and even fewer obtain or provide correct answers. As explained by Koch, MBM is all about "blocking and tackling" effectively in business...and in life...in order to succeed.

I especially appreciate Koch's skillful use of a reader-friendly device throughout the text that features relevant information within a boxed, pale blue background. For example, quotations, brief explanations, definitions, and graphics. Beyond its visual appeal, this device serves two practical purposes: it highlights key points, and, it facilitates periodic review of them later.

The material of greatest interest to me is provided in the last chapter, "Lessons Learned." It is important to keep in mind that Koch has obviously learned a great about business and about life during his central involvement in the evolution of his company. However, he also learned a great deal from his exploration of remarkably eclectic sources that are indicated in the Notes and Bibliography sections. In the final chapter, he shares what he has learned about "the science of success," hence the title of this book. It is possible, Koch notes, that people will gain a conceptual or professional understanding of MBM but lack sufficient personal knowledge and experience. As a result, they tend to misapply it.

"For this reason, before an organization can successfully apply MBM, its leaders must gain personal knowledge through a dedicated commitment to understanding and holistically applying MBM to achieve results. Gaining this personal knowledge involves self-modification that starts with understanding the underlying concepts. It also requires seeing how the concepts contribute to long-term profitability, and then repeatedly applying them over time."

To be successful, MBM requires a culture of what Koch characterizes as "principled entrepreneurship, "one in which everyone is engaged in a passionate pursuit of innovation "toward an unknown future of ever-greater value creation." Moreover, innovation only thrives within a system of discovery, ""of spontaneous order, of mutually adjusting individual initiatives." Koch cites Michael Polanyi analogy, which compares such a system of innovation with a group trying to solve a giant jigsaw puzzle. "The rate of discovery is highest when everyone works together in sight of each other, so that every time a piece fits, the others are alerted to opportunities for the next step. The rate of discovery is lower when the solution is centrally directed or when each person works the puzzle separately."

Those who share my high regard for this book are urged to check out Bill George's Authentic Leadership and True North, Michael Ray's The Highest Goal, Jason Jennings' Think Big, Act Small, Thomas Kelley's The Ten Faces of Innovation, Frans Johansson's The Medici Effect, Thomas K. McCraw's Prophet of Innovation, Lynda Gratton's Hot Spots, and Ram Charan's Know-How.

There are thousands of business books published each year, many of them by authors with little or no personal record of producing positive, measurable results for businesses in the real world.

This is not the case with author Charles Koch. Since becoming Chairman and CEO of Koch Industries in 1967, Koch has transformed the company from a small concern to a behemoth with 80,000 employees and $90 billion in revenues. Koch Industries stock value has advanced 2000% in book value during his tenure, despite the fact that it operates in mature industries (such as commodities) where competitive pressures typically result in narrowing margins.

Koch's book, "The Science of Success: How Market-Based Management Built the World's Largest Private Company" details the management approach behind Koch Industries stunning success. Drawing on a variety of disciplines, Koch's "Market-Based Management" approach takes the same dynamics, incentives and mechanisms that propel successful free market economies and retools them to manage business organizations.

The book is a fascinating read and offers valuable, actionable insights for business leaders. It deserves a place on every executive - and entrepreneur's reading list.

Finally, Austrian economics has triumphed---in the business world! Imagine, a billionaire thanking Ludwig von Mises and Friedrich Hayek for creating the world's largest private company, Koch Industries. Koch's book shows how his "Market-based Management" (MBM) strategy could revolutionize business, government, and non-profits.

Two years ago, Koch established the "Market Based Management Institute" at Wichita State University. Will it not be long before MBA students at Harvard and Stanford are assigned Mises's Human Action or Hayek's Individualism and the Economic Order? There's nothing like a big success story to transform the B school's pedagogy.

And there's nothing bigger on the scene today than Koch Industries, which has transformed itself into a giant commodity and financial conglomerate. The company has grown as fast as Warren Buffett's Berkshire Hathaway. Is the next paradigm shifting from Omaha to Wichita?

Economics of late has transformed itself from the dismal science to the imperial science, invading politics, finance, history, law, religion, and now business management. In Koch's MBM guidebook, the Austrian concept of opportunity cost of capital is now "Economic Value Added (EVA)," property rights has become "decision rights," and Hayek's rules of just conduct translates into "principled entrepreneurship." Koch's book is an essential translation of Austrian theory into business practice.

Charles Koch is a shy man. Unlike Buffett's company, Koch Industries is a private company, a situation Koch prizes. He doesn't have to worry about Sarbanes-Oxley, nor how quarterly earnings and executive stock option compensation distort the stock price. "Perverse incentives make managing a public company long term extremely difficult," he writes.

Undoubtedly, many businesses and B schools have matched Koch's performance by incorporating such MBM concepts as incentives, integrity, internal profit centers, local autonomy, economic value added, sunk costs, comparative advantage, and marginal price analysis. At Columbia Business School, John Whitney taught MBM for years, and I followed in his footsteps using Koch Industries, Whole Foods Market, and Agora Publishing as case studies. These companies are run by libertarian CEOs who apply market strategies to "create long-term value." Koch doesn't have a monopoly on these market concepts.

Koch has trademarked MBM throughout the book, which can only be justified by his unrelenting systematic application of its principles, and the work is peppered with numerous examples of successes and failures. In this respect, his book is too short for my tastes. In only 194 pages, there's not enough space to determine how much of Koch's success is due to MBM and how much to engineering brains, business experience and just plain luck. For instance, in a 15-page summary of the evolution of Koch Industries, he states, "Thanks to my brother David's leadership, KII has grown its process equipment and engineering business more than 500-fold." Amazing, but how was it achieved? Charles doesn't tell how David used MBM principles to accomplish this monumental goal.

Is "Success" a science? Koch goes to great lengths to prove that his MBM methodology is universal and objective, but Koch is not without controversy. My course at Columbia was rated highly by the MBA students, but an illiberal department chair refused to renew the course, calling it "too political." (At Columbia, can anything be "too political"?) Charles Koch's politics are libertarian, and he has been a major contributor to free-market foundations such as the Cato Institute and the Institute for Humane Studies at George Mason University. For many business schools, it's hard to separate science from politics.

Koch is no Keynesian businessman. According to his book, he is no fan of meaningless make-work projects, guaranteed employment, automatic pay raises, seniority, centralized planning, or running to the government for subsidies or trade protection. Most employees are Koch Industries are union, but must be flexible if they are going to survive. Koch aggressively searches for only "A" or "B" grade employees; those rated "C" either must improve or are let go. Koch Industries doesn't tolerate failure for long. I like his anti-Marxist slogan, "From each according to his ability, to each according to his contribution." Now that's marginal analysis at work!

Though anti-statist to the core, Koch reveals in his book some things that will surprise libertarians. For example, most libertarians practice "minimum" compliance with state rules, but Koch teaches "maximum" compliance with environmental and other government regulations. In today's litigious society, it is suicide to act otherwise: Koch Industries faces 159,000 lawsuits and employs 125 full-time lawyers.

Until now, Koch's Market Based Management, Principled Entrepreneurship, and other trademarked management techniques were taught to company officials and employees, and there was always a shroud of mystery about his guiding principles. His new book "Success" is a giant step in the right direction. Charles Koch has lived up to Ben Franklin's line, "It is incredible the quantity of good that may be done in a country by a single man who will make a business of it."

Reading this book is like sharing a scotch with a rich uncle. He lets you into his mind, and displays his reason. Mr. Kochs humility as a business man helps myself identify with his writing more than any other. Starting off with a brief history of the company he sets the stage of decision making in Koch Industries. Getting into the heart of the book you wonder if someone has gotten into your head and printed your thoughts. On more than one occasion I found myself pacing with agreement only to see my wife shaking her head in bewilderment. The seventh chapter on Incentives has what I believe the greatest value for society. During a time of government wage increases, cost of living adjustments, and payment based on tenure, it is refreshing to see a successful company utilizing incentives to evenly trade for value.

"Steak. No Sizzle" is the thought that came to my mind in describing Koch Industries and the success that Charles Koch has had in growing his company for the past 40+ years.

The business section of book stores are full of quick-fix books that are loud with sizzle, but leave one wondering where the steak is. Charles Koch's book, the Science of Success, is the steak. Written from the very successful Chairman and CEO of the world's largest private company, Koch gives good, core insight into the philosophy that he uses to operate and grow his business, Koch Industries.

That philosophy, called Market-Based Management (MBM) gets the focus set squarely on the bottom line of value added. It's that focus on the value added impact that makes the book and Koch's philosophy so valuable.

While it would take readers years to perfect the application of Koch's MBM philosophy, Koch would surely say that his approach is not a quick fix or an approach for everyone. Rather, it is an approach for those who are dedicated enough to want to make a valuable difference in their own life, profession or business.

I can't imagine it's easy being humble after having grown a business more than 2,000-fold, but Koch not only mentions that he's had his share of colorful failures, but also mentions frequently and with great emphasis that he and the business succeeded with great people around him.

No doubt that some of the great people in his life that he mentions, such as his wife Liz, his brother David, and one of his top officers, Rich Fink, have grown in their knowledge of MBM and have made a significant impact on the company by applying Mr. Koch's philosophy.

Readers looking for a straight forward and hearty approach to a value-adding philosophy will find it here, like the person looking for a good steak dinner who savors a hearty steak.