thE SCiENCE OF SUCCESS by Charles Koch. Who is Charles Koch. Charles Koch is an American businessman and the CEO of Koch Industries -‐ the second . Charles Koch has a lot of pelts. He has built Koch Industries into the world's largest privately held company, and this book is an insider's guide to how he did it. His "Market Based Management" (the term is trademarked), is "The Science of Human Action.". The Science of Success: How Market-Based Management Built the World's Largest Private Company is a book written by Charles Koch . Koch, Charles. " The Science of Success Summary - The Investors Podcast" (PDF). The Investors .
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THE SCIENCE OF SUCCESS: HOW MARKET‐BASED BUILT THE WORLD'S LARGEST PRIVATE COMPANY ‐ By Charles G. Koch. “The Science of Success: How Market-Based Management Built the Forty years ago, Charles Koch returned home to Wichita, Kansas to take the reins of the. The “science of human action” and “market-based management” About the Author Charles G. Koch is Chairman of the Board and CEO of.
We aggressively bought trucks and trucking companies. I spent virtually all my spare time studying history and the humane sciences. This approach was quite successful. As the growth of our crude oil gathering business accelerated. He gave us approval to download one.
When I informed him of this. I started to apply them. We renamed Rock Island in his honor. Our willingness to move quickly. At age We also developed the capability to build pipelines and to operate pipelines and trucks more economically than our competitors. Sterling and I continued to build our crude oil gathering business. He had a great influence on me and the company. This success started with our vision. This delayed building the pipeline and created a burden for the producers.
As our crude oil volume grew. We were willing to build a pipeline into a new field without a commitment from the producers as soon as there was any indication it would be economic.
In the years that followed. Other pipeline companies typically attempted to reduce their risk by requiring a commitment. We had a truck at a well site to move the oil as soon as the well began producing. I succeeded him as chairman and CEO. He was a John Wayne-type figure.
I was blessed to work with my father for six years until his death. We also began seeking other commodities for which our capabilities could create superior value. One of the most significant events in the evolution of the company was our acquisition of controlling interest in the Great Northern Oil Company. In turn. Using the capabilities developed in gas liquids.
Union Oil then began trying to sell its interest to independent refining companies. To counter this move. Koch Nitrogen has since become a leading international fertilizer manufacturing. I approached J. This brought us back to running a refining business for the first time in nearly 20 years. They responded by offering it at a price considerably above market. Howard with the idea of pooling our interests into a holding company.
Koch Exploration. Refining also provided a base to enter the asphalt business as well as the trading and distribution of other commodities. This acquisition brought new capabilities to Koch Industries and led to many new opportunities.
We have also used refining as a base to enter chemicals and. After acquiring the other half in I promised we would exchange J.
Howard readily agreed. That facility has since been expanded more than five-fold. We then added other solid commodities—such as pulp and paper.
In we began building our Business Development Group. Business Development facilitated the acquisition of two small forest products businesses.
To do this. Given our breadth of products. It is now a leader in a number of process technologies. After unsuccessfully pursuing a number of. David joined Koch Engineering in as a technical services manager and became president of Koch Engineering in He has greatly expanded and broadened its product lines and capabilities.
KII has grown its process equipment and engineering business more than fold. The quantitative and risk management capabilities we developed for commodity trading helped us build a financial trading business. We had previously identified forest products as one of those industries.
Our surplus liquidity. Howard and his son. Koch Genesis. It provides Koch Industries with a significant growth platform in the forest and consumer products industries. GP is also a leader in other segments of the forest products industry. Koch Genesis is focused on acquiring technologies and technology companies that can significantly enhance our existing businesses. Embracing this vision required both trust and a low time preference. David Koch and I shared a vision of building a large.
This vision also required that the company reinvest most of its earnings. In our view. Another experiment that got out of control was our attempt to apply our core capabilities model to agriculture. Given that a market economy is an experimental discovery process. That was certainly a great learning experience. Nothing could be further from the truth. One of the most extreme cases was our overblown petroleum and tanker trading in the early s.
When the Arab oil cutback hit in and The key is to recognize when we are experimenting and limit the bet accordingly. We were going to produce superior steaks to sell at premium prices. Koch companies have suffered when we forgot we were experimenting and made bets as if we knew what we were doing.
There have been a number of others.
As a corporation. They were successes. We also encountered partner issues and decades-long lawsuits similar to what my father endured. I believe most of our partner problems were driven by a conflict in visions. They stimulated an onslaught of government investigations and media attacks in the s and s.
It is worth noting. As such. This was done by applying the five dimensions of MBM in legal. To survive. Making it truly effective required broadening our view of who should be held responsible. Given all the complex. It involves selection. Even more. It required a monumental undertaking to integrate compliance into every aspect of the company. As we became much more effective in compliance and defending ourselves.
The remainder of this book addresses these dimensions and how the Science of Human Action was used to develop them. We improved. But we do not intend to rest on our laurels. I believe our ability to maintain that growth rate will be a direct function of the rate at which we improve our ability to apply MBM. There is no substitute for this. The man who tries methods.
This science is the study of how humans can best achieve their ends through purposeful behavior. Market-Based Management also draws on the lessons learned from the successes and failures of humans to achieve peace. It draws on the disciplines of economics. That certainly has been our experience at Koch Industries. For As shown in Figure 1. Such results are uncommon among large companies. Change is ever-present in the marketplace. Seventy years later. Just two outperformed the market average.
Despite all their assets and capabilities. Our approach to management has enabled us to succeed through decades of dramatic change. Energy prices have risen and fallen in repeated cycles. This process of creative destruction is the essential fact of capitalism. Economist Joseph Schumpeter famously described this as a process of creative destruction. Forbes found that only 31 of those companies were still independent and only 18 remained among the largest in the country.. Forbes produced its first list of the largest companies in the United States.
It is often more difficult to overcome success than adversity. It views the organization as a miniature society with unique characteristics requiring adaptation of the lessons drawn from society at large.
MBM teaches that we must continually drive constructive change in every aspect of our company or we will fail. At Koch Industries. We believe it is essential to drive creative destruction internally. Through this adaptation we have developed our MBM framework and ever-evolving mental models.
One consequence of this flawed thinking was that many spectacular discoveries were delayed until certain innovators. We must constantly remind ourselves that just because we believe or want a thing to be true does not make it so.
Koch Industries invests tremendous time and effort to ensure that our MBM mental models fit reality and are understood and applied throughout our businesses. In the process. People used to believe that the earth was flat and behaved accordingly. They shape and support our thinking.
A business with behavior based on faulty mental models is doomed to extinction. The quality of our mental models determines how well we function in the natural world. As Ludwig von Mises pointed out: Systematic study of classics in history.
We need to constantly ask ourselves if we. As with everything. As indicated. They must be neither overly complicated nor too simple. This study leads us to conclude that long-term. I was surprised to find that. It took me some time to see how understanding the conditions that lead to prosperity could contribute to our efforts to build the company.
Economic freedom is strongly correlated with income per capita. As I did so. It became clear because. The Science of Human Action applies not only at the macro level of societies and nations but also at the micro level of individual organizations.
I instinctively began to apply them in our company. Such costs should seldom be taken into account when determining what to do in the future because. I argued our test should be forward-looking and governed by the standard of opportunity cost. I suggested selling it immediately. In decision making. An example from the late s concerned one such introductory concept that. We should only hold the inventory if we have strong evidence that the price is likely to rise rather than fall further.
That is. We were addressing the question of when to sell some inventory. Given the choice. This leads to the concept of diminishing marginal utility.
For any exchange to occur. This is called demonstrated preference. In another example. Since people satisfy their highest values first. Because value is subjective. This explains why something as abundant as water. If someone downloads an apple.
To encourage entrepreneurship among our employees. Two entities both gain by trading with each other. This requires a continual reassessment of roles and responsibilities.
As we began to hire large numbers of new employees and move existing employees into new roles. The superior producer gains by concentrating on the production of the products for which it has the greatest relative superiority. The disadvantaged producer gains by concentrating on the production for which it is least disadvantaged.
After learning how this principle enhanced prosperity through trade. When replacing someone on a team. I became intrigued by the potential power of more advanced concepts and derivative models. I would mentor our people by raising relevant questions. In the s and s. In every meeting. This is. At the risk of oversimplification. In times of surplus capacity. We call this a price-setting mechanism.
It is a useful tool for competitive and investment analysis and for estimating the effect of changes in demand. The chart also indicates the competitive position of each plant. The lowest-cost plant is shown on the left and the highest-cost on the right. The model shown in Figure 3 helped us improve our ability to predict price movements and to determine the competitive position of each of our facilities.
The chart helps predict what the price will be during times of surplus capacity based on our view of future demand. We thought this would be an efficient way to better connect employees with our philosophy. Edwards Deming. I was only able to work with or mentor a decreasing percentage of our employees. Although MBM was comprised of these concepts or mental models.
By using Pareto charts. In the early s.
Its power came from ensuring that each part reinforces and leverages the others. As the company continued to grow. The system we selected was that of W. While applying a single dimension. We needed to find ways to teach the theory and practice of our concepts and mental models on a much larger scale.
The problem. To a person with only a hammer and no understanding. The electricians there were spending a large portion of their time measuring activity and drawing charts instead of doing electrical work.
We also learned we could not simply graft economic principles and our mental models onto an existing management system. One was that concepts and tools must be used only when they improve results. This point was driven home for me on a mids trip to the electrical shop at our gas liquids plant in Medford. Developing valued services from MBM required synthesizing theory and practice. We researched the key aspects of a market economy that would enable us to further develop our framework.
At its inception. Teams were formed to examine the role of property rights. I hit on Market-Based Management in I felt this name best reflected the influence of market principles and the need to provide a coherent management philosophy and practice.
The first step in codifying our own framework was coming up with a name. To facilitate the development of these mechanisms. We expected this team of internal trainers and consultants to help employees understand and apply our concepts and mental models to achieve results. The challenge. It also caused us to systematically articulate our own framework so our people could integrate theory and practice. The results of proper integration and application are far beyond what can be achieved with either theory or practice alone.
It can be facilitated by the tutelage of a mentor. At some point. Riding a bike. Personal knowledge. Theoretical grounding is necessary. Personal knowledge is the result of integrating theory and practice. Personal knowledge is the key to making discoveries. As we study a particular field.
It requires learning a new framework and mental models. Developing personal knowledge involves a personal transformation.
Other team members had little or no understanding of the theory. The process of discovery begins when we observe. Learning how to overcome the tendency for form to take precedence over substance was a key to getting results from MBM. To build a culture of discovery. Hypotheses that pass this hurdle can then be put to the broader test of working in practice. Employees used them to justify what they were already doing.
This improves our ability to perceive problems and opportunities when doing research. The genesis of this entire process is the development of personal knowledge that is passionately applied to solve a problem.
We can then begin to see patterns. Defining the particulars and prescribing exactly how MBM should be applied undermines the ability to use it to achieve superior results. To its credit. It reminded us that. We are now better at detecting and dealing with such tendencies. Accomplishing such a change involves a focused and prolonged effort to develop new habits of thinking based on these mental models.
In order to fully capture the power of MBM. This helped us more fully appreciate the value of having measures based on economic reality. This requires the most difficult and painful of all changes: A change in the way we think.
Success in applying new mental models comes only after frequent practice. Recognizing and resisting this natural tendency to bureaucratize everything has been another important step forward. Koch Industries grew through the application of market-based principles. We were not alone in this regard. The reality was far different.
This success fed on itself because it demonstrated to skeptics the power of the MBM framework. While business was becoming increasingly regulated. These changes have universally damaged the ability of businesses to create real value and contribute to societal well-being. The laws of economics seemed less and less relevant in a world where the un-. Around We needed to be uncompromising. The impetus toward regulation and litigation was fueled.
We believe the proper application of MBM offers an antidote to these problems. This reality required us to make a cultural change. If these efforts fail. The recent spectacular failure of several large companies. Striving to comply with every law does not mean agreeing with every law. Only then. The first is the economic means: Parties will not voluntarily enter into an exchange unless they both believe they will be better off.
The economic means creates wealth by making each participant. As a general system. The second is the political means: The economic means of profiting involves voluntarily exchanging your goods or services for the goods or services of others.
The political means of profiting transfers goods or services from one party to another by force or fraud. Examples are stealing. The political means. Society certainly has the power to enact laws. A company should not be exempt from environmental emissions laws because it is small or favored politically.
But for these laws to contribute to prosperity rather than undermine it. A coerced or fraudulent exchange leaves at least one of the parties worse off. We believe that to have a. The table on the following pages summarizes the application of the Science of Human Action in society the Science of Liberty.
A positive reputation is built by behaving consistently with sound principles. Doing this. Then the facts about real performance should be communicated. We must build a positive reputation based on reality. Chapters 3—7 provide a detailed examination of each of the five dimensions of MBM. This approach also enables an organization to build beneficial relationships and trust with people from all walks of life who share its values—those who are producers.
Doing so not only enables a company to stay in business.
To maintain these relationships requires that all employees act in a principled manner. Understand your goals and comparative advantages and how to create the greatest value for yourself. How societies can best achieve longterm peace.
Ensure that people with the right virtue and talents are hired and retained. Determine where and how the organization can best create value in society to maximize its own value long-term through a process of experimental discovery. How individuals can best develop. How organizations can best survive. Do what you have a passion for and is most rewarding to you. Seek those roles and acquire the necessary resources where you have a comparative advantage. Seek and share knowledge and determine what is profitable.
Ensure knowledge is optimally acquired. Constantly innovate and learn through experimental discovery. Ensure the right people are in the right roles with the right authorities. Employees are rewarded according to the value they create for the organization. Measure profitability wherever practical. Employees know what they are responsible for and are held accountable. Buddha beheld the vision of a spiritual world of stainless beauty and perfect peace. Copernicus fostered the vision of a multiplicity of worlds and a wider universe.
In a true market economy. They do this while consuming fewer resources. A n effective business vision begins and ends with value creation. It is contributing to prosperity in society. Value creation is the role of business in a market economy.
If all this is done in harmony with sound principles. By resources. In either case. In a true free market. Superior value can be created by converting these resources into a product or service that has greater value to the customer or by consuming fewer or lower opportunity cost resources to provide the product or service.
Koch companies turn crude oil into products such as gasoline. When businesses make unprofitable products. If we can make these products using fewer or less costly raw materials. The ability of a business to create value is greatly facilitated by a market economy that coordinates the various interests of a. As Vernon Smith has noted. It is not a question of whether there should be self-interest. The economist Adam Smith summed up this process when he said: We all tend to pursue our own interests.
Smith meant what Tocqueville called enlightened self-interest. Hayek have demonstrated that prosperity can only take place through spontaneous order.
Even with all of us seeking our own self-interest and even without any society-wide planning. The fact that new products and methods are constantly driving out old ones presents businesses with constantly changing challenges and opportunities.
Because this emerging order is not centrally planned. That self-interest can manifest itself in one of two ways when dealing with strangers. Adam Smith described this as the. Hayek described it as a spontaneous order. In a market economy. Michael Polanyi believed that science advances through a similar spontaneous order which he called the Republic of Science. It does so by developing a vision that guides it in how to create superior value for society.
Remember the Forbes listing of successful companies mentioned in Chapter 2?
Most of the largest U. We know a business is being guided by an effective vision to the extent it creates profit over the long term. Those that are not satisfying needs tend to die out. Because they did not continue to create value for society and therefore failed to generate sufficient profits. Competitors are constantly seeking less costly methods of production and superior new products that destroy the profitability of established products. The development of an effective vision begins by recognizing the ways in which an organization can create superior value for society.
This vision should guide everything the organization does. To maximize profit over the life of a product. It should be based on a realistic assessment of its capabilities as well as improvements it needs to make and the new ones it needs to add and on a detailed analysis to determine the opportunities for which these capabilities can create the most value.
We require a vision that guides us to do more and more. They did less and less for society as time went on.
The wide range of strategies available to slow this decline include: Hayek explained the need for experimental discovery: All businesses must constantly innovate. We must also limit the. To drive creative destruction internally. As writer George Will has reminded us: Economic problems are created by unforeseen changes which require adaptation. The world never stands still. To do this successfully requires that a business apply the processes of experimental discovery and creative destruction to its vision.
Leaders of the Interiors business at DuPont knew that to survive and grow they had to renew their products continually. Subsequent innovations improved softness and introduced other features. The latest innovations include products with better bulk. Their original nylon carpet product. Had the company simply relied on stain resistance to keep the product profitable.
Ongoing efforts to stay one step ahead of competitors and to anticipate what customers will value in the future have fostered continuing innovation. This essential insight is fundamental to success. Customers seldom know what they will value until they see it. While it is important to ask customers what they will value in the future. But who among us could have imagined the spectacular changes coming in information technology? Certainly not those mainframe users questioned decades ago.
Both a company and its customers gain when the company anticipates new value opportunities rather than just reacting to what customers value today. But thinking this way can lull us into complacency and make us vulnerable to creative destruction. In addition to slowing declines. In general. To do so. At Koch Industries overall. In short.
They might see synergies with other complementary assets they own. How do we create a vision? The development of an effective vision requires recognizing how an organization can create superior value for society and most fully benefit by it. Or they may have capabilities or innovations the seller does not have. A potential downloadr might not believe the business will decline as rapidly. This preliminary determination must be confirmed through the development of a point of view regarding what is going to happen in the industries where the organization believes these opportunities exist.
Based on our point of view. We then analyze its value chain and cost structure. We seek to understand the future drivers and level of profitability for the various segments of the industry. From this analysis. Point of view development involves intensive. Transaction Excellence and Public Sector. We enhance the application of these capabilities in our businesses through teams in each business. Virtue and Talents. Decision Rights. Decision Making Framework.
The core capabilities that currently represent our greatest competitive advantages and enable us to create superior value are: MBM Vision. Knowledge Processes. Koch Industries will continually improve these capabilities and develop additional core capabilities.
Our success with the pulp business encouraged us to seek further opportunities in forest and consumer products and ultimately led to the acquisition of GP. Operations excellence could improve compliance and cost and performance effectiveness. At KII. We believed MBM could improve vision development. Based on this reasoning. Trading could improve raw material and energy downloading. Innovation could apply not only in products and processes.
New opportunities exist in our traditional industries just as they do. Public sector could improve the ability to prevent and defend lawsuits and deal with political and communication challenges. Transactional excellence could enhance opportunity origination and analysis and financial structuring.
This requires setting priorities. In a complex business. At least two sets of criteria are needed to determine priorities. A key part of this process is taking into account the capabilities and appetite for risk of both the business and Koch Industries as a whole. The second set is determined by gap analyses that estimate the risk-adjusted present value of the opportunities relative to the resources consumed such as scarce talent or capital.
Without such a methodology. Koch companies apply this same vision development process inside. The first set includes those actions that are required to stay in business. Maximizing long-term value also involves creating an experimental discovery process that encourages new improvements.
Our losses in shipping and agriculture were costly examples of the failure to develop a reality-based vision and recognize that we did not have the capability to make bets of such complexity or magnitude. Both are profitable today. As Einstein taught: Opportunity cost must be considered in deciding what to do and in what order.
That same approach also allowed the Matador Cattle Co. KII has been hurt when we failed to do so. Koch Nitrogen and the Matador Cattle Co. When we are experimenting. New capabilities have been built. For an established organization.
Each must then assign responsibility for executing these priorities. An effective vision is the genesis of long-term success. Every vision should answer the questions. Even though a vision will change over time. Once established. Creative destruction will see to that. A shared vision guides the development of roles. Understanding what the business is trying to achieve and how it creates value helps each employee focus and prioritize.
The grounds of this are virtue and talents. Right conduct controls the greater one. Rules of just conduct are not a specific set of rules. To be a truly successful organization. Norms of behavior are how we behave and expect others to behave.
To function effectively. It also enhances adaptation to changing conditions. For a free society to function. Norms of behavior. When detailed rules or instructions are necessary. As the French writer Frederic Bastiat put it. Leaving the particulars to the person doing the work encourages discovery.
It also implies that laws must be applied consistently to all. Over-specifying and enforcing particulars undermines prosperity by encouraging inaction.
These lead to civility. The rule of law. It also facilitates corruption and abuse of power. The rule of law ensures equality of treatment not equality of outcome.
To the extent that particulars are enforced. It may be created intentionally by the organization or inadvertently by other forces. MBM requires a culture that has specific attributes. Enforcing general principles enables employees to challenge the particulars.
Every one of us must internalize these core values and exemplify them in all we do. Embrace change. Create real. Conduct all affairs lawfully and with integrity.
Seek and use the best knowledge and proactively share your knowledge while embracing a challenge process. Understand and develop relationships with customers to profitably anticipate and satisfy their needs. Eliminate waste. Demonstrate the sense of urgency. Ensure excellence in environmental.
Envision what could be. Strive for Encourage and practice teamwork. The first step is to ensure that policies and practices lead to a culture of value creation. We provide detailed explanations of these Principles and their role.
Treat others with dignity. Appreciate the value of diversity. These steps are essential if such principles are to truly affect workplace culture. Constantly seek to understand and constructively deal with reality to create real value and achieve personal improvement. Many companies have similar principles.
Developing the ability to apply these Principles routinely and instinctively to achieve results requires constant practice and reflection. Produce results that create value to realize your full potential and find fulfillment in your work. In addition.
Practice humility and intellectual honesty. Leaders should be selected from among those employees who have demonstrated competence in the execution of these steps and are positive role models for workplace culture. To be effective. In addition to living by these principles. A key talent for management positions is the ability to read people and identify those who are able to apply sound principles to achieve profitable results.
They hold themselves. We also provide regular feedback and will discipline and ultimately terminate employees who do not act in harmony with our Principles. Creating a beneficial culture requires mentoring and positive examples. For MBM to be applied effectively. Because leaders set the standard. Effective leaders provide frequent and honest feedback that identifies opportunities for improvement in a way that stimulates dialogue and change.
One knows chess. Employees with insufficient virtue have done far more damage to companies than those with insufficient talent. The ability to create real value depends on a principled.
Several years ago. Although employees are selected and retained on the basis of their values and beliefs. Such employees focus on core business issues. He saw no need to comply with it. We self-reported his violation and also terminated the employee. Both virtue that is. Virtue without the required talent does not create value. But talent without virtue is dangerous and can put the company and other employees at risk.
Leaders also provide opportunities for employees who best exemplify a beneficial workplace culture. There are a number of different kinds of intelligence.
This is why it is. We strive to find those who can create the most value through a diversity of perspectives. This is why we appreciate the value of diversity. In brief. Each intelligence entails the capacity for learning.
We strive to select. Diversity within a company is also important to help it better understand and relate to its customers and communities in this diverse world. A truly free society rewards people according to their individual merits. While all eight are important in society. Gardner identified at least eight different kinds of intelligence. The hallmark of this intelligence is a sensitivity to the meaning of words.
This is especially true of those who become completely disconnected from self-reality. These abilities are central to the effectiveness of anyone who speaks.
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Actions Shares. Embeds 0 No embeds. No notes for slide. Summary -The Science Of Success 1. Some Impressionistic takes from the book Charles G. About the Author Charles G. 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. 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. Backdrop Today, Koch is chairman and CEO of the largest privately-held company in the world, with 80, 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.
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. Prelude What is behind the success of Koch companies? 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. He also provides a systematic view of MBM at work within Koch companies by outlining five dimensions: Hayek 6.
Will it generate significant value for customers and society? They should exhibit these traits and characteristics: