There should be a ready-made market for a great new book just out this month: Charles G. Koch’s "The Science of Success: How Market-Based Management Built the World’s Largest Private Company." Academia, government, nonprofit organizations and even much of the business world could use a management primer that integrates economic and management principles against the backdrop of indisputable achievement.
Koch doesn’t just read books or give lectures about building and running a successful enterprise; he actually built one, and he runs it. Koch 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.
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 calls his resulting methodology "Market-Based Management," or "MBM." At first blush, some readers might wonder how much of MBM is really new, but in fact, Koch has a key insight here. Economic thinking can add significant value even in situations that don’t involve analyzing markets.
One economist who appreciated this point was the late Paul Heyne, who authored a college text I used to require of my freshmen students when I was a college instructor. In "The Economic Way of Thinking," Heyne showed how, when you really understand economics and how economies work, it can change the way you think about much of life.
For example, I would ask my students what it "cost" them to attend college. Invariably, they would give me a dollar figure that represented tuition plus room and board. But then I would ask them, "What would you be doing if you weren’t here for four years?" (A few were there for a lot longer). It made them realize that the "cost" of a college education isn’t just the checks that Mom and Dad wrote, but also all the income and experiences they themselves were not earning precisely because they were in college. Bingo. They had discovered "opportunity cost." I’d like to think that for most of my students thereafter, nothing ever "cost" so little again.
As another example, I explained to the students how the concept of "sunk cost" affected my behavior. I once bought what I thought was a "bargain" half-gallon of pecan ice cream for 99 cents and then quickly discovered the pecans were as scarce as kangaroo wings. After consuming a single disappointing scoop, I put the ice cream back in the freezer. Time and again, I’d see it in there, but couldn’t bring myself to pitch it. After all, I paid a buck for it! I wasn’t thinking like an economist. Then one day it hit me: That 99 cents was sunk. History. Nothing I could do about it. The only thing that mattered now was the future. Since I was probably never going to eat the rest of the ice cream, the economic thing to do was to get rid of it and make room for something better. I never flushed anything down the garbage disposal with more intellectual satisfaction than that ice cream.
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.
The Soviet system suffered big failures even in its core "expertise": maintaining rigid internal security. Remember when a young German named Mathias Rust flew his Cessna 172 in 1987 across hundreds of miles of Soviet terrain and then landed safely in Red Square? Bewildered onlookers, including police and security forces, watched as he enjoyed a nice little self-guided tour of the local sites. They didn’t act because they were instructed to do only what they were ordered to do, and reacting to a Cessna landing in Red Square wasn’t in the book. They were not allowed to be on-the-job entrepreneurs. Koch’s MBM leads to a very different environment indeed.
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.
At the Mackinac Center, we embrace change. We seek continuous improvement. We don’t think anything is ever done so well that we can’t improve it the next time. We think long-term, which often means that we forgo some attractive but ephemeral ventures that would distract us from our course. We employ the concept of opportunity cost so we get an accurate perspective on what it really costs to undertake a project.
We encourage our staff to be entrepreneurial by aligning the success of the organization to their own personal income and advancement. Like Koch and classical economists, we believe comparative advantage really is a key to success for both an economy and an organization, so we never promote a high-performing colleague into an administrative dead end, as many government schools do with their best teachers. We may be a nonprofit, but we don’t act as if it’s a virtue to be unprofitable. If I had had Charles Koch’s book at my side 20 years ago, however, I think we’d have become successful even faster.
This review hardly covers all the bases of the Koch formula or the MBM success stories within the Koch firm — which is all the more reason to read the book. For readers who have never made a connection between the market economy and the principles of organizational management, a revelation awaits on every page. For readers who think they already know these things, the book could well be a kick in the pants that makes them realize they have a ways to go to actually, consciously practice what they preach.
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Lawrence W. Reed is president of the Mackinac Center for Public Policy, a research and education institute headquartered in Midland, Mich. Permission to reprint in whole or in part is hereby granted, provided that the author and the Center are properly cited. Readers interested in learning more about "The Science of Success" can visit www.kochscienceofsuccess.com.
The Mackinac Center for Public Policy is a nonprofit research and educational institute that advances the principles of free markets and limited government. Through our research and education programs, we challenge government overreach and advocate for a free-market approach to public policy that frees people to realize their potential and dreams.
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