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Charles Koch is trying to share the secrets of his success. Will anybody listen?

Charles Koch is trying to share the secrets of his success. Will anybody listen?

Christopher Leonard is a business journalist and Schmidt Family Foundation Fellow at New America. He is writing a book about Koch Industries for Simon & Schuster and his work has appeared in Fortune, Bloomberg Businessweek and The Wall Street Journal.

When he sits down at a conference table in his office, Charles Koch can look out the window and take in a panoramic view offering physical proof that he has, indeed, cracked the code for creating prosperity.

Outside is the sprawling Wichita, Kan., headquarters campus of Koch Industries, a maze of dark granite buildings and crowded parking lots surrounded by security fencing and earthen walls.  There are small traffic jams on the roads around campus at 7:30 in the morning as thousands of employees pour into the complex for work. Koch Industries’ operations span the globe and touch virtually everyone — or at least everyone who eats, uses fuel and talks on smartphones. 

At 80, Charles Koch still comes into work every day. After he showed me into his office, I noticed that his broad desk is covered with neat piles of papers. Koch has even been working on nights and weekends lately, but not just on business matters. Koch is motivated by something more than making money — he wants to share the secrets of his success. He has been writing a book called “Good Profit,” which was published in October. The book outlines the unique and idiosyncratic philosophy, called “Market-Based Management,” that Koch has been working to codify since at least the early 1980s.

Koch has been on a rare media blitz this year to promote “Good Profit,” doing a round of major interviews that carry the air of legacy building for Koch, who usually avoids publicity. But the one thing nobody seems to ask about during Koch’s appearances is the book itself, or the meaning of Market-Based Management. More people are interested in the billionaire’s political activity, and with good reason: Charles Koch leads a network of conservative donors that plans to spend some $889 million during the 2016 election to reshape America’s politics, from the White House down to local state houses. Roughly $250 to $300 million of that will be spent directly on elections; the remainder will fund broad “educational” ventures like think tanks.

It is easy for outsiders to dismiss Market-Based Management as just another meaningless bundle of business-school jargon. But doing so would be a mistake. Whether you love or hate Charles Koch’s politics, you need to understand Market-Based Management. A close look at the philosophy helps explain why Koch Industries will almost certainly be larger, more influential and more profitable in the next 10 or even 20 years.

Management philosophy as world guide

Charles Koch writes in the book that the company’s goal is to double its profit every six years — a startlingly ambitious claim that seems to have gone largely unnoticed. It’s unclear how large those profits would be because Koch Industries is privately held and doesn’t report annual income. But the number would certainly be huge; Koch had roughly $115 billion in sales last year, according to an estimate by Forbes. The six-year profit goal also shows that Charles Koch isn’t thinking in terms of the 2016 election. His strategic horizon stretches out for decades. It always has. And Market-Based Management is at the heart of this thinking.

When asked why he was compelled to invent an entirely new management philosophy, Charles Koch immediately starts talking about math.

He has always excelled in math. That’s why he became an engineer. He got an advanced degree in nuclear engineering from M.I.T. because it came more naturally than other subjects. When he took over his family company after his father died in 1967, Charles Koch approached the task like an engineer. Math could explain nuclear engineering. Maybe it could explain people and business as well.

“I learned, okay, there are certain principles that guide the physical world. That it’s an orderly world, the physical world is. It follows certain laws,” Koch told Yahoo Finance over coffee (he drinks it black) during an extensive interview in his office. “And so I thought: Well, the same thing’s got to be true for how people can best live and work together. So I started reading everything I could on the subject. Whether that’s philosophy, of course philosophy of science, but philosophy in general, political philosophy, economics, psychology, anthropology, history … to try to understand what these principles are.”

Charles Koch claims that he and the management team around him have successfully discovered those principles – and they’re embedded in Market-Based Management.

“Good Profit” is actually the third iteration of Market-Based Management, or MBM as employees call it. The first draft of MBM was a glossy pamphlet printed in 1993 and distributed to Koch Industries employees. The second draft was Charles Koch’s 2007 book, “The Science of Success.”

One problem with all of these books is that you can’t learn Market-Based Management by reading about it. In fact, reading might be the worst way to learn about it. The philosophy is composed from the kind of words that have been beaten into a coma by countless management seminars. These are words that mediocre and failing corporations like to display on posters with snow-capped mountains in the background: words like Integrity. Value Creation. Knowledge. Change.

But Market-Based Management isn’t just a collection of slogans.  It is a very specific operator’s manual that’s used every day by virtually every employee at Koch Industries.

Interviews with dozens of current and former Koch Industries employees show that the philosophy is taken quite seriously within the company — and its effects are real. Other people might doubt its power, but not people inside Koch.

MBM is only learned through practice, like riding a bike. After a while, the system becomes ingrained. Koch employees often use phrases like “point of view” and “mental model” that only they understand, and that carry strategic significance.

Just consider that terribly vague word: knowledge. Within MBM, it means a lot more than you might think. Koch Industries is a machine that constantly sucks in information. Every time Koch Industries sells something to somebody, it is actually pinging the outside world with a small probe and gleaning knowledge.

For example, Koch started to see opportunities in the forest products industry back in 2002. In 2004, Koch bought two wood pulp mills from the then-publicly traded company Georgia-Pacific, which had been posting lackluster earnings for years. Koch Industries, which employs about 60,000 people in the U.S. alone, began to closely study forest products markets by operating the mills. Georgia-Pacific had an impressive footprint in the business: It controlled 54% of the U.S. market in consumer napkins, and was the largest maker of structural wood panels.  Koch became convinced that he could make Georgia-Pacific more valuable by adding his company’s commodities trading know-how to it, helping the company obtain cheaper raw materials. After operating the pulp mills for a short time, Koch bought the rest of Georgia-Pacific’s operations for $21 billion, including debt.

More recently, Koch invested heavily in a steel mill in Arkansas. That steel mill lets Koch Industries peer into markets it has not yet entered on a large scale. Expect more major acquisitions in the steel business if Koch likes what it sees. Gaining knowledge, then, is a concrete business strategy, even if it sounds like a slogan. A similar truth can be found for every aspect of Market-Based Management.

The best way gain an overview of how MBM works is to walk through the five components of the philosophy, as they are described by Charles Koch himself.

1. Vision. Charles Koch argues that any company needs to have a vision of where it wants to go. That seems obvious. But he also has specific ideas about what kind of vision is necessary.

One of Charles Koch’s touchstones is long-term thinking. Koch Industries has thrived over decades in the boom-and-bust business of commodities — and financial roller-coasters don’t scare the company. What matters is that results are profitable when measured over years and even decades.

On this front, Koch Industries is an unqualified success. When Charles Koch took over the company he charted a goal for how large the company should be when he retired, as measured by earnings. The firm is now 70 times that big.

“The status quo isn’t going to last,” Koch said. “So we need to drive creative destruction rather than be a victim of it. So that’s all part of our vision process which all feeds into long-term [thinking], because none of this is instant pudding. So you have to have a long-term perspective if you have this type of vision on value creation and building capabilities.”

2. Virtue and Talents. Charles Koch doesn’t think that strict and complicated rules get the best results. Human history, after all, can be read as one long, terrible saga of people knowing the rules, and then skirting or defying them (see: Cain v. Abel).

What’s better than setting rules is first hiring people with the right personal values, and then reinforcing those values with the right company culture. In practice, this means Koch hires a lot of hard-working Midwestern kids from farming towns who don’t think they’re entitled to a paycheck just for showing up. Then Koch perpetually reinforces a culture of humility and hard work. Employees at Koch get free coffee, but it comes in cups that are emblazoned with the 10 “Guiding Principles” that are the foundation of Koch’s culture. The first three principles are integrity, compliance and value creation, just to give a flavor.

All three books about MBM make it clear: If you don’t fit in with the culture, you won’t last long at Koch.

3. Knowledge Processes. Koch is learning constantly about its competitors and customers. But sharing that knowledge is just as important as learning it. The CEO ensures that knowledge is shared widely through a “challenge culture” that encourages employees to respectfully push back on ideas they think are wrong.

“That’s a big part of what we try to do,” Koch said. “Just don’t go along with your boss because your boss says [something]. If you think you have a better way, you have an obligation to challenge the boss. And the boss has an obligation to have all the people feel good about challenging, and reward them for it, rather than, ‘God, my career is threatened because I pissed the boss off.’”

4. Decision Rights. This is one of the most fascinating, and arguably most innovative, parts of MBM. Charles Koch thinks that private property rights are the cornerstone of successful capitalism. So he sought to create a private property system within his company, with each employee like a small landowner.

This is especially difficult to achieve at Koch Industries, which doesn’t have public stock to give workers so they can have an actual ownership stake. Instead, each employee is given “decision rights” and certain “roles and responsibilities,” to use MBM lingo. These rights and responsibilities are like a plot of land.

If an employee makes good decisions, the land under his or her tenure will increase. If they make bad decisions, their land will shrink. This synthetic property system generates a kind of inherited wealth: If an employee puts a deal together, she can get bonus payments for that deal even after she moves on to another job or a different division. The good decision-making carries forward. The property system also creates accountability. If a manager delegates authority to an employee, that manager is still responsible for actions that employee takes.

“It encourages everyone to focus. The whole concept of property rights in markets causes people to focus on where they can create the most value, and are rewarded for that,” Koch said. “The old style organization at a plant is… you have the operator with certain responsibilities, you have maintenance, you have engineering and stuff… But we said: Okay, we’ve got to have one owner for that plant.” The “owner” carries responsibilities, and reaps the rewards.

5. Incentives. If property rights focus people’s attention, then money focuses it even more. Not surprisingly, Charles Koch ties incentives to long-term goals.

Employees’ salaries are considered an advance against future earnings for the company and a large part of compensation is based on performance. One of the measures used to evaluate performance is the future value that an employee might create — so the incentives bake in the need to think about the long-term viability of a deal. Conversely, if an accident or legal violation hurts the company, a manager’s entire bonus might be wiped out.

Employees at Koch shudder at the terrible incentives imposed on publicly traded companies, which typically prioritize quarterly earnings results. Such short-term pressure can incentivize budget tricks, or worse, to meet Wall Street’s expectations every few months. By tying bonuses to future value, Koch helps managers think far past the next quarter.

Koch is emphatic that other companies can’t pick or choose which elements of MBM to use. It’s all or nothing, a process of “self-modification” as he describes it.

Whether MBM will be adopted by other firms is unclear. Koch said he gets inquiries about importing the system, but he can’t always spare the senior managers who really understand the philosophy to train other companies. Those managers are too busy using MBM on the Koch campus, and too focused on doubling profits over the next six years.

Koch is working on that too, but he also seems to have a broader mission in mind.

One idea permeates all three books about MBM. It’s that the same rules governing prosperity at a company also govern the well-being of people and societies. Koch firmly believes this and is determined that other people realize it, too.

“I might do another book if I have it in me, which will be the broader application of these principles beyond business. Like in how to run your life, on implications for policies that enable people to practice these principles,” Koch said. “I want to give as many people that opportunity to learn these same principles and values, and have it transform their lives.”