Book Review: The Science of Success, by Charles G. Koch

[morgan_polotan]

The Science of Success, by Charles G. Koch

In the Science of Success, Koch Industries CEO Charles G. Koch takes the same principles that make societies free and prosperous and applies them to companies. He calls this process Market Based Management (MBM), and he used it to grow his company into the largest privately owned company in the world, with over $100 billion in revenues in 2009.

Part-philosophy, part-economics, and part-management science, The Science of Success should be read by every executive of every company in the world. In it Koch discredits command-and-control corporate hierarchies, functional departments, and old-school compensation plans based on education and/or experience. Koch argues that in order to be successful, companies should be planned like free societies, where each individual is free to pursue his or her rational self-interest within certain mutually accepted rules of conduct.

This revolutionary idea is applied through 5 Dimensions, which Koch describes in the book:

1. Vision: Determining where and how the organization can create the greatest long-term value.
2. Virtue and Talents: Helping ensure that people with the right values, skills and capabilities are hired, retained and developed.
3. Knowledge Processes: Creating, acquiring, sharing and applying relevant knowledge, and measuring and tracking profitability.
4. Decision Rights: Ensuring the right people are in the right roles with the right authorities to make decisions and holding them accountable.
5. Incentives: Rewarding people according to the value they create for the organization.

For this blog post I will describe how MBM handles the concepts of Decision Rights and Incentives differently from traditional companies.

DECISION RIGHTS

Koch correctly points out that the biggest problems in society have occurred in those areas thought to be best controlled in common: the atmosphere, bodies of water, air, streets, the body politic and human virtue. This is known as “tragedy of the commons”, because when there are no clearly defined property rights in a society, no one has an incentive to take care of the thing they use.

In an attempt to replicate the positive effect of property rights in a company setting, MBM uses the idea of decision rights. Decision rights should reflect an employee’s demonstrated competitive advantage, meaning he or she can perform an activity more effectively at a lower opportunity cost than others. The key point is that this authority is based on the degree to which an employee has demonstrated a competitive advantage in that area, NOT arbitrary factors like experience, education, seniority or being chummy with the boss. For example, an employee who has demonstrated a superior ability in accounting would have significant authority to approve financial statements. However this would not automatically grant him a similar authority to hire and fire junior accountants. Contrast this with the situation in many corporations, where technical excellence can get you promoted to a management position in which you are responsible for leading a team of people, despite demonstrating absolutely no management ability.

INCENTIVES

Abraham Maslow stated that the central problem of management is, “how to set up social conditions in any organization so that the goals of the individual merge with the goals of the organization.” That means that every employee in MBM is considered an entrepreneur, and is paid a portion of the value they create for the company. That means no cost-of-living adjustments, no automatic promotions or bonuses due to seniority, and no golden parachute severance packages if you run the company into the ground (I’m looking at you Wall Street).

Compensation in an MBM company is based on the long-term, real value you add to the company. If you take unnecessary risks that lose money for the company, your compensation will be decreased accordingly. On the other hand, if you are the leader of a project that is financially successful in the long-term, your compensation will be increased accordingly. Compensation isn’t set in stone, so employees cannot rest on their laurels but must continually strive to add value.

Also, MBM strives to tailor incentives for each employee. What any individual employee values is highly subjective and includes both financial and non-financial components. Just as in a free society, some citizens may value a high salary, some may value time freedom, and some may value a remote working agreement. The variations are endless. In MBM, compensation packages, where feasible, are tailored to the individual and may be different for different employees. Some employees may be awarded with company stock, increased vacation time, or the ability to bring their kids to work. It all depends on the unique situation surrounding the employee.

Those are only two of the vast number of differences between a traditional company and an MBM company. To get the rest, you’ll have to read the book.

 

 

Cross post