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Schumpeter: Charles Koch is a rare thing, a businessman besotted with ideas

His theory of management, inspired by the Austrian school of economic thought, worked wonders at Koch Industries

December 9, 2016

min read

Charles Koch may well be the most demonised businessman in America, with his younger brother, David, a close second. Journalists argue that he is the mastermind of the country’s vast right-wing conspiracy. Lunatics have made death threats. The ultra-rich, particularly those who made their original fortunes in oil and gas, are supposed to make amends by giving their money to liberal causes. The Kochs have instead spent hundreds of millions backing conservative political causes (though Charles Koch has no love for Donald Trump), lobbying for lower taxes and attacking the idea of man-made global warming.

Mr Koch doesn’t come across as Dr Evil. True, the headquarters of Koch Industries is a collection of black boxes outside Wichita, Kansas; the security screening is rigorous. But its CEO has more of the air of a university professor. Despite his $40bn fortune, he lives in a nondescript neighbourhood in one of America’s most boring cities, puts in nine or more hours a day in the office and lunches in the company canteen. He doesn’t seem that interested in his surroundings: complimented on the firm’s art collection, he says his wife takes care of that sort of thing. What he is really interested in is books and ideas.

It was as an engineering student at the Massachusetts Institute of Technology in the 1950s that he first fell in love with ideas. There he hit on the subject that has preoccupied him since: why some human organisations flourish while others stagnate. He gorged on the Austrian school of economics—F.A. Hayek, Joseph Schumpeter and, his personal favourite, Ludwig von Mises, Hayek’s mentor. He devoured American polemicists such as F.A. “Baldy” Harper, whose treatise of 1957, “Why Wages Rise” (because of productivity improvements by workers, not union action), he describes as “life-changing”.

Since then his reading has taken him far and wide. The bookshelves in his office are stuffed with works of history, biographies and the latest titles with big ideas. He is surprisingly keen on Howard Gardner, a quintessential Harvard-Yard liberal, and his theory of multiple intelligences (linguistic, musical and interpersonal among them). But Mr Koch found the answer to his question about how organisations prosper by reading the classical liberals: he regards the “spontaneous order” of the free market—the notion that systems are best left to correct naturally, free of human intervention, with the price mechanism allocating resources to the most efficient use—with the same awe with which he regards the natural order of the universe.

Mr Koch has used his reading to forge a theory of management which the Charles Koch Institute, his think-tank-cum-philanthropic outfit, has trademarked as market-based management or MBM. The main idea is that market signals should operate just as vigorously within organisations as between them. Workers should be paid according to the value they add rather than their position in the hierarchy. Koch Industries keeps base pay low (it is regarded as just a down-payment on the year’s value-added reward) and workers are often paid more than their bosses. Companies should grant “decision rights” to those employees who have records of making choices that boost profits.

As Mr Koch’s philosophy took shape, so his company boomed. When he took over as chief executive from his father in the late 1960s Koch Industries was a small company centred on oil and gas with $200m in yearly sales and 650 employees. Today it is the second-largest private firm in America, with $100bn in annual revenues and more than 100,000 employees. It is one of the world’s largest commodities traders, operates three ranches covering more than 460,000 acres, processes some 600,000 barrels of crude oil a day and produces a wide range of materials such as paper towels, nylon and spandex. Koch Industries estimates that its value has increased over 4,500 times since 1960, outperforming the S&P 500 index by a factor of nearly 30.

Yet MBM has attracted remarkably few imitators. Mr Koch says that Morning Star, a California-based tomato producer, has also experimented, independently, with an internal-market system, but that hardly suggests a fashion. One reason may be that Koch Industries is based in the Midwest, away from the great business-theory factories such as Harvard or Stanford. Another is that it is easy to imagine MBM degenerating into a time-consuming bureaucracy. In any case, the firm’s success probably owes as much to Mr Koch’s managerial drive as to MBM (insiders joke that Koch stands for “keep old Charlie happy)”, and to two big insights: that its core competence in processing, transporting and trading can be applied to a wide range of commodities; and that the Midwest is full of first-class engineers and technicians educated in places like Murray State University and the University of Tulsa.

The wizard of Kansas

Even if MBM is not quite the magic formula that Mr Koch claims, however, it serves two clear purposes. It provides a diverse and rapidly growing company with a glue. Koch employees speak of MBM with the same enthusiasm that General Electric’s employees once talked about Six Sigma. Unsurprisingly, many have read Mr Koch’s books on MBM, “The Science of Success” (2007) and “Good Profit” (2015). For the less scholarly, MBM is funnelled into ten “guiding principles” (such as “principled entrepreneurship”) printed on coffee cups and posters throughout the group.

His philosophy also keeps the firm focused on Schumpeter’s idea of creative destruction. Mr Koch is good at spotting opportunities (buying Georgia Pacific, a pulp and paper firm, in 2005 for $21bn, produced a spell of fast growth). Less obviously, he is always pruning businesses that start to fade. Koch Industries could easily have been a low-growth energy company stuck in the middle of the Great Plains. That it has instead succeeded in doubling its earnings every six years or so since the 1960s is thanks in large part to Mr Koch’s unconventional and scholarly mind.


© The Economist Newspaper Limited, London (Dec 2016)