Austrian Lessons for Creating a Vibrant Company

Sept. 12, 2005
Summary of Presentation

The Austrian School of Economics emphasizes entrepreneurship as the driving force of economic development, and it recognizes free markets – based on private property and the rule of law – as essential for entrepreneurship to flourish. The truth of these concepts is abundantly evident in the advance of prosperity around the globe in the past few decades. Economic data from countries ranging from Ireland to eastern Europe and east Asia overwhelmingly support that conclusion.

Less noticed, however, is the applicability of those same principles to the growth of individual businesses. Over several decades, through trial and error — and many missteps — U.S.-based Koch Industries, Inc. has learned how to apply them in its businesses to achieve results.

By applying its unique Market-Based Management® philosophy, which is rooted largely in concepts from the Austrian School of Economics, Koch has achieved tremendous growth, becoming one of the largest privately held corporations in North America. In the last 45 years, Koch Industries has grown 1,600-fold. By contrast, the U.S. stock market grew only a little more than 100-fold in the same time period, assuming the reinvestment of dividends. And only 2 percent of the U.S. companies on the original S&P 500 list have grown more than the stock market as a whole.

Just as the Austrian School principles of entrepreneurship, private property, free and open markets, and the rule of law are vital to prosperity and economic growth, these same concepts can be adapted within a company to foster success and growth.

One concept we have used to great benefit is that a market economy is an experimental discovery process for finding and delivering what people value. One manifestation of this process is what Austrian economist Joseph Schumpeter called a process of creative destruction, whereby less effective firms, products, and methods are constantly being replaced by those that produce greater value.

Creative destruction and other market-based concepts are central to Koch’s business approach. We search relentlessly for opportunities to improve – our structure, organization, systems, products, and even our businesses. As more and more companies have learned the hard way, for a business to survive and prosper in the long term it must create real value, not the illusion of value. This requires that it have competitive advantages that it continually improves to stay ahead of the competition and respond to ongoing changes in what people value. If a company doesn’t drive creative destruction internally, it will be among those destroyed.

Our approach to creating value and bringing about creative destruction is to identify the key factors in a market economy that drive value creation and bring them into the firm. We call this Market-Based Management®, which we apply through five dimensions: Vision, Virtue and Talents, Knowledge Processes, Decision Rights, and Incentives.

Here is a brief overview of the five main dimensions of MBM:

1) Vision: Our approach to Vision is based on concepts drawn from the Austrian School of Economics, such as uncertainty, experimental discovery, creative destruction, comparative advantage, and real value creation. Therefore, we constantly seek opportunities for which our capabilities will create the greatest value, and exit those that don’t prove out.

2) Virtue & Talents: Virtue and talents covers what Koch seeks and expects in its employees. We have found that virtue is at least as important as talent. Accordingly, we believe long-term business success requires embracing certain core values.

Our core values, what the Austrian economist and Nobel laureate Friedrich von Hayek called Rules of Just Conduct, are articulated in our Guiding Principles. Many companies have something similar, but they too often remain paper principles. What makes us different, if not unique, is that we take the difficult steps to ensure that these principles reach the hearts and minds and change the habits of every employee.

We ensure that they affect every aspect of an employee’s career – whether he is hired and retained and how he is rewarded. We also evaluate all policies to ensure that they lead to a culture of initiative and responsibility rather than one of entitlement and unaccountability.

3) Knowledge Processes: This dimension is rooted in the concept that market economies are highly effective at anticipating and communicating what people value and how best to satisfy those values. Similarly, we strive to help our people better anticipate and deliver what our customers value. We do this, first, by ensuring employees know how the Company creates value. Then, we ensure that our financial statements reflect economic reality. We measure profitability wherever practical. We encourage a strong challenge culture to provide discipline and stimulate thinking. We also give our people tools to help them create value. Having widespread economic thinking skills is vital to our long-term success, so we teach the application of economic thinking throughout the company.

4) Decision Rights: Decision rights can be thought of as property rights within the firm. This dimension is based on the fact that, in a market economy, control of property (property rights) is constantly earned by people who make decisions that create value and lost by them when they no longer do so and incur losses. In our Company, decision-making authority is set, not automatically by hierarchy, but more by proven knowledge and comparative advantage. Employees develop a written statement of their Roles, Responsibilities, and Expectations so they know what they are responsible for and can be held accountable.

5) Incentives: Finally, we attempt to replicate the way incentives work in the marketplace, in which entrepreneurs are rewarded by getting to keep a portion of the value they create in society. Likewise, our philosophy is to pay our people a portion of the value they create for the Company. Our emphasis is on long-term value. The key is a system in which employees can only promote their individual interest by promoting the general interest.

We have found MBM® to be extremely powerful, but also extremely difficult to implement. We must constantly fight the tendency toward form over substance. Learning to do so is a key part of making MBM work.

We at Koch Industries owe a huge debt of gratitude to the giants who created the Austrian School of Economics. They developed principles that have enabled us to gain an understanding of how the world works. This understanding, applied within our businesses, enabled us to develop tools from these principles that helped us succeed beyond our wildest dreams. Koch’s success in applying market concepts internally may be instructive for other entrepreneurial organizations and for society as a whole.