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Hugh Hewitt Book Club

“Good Profit” by Charles G. Koch

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I interviewed Charles G. Koch about his fascinating new book Good Profit: How Creating Value for Others Built One of the World’s Most Successful Companies this Thanksgiving Eve:

Audio:

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Transcript:

HH: Special Thanksgiving eve hour and a half ahead. Charles Koch is one of the owners of the Koch Industries, and he has a brand new book out, Good Profit: How Creating Value For Others Built One Of The World’s Most Successful Companies. He joins me, I believe, from Wichita today. Charles Koch, welcome to the Hugh Hewitt Show.

CK: Hey, thanks, Hugh, thanks for having me.

HH: It is terrific to have you. I’ve got to tell my audience how this interview came about, because it is consistent. As I read Good Profit, I was struck by a lot of things, we have a lot of time to talk about it, but I was struck on Page 213. You wrote, “Motivating external parties to support the company also requires that our employees deal with them in a way that is in the best interest of the company as a whole.” And I thought of Kevin Gentry, who was sitting next to me on an airplane, Charles, and so I was reading Peggy Noonan’s book, and leaned over and said you’re Hugh Hewitt, aren’t you? Yeah. I think you’d like Charles Koch’s book, and he handed me Good Profit, his own copy. And then from that came this interview. Isn’t that the perfect example of how your corporation works with people?

CK: Well, that’s sure the way we try. Good for Kevin. He’s internalized these messages well.

HH: That’s exactly, you talk about internalizing MBM, market-based management, and I want to talk about that. But that’s the overall message. This is not easy, this is not a slogan book. This is a way of thinking.

CK: No, and it requires, really, turning these principles and concepts into habits so you do them, so you don’t need to think about them. That’s just the way you approach problems and opportunities, and approach dealing with other people.

HH: Well, Kevin gave me that book, and I started reading it, and here’s what got me. An investment of $1,000 Koch Industries in 1960 would have a book value of $5 million dollars today. The company was worth $21 million in 1961 when your father passed, and it’s now valued at $100 billion dollars based upon the Forbes estimate of your brother, David’s, and your net worth. It has 100,000 employees. I mean, in your wildest dreams, Charles Koch, did you ever imagine in 1961 it’d be this big?

CK: No, as a matter of fact, when I’m, I’m very mathematically-oriented. When I came to the company, I said okay, I’ve got all these ideas, and if I’m successful in applying them, here’s how much we can grow. And two years ago, we surpassed 70 times my lifetime ambition. So once again, it’s better to be lucky than smart, but it just shows the power of these basic principles and values. And they transformed my life and enabled me to accomplish more than I ever dreamed I could, and that I have the talent to accomplish. And that’s one of the reasons I wrote this book, to help give other people that same opportunity to learn those same principles.

HH: And I stress for the audience, Koch is operating in 60 countries. It has got 9 different companies within it, and six core capabilities. We’ll talk about all those in the next hour and a half. But I wanted to start on what you just touched. Why bother, Charles Koch? You’ve got $100 billion dollar company that you and David Koch run. You’ve got 100,000 employees. There’s an opportunity cost, as you well know, that goes into writing a book like Good Profit. Why do it?

CK: Well, that was one reason, to share the ideas that transformed my life. And another one is that I wanted to convince businesspeople that the way to succeed long term is to create, is the focus on creating value for others. Now you want to be compensated for that, but that’s the starting point. And when I say others, I start with creating value for customers, but then you need to create values for employees, or they won’t want to work for you. You need to create value for suppliers, or they won’t want to supply you. And you need to create value for your communities, or they won’t want you in your community. And when you do that, then you have the best chance of succeeding long term. So it isn’t altruistic, it isn’t self-sacrifice. It’s what I call a system of mutual benefit.

HH: It’s very well laid out, but I’ve got to tell you, there are some things as a journalist and a lawyer, and I don’t think you’re too high on either journalists or lawyers. There are some things that stick out in the course of this book that I wanted to start with, rather than wait for them in the turn that they come up with. One is the fact that in 1974, you built a house in Wichita, and you’re still living in that house. I find that to be one of the most striking things.

CK: Well, it’s a great house, and I said, we believe in division of labor by comparative advantage in our family as well as we do in business. That is each, everybody benefits when each person focuses on what they can do best and have a passion for, and then freely exchange and share in that. And that’s, my wife and I have that, and she’s much better at building houses and doing all that stuff. So I told her what I wanted, and then she built a much bigger house than I asked her for. And those were turbulent times. We had wage and price controls, we had the oil crisis, the shipping crisis, and I thought we were going to go broke. And so I remember sitting in 1974, when we’d just dug the basement, and with my feet hanging down in there, saying honey, I think we can afford to fill it up, but I’m not sure we can afford to finish it.

HH: Yeah, it’s an amazing story, and it says something about, and your defense of Wichita as a capital for your home base, and there’s lots we’ll cover. Let me tell you, though, what stuck out the most, Charles. You may find this interesting. I don’t know how many people actually read the books before they talk to you, but I do. And I always write down my favorite anecdotes. Here is the most telling anecdote from Good Profit. “It’s been almost 20 years since August, 1996, when Danielle Smalley and Jason Stone smelled something suspicious near a Koch pipeline. They got in their car, they turned it on, and the car blew up, because there was a leak. And you write about this. You’ve, in fact, you volunteer all the warts on the Koch Industries story, and it really seared into you, and it produced this 100 Times 100, 10,000% compliance attitude within Koch that I found, I found it fascinating, and I also found it admirable that you would remember Danielle and Jason in your book.

CK: Well, those are, I mean, people ask me what are my biggest disappointments and things I regret, it’s when people, because of us, were hurt, or worst of all, lost their lives. And so when we have something like that, I mean, that is number one for us is protecting people’s lives, and then protecting the environment. And we’re accused of having a lot of pollution and stuff, and we do, because we make more things in different ways than about anybody in any company in the country. But every plant we buy, every company we buy, the first thing we do is improve safety and environmental practices.

HH: It’s actually revelatory, and I think it will have an impact on may other industries that you’ve saved $800 million dollars in energy conservation in the last four years, $800 million dollars in turning off the light costs, I guess.

CK: Right, and we, and we’re using information technology and other techniques we’ve developed. We sell systems now to help other people do that. For example, at Georgia Pacific, we’re designing what we call the bathroom for the future, not for your homes, but commercial bathrooms, of which there are millions of them. And we design in their systems to control the temperature and the lighting, depending on when people are in or out, and the frequency of using them. And so we can save tremendous amount of energy on that, plus the other benefits we can bring by this technique.

HH: It’s really amazing, the whole story of how you evolved, the iterations of the company, which we’ll talk about. But I want to close this first segment on 10,000% compliance, 100% compliance required 100% of the time. And if someone doesn’t buy into that, you don’t hire them at Koch.

CK: Right. And if they don’t practice it here, I mean, we’ll work with them to get them fully committed to that. And if they’re not, they need, they can’t stay here. We cannot tolerate that.

HH: Given the target on Koch Industries’ back, I’m glad you developed that years ago. But that’s 25 years in the making, isn’t it? I mean, you’ve been practicing that for at least a quarter century.

CK: Yes, no, that’s exactly true. And we constantly work at getting better at it, because we’re not perfect, and never will be, particularly when you have 100,000 employees that are in 60 countries. But that’s job one here.

HH: And there are other jobs as well. Don’t go anywhere, America, this is a special Thanksgiving Eve presentation. I told you how I came upon the book, Good Profit, by Charles Koch. And Charles will be my guest this hour and half of next, so don’t go anywhere.

— – – – – –

HH: Charles, when you were a young man, you write, you were an idealistic man in your 20s. “I became passionate about the urgency of finding freedom-fueled solutions to human problems, even if the solutions were radical.” And you cite Adam Smith, Hayek, Harper, Ludwig von Mises, Michael Polanyi, I didn’t, I’d never heard of him before, and I’m going to come back to that, Thomas Sowell, of course, I know about. But you really committed early on right out of MIT to this worldview.

CK: Well, I started by, I learned at MIT that it’s an ordered universe, and that if you want to do well in the physical world, you need to understand the principles by which it operates. And so I became passionate about philosophy of science, the scientific method, and that’s where I found Polanyi among all the philosophers of science I read. And then when I moved to Wichita, I had a hunch that there were principles that determined how well people, how well societies could live to work together to make each other’s lives better. And so I started reading everything I could on the subject from all different perspectives, and all different disciplines. And out of that, I concluded that there were these basic principles that I’ve been applying and trying to better understand and develop ever since.

HH: Now I’ve read some of these authors, not all of them. And as I said, I’ve never heard of Polanyi until your book. And the Republic of Science essay, which I’m going to find some time to find and read, you summarize as saying a free community of scientists constantly sharing knowledge and ideas, testing hypotheses, experimenting and adjusting according to what honestly works, rather that succumbing to establishmentarian pressures is the ideal. But let me ask you, Charles Koch, we’ve had science corrupted a little bit. I remember the Nuclear Winter Scientists. Then I remember the Union of Concerned Scientists being totally wrong about nuclear weapons and Reagan. And now we’ve got the Stalinist scientist club on climate change. I mean, has science lost the ability to have that free community of scientists that critique each other?

CK: Well, on certain issues, when an issue becomes politicized, then it loses that, because those who disagree with the government’s policies then are demonized and stigmatized, and kind of drummed out of the profession. And those that go along with it are rewarded and compensated and promoted. And so we have that on issues, but that’s always been the case. That’s what the Inquisition did to Galileo. That’s what Lenin and Stalin did in the Soviet Union. And that’s what created, or they promoted Lysenko, who had this…

HH: Yeah.

CK: …view on the inheritability of acquired characteristics, which caused mass starvation. So this is a very dangerous thing to mix government and, or religion and science.

HH: Do you think it’s possible to, this is not part of Good Profit, and I want to get back to MBM, because I think this is valuable time and I don’t want to waste it. But there’s an opportunity cost here. Do you think science can be saved, because I am not against any reasonable conclusion that scientists reach for non-political reasons. I want to know the truth, and I think you write at some point truth is the highest value in Koch Industries. That’s what gets rewarded. I want to know the truth about climate change. I just don’t know who to trust anymore, Charles.

CK: No, and that’s true on both sides. It’s become so politicized, that people are posturing to fit their position. And it’s what Einstein practiced and Karl Popper preached, that to have the scientific method, you develop a testable, refutable theory, and then you search equally for ways to disprove it that you do ways to prove it. And now we have what Einstein criticized, is so-called scientists having a theory and then running around and just finding the pieces that will support it.

HH: Right.

CK: So that is anti-science.

HH: It is, and I don’t know how we get out of this dilemma, but that’s a debate for another day. Let me tell people they’re going to be surprised on Page 42 to learn that Koch Industries will lose hundreds of millions of dollars if the Keystone Pipeline is built. This is what we in the law call an admission against interest. And the evidence codes value admissions against interest very highly, because they’re not part of what you ought to be writing about. But you’re writing about Keystone Pipeline even though it will cost you hundreds of millions of dollars in transportation.

CK: That’s right. Well, it will, if a pipeline is built to the Gulf Coast, which Keystone would, it would lower our competitors’ crude oil costs by $3 dollars a barrel. And we import 250,000 barrels a day, so it would cost us $250,000 dollars a day.

HH: But you still support it?

CK: But we support it, and that’s, it’s hard to believe, but we take, just as in our business, we take the long term view, and we take the long term view in policy as well, that is we try to run our businesses in a way that creates value for others, and thereby, we will benefit. We believe the same thing about policies that will make the country better, that will make people’s lives better. So we, our starting point on supporting or opposing any policy is will it help make people’s lives better. Will it enable people to better improve their lives? And then that’s the position we take, not whether it makes money short term or loses money short term for us.

HH: And I defy anyone to read this book…

CK: Money to us is very short-sided, just like it is trying to trick your customers into paying you more or defrauding them. It may make you a quick buck, but long term, it’s going to cause you to fail.

HH: I can’t believe anyone would believe other than you believe that if they read this book. I really think at the end of this, in fact, that story of Sterling Varner ripping off on your sales team for celebrating a customer skinning is the very long view. He was so angry. We’ve got a minute to the break, Charles, you might tell people that story.

CK: Well, yeah, well, it wasn’t even that we skinned them. I mean, we made a good deal, but it was a good deal for our customer. But our guys were bragging how they outsmarted our customer. And Sterling exploded, and he said these, this customer is our friend. They give us preference on business. They support us, and you’re laughing at them? You ought to be ashamed of yourself. If we laugh and look down on our customers, soon we won’t have any, and then we won’t have any business. You boys need to go hide your heads.

HH: It’s an amazing anecdote, among many. I’ll be right back with Charles Koch. Good Profit is linked over at Hughhewitt.com, America. If you don’t know what market-based management is, you’re a little bit behind. Some of these terms are familiar to all of us, like opportunity costs and sunk costs. And I’ve talked about them for years on the program. But if you want them explained in the context of a company that’s been evolving since it was founded by Charles’ father, Fred, then stick around. Lots more ahead on today’s Hugh Hewitt Show.

— – – –

HH: He took it over from a very interesting character. Fred Koch is his father, and I want to spend this segment and next, Charles, talking about your dad, because I’m just fascinated by this man. He went to MIT like you did. He had no money. He had to mop decks on a tramp steamer to put together his tuition. And he starts, and he invents a cracking process, a thermal cracking process for converting heavy oil into gasoline. I don’t know what that is. But the patent club, the bigs, went after him, and they never let up for 20 years.

CK: No, that’s right. And it was fascinating how he developed it. He did not have a laboratory, but he started out working for Texaco in the lab, and he was, he worked on their version of a cracking process, which mainly did the cracking in a vessel. And you crack, which just means you break the big molecules into smaller ones, in vessels. And then he went to work for the gasoline products company, which did consulting, and sold licenses for cracking and other processes. And so he learned more, and then he was hired from there to become chief engineer, this was at age 25, of a small refinery that was being built in the U.K. And so he said I think it will work better to do more of the cracking in the pipe, and we’ll have less coke laid down, we’ll have longer run times, and it’ll be cheaper. And so he was able to do some there. And then he left and joined an engineering company, because he wanted to be in business for himself. He became a partner in it. And he kept experimenting with each one, doing more and more cracking in the pipes, and finally, he figured out that he could get rid of the vessels altogether, and do all the cracking in the pipes, not lay down the coke, not have the down time, and developed this far superior process, which unlike the major oil companies who have controlled all of the cracking technology, who charged them a big royalty, 10% of the price of the gasoline, so they could keep the independent refiners less competitive. He did it without a royalty. And of course, they couldn’t stand that, so they sued him and all his customers and put him out of business in the U.S. And finally, it was Winkler-Koch and my father won every lawsuit but one, and they found out the judge had been bribed, and so he collected a million and a quarter dollars for conspiracy and restraint of trade. And he told me, this is all over 20 years, as you said. He said that son, never sue. The lawyers get a third, the government gets a third, and you get your business destroyed.

HH: Yeah, you know, as a lawyer, as a partner in a big law firm, I have to say good advice, but you’ve got to hire good ones when you are sued. Nevertheless, he ends up forced to go to Russia. This is the amazing thing I learned in Good Profit. He goes over to Lenin’s Russian, 1929-1931. He builds 15 cracking units there. He lays the foundation for a company, and then, I mean, he’s an interesting guy. He got sick. He had to get repaired. He had to get fixed. And all the while, ad you put it, you don’t have a country club upbringing, even though the company’s doing pretty good. You’re out on a line camp in Montana in the middle of nowhere bunking with Bitter Root Bob. I mean, he had an interesting view on child raising, didn’t he?

CK: No, yeah, he said, he announced early on that he didn’t want any of his sons to be country club bums, and for whatever reason, I bore the brunt of it. So he started having me work in all my spare time starting at age 6. And so I milked cows, dug ditches, shoveled out stalls, you name it. And so I learned to work. So that’s about all I do is work, because he ingrained that habit in me. And he also, he also stressed integrity, humility, treating others with dignity and respect, and always having a thirst for knowledge. And that’s how he developed this cracking process, just constantly learning more, thinking how to improve it. And that’s what I’d recommend to anybody to succeed. You understand what you’re good at, and then you learn everything you can that may be relevant to that, and you constantly improve. You work every day on doing better.

HH: He also had a very good eye for talent. I mean, he assessed you and your brothers in this 1948 letter he sent to a friend in Pittsburgh. I don’t know how you got ahold of this, but he had a pretty uncanny precision with regards to you and your three brothers, even in 1948 before you were men.

CK: Yeah, no, that’s absolutely right. No, he was, he had great insight, and he was more of an inventor. I’m more in the philosophy and organization and that kind of things. That’s the way my mind works.

HH: Well, we’ll come right back after break, America. More Charles Koch when we return.

— – – — – –

HH: Charles Koch, you got expelled from Culver Military Academy. You almost got thrown out a second time, because the cadet captain threw your clothes on the floor before an inspection, and you put his face in the window. By the way, why did the cadet captain throw all your stuff on the floor right before inspection?

CK: Well, my roommate and I kind of had an attitude. We were proud that we had the highest grade average in that cavalry, and the lowest rank. And he was worse than I was. Like he wouldn’t get up at reveille, he would get up at the three minute warning and just kind of slap his stuff together. I tried to be halfway neat, but he saw the captain came in for inspection and saw my roommate’s mess, and tore his stuff, and then he says well, I might as well tear up Koch’s here as well, and he threw all my clothes out and ripped up my bed, and I lost it.

HH: And you almost didn’t get to MIT. It’s a great story. You have a very interesting backstory, Charles, which I have not seen written anywhere before. Is this new to Good Profit? This is your second book. Did any of this backstory make it into Secrets of Success, the first book?

CK: No, no, the Science of Success.

HH: The Science of Success, yeah. Well, I think this backstory is what sells books and gets people to read the content. They’ve got to know the guy who’s writing to them. You’re also a skeptic, by the way. Even though there’s a Bible verse in here, the stone the builders rejected has become the cornerstone, you are not yourself a believer.

CK: Well, I’m, to me, that’s as well as Karl Popper and Einstein and others, and other philosophers point out, skepticism is the foundation of the scientific method, because you don’t accept anything on face value. If you do, you will always follow common practices, and you won’t come up with anything new. So yeah, I’m a skeptic about everything, and want to understand it better, explore it, and test it. And that’s how I came up with market-based management, just by, I didn’t believe any of the current management practices were that solid, and I’d read all these different management practices, and saw what was being taught at business schools, and I said there’s got to be a better way. So I started studying philosophy, psychology, economics, everything I could to come up with this.

HH: You were a student for a while of Deming, right? You bought Deming for a while, and you were an Arthur Little consultant, but eventually, you found that Deming did not have the secret that you needed?

CK: Well, no, what I, I was coming up with these market-based approaches, this philosophy, and but I didn’t know how to build an overall management approach. And so I saw Deming, and I said well, I believe we can attach these economic and psychological principles, attach that to Deming. But I found out there were too many inconsistencies, so I needed to start from scratch.

HH: And it comes down to five big concepts – vision, values and talents, knowledge processes, decision rights, and incentives. I’ve got to tell you, Charles Koch, the one I find most difficult to conceptualize, I think I’d have to see it in practice, is decision rights, the property rights that you try and create within a company over decision authority. Do you find that that is the most difficult for people to get? Or is that just Hugh?

CK: Well, no, it is difficult. Let me just summarize how we practice it that’s different than the way many companies practice it. The first thing is to have an owner for any initiative, otherwise, you have the tragedy that happens, and no one’s responsible. And if everyone’s responsible, no one is, so one person has to take over all responsibility Then you set up a decision making system where you only have people involved in the decision chain who can add value to it. So you don’t have this huge hierarchy and all these committees and stuff who add no value and just slow down the process and have people give up on anything new, because it’s so difficult to get it approved. Then you set roles by comparative advantage. That is our ideal, is every role would be given to somebody who was really good at that particular activity and had a passion for it.

HH: Right.

CK: And when we change, somebody leaves a role, then we re-optimize all the roles to fit each person’s comparative advantage. And when you do that, both the productivity and the innovation skyrockets.

HH: Now it’s exhausting reading Good Profit, because I think of all the changes I would have to make even in running a radio show to fully implement market-based management, because there is a lot of sunk costs, right, after 15 years on a radio show. But you tell people that they don’t have to do this overnight.

CK: Oh, no, you can’t, because I mean, there’s a lot to this, and you can’t just learn the concepts and then do it. I mean, it’s like learning to play chess or learning to play golf. You don’t just read a book and you know the concepts and you become an expert. The only way you become an expert is you practice it over and over until it becomes second nature to you. It’s what Polanyi called developed, turn conceptual knowledge into personal knowledge. Make it a part of yourself. It’s like a concert violinist doesn’t have to think about how to hold the violin and move the bow and stuff. She is thinking only about how to create the hole, some beautiful music, because all the parts are like an extension of her body. She doesn’t have to think about how to move them.

HH: You know, you quote Mary Beard on Page 76, “Action without study is fatal. Study without action is futile.” How long did you study MBM before you think a company ought to begin to integrate it?

CK: Well, it depends on the leadership. The owners and the top leaders have to turn it into personal knowledge. They cannot just memorize a few concepts or have a few checklists, check the box, things. It will not work. It’s like I say on incentives. Okay, we have a number of ways to implement our incentives compensation program. But if the people running it don’t internalize it, the purpose of our incentive compensation program is to motivate every employee to consistently contribute to increasing the long term value of the company by principled entrepreneurship. It isn’t going to work.

HH: I’ll be right back with Charles Koch to expand on that. The employee and incentives for them matters a lot in Good Profit.

— – – – — –

HH: When we went to break, this is a short segment, Charles Koch, and you’re talking about your employees and how you incentivize them. I may come back to that next hour. But I made a note on Page 119, your interview process is a marathon. And you hire when you find talent, even if there’s not an opening. Those are two takeaways I think any employer will get from Good Profit.

CK: But the most important part of it is that we interview to hire first on values. And we found if we hired talented people without good values, they create much more damage than they create value. I mean, it’s like what John Adams said about the free society they were trying to create here. This is a system that will work for moral people. It will work for no other.

HH: Yeah.

CK: And that’s what we found here. And so the most important thing for us is hire people with good value, with integrity, humility, the desire to create value, and treating others with dignity and respect.

HH: You know, the two most surprising sources of authority in Good Profit are Jack Clark, the rugby coach at UC Berkeley and Monty Python, which comes up at the end. But Jack Clark, I’d never heard of Jack Clark before. How did you find Jack Clark?

CK: Well, I met him at an outing, and he did a presentation on their values, and that he coaches first on values and building a culture. Like he said, you can sum up our philosophy this way – grateful for everything, entitled to nothing. And so I said Jack, would you write that up? I’m writing a book. I want to include that, because that is so close to what we do. And I will send you my, our guiding principles, our ten guiding principles, which represent who we are as a company. And may companies have a set of principles, but in many cases, they’re just something they post on the wall or stick in the drawer or check the box. Here, they guide everything we do – who we hire, who we retain, who we promote, who we reward, and how we expect everybody to behave.

HH: All those principles, all those values, are included not only integrated throughout the entire Good Profit book, but also in an appendix that makes it easy to review. The book is linked over at Hughhewitt.com. Charles Koch is sticking around for a couple more segments, America. Don’t go anywhere, because I want to get into learning by adversity. I want to talk about the challenge method by which anyone can bring anyone, anything to anyone’s attention in Koch Industries, and how you maintain that vision over a long period of time, and some of the traps like confirmation bias that you want to avoid, and the one that I learned about most recently, is recency bias. I had never heard about that before until I read Good Profit. Lots ahead.

— – — –

HH: It’s a special conversation. I don’t often have the chance to talk to someone like Charles Koch, and so I take full advantage of it. The last conversation I had, well, like this one was with General Stanley McChrystal, but he was in the studio about his book, Team Of Teams. And there’s quite a lot of similarity between Charles Koch’s new book, Good Profit: How Creating Value For Others Built One Of The World’s Most Successful Companies, and Stanley McChrystal’s Team Of Teams. Has anyone told you, Charles Koch, that a lot of your thinking has its reflection in how the SEALs operate, for example, their challenge theory? After every mission, they have a hot wash where the most junior member is encouraged to critique everyone up to and including the senior member of the command.

CK: Right, I know quite a number of former SEALs, and I find we’re fairly sympatico. So…

HH: It’s pretty amazing to me, those two books. But let’s talk about a couple of things I watned, I have on my must cover list – knowledge processes. All four Koch Brothers have had prostate cancer. You’re all survivors. But your brother, David, had the most severe case, and he’s been about funding cancer research all over the world. He’s got the Koch Institute for integrative cancer research at MIT. And as I was reading about this, I thought about that scene from the movie, Apollo 13, where they pour everything in the capsule onto a table, and they say make a return vessel out of this thing. He’s really reinvented cancer research, hasn’t he?

CK: Well, right, and when I first learned about the David Koch Institute at MIT, and went back there and saw what they were doing, I was amazed. They were, it’s like they had just read Polanyi’s Republic Of Science and put it to life, because they don’t have laboratories, one for the biochemist, another one for the molecular biologist, another one for the engineer, another one for the chemist. They identify a particular problem, and put all those different disciplines together to work on how to identify a cancer, what’s a treatment, what’s the delivery mechanism. All of that, those people working together, and so they’ve had a number of breakthroughs by applying, exactly applying Polanyi’s philosophy, the Republic Of Science.

HH: You also stress external networks and bringing in external information when necessary while warning about consultants hide and seek for a thousand a week. Has anyone from, say, Bain or McKenzie ever looked over MBM, market-based management, and given you an assessment of it?

CK: I don’t think so.

HH: It would be interesting to me to find out what the consultants who are considered the best in the field think about it, because it’s really a consultant’s book. And I know you’ve got all sorts of levels at which people tap into this. Can you explain why you’re so invested, Charles, in spreading this word or this process?

CK: Well, it’s, well, there are two reasons. The first one is to share, I mean, I learned, as I said, that certain principles and values that transformed my life and enabled me to accomplish more than I ever dreamed of. And then the second one is to convince businesspeople that the way to succeed long term is to create value for others, and then to show you how we’ve done it rather than this present system of cronyism and corporate welfare where such a high percentage, the estimates are a third of the economy is now involved, or more, is now involved in that activity as opposed to creating value for their customers.

HH: Do you have a bias for…

CK: And so if we want to survive as a free society, we have to stop that, and stop this drip toward a two-tiered society in which the opportunities are being destroyed for the disadvantaged, and the wealthy are getting corporate welfare.

HH: Do you have a bias for the closely-held corporation over the publicly-traded, because one of my, it’s sort of a theme throughout Good Profit, is that you are able to do things and make adaptations and run away from bad decisions and embrace evolutionary ones because you didn’t have quarterly profit statements that you had to worry about, even though you’ve had a goal of doubling your return every six years, which you’ve more than met. Do you have a bias towards privately-held companies over publicly-traded ones?

CK: Oh, absolutely. I say, people ask me when we’re going to go public, and I say well, it will literally be over my dead body, because well, when I started trying to develop market-based management and apply it, I had so many missteps and so many screw-ups as I kept experimenting to try and find what would work, that I would have been fired long ago if I’d been in a public company. And so you can take a much longer view if you have the right stockholders. Now if you have the wrong stockholders in a private company, you can’t do it, either.

HH: True, true.

CK: But if you have people, and this is what I say on anybody you want a partnership with, whether it’s in business, as a friend or a spouse. To have the best, you need three things. You need to share a vision, values and bring complementary capabilities, so you benefit each other. And when you have those three, the odds are you’re going to be very successful in whatever you’re doing.

HH: You know, the capabilities evolution of Koch really surprised me. You went from oil, moving oil, collecting crude oil, to gas, liquids, to natural gas, to nitrogen fertilizers, to pulp, to Georgia Pacific, to Guardian Industries, which is a global glass manufacturer, to Molex, which produces these touch systems. And it wasn’t, you didn’t want to dominate an industry. You simply wanted to evolve on the capabilities basis that you had built.

CK: No, that’s right. That’s our philosophy, that first of all, you understand what your capabilities are, and then you identify the opportunities for which they can create the most value. And then you constantly work to improve your capabilities and add new complementary ones. And you look at our pattern of growth, that’s what we did. We said okay, what are our capabilities? What else can we do next that will create superior value? And then once we get in that, okay, what capabilities do we need to add to be even better, and so on. So it doesn’t look like a logical progression, but it was.

HH: You’re also very candid about the blow ups – the tanker over-purchase in the 70s, the agribusiness disaster of the 90s. If you’re going to have a big company, you’re going to have some failures, and you can’t be afraid of that.

CK: No, we’ve had many more failures than successes, but what we do is we don’t try to cover them up. If we have a failure, we admit it. We get rid of it, learn from it, and then build on our successes. And so what we encourage all our people to be constantly experimenting, finding new ways to do new things and do existing things better, and do that in an extreme way, what is called creative destruction, that is find new ways that will replace the existing ways of doing things. And when you do that, you build a culture so people aren’t afraid to experiment, aren’t afraid to fail if they design it properly and are thoughtful about it and we’d learn from it. And they’re not hurt in their careers, but they’re rewarded. Then you have this kind of creativity and growth that we do.

HH: But Snodgrass, who you quote at the end, said thank you for sharing your market and customer philosophy. Is he unique? Or do you think if you drilled down into your 100,000 employees, what percentage would agree with him it’s a culture of discovery, and they just thrive in the Koch Industries milieu?

CK: Well, that’s one of the things that keeps encouraging me, Hugh, is the people who’ve been exposed to this philosophy and have tried to live by it, particularly like Bud, who had been retired many years, had nothing to gain from writing me ten years or so after he retired, writes me that it transformed his life, as it did mine. And so that’s why I’m so anxious to share it, is that it can really improve people’s lives when they embrace it. But it’s not easy.

HH: No, it’s not. Two more segments, America, with Charles Koch. Don’t go anywhere, because these are the traps. He has an incredible chapter on decision making framework, and some of the decision traps that are out there. I can’t give you an entire book in an hour and a half, but I can incentivize you’re going to do that. But before I do that, I’ve just got to ask, when you’ve got case studies after case studies, were people worried about this book at Koch Industries, Charles Koch, when it came out? We’ve got a minute to the break. Were they afraid that they were going to see their names in lights here that they didn’t want?

CK: They might have been, and I had some names in here, but there were too many names to include, so I either had to include almost none, or the only one I really included was Sterling Varner, since he was such an important part of my career.

HH: Yeah, I noticed that. I figured you, I just thought you must have airbrushed out names for a reason, and that, there, I just heard why. Don’t go anywhere, America, Charles Koch for two more segments. Decision traps that you want to avoid, that’s a promise that I’ll deliver on after the break on the Hugh Hewitt Show.

— – – – —

HH: I want to give a value proposition. If you listen to this segment and the next one, you’ll have a better company. And this is about decision traps. First of all, Charles Koch, tell people what a decision trap is.

CK: Well, a decision trap is a logical, what seems like a logical plausible way of arriving at a decision, but because it doesn’t fit reality, causes you to make bad decisions.

HH: And there are a number of specific traps. It’s sort of like an obstacle course to getting to the right decision. And I want to walk through each of them. Overconfidence – how often does that show up, Charles Koch?

CK: Well, what I like to say is success is the worst enemy of success, because then you lose your humility, and you think you know all the answers, so you don’t use the best knowledge, and you don’t do sufficient analysis.

HH: Framing?

CK: Well, framing is thinking that because it will give a good return on what you’re doing, that it’s worthwhile doing, whereas if you’re losing a bunch of money, and this will just reduce your losses, it’s really a waste.

HH: You see, that, I thought how you frame the approach to a decision is one of the things I have to really incorporate, because if you look at it the wrong way, or as you say, a directionally-correct point of view, you still stop making framing errors at the beginning. And I also thought anchoring, that is irrelevant information or first impressions is a terrible thing to suffer from, I mean, if you really invest in first impressions.

CK: No, absolutely, and that happens all the time. We get preconceived notions, and that’s the problem with our mental models. If we have a faulty mental model, then we reinterpret everything in the context of that model. And if that model is wrong, it just causes all kinds of bad decisions.

HH: What is the status quo trap?

CK: Well, you think the future is going to be like the past. An example I use here is IBM believing that people will continue to use their mainframes, and they didn’t look out at how technology was changing, and there could be such a thing as personal computers and the internet, which will make most of these mainframes obsolete.

HH: You know, I spent an entire hour with Megan McArdle about her book, The Upside Of Down, about failing, and that’s where this audience knows about sunk costs. But you spend quite a lot of time talking about don’t count sunk costs. That’s the biggest, I mean, that’s a huge trap for people, Charles Koch.

CK: Yeah, if you think gosh, I have this money invested, and therefore I’ve got to recover it, well, forget it. That money is gone. Think about how to optimize the future.

HH: What would you say about sunk costs in Common Core? It just seems to me Common Core is shredding the math framework in the United States. As an engineer, it’s got to worry you.

CK: Well, I put this in William Easterly’s concept, that the tyranny of experts. That is you have a few experts tell you the best way, and then no one can innovate.

HH: Yup.

CK: You require that best practice. Well, the horse and buggy was best practice a hundred years ago.

HH: Yeah. And well, I’m afraid we’ve done that now with Common Core math. It just seems to me that it’s a nightmare that’s slowly rolling out, and no one knows how to stop it. And it’s a sunk cost, because all these districts have invested in it, and all these companies have said yes, and everyone gave it a big cheer, and they don’t know that you’ve got to walk away from a disaster when it’s a disaster.

CK: Well, and you’ve got to drive creative destruction and experimentation, and free each of these schools to experiment and have school boards where the parents hold them to a high standard, and that look, your job is to help the kids develop and improve their lives. It isn’t a safe home for bad teachers.

HH: Now confirmation bias, again, familiar to this audience. I’m curious after the last election, where we all thought Romney was going to win, and maybe there was confirmation bias going on. It certainly was with me. I was looking at all the rosy stuff, and I wasn’t paying attention to what could go wrong on Election Day. How do you fight confirmation bias?

CK: Well, once again, you’re a skeptic, and you apply the scientific method, which is you look for evidence to disprove your thesis with at least the same diligence you look for evidence to support it.

HH: Do you think that your political activities have fully incorporated that in the aftermath of 2012?

CK: Well, we did a lot, and we’ve improved a lot, but we have a long way to go, like we do in everything else. And that’s, in that aspect of what we’re doing, that’s what I’m pushing hard on, that we challenge everything we’re doing, and get rid of the stuff that hasn’t worked, or at least change it radically.

HH: Recency bias is a new concept to me. And I found it fascinating. This is where recent events, and I thought of 9/11, for example, and the TSA that you and I run into every time we get on an airplane. Recency bias is the over-valuing of that which was dramatic or recent in your past. How widespread is this problem in a corporate culture?

CK: Oh, it’s, I mean, for example, if we’ve had high margins in a product for a number of years, people believe it’s going to last forever. And then I say no, no, I don’t want to look at the best case. I want to look at the best it could be and the worst it could be. And typically what they do, okay, we’ll go up for down 10%. Well, that’s not it. You’ve got to understand what could happen. And this is the most difficult thing for people to do is to think things could be radically different than they are today, and understand what drivers are out there that could bring that about.

HH: The last segment, last issue in this segment, leaders past rejections can deeply damage a corporate culture, and you cite the shipping business became radioactive for Koch, because it was your big disaster in the 70s. And that bears some expansion, Charles Koch, because I’ll be you that goes on in every company in America.

CK: Oh, absolutely. If anytime, and in this case, and I wasn’t, I was criticizing what we did, but it wasn’t that we should never get in shipping. It was that the way we approached it was foolhardy. And so, but, so I started to say guys, you know, we’re doing all this shipping around the world. We need to look at the shipping part of it. That’s a big part of the business. Boy, and they were afraid to, because they didn’t want to get hammered the way that we had before. And finally, we’ve gotten into it, and we’ve done very well, because we have a much sounder approach. But it took a long time to get over that.

HH: Because it was radioactive, right?

CK: Absolutely.

HH: People were afraid. Lots of lessons like that. One more segment, America, with Charles Koch. It’s a fascinating book. Good Profit is linked over at Hughhewitt.com, a perfect Christmas present for anyone in your life, Thanksgiving present as well, who has a company small or large, or on the way to becoming enormous. Good Profit will get them there quicker with market-based management.

— – – —

HH: I want to thank Charles Koch for spending this much time with me. It’s a fascinating book, Charles. I have to tell people when they read that you write Koch is whispered around the company as standing for Keep Old Charlie Happy, I think that’s very funny, very self-effacing, and it gives a sense of what the book is, or charts for Charlie. But tell me now how you expect it to endure after you go to your reward. How do you pass down generationally this kind of an approach as Fred passed it to you?

CK: Well, my kids are, have embraced this philosophy. I started teaching it to them when they were in kindergarten. And so they get it, and I’ve been preaching and practicing it here for, in varying degrees, for over 50 years now. And we have a team of leaders and people throughout the company who have internalized this not just conceptually, but turned it into personal knowledge, that is made it a part of themselves. So this is the way they think and behave, and they are great role models for it. So I mean, it’ll be different when I’m gone, but it may be a lot better as well.

HH: Oh, interesting. That’s very interesting. There’s a bell curve in everything, I believe, and you know, you’ve got Georgia Pacific, Green Bay Broadway Mill which is at one end of the bell curve. I’m not asking you to name names, but do you know which part of Koch Industries is at the other end of the bell curve?

CK: You mean, which is furthest behind?

HH: Yeah.

CK: Ooh, I wouldn’t want to mention any names like that, but…

HH: I don’t want you to name it. I just want to know if you know what it is. I don’t want you to name it. I just want to know if you know what it is.

CK: No, I wouldn’t say worst. I know some that are not up with others. I mean, obviously, there’s variation in everything, and we want variation. We want diversity. We want different people approaching it differently, and then we try to build this knowledge sharing culture. And we’re working hard on that to create what I call, or Hayek called a spontaneous order, which the ideal here is that, is to have the right vision, and the right people with the right values in the right roles with the right incentives. And if you have that, people don’t need to be told what to do. They know what to do, and they want to do the right thing.

HH: It’s well said. Great place to end. One last question. Are you an optimist about the country, Charles Koch?

CK: Well, I’m an optimist in this thing. With the technology that’s been developed, if we had a system that wouldn’t inhibit it, that wouldn’t stifle these innovations, that wouldn’t create obstacles to the disadvantaged in having opportunities, that wouldn’t promote corporate welfare and wasteful spending, we could have the most wonderful society that everyone, that anyone ever dreamed of. And that’s what I’m working for, and I need a lot of help.

HH: Well, well said. Good Profit is a great step along the way. The book, America, is linked over at Hughhewitt.com. Charles Koch, thank you, great pleasure talking to you.

CK: Thank you, Hugh, great questions, I appreciate them.

HH: My pleasure.

CK: Thank you.

End of interview.

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