This podcast answers the following questions:
- Who is Charles Koch and what is his book, The Science of Success, about?
- What are the important takeaways from The Science of Success?
- What are the 5 principles of Market Based Management?
- Ask The Investors: How do I account for stock splits when calculating Intrinsic Value?
This article provides an overview of Billionaire Charles Koch’s book, The Science of Success. If you want to read our executive summary of The Science of Success, view this page instead. If you would like to download all of our book summaries, click here.
Who is Charles Koch and what is his book The Science of Success about?
Charles Koch is an American businessman and Billionaire who ranks as the 6th richest person in the world (43 billion dollars). He is the co-owner and CEO of Koch Industries, a business originally founded by his father. Since Charles Koch’s start in the company in 1961, the company has grown more than 2000 fold. Koch attributes this high and sustainable growth to a system he developed called Market Based Management (based on 5 key principles). In The Science of Success, Charles Koch explains each of the principles in detail.
What are the important takeaways from The Science of Success?
1: Change adaptation. This is a main theme throughout the book. Charles Koch is a firm believer that as a leader, CEO, and owner, you need to be prepared for your business to change course and move with the market. You can’t look for a regimented checklist that remains stagnant over time. The key to success is embracing change.
2: Opportunity cost. Koch found that a set of laws governed human behavior. For example, most people place too much emphasis on past decisions. Instead, Koch prefaces the power of now and what’s to come. In the book, he provides an example of this concept. He discusses a time when his employees were hesitant to sell some inventory they had recently acquired. The reason they didn’t want to sell is because they would have to take a loss on the sale (because they purchased it for a higher price). Koch immediately wanted to understand what would be done with the capital that would be generated from the sale of the inventory. When he discovered that he could employ the capital at a higher return by selling it at a loss and purchasing a new asset, he quickly chose to sell the inventory at a loss. This is what he means by the term “opportunity costs”. If there is one thing we have found prevalent amongst most billionaires, it’s this strong understanding of opportunity cost.
This is similar to stock investing too. Let’s say I originally purchased stock for $10. If the company turns out to have bad fundamentals, and the price drops to $8, I should constantly be assessing my opportunity costs for switching into a different asset. Stig and Preston have built a calculator to help people determine their opportunity cost at BuffettsBooks.com. What typically happens for most investors is they only focus on the “red” loss, even if the account stays at a loss for ten years. This example also illustrates that you are always making a decision, even when you think you aren’t! Taking no action is still a decision.
What are the 5 principles of Market Based Management?
Market Based Management is the process that Charles Koch is using for his entire decision making process, and each principle has been devoted to a chapter in the book.
1. Vision: The organization should focus on where and how it can create long-term value to the company and society. This important take-away can best be described by his quote: “Success is harder to overcome than adversity”. Previous successful companies like Sears, Kodak, and Xerox are examples of companies that have not been able to embrace the change of customer preferences, and therefore fail to deliver the long term value like Koch Industries.
2. Virtue and Talent: Hiring the right talent with the right virtues is probably the most important task as you’re growing your business. Too often businesses achieve success, and feel that they are obliged to hire new staff, regardless of the talent available. Charles Koch on the other hand would rather sit on an empty seat and forego revenue than hire the wrong person. People are the foundation of every organization for better or for worse.
4. Decision Rights: The right people should be in the right roles with the right authorities to make decisions. Even if responsibilities are delegated, the leader is still responsible for the action that their subordinates are performing. If you have a culture where this is present, you will also have a culture where employees are thinking like owners.
5. Incentives: Make sure that the interests of the employees and company are aligned. This is more complex than it sounds, as there’s often a cost (tangible or intangible) to every incentive. For instance if you give an incentive for a faster delivery, the cost might be poorer quality. Charles Koch encourages his leaders to tailor incentives to their employees. The only constraint is that incentives should be focused on long-term gains to the individual, company, and society.
Ask The Investors: How do I account for stock splits when calculating Intrinsic Value?
The Investors answered that on BuffettsBooks.com they have two models for calculating the intrinsic value of stock. One method is a similar way of calculating a fixed income security, which is bound by time. That’s the calculator presented in lesson 21. Another model is the DCF calculator, which is NOT sensitive to stock splits and can be found in lesson 35. Both models have their individual strengths and weaknesses, and if you want to dig even deeper into the differences, the best approach is to visit the Warren Buffett Forum and discuss your intrinsic value calculations with Preston, Stig and the other people in the BuffettsBooks Community.
Books and resources mentioned in this episode
Charles Koch Discussing Economic Freedom and the role of a Business