Market Based Management®

Principles and Practice

YEK, August 22, 2008

The goal of this seminar is to provide you with:

• A clear understanding of the principles and mental models underlying MBM

• Examples of what MBM looks like in practice• Challenges to your thinking• Ideas about how to apply MBM to improve your

organization• An excuse to have a little fun.• But only just a little, so sit up straight.

What makes MBM so great?

• In 1987, Forbes republished its original “Forbes 100” list and compared this to its 1987 list of top companies.

• Of the original group, 61 had ceased to exist.

• Of the remaining 39, 18 had managed to stay in the top 100.

• Of the 18 that stayed in the top 100, only 2 performed better than market average.– (Kodak and GE)

In 1917, Forbes formed the first list of 100 largest American companies

Standard & Poor’s 500

• Of the 500 companies originally in the S&P 500 in 1957, only 74 (14.8%) remained on the list through 1998.

• Of these 74, only 12 outperformed the S&P index itself over the 1957-1998 period.

HOW WILL WE SURVIVE?!?

The doomed 98 percent

• They didn’t change

• They changed, but not fast enough

Creative Destruction

“The world is too big for us. Too much going on, too many crimes, too much violence and excitement.

Try as you will, you get behind in the race, in spite of yourself. It’s an incessant strain, to keep pace…And still, you lose ground. Science empties its discoveries on you so fast that you stagger beneath them in hopeless bewilderment.

The political world is news seen so rapidly you’re out of breath trying to keep pace with who’s in and who’s out. Everything is high pressure. Human nature can’t endure much more!”

Atlantic Journal

June 16, 1833

The Question:

Is the world changingor

Is it not changing?X

The doomed 98 percent

• They didn’t change

• They changed, but not fast enough

• They changed, and they changed fast, but they changed the wrong things

Change happens Subjective value

Pride goes before a fall

Trust matters

Buy

low

, sel

l hig

h

Smarter than anyone ≠ smarter than everyone

Innovation drives markets

People crave fulfillment

Lesson:

To survive in the face of creative destruction, we must master timeless

principles

Lesson:

To survive thrive in the face of creative destruction, we must master timeless

principles

Timeless

1. Integrity

2. Compliance

3. Value Creation4. Principled

Entrepreneurship™

5. Customer Focus

6. Knowledge

7. Change

8. Respect

9. Humility

10. Fulfillment

Koch Guiding Principles

Market Based Management®

A management philosophy that enables an organization to succeed long term by applying the principles that allow a free society to prosper.

North Korea

South Korea

(the dictator’s pad)

High Income Countries ($11,456 or more annual income per capita)

Upper Middle Income Countries ($3,706 to $11,455/capita)

Lower Middle Income Countries ($936 to $3,705/capita)

World Development Report, World Bank, 2007Figures adjusted for cost-of-living differentials

Luxembourg 64,400

United States 45,850

Japan 34,600

Canada 32,600

Italy 29,900

New Zealand 26,340

S. Korea 24,750

Estonia 19,680

Romania 10,980

Brazil 9,370

China 5,370

India 2,740

Haiti 1,050

Rwanda 860

Ethiopia 780

N. Korea 580

Low Income Countries ($935 or less annual income per capita)

2007 Index of Economic Freedom

1. Hong Kong2. Singapore3. Australia4. United States5. New Zealand5. United Kingdom7. Ireland8. Luxembourg9. Switzerland10. Canada11. Chile12. Estonia13. Denmark14. Netherlands14. Iceland

143. Bangladesh144. Venezuela145. Belarus146. Burundi147. Chad148. Guinea Bissau149. Angola150. Iran151. Republic of Congo152. Turkmenistan153. Burma154. Zimbabwe155. Libya156. Cuba157. North Korea

Top 16 Bottom 16

Wall Street Journal/Heritage Foundation ranking of 157 countries

Lesson:

• Economic freedom entrepreneurial innovation and productivity

• Entrepreneurship and productivity

PROSPERITY

Economic Thinking

Subjective Value

Depends on

• Buyer expectations (taste and perception)

• Alternatives• Circumstances• Time

Does NOT depend on

• Cost to produce• List price

Value determined by the consumer’s expected satisfaction

• Stores used to pay 10¢/bag of whole carrots and sell them for 17¢/bag.

• They began paying 50¢/bag for baby carrots and selling them for $1/bag.

• American consumption rose from 6 to 10.5 pounds/person/year.

Digging the baby carrot By Elizabeth Weise, USA TODAYAugust 11th, 2004

...Tired of the wastefulness he was seeing (400 tons/day), Mike Yurosek whittled "babies" from grown-up castoff carrots.

Know Thy Customer“What we sell is the ability for a 43-year-old

accountant to dress in black leather, ride through small towns and have people be afraid of him.”

Harley Davidson Executive

Why Buffets Make Us Miserable

• Hidden cameras in pizza restaurant

• Random sample chosen for free buffet

• What do you predict happened?

• Why?

Sunk Cost

Cost already incurred in a project that cannot be changed by present or future

actions.

The value of the most valuable alternative foregone when you choose to use a resource in a particular way.

Opportunity Cost

Opportunity Cost

A = $100 B = $80 C = $30

• What’s the opportunity cost of B?

• What’s the opportunity cost of A?

• Have you ever seen a heading for “opportunity costs” in an accounting ledger?

Foundations of Prosperity

• Rule of law and a principles culture

• Property rights

• Freedom of contract

• Market mechanisms and free speech

Value-creating entrepreneurs• Self-interest

The MBM Framework

Value-creating entrepreneurs Vision

Rule of law, principles culture

Property rights

Freedom of contract

Prices, profits, losses, and free speech

Virtue & talents

Decision rights

Incentives

Knowledge processes

Prosperous SocietiesSuccessful

Organizations

VisionQuality

Teamwork

ExcellenceChange

Responsibility

Leader

Service

Success

Innovation

Initiative

Dilbert does vision

“The New Venture Mission is to scout profitable growth opportunities in relationships, both internally and

externally, in emerging, mission-inclusive markets, and explore new paradigms and

then filter and communicate and evangelize the findings.”

Vision Actions

Vision Actions

The way we’ve always done it

What makes us feel righteous

Value-creation process

CapabilitiesMarket

Opportunities Venture

ExperimentsValue

Creation

Lessons for Leaders• Leaders: eat, drink, breathe, sleep, and

SPEAK vision.

• Help people connect their daily work to the accomplishment of something big.

• Separate ends from means.

• Relentlessly and honestly assess capability.

• Play your strengths.

“The most pathetic person in the whole world is someone who has

sight but no vision.”

Helen Keller

The MBM Framework

Value-creating entrepreneurs Vision

Rule of law, principles culture

Property rights

Freedom of contract

Prices, profit, and loss

Virtue & talents

Decision rights

Incentives

Knowledge processes

Virtue and Talents

Virtue = Values and Beliefs

Talents = Skills and Knowledge

Knowledge and Skills

Values and Beliefs

Consistentwith desiredculture

Inconsistentwith desiredculture

4

2 1

3

Inadequate for job expectations

Adequate for job expectations

Somebody once said that in looking for people to hire, you look for three qualities: integrity, integrity, intelligence, and energy.intelligence, and energy. And if they don't have the first, the other two will kill you.

You think about it; it's true. If you hire somebody without the first you really want them to be dumb and lazy.

Warren Buffett

Lessons for Leaders• Never compromise on values.

• A principles-based culture frees managers to become leaders.

• Make assessment of principled behavior part of the review process.

ZZ

•Methodical•Analytical•Task-Oriented

•Visionary•Determined•Leader

ZZ•Bold•Innovative•Risk-Taker

Thinking of ordering pizza tonight

The MBM Framework

Value-creating entrepreneurs Vision

Rule of law, principles culture

Property rights

Freedom of contract

Prices, profit, and loss

Virtue & talents

Decision rights

Incentives

Knowledge processes

Decision Rights

Ownership Accountability

Roles

Responsibilities Expectations

Decision Rights

• The bank

• The Nike zone

• Best isn’t always best, or, what the Ph.D. economist learned from his secretary

Comparative Advantage

1. The ability of a person, business, or country to produce a good or service at a lower opportunity cost than some other entity.

2. Advantage of producing a particular good or service relative to producing other goods or services.

Comparative Advantage

“Are you working on the thing that you are best at?” (Gallup)

“An army of one.” (U.S. Army)

Lessons for Leaders

• Don’t make Michael Jordan the coach.

• Don’t base a person’s authorities on what the guy before him did.

• Connect everyone’s duties to mission.

• For the love of all that’s holy, assign refrigerator duty to someone.

The MBM Framework

Value-creating entrepreneurs Vision

Rule of law, principles culture

Property rights

Freedom of contract

Prices, profit, and loss

Virtue & talents

Decision rights

Incentives

Knowledge processes

Incentives

• Incentives are subjective

• Incentives include financial and non-financial

• Individual performance varies considerably

5Mean

# ofEmployees

Performance

1 2 16 32 64

A market-based approach to compensation:• Aligns individual incentives with the

organization’s goals

• Attracts and retains top performers

• Motivates improved performance

• Encourages principled entrepreneurship

A market-based compensation philosophy:

Pays for long-term value added, and not for:

• Job title

• Time with the organization

• Degrees and certifications

• Similarities in job classifications

But wait; there’s more!

A market-based compensation philosophy also entails:

• No guaranteed annual increase

• No centralized job evaluation process

• No centralized formulas, formal pay structures, ranges, limits, or budgets

The Lake Wobegon EffectOnline Dating Analysis: Highlights

– 4% of men claimed income of $200k v. 1% national average

– Men and women were 1 inch taller than national average.

– 70% of women claimed “above average” looks, 24% “very good” looks.

– 67% of men claimed “above average” looks, 21% “very good” looks, and less than 1% “less than average” looks.

Lake Wobegon meets Wall Street

• 1999 - HP had missed earnings projections for 9 consecutive quarters

• 75% of employees throughout this period were rated as “exceeding expectations”

The MBM Framework

Value-creating entrepreneurs Vision

Rule of law, principles culture

Property rights

Freedom of contract

Prices, profit, and loss

Virtue & talents

Decision rights

Incentives

Knowledge processes

Reality Curve

Perception Curve

Honestand

FrequentFeedback

Knowledge processes in a free market

Market mechanisms (e.g., prices, profits, and losses) and free speech convey information about value creation and destruction.

This information swiftly yields positive and negative consequences for market participants.

Knowledge processes in an organization• Key drivers of value

• Key cost drivers

• How are we doing?

• How could we be doing?

Knowledge Processes

• Internal Markets

• Measures

• Knowledge Sharing

• Challenge Process

Knowledge Processes

• Internal Markets– Company X websites– University space battles

• Measures

• Knowledge Sharing

• Challenge Process

Knowledge Processes

• Internal Markets

• Measures– Internal costs and profitability– Benchmarking– Opportunity cost

• Knowledge Sharing

• Challenge Process

Knowledge Processes

• Internal Markets

• Measures

• Knowledge Sharing– The bent part

• Challenge Process

Knowledge Processes

• Internal Markets

• Measures

• Knowledge Sharing

• Challenge Process– Its absence = lack of leadership and courage

Yes-men only, please“At a meeting, it is appropriate for a subordinate to

say nothing substantive until he hears his superior take a position or give a cue. Then it is appropriate for the subordinate to chime in with information and other statements tending to support the superior’s line. You don’t do this. You just say what you think.”

* Bill Niskanen, The Suicidal

Corporation: How Big Business Fails America

Lessons for Leaders• Shrink overhead

• No hidden time

• Striving to measure and failing is better than declaring something unmeasurable

• If your people don’t speak up, YOU are at fault.

Learning by Doing“People often assume that you have to have great hands to become a surgeon, but it’s not true. To be sure, talent helps… Nonetheless, attending surgeons say that what’s most important to them is finding people who are conscientious, industrious and boneheaded enough to keep practicing this one difficult thing day and night for years on end… And it works… Indeed, the most important talent may be the talent for practice itself… a person’s willingness to engage in sustained training.”

Atul Gawande, Surgeon.

"It is a common delusion that you make things better by talking about

them."

Dame Rose Macaulay

Questions & Answers

Tony.Woodlief@MBMInstitute.org