The Science of Success

Market Based Management

But first, a few words about the Austrians

The Use of Knowledge in Society

Fredrick Hayek1944

American Economic Review

In the context of the planning problem: P

S

Q* Q Is finding Q the whole problem?

From The Use of Knowledge…Today it is almost heresy to suggest that scientific knowledge is not the sum of all knowledge. But a little

reflection will show that there is beyond question a body of very important but unorganized knowledge

which cannot possibly be called scientific in the sense of knowledge of general rules: the knowledge of the

particular circumstances of time and place. It is with respect to this that practically every individual has

some advantage over all others because he possesses unique information of which beneficial use might be

made, but of which use can be made only if the decisions depending on it are left to him or are made with

his active coöperation. We need to remember only how much we have to learn in any occupation after we

have completed our theoretical training, how big a part of our working life we spend learning particular

jobs, and how valuable an asset in all walks of life is knowledge of people, of local conditions, and of

special circumstances. To know of and put to use a machine not fully employed, or somebody's skill which

could be better utilized, or to be aware of a surplus stock which can be drawn upon during an interruption

of supplies, is socially quite as useful as the knowledge of better alternative techniques. And the shipper

who earns his living from using otherwise empty or half-filled journeys of tramp-steamers, or the estate

agent whose whole knowledge is almost exclusively one of temporary opportunities, or the arbitrageur

who gains from local differences of commodity prices, are all performing eminently useful functions based

on special knowledge of circumstances of the fleeting moment not known to others.

The knowledge problem

The economics of hurricanes:

The plywood problem: A grand web of coordination. How is it done?

The use of Knowledge in the Firm

• (Not an article title)

• The M form firm

• Decision Rights

• Locate decision rights and responsibilities where they will do the most good.

Locate decision rights and responsibilities where they will do the most good.

• Sensible on it’s face, but what does it mean?• What kind of information is required to make

a decision?• As Hayek, for some kinds of actions, the

important knowledge is specific to the time and place, and perhaps fleeting.

Two types of knowledge

• General and scientific: Decision rights are likely to belong in the home office of a company

• Specific to time and place: Decisions rights are likely to reside at a divisional or local office of a company.

Ummm. Ferinstance?

• Estimates of construction costs where local conditions matter (Consider techniques)

• Pricing used goods versus pricing new goods • Choosing what books to carry in a bookstore• The recipe for beer• Prescription antibiotics• Décor for a restaurant chain

More Hayek:The Meaning of Competition

• The textbook model of competition deprives the verb “to compete” of all meaning.

• Competition as a process of discovery.

• Discovering prices, yes, but also discovering products.

On to The Science of Success

Charles Koch and Koch Industries

KII (Koch Industries Incorportated)

One of the largest privately held firms in the worldRevenues, 2006, 90 billion

Major Components

• Invista (Textiles inputs, once a part of DuPont)• Georgia Pacific (Lumber products, materials)• Pipelines and transportation• Minerals• Energy• Trading• Fertilizer

Politics

• Conservative• Donates to politicians, mostly Republicans• An obsession at the New Yorker, MSNBC

• Fred Koch, the company founder, worked in the Soviet Union in the 1930s, becomes a staunch anti communist.

Why this book?

• The theme of this course has been, what ideas that are accepted principles in economics are readily carried into business management

• And related, to that, how does economics help us to better understand accepted business principles

Why this book?

Koch Industries uses economics, often quite explicitly, in selecting the structure of the businesses and its conduct.

You will frequently find, in SoS, direct use of economic principles.

Structural and resource-based approaches are in evidence, though not equally.

The Science of Human Action

• This is Ludwig von Mises.

• Purposeful actions

• A normative foundation

• This chapter is in part devoted to recognizing the position of a company in society.

Key ideas for us in this chapter

The Five Dimensions• Vision: Create long term value. (planning)• Virtue and Talents: Personnel policy, broadly

understood. • Knowledge Processes: Acquiring and applying

knowledge, tracking profitability• Decision Rights: Authority and responsibility• Incentives: Rewarding people

Economics Exposed

Opportunity cost“An example from the late 1960’s concerned one such introductory concept that, in spite of being widely taught, was not widely practiced. We were addressing a question of when to sell some inventory. I suggested selling it immediately, but was told the price was below what we had originally paid, so we should wait until it recovered. I pointed out that this shouldn’t be the test, because what we paid was now a sunk cost. “

(This is followed by a statement of the sunk cost rule. )

More of this

Subjective ValueAnchored in people’s willingness to pay, which is a matter of preferences.

Discusses diminishing marginal valuation and the diamonds and water paradox

And still more

Comparative advantage:Unless two people (nations) are exact multiples of

each other in terms of productivity, they will each have a comparative advantage, even if one is absolutely better in each activity.

The more productive party will benefit from practicing the activity in which it has the greatest advantage. The less productive party will benefit from practicing the activity in which it is least disadvantaged.

Supply

P. 37 shows something that looks like a supply curve. Sort-of. It reflects that firms have different cost structures. Firms will enter and exit an industry as price fluctuates. The diagram and related discussion shows how knowledge of competitors cost structures can provide useful productions about the market.

Beyond that….

The economics is less explicit.

But note this: “To its credit, the development group pioneered

the use of internal markets… . This helped us more fully appreciate the value of having measures based on economic reality.”

This is transfer pricing.

The Vision Thing

“Determine where and how the organization can best create value in society to maximize its own value long term through a value of experimental discovery.”

What is this?

“Determine where and how the organization can best create value in society to maximize its own value, long term, through a process of experimental discovery.”

Porter? RBV? Something else?

Any novelty here?

Basic Economics

• “Creating superior value means generating greater value from resources consumed than alternative uses.”

• (And how do we know the value in alternative uses?)

• “A vision statement is the organization’s view of how it plans to create value.”

Some RBV

(Regarding the erosion of profitability over a product’s life…)

The wide range of strategies available to slow this decline include: developing good customer relationships; maintaining a strong brand with the quality and consistency to back it up; developing hard to duplicate distribution channels; establishing long term sales or supply contracts; developing new applications;”

(continues with IP protection, benefit/cost improvements.)

(Still on vision: Innovation)

• Stainmaster example.

• “It is natural to think that if customers don’t complain, they are satisfied.”

• “Customers seldom know what they will value until they see it.”

Structure? RBV?

It is apparent from Koch Industries’ vision and the diversity of its businesses that we view ourselves as bound by capabilities, rather than our industries or products, as is more typical.

Next up: Virtue and TalentsThe personnel chapter

Next up: Virtue and Talents

Insure that people with the right virtue and talents are hired and retained. Maintain a culture based on the MBM principles.

Virtue is singular, but talents is plural.

MBM Guiding Principles

• Integrity• Compliance• Value creation• Principled entrepreneurship• Customer focus• Knowledge• Change• Humility• Respect• Fulfillment

Talents

Multiple Intellegences

(It takes all kinds to make a world)

Lessons from a week at leadership school

It takes all kinds to make a world

All of us are better than any of us. (Actually, this one is nonsense)

Different kinds decisions require different processes

Decisions, decisions

• Does the decision require information from others?

• Does the decision require buy-in from others?

• Does legitimacy require consultation, even voting, from others?

• If not, make a decision.

But seriously folks…

• Talents are important.

• A key R in the RBV

• Accommodation and appreciation

Knowledge Processes

• “Ensure that knowledge is optimally acquired, shared and applied. Measure profitability wherever practical.”

• Analogy to the market process of Austrian economics. Competition as a process.

• The last three chapters draw heavily on economic reasoning.

Your assignment

• Read pages 99-154 if you haven’t already

• Identify three places in each chapter that are right out of economics

• Identify two more that reflect economics.

• Bring your list to class.