For those of you who believe in the free market and are interested in learning how you can apply its principles to your working life, Charles G. Koch’s The Science of Success (Amazon / WSJ review) is a must read.

As chairman and CEO of Koch Industries, Inc. since 1967, Koch has built the largest and most profitable privately-held company in the world, an industry leader in sectors as diverse as oil refining, chemicals, fibers and polymers, financial trading, ranching, and forest products.  He has also supported a wide variety of prominent market-oriented research and advocacy groups, including the Cato Institute, the Institute for Humane Studies, the Mercatus Center, and Citizens for a Sound Economy Foundation, which later became Americans for Prosperity Foundation.                             

In The Science of Success, this giant of the for-profit and non-profit worlds shares the management philosophy behind his many successes, an ingenious application of free market principles to the internal functioning of organizations.  He calls his approach Market-Based Management (MBM).

Koch’s achievement with this book is to describe in clear terms and with excellent support from diverse research in science, philosophy, economics, and other fields how the principal insights of free market economics can be applied, through MBM, within organizations of all sizes.  While he focuses primarily on his own company and therefore on the for-profit sector, there are lessons here that are highly valuable for the public and non-profit sectors as well. 

The whole of MBM, according to Koch, ultimately rests on one simple question: “Is this creating value?”  The five dimensions of MBM, all of which relate back to value creation, are vision, virtue and talents, knowledge processes, decision rights, and incentives.

Vision is about how an organization can best create value.  Koch argues that value creation is essential to any organization’s long-term success, and for companies operating in a free market the best gauge of value creation is profitability.  Koch says “in a true market economy we can only prosper by providing others with what they value.”  The vision in MBM reflects the organization’s core competencies and how they can best be used to maximize value creation. 

Virtue and talents are about maximizing human resources, which means retaining and recruiting the best workers in the industry and creating an environment in which they can succeed, and helping below average workers improve or letting them go.  Koch also stresses the centrality of virtue, including integrity and full compliance.  The bottom line for talent is results, that is, creating value.  Koch puts it starkly: “any employee who is not creating value does not have a real job in the MBM sense of the word.”

Knowledge processes are about replicating market information mechanisms within the organization.  Koch says: “In a truly free economy, profit and loss is the market’s objective measure of the value a business is creating in society.”  Within an organization, measurables are critical to creating accountability and a form of internal market discipline.  He therefore argues it’s critical to use market-prices for internal transactions, rather than cost-based pricing, to be able to properly assess the profitability of units within the organization.

Decision rights are a method of introducing something like property rights within an organization.  The idea is to confer responsibility and authority on members of the organization commensurate with their proven accomplishments—giving them deserved ownership over their projects.  The expectations for them should be open-ended, aimed toward maximizing value rather than meeting fixed targets. 

Incentives are used to properly encourage and reward value creation and entrepreneurial risk-taking.  One example of how to use incentives effectively is that Koch pays sales commissions not as a small percentage of the total sales price but as a large percentage of the price above the product’s opportunity cost.  To encourage more entrepreneurial risk-taking, Koch suggests counting foregone opportunities on a par with failed ventures.  Koch cleverly refashions Marx’s famous rule: “From each according to his ability, to each according to his contribution.” 

Free market conservatism provides us with the concepts that we know work—individual responsibility, free trade, profit-maximization—in formulating government policies.  But they can also inform how we run our businesses and do our jobs.  Charles G. Koch, a true hero to the free market movement and a proven expert in the science of success, has provided us with an excellent template for putting these ideas into action.

Mr. Kerpen is policy director for Americans for Prosperity Foundation.