3.
TRANSFORMING KOCH INDUSTRIES
“The philosophers have only interpreted the world … the point is to change it.”
KARL MARX1
I was 31 when I succeeded my father as chairman and CEO of the family business.
The year was 1967, and my elevation was no cause for celebration. Fred Koch had just died. A heart attack early in the year had put him in the hospital. A second heart attack had followed, and the third, in November, proved fatal. To honor my father’s memory, we renamed Rock Island Oil & Refining, our parent company, after him. The business has been Koch Industries ever since.
I wanted to honor my father in another way: by transforming his company and bringing it to new heights. Because of my studies in so many disciplines, I was swimming in a sea of concepts and principles—ideas that I wanted to apply to the company to make it better and grow.
My idea was to apply the theories I was learning to enable Koch Industries to succeed by empowering our employees to succeed. I envisioned our employees using their aptitudes to better serve our customers and society—benefiting themselves and building the company from the bottom up.
Simultaneously, I was applying these principles outside the business. In the 1960s, I began speaking on college campuses and elsewhere about how best to foster human flourishing. (This included arguments against America’s involvement in the Vietnam War, among other issues.) I also took my first steps in philanthropy, focusing on helping students apply these ideas to realize their potential.
Business took most of my time, especially in those early years, but my goal was to get those newly acquired concepts into practice in every part of my life.
In the 1960s, our businesses consisted of a company that made a specialized chemical separation product (Koch Engineering), a crude oil–gathering company (Rock Island Oil), and cattle ranches. I first worked at Koch Engineering, which my father turned over to me carte blanche. At my father’s request, I also quickly got involved in the oil-gathering business, which generated the bulk of the company’s income.
I dedicated all my spare time to learning the principles of progress, and a good part of my company time to figuring out, through trial and error, how to apply them to get results. It gave me great insight into the company’s strengths—and its weaknesses.
A STRUGGLING COMPANY
What I discovered both saddened and motivated me. My father’s failing health had prevented him from effectively managing the business. The company had neither the vision nor the willingness to work to improve and better serve our customers. It was on a fast track to nowhere, which would eventually end in us going out of business.
Worse, I found miniature versions of the paradigms and approaches that had held back humanity for millennia.
For one, control and protectionism ruled the day. Managers thought they always knew best, believing that their ideas were naturally superior to those of the rank-and-file. There was a near-total unwillingness to ask for or listen to feedback.
For example, the president of Koch Engineering would send questionnaires weekly to his subordinates, making them explain each expense item, no matter how small. As a result, they had much less time for productive work. So not only was there no innovation, the office equipment was obsolete and the bookkeeping was six months behind. His attempts to control and micromanage people held the entire company back.
As for protectionism, the company resisted changes to the status quo and had an aversion to trial and error and risk-taking of any kind.
Case in point: it refused to let customers verify that its custom-designed product would deliver the promised benefits. They feared customers would copy its design methodology. In another attempt to avoid competition, the company had also contracted with multiple shops in Europe, with each making different pieces of the product, and still another shop assembling them. The whole system was extremely costly and wasteful, leading to sizable losses. Such are the consequences of protectionism.
If our employees had the opportunity to transform themselves, they would transform the company, and in turn help transform society.
The oil-gathering company, Rock Island, was hardly better. Its management opposed extending the business beyond southern Oklahoma, so our little piece of business, while profitable, was essentially frozen. The managers were afraid to compete with the major oil companies, so they settled for what they had. This is just another form of protectionism—the unwillingness to try new things out of fear they may fail.
The more involved I got, the more problems I found, giving me more opportunities to improve results by applying the principles of progress. Mercifully, I wasn’t the only one to see them. Many employees knew we could do things better and had constructive suggestions—ideas that, when combined, could begin to transform the company from the bottom up. They were just being stifled, ignored, and controlled.
This counterproductive approach created a destructive downward cycle: when employees know that no one will listen to them, they keep their ideas to themselves. Worse, they stop looking for ways to improve things and opportunities to apply themselves. This resulted in a stagnant company, just as control and protectionism had caused countless societies to stagnate.
The lessons of history should have been obvious: everyone is capable of contributing. When they are empowered to do so, the results are far superior.
UNLEASHING OUR EMPLOYEES’ POTENTIAL
In the mid-1960s, we had about 300 employees, and every single one had abilities they could apply to benefit the company and themselves. They simply needed a better environment, one in which they could discover their aptitudes, develop them into valued skills, apply them to maximize their contributions, and then do it all over again. Individuals who follow this path—it is unique for each person—continually learn, grow, and contribute at a higher level, greatly increasing their ability to succeed, whatever their calling.
My task was clear: change the company’s culture to one of empowerment, not control.
I knew this was the key to Koch’s future. If our employees had the opportunity to transform themselves, they would transform the company, and in turn help transform society. I believed employee empowerment would allow Koch Industries to experience a Great Enrichment of its own.
My task was clear: change the company’s culture to one of empowerment, not control.
In my early conversations with management and employees, I was explicit about my intentions. My goal wasn’t to give all the answers, which I didn’t have. Rather, it was to provide the vision, philosophy, and tools for our employees to find answers themselves, to solve problems using their own unique abilities and knowledge. We needed to ask, not tell; to experiment, not stifle.
The most important person who had the same vision was Sterling Varner. He is proof that everyone can contribute, and that so-called “ordinary” people are capable of extraordinary things. He became the greatest success story in the company’s history.
Sterling was born in an oil-field tent and delivered by his grandmother, since no doctor was available. Throughout his life, he stuttered and was beset with serious health problems, including a botched appendectomy and lung damage. His college education consisted of two years at the Murray State School of Agriculture in Tishomingo, Oklahoma. He came to the company as a clerk in a 1946 acquisition.
Sterling was the sort of fellow most folks wrote off until they got to know him. He had great people skills and a first-rate entrepreneurial mind. I immediately recognized it when I started working with Rock Island. Unlike many others, including nearly all the management, he thought we should aggressively expand our oil gathering, and he had great insights on how to do it. So, together, we pushed to make it happen.
We aggressively bought trucks, trucking companies, and pipelines, in addition to building our own pipelines in every new oil field anywhere in the United States and Canada. Far from just trying to maintain the existing business, Sterling and I dreamed of becoming the largest oil-gathering company in North America. By the 1990s, we accomplished our goal, moving about a million barrels of oil a day.
A PROFILE IN PARTNERSHIP
IT’S HARD TO EXPRESS just how much Sterling Varner meant to me.
That’s true, even though we had quite different aptitudes. In fact, it’s that difference, combined with our shared vision and values, that made us so close. We made each other better.
Our differences were many.
Born in a tent, he faced steep barriers from day one. I didn’t.
He was a people person. My strength is concepts.
He could turn a phrase in any situation. I prefer paragraphs—long ones. In fact, his one-liners are so legendary in the company that we call them “Sterlingisms.”
One of many that I remember is, “Don’t confuse motion with progress.”
It was precisely because of our differences that we were able to accomplish so much together. Sterling’s quiet but powerful influence can be seen behind so much of the company’s early success.
We did share some similarities. Both of us were raised in families that prized integrity. That was probably what drew me to Sterling in the first place.
Sterling’s character was evident to all. At a meeting in the early 1970s, after striking a particularly good business deal, a few of our salespeople started joking and laughing about how they had outsmarted the customer. Sterling blew his stack.
He came down hard on them: “Stop it! You boys are way out of line! Our customers are our friends. They are the ones who keep us in business, and we don’t take advantage of or laugh at our friends. It’s not right. And if we do, we won’t have any friends and we won’t have any business. … We have to earn their trust, and that starts by treating them with respect.”
Sterling, as usual, had said exactly what needed to be said when it needed to be said. And he certainly said it better than I would have. I have lost track of how often that was the case.
Sterling was born in a tent at an oil field. He overcame early hardships to become president of Koch Industries.
Sterling was an ideal partner and friend. In 1968, we were working on opportunities in Alaska.
After retiring, Sterling loved being at his Shadow Valley ranch in eastern Kansas.
Sterling taught me many lessons over the 60-plus years I knew him, and I’d like to think I did the same for him. None was more vital than the importance of partnership.
He was living verification of my theory that you accomplish the most when you surround yourself with people who are good at the things you’re not. People who bring a different perspective. Sure enough, that’s who Sterling was to me.
But, as I said in my eulogy at his funeral in 2009, he was much more than that: “He was a mentor, and my closest advisor and confidant. He was one of the best friends I ever had … like an older brother that I loved and respected.”
— CHARLES KOCH
In Sterling’s story, we see how anyone can become contribution motivated. He overcame tremendous personal barriers and unearthed his gift, enabling him to better his life and the lives of others. By the time he retired, that son of an oil-field mule contractor was president and COO of Koch Industries, and he was a contributing board member until his death in 2009.
Sterling didn’t build our oil-gathering business by himself. Just as he was empowered to use his gifts, we were all empowered to do the same. Our salespeople, our pipelayers, our truck drivers—all employees were given the chance to act on their ideas, see and seize opportunities, and better serve customers, and were rewarded in turn. Their success spurred them to find more ways to contribute, in a cycle of continual transformation and value creation. All of us focused where we could accomplish the most in the spirit of bottom up.
One of the greatest lessons I have learned is that people who are overlooked may have the most to contribute.
Like Sterling, nearly all our employees have come from humble roots. This often surprises people, especially those who assume that success comes from grand plans and so-called great leaders rather than regular folks. We found that a great leader is someone who empowers those they work with, which describes Sterling Varner perfectly. One of his favorite sayings was, “I get things done through people.”
An Ivy League–educated journalist from a famous New York business publication once asked me, “Doesn’t your location in Wichita make it hard to attract top talent?” She probably meant no offense, but her subtext was clear: “How do you convince Harvard and Yale grads to come work for you?”
The answer is, we don’t (or, I should say, we rarely do). Other companies might prefer to hire Ivy League graduates, but we’ve had much more success hiring from Wichita State, Kansas State, and Oklahoma State. Sure enough, the four employees who succeeded me as president of the company hailed from Murray State School of Agriculture (but didn’t graduate), Texas A&M, the University of Tulsa, and Emporia State University.
One of the greatest lessons I have learned is that people who are overlooked may have the most to contribute. This is true not only of those who went to colleges you have never heard of but also of college dropouts and those with high school diplomas or less. You’d be astounded how often they have the virtue and talents we need, more so than the most credentialed Ivy League grads.
MORE IDEAS, MORE PROGRESS
My efforts to empower employees regardless of education, background, or belief have always been grounded in a simple reality: different people have different abilities and knowledge. The history of innovation encompasses different ideas combining to create something better (think back to chapter two). The success of the company depends on the same thing.
That is why we encourage our employees to proactively share their ideas. We got this concept from the scientist-philosopher Michael Polanyi, who coined the term “Republic of Science.” He theorized that progress comes from individuals in different disciplines and with different perspectives freely sharing knowledge and challenging one another, which spurs innovations (a great illustration of bottom up).
To benefit from everyone’s unique knowledge, we liberate and urge our employees to proactively offer suggestions. Supervisors at every level are held accountable for soliciting their employees’ ideas and applying those with merit.
This is central to what we call the “Challenge Process.” It can be summed up simply: anyone can challenge anything—ideas, recommendations, ways of thinking, etc. We encourage rigorous questioning and brainstorming, in a spirit of intellectual humility and constructive improvement.
This is essential to overcoming the natural tendency to defer to authority. Empowerment also demands it: one of the biggest problems throughout history has been a hostility to challenge by those at the top. Generally, the rulers and powerful refused to listen to others, especially those they thought beneath them. Worse, they took challenge as a threat to their dominance, often punishing or executing the challenger. While they may have had a monopoly on power, they never had a monopoly on truth or knowledge.
No wonder humanity muddled on for millennia without any meaningful improvement.
The lessons of history apply to business. CEOs don’t have a monopoly on good ideas, either. You never know where—or whom—a brilliant idea will come from. But if you stifle even a small portion of people, chances are the idea will never arise. The principle of openness is non-negotiable for progress.
For the record, this practice of challenge applies to me the same as anyone else. Informally, it’s a daily part of my work life. Formally, the leaders of Koch’s various companies and capabilities typically meet every two months in what we call a “Discovery Board.” Any of the 30 or so participants can bring up a problem or opportunity, and the rest of us respectfully challenge it. Most of the time my ideas get pushback from quite a few people. I never leave the room unscathed, or without a better solution.
Some time ago, another reporter asked me why I tolerate this. She asked, “You don’t fire them?” I laughed out loud! “There’s no place for fragile egos here,” I said. “What damages your self-esteem more: being shown the flaws of your proposal early, or failing to seek objections only to endure a massive failure?” Challenge is critical for everyone in any organization, the leaders especially. As I told the reporter, “I love it.”2 I also depend on it.
A CULTURE OF CONTRIBUTION
As Koch has expanded, our top priority has been to implement the principles of progress within our company. This is a difficult process, especially when we acquire companies dominated by the control mentality.
One of my earliest challenges as CEO took place in 1969 when we acquired full ownership of an oil refinery in Minnesota. Its culture was so hostile to new ideas that a number of employees went to extremes to prevent any change. People nearly died from the violence of the ensuing strike.
It was a brutal nine-month struggle, but in the end, we were able to begin to gradually change the culture from control and protectionism to empowerment. Today, the Pine Bend refinery is much larger, much safer, and more environmentally friendly, and it uses fewer resources, primarily because our employees have become contribution motivated rather than negatively motivated. It has been transformed, with employees leading the way, in innovation and superior performance.
We encountered another setback in implementing our bottom-up philosophy at our metal fabrication plant in Bergamo, Italy, in the 1990s. Its union leaders rejected the approach, saying: “This might work in the United States, but it’s not going to work in Italy. Here, managers think. Workers work. You’re asking us to do the manager’s job.”
They were right about that last part—we wanted them to think creatively and constructively instead of doing everything as they had in the past. If they did, they would find success and fulfillment by making innovations that created more value for others. And they ultimately did.
Similarly, after acquiring Georgia-Pacific in 2005, we began implementing the principles of empowerment at its many locations, including a substantial manufacturing plant in Green Bay, Wisconsin. As was the case with those at our Italian facility, most of the Green Bay employees were being controlled rather than encouraged to contribute.
One example stands out. The employees running the machinery on the shop floor had the best knowledge of those machines, but only senior managers could push the “stop” button in an emergency. If non-management employees saw something wrong, they had to find a manager instead of addressing the safety matter immediately themselves.
This illustrates one of the dangerous consequences of control. That rule was the first to go when we began empowering employees. It was an early sign that we trust employees to do what’s right, and we wanted them to see themselves as partners in the company’s success.
We have found that control is ingrained in essentially every company we acquire. When Koch purchased Georgia-Pacific, its senior management worked on the top floor of a 51-story building, which had a special elevator just for that floor. No employee was permitted on the floor without a jacket and tie, even though the rest of the company had a “business casual” dress code.
We knew this wouldn’t do. It sent the signal that managers were set apart, somehow better than everyone else. So we moved these leaders downstairs with their teams and converted the fifty-first floor into meeting rooms available to all employees.
Similarly, at Koch’s headquarters in Wichita, we don’t have an executive dining room or anything like that. When I get lunch, I go to the cafeteria, pick out my food, and pay like everyone else. Employees regularly approach me with their ideas. That’s exactly what should happen in a culture of empowerment.
Some of our greatest successes have come from our acquired companies, as employees who were once held back became empowered to discover how they can best contribute.
Take Mike Cooper, a master technician at Georgia-Pacific. With a career spanning 40-plus years, he used to worry about whether his job would be automated. That’s a legitimate fear, and many companies stoke it by failing to help their employees find new ways to apply themselves. By contrast, as we implemented our principles at GP, Mike came to see that automation could create more opportunities for him, not fewer. The company supported Mike by providing him training, recognizing that we all need assistance to succeed.
Soon, Mike’s facility was filled with laser-guided vehicles that did his old job, loading pallets of paper into shipping trucks. One day, he noticed that costly mistakes were being made on the back end, so he used his own skills to design a solution on the front end. He created a device to adjust the vehicles’ sensors, making them more precise when loading.
Mike was rewarded and now holds a patent for his invention, which is used across the company and saves a lot of money that we invest more effectively elsewhere.3 He is one of a great many Koch employees over the years who saw a problem and used their talents to solve it. (The company did its part by removing barriers in his way.) Every employee who succeeds moves the company and society forward.
One reason for our progress is that it is widely known at Koch Industries that the reward for success will be greater than the penalty for failure. Throughout history, inventors and entrepreneurs have experimented for the same reason. To encourage our employees to do the same, we have cultivated a culture of prudent risk-taking—asking employees to experiment—and we ensure that they share in the profits if they find a better way to serve customers. The same is true when they find a way to use fewer resources, which we can then devote to other needs.
In practice, this means that even the most junior employee can dramatically increase their income. Recently, two technicians at our Wichita analytic lab together doubled their normal income by developing a test method that enabled us to significantly increase throughput at one of our plants. At Koch, anyone can earn more than his boss by creating more value. We put no limits on incentive pay, which is entirely dependent on an employee’s contribution.
Once again, this is essential to empowerment: if you know you’ll succeed by helping others, then you’ll focus on doing so. That, after all, is the story of progress.
A COMPANY TRANSFORMED
What has been the result of the application of these principles? Nothing short of the transformation of Koch Industries.
When I returned to Wichita, the company was relatively small. We had one low-volume manufactured product, a small oil-gathering system in Oklahoma, and a ranching business. We weren’t doing very much, and we weren’t doing it very well.
Empowerment changed everything, slowly at first and then faster than I anticipated—just like the Great Enrichment. Our employees began to see new opportunities, applied themselves to make the most of them, and then found still more opportunities. Not only did they improve the existing parts of the business, they also found new businesses to enter.
Just as employees applied their abilities to find new success, the company applied its capabilities to do the same. Up and down Koch Industries, we have continually worked to succeed by increasing our contribution to customers, employees, and other key constituencies.
Where we are now looks nothing like where we started.
Recall my first assignment at Koch Engineering, which was failing in the 1960s. Now it’s a leader in separation and combustion technology, pollution control, engineering and construction, and many other fields. One of our oldest and stodgiest businesses is bursting with new ideas. Its revenue has increased more than a thousandfold—and its net income even more—for the simple reason that it’s filled with employees who want to contribute, and do.
Remember that small oil-gathering system? As you already know, we turned it into the nation’s largest. That successful transformation required building a trading capability that turned into a large commodity-trading business. We then took the lessons learned and applied them to gas liquids and natural gas. Next we used our gathering capabilities to create distribution businesses in energy, asphalt, and fertilizer, among others. Fertilizer distribution also gave us the opening to build a much broader fertilizer business. Once again, our expanding success flowed directly from our employees’ expanding contribution, a process that continues today.
These are the never-ending cycles I mentioned in the introduction—what we call virtuous cycles of mutual benefit.
Without going into too much detail, a virtuous cycle starts when a person discovers, develops, and applies her unique ability to create value in the lives of others. The more she develops and applies it, the more she expands her horizons and discovers new opportunities to succeed. As she uses her abilities to a greater degree, she reaches new levels of achievement in a process that repeats over and over. While individuals create these cycles with the development of their aptitudes, a company does so by applying and expanding its capabilities.
Beyond the two mentioned above, we have created these cycles in three other areas.
The Pine Bend refinery is the foundation of our largest cycle. What started with oil refining has grown into chemicals, nylon, paper and building products, glass, and renewable energy, putting us in the business of everything from airbags to paper plates to energy-efficient construction materials. We’ve also created a cycle with investments that help other companies improve their businesses.
Our most recent is perhaps our most exciting: electronics and data technology. Through technology, much of what used to be dull or dangerous work at an office, chemical process plant, or manufacturing facility can now be handled by a technological solution, freeing employees to do higher-value, more challenging, rewarding work. This gives employees in all kinds of roles a much better chance to self-actualize.
Our employees’ success has always been the source of our success. And what a success it has been. As I mentioned in the introduction, Koch Industries has grown 7,000-fold since 1961—43 times the growth of the stock market, an increase of up to four orders of magnitude. An investment of $1,000 in the company when I came back to Wichita would be worth $10 million today. Where then we had revenues of $12 million, we now have annual revenues of around $120 billion—a 1,000,000 percent increase.
These numbers surpass everything I thought possible. In fact, shortly after I joined, I plotted out my vision for the company’s growth. By 2019, we had exceeded my lifetime goal eightyfold.
While it’s tempting to look at this transformation and think that it all happened because of top management, I give the lion’s share of credit to our employees, as would any other executive, past or present. We certainly played our part—everyone does in bottom-up progress—but so did our employees. Whenever you read this, they will still be innovating, creating, and challenging on every front. That’s what empowered people do, and the results are amazing.
It may also be tempting to look at Koch Industries and see nothing but good outcomes. This is false. The path of progress is never straight and is always full of pitfalls. The biggest ones have been homemade—when we failed to follow, or pretended to follow, the principles of progress, such as openness, empowerment, and mutual benefit.
From the beginning, I personally had more failures than successes. As for the company, we’ve made many bad bets, from animal feed to pizza dough to tankers to drilling rigs. In that respect, the company’s experience was no different from that of an individual. What’s more important than the setback is the lesson you learn from it. Far from stopping you, setbacks should cause you to rethink the path forward.
I often recall Thomas Edison’s response to being consoled over the lack of results in his nearly 10,000 attempts to develop a new battery: “I have gotten a lot of results. I know several thousand things that won’t work!”4
To this day, we continue to search for new ways to succeed, not only through innovation with our products but also with how we empower our employees. Over the years, we developed a framework called Market-Based Management® to help every employee understand the principles of progress and contribute to a greater degree.
Since describing this framework in my book Good Profit, we have made significant revisions in the spirit of continual transformation, all of which are reflected in my recent short book, Continually Transforming Koch Industries Through Virtuous Cycles of Mutual Benefit. The last of our Guiding Principles has been changed from fulfillment to an even more powerful concept—self-actualization. (All our Guiding Principles can be found in an appendix in this book.) It has helped our supervisors at every level better enable our employees to realize their potential.
What was true in the 1960s is still true today: we thrive when our employees flourish, and their contributions move society forward.
THINKING BIGGER
America certainly needs a better business culture. As I describe in chapter eight, many companies still control their employees, rig the system instead of creating value, or both. I will continue to advocate for more businesses to break down the barriers that hold them, their employees, and our country back. I will always call on all companies, and all business leaders, to practice Principled EntrepreneurshipTM—doing well by doing good.
Yet to me, transforming business is just one part of a larger opportunity: transforming society for the better. At the same time we were breaking down barriers holding back our employees, I was working to break down barriers holding back people from all walks of life. The control mentality was alive and well across so much of America. (It still is, as we’ll discuss.) So, just as I applied the principles of progress to foster the company’s success, I sought to help implement them to spur a new era of progress in our country. My goal was, and is, the same in philanthropy as in business: to empower people. Enable them to build a better future for themselves and everyone else.
This looks a lot different for our country than it does for Koch Industries. The principles are the same, but their practical application has to be much more widespread. The control mentality takes many more forms—and holds back many more people—in society than it does in a single company. Overcoming it requires an even greater effort, from even more leaders—Social Entrepreneurs like you.
That brings us to the big problems in our country, and how you can help solve them.