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The Science of Success

Market Based Management

But first, a few words about the

The Use of Knowledge in Society

Fredrick Hayek
American Economic Review
In the context of the planning problem:

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
coperation. 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


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 its 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

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
Dcor 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

On to The Science of Success
Charles Koch and Koch Industries

KII (Koch Industries Incorportated)

One of the largest privately held firms in the

Revenues, 2006, 90 billion
Major Components
Invista (Textiles inputs, once a part of DuPont)
Georgia Pacific (Lumber products, materials)
Pipelines and transportation
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
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
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 1960s 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 shouldnt 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 Value
Anchored in peoples 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

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
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

A vision statement is the organizations view

of how it plans to create value.
Some RBV
(Regarding the erosion of profitability over a
products 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
(Still on vision: Innovation)
Stainmaster example.

It is natural to think that if customers dont

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 Talents
The 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
Value creation
Principled entrepreneurship
Customer focus

Multiple Intellegences

(It takes all kinds to make a world)

Lessons from a week at leadership
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

Decisions, decisions
Does the decision require information from

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 havent already

Identify three places in each chapter that are

right out of economics

Identify two more that reflect economics.

Bring your list to class.