How Good Profit Built A $125 Billion Business

To investors,

I have been reading one book per week this year. This past week’s book was Good Profit by Charles G Koch. Highly recommend reading it. If you are interested in the individual highlights that I made in the physical book, you can read those here. Hope you enjoy these notes every Monday morning.

Book’s main argument:

Koch Industries is estimated to produce $125 billion in annual revenue, which makes it the second largest private company in America. CEO Charles Koch has a unique business philosophy that revolves around “good profit,” or profit that is created through economic means instead of political means. This book delves deep into how the Koch brothers built their father’s business into a multinational conglomerate by simply solving customer problems. Create value for others or eventually be disrupted.

5 Big Ideas:

💡 Idea #1 — Koch Industries is laser-focused on creating “good profit.” Koch writes:

What I consider to be good profit comes from Principled Entrepreneurship – creating superior value for our customers while consuming fewer resources and always acting lawfully and with integrity. Good profit comes from making a contribution in society – not from corporate welfare or other ways of taking advantage of people. 

This value creation can be for various participants in the market.

We earn profit by creating value – for customers, society, our partners, and every employee who contributes. That is good profit. 

The Koch obsession with good profit means that they are against profits obtained via political means. Koch writes:

Too often, Washington chooses winners and losers in the economy. This is corporate welfare, and it’s the opposite of freedom and good profit. 

Market-Based Management emphasizes Principled Entrepreneurship over corporate welfare, virtue over talent, challenge over hierarchy, comparative advantage over job title, and rewards for long-term value creation over managing to budgets. 

💡 Idea #2 — Great companies are designed the same way that great societies are designed. Koch explains what makes a great society:

Free societies, which are based on respect for what people value, enjoy the greatest prosperity. 

Societies that don’t embrace freedom wind up with the least prosperity. 

This prosperity is obtained by individuals and companies that figure out how to create value for others. Koch writes:

From antiquity to today, the best societies, as well as the best companies, have been the ones with a framework of freedom in which individuals can improve their lives by improving the lives of others.

💡 Idea #3 — Koch Industries is relentless in their pursuit of creative destruction. Koch writes:

Koch strives to drive what Schumpeter called creative destruction, creating “the new commodity, the new technology, the new source of supply, the new type of organization.”

The point of creative destruction is not to destroy for the sake of destroying, but rather to create value.

Value creation is the upside of creative destruction. It makes people’s lives better, thereby contributing to well-being in society. A successful company creates value by providing products or services customers value more highly than their alternatives.

The creative destruction philosophy is essential to survival in the eyes of Koch. He writes:

MBM (Market-based management) teaches that we must continually drive constructive change in every aspect of our company or we will fail. As a result, we constantly pursue disruptive innovations and opportunities through internal and external development as well as acquisition. Similarly, we shed businesses and assets that are unprofitable or worth more to others. We believe we must drive creative destruction faster than our competitors; otherwise it will drive us out of business.

💡 Idea #4 — Your business will not survive, nor grow into a large company, if you fail to have a clearly defined vision. Koch writes:

Despite our superficial differences – David and I have gotten along as business partners for half a century because we have always shared the same vision for Koch: to innovate, grow, and reinvest in order to maximize long-term value by applying our core capabilities.

While Koch’s approach to company building may seem different, they are still following the simple rule of compounding.

Koch’s emphasis on compounding (sometimes called “the most powerful force in the universe”) is another difference between the vision of our company and that of many others.

A strong, clear vision will also make other aspects of your business, such as recruiting, easier than it would be without a strong vision. Koch writes:

Having a clear vision is critical to attracting the best talent, as well. Understanding what a business is trying to achieve and how it creates value – in other words, its vision – not only enables employees to focus and prioritize; it helps them develop and find fulfillment. Having a shared vision guides the development of roles, responsibilities, and expectations. That’s why getting the vision right, helping employees (especially leaders) internalize it, and updating it as often as necessary is essential.

💡 Idea #5 — It is essential to get incentives right for your company, team, customers, and community. Koch focuses on these incentives every single day. He writes:

If profit is generated by Principled Entrepreneurship — by creating long-term value by economic means — then the interests of the company are in harmony with the interests of its customers, suppliers, communities, employees, and society at large.

The incentives aren’t just for customers and the company though. Koch ensures that employees are paid based on how much value they create for the business. He explains:

Since we strive to profit by creating value for our customers and society, our philosophy is to pay employees a portion of the value they create for the company.

Koch realizes that a private company has very different incentives than a company in the public markets. He is religious about their private status. He writes:

Another type of perverse incentive is endemic at publicly traded companies: the quarterly earnings report. Management at a public company is under a great deal of pressure to meet quarterly earnings forecasts, because falling slightly short can cause a significant drop in the stock price. Consequently, management is motivated to make decisions that optimize short-term earnings at the expense of maximizing real long-term value.

Such decisions may include underinvesting in attractive cyclical or long-term opportunities, ignoring needed write-downs, or even manipulating the books. Perverse incentives like these make managing a public company extremely difficult. They also make it clear why Koch Industries prizes its private status, and why I’d counsel any entrepreneur to do everything possible to keep her company private, no matter how big it grows. 

Memorable quotes:

1. To be truly rich is to live a life of meaning.

2. Good profit is earned through principled entrepreneurship — helping people improve their own lives.

3. Businesses with good ideas but poor execution ultimately fail.

4. We have found that aligning incentives with performance almost always improves outcomes.

5. Beware: Perfection is the enemy of progress

6. People tend to take better care of things they own.

7. The lesson is that societies are most prosperous when knowledge is most plentiful, accessible, relevant, and inexpensive.

8. Dedicating a full-time, A-level performer to a particularly thorny problem is often the key to successful innovation.

9. “Grateful for everything; entitled to nothing.” - Coach Clark

10. Arrogance is one of the most destructive traits in an organization. 

11. The best coaches place as much emphasis on virtue as on talent.

12. Now, more than ever, if you don’t have a culture of innovation, your days are numbered. 

13. In a truly free society, people and businesses gain by serving others. 

14. Short-term profits, while necessary, are not sufficient for long-term business success.

Pomp’s Takeaways:

This book has become my favorite business book. That is the greatest endorsement that I could give to something that I have read. Many of the concepts are timeless, but Koch is able to tie them into his overarching thesis that companies should be run like prosperous societies.

My first big takeaway was the idea of good profit. Every company is focused on making money, but there are few that focus on making money the “right way.” Good profit dovetails nicely into Koch’s focus on creating value — for customers, employees, and the local community. That was refreshing to read.

My second big takeaway was how strongly Koch felt about staying private. It essentially boils down to perverse incentives, and I probably shouldn’t have been surprised given that Koch is $125+ billion revenue business in private markets, but it was still fascinating to read. The principled approach is hard to call out because it appears to run throughout the organization and thought process.

My third big takeaway was how hard Koch was still working at age 79 when he read the book. Here is what he said:

Why, at the age of seventy-nine, do I put in nine-hour days at the office and then go back to work at home after I’ve exercised and had dinner with Liz? It’s not for mortgages or tuitions (at least not anymore), since our children are grown, educated, and married. I certainly don’t claim to lead an ascetic life, but neither accumulating material goods nor amassing a big pile of money has ever been an incentive for me to work. My motivation to work hard has always been my need to lead a life of meaning – a fulfilling life. I want to do my best to make a difference in the world. I would rather die for something than live for nothing. Making good profit — earned by economic means instead of political ones — is a measure that tells me people value my contribution. No wonder, then, that it is one of my incentives.

That is just incredible to read. It speaks to Koch as a person, but also the energy and commitment that is set from the top of an organization.

My fourth big takeaway was how Koch treats employees like mini-entrepreneurs. They give them a strong, clear vision to follow and then turn them loose. The right people will solve problems, create value, and drive Koch Industries forward. The company will then do whatever they can to compensate these star employees with compensation that is commensurate to their contribution.

My final big takeaway was the obsession that Koch and his leadership team have with preventing disruption from happening to them. He talks about beating competitors to creative destruction, he mentions that innovation is the key to their sustained success, he calls out the fact that Koch is never too big to fail, and he highlights Coach Clark’s famous saying “Grateful for everything; entitled to nothing.”

It takes immense humility to run a $125+ billion annual revenue business and be focused on preventing a newcomer from eating your lunch. I love reading about people who are razor sharp, even though they are on top of the mountain. That unquenchable thirst for winning is a hell of an advantage in business.

As I mentioned, this past week’s book was Good Profit by Charles G Koch. Highly recommend reading it. If you are interested in the individual highlights that I made in the physical book, you can read those here. Hope you enjoy these notes every Monday. Feel free to leave a comment - I read all of them.

-Pomp

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