Good Profit

Today we visit the book Good Profit by Charles Koch.

As you will probably quickly realize, the book is written by one of the leading libertarians and largest republican donors today. It would be easy to simply think that this book must have a political slant. On the other hand, Charles Koch is the CEO of Koch Industries, which is the second-largest private company in the US with revenues of $110BB (Cargill is the largest with revenues at about $115BB). He is also the 18th richest person in the world with a net worth of about $45BB (his deceased brother, David Koch, was number 11 on the list with a net worth of around $51BB and his other two brothers are wealthy as well). Regardless of political affiliation, there are lessons to be learned from successful executives who manage a conglomerate of businesses.

Good Profit is a distillation of the Market-Based Management (MBM) philosophy that Koch Industries has developed over time. Here are a few excerpts that stood out to me and are concepts that caused me to think about personal or project-related issues.

Trusted Teammates

Being aggressive, providing the best service, and developing the best relationships still describe our aspirations today—no matter the business

…mutually beneficial voluntary transactions based on trust are the hallmark of economic freedom and vital to good profit.

Aspects of the above excerpt that focus on “relationships” have been bolded. A key component of getting work done efficiently is to build relationships over time. Building those relationships involves:

  • Identifying competent members of your team
  • Giving them (or getting) clear instructions and expectations
  • Paying or rewarding them on time
  • Avoiding being difficult to work with as long as expectations have been met 

While I have worked in a number of different project management situations, the pursuits where the project team has already worked with each other in the past and seen benefit from doing so have been the best. While possibly not the least costly, as one can always find consultants or employees that undercut others, those arrangements have produced work that has been the most timely and of the highest quality. 

With a new consultant, or an untrusting one, there are all sorts of delays regarding getting accustomed to each team member’s style, how each team member produces their share from time and quality perspectives, potential difficulties that could arise from changes in the project, and billing once the work is completed. 

While I have never experienced the following situation, I have read about good deals that were done with competent parties based on a handshake. Such an agreement is fraught with danger but if the parties are capable and dealing from a place of mutual trust, the partnership and deal better for quick decisive action. 

The primary focus in building relationships is developing trust. A novice in the marketplace simply does not have trust built up in others. They have not established a reputation either. Being diligent about placing controls around a new relationship is prudent at this phase of little to no experience. However, once trust is built, with your team members and yourself, it is better to have quicker agreements than a long bidding process. With expedited team-building, the energy can be spent on implementing the project, as opposed to making your working arrangement iron-clad. 

Finally, to go back a few paragraphs about working with teammates you have past experience with, having a small but competent team to draw from is all one really needs to be effective in implementing projects. A great deal of time is wasted gathering more competent teammates and getting competitive proposals to squeeze out the last bit of profit. If a project is lucrative, it likely does not hinge on whether a consultant can come in low on their proposal. Additionally, if a decision is made to go with a different consultant as opposed to a tried and tested member of your team, there could be relationship damage and can lower the level of trust.  Being comfortable with your team ahead of confidently moving forward is the order that should be aspired to.

Question: Are teams being cultivated personally or professionally such that the above bullets are met?

Chose Well

Koch treats a portion of the potential profit from a missed opportunity as an actual loss when determining an employee’s incentive compensation.

Working on a profitable activity is wasteful when there is an even more profitable activity that could be performed instead.

This is a concept that was discussed in the context of employee output and their incentives. Oftentimes, it is thought that as long as a task is profitable, then it is worth doing. Time and energy is spent on maximizing profit within that task. What Koch is trying to say here is that the task itself should be questioned in the context of other pursuits that could be done instead. A decision to go down one path means that the other paths are not followed. 

Let’s say that a division manager chooses between producing Product A or Product B.  At the time of the decision, both products seem as though they would cost about as much as each other and make about as much as each other, so the decision about which product to pursue is a toss-up. The information at the time indicates that Product A should be built as it would be slightly more lucrative than Product B. 

In the end, Product A costs $2M to implement and makes back the company $3M. That is a decent profitable return. However, a competitor built Product B at a cost of $1M and made their company $4M. While the choice to go with Product A was the best given the information at the time of the decision, it meant that their profit was only $1MM and not the $3MM for Product B. Koch is saying that Product A should not be celebrated (through big bonuses) when the company in the end missed out on a much larger opportunity. 

This concept, that other projects may be better than the one you have chose, despite being diligent and choosing appropriately at the time, seems harsh. In the decision, the team did their best to make the right one. In this scenario, it was also profitable. However, looking back after the project is complete and reviewing the other avenues can be an appropriate model to look at how effective those efforts were.

Question: What are you or your organization working on that look inadequate compared to what else you/they could be doing with their time? More importantly, what are you about to make a decision on that could look bad in retrospect?

Better Plans

…a buyer almost always has a different vision.

When a company/division/asset is bought from the current owner and changes hands to a new owner, the new owner believes that the investment will be more valuable under their direction. 

A good example is an old traditional downtown office building. The current owner has been managing leases and keeping up on property maintenance. They are doing an adequate job of it as it is regularly filled up and gets good rents. A new buyer comes along and would like to kick out the tenants, rip out most of the insides, and alter it such that it is an open creative office. This new buyer plans on spending a lot of money and time on this transition but believes that as a result, they can get higher rents for the new space, have to maintain the property less, and spend a reduced amount on utilities. The new buyer believes that all of their planned work will be worth it as the new office building’s value appreciates much more from their efforts.

Could the old buyer have done something similar? They could have but they either a) did not have the idea to do so or b) did not have the skillset or risk-tolerance to implement a large capital improvement project. Either way, it is a more valuable asset in the hands of new ownership than it was with the old one.

Question: What is it that you own that could be more valued/appreciated by someone else? What is something that another owns that you would have a better idea for how to operate it?

Insurance Fallacy

purchasing insurance can provide a false sense of security that diminishes appropriate risk evaluation and mitigation.

we had a balance sheet that (while nothing like those of the majors) gave the producer the confidence that we could always pay for the oil—and pay promptly—even under adverse circumstances.

Insurance is a business. They make money (premiums) by paying out to the policyholder in the event that something goes wrong. I say that it is a business because the insurance company makes more on premiums coming in (revenues) than the amounts they have to pay out (expenses). If the company is not profitable, if revenues do not exceed expenses, then the insurance company goes out of business.

To rephrase the above, an insurance company will in aggregate charge more to insure against incidents than it would cost to reimburse their clients for those incidents. More succinctly, a policyholder pays more for insurance than the risk-adjusted cost of the incident.

So why does insurance make sense for policyholders? 

Most policyholders do not have the financial wherewithal to stomach the costs of dealing with an event. For instance, the leading cost of bankruptcies in the US is  medical claims. If someone gets cancer without health insurance, they likely cannot pay for the treatment. Insurance helps to smooth out the bumps in the road. The regular expense of carrying an insurance policy for various coverages is more palatable than the very rare occurrence where someone would have to pay out if an unforeseen event happened.

For most people and companies, carrying insurance policies makes sense to avoid that crippling obligation incurred if insurance was not carried and an incident happened. I say for most people because, if one can self-insure, meaning they have enough cash to cover the unfortunate event, then one can forego the expense of paying for insurance. For living costs or project costs, if insurance does not need to be carried then expenses are lower, making the person’s lifestyle or the project cheaper. 

If a party has enough money, then their lifestyle or project can be cheaper to operate. The rich keep getting richer. But the main point is that if a negative occurrence in your life or the life of a project occurs, and it does not throw your finances into shambles, then paying for insurance is not a smart use of money.

Another point made here is that insurance may provide a false sense of protection. Something may go wrong, and if the company wasn’t diligent about it, if they didn’t realize how the exposure of the risk they could be taking by not paying attention to those risks, then they may increase the chance of having to use that insurance. It’s like walking around smoking three packs of cigarettes a day because you have really good health insurance. You still are increasing your chances of getting lung cancer and even if insurance pays for it all, you still have to deal with having lung cancer. 

Question: What insurance do you carry that could be self-insured against? What are areas of your life where insurance is needed because you can’t self-insure? Does carrying insurance in that area of your life lead you to act more reckless?