Topeka ? Charles G. Koch is a capitalist who believes the role of business is to create value in our society. If it doesn’t, he said, the business should be shut down or sold.

Koch, 71, chairman of the board and chief executive officer of Koch Industries Inc., used his studies of science, engineering, sociology, economics, philosophy and psychology to pen his book, “The Science of Success: How Market-Based Management Built the World’s Largest Private Company.”

He says his philosophy of market-based management is responsible for growing Koch Industries 2,000-fold since 1961, when he joined the company.

Under his leadership, Koch Industries has grown in book value by 18 percent annual return – much better than Standard & Poors 500 Index return of 10.4 percent from 1965 to 2006. A $1,000 investment in Koch Industries in 1960 would be worth $2 million today.

Koch, whose net worth has been estimated by Forbes at $12 billion, is shy of reaching Warren Buffett’s astounding 21 percent annual return.

While Buffett lets existing management run businesses separately, Koch applies market-based management toward acquisitions and operations.

“He (Buffett) lets existing management run it and run it separately, and it’s been a great formula for him, but ours is different,” Koch said.

“Ours is to identify our capabilities, which we will draw upon all our companies, and try to find new opportunities for which we can apply those capabilities. By applying our capabilities, we can increase the value quite a bit.”

Market-based management begins with a vision for determining the greatest long-term value; using virtue and talents to ensure employees with the right values, skills and capabilities are hired, retained and developed; creating, acquiring, sharing and applying relevant knowledge and measuring and tracking profitability; and ensuring the right people are in the right roles with the right authorities to make decisions and holding them accountable.

Market-based management rewards people according to the value they create for the organization.

Taking over the family business

Koch’s father, Fred C. Koch, was born in 1900, the son of Dutch immigrant Harry Koch. Fred Koch, who graduated from Massachusetts Institute of Technology with a chemical engineering degree, co-founded an engineering firm in Wichita in the late 1920s, developed an innovated crude oil refining process and participated in the oil development of the Soviet Union, but found the communist country to be a land of “hunger, misery and terror.”

Fred Koch ran Wood River Oil and Refining Company (the predecessor company to Koch Industries Inc.) & Koch Engineering from 1950 until his death in 1967.

Charles Koch earned his bachelor’s and two master’s degrees in engineering at MIT and was made chairman and CEO of Koch Industries in 1967 after his father died.

In December 2005, Koch spent $21 billion to buy Georgia-Pacific, adding lumber and paper to its other businesses in petroleum refining, chemicals, pipelines, commodity trading, fertilizer, finance and production of nylon fiber and polymer products.

The acquisition made Koch Industries, with $90 billion in revenue, larger than food giant Cargill, which had $75.2 billion in sales in 2006.

As part of the value creation process, market-based management requires a challenge process and intellectual honesty.

“How are we going to learn if people we work with won’t tell the truth?” Koch asked.

If you go your whole life punished for challenging others, then you may have a strong reluctance for doing it. But, he said, market-based management requires people to challenge ideas, including the boss’ idea.

“It’s our responsibility as employees and particularly as leaders to find the best sources to compensate for our weaknesses so we can make the best decisions,” Koch said. “This is part of your job to challenge. For example, if you see waste in your area and you grouse around the water cooler, ‘They are wasteful’ – well, you are not doing your job. Your job is to help us create value. If you just sit there and whisper about it, what good is that?”

Even if you lack resources or authority, Koch expects the employee to speak up when there is an opportunity to create value.

“Look at all the great entrepreneurs, like Bill Gates. They didn’t say, ‘Oh woe is me, I don’t have money.’ The ones who create value, they go out and get the money and build on it, and they work twice as hard, because they’ve got to do that, too,” he said. “That’s what value creation is all about. It’s overcoming obstacles to find a way to make a contribution.”

Koch said the company has had its share of mistakes, but they have learned from them. The company has exited nearly 40 businesses, including prepackaged pizza dough and meat processing.

Creative destruction

Koch said change is occurring at an accelerated rate, resulting in new and better products, better methods and new companies that are driving out those less effective. Joseph Schumpeter called this process “creative destruction.”

“We hire those with the talents to drive creative destruction,” Koch said. “We find out what is going on in the world that is at the cutting edge, so we can adopt and leapfrog our competitors.”

If a company is content to please customers without changing, the business will lose value because customers’ demands change.

“What do we need to know to anticipate what our customers are going to value in the future?” he said.

He said market-based management should be applied as a whole.

“To have this approach be transformative, it has to be applied holistically,” he said. “These parts have to be in harmony and applied as an integrated whole. And then you get the power.”

He expects employees and businesses to exceed regulatory compliance while finding ways to beat the competitor.