If you’ve heard the phrase “market-based management,” you might wonder what the buzzwords actually mean. Tony Woodlief, president of the Market-Based Management Institute, recently discussed the topic with Mitch Kokai for Carolina Journal Radio. (Click here to find a station near you or to learn about the weekly CJ Radio podcast.)

Kokai: People probably have heard this term somewhere: market-based management, MBM. What is it?

Woodlief: Well, it’s a management philosophy that originated at Koch Industries, which is the largest privately held company in the United States, and the world, in fact.

Kokai: And we should explain, this is K-O-C-H, not Coca-Cola.

Woodlief: Right. I still have family members who think I can get them discounts on 12-packs of Coca-Cola, and I cannot! It’s an oil and gas company based in Wichita, Kansas, and they have operations all around the world in a variety of areas. So the management philosophy was developed by Charles Koch, who is the CEO of this company. He had a real grounding in economics and history and philosophy. So what he observed years ago is that, just like you have prosperous societies that have features about them that make them different from very poor countries, you have companies that have a way of managing themselves that makes them very different from companies that aren’t as successful. So the basic idea behind market-based management is that, just as you see in a market — entrepreneurs flourishing and developing new products that we all can use and appreciate — you want to have that same entrepreneurial impulse inside your business. So you create the right incentives and a clear vision and measurement and those sorts of things to get entrepreneurial behavior in your company.

Kokai: This might sound good conceptually to folks, but bringing it to the level of how this would affect them, how might an operation that’s using market-based management be different from the types of companies that most of us are used to?

Woodlief: That’s a good question. I think it’s in small and large ways. Some of the smaller things are that what we measure is a little different. For example, if you have a sales force, very often you’ll find a company is paying their sales force to work against them. You’re essentially rewarding your sales people for bringing in volume rather than focusing on profitable sales. Or you’ll find that your sales people are spending all their time with the least profitable customers because they’re the largest customers, and so attending to the right numbers can lead you to different behaviors. That’s just a small example.

At the biggest level, essentially what we’re talking about is helping the owner or the manager transition from being somebody who makes all the decisions and has to deal with all the problems, into being a coach and a leader on a team of people who can use their own brains. And that, I think, not only leads to a more successful company because you’ve got more brains involved, but it also allows the manager to be the person that he probably envisioned being when he first got into management, instead of a prison warden or a babysitter or somebody who has to solve problems that common sense ought to be able to solve.

Kokai: This is not a case, from what I understand, of people just going out on their own and figuring out what they’re going to do and trying to organize that chaos, but there is some management involved.

Woodlief: Correct. Obviously it’s based on principles of a free market; that’s why we call it market-based management. But that doesn’t mean it’s libertarianism in the business, where anybody can do whatever he thinks is best. You begin with a very clear and compelling vision – not a vision statement, because every company anymore has a fancy vision statement that most people don’t understand — but instead, clarity among all the employees about what they are trying to accomplish. And then from there, you’re making sure that these people have the right authority to pursue that vision, so they have leeway to pursue the vision. And you’re protecting yourself as the business owner by being very careful about who you hire, by choosing not just people who have the right skills but who have a set of values and beliefs that promote entrepreneurial behavior. They have integrity, they’re honest, they’re humble – so you’ve been very careful choosing them, you’ve given them a clear vision of what you want them to achieve, and then you’re giving them the authority to go pursue that vision with incentives in place so they know if they knock themselves out and hit a home run for you, there’s something in it for them, too. They’re not being paid just for the time they put in, they’re being paid for the value they create. Then behind all that, you have a set of measures to measure individual performance, the performance of your plant, the performance of assets, on-time delivery, whatever it is that’s important for your business to achieve. And so you put all that together, and you’ve got a system that works well and is harnessing the dispersed knowledge of people in the business instead of the handful of people at the top making all the decisions and not using the brainpower of the people who are closest to the work, which is often what happens in a company.

Kokai: Now I am guessing that as the president of the Market-Based Management Institute, you would tell us that individual companies that adopted this method would be better off. How would our society be better off if more companies, nonprofits, [and] other organizations used these types of principles?

Woodlief: That’s a big question. I’ll try not to answer it with a lot of big words, which I’m not competent to use. I think it’s not always the case that this is better for everybody because it puts a lot of responsibility on individual employees to start using their own brains and making decisions and being held accountable for them. And it puts a lot of responsibility on managers to coach and lead rather than have a formula for how you pay people, make all the decisions yourself, do things the way you’ve always done them. So there is more opportunity for action but there is also more opportunity for failure, and not everyone wants that.

The reason we think it’s valuable for a company — obviously it’s been very useful for Koch Industries, which is a very successful company — our point of view is that when you give employees the opportunity to think like and behave like entrepreneurs, work becomes more fulfilling, they use their talents more appropriately, they have a stronger part in doing something that’s worthwhile in society. I think for a lot of people, they get stuck in jobs where they have no real say in how the job is done. They have ideas for how it could be done better, but they know nobody’s going to listen, or if they stick their necks out and try to do it differently, if it succeeds there’s nothing in it for them. If it fails, they get punished. So they’re smart and they don’t try to do anything differently. And that leads to a very unfulfilling life. We spend the majority of our waking hours at work; it ought to be something that we think is worthwhile. So our belief is that this management philosophy helps make work more worthwhile, more fulfilling for people, and it makes the company more profitable.

Kokai: If more firms used this type of management, do you think that would help with America’s long-term economic growth?

Woodlief: I think so. We see that the majority of job growth comes from small businesses. They’ve always been the engine of change and entrepreneurship and growth and prosperity, but small businesses have a tougher and tougher time with global competition, so it’s not a guarantee [that] because you have a good idea, you’re going to be able to make a go of it. So anything that can help a smaller business grow and employ more people is going to be good for society.

Kokai: If someone wants to learn more about these principles or about your institute, what’s the best thing for them to do?

Woodlief: We have a Web site: mbminstitute.org. Also, our CEO, Charles Koch, has written a book called The Science of Success, and in that he lays out these five components of market-based management, he talks about the principles that have driven success of Koch Industries and tries to give some meat to the bones of this framework. That’s where I’d start — with his book.