“In Palm Beach,” said Nestor Weigand, “[Charles] was very respectful to Billy. He didn’t ignore him. He didn’t punch him, but he was there, then he was gone. I don’t think that there’s a tremendous amount of conversation between times.” He added, “They’re definitely not friends.” Charles seems to have difficulty even uttering Bill’s name, let alone calling him a brother. He referred to Bill in one 2012 interview as “the brother of the twin.”
Bill describes his relationship with Charles as one of “peaceful coexistence.” But the peace between the brothers remains a delicate one. Bill’s longtime spokesman, Brad Goldstein, mixing military metaphors, suggested that it would not take much—an errant interview perhaps—to reignite “the war between the north and the south” or provoke a “nuclear escalation.”
CHAPTER TWELVE
Planet Koch
Unshackled from the bitter feud that had consumed the Koch family for two decades, and with the onslaught of prosecutions by environmental regulators behind him, Charles led Koch Industries into a period of explosive growth. It was an unprecedented spurt even for a company that had expanded by more than a thousandfold since the early 1960s. Charles attributed this expansion to a management system that blended his libertarian ideology into all aspects of the business. Just as General Electric has Six Sigma, Koch Industries runs according to the precepts of Market-Based Management.
In April 2004, the rapidly growing company completed its largest-ever acquisition, buying the textile-maker Invista—owner of such trademarked brands as Lycra and Stainmaster—from DuPont for $4.2 billion. Soon Charles pursued an even more ambitious deal. The negotiations played out during the fall of 2005, heating up over a weekend in early November when he was supposed to have been kicking back with a small group of friends and family. The occasion was Charles’s seventieth birthday and the Kochs had invited their guests to celebrate the milestone with them in Indian Wells, the resort town near Palm Springs where they own a 7,500-square-foot vacation home. The five-bedroom, eight-bathroom mansion sits behind the unmarked gates of the Vintage Club, an exclusive community where neighbors include Bill Gates, Lee Iacocca, and Phil Anschutz; before a new member can even fork over the $300,000 initiation fee, a sponsor and three other members must attest to his or her bona fides.
Charles is an avid golfer who regularly shoots his age, and he often unwinds by hitting the links at one of the local courses, but that weekend he was sidelined by an injury. He nevertheless accompanied David, John Damgard, and other friends on a golf outing at The Reserve, a nearby country club where Charles belongs, if only to satisfy the course rule that members accompany their guests at all times. While adhering to that regulation, Charles violated another: He was glued to his cell phone as he watched his guests play from the shade of a golf cart.
“You’re not very good company, Charles! You’re on the goddamn cell phone!” Damgard called out.
It wasn’t just Charles’s friends who noticed he was constantly on the phone. Before long, a member of the security staff drove up to remind him of the course’s no cell phone policy. “It’s my job to make sure people obey the rules out here,” he told Charles apologetically. Charles put his phone away. But after the guard left, he pulled it out again, glancing around occasionally with his ear to the receiver.
Soon, the security staffer came back to issue the billionaire another warning. “You’re putting me in a tough position, Mr. Koch—that’s the second time I warned you about that cell phone.”
“Okay, okay,” Charles said. The phone went away, but moments later he had it back at his ear.
The irritated guard later drove up a third time: “Mr. Koch, the rules are the rules. I’m really sorry but I have to turn you in, you’re going to get a letter”—a formal reprimand from the club’s management.
This time Charles shrugged, and kept the phone to his ear.
“Charles, what in the hell could be so goddamn important?” Damgard asked after the guard sped off.
“I can’t tell you,” he replied sheepishly.
This piqued Damgard’s interest. Something big was up. When he later pressed Charles again about the cell phone episode on the golf course, the CEO came clean. He’d been monitoring Koch’s bid for a Fortune 500 company.
“I just bought Georgia-Pacific,” Charles said.
Offering $48 per share, a 39 percent premium above where Georgia-Pacific’s stock was trading, Koch paid $13.2 billion in cash for the company and assumed $7.8 billion in debt. At the time of the $21 billion buyout, Koch Industries had some 30,000 employees scattered across the world, 18,000 of whom had been absorbed through the Invista deal. The massive acquisition of Atlanta-based Georgia-Pacific, with 50,000-plus workers and some $20 billion in annual sales, nearly tripled Koch’s workforce and catapulted the company to America’s largest private corporation (at least until the spot was reclaimed by Cargill). The company now boasted a population larger than some island nations.
The deal also had a sentimental dimension to it, completing an arc of history connecting the Koch brothers’ future to their past. It added to their extensive holdings a battered industrial plant located a few miles outside of Quanah, Texas, Fred Koch’s birthplace. Generations of Quanahans had pulverized gypsum into plaster there, and they now produce joint compound and slabs of wallboard bound for Home Depot, Lowes, and beyond. Fred himself had toiled at the plant one summer as a teenager.
At first glance, Georgia-Pacific seemed an odd fit for the satellite of companies that composed the Koch universe. It was a marquee-name paper, pulp, and forest products conglomerate that retailed popular consumer brands. Moreover, until Charles took Georgia-Pacific private, it was a publicly traded concern. Koch Industries, by contrast, was militantly private and, with the exception of its ranch holdings, had labored largely as a middleman in the oil and petrochemical industries, leaving the extraction and retailing to others but handling everything in between. What use would a petrochemical company that prized its under-the-radar status have with the maker of Brawny paper towels, Dixie cups, and Angel Soft toilet paper?
The answer lay in Koch’s unique operating style. The company did not define itself by the products it peddled, but by the capabilities it possessed. “We thought we were in the oil business,” a Koch executive once put it, “but we found out our real expertise is in the gathering, transportation, processing, and trading business.”
Viewed through this lens, Koch and Georgia-Pacific complemented each other in many ways. At their essence, both were conglomerates that excelled in processing raw materials—whether timber or gypsum or petroleum—into a wide range of products.
Few CEOs would have seen the wisdom of acquiring Georgia-Pacific, a company saddled with tens of thousands of asbestos-related lawsuits and billions of dollars of debt. But this was precisely the type of deal that Charles and his fellow executives sought out, involving a troubled company with the potential for a dramatic turnaround. They hoped that taking the company private would relieve quarterly earnings pressure and help refocus Georgia-Pacific on creating long-term profits. Koch Industries’ strong cash position would help reduce Georgia-Pacific’s debt load, enabling it to reinvest more of its earnings into the company’s manufacturing operations.
Charles possessed an uncanny ability to sniff out profitable ventures, and when he occasionally mired the company in money-losing deals, he quickly cut his losses. The results of his leadership spoke for themselves. Between 1960 and 2006, the company’s revenues increased from $70 million to $90 billion. During that timeframe, an original investment of $1,000 in Koch Industries would have swelled to $2 million, a rate of growth that outperformed the S&P 500 by a factor of 16. This was not just dumb luck. Charles had a formula.
Charles is not a religious man, but he is devout. He once read the Old Testament cover to cover, but his purpose wasn’t worship but to glean the secrets of its power and influence. He adheres to an economic theology; his prophets are free-market thinkers. He learned
to see the world through an economic prism—a series of transactions, each one guided by the innate laws of human behavior, a ballet of consumption. It didn’t matter whether you peddled formaldehyde or free-market dogma itself, the same rules applied.
One of the aspects of Charles’s personality that friends and colleagues comment on most, aside from his competitiveness, is how consistently his belief system permeates every corner of his life. “Whatever switch the rest of us have where we choose whether to integrate what we believe with what we do, he doesn’t have that switch,” said Tony Woodlief, the onetime Koch management consultant and a former vice president at Charles’s charitable foundation. “He just doesn’t have room to believe something and not act on it.”
This explains the libertarian-tinged ethos of Koch Industries, which traces back to the 1960s, when Charles earned the autodidact’s equivalent of a Ph.D. in Austrian economics in his book-strewn apartment. One thing that irked him about the budding libertarian movement, which he would spend so much time and money working to cultivate, was its reliance on untested theories. Theory interested Charles only insofar as it informed action. Koch Industries became his real-world laboratory.
Within the microcosm of his company, Charles worked to conjure the free-market utopia that the millions of dollars in contributions he channeled to think tanks, pressure groups, universities, and politicians had failed to bring about in the world beyond his control. It wasn’t until the 1990s, when Charles hit upon a name for his management philosophy, that he began a systematic effort to diffuse it through every strata of his business empire, from boardroom to mail room. He developed Market-Based Management, he said, through the study of the conditions that allow free societies to prosper—what Charles called the “science of liberty.”
First he flattened Koch Industries’ management structure. Wherever possible, he decentralized decision making and pushed it down to the lowest levels. In lieu of property rights, the company granted its workers “decision rights”—the authority to manage the assets under their command. This extended not just to managers or supervisors, but to mechanics, factory workers, and mail clerks, who often possessed valuable, but untapped, knowledge their superiors up the food chain did not. Employees who had previously kept their heads down and did their jobs now had the ability to modify equipment to operate more quickly or tweak refinery output on their own initiative.
“I went out and interviewed people and they were tearful,” Woodlief said. “We’re talking people without high school degrees, getting paid by the hour, no air-conditioning, at a manufacturing plant, but for these people their lives really had changed. Like one guy, he points out his work area with pride because now he is in charge of it. He decides how the work will come through it. He has authority.”
Charles’s management regime encouraged employees to challenge ideas, even those of their superiors. It deemphasized job titles—and in some cases eliminated them entirely—and the responsibilities and authority of people who held the same positions varied widely based on their strengths and ability. Koch’s employees were taught to think of themselves as business owners and drilled repeatedly on the imperative to create value in everything they did. The company removed salary caps and aligned incentives to harness employees’ entrepreneurial instincts; the company limited employees in their earning power only by the “value” they brought to Koch Industries. At the company’s highest echelons, executives often received six- and seven-figure bonuses. An especially capable employee could sometimes pull down more than his or her supervisor, after the company awarded incentive compensation.
The widespread application of Market-Based Management quickly upended the paradigm of the ideal Koch employee. “What was fascinating was that some people who had been exemplary employees in the old regime, where you kept your mouth shut and did what you were told, a lot of them didn’t make it,” Woodlief said. “Some of the troublemakers became exemplary employees, because when you think about an entrepreneur, that’s somebody who’s perpetually frustrated, who always sees a better way of doing it and gets really pissed off.”
Charles ran his company as a meritocracy; degrees and credentials often mattered little. High school–educated farm boys from Oklahoma ran multimillion-dollar divisions and ambitious twenty-somethings skyrocketed through the ranks. “If they find somebody who’s really going to do well, they give him every opportunity to grow as fast as he can grow,” said one former Koch employee who managed a division. “There’s no, ‘Oh you have to be around for five years before you do this’ type of thing. If you do well, your next step comes pretty fast.”
But in cultivating a free-market atmosphere within his company, Charles inevitably invited in some of its more carnivorous aspects. A cutthroat culture developed. Internal rivalries formed. “Everybody’s after everybody else’s throat,” one ex-employee told The Wichita Eagle.
As the new corporate culture took root, morale suffered initially and middle managers feared for their jobs. During that period, in the late 1990s, Koch Industries faced a wave of discrimination lawsuits by middle-aged employees who claimed, in some cases, that the company used Market-Based Management as a pretext to sweep them out the door to make room for younger, hungrier employees. One suit, brought by a forty-eight-year-old Koch lawyer who alleged he’d been unfairly demoted and subsequently fired, accused the company of “generally hiring one type of ‘clone’ that fit Koch’s image of itself—young, white male, sharp, aggressive, and consistent with Koch’s management philosophy.”
As Charles and his inner circle tried to simulate market conditions within the company, the road away from serfdom was not without its share of wrecks. Taking the Austrian model to its logical extreme, the company created internal markets through which business units purchased and traded for services. Part of the idea was to curb the overconsumption of company resources by putting a price tag on the use of a lawyer or lobbyist or the commissioning of a market research report. “Accountants started billing people in 15-minute segments for paperclips and pencils,” sighed a senior Koch executive. “It was a disaster. The whole system broke down.”
With Market-Based Management came a buzzword-laden vernacular—“Kochspeak,” as some employees called it with a roll of the eyes. Terms like “comparative advantage” (the ability to produce something at a lower cost than competitors), “creative destruction” (Joseph Schumpeter’s term for the sometimes messy process of innovation, where old methods are obliterated so new ones can rise up), and “fatal conceit” (Hayek’s notion that the premise of socialism is logically flawed) were soon on the lips of Koch managers. The company encouraged executives to read Mises and Hayek, and in some cases they drew just enough knowledge from these free-market thinkers to be destructive with it; while fluent in the esoteric language of Market-Based Management, they misapplied it completely. “The concepts became little more than buzzwords,” Charles acknowledged. “Employees used them to justify what they were already doing, or worse, what they wanted to do.”
Market-Based Management hinged on measuring performance, especially employee performance, and the company placed a major emphasis on quantifying in granular detail each worker’s contributions to the company. Koch based its incentive system—what employees called “I-Comp”—on these evaluations. Assessing how much money an employee had earned for the company was a relatively straightforward task when it came to, say, a commodities trader in Koch’s financial division or a refinery manager, but there were many other workers whose economic value was harder to compute. What about the employees who maintained the company’s pipelines? Technically, the more diligently they did their jobs, the more they sliced into the company’s profits.
The former manager of a Koch research group recalled his boss once asking him to evaluate the members of his staff “based on their contribution to the bottom line”—the literal dollars and cents they had earned for the company. He balked. “I said, ‘I can’t do that. I can’t tell you how much value in term
s of sales and profit a particular technician does. It’s an outrageous question. He’s too far from the action. He has too little control. I can’t tell you that this particular employee earns this much for the company and thus should get this amount of money.’ ”
A few months later, the manager attended a Market-Based Management seminar in Wichita led by Charles. After the CEO’s spiel, he asked for questions. The manager raised his hand.
“Charles,” he said, “I’m having difficulty relating what my technicians do to the company’s bottom line. My problem is, they don’t have any real control. There are all kinds of decision makers in between them—their supervisors, me, the product managers, salespeople, pricing.”
Charles seemed perplexed by the question. “Why,” he asked, “are you trying to do that?”
The impression that had filtered down from upper management was that Charles had wanted all employees to be evaluated based on their individual return to the company—but, in actuality, the CEO’s definition of “value” was more expansive. “We’d all been doing something that had been misunderstood from something Charles had said,” the manager recalled. “There’s a lot of stuff that goes on in Koch because of Market-Based Management [that] doesn’t always reflect what Charles wants.”
Whether or not employees misinterpreted Charles’s management edicts, his relentless emphasis on profits and value creation may have had dangerous, even deadly, consequences. In the Danielle Smalley case, as well as other lawsuits involving Koch’s dilapidated pipelines and environmental negligence, lawyers repeatedly cited Charles’s management philosophy as a key factor.
“Koch has a pattern of delaying needed repairs and maintenance, often neglecting them entirely,” Linda Eads, the former Texas deputy attorney general, noted in a 2001 affidavit. “One reason for this failure to operate safe pipelines comes from Koch’s so-called Market-Based Management approach. For example, under this management philosophy, each section of the Koch pipeline must show a profit, and this profit must increase every quarter. Environmental and safety compliance does not pay off quarter by fiscal quarter, and thus employees are not rewarded or encouraged to strive for safety or compliance. Indeed, safety improvements are regularly delayed or ignored even when recommended by employees. Employees at Koch are told that every decision has to be judged by its economic effect and how the decision will affect the company’s profitability.”
Sons of Wichita: How the Koch Brothers Became America's Most Powerful and Private Dynasty Page 25