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TO PREPARE:

READ: Maciariello and Linkletter, Ch. 6 – “Effective Leadership as a Liberal Art.”

READ: Tolstoy on Lincoln

READ: “Chainsaw” Al Dunlap: http://content.time.com/time/specials/packages/article/0,28804,2025898_2025900_2026107,00.html (Links to an external site.)

READ: Larry Spears, “Character and Servant Leadership: Ten Characteristics of Effective, Caring Leaders,” The Journal of Virtues & Leadership, Vol. 1 Issue 1, 2010, 25-30. http://www.regent.edu/acad/global/publications/jvl/vol1_iss1/Spears_Final.pdf (Links to an external site.)

Deliverables

After covering the required readings for Lesson 8, pay special attention to the article by Larry Spears, “Character and Servant Leadership: Ten Characteristics of Effective, Caring Leaders.”

1. Larry Spears describes 10 aspects of Servant Leadership in the article. Can you identify among these 10, the characteristics of a moralist? How do the Trust Conditions, Autonomy Preference, and Identity Utility apply?
2. Based on these 10 aspects and the material in Lesson 8, what can good leadership accomplish? What does “bad” leadership accomplish? (Don’t forget to read about “Chainsaw Al.”)

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1 2 DRUCKER’S LOST ART OF MANAGEMENT Readings in Management as a Liberal Art Table of Contents: Forward by Joseph Maciariello Innovation and Entrepreneurship based on Drucker’s Principles: Chapter 2, “Management and Liberal Arts Traditions: Bridging Two Worlds,” Drucker’s Lost Art of Management by Joseph Maciariello and Karen Linkletter Leadership Based on Drucker’s Principles: Chapter 6: “Effective Leadership as a Liberal Art,” Drucker’s Lost Art of Management by Joseph Maciariello and Karen Linkletter Strategic Management: Chapter 3 “Queens, Factory Girls and Schumpeter,” Good Profit by Charles G. Koch Marketing Management: Chapter 7 “Virtues and Talents” Good Profit by Charles G. Koch Management of Information Systems: Chapter 8 “Knowledge Processes” Good Profit by Charles G. Koch Operations Management: Chapter 9 “Decision Rights” from Good Profit by Charles G. Koch Quantitative Analysis for Decision Making: “Case Study #2: Insurance at Koch” from Good Profit by Charles G. Koch Accounting for Decision Making: Case 3: “What is a Growth Company” from Management Cases, Revised 2008 edition by Peter F. Drucker—forward by Joseph A. Maciariello Corporate Finance: Case 24 “Corporate Image to Brand Image: Yuhan-Kimberly from Management Cases, Revised 2008 edition by Peter F. Drucker—forward by Joseph A. Maciariello Management and Liberal Arts Traditions: Bridging the Two Worlds 3 Foreword The basis of the practice of management as a liberal art (MLA) starts from the observations and critical analyses of all the writings of Peter Drucker. The goal is to arrive at specific generalizations to form the framework that could be applied in today’s environment and managerial practice. The Management as a Liberal Art Research Institute seeks to formally integrate the practice of management and the disciplines within liberal arts to support executives in all sectors of the economy and society. Liberal arts, per se, is a complex array of disciplines that can range from music to philosophy. Components of the liberal arts have a direct application to the practice of management, and it is this amalgam of both liberal arts and management science that forms the genesis and purpose of the Management as a Liberal Art Research Institute. There are both narrow and broad dimensions to the practice of MLA. The narrow pattern tries to affirmatively answer the multidimensional question articulated by C William Pollard: “Can the business firm produce goods and services, excel at serving the customer, make money, create wealth for shareholders, and also be a moral community for the development of human character and social concern?” —C William Pollard, The Tides of Life, 2014, p. 99 The broad dimensions of this subject also follow from the philosophy of Peter Drucker in his publications on society and management. For a society to be functional its executives should provide dignity and justice for its employees; its managements’ basis of power and authority should be legitimate and adhere to the values of society, and its executives should keep to these values while possessing the competence and integrity to lead change. The practice of management as a liberal art, the MLA Research Institute and this book hold to both the narrow and broad aspects of the subject. They should serve you well in your early career as well as help you grow to meet the challenges of the future. This book can also serve the experienced executive with the opportunity to revisit the position of a manager in today’s ever-changing society and provide the tools for self-reflection. 4 DRUCKER’S LOST ART OF MANAGEMENT My best wishes for your success and well-being. Joseph A. Maciariello Director of Research The Joseph A. Maciariello Management as a Liberal Art Research Institute Management and Liberal Arts Traditions: Bridging the Two Worlds 5 Introduction I was fortunate to have been one of Peter Drucker’s graduate students in the late 1970’s and my friendship continued for years following. Peter was a brilliant individual but not the kind of brilliance one typically imagines. He didn’t expand our understanding of energy and light as did Einstein’s E = MC2 formula, nor did he help us understand the universe as did Steven Hawkins, but instead he had the ability to look at how managers function in a work setting and articulate how a manager could improve. In his voluminous and clearly articulate body of work, he stated what was obvious to everyone after he said it! In The New Realities, Peter Drucker wrote, “Management is what tradition used to call a liberal art – “liberal” because it deals with the fundamentals of knowledge, self-knowledge, wisdom, and leadership; “art” because it deals with practice and application.” His writings allow us to “read between the lines” and take material from different sources of his authorship and develop the theme that has the potential to be one of the most significant insights for managers since the scientific study of work initiated in the early 1900’s by Henry Fauol and Frederick Winslow Taylor. This may seem a bit simple, but Management as a Liberal Art is just about understanding people as individuals and treating them with respect. Drucker used the word “art” in conjunction with management, because there is no single “recipe” or formula that can be taught to students and practioners that addresses each and every management challenge and/or situation. The word “liberal” refers to favoring or permitting freedom of action (think of Drucker’s principle of Management by Objectives that encourages managers to let subordinates have an equal say in how they do their jobs). As Peter stated: “No organization can do better than the people it has” from Managing the Non-Profit Organization. Peter’s gift to the world was his ability to state the obvious in terms everyone could easily understand and apply. MLA is the new gift that Peter Drucker leaves us to improve management forever. This book is a compendium of material from three very relevant sources: Peter Drucker, Joseph Maciariello and Charles Koch. Collected in this edition, it can serve as a single publication for the design of an academic course in graduate business programs. Students and faculty at California Institute of Advanced Management (CiAM) have found it to be very useful as they incorporate MLA into their curriculum. MLA is a new body of thought that should be taught in every graduate school of business throughout the world as its time is right and its time is now! 6 DRUCKER’S LOST ART OF MANAGEMENT Dr. Eric J. McLaughlin Vice President and Chief Academic Officer California Institute of Advanced Management (CiAM) Management and Liberal Arts Traditions: Bridging the Two Worlds 7 Divisions between Management and the Liberal Arts If education, particularly in America, has always emphasized the importance of both instilling cultural values and developing the ability to function in society, then what is the source of the current divide between management and the liberal arts? When did the liberal arts become irrelevant to the training of managers? And when did the business of organizations and the concern with a functioning society become divorced from the interests of those engaged in the liberal arts? To understand the origin of this split between management and the liberal arts is to begin to understand how to repair it. The disruptions associated with the rise of the modern corporation in the United States have been well documented. Beginning with the railroads in the 1860s and 1870s and continuing with entities such as Standard Oil and Carnegie Steel, modern capitalism was met with growing trepidation and suspicion on the part of the American public, as increasingly larger and larger companies wielded more and more power. Labor unrest, such as the Great Railroad Strike of 1877 and the Haymarket Riot of 1884, coupled with a growing urban population of immigrants, added to public concern that the price of progress was perhaps too steep. Progressive reformers sought solutions to poverty, corruption, crime, and other urban ills, while government did little to curb the power of the trusts; in fact, a great merger boom in the late 1890s created even larger organizations with even more economic and political power. Amid these disruptions of late nineteenth-century society, the leaders of the burgeoning private sector sought to legitimize their authority. As Rakesh Khurana has argued, managers saw that affiliating themselves with the modern research universities would validate business as a profession. Just as higher education had dedicated itself to a tradition inherited from the liberal arts ideal, management, too, could embrace “its own rationality, disinterestedness, and commitment to commonly held values” (Khurana, 2007, p. 87). Through its retention of the liberal arts curriculum, albeit modified through the elective system and acceptance of the “liberal-free ideal,” the American university continued the traditional emphasis on character formation and human development through the tumultuous late nineteenth century. Any group of practitioners wishing to consider themselves “professionals” would be well served by having some attachment to that moral and ethical tradition. It is not surprising, then, that the first business school sought to capitalize on the trend toward scientific specialization while retaining elements of the liberal arts tradition. The University of Pennsylvania’s Wharton School of Business, established in 1881, was the first university-based business school; by 1893, there were more than 500 commercial business colleges in the United States (Khurana, 2007, p. 89). As did Penn, Dartmouth and Harvard responded to the growing call for management training and 8 DRUCKER’S LOST ART OF MANAGEMENT founded their own schools of business: Tuck School of Administration and Finance (1900) and Harvard Business School (1908), respectively. The curriculum at each school reflected the interest in science that permeated university debates at the turn of the century. Scientific management, notably Taylorism, the scientific study and analysis of work to improve productivity, dominated the coursework at business schools, as managers sought to put themselves on the same level as other professionals by emphasizing the rational nature of their discipline. Yet, Harvard, Dartmouth, and Penn all came from the liberal arts tradition, and thus valued the inherited ideals of character formation and the development of well-rounded citizens and leaders. There was, therefore, a concern that the new business schools needed to be differentiated from the existing commercial schools. Key to this process of differentiation was the linkage with the liberal arts tradition inherent in each school. Wharton’s mission was to educate America’s upper crust who had inherited family money and needed to develop the “social consciousness and moral character” behind a life of service to the community, whether through business or government employment. Tuck mandated a “3 + 2” curriculum, in which students were required to complete three years of liberal arts study before they enrolled in the graduate business program; the idea behind this structure was to develop graduates who were broadly educated, not just interested in making money. Similarly, Harvard’s business program required incoming students to have a liberal arts education. Referencing Harvard’s founding document, which stated that the institution’s mission was “to advance Learning, and perpetuate it to posterity, dreading to leave an illiterate Ministery to the Churches, when our present Ministers shall lie in the Dust,” Owen Young said in his dedication speech for Harvard Business School that “the Harvard Graduate School of Business Administration will do its utmost to guard against an illiterate ministry of business when our present ministers shall lie in the dust.” Linking the new business school with the liberal arts college’s founding ensured that the values of old would be inscribed on the new institution (Khurana, 2007, pp. 105-121). Just as the university-based management programs gained a foothold, government began to scrutinize the private sector more closely. Progressive literature, such as Frank Norris’s The Octopus (1901), which indicted the railroad monopoly in the west, and Ida M. Tarbell’s The History of the Standard Oil Company (1904), exposed some of the more questionable practices of American capitalists. President Theodore Roosevelt instigated actions to reign in big business, including the Expedition Act of 1903, which ordered circuit courts to give antitrust suits priority. Roosevelt also created the departments of Commerce and Labor, recognizing the need for government intervention in business affairs. The Panic of 1907, which seized the nation’s financial system, precipitated a series of reforms; the Pujo Committee Management and Liberal Arts Traditions: Bridging the Two Worlds 9 hearings on banking policy and practices would eventually lead to financial reforms under the administration of Woodrow Wilson, such as the creation of the Federal Reserve System. The new university-based business schools responded to this changing environment. In order to promote the professionalism of businessmen, the new business schools emphasized scientific management and rationalism in their curriculum in the early twentieth century. Much of the disorder of late nineteenthand early twentieth-century society involved labor disputes. Frederick Winslow Taylor devised scientific management to improve the economic welfare of labor and to reduce labor-management conflict. Taylor’s approach to management stemmed from his belief in the common interest between the worker and management. If by the use of scientific management Taylor and his followers could increase the productivity of both labor and capital, the result would be lower unit cost, higher wages, and higher profits. Taylor thus saw congruence between the interests of labor and management. Taylor’s influence on the business school curriculum increased after World War I, when management training was in high demand. After the United States entered the war in 1918, the needs of war production placed unprecedented demands on businesses, and the obsession with efficiency and planning reached new heights. President Woodrow Wilson created the War Industries Board to oversee the production of war materiel. Headed by Bernard Baruch, a successful investor on Wall Street, the War Industries Board exercised broad authority over the public sector. Herbert Hoover headed the Food Administration, using propaganda campaigns to entice the public to regulate its food consumption through such gimmicks as “Meatless Tuesdays.” The War Industries Board served as the model for a new concept of capitalism involving cooperation between government and business. By 1920, big business was no longer seen as the source of disruption. Instead, business, and its managerial professionals, held the answers to regulating the ups and downs of society. Most Americans believed that management, planning, and efficiency were the key to social order and prosperity. Scientific management and efficiency were not the only subjects stressed in business school courses, however. As discussed earlier, the belief in science and rational forward progress faced challenges in the late nineteenth and early twentieth centuries. Political upheaval, social disorder, and the technological realities of World War I, which included mustard gas and mechanized warfare, indicated that science and technology did not necessarily promise improvements to the human condition. In the new business schools as well as the research universities, the liberal arts remained the source of moral grounding for students in light of the seemingly immoral face of modern technological developments. In American colleges and universities, faculty sought to reinstate the primacy of the humanities through such vehicles 10 DRUCKER’S LOST ART OF MANAGEMENT as the core course and canons of “great books.” Business schools wrestled with how to incorporate the ideals of the liberal arts into their curriculum. In graduate programs, students were expected to come armed with undergraduate training in the humanities before they began graduate study in business; however, that did not answer the question of how to instill professionalism and a social conscience in the curriculum itself or how to sow those values in undergraduate business programs. The result was a rather shotgun approach to curriculum development, with each school creating its own course structure haphazardly. Some schools organized their courses to train managers for specific jobs, while others sought to link management closely to economics or to restructure traditional liberal arts courses (math, English, and history) to make them relevant to businessmen (accounting, business correspondence, and business history). It was not until the Great Depression that business school curriculum became more standardized, as more and more university deans expressed concern about the quality and goals of programs (Khurana, 2007, pp. 154-170). During the Great Depression, American capitalism came under scrutiny by those in academe as well as practicing managers and executives. In the early years following the stock market crash of 1929, most Americans continued to embrace corporatism, the cooperative relationship between business and government that reigned during the presidency of Herbert Hoover. However, as economic conditions deteriorated, and as the business experts seemed not to have the answers to the nation’s woes after all, management as a profession came under fire. Trained business professionals, the trustees of commerce, clearly could not solve the economic malaise that plagued the country. With the election of Franklin Delano Roosevelt in 1932, Americans rejected the model of the business elite as expert and replaced it with a new emphasis on planning and bureaucracy in the public sector (Kennedy, 2009). Faced with this new attitude, managers and the business schools that trained them sought to shore up the image of both corporations in general and management as a profession. Two Columbia University professors, Gardiner Means and Adolf Berle, published The Modern Corporation and Private Property (1932, 1933), in which they argued that American businesses were no longer run by owner-managers with a vested interest in the company. Instead, ownership in companies had become diffused among many people through profit sharing and pension plans. Corporate managers thus had a passive role and were only interested in the company’s profitability, not its day-to-day operations. The modern corporation, Berle and Means concluded, created a new form of property ownership in which the shareholders were subjected to the priorities of powerful managers. The Modern Corporation and Private Property presented the case for managers to consider their obligations to society, not just their own interests. In a time when corporate management was blamed for causing the Great Depression, Berle Management and Liberal Arts Traditions: Bridging the Two Worlds 11 and Means called on managers to understand their responsibilities for serving a much broader, diverse group of shareholders: the general public itself (Berle and Means, 1933). Business school curriculum also reflected the public’s new attitude. Academics criticized the increasingly specialized and technical bent to business school coursework, arguing that managers were no longer inculcated with a sense of social and ethical responsibility. Some called for more liberal arts courses in business schools, stating that a return to the earlier ideals of education would restore a sense of morality in graduates. Many schools created new courses designed to demonstrate the relationship between business and society. Others incorporated new elements into existing classes; for example, Harvard professors began to discuss the importance of government regulation of the private sector. In an effort to respond to the drastic changes taking place during the 1930s, business schools entered a period of “introspection that helped set the stage for a renewal of purpose” (Khurana, 2007, pp. 180192). Postwar Challenges This renewed sense of purpose was short lived, however. After World War II, most business schools returned to their former hodgepodge approach to curriculum “unified by little but the frayed idea of management as a distinct subject of study” (Khurana, 2007, p. 197). In spite of this, the demand for professionally trained managers boomed as America’s corporate sector expanded. During the war, government and business adopted the corporatist model of cooperation that dominated the period after World War I. After the bombing of Pearl Harbor brought the United States into World War II, Roosevelt established the War Production Board, which, like the earlier War Industries Board, oversaw production for military operations. Under the command of Don Nelson, Sears’s top executive, and other “dollar-ayear” men who agreed to work for no salary, the War Production Board imprinted the influence of corporate executives on the conduct of the war. Marketing campaigns aimed at the public sought to promote conservation, and advertising techniques were used to instill brand loyalty among the troops. Managerial training in productivity paid off in spades, as the private sector produced armaments and supplies on a massive scale to support the war effort. Following the war, firms faced challenges associated with idle production capacity; factories that had churned out planes and tanks now needed to make something else that people would buy—and buy in large quantities—or sit idle. In many cases, firms diversified in order to use their manufacturing facilities. General Electric and Westinghouse expanded into consumer appliances, and DuPont embarked on an aggressive research and development program to replace its explosives business with other products. As 12 DRUCKER’S LOST ART OF MANAGEMENT firms diversified, they became more complex, restructuring along divisional lines in order to manage these new enterprises (Chandler, 1977, pp. 299-303). As corporations became more complex, so did issues involving management. The massive expansion of America’s private sector in the post—World War II era drove a heavy demand for trained, professional managers to help run the newly restructured firms as well as the up-and-coming businesses in budding industries such as consumer credit. The GI Bill, or the Servicemen’s Readjustment Act of 1944, which provided unprecedented access to higher education for most white American men, resulted in a flood of new students in the nation’s colleges and universities. Many of these incoming students opted for degrees in business (Khurana, 2007, pp. 211-212). The growing demand for and supply of trained managers threw the business schools in the spotlight, and as had occurred in the 1930s, questions of quality and mission surfaced. Despite reform efforts during the Depression, business schools lacked academic credibility well into the 1950s. University faculty in other departments viewed the business department or school as little more than a place for vocational training; business courses were seen as lacking in academic rigor, and department faculty’s research was considered second rate at best. In the 1950s, two research entities, the Ford and Carnegie foundations, reported on the quality of American management programs. Both foundations had substantial impact on higher education, as they gave generous endowments to fund academic research. In 1959, the Ford and Carnegie foundations presented their respective reports; Ford’s report, titled Higher Education for Business, garnered most of the attention. The tone and content of the Ford document shattered the image and confidence of the business school community. Both studies concluded that business education in America lacked any cohesive curriculum, failed to instill any sense of professionalism and accountability to society, and suffered from a serious absence of academic quality and content. Management curriculum, the authors argued, should reflect the knowledge that management was a science involving methodologies that could be taught in a systematic way. Reflecting the idea that business education should mirror the modern research university, the Ford report posited that business faculty needed to engage in state-of-the-art research to ensure that students were kept abreast of the latest developments in management science. In part, the Ford report was indicative of broader changes in the American economy and economic inquiry. By the fifties, the American corporation and its representative, the white-collar manager, were ingrained in popular culture. In 1954 approximately 27 percent of the workforce was employed in occupations classified as white collar (Solomon, 1954). C. Wright Mills’ White Collar: The American Management and Liberal Arts Traditions: Bridging the Two Worlds 13 Middle Class (1951) and William Whyte’s sociological study The Organization Man (1956) characterized the corporate manager as a conformist bureaucrat, exposing fears of the controlling power of modern business. Dramas such as Rod Serling’s award-winning film Patterns (1956) and The Man in the Gray Flannel Suit (1957) captured many of the concerns Americans had about the impact of corporate life on men and their families. The nature of managerial work and the corporate environment came into question: were these new white-collar workers turning into soulless “yes men,” willing to sacrifice their individuality and moral fiber for pecuniary gain? If so, a drastic change was needed both to reform the way this work was done and to change the attitude of the workers themselves. Simultaneously, literature on management began to proliferate. Drucker’s The Practice of Management (1954) put management on the map as a discipline worthy of study, while Abraham Maslow and others were applying behavioral psychology to the world of work. In economics, John Maynard Keynes’s ideas continued to rule the day, but increasingly the field was dominated by those using mathematical models and quantitative methods to evaluate human decisions and behavior. Kenneth Arrow’s work on general equilibrium and social choice theory involved innovative use of mathematical models to influence public policy decisions. Thus, as popular culture reflected a corporate world lacking in human dignity and integrity, economists and management theorists countered with a portrait of a cool, calm world based on rational decisions made by trained professionals. The Ford and Carnegie foundation reports transformed the American business schools. Business faculty, like their peers in other fields, pursued increasingly specialized areas of research, establishing their scholarly credibility. The curriculum at most major schools (except for Harvard, which retained its famous case study method) fell into a prescribed model of coursework; by 1970, one could describe a “typical” MBA program. But, as Khurana argued, the attempt to turn out professional managers via such standardized, academically oriented programs had a cost. By focusing on rational decision making, the business schools lost their original concept of professionalism, which “had always rested on combining mastery of specific knowledge with adherence to certain formal or informal codes of conduct and, even more fundamental, to an ideal of service” (Khurana, 2007, p. 291). In other words, the emphasis on quantitative methods and management science eradicated the ideals of the liberal arts. The human component of management was lost. This became apparent in the structure and management of many American companies. As firms expanded and diversified in the post-war environment, they experimented with varying degrees of centralization and decentralization. The larger and more diverse firms became, the more their managers relied on financial statistics and information systems to control daily operations. In fact, many of the 14 DRUCKER’S LOST ART OF MANAGEMENT large conglomerates created during the 1950s and 1960s defied conventional management wisdom, and could only be justified on financial bases. Seeking new investments in a postwar boom environment, companies began to look outside of their areas of expertise to identity acquisition possibilities. Textron, the first such conglomerate, was made up of defense manufacturers, a golf cart company, a financial services wing, and a consumer products division. Whereas the mergers during the late nineteenth century had emphasized developing supply networks, refining distribution systems, or reducing competition, the new merger wave created companies with unrelated businesses in different markets with different customers. Such investment decisions were based on financial projections, as companies looked for new opportunities to invest funds thrown off from their “cash cows.” Management theorists emphasized decision models, systems theories, and strategic planning. Robert McNamara and his “whiz kids” brought rationalization and statistical analysis to a new level of importance at Ford. Thus, in spite of work by Drucker and others emphasizing the human component of management, the fifties and sixties were decades in which analytical managers were king. Social and Economic Upheavals The shift toward analytical skills and increasing specialization in the business schools went unchallenged until the social and economic upheavals of the late 1960s and 1970s. The civil rights movement spawned a new culture in which tradition and inherited values were questioned, leading to student activism and protest around such issues as the war in Viet Nam, women’s and gay rights, and the role of the militaryindustrial complex. Watergate caused a serious crisis of faith in government, and the financial shenanigans of conglomerate LTV Corporation, which resulted in its bankruptcy, tarnished the image of the private sector. The American of this zone of indifference. (Barnard, 1938/1968, p. 167) Effective Leadership as a Liberal Art 23 This rather clinical description of individual loyalty illustrates Barnard’s understanding of the realities of human interactions within the workplace: dictatorial mandates from above will not foster employee loyalty; instead, managers need to understand each individual’s zone of indifference and recognize that some decisions will require justification and explanation in order to be legitimized. Barnard explains that one of the worst mistakes leaders can make is poor communication; authority must be earned through trust and clarity of direction. He warns that “the determination of authority remains with the individual. Let these ‘positions’ of authority in fact show ineptness, ignorance of conditions, failure to communicate what ought to be said, or let leadership fail (chiefly by its concrete action) to recognize implicitly its dependence upon the essential character of the relationship of the individual to the organization, and the authority if tested disappears” (Barnard, 1938/1968, p. 174). Barnard clearly understood the importance of management showing its legitimacy through words and deeds; titles alone would not suffice to guarantee cooperation and loyalty. The horrors of World War II and the rise of totalitarian governments added a new dimension to leadership theory in the 1950s and 1960s. Abraham Maslow, the son of Jewish immigrants, sought to understand why people rallied around leaders such as Hitler and Stalin; his later work focused on human behavior within industrial organizations. Drucker referred to Maslow as “the father of humanist psychology” (Drucker, 1974, p. 195). Maslow is best known for his hierarchy of needs, which is based on a pyramid of human aspirations. At the top of the pyramid is human self-actualization, which Maslow defined as “the full use and exploitation of talents, capacities, [and] potentials” (Maslow, 1954, p. 150). He posited that people cannot achieve self-actualization until other needs below this level have been met, including physiological, safety, and social needs. Because these lower-level needs have been met, self-actualized people are well-adjusted, according to Maslow. They have a calling or vocation to which they are dedicated, are emotionally stable, accept themselves and others, and exhibit a high degree of creativity and independence. Maslow later applied self-actualization to his analysis of industrial organizations through his observations of Non-Linear Systems and his readings of Drucker’s The Practice of Management [quoted by Maslow as “Principles of Management,” Maslow, 1998, p. xxi], McGregor’s The Human Side of Enterprise (1960), and texts in the field of social psychology. He wrote his observations in journal form, developing the concept of “Eupsychia,” which he defined as “the culture that would be generated by 1,000 self-actualizing people on some sheltered island where they would not be interfered with” (Maslow, 1998, p. xxii). In essence, Maslow sought to identify the attributes of an ideal society to point 24 DRUCKER’S LOST ART OF MANAGEMENT the way for improvement and change in the modern industrial world. If a society of organizations were populated solely by self-actualizers, what would that society look like? This ideal would then serve as a blueprint for the actual management of society’s organizations. In Maslow’s words, “How good a society does human nature permit? How good a human nature does society permit? How good a society does the nature of society permit?” (Maslow, 1998, p. xxii). Maslow described the qualities of “enlightened management” and the assumptions that underlay these qualities. As he did so, he took Drucker and others to task on many points. In particular, Maslow criticized the assumption that people in an organization would not be driven (or paralyzed) by fear: “On the whole, where fear reigns, enlightened management is not possible. In this and in may [sic] other places, Drucker reveals his lack of awareness or knowledge of psychopathology, of evil, weakness, bad impulses, etc. There are many people in the world, especially outside of the United States, for whom Drucker’s management principles will simply not work at all” (Maslow, 1998, p. 26). Drucker, Maslow argued, was not only too general in his assumption (that all people will be motivated by the same things) but also too naïve in his view that people will not exhibit bad behavior in organizations. Maslow showed that not all leaders would be “enlightened,” and that not all followers would be driven by the same motivations. Another important contribution to leadership theory came from Douglas McGregor’s 1960 work The Human Side of Enterprise. McGregor claimed that there were two primary styles of management, “Theory X” and “Theory Y,” and argued that Theory Y was the preferred style. Theory X managers assumed that people dislike work and would avoid it as much as possible; this management style embraces command and control from above. The problem with Theory X leadership is that it does not motivate people whose lower-level hierarchical needs have been met. Direction and control from above will be entirely ineffective if social interactions and the need for self-esteem motivate employees. As a result, employees will begin to dislike their work, learn to expect constant direction and supervision, and avoid taking any risks that might anger those at the top. In short, Theory X leadership is a self-fulfilling prophecy. In contrast, Theory Y managers assume that work is natural and that people want to be productive; this style emphasizes fostering independence and creative abilities. Looking for self-esteem and social fulfillment, employees will actually seek out responsibility, and they genuinely will be interested in exercising their mental abilities. Expectations breed actions (as happens in Theory X situations), and employees respond favorably—as Theory Y leaders would expect. Effective Leadership as a Liberal Art 25 McGregor’s work received wide acclaim and was adapted to many organizations. The Scanlon Plan, for example, was an effort to apply Theory Y management to an entire organization. Companies adopting this plan implemented cost-reduction sharing plans and established formal means for employees to contribute ideas. William Ouchi’s “Theory Z” (1982) was intended to be a combination of Theory Y and Theory X management styles. Kurt Lewin (1947, pp. 5-41), who worked with McGregor at MIT, popularized the theories of group dynamics embodied in “T-Groups,” or training groups, which emphasize the diffusion of decision making throughout an organization. In 1978, John McGregor Burns published his groundbreaking work Leadership. In his book, Burns contrasted two styles of leadership: transactional and transformational. Transactional leadership emphasizes a relationship involving a mutually beneficial exchange between two people. Using this model, leaders and followers engage in discrete transactions that emphasize self-interest. Transformational leadership, on the other hand, appeals to people’s higher ideals and values, which serve as motivators rather than self-interest. In Burns’s words, “leaders engage with followers on the basis of shared motives and values and goals” (Burns, 1978, p. 36). In two connected passages in his book, Burns captures the essence of what leadership is not and what leadership is: Many acts heralded or bemoaned as instances of leadership—acts of oratory, manipulation, sheer self advancement, brute coercion—are not such. Much of what commonly passes as leadership— conspicuous position-taking without followers or follow through, posturing on various public stages, manipulation without general purpose, authoritarianism—is no more leadership than the behavior of small boys marching in front of a parade, who continue to strut along Main Street after the procession has turned down a side street toward the fair-grounds… The test of their leadership function is their contribution to change, measured by purpose drawn from collective motives and values. (Burns, 1978, p. 427) Bernard Bass further developed Burns’s concept of transformational leadership, describing the ways in which transformational leaders function. One of the important contributions of Bass was the role of charisma in transformational leaders; to Bass, charisma was an important component of transformational leadership, and not always a positive one. Bass argued that transformational leaders were not always aligned with a higher moral force (Bass and Riggio, 2006, pp. 1-18). One of the issues that has loomed over the study of leadership has been whether leaders are characterized by some specific set of traits or whether leadership is a more complex process. Burns’s and Bass’s work on transformational leadership moved the discussion toward an analysis of process rather than simply a 26 DRUCKER’S LOST ART OF MANAGEMENT list of character traits, but certain personality attributes, such as charisma, remained pivotal. Warren Bennis and Burt Nanus studied 90 leaders they identified as transformational, and they developed a list of traits they had in common (Bennis and Nanus, 1985). Although the expanded list of leadership attributes contributed to the work on the subject, the primary innovation of Bennis and Nanus’s work was the idea that leadership could be learned; the traits they identified were not innate qualities but rather obtainable through practice (much like Aristotle’s concept of acquiring an ethical view of life). More recently, the concept of servant leadership has gained ground. Although developed in the literature extensively in recent years, the idea came from the work of Robert Greenleaf, who published The Servant as Leader in 1970. Greenleaf’s thesis is that effective leaders serve others, particularly those who follow them. Servant leadership is other focused, and it usually involves providing subordinates with a considerable degree of freedom based on trust and respect. Jim Collins’s 2001 book Good to Great advanced the idea of “Level 5 leadership.” Collins evaluated the managements of 11 companies whose public stock had underperformed or tracked the market and then had consistently and significantly outperformed stock indexes for 15 consecutive years. In doing so, he postulated that leaders of these companies tended to focus first on selecting the best team of people; then decisions are made about the mission or direction of the firm. In Collins’s lingo, Level 5 leaders focus on “who, then what” as opposed to Level 4 leaders, who focus on “what, then who.” Level 5 leaders are less concerned with their own personal qualities than with surrounding themselves with the most capable people they can; thus, according to Collins, these leaders possess the quality of humility as well as attention to organizational mission. Peter Drucker’s Model of Effective Leadership Drucker’s idea of leadership synthesizes many of these interpretations. For Drucker, the test of effective leadership is not getting one’s way; it is not the frequency of media appearances, nor is it the amassing of wealth. Effective leadership does not involve coercing people, silencing individuals with fear, or utilizing humiliating tactics to carry out orders. Rather, effective leadership is assuming responsibility for getting the right things done (“Leadership Means to Get the Right Things Done,” 2002, p. ii). It is about communicating with people, uniting them behind a shared mission and values, and mobilizing energies toward accomplishing the mission or purpose of an organization. It is not about “me” or “I” but rather “us” and “we.” An effective leader leads followers with dignity, and inspires them toward achievement. Drucker says that “leadership is not magnetic personality—that can just as well be a glib tongue. It is not ‘making friends and influencing people’—that is flattery… Leadership is lifting a Effective Leadership as a Liberal Art 27 person’s vision to higher sights, the raising of a person’s performance to a higher standard, the building of a personality beyond its normal limitations” (Drucker, 2008, p. 288). As iterated in the discussion of transformational leadership, Drucker’s interpretation is that leadership responsibilities require that a leader seek congruency between his or her values and goals and the values and goals of followers—everyone must be “on the same page,” or nearly so. Achieving congruency is the essence of leadership and followership. President Dwight D. Eisenhower emphasized this very point in his remark that “leadership is the art of getting someone else to do something you want done because he wants to do it” (“Great Leadership Quotes,” n.d.). Unlike Bennis and Nanus, Drucker believed that effective leadership is not about specific leadership qualities, despite this teaching found in numerous books, articles, and journals. He noted that some of the most effective leaders have little commonality of highly acclaimed leadership qualities or of a particular “leadership personality.” Abraham Lincoln, Winston Churchill, Dwight D. Eisenhower, Franklin Roosevelt, George Marshall, Alfred Sloan, and the Reverend Theodore Hesburgh were all very effective leaders of public, private, and social sector organizations. They shared few distinctive personality characteristics. As Bass notes, charisma remains a valued quality in leaders, in spite of the fact that not all charismatic leaders have been effective. Drucker, too, commented on the popularity of charismatic leaders: “Every CEO, it seems, has to be made to look like a dashing, Confederate cavalry general or a boardroom Elvis Presley” (Drucker, 2008, p. 288). Charismatic leaders easily attract followers because of their charm and presence. But charm, a magnetic and flattering personality, a glib tongue, and popularity among influential friends in high places are personality characteristics of many charismatic leaders. As Bass and Drucker have both argued, these personality characteristics have nothing to do with effectiveness. A vice president of human relations once asked Drucker “to run a seminar for us on how one acquires charisma” (Drucker, 2008, p. 288). The question posed by the vice president implied that leadership requires the pursuit and successful acquisition of popularity among followers. It is a major error to substitute charisma for effectiveness. Charisma may be “the undoing of leaders” (Drucker, 2008, p. 289), as it was in the case of Civil War general George B. McClellan. Charismatic leaders often become set in their ways and demand that things be done “their way.” They become convinced of their superiority and of the infallibility of their ways, 28 DRUCKER’S LOST ART OF MANAGEMENT and as a result they are unwilling to consider conflicting opinions of others and to properly evaluate risks and feedback from their actions. Unable to amend their ways and to change, these leaders become abnormally vulnerable to failure and to the creation of harm. Three of the most charismatic leaders of the twentieth century—Stalin, Hitler, and Mao—were “misleaders who inflicted as much evil and suffering on humanity as have ever been recorded” (Drucker, 2008, p. 289). The importance of shared values in Burns’s model of transformational leadership is reflected in Drucker’s belief in the crucial role of the mission statement for an organization. In his model, the foundation of effective leadership is built upon a concise statement of the purpose or mission of an organization. “The leader’s first task,” says Drucker, “is to be the trumpet that sounds a clear sound” (Drucker, 2008, p. 289). If the mission is wrong, the organization will be misdirected. So, leadership begins by defining the mission and purpose of the organization, then by thinking through the implications of the purpose for others. Once the leader clarifies the mission, then the leader’s task is to implement it by following the repetitive leadership tasks of setting goals and priorities; organizing resources; communicating and motivating others to perform; establishing standards and measurements; and further developing the performance capacity in people, including himself or herself. That means that leadership is a means to an end—the mission it serves is the end. That view is championed again and again by some of the most effective leaders, and is prominent in the Level 5 leaders in Jim Collins’s book Good to Great (Collins, 2001). Drucker’s favorite mission statement was written in 1917 and belonged to Sears Roebuck. This mission statement stated: “It is our function to be the informed and responsible buyer for the American farmer, and later on for the American middle class” (Buford, 1998, p. 4). Merchants adopted the perspective of the customer and in the process defined their role in the company as buyers for customers rather than as sellers to customers. If merchants bought the wrong merchandise—things the customer didn’t want or need—nothing could be done to move it off the shelves and it would have to be sold at clearance. After establishing this mission statement, President Julius Rosenwald asked each of his store managers, “What does this mean for you and your people?” By doing so, he radiated the impact of the mission statement throughout the organization. This mission statement effectively captured what the organization was about, and it brought it to life in the day-to-day work of each person within the company. A mission statement should lead to agreement among team members, guide formulation of strategy, direct the mobilization of all resources, and utilize the energies of people to accomplish the mission. The well-known credo of Johnson and Johnson (J&J), for example, illustrates the phenomenal power of a Effective Leadership as a Liberal Art 29 good mission statement (Johnson and Johnson, n.d.). It helps the people of J&J to make a difference, to make the world a more caring and self-respecting place. Mission statements do not last forever; they must be revisited and amended. Most have a short life because change is a universal aspect of organizational life. For example, in 1908 AT&T began with the mission to bring a telephone to every household and to make telephone service affordable. It achieved this goal in 1960, but it failed to revisit its mission. AT&T floundered until in 1982, when it was the target of a lawsuit brought by the Antitrust Division of the U.S. Department of Justice. When the lawsuit was settled AT&T agreed to break itself up into several firms. Seven other regional (or “Baby Bell”) companies were created, and AT&T became the long-distance provider. The second requirement for Drucker’s model of effective leadership is acceptance of the fact that true leadership is responsibility for the mission and support of those led. It is not primarily status and power. Effective leaders do not fear strength in subordinates or associates; rather, they seek it. They know that strong subordinates create strong outcomes. Effective leaders support, push, encourage, and glorify in strong subordinates and are generous with recognition when a job is well done. But they accept responsibility for the outcomes under their command. A widely quoted phrase succinctly summarizing the ultimate responsibility of the leader, even for failures of subordinates, is Harry Truman’s “The buck stops here.” According to Drucker, “Effective leaders are rarely permissive. But when things go wrong— and they always do—they do not blame others”4 (Drucker, 2008, p. 290). By emphasizing responsibility, not rank, “the effective leader sees leadership as responsibility” (Drucker, 2008, p. 290). This comes very close to Greenleaf’s idea of servant leadership, defining the leader as servant, first to the mission and then to subordinates whose effort he or she must encourage and support to accomplish the mission. The third requirement of Drucker’s effective leaders is that they earn trust. Trust is earned when leaders effectively pursue the mission of their organization and are true to their word. Trust is derived from belief in the integrity of the leader. It is based primarily on being consistent to the mission and to followers. A leader is always on display before followers. Therefore, there must be consistency between a leader’s action and what he or she says—in other words, between the leader’s professed beliefs and actions. The need for the leader to earn the trust of followers is nothing new—it reflects the wisdom of the ages, but it is a critical ingredient for achieving effectiveness. Integrity is so critical to leadership that Drucker considered its absence a major disqualifier for positions of responsibility, for, “by themselves, character and integrity do not accomplish anything. But, their absence faults everything else” (Drucker, 1967, p. 87). This consideration does not minimize the need 30 DRUCKER’S LOST ART OF MANAGEMENT for other talents in effective leaders, but it does emphasize that other talents of leaders can be rendered ineffectual by lapses in integrity. The qualities of character and integrity in leadership are featured prominently in this chapter, given their importance to success. Misleaders—or “toxic leaders” (Lipman-Blumen, 2006, p. ix)—exist at every level of the organization and they are contaminating influences. How can you tell if you are following an effective leader or a misleader? Misleaders do not believe in their mission; instead, they seek personal power. Often the most important thing to a misleader is self-aggrandizement. Frequently, misleaders display “histrionics,” an attempt to maintain a stage presence; therefore, it is not uncommon for misleaders to possess charismatic personalities. Many effective leaders also possess charismatic personalities, but they use their charisma in pursuit of the mission. Effective leadership is critical in times of crisis. As Indian cricket commentator Navjot Singh Sidhu notes, “Anybody can pilot a ship when the sea is calm” (Sidhu, n.d.). The inevitable event in an organization is the crisis. The most important thing for the leader to do is to try to anticipate the crisis and to make her or his organization capable of averting it through anticipatory actions. The essential preemptive action for overcoming the inevitable crises is to create an organization that is opportunity focused and on the offensive at all times, rather than an organization that is constantly on the defensive. Becoming battle alert requires that an organization shed its unproductive products, processes, services, and people. It then demands that an organization institutionalize processes of change—entrepreneurship and innovation at every level. If it is not possible to avert a crisis, the leader must have belief in the worthiness of the ultimate purpose of the organization and confidence and optimism in his or her ability to lead the organization through the crisis. How does one gain such confidence? First, there is no substitute for having gone through one or more crises in one’s life and having learned successful adaptive behaviors. That requires the presence of technical as well as interpersonal competencies. Second, being thrust into a culture in which a person is essentially a foreigner requires a person to learn adaptive behaviors in order to succeed in the new culture.5 Finally, a third approach for gaining confidence and direction is to anchor the organization in a solid credo that provides life-giving values and direction to help the organization in both good times and bad. From these kinds of experiences and values, the leader should know how to behave in a crisis, possess self-confidence for decisive action in the midst of a crisis, and have gained the trust of others so that both leader and followers can successfully navigate a crisis. Effective Leadership as a Liberal Art 31 Leadership succession is the toughest problem facing any organization. According to Drucker, the focus of leadership succession should be on choosing a leader who will maintain or build a high spirit of achievement. Maintaining the spirit of an organization depends on maintaining continuity in leadership with leaders who share similar values and who are willing to embrace necessary change. Succession is especially difficult when new leadership is following that of a founding entrepreneur. Organizations should be aware of the danger of trying to duplicate exactly the style and behavior of someone, such as the founder, who has made a lasting impact on the organization. Conditions facing an organization in the future may call for a person to have entirely different strengths. How should an organization go about selecting a new leader? One must think through the strengths required by the assignment that the new person will assume. It is best to have open and honest conversations with some people who previously have worked with each candidate to determine that person’s strengths and weaknesses. A good appraisal of a candidate’s record of past performance will include an assessment of both successes and failures. The highly spirited organization, one with a high esprit de corps, creates the right practices and the right “soil” for the development of new leaders. Strong leaders develop the full capacities of the people who follow them, and they lead their people to accomplishments that exceed even the highest expectations of those led. Observed Drucker: It is typical of the most successful and the most durable institutions that they induce in their members an intellectual and moral growth beyond a… [person’s] original capacities. (Drucker, 1946, p. 28) Such an achievement is possible by using right leadership practices, not through personality traits, charisma, or luck. Right practices include providing challenging assignments, having high expectations for those led, and granting the autonomy required for people to develop their strengths. Max De Pree summarizes role of leaders in simultaneously granting individual autonomy and achieving organizational goals: Delegate with a certain abandon so that people have space in which to realize potential, in which to be accountable, in which to achieve. I don’t believe we can achieve organizational goals without that congruency. I believe it is more the responsibility of the leader to forge that integration [of individual development and organizational goals] than it is the individual. (Drucker, 1990, pp. 39-40) 32 DRUCKER’S LOST ART OF MANAGEMENT The teachings on effective leadership just described are closely aligned with servant leadership as described in Chapter 5. Yet, servant leaders, while exhibiting empathy and compassion toward those served, also retain a pragmatic orientation toward results. It is toughness and compassion at the same time, so-called tough love. Servant leadership places great emphasis on listening, empathizing, and really “leaning in” toward the experience of those being led while pursuing results. Through servant leadership, leaders raise the dignity and self-respect of those being led. They do so by assuming responsibility for the development and enrichment of the people served. Servant leaders encourage those being led to assume high levels of responsibility and to realize self-esteem and fulfillment as they perform. Robert Greenleaf describes the origins of servant leadership from Hermann Hesse’s novel Journey to the East. In the book, Hesse tells the story of Leo, a servant who tends to a group of travelers on a journey. During the course of the story, Leo is lost, and the travelers find that they are unable to function without him. As Greenleaf remarks, the message he gained is that the servant was, in fact, the leader of the group, even though he performed the more mundane and routine tasks on the journey (Greenleaf, 1977, pp. 21-22). Although it is clear that Greenleaf’s concept of servant leadership is grounded much more in existential and process philosophy than religion, many have chosen to interpret servant leadership in the context of the Judeo-Christian tradition. Other examples of servant leadership in organizations abound. Wal-Mart positioned itself as a “national Christian icon” through its systematic implementation of a Judeo-Christian model of servant leadership (Moreton, 2009, p. 122). In mostly Muslim Malaysia, Francis Yeoh uses his Christian values to guide YTL Corp., insisting on ethical behavior throughout the organization (Karlgaard, 2004, p. 2). Servant leaders who model themselves in the Judeo-Christian tradition typically do so as a reflection of their own personal beliefs, striving to fulfill the moral obligations of their faith in every aspect of their lives. In servant leadership, providing dignity through leadership is very instrumental to the development of the person, and to the achievement of the mission of an organization. When asked about his reputation for developing people, Max De Pree, then chairman of Herman Miller, Inc., said: I would have to begin with a very personal observation, which is I believe, first of all, that each of us is made in the image of God. That we come to life with a tremendous diversity of gifts. I think from there, a leader needs to see himself in a position of indebtedness. Leaders are given the gift of leadership by those who choose or agree to follow. We’re basically a volunteer nation. I think this means that people choose a leader to a great extent on the basis of what they believe that leader can contribute to the person’s ability to achieve his or her goals in life. This puts the Effective Leadership as a Liberal Art 33 leader in the position of being indebted—in the sense of what he or she owes to the organization. (Drucker, 1990, p. 37) Theologian R. C. Sproul makes the link between the treatment of a person and the performance of that person. Sproul demonstrates that when a person’s dignity and self-worth are respected, increased production and higher quality are its by-products. When treated without respect, a person is downtrodden and uncommitted, and little production and bad qualities are the by-products (Sproul, 1991, p. 17). C. William Pollard, while in the process of writing his book The Soul of the Firm (1996), offered the view that “when the purpose of the firm is linked to the growth and development of a person in God’s image, it unleashes powerful forces in the mind and spirit of the worker” (Maciariello, 1996). He provides numerous examples that affirm this view from his work at ServiceMaster. While there are many reasons why leaders like De Pree and Pollard believe it is so important to be able to raise the issue of God in the workplace, the development of the human being at the workplace is the central issue. In the Judeo-Christian tradition, being created in the image of God recognizes that the human being has inherent dignity and status. As with other religious traditions, it provides guidelines for establishing right and wrong actions—and thus standards for what are considered responsible behaviors. Judeo-Christian interpretations of servant leadership typically emphasize the role of a higher spiritual authority in guiding an organization’s mission. They also provide the moral basis for recognizing the potential for human development; by seeing all as created in God’s image, these leaders have a religious imperative for upholding standards of equality and fairness in the workplace. Finally, the Judeo-Christian tradition creates the imperative for developing a healthy sense of community in the workplace within which the individual can find status and personal fulfillment through meaningful associations as part of a highly motivating organization. We have addressed this topic at length in Chapter 5, but here we see how some leaders have connected their religious beliefs to their leadership philosophy. We turn now to discuss a specific example of an outstanding leader, a historical figure who has been the subject of much scholarly inquiry and public interest—Abraham Lincoln. Economic Freedom as a Condition for Creative Destruction Because organizations are miniature societies, MBM, when properly implemented, achieves the same positive outcomes as free national economies that generate widespread well-being and opportunity. Free societies generate these benefits even when they don’t have great natural endowments. Hong Kong and Singapore, for example, were not blessed with abundant natural resources, but their standard of living is among the highest in the world. While it’s true they don’t have the same level of social and political freedom as New Zealand or Switzerland, they do offer people the greatest economic freedom compared to all the other countries in the world—and thus some of the greatest opportunities. The Fraser Institute’s Economic Freedom of the World Index takes into account many factors that affect the ability of people in a particular country to choose how they work, produce, consume, and invest. Those factors include property rights, free trade, sound money, and harmful regulation. Greater economic freedom is strongly correlated with not only higher income per capita, but with longer life expectancy, better environmental quality, improved health and education, less corruption, and better living standards—especially for the poor. Empirical study should lead one to conclude that long-term, widespread well-being is much more likely in free societies. By the same token, examples of prosperity in unfree societies—based on such things as superior natural resources—are few and far between, and generally short-lived. Life for the overwhelming majority of people who haven’t been blessed to live in a free society has been, as Hobbes put it, “poor, nasty, brutish, and short.” Businesses can create much more well-being in free societies that are ordered through voluntary cooperation and competition than in unfree societies that are ordered through government mandates. In a society with rules of just conduct, in order to benefit ourselves we must benefit others. Adam Smith summed up this process when he wrote, “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” Self-interest is often confused with selfishness or self-absorption in modern dictionaries and textbooks. Alexis de Tocqueville’s respect is evident for the enlightened self-interest he observed in the American economy of the 1800s, as he watched people benefit themselves by benefiting others: “Americans… are fond of explaining almost all actions of their lives by the principle of self-interest rightly understood; they show with complacency how an enlightened regard for themselves constantly prompts them to assist one another.” 34 Queens, Factory Girls, and Schumpeter 35 It is not a question of whether or not there should be self-interest, because the opposite of self-interest is extinction. The essential question is how to channel that self-interest for the general good. “No individual could survive in a world of scarce resources without a strong measure of self-interest, one that includes at the very least his own family and close associates,” wrote noted law professor and prolific author Richard Epstein. “That self-interest can manifest itself in one of two ways when dealing with strangers; through either aggression or cooperation.” Whether in civil society or in business, mutual benefit is achieved only when rules are in place to make sure people don’t use aggression (force or deceit) to advance their self-interest. According to Nobel Prize-winning economist Vernon Smith, these “beneficial rules of exchange” are “the right of possession, its transference by consent, and the performance of promises.” This system encourages profiting by economic means, not political means. Businesses that don’t create value by economic means are undermining wellbeing for all. Political economist Franz Oppenheimer clearly distinguished these “two fundamentally opposed means” by which people obtain resources to satisfy their desires. The economic means of profiting involves voluntarily exchanging your goods or services with others for money. Parties will not voluntarily enter into an exchange unless both believe they will be better off. Therefore, you can only profit over time in a system of voluntary exchange (a market) by making others better off. The political means of profiting transfers goods, services, or money from one party to another by force or fraud—for example, by laws or regulations that redirect consumer choices or that violate Vernon Smith’s rules of exchange and fail to hold accountable those who don’t fulfill their side of a contract. When all of us act out of self-interest, governed by beneficial rules of exchange, value is created by economic means. This results in the harmonious system, not ordained by government, that Hayek described as “spontaneous order” in society. In the 1940s, Hungarian-born polymath Michael Polanyi, who ranks with Karl Popper as one of the greatest philosophers of science, found that organizations have their own spontaneous order—and it is this order that is so beneficial to creating value in society. Polanyi’s spontaneous order is what the union leader near Bergamo thought was too radical to implement in Italy. “Workers work, managers think,” is a command-and-control approach, and command-andcontrol companies are less innovative and less competitive over time. Such companies have a much harder time making silk stockings that are affordable for factory girls than the companies that do so through beneficial incentives and generalized rules of conduct. 36 GOOD PROFIT Smith and Hayek demonstrated that prosperity can take place only through spontaneous order, an order that results from unscripted human action, not human design. Smith described this as the “invisible hand” by which, in the proper system, man is led “to promote an end which is no part of his intentions.” Hayek showed how prosperity requires that the knowledge dispersed throughout society be put to productive use, saying it “cannot be gathered and conveyed to an authority charged with the task of deliberately creating order.” This point was memorably illustrated by economist Thomas Sowell in his book Knowledge and Decisions: “When Soviet nail factories had their output measured by weight, they tended to make big, heavy nails, even if those big nails sat unsold on the shelves while the country was crying out for small nails.” In other words, when governments plan how people should run their lives, everybody (but those in power) loses. But when people and companies are free to innovate using their knowledge of what they and others value, consumers benefit, enabling business to generate good profit. Only spontaneous order, resulting from unscripted human action, can answer the demand of people who need nails. By harnessing the principles of free societies—which generate knowledge obtained from prices and profits and loss—organizations benefit tremendously. The knowledge obtained by understanding the drivers of profits and losses enables an organization to determine the number and types of nails needed. Replicating the way the scientific community organizes itself, wherein knowledge is shared freely with a commitment to disproving even the most cherished hypotheses, leads to innovation. Likewise, it provides powerful benefits for organizations. Polanyi makes this parallel, comparing the scientific community to business in his 1962 paper “The Republic of Science”: The community of scientists is organized in a way which resembles certain features of a body politic and works according to economic principles similar to those by which the production of material goods is regulated. Much of what I will have to say will be common knowledge among scientists, but I believe that it will recast the subject from a novel point of view which can both profit from and have a lesson for political and economic theory. Certainly Koch has benefited from the theories espoused in Polanyi’s “The Republic of Science.” (I used the methodology he described to write this book, soliciting input from knowledgeable sources throughout Koch.) We are able to create superior value for customers because we attempt to replicate a Queens, Factory Girls, and Schumpeter 37 free community of scientists—constantly sharing knowledge and ideas, testing hypotheses, experimenting and adjusting according to what honestly works—rather than succumbing to establishmentarian pressures. People used to think the sun revolved around the Earth because it fit their notion that everything ought to revolve around the Earth. Humans lived on Earth, after all. Thus they had a “mental model” that wrongly assumed the Earth was the center of the universe. The consequences of this faulty model delayed scientific advancements, and even landed a dissenting physicist—Galileo—under house arrest for daring to challenge religious dogma enforced by government. Mental models are intellectual structures that enable us to simplify and organize the myriad inputs we get from the world around us. They shape and support our thinking, decision making, opinions, values, and beliefs. Ludwig von Mises said of mental models, “They are a necessary requirement of any intellectual grasp of historical events.” Yet Buddha warned us not to believe anything just because it is commonly accepted, or even on the authority of our teachers but only when, “after observation and analysis, when it agrees with reason, and is conducive to the good and gain of one and all.” The quality of our mental models determines how well we function in the physical world. The same is true for the economic world, which is why Koch Industries invests tremendous time and effort to ensure that our MBM mental models fit reality. Any business with behavior based on faulty mental models will eventually fail. We must constantly remind ourselves that just because we believe or want a thing to be true does not make it so. The most reliable signal that a business is using reality-grounded mental models and providing service that customers truly value is a profit made over time under beneficial rules of just conduct. Short-term profit, created by liquidating assets and avoiding expenditures necessary for long-term success, can be illusory. (The opportunity for us to buy Chrysler Realty presented itself in 1979 because Chrysler, which had been showing “profits,” was actually on the verge of bankruptcy due to its failure to make necessary investments.) When one of our businesses is profitable in the long term, we have some confidence that we are achieving our goal of creating value by helping people improve their lives, and doing a superior job of using resources more efficiently than our competitors. 38 GOOD PROFIT Consuming as few resources as possible while creating value for customers leaves more resources available to satisfy other needs in society. Long-term profitability indicates that the resources consumed have a higher value in that use than in alternate uses—customers are voting for one use over another with their dollars. An entrepreneur’s resources are not just capital, raw materials, and energy. They also include knowledge, labor, time, and other inputs. Superior value can be created by converting these resources into a product or service that has greater value to the customer than its alternatives, or by consuming fewer or lowercost resources to provide the same product or service. For example, more value is created by making fabric with LYCRA than with commodity spandex. Producers of fabric are able to run their production lines faster because the LYCRA fiber breaks less. It also lasts longer and recovers better after stretching than does commodity spandex. When gasoline is made by a more energy-efficient process, or in a way that produces a higher yield, the resulting product may be the same, but resources are conserved. While we often tend to focus on the direct benefits we can see, like cheaper goods for consumers, the “unseen” benefits to society as a whole can be even greater over time. Koch companies turn crude oil into products such as fuels and asphalt, and polymers into fibers for carpets and clothes. If we can make these products using fewer or less-costly raw materials, several good things happen. The resources saved are available to satisfy other needs, enabling people throughout society to benefit from lower prices while allowing Koch to earn good profits. We reinvest these profits to create new products enabling us to hire and reward employees. In a free market with property rights and beneficial rules of conduct, profitability through voluntary transactions is not a signal that one party is taking advantage of another. Quite the contrary, “good” profitability is the appropriate measure of an enterprise’s contribution to society. That is why a business that continues to be unprofitable should be restructured, sold to a better-suited owner, or shut down. If a business requires subsidies or protective laws to survive or employ more people, it is not generating good profit. Although I do not want to minimize the stress and fear that often accompany loss of employment, virtually everyone would be better off if those people were employed where they could be more productive. Change is ever-present in society, the economy, and politics. Companies, products, methods, and individual skills are constantly being replaced by superior alternatives. By relentlessly applying a Queens, Factory Girls, and Schumpeter 39 business philosophy that seeks rather than runs from these alternatives, all of us at Koch have worked hard to counter the tendency toward long-term decline of those who don’t innovate. Companies must realize they are not competing just on price and output of existing products. They have to relentlessly strive to come up with new and better products and produce them more efficiently than the alternatives. They also need to constantly improve the way they’re organized, so they can innovate and eliminate waste better than their competitors. This is what MBM enables Koch to do—and it is what MBM can enable you to do…
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