Later On

A blog written for those whose interests more or less match mine.

I have to say that I like some Koch Industries ideas and principles

leave a comment »

And it’s easy to see why they despise Donald Trump, just in terms of business acumen. A very interesting article by Christopher Leonard in the Washington Post:

Charles and David Koch are best known for their controversial political empire, where they ply their combined personal fortunes of nearly $96 billion into conservative causes and candidates across the nation.

They’re less known for the business empire that’s enabled that wealth: Koch Industries. One of the United States’ biggest companies — whose annual revenue of $100 billion is more than that of Goldman Sachs, Starbucks and Honeywell International combined — Koch owns brands that are fixtures of American households, such as Brawny paper towels and Lycra. But because it’s privately held, how it has grown so big has remained something of a mystery.

A year-long look into Koch Industries’ $21 billion purchase of wood and paper giant Georgia-Pacific, involving interviews with Georgia-Pacific employees from the factory floor to the executive suite, offers a rare view into how the brothers run their businesses. The company’s approach, examined for a forthcoming book, aligns with the brothers’ brand of economic conservativism, which stresses the power of the market and skepticism of government. At times, its approach is at tension with their philosophy.

Charles Koch often frames his political giving in economic terms, saying that the free market is better able to solve society’s problems than the state. As chief executive of Koch, one of his strategies has been to shield his companies from the market pressures that many public firms face.

That shield also makes it difficult for outsiders to judge whether Koch Industries is a good steward of its investments. Outsiders are left to wonder: What does it mean to become part of Koch? What can public companies learn from Koch’s management techniques once it takes another company private? What can employees expect if Charles Koch becomes their boss?

Charles Koch, who did not comment for this story, has implemented deep changes at Georgia-Pacific. Most of them exploit one of Koch’s key advantages: The company is privately held, with essentially only two shareholders: the brothers. This gives the firm flexibility to operate in a way that makes it more nimble than many publicly traded firms.

After taking Georgia-Pacific private, Koch jettisoned annual budgets and quit focusing on quarterly earnings. Reinvestment has skyrocketed. Strategic thinking has shifted years, or decades, out.

The strategy makes Koch Industries somewhat of an outlier among major American corporations, fighting the tide of shareholder-return management strategies that many critics say have led to an excessive focus on short-term returns. Charles Koch perpetually reminds his managers they want to achieve the highest return on investment, but he’s willing to take 10 or 20 years to get it.

“If you need to wreck your budget to do what creates the most value, you should wreck the budget,” said David Robertson, president and chief operating officer of Koch Industries, summarizing his boss’s philosophy.

Yet to achieve success, Koch has at times had to compromise some of his principles. Koch has used his political power to crusade against what is sometimes called “crony capitalism” — the use of tax breaks and subsidies to benefit some companies over others. And yet Georgia-Pacific made use of one such tax break to ride out the recession.

Whatever the approach, it seems to be working for the company’s bottom line. Georgia-Pacific’s debt rating has climbed from junk status to high investment grade. Annual net income averages just slightly more than $1 billion a year, according to Koch Industries, compared with $623 million before the acquisition.

Seeing value others missed

Like almost virtually everything with Koch Industries, the deal began in secret. Not even senior managers at Georgia-Pacific knew what was coming when a small delegation of Koch employees arrived in 2003 and started asking questions. Koch had amassed most of its influence in the energy business, owning oil refineries. But its sprawling business interests span agriculture, minerals, materials engineering and even cattle ranching.

One afternoon, Koch executives met with Georgia-Pacific executives on the 51st floor — reserved for Georgia-Pacific executives and their guests — of the company’s headquarters. Over lunch served on fine china, Wesley Jones, who oversaw Georgia Pacific’s wood-pulp mills, explained how they operated, where it bought timber and where it sold pulp, and the potential growth of Asian markets.

One of the visitors listening was James Hannan, who worked for Koch Industries and would be installed as Georgia-Pacific’s CEO in 2007. (Today he is an executive vice president at Koch Industries.) He wasn’t used to wearing a tie — Koch culture was much more informal.

Hannan and his team thought ­Georgia-Pacific’s pulp mills could push Koch into a new industry while allowing the company to build on what it did best. Pulping wood turned out to be not all that different from refining oil. At Koch’s oil refineries, crude oil was pumped in one end and then heated and processed in big towers, making gasoline and other products. At Georgia-Pacific’s pulp mills, truckloads of pine trees were fed into one end of the mill and cooked down into a fibrous goo and sprayed into churning machines that make long rolls of dense pulp material.

The Georgia-Pacific mills were attractive for another reason. Koch executives believed they were undervalued in a way a privately held company could exploit. The company had been on a decades-long spree buying a lot of businesses that didn’t fit neatly together — Georgia-Pacific made high-profit tissue paper and lower-profit wood pulp. The markets for tissue paper and plywood were so different that bank analysts had a hard time putting a single value on a company that was heavily involved in both. The pulp line was cyclical and dragged down the value of the consumer-products business.

Koch Industries wasn’t bothered by the boom-and-bust cycles of the wood-pulp business. Volatility was Koch’s bread and butter. Koch bought Georgia-Pacific’s pulp division in 2004 and renamed it Koch Cellulose. Koch put Jones in charge.

After Koch took the pulp mills private, Jones noticed an immediate change. The biggest, most obvious change was Koch’s willingness to reinvest its profits.

The art of killing dividends

Georgia-Pacific had been skimping on capital spending at its pulp mills for years, Jones said. That was partly because the company had to pay off the roughly $3.5 billion in debt it took on to buy Fort James, a tissue maker. The firm had about $8.7 billion in total debt in early 2005. Georgia-Pacific also paid out generous dividends to shareholders, a common practice that public companies employ to make their shares more enticing.

The company’s strategy was to run its mills as long as possible without shutting them down for repairs, Jones said. It delayed the purchase of new equipment that might have made the plants more profitable. The strategy worked for a while, Jones said, but by 2004 the equipment was starting to show serious wear and tear.

“We were trying to spend as little as possible,” Jones recalled. He said he was frustrated with the lack of investment. “There’s a lot of smaller stuff that we had to have fixed.”

Under Georgia-Pacific, Jones undertook a laborious, bureaucratic process to get new investments approved. He was girding himself for the same under Koch. He badly wanted to install a new set of more-efficient processing towers at Koch’s pulp mill in Brunswick, Ga. After the Koch purchase, he talked about it on the phone with a Koch executive in Wichita, saying they had cost $35 million to $40 million.

To Jones’s surprise, the investment was approved. On the phone. That was a first.

“I remember putting the phone down and thinking, ‘Damn,’ ” Jones said, shaking his head. “It was like a month or two after the acquisition. I was floored.”

Executives at Koch’s headquarters in Wichita were accustomed to such quick approvals. Charles Koch requires that 90 percent of the company’s profits are reinvested. He fought a legal battle for roughly 20 years against his younger brother Bill Koch, who along with other shareholders wanted to pull more cash out of the firm. Charles Koch refused.

To be sure, the relentless drive for profits has led to criticism of Koch’s business practices in the past. In 2000, the company paid what was then the largest civil fine ever — $30 million — for violating pollution laws after its pipelines sprung hundreds of leaks. Its oil refinery in Minnesota was fined for improperly dumping ammonia into local waterways. In such cases, Charles Koch has said, members of management had misinterpreted the company’s philosophy.

As it spent money on Georgia-Pacific’s pulp mills, Koch Industries liked the results.

“We were able to demonstrate relatively quickly that the improvement opportunities were there,” Jones said.

In late 2005, Koch Industries announced that it was buying all of ­Georgia-Pacific for $21 billion.

The timing of the deal could not have been worse.

Riding the crash

Koch took full custody of Georgia-Pacific just as the nation’s housing bubble burst. Georgia-Pacific made plywood, lumber and gypsum building panels used in everything from apartment buildings to new restaurants. The market collapsed.

When Georgia-Pacific hit a rough patch in 2009, it made use of a highly controversial tax credit for a pulping byproduct known as “black liquor,” the company acknowledged to The Washington Post. Critics said the creation of the tax credit in 2007 was a backdoor bailout for some wood companies in lean times.

“Of all the tax loopholes I’ve seen in the last three decades, none is more despicable than the totally unintended and unproductive black-liquor tax credit,” Marty Sullivan, a tax consultant and former staff economist with the Treasury Department, said in an email.

Karen Cole, a Georgia-Pacific spokeswoman, said: “We did not advocate for this tax credit, but ultimately we did participate in it — not doing so would have put us at a competitive disadvantage. We have consistently opposed all subsidies, mandates and programs that distort the market and will continue to do so, even when they benefit us.”

The market collapse was particularly bad news for Jose Casanova, a manager of Georgia-Pacific’s gypsum mill outside Savannah, Ga. Casanova said the market for his products tanked just as the plant opened a newly expanded production line. Sales were low for years afterward. But Casanova, who had worked for ­Georgia-Pacific since 2000, noticed something surprising. Koch didn’t pull back its capital spending.

Koch installed new safety fencing around the machines, hoping to cut down on lost-time accidents. The yellow metal barriers would discourage employees from manually dislodging jammed machines or trying to clean around conveyor belts while they were will running.

“We didn’t think it was possible — until we implemented it,” Casanova said. “Now we need to make sure the equipment is reliable. Then you don’t need to access the equipment and risk getting hurt.”

Koch’s experience with volatility created another practice that soon swept through Georgia-Pacific.

In the 1980s, Koch stopped routinely using annual budgets — those financial documents that for many public companies are akin to divinely inscribed stone tablets, dictating which financial targets would be hit in a given quarter. The power of budgets was logical for public companies — if sales or profits are below expectations, even for one quarter, it can hurt the stock price.

During the oil shocks of the 1970s and ’80s, Koch executives realized that budgets were all but worthless — it was all but impossible to predict how much Koch needed to pay for oil six months or a year down the road.

Instead, Koch uses “plans” for each year, sketching out revenue, costs and profits it anticipates, mainly used so executives can better plan acquisitions. Managers aren’t judged on how closely they adhere to the budget — just on whether they expand their business.

“The difference is that many companies go to painstaking detail on every line item in their budget in an effort to, I’ll say, predict the future,” Robertson said. “What we determined is that we weren’t very good at predicting the future. So why do we want to spend an inordinate amount of time trying to?”

A new culture . . .

Continue reading.

I certainly resonate with investing in the productive capability of the enterprise (which includes taking good care of employees), and with the folly of trying to stick to a budget made the previous year in a culture in which any variance (regardless of external conditions) from the budget is very difficult to secure. I’ve worked in that situation, and what it seems to lead to is a culture of lying and deceit.

For example, one division at which I worked was presumed to generate a certain (relatively high) profit each year. That was written into the budget, and budgets were treated as sacrosanct. So if external conditions went awry, the fear of being penalized by corporate for varying from the budget led division executives to use accounting tricks to hide the facts and make it seem as though the budget was working. So the 10% goal was “met,” in a sense, and since the division seemed to meet its goal, then the following year’s profit goal from corporate was unchanged because it was viewed as doable and was a good profit—quite a good profit.

This went on for a few years, then the CFO and CEO were fired for cooking the books. All the falsehoods were exposed and the problems recognized and written off. A new CFO and CEO were named, and they started with a clean slate—and the same profit goal. They were forced into the same effort, and it worked for a few years, then it blew up again, and the cycle was repeated. No one seemed to learn anything, in part because corporate was remote and interested only in that (unrealistic) profit goal because it was needed to keep the stock price up.

It was nuts.

What’s odd about Koch is that he doesn’t seem to see that, just as he invests in his businesses to grow their productive capability, the government should invest in its citizenry and infrastructure the same reasons: cutting back on maintenance and social support makes no more sense in a country than in a business: businesses that invest in their physical plant and in their personnel can thrive (as Koch has shown), and countries that keep their infrastructure in good maintenance and expand as needs require (e.g., better railways, more ways to get from A to B at lower cost overall, ensuring that the environment is in good shape, that citizens are provided pure foods and effective medications) and provide their citizens a good education and training as needed—and a good education includes teaching them what is required of citizens for the good of the country (e.g., being informed on major issues, voting in elections)—that is, teach them their civic responsibilities. Just as a business can be destroyed by not investing in productive capability in order to provide bigger dividends, so a country can be destroyed by cutting back on protecting the environment, keeping the infrastructure current and in conformance with what we now know about such things, making sure citizens are educated and healthy, and so on, just in order to deliver a big tax cut to the wealthy (as we see in the GOP effort regarding Medicaid).

The US is like a badly run company, including having Donald Trump heading it up.

Written by LeisureGuy

8 July 2017 at 2:47 pm

Posted in Business

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s