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The CFO of the United States's largest private company explains what it's like to not worry about earnings.
Lori Calabro, CFO Magazine
January 1, 2008
As executive vice president and CFO of Koch Industries Inc., the largest private company in the United States, Steve Feilmeier enjoys certain benefits. "We don't worry about our earnings," says the former PepsiCo executive. "We care deeply what our earnings are, but unlike a public company that reports every 90 days, our earnings are flashed and that's it. There's no discussion."
Instead, with $95 billion in revenues and 80,000 employees, there are plenty of other things to discuss, says the 46-year-old Feilmeier. These include which potential acquisitions to add to the commodity and financial conglomerate's stable; how to coax the best talent to its Wichita headquarters; and how to apply the ideas of "Market-Based Management," a philosophy espoused by CEO Charles G. Koch and recently outlined in Science of Success (John Wiley & Sons, February 2007).
That philosophy is based on allowing the free market to create long-term value, and it is executed by fostering internal entrepreneurialism. Says Feilmeier, "We're much more interested in hiring people with the right values and beliefs than those with the right skills and knowledge, although you have to have both dimensions."
How do you describe market-based management (MBM)?
Some might think of it as just good-old-fashioned common sense. But it's much more than that. It's how you take certain fundamental concepts — vision, virtues, talents, knowledge systems, decision rights, and incentives — and apply them consistently and holistically inside your firm. Take vision. A large retailer might say it wants to be the best, lowest-cost retailer. Our vision simply says that we want to take our capabilities and apply them to those opportunities that will create the greatest value for Koch Industries. As a private company, we don't have to be in any specific industry. So we want to be only in those industries where we can apply our capabilities. It gives us many more opportunities to reinvest our capital.
How did your acquisition of Georgia-Pacific exemplify your capabilities?
When we bought Georgia-Pacific [in 2005, for $21 billion], people said, "That doesn't fit you. You're an energy company, and, at best, a chemicals and fibers company to [complement] that." And we said, "No, if you look at our capabilities, what we do as a general construct, we process commodities through various large, complex, technologically advantaged plants. And then we go to market in bulk, typically with a trading capability." So [if you compare] a refinery that processes crude oil with a fertilizer facility that processes natural gas with a chemicals plant that processes naphtha, a pulp-and-paper company that processes trees and goes to market in bulk has many of the same capabilities.
How does MBM translate in finance?
Let me give you an example [concerning] knowledge systems. One of our principles is to transfer-price everything internally at market-based pricing. So whether it is a headquarters function or a chemical plant that produces chemicals for another plant, we will always attempt to transfer-price those things at market. We believe that the alternative for any given asset should always be considered [in order] to best optimize the profitability of that asset. If you simply transfer price between two different divisions at cost, then you may be subsidizing your whole operation and not know it. If I can buy chemicals from a third party at a price that is less than what I can buy [them for] internally, I ought to know. It doesn't mean that I will, but it's certainly an important knowledge system to have.
When it comes to compensation, what metrics do you use?
We don't have any compensation systems that are hard and fast; they're based on the value that we create together. And we go through a rigorous examination each year and talk about what that means. [That process] really avoids the subsidization that might occur when you have a typical pay structure like the Hay system, or levels where you are going to be in a range and have an entitlement-oriented mentality.
How does it work in practice?
It's based on a tremendous amount of input, first from the team that the person works with (peers, direct reports, supervisors, and customers). We also attempt to gather information about the value that person added during the year. The [example] I like to talk about most is the person who runs our payroll department. When was the last time you called payroll and said, "Hey, thanks for getting my check"? Probably never. If it's wrong, though, I guarantee that phone call is made. We have a person in our payroll department who's phenomenal, [meaning] we never hear a word about anything out of payroll. And so we make sure that person is rewarded above what he or she might get in the role somewhere else.
What advantage do you have in not having to report quarterly earnings?
[It means] we are not going to be judged by whether or not we hit our earnings target. I've talked with many CEOs and CFOs who agree [that] it is the most ridiculous form of judgment. It starts with the media. CNBC will report the earnings of a public company within seconds after they are announced, and then have immediate commentary saying whether or not that company is doing well. How can anybody know if the decisions that were made in the last 90 days to advance the business over the next 20 years are really good or not? And companies would never admit that their decisions are different as a result of that [judgment], but I guarantee you they are. We don't hesitate on those decisions, because we're only trying to impress ourselves here.
Any advice for your counterparts toiling in the public arena?
The first advice, which would be very self-serving, is to consider going private. Barring that, [CFOs should be concerned about] the growth in government spending. Because of the continued growth of government and the trend toward overcriminalization of mistakes, the environment we live in right now in the United States may become a much more difficult place to do business in. I know it's not in the sphere of most CFOs' responsibilities to worry about things they can't control, but it's something they have to be much more knowledgeable about in the future.