From Free Life, Issue 30, May 1999
ISSN: 0260 5112

The authors argue that firms would become more efficient and effective if they made greater use of market-based mechanisms in allocating resources within the firm.

They begin with the familiar talk about global competition, the accelerating pace of change and the consequent importance of the learning organisation. Competitive advantage depends upon the timely and economic collection and exploitation of information. This is leading to the demise of bureaucratic organisations with their functional departments and hierarchical structures. They are being replaced by flatter organisations, with tiers of management stripped out and decision-making devolved down to staff who are closer to the customer, with staff organised into cross-functional teams (which might exist only for the duration of a particular project), and with non-core services contracted out to suppliers who are seen as partners of the contracting organisation. All this is facilitated by developments in technology, particularly the computerisation of design, of manufacturing, and of management information systems.

The authors briefly describe developments in the theory of the firm stemming from R H Coase's work according to which, roughly, firms (or ‘hierarchies') exist because the costs of planning, co-ordinating and giving orders are sometimes lower than the costs of entering into contracts in the marketplace. But they emphasise the benefits of hybrid forms of organisation, such as internal markets, which combine features of hierarchies with features of markets so that organisations can be more adaptive to their changing environments. They support this with a number of illustrations of the use of market principles in the firm:

(a) Koch Industries' "Market-Based Management" emphasises leadership and devolved management of profit centres combined with matrix management;

(b) Barclays Bank let each of its 30 businesses decide on commercial grounds where to buy their computer services and as a result the in-house IT department improved its performance to the point where it was winning contracts for work with other leading companies;

(c) McDonald's combines a rigid standardisation of type and quality of product with local managerial discretion over other matters (e.g. marketing campaigns);

(d) Nordstrom uses individual bonuses to reward its sales people who compete against each other, Japanese companies use team bonuses to encourage co-operation and pursuit of corporate goals, while Wal-Mart uses a combination of both.

First, there is devolution of decision-making, i.e. the attempt to ensure that more decisions are taken "on the ground" where the knowledge is. This is a Hayekian principle which is being applied in all kinds of different organisations, public sector as well as private sector.

Second, there is divisionalisation, where a company makes each of its separable lines of business (or ‘divisions') into a profit (or investment) centre which operates largely as an independent company. The question that arises with this arrangement (and which the authors do not really answer) is why does the company exist, i.e. what value does it add over and above that produced by the separate profit centres? Or, to put it another way, why shouldn't each of the different profit centres go their own way, i.e. actually become independent companies?

Third, there is internal trading, where some parts of the organisation sell their goods or services to other parts of the same organisation. The internal sellers could be providers of support services (such as accountancy, personnel, computing, legal, etc.) or they could be a step back in the supply chain, e.g. supplying components to the divisions which make finished goods. The internal buyers may or may not have the option of buying such goods or services from the external market instead (as in the case of Barclays mentioned above).

Note that devolution and divisionalisation need not involve internal trading (e.g. in a highly diversified company, the different divisions may be in different industries altogether). It is internal trading, I think, that is normally meant when people refer to an internal market.

I spent more than five years assisting in the development of an internal market for support services at a London council, with limited success. I think I would draw two main lessons.

First, it is a waste of time having the users argue with the providers over cost, because the users just do not have the information about the operational details of the provider's service to enable them sensibly to negotiate cost reductions (and, in the absence of a detailed formal specification, a comparison with potential external suppliers only begs questions about the completeness and quality of the service that would be provided). Pressure for cost reduction is best exerted from the top (possibly, but not necessarily, by making use of the external market via formal competitive tendering).

Second, big improvements in the quality, suitability and responsiveness of support services can be secured when the providers meet their users on a regular basis to discuss what work has been done and how, what problems there are and how things could be improved. Such dialogue encourages the providers of services to treat their users as customers, to see their point of view, and can tap user ideas for service improvements.

In short, there are benefits to be had from internal markets; but they are not, perhaps, exactly the benefits one would have expected.

Danny Frederick