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For the sake of scaling, enterprises tend to create internal service divisions that are bureaucratic and monopolistic: Accounting, Procurement, R&D, Human Resources are usually run as subsidized monopolies. The pool that pays for their services is covered by an overhead charge imposed on the units served.
In general, subsidized monopolies are generally insensitive and unresponsive to the users of their services, but they are sensitive and responsive to those who subsidize them. Subsidizers are often not users of the service, hence less aware of the services’ deficiencies from the users’ point of view. In addition, bureaucracies try to ensure their survival by becoming as large as possible; they operate on the (not unreasonable) assumption that the larger they are, the more important they are and the more difficult they are to eliminate.
Centrally controlled corporations stimulate the increases in costs of internally provided products and services because the supplying units do not need to compare their costs and prices with those of external suppliers. How can you value a subsidized internal unit? It’s impossible. In a market controlled enterprise, users, not subsidizers, evaluate suppliers and express their evaluation in a way that counts – by their purchases.
As organizations of any kind become larger and more complex, the ability of centralized controllers to know all they need to know to manage their organizations effectively diminishes. Thats’s why an enterprise based on market economy works better in large systems: it disperses economic control among many enterprises that must compete with others in order to survive. And survival requires meeting or exceeding the expectations of customers and consumers.
A few requirements are important for an internal market economy to work within an enterprise:
- Every unit within the enterprise has to be either a profit center or a cost center that is part of a profit center that is responsible for the cost center’s performance. Profit Centers are not always expected profitable but they have to be accountable.
- Profit Centers have the freedom to buy any service or product they want from whatever source they want, and to sell their outputs to whomever they want at whatever price they want or are are willing to accept.
- A corporate unit that reduces the value of the corporation shouldn’t be part of it no matter how profitable it is when looked at separately. For that reason, the enterprise has the ability to intervene in a unit’s purchases and sales bot only when it benefits an organization as a whole.
- If there any executive reasons to buy services from internal resources even though outside suppliers are cheaper, the executive can force the unit to buy from within but has to pay the difference out of his own unit’s budget. This means that a selling unit will never have to sell its output at a price lower than it wants to and can.
- A manager doesn’t tell his or her subordinate units what to buy and sell unless a negative effect on other parts of the corporation or the corporation as a whole can be perceived.
- The executive units receives income from two sources: a) it charges for the operating and investment capital it supplies to subordinate units b) it imposes a tax on the profitability of each unit.
- Each profit center can accumulate profit up to a certain level that all stakeholders agreed on. Profits in excess of the specified amount will be passed up to the corporate level for its use.
Why a market enterprise?
Every enterprise unit operating within an internal market economy becomes a profit center. Therefore, for each unit the same success metrics can be applied. It allows managers to hone their skills better since they have a lot of autonomy and it gives each stakeholder an opportunity shine. Managers will be more concerned to get all the information they need to run a profitable unit and offering that information to other units to improve interactions.
The biggest challenge in implementing this system is the tendency of managers to withhold information. They fail to see that empowering all stakeholders might decrease their stranglehold on information and power but, at the same time, empowers all stakeholders to run a much more profitable organization. And an organization everybody is invested in. It is often recommended to remove managers that are more concerned with their own power base and not the overall health of the organization.
These managers often form connections with units that are unable to compete effectively or are no longer needed in the enterprise. While dealing with these challenges, the enterprise should never forget that without converting to a market enterprise, the whole organization might become extinct.
In the next installment, we will talk about organizational structures.