Internal Markets

[Oliver Sutton]

Great article from John Naughton in the Observer on Ronald Coase.

http://www.theguardi...nomics-internet

The thing that puzzled him was this: economic theory postulated that the market provided the most efficient way of co-ordinating economic activity, and yet no large company seemed to use the price mechanism as a way of co-ordinating its internal activities. Instead, big corporations operated as command-and-control mini-economies of the kind despised by economists. How come?

If this was obvious 80 years ago why did idiots like John Birt try and impose internal markets on the BBC? Ditto the NHS.

[Guest_GradualCringe_*]

Internal markets don't work in the NHS and such like is because they are a form market socialism (see the work of Oskar Lange, of which there are some very persuasive critiques), not ultimately governed by prices and markets.

I don't know of any company that can ignore prices, profitability and revenue streams, unless it can call and rely upon sizeable government back handers.

The logical conclusion of the article is that a company over a certain size can create products and services nobody wants (even do nothing at all) and remain in business.

And before anyone mentions banks, they are the recipients of possibly the biggest tax payer bail out in history.

Edited September 12, 2013 by GradualCringe

[Oliver Sutton]

The logical conclusion of the article is that a company over a certain size can create products and services nobody wants (even do nothing at all) and remain in business.

Please explain.

[tomandlu]

The logical conclusion of the article is that a company over a certain size can create products and services nobody wants (even do nothing at all) and remain in business.

Nope - it's just saying that using the free market has a cost, hence both the existence of, and the behaviour of, companies and firms.

[interestrateripoff]

http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0335.1937.tb00002.x/full

The paper cited is here.

Economics if full of contradictions because it isn't a science, it's mere opinion which sometimes proves correct at certain time points.

Internal markets can work, but they can also fail especially if you have people running them who are working towards other contradictory goals.

[Guest_GradualCringe_*]

[/size]Please explain.

No company can be fully command and control unless it can forcibly command a revenue stream too, without which of course, re-organisation of production within a company, although initiated by a manage or director, will ultimately be constrained by a budget.

Edited September 12, 2013 by GradualCringe

[tomandlu]

No company can be fully command and control unless it can forcibly command a revenue stream too, without which of course, re-organisation of production within a company, although initiated by a manage or director, will ultimately be constrained by a budget.

I still don't get what you're saying.

[Guest_GradualCringe_*]

Nope - it's just saying that using the free market has a cost, hence both the existence of, and the behaviour of, companies and firms.

and yet no large company seemed to use the price mechanism as a way of co-ordinating its internal activities. Instead, big corporations operated as command-and-control mini-economies of the kind despised by economists

No company can command a revenue stream (i.e. go round to peoples homes with a big stick and ask for donations). Ultimately it has to rely on budgets, prices, and their customers (i.e. the market)

Edited September 12, 2013 by GradualCringe

[tomandlu]

No company can command a revenue stream.

Who said they could?

[Guest_GradualCringe_*]

Who said they could?

From the article:

and yet no large company seemed to use the price mechanism as a way of co-ordinating its internal activities. Instead, big corporations operated as command-and-control mini-economies of the kind despised by economists.

Has the person who wrote this article ever worked for a proft making company? I don't know of any activity within a company I've worked for/had a hand in running that wasn't constrained by prices and/or a budget of some sort i.e. decision making was guided by market prices.

For the quote to be true, i.e. for a company to successfully stay in business and ignore prices i.e. continually do any old thing because the managing director thought it would be a good laugh for example, it would have to have the ability to call upon an abitrary stream of revenue.

Edited September 12, 2013 by GradualCringe

[Executive Sadman]

Have they ever been implemented as originally planned?

Its a bit like those saying the car dependent road plans of the 60s and 70s never worked...well of course not, they only built about 5% of them! If you fail to implement the other 19/20ths of the plan, obviously the objective isnt going to be met...

[tomandlu]

From the article:

Has the person who wrote this article ever worked for a proft making company? I don't know of any activity within a company I've worked for/had a hand in running that wasn't constrained by prices and/or a budget of some sort i.e. decision making was guided by market prices.

I think you're misunderstanding both the premise and the article. It's not saying that the price mechanism is irrelevant or even ignored - just that the cost of transaction in the free market may be greater than the savings, which is why firms exist - they are internalising parts of their process, and classical economics expects that to be more expensive that contracting in the free market. It will make it harder for the firm to respond to price signals, but the benefits outweigh that (until they don't). The mistake in the standard model would appear to be that it doesn't consider the transaction cost.

[Oliver Sutton]

Has the person who wrote this article ever worked for a proft making company? I don't know of any activity within a company I've worked for/had a hand in running that wasn't constrained by prices and/or a budget of some sort i.e. decision making was guided by market prices.

That's external prices. Different from creating an internal market.

[fluffy666]

No company can command a revenue stream (i.e. go round to peoples homes with a big stick and ask for donations). Ultimately it has to rely on budgets, prices, and their customers (i.e. the market)

It's more an internal matter.

For example.. a software company will design and build a piece of software, internally using command and control.. (or at least design and arguing). The market only comes into it when the company tries to sell it against a competitor.

It does not have each employee write their own version of the software and have them compete internally.

[Dorkins]

Has the person who wrote this article ever worked for a proft making company? I don't know of any activity within a company I've worked for/had a hand in running that wasn't constrained by prices and/or a budget of some sort i.e. decision making was guided by market prices.

For the quote to be true, i.e. for a company to successfully stay in business and ignore prices i.e. continually do any old thing because the managing director thought it would be a good laugh for example, it would have to have the ability to call upon an abitrary stream of revenue.

This is not what is meant by a "command economy". In a command economy there is a decision maker (senior management) who decides what fraction of the available resources (a budget) should be allocated to various activities. Generally this means there will be only one unit carrying out each activity within the organisation which other units are compelled to coordinate with e.g. one HR department, one IT department, one finance department, one marketing department etc. Because these units don't make revenue from each other so can't expand themselves when demand increases, they may need to ration the amount of service they are able to provide. The only way each unit can get more resources is to convince the decision maker to give them some.

With an internal market, you might have three different IT departments each offering their services to the other units at different prices. Units would be free to choose whichever IT department best meets their needs. IT departments could use the revenue they collect from other units to expand and take market share from other units.

Edited September 12, 2013 by Dorkins

[EUBanana]

I don't think companies are generally big enough to have 3 IT departments in competition. Though I suppose if you have the likes of Eidos, with software houses all semi-independent across the world, then that is something like that.

[Guest_GradualCringe_*]

This is not what is meant by a "command economy". In a command economy there is a decision maker (senior management) who decides what fraction of the available resources (a budget) should be allocated to various activities. Generally this means there will be only one unit carrying out each activity within the organisation which other units are compelled to coordinate with e.g. one HR department, one IT department, one finance department, one marketing department etc. Because these units don't make revenue from each other so can't expand themselves when demand increases, they may need to ration the amount of service they are able to provide. The only way each unit can get more resources is to convince the decision maker to give them some.

With an internal market, you might have three different IT departments each offering their services to the other units at different prices. Units would be free to choose whichever IT department best meets their needs. IT departments could use the revenue they collect from other units to expand and take market share from other units.

A command economy is one organised purely by arbitration (whatever that might be, be it a moral code, dice, or a plan formed by such heuristics), rather than market prices.

There is competition within large companies, resources are strongly organised along the lines of "Those that produce product A", and "Those that produce product B". Clearly if Product A is a runaway success and generates lots of revenue, the company are going to direct resources to further Product A, further, supporting infrastructure and staff will be broadly organised (IT, etc.) along those lines too. In very large companies, Product A and Product B will often be split into business units and each will support themsevles directly from the revenue they generate.

There can never be proper internal markets within an organisation such as the NHS, because revenue really is rationed from the top down, and not generated from the bottom up.

[EUBanana]

There's the notion of having stuff done in house or contracted out too, that essentially is an internal market of sorts, as your in house guys are having to essentially bid for work from within the same company.

[fluffy666]

I don't think companies are generally big enough to have 3 IT departments in competition. Though I suppose if you have the likes of Eidos, with software houses all semi-independent across the world, then that is something like that.

This is the whole point..

It's also why big companies can end up extremely inefficient, especially if their revenue is fairly constant.

[Guest_GradualCringe_*]

It does not have each employee write their own version of the software and have them compete internally.

To be bloody minded, individual employees may well compete with each other for better pay and conditions i.e. a greater share of available resources from the company.

On a large scale however, a company will direct man power toward products that are selling successfully, over those that aren't.

[Guest_GradualCringe_*]

This is the whole point..

It's also why big companies can end up extremely inefficient, especially if their revenue is fairly constant.

Which is the crux of the argument against centrally planning complex processes, and why a company will often split itself into inividual business units to avoid this problem.

It's also why this doesn't work for the NHS, because the smaller units of the NHS don't get to generate or allocate revenue. There's no real measure of success or failure.

Edited September 12, 2013 by GradualCringe

[Dorkins]

There is competition within large companies, resources are strongly organised along the lines of "Those that produce product A", and "Those that produce product B". Clearly if Product A is a runaway success and generates lots of revenue, the company are going to direct resources to further Product A

Nobody is saying there's no competition within command economies. Of course there is. Soviet coal mines used to compete with each other to be the one producing the most coal.

http://en.wikipedia.org/wiki/Stakhanovite_movement

http://en.wikipedia.org/wiki/Socialist_competition

And yes, a good leader of a command economy will tend to allocate more resources towards the parts of his organisation which are performing well and ought to expand further, but the fact remains that those resources are being redirected because he commands it and not through the invisible hand of the (internal) market acting on price signals within the firm itself.

[Dorkins]

the smaller units of the NHS don't get to generate or allocate revenue. There's no real measure of success or failure.

Smaller units within the NHS most certainly do have their success or failure measured. The government collects data on patient outcomes wherever it can.

If you are anybody but a salesman within a firm, it's likely that your boss measures your success or failure in non-monetary terms too.

[Guest_GradualCringe_*]

Nobody is saying there's no competition within command economies.

The key difference is that in a command economy the winner is judged by committee via some abitrary measure, not by a system of prices.

[interestrateripoff]

Smaller units within the NHS most certainly do have their success or failure measured. The government collects data on patient outcomes wherever it can.

If you are anybody but a salesman within a firm, it's likely that your boss measures your success or failure in non-monetary terms too.

The trouble is what data are you collecting. If say for example you are collecting data on heart surgery and you have one surgeon doing high risk surgery which by it's very nature has a higher probability patients will die can you compare him to a surgeon doing low risk heart surgery and claim he's being unsuccessful?