This article appeared in Forbes ASAP (June 1993)
Can Xerox do it? Can any company blend entrepreneurial zeal with corporate might? Speed and agility seem inherently incompatible with size and power. No one expects a 320-pound defensive lineman to be a brilliant punt returner. Why should anyone expect a corporate Goliath to be as nimble as a high-tech start-up? Because the cataclysm of accelerating change unleashed by the microchip will tolerate nothing less.
Some executives, like those running ICI, the British chemicals giant, see no way to marry quickness with mass and have decided to split their company into two separate corporations. But others, like Xerox's Allaire, believe they have invented a new organizational architecture -- one that will work in an era of dizzying technology and market shifts. After tearing down their traditional functional hierarchies, these CEOs replace them with collections of relatively independent business units. Often comprised of self-directed teams, the business units are then arranged in what are variously called "networked," "clustered," or "horizontal" organizations.
So far so good. But is such radical restructuring radical enough to deliver on the dream of flexibility with power? Not according to a small band of executives and consultants who believe in "internal markets." They see the creation of free flowing buy/sell relationships among the teams and business units within a company as the only way to imbue corporate functionaries with the true spirit of enterprise.
Proponents of internal markets draw their inspiration from systems thinkers like MIT professor emeritus Jay Forrester, who recently called American corporations, "some of the largest socialist bureaucracies in the world. They have central planning, central ownership of capital, central allocation of resources, subjective evaluation of people, lack of internal competition, and decisions made at the top in response to political pressures." While American executives are busy calling for free markets in the former Soviet Union, internal market champions want to see free markets inside American corporations.
Led by Russell Ackoff, professor emeritus at Wharton and head of INTERACT, the Institute for Interactive Management, these pioneers argue that destroying the chain of command is just half the battle of creating highly responsive organizations. After the hierarchy comes down, a fundamentally new kind of coordination system must replace commands issued from on high. As Boris Yeltsin might put it, market prices are the only alternative to edicts from corporate commissars.
In an internal market, every business unit operates like an independent company. Each one decides whether to buy its inputs from internal sources (other units of the corporation) or from outside suppliers. With minimal restrictions, units also have the right to sell their products to insiders or outsiders. Prices are determined by arms-length negotiation, not by some accountant's clever transfer pricing formula.
Internal markets also abolish corporate overhead allocations. Functions like MIS, accounting, and legal must sell their services to other units. At Weyerhaeuser, for example, the MIS department started losing its internal customers as soon as those business units were freed to make market choices. High costs, imposed by the amortization of outmoded mainframes and over staffing, had driven the MIS department's prices to uncompetitive levels. The unit saved itself by cutting staff and employing underused high speed laser printers on printing jobs for nearby companies
The sudden onset of entrepreneurial behavior is typical once market reality sinks in. Faced with competitive prices and costs, managers and workers can see, often for the first time, whether they're actually adding any value. Instead of elaborate, and infrequent "benchmarking" exercises, quality, cost, service, and delivery are rated continuously against the best the world has to offer. Instead of avoiding tough cost-cutting decisions by "outsourcing," every cell of the corporate organism is exposed to the market's harsh discipline.
Clark Equipment, the South Bend, Indiana construction equipment maker, has probably pushed internal markets further than any other large American firm. Clark installed its internal market in 1982 after a worldwide study of component sources had revealed that the cost and quality of Clark's components (drive-trains, transmissions, axles, etc.) weren't even close to world-class. Obviously, without globally competitive components, Clark had no hope of assembling first-rate products. With the industry in the midst of a deep recession and the company's very survival in doubt, Clark's management saw no alternative but to subject every unit to the same market forces that were driving outside competitors to excellence.
Without any further intervention by corporate, Clark's business units began transforming themselves. To prevent their internal customers from deserting them for outside vendors, managers slashed head counts, wrote off outmoded assets, invested in state-of-the-art facilities, redesigned products, and instituted new quality controls. And though several internal customers left the fold for a while, most are back, because Clark's components are now world-class. In fact, Clark's Melroe division in Fargo, North Dakota, has won several awards for its innovative "Bobcat" miniature bulldozers. Overall, Clark's revenues, profits, and stock price have soared since the dark days of 1982.
With results like these, you might expect companies to be clamoring for more information on internal markets. But except for isolated experiments at Kodak, Armco Latin America, and Esso Petroleum Canada, there's been no rush to adopt internal markets. Though INTERACT's Russell Ackoff contends, "No single thing can produce as profound a change in a corporation as shifting to an internal market economy," he's had a tough time convincing companies to come aboard.
Perhaps the reason for the lack of corporate enthusiasm lies in Ackoff's promise of "profound change." True organizational transformation is gut-wrenching. You lose control. Friends get fired. Divisions are shut down. The market becomes the master. As one Clark Equipment executive put it, "Nobody wants to undergo the pain of real change unless you're first convinced you're going to lose the company. You only turn to the market when there's no way to avoid it."
Like their Soviet counterparts, America's corporate commissars grew up in a culture insulated from the market's vagaries. Executives may know the rules of the corporate game, but many are lost when it comes to the entrepreneur's street-smart skills. Similarly, employees may moan about the stifling bureaucracy, but at a deeper level, they are co-dependent on the managers who control their working lives. If these good corporate citizens had wanted to risk their livelihoods on the front lines of commerce, they would have joined start-ups.
But putting aside the politics of radical change, a terribly mundane reason for avoiding internal markets remains. How could a big company like Xerox keep its books straight with thousands of teams cutting deals among themselves and with outsiders? The cost and complexity of bookkeeping would overwhelm an internal market's benefits. In short, the high cost of handling the information generated by market transactions compels companies to rely instead on command-and-control hierarchies. Indeed, it was precisely this argument, first made back in 1937 by Ronald Coase of the University of Chicago which explained the emergence of large, centralized firms.
Ironically, by 1991, when Professor Coase finally won the Nobel Prize for this insight, information technology was well on its way to obsoleting his rationale for central control. And today, according to Dave Spicer, vice president of financial applications at Oracle Corporation, several multi-nationals are using the latest generation of database software running on client/server networks to implement internal markets. "Distributed databases allow low cost consolidation of results even though the transactions are completely decentralized," says Spicer. "Without distributed databases, keeping all those ledgers in synch is impossible. With them, it's easy."
For visionary CEOs like Xerox's Paul Allaire, the moral of the story is this: Your people will act like entrepreneurs only if you subject them to the same market forces which drive real entrepreneurs. Without an internal market, even the most elegant organizational architecture will never blend agility with size. But if you can overcome the political resistance to profound change, information technology can now make your impossible dream possible.
Copyright The Bionomics Institute 1993