In a company that functions as an internal market economy, every part of the corporation that has at least one internal and one external customer operates as a profit center. All other parts operate as cost centers, each of which is part of a profit center. (This does not mean profit centers must be profitable. Most corporations maintain unprofitable units for various reasons, such as prestige.) Profit centers are free to buy whatever goods or services they want from whatever sources they want at whatever prices they want. Similarly, they are free to sell their output. These purchasing and selling decisions may be overridden by higher-level authorities who, when they do so, must pay the additional costs involved in case of a purchase, or compensate the units involved for lost profit. These higher-level authorities must themselves operate as profit centers whose income derives from a tax used to cover only the cost of their operations and from income generated by the capital they provide to, or invest in, their subordinate units.
An internal market economy provides managers with the information they need to run their businesses efficiently and effectively. It makes benchmarking unnecessary and avoids the need for the massive downsizing now so common among large corporations. It creates opportunities for internal synergy and provides a measure of its costs and benefits. It reduces internal conflict, because those who associate by choice tend to get along better than those who have cooperation forced on them. It allows inefficient parts of a corporation to go out of business, thus enabling a corporation to make effective make-buy decisions on services as well as goods. It also enables efficient parts of the corporation to grow profitably by selling their output externally as well as internally. And it enables the corporation to decide when one of its units would be better off outside than inside the organization. Finally, contrary to popular rationalization, it reduces accounting, because while each profit center is required to provide only a P&L statement and a balance sheet to higher authorities, those authorities must pay for any other information they want. It should be noted that in such an economy, most managers become general managers.
— Russell L. Ackoff
Posted by Administrator / Management and Strategy
