market process management

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David Parker Aston Business School, Aston University, Birmingham B4 7ET, UK Market process management . For organizations information is becoming a critical factor of production. . It is often said that competitive advantage now lies with those organizations that are able to acquire, assimilate and act upon information quickly and efficiently. . Competitive advantage is said to lie with the ‘learning organization’. . This study considers how an attention to market principles can help improve the ability of organizations to handle information and learn. . Market process management requires removing the command and control systems of the old-style Taylorist corporation, in favour of devolved decision making with an increased reliance on internal markets. . This approach requires an attention to pricing in terms of internal opportunity costs and recasts the role of management as facilitators and regulators. # 1998 John Wiley & Sons, Ltd. Introduction Information is becoming the critical factor of production for more and more organizations (Drucker, 1993). To survive in the modern, turbulent world organizations need to be able to assimilate, process and interpret informa- tion quickly and accurately. In consequence, it has become something of a cliche ´ to say that competitive advantage lies with the ‘learning organization’; the organization which con- stantly monitors its external environment, # 1998 John Wiley & Sons, Ltd. Strategic Change, July 1998 Strategic Change Strat. Change 7, 237–245 (1998)

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Page 1: Market process management

David ParkerAston Business School, Aston University,Birmingham B4 7ET, UK

Market processmanagement

. For organizations information isbecoming a critical factor ofproduction.

. It is often said that competitiveadvantage now lies with thoseorganizations that are able toacquire, assimilate and act uponinformation quickly and ef®ciently.

. Competitive advantage is said to liewith the `learning organization'.

. This study considers how anattention to market principles canhelp improve the ability oforganizations to handle informationand learn.

. Market process managementrequires removing the command andcontrol systems of the old-styleTaylorist corporation, in favour ofdevolved decision making with anincreased reliance on internalmarkets.

. This approach requires an attentionto pricing in terms of internalopportunity costs and recasts therole of management as facilitatorsand regulators.#1998 John Wiley & Sons, Ltd.

Introduction

Information is becoming the critical factor ofproduction for more and more organizations(Drucker, 1993). To survive in the modern,turbulent world organizations need to be able

to assimilate, process and interpret informa-tion quickly and accurately. In consequence, ithas become something of a cliche to say thatcompetitive advantage lies with the `learningorganization'; the organization which con-stantly monitors its external environment,

# 1998 John Wiley & Sons, Ltd. Strategic Change, July 1998

Strategic ChangeStrat. Change 7, 237±245 (1998)

Page 2: Market process management

learns, adapts, and responds speedily tochange (Burgoyne, 1992).

The purpose of this paper is to demonstratehow an attention to market principlesimproves the ability of organizations to under-take this task. Market process management

(MPM) requires removing the commandand control systems of the old-style Tayloristcorporation in favour of devolved decisionmaking with an increased reliance on internalmarkets. One result is senior managers who areno longer `directors' and `planners' but marketfacilitators and regulators.

From Taylorism to marketprocess management

Hierarchical command and control structuresare products of F. W. Taylor's `scienti®cmanagement', which dominated managementthinking for much of this century.

Frederick Winslow Taylor (1856±1915)began his career as a worker in industrybefore becoming an engineer and later one ofthe ®rst management gurus. He was primarilyinterested in ef®ciency. To achieve ef®ciency,he advocated a form of management involvingspecialism or division of labour between `staff'and `line' (Taylor, 1911). Taylor viewed the lineworker as essentially dumb and capable of onlyrepetitive directed tasks. The scienti®c bestway of doing the job was to identify `thinking'with management and `doing' with workers.The role of management was to plan strategies,de®ne tasks, change work, evaluate and rewardperformance and hire and ®re those on theline.

The Taylorist corporation worked well forrepetitive tasks in modes of production whereconstructive thinking was not required bymost employees. But the weakness ofTaylorism lies in its underlying rationaleÐlarge-scale, depersonalized production toachieve economies of scale in manufactureand centralized (at the top) informationprocessing. The pyramid or hierarchical com-mand structure considered necessary to planand control the organization inevitably slows

down decision making and exacerbates latenthostility between workers and management.Looking back at the hey-day of this productionmethodÐfrom the 1920s to the 1960sÐitproved best at coping with relatively stablesituations in the external environment.

Today the distinction between thinkers anddoers is increasingly redundant. The inherentbureaucracy involved with centralized control

in the Taylorist corporation is rightly seen as anobstacle to change (Tirole, 1986), whilesustained success requires a constant ¯ow ofinformation throughout, and not just up anddown, the organization. Whereas the Tayloristcorporation has instructions and rules ¯owingdown the organization, to the `doers', andreporting of results ¯owing in the oppositedirection, in many lines of business successnow requires knowledge to be more laterallydirected and more highly diffused. Organiza-tions are adopting forms of decentralizedorganization to cope with the instability,uncertainty and pace of change in the marketplace (Kanter, 1990; Bartlett and Ghoshal,1989; Tiernan, 1993). In the US, Rank Xerox,Du Pont and General Electric are experiment-ing with cluster-type structures. In the UKBritish Petroleum is now structured around16 clusters supported by three functionalareas: business services, engineering resourcesand technology development. Clusters do awaywith much of the organizational hierarchy ofTaylorism and economize on administrationand management costs.

Other companies are experimenting withdifferent types of decentralized management,including the formation of `quasi-®rms' within®rms. For example, the Taiwanese electronics®rm Acer has divided itself into a network ofdifferent businesses, each with its own man-agement, personnel and salary structure. TheHQ employs only 80 people and obtains its

The distinction betweenthinkers and doers is

increasingly redundant

# 1998 John Wiley & Sons, Ltd. Strategic Change, July 1998

238 D. Parker

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revenue from dividends from the separatebusinesses and from charging other partsof the business for its services. Individualdivisions do not have to buy from otherswithin the group and when they do, they areexpected to pay normal market prices (Econo-

mist, 1996). Hewlett Packard is another pace-maker in the use of internal markets, the themeof this paper.

Adapting quickly to consumer needs hasbecome not simply a source of competitiveadvantage, but the essence of survival. As moreand more markets are liberalized and competi-tion increases (telecommunications and thepower industry are recent examples in Europeand North America) businesses need to movedecision making closer to the market to com-pete. This requires a method of supply andservice delivery which places a premium oninformation, which in turn changes the natureof the workforce and the way it is organized.Leading edge organizations are becoming¯atter, less formalized and leaner (see Box).

Leading edge ®rmsChanges

. ¯atter structures (delayering)

. less bureaucracy

. end of the management pyramid

. end of scienti®c management

. wider spans of control

. divisionalization/dismemberment

. cross-functional teamworking, clusters,networks

. less formality

. joint ventures and collaboration

. managing the ®rm as an organism not amachine

Threats

. more dif®culty in remaining incontrolÐexcessive instability

. lack of organizational coherence

. information overload

Of course, as `command and control'systems break down, there are substantialrisks. Organizations as business clusters,teams and network working threaten manage-

rial breakdown, control loss, organizationalmisdirection and duplication. Also, withdevelopments in telecommunications and theInternet, organizations face `informationoverload'. It is important to recognize thatinformation is not an asset unless it is turnedinto useful information which can impactproductively on decision making. It is import-ant in the new `learning organization' that whatis `learned' is information that improves theorganization's competitivenessÐand that therest is discarded. There is no point in infor-mation for information's sake or learning forlearning's sake!

What is MPM?

Humans differ in their knowledge, skills,capabilities and attitude and it is preciselythis rich heterogeneity that is an organization'smost valuable resource. A company thatpromotes multiple sources of decisionmaking gains competitive advantage by tap-ping into all of the abilities within it. This isthe purpose of MPM.

. MPM is concerned with the adoption ofinternal markets, using market principlesto allocate resources in organizations inplace of former command and controlsystems.

MPM offers a new way of making sense ofinformation and capitalizing on it. It meanstaking the bene®ts of the market as resourceallocator and internalizing those bene®ts. Itinvolves replacing management top-downcontrols with devolved decision makingbased on internal prices. As the Austrianeconomist Freidrich Hayek wrote in 1948:

The real central problem of economics as asocial science . . . is how the spontaneousinteraction of a number of people, eachpossessing only bits of knowledge, bringsabout a state of affairs . . . which could bebrought about by deliberate direction onlyby somebody who possesses the combined

# 1998 John Wiley & Sons, Ltd. Strategic Change, July 1998

Market process management 239

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knowledge of all these individuals. (Hayek,1948, p. 79.)

Hayek intended his comments as a criticism ofeconomic planning by the state. But hisargument can be easily restated in terms ofthe information problem facing organizationstoday:

. The real central problem of managementis that it is the spontaneous interactionof people within the organization, eachpossessing only bits of knowledge, thatbrings about competitive success and thatthis can only be achieved by the deliberatedirection of a senior management if thatmanagement possesses the combinedknowledge of all of its employees andcontractors.

Today more levels of the organization need toinput information about the external marketand take decisions and more levels need tocontribute to planning and improved pro-duction. But how is this to work? Organiza-tions need to ®nd a way of ensuring that everyperson in the organization, each of whom maypossess a vital piece of information necessaryto achieve competitive success, can input thisinformation into the decision-making process.Top-down direction by senior management isnaive for it can only be optimal if the manage-ment already possesses all of the necessaryinformation. The challenge is to ®nd a bettermeans of aggregating information withinthe organization so as to improve internalresource allocation.

Interestingly, the challenge facing manage-ment today is equivalent to that faced byAdam Smith and other economists twocenturies ago, when considering how informa-tion could be best handled within economies.The choice was similarÐbetween planningand markets.

One approach to organizations and marketsis to see them as very different forms ofresource allocators. This is the approachtraditionally adopted by economists and organ-izational theorists. Markets use prices and

organizations allocate resources by manage-ment commands. In 1937 the Nobel prizewinning economist Ronald Coase drew a sharpdistinction between resource allocation in theorganization and resource allocation in themarket based on what has become known astransaction costs (Coase, 1937). In morerecent years the American Oliver Williamsonand others have explored these costs in somedetail (Cowen and Parker, 1997). Williamsoncoined the term `markets and hierarchies', todistinguish resource allocation by prices andallocation by management direction (William-son, 1975).

However, many economists now reject thenotion of a distinct boundary between organ-izations and markets. These economists inclineto the view that organizations and markets aresimilar and de®ned by the nature of the

contracting within them. Market transactingis obviously most appropriate for repeated spotcontracts, such as the purchase of the dailynewspaper, the weekly purchase of the familygroceries or the less frequent purchase of a caror a house, though markets can cope withmore complex situations, such as those invol-ving contingencies, as in insurance markets. Ascontracts become more incomplete or whererepeated spot contracting would be costly,however, employment contracts are preferred.

Employment contracts are typically morebroadly de®ned, for example permitting man-agement to direct labour within widely de®nedemployment terms. Such contracts do awaywith the need to enter into new spot contractseach time the nature of the worker's taskchanges and hence economize on transactioncosts. Transaction costs are the costs ofnegotiating, monitoring and enforcing con-tracts. The more complex the contracting,the more likely it is that transaction costs willbe minimized through employment ratherthan market trading. In other words, market

Organizations and marketsare similar

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240 D. Parker

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contracts are not always the most ef®cient incost terms and the case for hierarchical formsof organization is made in terms of econo-mizing on transaction costs (Casson, 1994).What the current trend towards delayering,team and cluster working, and so on, suggestsis that transaction costs are shifting in favour ofmarket contracting.

Operationalizing MPM

It seems that there is no formidable barrier tousing markets within organizations. Increasingnumbers of organizations are already, in effect,adopting MPM. What is required is a systematicconsideration of market principles at all levelswithin the organization.

When introducing MPM, the ®rst decision tomake is to ascertain where markets can mostusefully replace management directives andcontrols. The most obvious is in relationsbetween discrete clusters and teams orwithin networks, though the use can be moreextensive. In making the decision, it is import-ant to consider the transaction costs. Will it bemore cost ef®cient, without affecting thequality of delivery, to use price signals ratherthan rules and regulations to direct resources?The relative costs may not be obvious andexperimentation is a way of discovering thecosts where more direct computationalmethods are absent. This involves introducinginternal markets where they appear likely to beappropriate, checking on the resulting bene®ts(in terms of cost savings and improvedservices) and then extending the process intofurther areas of the business. This processshould continue until further gains are notachieved.

The next stage is to design the pricingsystem. This has implications for the installa-tion of appropriate accounts. Modern compu-terization has considerably reduced thetransaction costs of accounting for resourcestransferred within organizations, but MPM maywell require a re®nement of existing account-ing practices, including an extended use of`activity based accounting' and more accurate

apportioning of joint costs. This is anotherreason for a phased introduction of MPM.

. In setting internal prices it is importantthat they re¯ect true economic costs to the

organization. These costs may not be thesame as prices external to the organiz-ation. Internal prices should not be setsimply to re¯ect external, market pricesfor the same transaction. Instead, a set of(shadow) price signals should be estab-lished. A standard approach to transferpricing tends to mimic market prices,when the focus should be on if and howtransfer prices should differ from externalmarket prices. In practice, transfer pricesare often determined by negotiation acrosscompany divisions, or are simply imposedby managers, but such prices are unlikelyto be optimalÐthey are best seen as astarting point.

Organizations purchase or employ a particularset of resources precisely because thoseresources have special value to the organiz-ation, or can be deployed in some new andinnovative way. Therefore, transfer prices

should re¯ect the value of the resources to

the organization, rather than the value of

the resources to the outside market. To theextent that an organization has a comparativeknowledge advantage in using or owning aresource, its transfer or internal price shouldbe higher than equivalent market levels. Thishigher price internalizes the added bene®ts tothe organization from its use or ownership ofthe resource. In other words, it more accu-rately represents the internal opportunity

cost, that is the value of the resource interms of its alternative use by the organization.

Corporations have used transfer prices withincreasing frequency (Halal et al., 1993; Gableand Ellig, 1993, p. 41). Nonetheless, often theyallocate resources without any estimate of theinternal opportunity costs, for example, in thecase of corporate services, such as accounting,purchasing, and personnel. Business units paya ®xed price or `tax' to the centre for theseservices, but this provides no incentive for

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Market process management 241

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the user or the supplier to allocate and use theresources ef®ciently. In consequence, theresources are typically overused. Producers ofoverhead services, pressed to meet increasingdemands, then lobby for more resources. Ifthese demands are met, senior management issinking resources into an inef®cient operationin internal opportunity cost terms. That isto say, the resources could be better usedelsewhere within the organization.

Measurement and accounting problemsand interdependencies within the organizationlimit an unthinking application of internalpricing (Hennart, 1991). Nevertheless, usedwith care, internal-market signals help toallocate resources ef®ciently. Once proper

internal prices are set, they will need to bealtered and re®ned over time, as in any market.The most obvious approach is to raise the pricewhere demand for an internal service is highand reduce it where demand is low. The highcharge prices out marginal uses and indicatesto management that there is a case to expand afacility; a low price indicates that there is a casefor reducing the activity, contracting it out to acheaper supplier, or ending it altogether.

Prices also enable pro®t and loss accountsand balance sheets to be created for eachactivity within the organization, includingtemporary clusters and networks. In this waypro®t provides an important indicator of thesuccess of particular ventures within thecompany, just as it does in the wider economy.Under MPM, localized pro®ts play a greatlyenhanced role in internal decision making,replacing more cumbersome and less effectivemethods of command and control.

MPM also has implications for the role ofmanagement within organizations. Managersare no longer directors of resources. The roleof management becomes one of creatingan environment in which internal markets

¯ourish, so as to achieve corporate goals.Competition between divisions and teamsacts as an important internal incentive mech-anism. At the same time, the organization mustavoid under-investment in divisions resultingfrom a concentration on localized risks, that arediversi®ed away at the corporate level; or anover-narrow focus on the short-run interestsof the division over the long-run interests ofthe whole corporation; or the manipulation ofaccounting ®gures to gain internal advant-age. In other words, management remainsresponsible for strategic direction, designingthe internal markets, and regulating andmonitoring the overall performance of theorganization.

The proper role of management can beunderstood in terms of a division of labour. Theacquisition and use of knowledge is critical toorganizational success, yet it would be uneco-nomic for everyone in the organization toattempt to acquire and use all of the necessaryknowledge. Also, a given piece of knowledgewill not have the same impact on all sections ofthe organization, any more than it has the sameeffects in all parts of an external market.Learning in organizations, in terms of know-ledge acquisition and interpretation, musttherefore occur at appropriate levels. Seniormanagement, as the strategic decision makers,have the task of interpreting information about®nal success or failure and giving the entireorganization a sense of direction. At the sametime, however, it is essential that particularknowledge is diffused to those areas of theorganization, including other managementlevels, where it will provide the greatestbene®t. The important point is that aggrega-tion of knowledge and its useful disseminationis achieved in organizations with internalmarkets more through price signals thanbureaucratic structures.

It is in ensuring a corporate coherence thatinstitutions such as mission statements, cul-tures and routines are best appreciated. Institu-tions include any form of constraint thatindividuals devise to shape human interaction(North, 1990, p. 4). They include formalconstraints (laws, constitutions, rules) andinformal constraints (norms of behaviour,

Internal-market signalshelp to allocate resources

ef®ciently

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242 D. Parker

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customs and conventions). Institutions are theresult of cumulative learning through time, andare re¯ected in the ideology, beliefs, and mindset of a society. The economists' notion of awell-functioning market makes critical assump-tions about institutions and the way in whichthey place restraints upon behaviour: `. . . wheneconomists talk about ef®cient markets, theyhave simply taken for granted an elaborateframework of constraints' (North, 1990, p. 66;see also North, 1991). The background featuresof a social order in a market economy are vitalto its smooth running and this applies equallyinside organizations as in external markets.There need to be rules and norms of behaviour,including well de®ned and protected propertyrights (setting out who has the right to controland bene®t from what), accepted laws ofinternal contract and traditions of trust andethical behaviour, along with incentives toachieve an ef®ciently operating marketeconomy.

Clearly de®ned property rights within organ-izations parallel property rights at the economylevel; while favourable incentives require theproper speci®cation of rights and responsi-bilities over outcomes within the organization.The larger the organization, the more complexthis tends to become. In response, behaviouralnorms and routines develop to minimize thiscomplexity. Corporate culture is similar tosocial culture and constrains and shapesindividual behaviour (Peters and Waterman,1982; Casson, 1991; Johnson and Scholes,1997). It therefore contributes to reducingtransaction costs within organizations. Utiliz-ing the culture, organizations rely on trust,accepted procedures and routines, and not juston direct incentives, to limit opportunistic andself-seeking behaviour (Nelson and Winter,1982). Also, just as governments can reducetransaction costs in market economies, forexample by de®ning and protecting propertyrights, and increase transaction costs throughbureaucracy, regulation, and red-tape, thesame is true of management at the organizationlevel. Red tape imposes considerable costs,especially where organizations are trying toencourage more devolved forms of decisionmaking and learning.

In summary, management's task under

MPM is to mimic the state in its relationship

to a successful market economy. In all casesthe role of management includes establishingand regulating the governance structures,procedures and routines of the internal mar-kets; similar to the way the state establishes theground rules for the operation of an effectivemarket economy and regulates behaviour andoutcomes. Beyond this there are variouspossible approaches that might be adopted,from a laissez faire to a more dirigiste type ofmanagement, with the degree of interventionin internal markets re¯ecting `market failure',as in the wider economy. Management inter-vention in internal markets can be rationalizedin terms of public goods, externalities andother forms of market failure, such as mon-opoly, in much the same way that the role ofthe state is rationalized by economists within amarket economy. Public goods within anorganization are those where bene®ts areshared and where claims on the resources arenon-rival and non-excludable; examples mayinclude central heating and security services.These are often supplied to all parts of thebusiness in particular locations and the cost ofsupplying one particular part of the businessmay be non-separable. Externalities arisewhere provision of a good or service to onepart of the organization imposes costs orbene®ts on other parts, for example theintroduction of new computerized systems ornew forms of distribution. In the cases ofpublic goods and externalities, managementmay choose to regulate the level of the relevantactivity or stimulate or depress it throughcentral subsidies and taxes, respectively.Market failure through monopoly would arisewhere a department or section provides aunique service vital to other parts of theorganization's operations. In which case, thisactivity will need careful regulation by centralmanagement to ensure that there is no abuse ofmarket power to the detriment of the entireorganization. Monopoly does not rule out,however, the use of regulated internal prices.

Central management might also take onmore of a direct role in planning operationsand stimulating investment, but such activities

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Market process management 243

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should always be assessed in terms of the over-all impact on the internal markets. Plannedeconomies have had patchy success andcentral planning by management involves aplanned, internal economy. The costs ofcentralized planning within organizations maymore than outweigh the bene®ts, as in theeconomy at large.

In general, management's task is to intro-duce and maintain the necessary institutionsfor economically ef®cient, internal-markettransacting. Management should provide anenvironment in which internal markets oper-ate ef®ciently and do this without introducingdamaging bureaucracy and excessive centraltaxes. Strategy formulation under MPMbecomes a matter of setting objectives anddetermining the optimal balance of internalmarkets and managerial intervention to bestachieve these objectives. Strategy implementa-tion involves operating, policing and, wherenecessary, regulating the internal markets toensure that the objectives are achieved. Over-all, strategy is concerned with ensuring that theinformation held by individuals within theorganization is aggregated and utilized success-fully through the internal markets.

Conclusions

Information as a factor of production ismaking old Taylorist structures and commandand control methods of internal resourceallocation redundant in a growing number ofindustries and services. The successful use ofinformation requires a means of assimilating it,but without leading to `information overload'within the organization and while ensuringthat those who most need the informationreceive and act on it. This requires a change inthe way information is transmitted or pro-cessed within the organization.

Flattening hierarchical structures anddelayering management is one response thatorganizations have adopted. This removessome of the impediments to speedy informa-tion processing but it does not, in itself,provide a means for effective informa-tion aggregation and utilization. Also, as

organizations fragment into clusters, teamsand networks there are obvious dangers ofincoherence and a loss of strategic direction.Loose coupling brings real risks in the formof organizational anarchy and breakdown.This places new demands on organizationalstructures and processes. Organizationsrequire new ways of assimilating and adaptingto complex and often confusing informationalsignals in the external environment andinternally generated. These same complexitiesof information are well handled in marketeconomies, day in and day out.

. MPM is concerned with improvinginternal resource allocation through theuse of markets. Most organizations dependon markets for the purchase of inputs andthe sale of outputs. MPM requires a newmind set which removes the boundary ofthe organization and recognizes that whatworks well for inputs and outputs maywork just as well for resource allocationwithin the organization.

MPM requires a proper understanding ofinternal pricing using the concept of internalopportunity costs. It rede®nes the role ofmanagement as a form of governance, estab-lishing and regulating the internal markets andproviding corporate coherence, in a mannersimilar to the role of the state in a marketeconomy. This leaves internal prices andresulting localized pro®ts and losses to provideinformation about where resources are bestemployed within the organization. In otherwords, it is not the case that internal resourceallocation requires a fundamentally differentapproach to the way resources are allocated inexternal markets. The notion that there is adistinct boundary between markets and organ-izations lay behind much of the confusionabout the role of internal markets in the past.

History shows that markets promote indi-vidual discovery, innovation and high pro-ductivity. They are a means to capitalize uponindividuals' potential contribution to eco-nomic well-being. Potentially this is as trueinside organizations as without.

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