Market-Based Management

7 May 2006 at 6:20 pm Peter G. Klein 12 comments

| Peter Klein |

I first heard the term “market-based management” (MBM) in 1994 or 1995, attatched to the now-defunct Program on Social and Organizational Learning at George Mason University. The theory was described in a few papers (one example here) and, as I recall, a monograph. My impression was that the principles of MBM were unobjectionable, but unremarkable: strong mission, values, and culture statements combined with decentralized decision-making and incentive compensation. The main innovation seemed to be the addition of an “Austrian” gloss (e.g., “Taylorism suffers from a fatal conceit….”).

This weekend’s Wall Street Journal profiles Koch Industries’s Charles Koch, who not only practices market-based management but actually trademarked the term. Writer Stephen Moore notes, somewhat delicately: “Some of the ideas that undergird Market Based Management seem fairly commonsensical to me, and I’m not entirely sold on the notion that this program somehow represents a seismic breakaway from what is taught at Harvard Business School.” Indeed, the idea that organizations can sometimes exploit “market-like incentives” would hardly surprise Chester Barnard, Alfred Chandler, or Oliver Williamson, let alone Alfred P. Sloan.

A more fundamental problem is that while decentralization provides benefits (more effective use of specific knowledge, conservation of central managers’ time, and so on) it also brings costs (agency problems, rent-seeking, coordination failure, etc.). To my knowledge the MBM literature has yet to identify or analyze the relevant tradeoffs. Jensen and Meckling’s (underappreciated) 1992 paper represents one attempt to grapple with these problems; this recent Foss-Foss-Klein paper suggests a slightly different approach. In short, all organizations represent a blend of market and hierarchy. The trick is to find the appropriate mix. Simply describing the virtues of “market” doesn’t get us very far.

Entry filed under: - Klein -, Austrian Economics, Management Theory, Strategic Management.

We Got a Contract, We Got a Contract!! The New Bashing of Economics: The Case of Management Theory

12 Comments Add your own

1. Teppo | 7 May 2006 at 6:46 pm

One of the best papers to read about markets in hierarchy is Todd Zenger and Bill Hesterly’s (1997) Organization Science piece – “The Disaggregation of Organizations: Selective Intervention, High-Powered Incentives, and Molecular Units” (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=10165) –
highly recommend it! Of course (as you’d well know!), Nicolai has his Organization Science piece on Oticon, excellent as well (he is humble about it, but the paper is very good!).
2. Matthew De George | 7 May 2006 at 9:17 pm

Interesting. My ManageWithoutThem model is supposed to be a market-based approach to the management of firms. I think the important part is recognizing that the values, mission, etc approach still relies on some sort of intervention. There is simply a lack of diversity in management models used within organisations. In every new management fed there is always this assumption that there is a management class (who are likely not owners). Anything that raises the possibility of at least as much diversity in management systems as there are in economics systems is a good thing. Currently, a whole class of economic organisation (i.e. market economy) is largely ignored by organisations internally. At the very least, limits of control and knowledge mean that there is already a black-market of coordination going on with each and every organisation.
3. Nicolai Foss | 8 May 2006 at 3:03 am

The best contribution within the marked-based management stream is, IMHO, Tyler Cowen and David Parker, Markets in Firms: a Market-Process Approach to Management. This is a small pamphlet (appr. 90 pp) from the IEA in London. It — perhaps in contrast to the rest of the MBM stuff — does deal with the tradeoffs that Peter talks about.
4. Juan | 9 May 2006 at 12:54 pm

I see a great similarity between Market Based Management and Value Based Management.
I would also suggest the reading of the book by Erik Stern “The Value Mindset: Returning to the principles of capitalist enterprise”. McKinsey and Stern & Stewart have both stressed the importance of making employees act like entrepreneurs and remunerate them according to the increase of economic value added (EVA).
Does somebody know if Koch Industries has a centralized company image strategy or each business unit makes its own decision?
5. orgtheory.net » Blog Archive » markets in hierarchy - three classics | 16 May 2006 at 4:49 pm

[…] Organizations and Markets has raised the issue of market-based management (or, infusion of market-mechanisms into organizations). Three important org theory articles (perhaps even 'Kingian' classics) in this domain are: […]
6. Organizations and Markets » Emergence of the East India Company | 21 July 2006 at 2:29 pm

[…] Via Craig Newmark. Related: my earlier post on market-based management. […]
7. Sukumar Daniel | 13 December 2006 at 11:27 am

The first time I heard about market based management was yesterday.

My professor Dr. Richard Baskerville said I should see the theory on MBM as the story i was telling him about my work in establishing an internal IT service delivery mangagement for the ING bank in its entry into the new indian market seemd remarkably similar.

I am very excited about what I have read about the theory and woudl like to meet any one who has applied this theory to the management of Internal IT groups within a regulations driven banking environment.
8. Joseph Wang | 9 April 2007 at 2:27 pm

The basic problem I see with market based management is that suppose a company would be better off having its divisions operate as autonomous entities. What then would be the economic point of having those divisions act in an internal market rather than spinning them off as separate companies and having them act in the external market?

In the case of Koch Industries, it would seem to me that the only point of having MBM is so that Koch can keep his empire in one piece, and given that to be the case, what he is doing is probably not a bad idea, but whether it is generalizable to situations where people don’t have these non-economic motivations and where there is a liquid market of control is questionable. There are parallels here to the situation with Chinese state-owned enterprises.

My experience with having companies “make employees act like entrepreneurs” is not very good. The problem is the same as MBM. If the company wants the employee to act like an entrepreneur they can and should provide seed capital for the employee to start their own company, and be a “real entrepreneur” rather than a pseudo-entrepreneur. The trouble with pseudo-entrepreneurship is that you often end up with the worst aspects of a company (small company risk with big company bureaucracy).
9. Marcin Tustin | 11 April 2007 at 4:05 am

Joseph Wang, the reasons to have such a form of organisation are that the company may own assets which are more valuable together, rather than apart, and selling to the market may have significant transaction costs, or greater transaction costs than if one uses these assets inside a firm.
10. twofish | 11 April 2007 at 11:54 am

Marcin Tustin: Color me cynical…..

I worked at a major company that had several divisions that had nothing to do with each other. You can easily come up with “synergy” arguments to not justify a spin-off, but what I found about these arguments is that they tend to radically overestimate the costs of keeping things apart and radically underestimate the costs of splitting things apart. What happens is that if you come up with an argument that suggests keeping things together, that argument becomes part of the conventional unspoken wisdom. If you have an argument against keeping things together, then people will “analyze that argument to death.”

And if there really are good reasons not to break up a company, why create an internal market instead of a centrally planned hierarchy? Once you have divisions competing against each other in an internal market, then this can (and in the case of the company I am familiar with did) kill any sort of internal cooperation or joint management of shared assets. What you ended up with is all of the transaction costs of a full market without the benefits of flexibility and large networks.

The issue with MBM is that there are sometimes internal corporate reasons for this. Splitting up a company removes an entire layer of management, which is a bad thing if you happen to be in that layer of management. At the same time, imposing centralized control, kills a lot of the fiefdoms within a large company.

Getting back to the topic. This institutional bias might be why there is so little criticism of MBM in the business literature. Bringing up the problems with MBM, might strongly conflict with the institutional interests of the people who are interested in MBM, since the decision to go with MBM may be the result of internal corporate politics rather than a rational economic analysis.

This is fine when a company is profitable. However, if a company starts seriously losing money, Wall Street will come in and take the decision out of the hands of management (which is what is happening in the major company I’m familiar with.)
11. jonboy | 21 April 2007 at 7:53 pm

Now that the book “Science of Success” by Mr. Koch is on the shelf, I suggest you read it. Your comments are well versed, but as an individual of an MBM company I believe we can all make these generalizations. But it takes a commitment to acheive an in depth understanding of what lies below and above the foundation of Market Based Management. Everyone can talk about it, but few take the selfless steps to practice it. A very rewarding experience. I only wish my university would have taught me this approach 30 years ago.
12. Market-Based Management « Verden fra min altan | 16 January 2008 at 8:15 pm

[…] Nu er jeg snublet over “The MBM Institue“, der også har en blog, og endda et indlæg om det af Peter Klein på Organizations & Markets-bloggen. […]