Internal market organization

Units inside one firm run as small enterprises that buy from and sell to one another, and often to and from outside, while the center sets the rules and the infrastructure of the market.

What it is

An internal market organization runs the units of one firm as small enterprises. Each unit answers for its results as if it were a firm, trades with the other units, and within limits trades outside. The center sets the market's rules and infrastructure and leaves most decisions to the units. Coordination runs through prices and internal contracts, not a chain of command.

Four of its levels on this explorer's dimensions rest on theory, one contested. Grouping spans function or process and product or purpose (Halal 1994; Adler and Hiromoto 2012). Centralization is decentralized (Halal 1994; Zenger and Hesterly 1997), and boundaries selective (Halal 1994). The mode of exchange is contested: Halal places it at the market, while Zenger and Hesterly's selective intervention of market elements in hierarchy spans market and bureaucracy. The rest are our judgment: specialization and formalization medium; layers flat; decision rights at limited vertical decentralization, the nearest of Mintzberg's (1980) types; standardization of outputs; lateral mechanisms at direct contact and liaison roles; and moderate differentiation with some integrating roles.

Where it came from

William Halal, Ali Geranmayeh, and John Pourdehnad set it out in Internal Markets (1993), whose first chapter is Russell Ackoff's on the internal market economy. In 1994 Ackoff's The Democratic Corporation called the design the internal market economy, and Halal's "From hierarchy to enterprise" argued that centralized hierarchies are decomposing into decentralized, market-driven systems whose executives leave most decisions to the market.

The move is older than the name. Peter Drucker (1974) set out simulated decentralization, and nineteenth-century American plants ran on inside contracting, which John Buttrick (1952) described at the Winchester Repeating Arms Company. Kazuo Inamori, Kyocera's founder, developed amoeba management, which no source read dates.

The problem it answered was how a large hierarchy can break into units that deal like firms.

Where it fits

No cell tests the form against its factor, though all but the age, munificence, technology, and interdependence cells draw on studies of it. One cell is theory and eleven our judgment, two contested; three draw on Burton and Obel (2004), the most developed scholarly fit model.

• Size. Our judgment: strain small, partial medium, fits large. In a small firm internal trading adds contracting overhead with little to break up; Halal (1994) and Zenger and Hesterly (1997) write only of large firms.
• Age. Contested, both judgment. Halal (1994): partial young, fits established and old, since internal markets are usually introduced to break up an existing hierarchy. Hannan and Freeman (1984): partial old, since inertia rises with age, and attempts at reorganization raise death rates, so reorganizing an old organization into this form is itself a hazard.
• Environmental uncertainty. Contested, both judgment. Halal (1994): partial stable, fits shifting and unpredictable, since trading units act on local signals. Stark (1986), a comparative analysis with one national reform as its case: partial throughout, since market-economy firms met labor uncertainty with internal bureaucratic rules and the socialist firm, in a bureaucratic environment, with internal markets.
• Environmental complexity. Our judgment: partial simple and moderate, fits complex, since prices let each unit act on what it knows (Burton and Obel 2004; Zenger and Hesterly 1997).
• Munificence and hostility. Our judgment: partial throughout. Burton and Obel (2004) point both ways: at high hostility, lower centralization and low formalization; at extreme hostility, maybe only for a time, centralize. Staw, Sandelands, and Dutton (1981), a review of earlier evidence with no new data, describe control constricting under threat, a tendency; Cameron, Kim, and Whetten (1987), a six-year study of 334 institutions of higher education, later found centralization affected by turbulence but not by decline.
• Diversity. Our judgment: fits single and related, strain unrelated, since unrelated businesses have little to exchange (Zenger and Hesterly 1997; Halal 1994).
• Strategy. Our judgment: strain defender, partial analyzer and prospector. Burton and Obel name low centralization a misfit for a defender, and an internal market spreads decisions across trading units; no work read, Halal (1994) and Zenger and Hesterly (1997) among them, ties the form to the other two.
• Technology. Our judgment: fits routine, partial mixed, strain nonroutine, on Ouchi's (1980) conceptual argument that markets are efficient when performance ambiguity is low; reading Perrow's (1967) nonroutine work as high ambiguity is the inference. Hickson, Pugh, and Pheysey (1969), a multi-organization comparative survey, and Mohr (1971), a quantitative field study, studied technology and structure, not this form, which limits every technology cell, as Pennings (1975), a quantitative field test of the structural-contingency model, limits the varying environment cells. Donaldson (2001) attributes Mohr's and Pennings's null fit and performance results to methodological limitations.
• Interdependence. Theory on Thompson (1967): fits sequential, strain reciprocal. The earlier of two sequential divisions sells its output to the later; continuous mutual adjustment cannot be priced deal by deal. Pooled fits is our judgment on Halal (1994): units drawing on a shared pool can be charged for it.
• Knowledge intensity, global integration, and local responsiveness. Our judgment: partial throughout. Zenger and Hesterly's (1997) small units and Jaquette, Kramer, and Curs's (2018) university academic units sit at very different training levels; neither work, nor any other read, ties the form to training levels or to pressures across countries.

What it does well

It puts decisions where the knowledge is. Trading units act on local signals (Halal 1994); decision rights, organizational economists argue, belong with specific knowledge, with measures and rewards checking the costs of delegating (Jensen and Meckling 1992). Small units carry the high-powered incentives of small size (Zenger and Hesterly 1997, a conceptual article). In our reading, prices show which units lose money.

Inside companies these strengths are argued, not shown. Zenger (2015), a commentary on one company, reads Valve's design as composed internal markets but cannot tell whether it causes the firm's high revenue per employee. Foss and Dobrajska (2015), a conceptual argument on the same case, hold that Valve does not challenge fundamental organization design theory and that managerial authority may be growing in importance.

What it costs

The market has to be built and run: the center writes its rules and builds the exchanges' infrastructure (Halal 1994), and, in our reading, dealings once settled by instruction must be priced and recorded.

The center must give up stepping in. Foss (2003), one case study, argues that managers cannot easily commit, credibly, not to intervene in delegated decisions.

Drucker (1974) judged his own version a poor fit on all his design specifications. Williamson (1975, 1985), drawing on Buttrick, lists inside contracting's defects, a bilateral monopoly position among them.

How it fails

The center cannot keep its hands off. Delegated rights are taken back case by case, so decisions are owned twice (our reading: jurisdictional gap or overlap). Foss (2003), one case study, finds that at Oticon frequent meddling caused a severe loss of motivation and arguably the move to a more structured organization. Lee (2024), one ethnographic case study, gives another cause: the practices holding decentralized authority in place are cognitively, emotionally, and temporally demanding, so hard to sustain.

The market exists in name only. Prices and contracts are installed, but the incentives are too weak and the constraints too strong to produce the effects expected (our reading: model and world divergence). Mays, Mulligan, and Goodwin (2000), a review of the evaluations of one national reform, found little measurable change tied unequivocally to the NHS quasi-market's mechanisms.

Units chase their own numbers. Where output is hard to measure, a unit can earn its price while the whole loses (our reading: goal displacement and metric gaming, and local optimization against the global constraint). The premise is Ouchi's (1980) argument that markets fail under high performance ambiguity; no study of the form shows it.

Pricing every exchange costs more than it saves. Where units must adjust to one another continuously, or in a small firm with little to break up, internal contracting adds overhead (our reading: coordination overhead overrun). No study of the form measures it; it rests on the interdependence cell's reading of Thompson (1967) and the size cell's judgment.

The profile triggers two misfit rules: authority spread wide in an analyzer and in a defender. The analyzer rule is undisputed, so it sinks the form in the explorer: Burton and Obel (2004) call low centralization a misfit for the non-innovating analyzer and recommend medium for the innovating one; the strategy cell, merging the two, reads partial. The defender rule is contested, so it flags and does not sink: Burton and Obel's proposition gives the strain cell, while Mintzberg (1980), a synthesis of earlier research offering propositions without a new test, places the professional bureaucracy, with extensive decentralization, in complex but stable environments, so wide authority is not ruled out where the domain is stable.

The rules are propositions, untested singly, with three limits: an earlier version was tested only as a set, finding lower return on assets with misfits (Burton, Lauridsen, and Obel 2002, a quantitative study of 224 Danish small and medium-sized firms); the interaction form of fit went unsupported (Drazin and Van de Ven 1985, a quantitative study of 629 work units in two states' employment security agencies); and firms in perfect institutional fit lost slightly by striving for contingency fit (Volberda and colleagues 2012, a survey of 3,259 respondents in 1,904 companies).

What the research found

The search of work since 2010 found no multi-firm quantitative study of internal markets inside companies.

Kuntz and Vera (2007), a quantitative study of hospitals, read in its abstract, found that modularization as a whole did not improve performance, while internal market mechanisms, like process orientation, had positive efficiency effects; its sample unstated, probably shared with another of their studies.

The university tests disagree. Jaquette, Kramer, and Curs (2018), a quasi-experimental comparison of four universities with synthetic controls, found higher tuition revenue after adoption of responsibility center management at three and no change at the fourth; they measured institution-level revenue only, not the units' behavior. The most recent, Kelchen (2026), a national panel of 154 universities, found no evidence that adoption changed master's programs, closures, or degrees, a limit, he reads, on unit leaders' incentives and somewhat counter, he notes, to the earlier finding; incentive strength could not be coded at most universities, and comparison universities also used some unit incentives.

Takeda and Boyns (2014), one company traced through published sources, largely self-authored, tie amoeba management to Japanese influences and Inamori's philosophy; Urban and Czerska (2016), three case studies, measured no outcomes; and Adler, Hiromoto, and Suzuki (2019), a conceptual review, argue that earlier research wrongly conflated it with organizational ambidexterity.

Two dissents. Ghoshal (2005), recorded against organizational economics, the source of most of this theory, argued that management research's ideologically inspired amoral theories, propagated by business schools, have freed students from moral responsibility. Ghoshal and Moran (1996), an argument, not a test, hold against transaction cost economics, behind the inside-contracting account, that organizations are not mere substitutes for failed markets but govern some activities by a logic of their own.

The evidence ledger holds 13 studies filed under this form.

In practice: one published case

The UK National Health Service, as the source names it, is one case study, of the public-sector variant and not of a company. The source is Mays, Mulligan, and Goodwin (2000), a review of the research on one public system's reform.

In 1991 and 1992 the NHS was turned into a quasi-market. General practices could volunteer to become fundholders that purchased elective care for their patients. Health authorities became purchasers of emergency, unplanned, and elective services. Providers of hospital and community health services were converted into NHS trusts, separate from their local health authorities.

The review gathered the published and unpublished studies of the reform from 1991 to late 1998. It assessed each of the three elements, fundholding, health authority purchasing, and the trusts, for its effects on efficiency, equity, quality, accountability, and choice and responsiveness. It found relatively little measurable change that could be tied unequivocally to the core quasi-market mechanisms.

Mays, Mulligan, and Goodwin conclude that the incentives were generally too weak and the constraints too strong to produce the consequences that either the supporters or the critics of the quasi-market had predicted. They add, though, that the reforms changed irrevocably the way in which the NHS operates.

Source: Mays and colleagues 2000. The British quasi-market in health care: a balance sheet of the evidence, Journal of Health Services Research and Policy 5(1), 49 to 58; a review of the evaluations of one national internal-market reform.

Variants and near relatives

The internal market economy is Ackoff's (1994) scheme and the form's core, parts dealing like firms. His multidimensional organization (Ackoff 1977, text not read; restated 1994) has input (functional) units, output units that must use them as sources of supply, and market units that act as profit centers. Ackoff sets it against the matrix, whose employees have two bosses; it is neither transnational's multidimensional and reconfigurable organization nor the Front-back organization, whose fronts and backs are joined by designed linking processes.

Amoeba management is Kyocera's system: small, customer-focused units that operate independently (Adler and Hiromoto 2012) and, on Kyocera's and Inamori's own practitioner accounts, keep profit and loss accounts and trade with other units.

The internal hybrid is Foss's (2003) term for a hierarchy infused with market control; his case, Oticon's spaghetti organization, is taught under the Self-managing organization.

The public-sector internal market (quasi-market) splits a public service into purchasing and providing units that contract inside one system, as in the case; New Public Management, the doctrine behind quasi-markets, is out of scope as a doctrine, not a form.

Responsibility center management devolves a university's budget to academic units under formulas that reward raising revenue and cutting costs, so resources follow formulas, not the center's case-by-case decisions.

Simulated decentralization is Drucker's (1974) fourth design principle: units that are not businesses set up as if they were, trading at internally set transfer prices.

Intra-enterprise subcontracting partnerships were Hungary's 1980s economic work partnerships (VGMKs): employees formed separate undertakings doing contract work for their own enterprise (Héthy 1986, a comparative review), which Stark (1986) reads as internal market transactions. Yugoslavia's basic organizations of associated labor, under the Cooperative organization, are the self-managed counterpart: law split enterprises into bargaining units.

Inside contracting had the firm supply floor space, machinery, materials, and working capital and sell the product, while inside contractors hired and supervised their own crews for a piece rate (Buttrick 1952): the units were the contractors' crews, not units the firm staffed. Williamson (1975) sets it between putting-out and the authority relation; unlike putting-out, production stayed inside the firm's walls.

The Network, modular, and virtual organization, the nearest neighbor, moves activities out to other firms under contract. Ownership alone does not separate them: its internal network (Snow, Miles, and Coleman 1992, ungraded here) is business units in one firm owning most or all of the assets. This form's move is the price among owned units. The Self-managing organization removes the manager-subordinate authority relationship from the formal structure; here a center keeps authority over the market's rules. Haier's rendanheyi, taught there, joins the two in our reading: its market-facing microenterprises hire and fire internal suppliers or contract outside. The Cellular organization's cells share ownership, know-how, and infrastructure and split as they grow, and the corporate center's shared services center is one internal supplier of support services; here the units themselves trade at prices, and often outside.

The M-form's general office decides its divisions' capital and dealings; these units settle them by price. In its recombinant variant (Galunic and Eisenhardt 1996, an inductive field study of ten divisions in one corporation), divisions compete in an internal market for charters; in our reading, they do not trade at prices. Galbraith's (2002) reconfigurable organization, under Adhocracy (innovative organization), coordinates partly by internal prices, markets, and marketlike devices, this form's device.

Moving into or out of it

Urban and Czerska (2016), three case studies, found companies introducing amoeba management along paths matched to their management styles and cultures.

Oticon's internal hybrid gave way about a decade later to a more traditional matrix (Foss 2003, one case study). At Winchester, Buttrick (1952), a historical case study of one firm, found the gun shop's contractors fell from 18 in 1904 to none by 1914, replaced by foremen; costs rose, but the superintendent judged company control better.

No study read measures the transition cost. Hannan and Freeman (1984) argue that attempts at reorganization raise death rates and set the liability-of-newness clock back toward zero; Amburgey, Kelly, and Barnett (1993), a quantitative study of organizational change and failure rates, report effects varying by type of change and over time, and Brüderl and Schüssler (1990), a quantitative study of business mortality in West Germany, found risk peaking one to fifteen years after founding, not at it. Donaldson (1995) argues that population ecology understates managers' capacity to adapt structure.

Change & Transformation explains running a reorganization.

The thinking behind it

William Halal (1994): internal markets, with the center building the market's infrastructure.

Russell Ackoff (1994): the internal market economy and the multidimensional organization, argued from practice, not tested.

Peter Drucker (1974): simulated decentralization, non-business units run as businesses at transfer prices.

Todd Zenger, with William Hesterly (1997): molecular units, explaining the form by the incentives of small size.

Nicolai Foss (2003): the credible-commitment problem, explaining why internal hybrids are hard to sustain.

Kazuo Inamori (2012): amoeba management, a founder's account of small self-accounting profit centers.

John Buttrick (1952): the inside contract system in nineteenth-century plants.

William Ouchi (1980): markets, bureaucracies, and clans, predicting that prices control well only at low performance ambiguity.

James Thompson (1967): pooled, sequential, and reciprocal interdependence, the basis for which exchanges prices can carry.

Also called

Internal markets, as Halal (1994) uses the term; internal market economy (Ackoff 1994); internal hybrid (Foss 2003); quasi-market, the public-sector term (Mays, Mulligan, and Goodwin 2000); simulated decentralization (Drucker 1974); composed internal markets (Zenger 2015).

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