Introduction to Market-Based Management

Introduction to Market-based Management

Summary

This booklet has been written by representatives of the Koch Industries. It basically outlines the main reason that was responsible for their massive growth in such little time. According to them, the growth of the organization was a result of their management philosophy known as “market-based management.”

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The world is in a state of flux. It constantly changes and it is very important that businesses are aware of these changes so that they can operate accordingly. It was thought that a specialist with brains must be hired by organizations in order to understand the changing environment better, however, organizations kept on failing. The reason behind this failure was because of the belief that one leader or experts in a field know what’s best for everyone. But the reality is that one head or specialist cannot understand the environment on his own and make decisions for the entire organization. This knowledge of the environment is diffused among a wide range of people and therefore the organizations fail when they fail to utilize this knowledge. Market based management is a system in which the knowledge and creativity from all the employees in an organization is gathered. A market-oriented system is better because it allows people to use their knowledge and act accordingly. It helps the organization by creating a framework to understand different management tools like just-in-time inventory, total quality management, and other ideas for improving organizational performance.

Now the question remains how this can be implemented as gathering the knowledge and synchronizing the decisions of thousands of employees could get a little messy. One thing is for sure, the traditional command control that is prevailing in organizations is not the answer to this problem because it limits the knowledge of individuals. Organizations should therefore merge market based systems in their management. This is exactly what Koch Industries applied in their daily management practices. At first, the philosophy was more or less implicit. However, with time they realized that it would be better for the organization if this philosophy was to be made the framework of the organization.

Just like the way countries and societies benefited by adopting market based systems in their economies, organizations and businesses also benefit when the hierarchical differences and other command control characteristics are reduced. Many contemporary management theories support this. According to the recent theories concepts like employee empowerment, decentralization of responsibilities and decision making and organizational learning are promoted. These concepts allow diversity in opinions and ideas and hence better opportunities to succeed.

Market based management is often misunderstood by people. Firstly, it is very different from the market system in the society where everyone strives to achieve their own goals. In an organization, a market based management system is all about realizing ways that encourage employees to work towards a common goal more effectively. It is also misunderstood because secondly, it is thought that market-based management is all about understanding the market and responding to it only. There is much more to it. Thirdly, it is different from industrial democracy and participative management in the sense that although the main concept of centralized management is the same, market based management suggests different resolutions to managerial coordination problems. And lastly, markets are seen as being competitive therefore market based systems are also assumed to be all about creating competition within the organization. This is untrue because market based system is about a mix cooperation and competition.

There is a concept known as “market process analysis” which is a method of understanding human interaction and action. This method allows us to understand successful and peaceful operations of different social organizations. The market system is largely affected by this. There are six elements of a market system that are used to develop the framework of a market-based organization. These elements are division of labor, property rights, rules of just conduct, the price system, free flow of ideas, and market incentives. These will now be discussed in more detail.

Division of labor and the Mission system

The mission system of an organization is a basic direction for and of everyone in an organization, just like a division of labor is in a society. The society benefits by increased productivity when labor is assigned to people who specialize at it. The concept of comparative advantage comes in when explaining how productivity is increased. Since there are limited resources, these resources should be doing what they are best at which gives them an advantage over others. Only market system allows this to happen as in command based societies, the government assigns labor to people who may or may not specialize at it. This is how division of labor is applied in a market based society. In similar fashion, organizations also have comparative advantage over others in the industry. There are certain things that one organization might be better at and this is its competitive advantage. The organization will concentrate on this more because this will allow it to be efficient. It will allow it to produce more value to the customers. In an organization, the mission statement provides benefit as it helps in outlining it competitive advantages. Once these are identified, the organization is in a better position to concentrate on them and hence ensure long term profitability.

Koch industries also benefited by finding out its competitive advantage through its mission system. It was believed that Koch Industries was in the oil business, however the mission system outlined that the organization has advantages in purchasing, transportation, processing, sales and trading and hence, these became its core competencies. The mission system of Koch Industries helps in understanding the business, knowing what to do, how to do it, and monitoring progress as well.

Property Rights, Roles and Responsibilities

Roles and responsibilities that are assigned to people are like property rights in a market system. The property rights allow people to use their property, earn income from it or sell it. Both property rights and value added give incentive to organization to serve customers. When these organizations make profit, it means that they are performing well and that they are contributing to the society. Losses on the other hand mean that organization is decreasing the value of a particular something. Therefore we can say that earning a profit or loss provides feedback to organizations regarding their service/operations. In a market system, the people are owners of private properties therefore they have a higher incentive to take care of it in order to preserve its future value.

Just like a private property rights, when role and responsibilities are assigned to employees, they have an incentive to perform better. They are accountable for what they do once these are assigned to them. When roles are assigned to someone, he is allowed to use his personal knowledge, make judgments and also face the consequences of his actions. ‘Tragedy of commons’ is a phenomenon in which no one takes care of public property because he has no incentive to do it. This phenomenon is also there in organization when clear roles and responsibilities are not assigned. People start to believe that it is someone else’s responsibility and failed to make sure that that task was carried out.

Koch Industries assigns these roles very carefully based on their demonstrated ability to make good decisions and satisfy customer needs. Each person is made to use his time in a way which will ultimately be beneficial for the organization in the long term.

Rules, Values and Culture

Values and culture help people in decision making and behaving within an organization, just like laws and regulation in a society. Every society has rules and regulations that direct behavior. These can be both formal (written) or informal (understood). These rules and regulations make the behavior of the public more predictable. Just like in a society, the values and culture of an organization also direct the behavior of the employees in an organization and make their behavior more predictable. The culture and values also allow the employees to move towards the mission in an organized fashion.

Koch Industries has certain corporate principles that are in writing. These teach employees to respect others knowledge and expertise, show integrity in operations, be open to new ideas etc. These may be very obvious in nature but these principles need to be there explicitly because if these rules are not followed by the people of that organization, the business will suffer. The end result which if organizational learning will not be achieved.

The Price System and Internal Markets

The price system determines the demand and supply and similarly, in an organization internal market gives the people critical information.

Millions of people achieve their individual goals simultaneously in a society through the market system. The price system assigns prices to commodities and these prices help people on making choice and deciding on what is attractive and what’s not. The demand and supply of goods and commodities determine the price that will be paid by the general public.

Within an organization, an internal market system is used my numerous organizations to make resource allocation decisions. They hire external companies for their corporate services. Value added decides on the budget that will be allotted to such services. With time, the size of the corporate staff continues to change according to the ability to serve internal customers.

Koch industries has adopted a very efficient internal market system. This system is organized by keeping non profit business units that work to capture the benefits of internal market without ruining the teamwork spirit.

Generation and Communication of Knowledge

Free flow of ideas in a market system are like open communication in an organization. An organization must make decisions after carefully analyzing all the information and knowledge that is available with them or the employees working in the organization. A market based system allows better information to flow throughout the society though its price system. Other elements of a market system also promote greater use and sharing of knowledge. First of all, knowledge is available with everyone. A market system allows people who have the suitable knowledge to make decisions for themselves and the society. However, in market based management system, since the lower levels of employees do not have the ability to see the organization as a whole, they cannot make decisions. Instead, they give their suggestions and opinions which will be considered by the top management. Secondly, knowledge is into always very obviously out there. It is tacit and a market based management system allows the employees to be flexible and make use of this knowledge.

Lastly, there are times when something is new. This type of knowledge is untested and the way an organization handles such knowledge is very important. In contrast to a market based system where there is a chance of getting punished if something does not go the way it was planned, a market based system allows people to try out new things and experiment. People in such systems do not hesitate to express their opinions if these have not been tested before.

Incentives, Compensation and Motivation

And lastly, in a society the incentives are profits which indicate value added, and in an organization motivation and compensation systems provide similar incentives. Profit is a motivating factor for entrepreneurs to give maximum value to customers and produce at minimum costs. In organizations, what motivates the employees has been a very heated debate. It could be both material and immaterial factors that motivate employees to work hard.

In a market based system, the approach is completely different. This system motivates people to naturally do the right thing. This system clearly defines roles and responsibilities, ensures mutual benefit for employees and the organization both, encourages adherence to rules and regulations and offers multiple rewards for behaving in a desired manner

Result

After applying these elements in the organization, the ultimate result would be social learning in a society and organizational learning in an organization. A market system allows rich flow of information and learning. Information flows better because of the price system and property rights ensure communication to take place. Also, learning takes place because entrepreneurs strive to give value to consumers because of the profit motive and in the process new things are tried and hence learning occurs.

Just like societies, when market based systems are applied in organizations, the result is organizational learning. This is an organization which makes use of all the minds available to them. This kind of a organization understands the fact that the environment now has a very strong control on the organization. Also this environment keeps changing therefore there is a critical need to use the knowledge of anyone and everyone is available at all times so that the changes can be managed in a better way.

Changing the management of an organization must be difficult however organizations need to understand that taking this step is very important for organization’s survival. When these elements are aligned in a society, the results are tremendous. Similarly, in an organization, when these elements are aligned, we have what we call organizational learning where people are more likely to effectively follow its mission statement. The six elements of a market system discussed above need to be included in a organization all at once so that maximum benefit can be achieved. It is very important for organizations to understand the importance of these elements. These are all interrelated and in order to stay ahead of the competition, an organization must work on these all together.

References

1. Koch, C. G. Introduction to Market-Based Management.

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