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Market-Based Management

May 7, 2006
[Cross posted at Organizations and Markets]

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 paper by Kirsten Foss, Nicolai Foss, and myself 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.

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