Internal Market

The notion of internal market refers to the introduction of market-type mechanisms within organizations. Such market mechanisms include internal contracts and the internal charging for and trading of particular services between units of the same organization. These units then act as purchaser or provider vis-à-vis other units—or both concerning different products and services. Internal markets belong to a cluster of market-type mechanisms, including outsourcing, vouchers, user chargers, and so forth.

This definition of internal market should not be confused with the European Union's internal market program.

The underlying assumption behind the development of internal markets is that the introduction of incentives leads to more efficient performance of organizations overall. In particular, information generated via the price mechanism is seen as an essential indicator of an organizational unit's performance. For example, the argument has been made that large organizations with considerable fragmentation and internal decentralization have inherent problems of centralized control over resource use. An internal market, with different parts of the organization competing for service orders, is said to allow for enhanced performance. In contrast, the view that organizations exist precisely to overcome the transaction costs of market systems or to provide for redundancies or other socially desired properties by avoiding market incentives is being downplayed.

Although competition (concerning promotion, resources, etc.) has a long tradition as a doctrine for organizational governance, the concept of a formalized internal market for products and services gained currency as a reform idea within private-sector corporations in the 1960s and 1970s. Within the public sector, the idea of internal markets ranked among the key themes of the so-called new public management.

Areas of application of internal markets include the relationship between internal service agencies (for example, procurement, organizational consultancy, construction) and policy departments. The agencies or departments that consume the service are given budgets for services that were previously free of charge. Hence, these agencies have an incentive to limit their use of common services. The idea was also emulated in the design of overall organizational setup of local governments.

Possibly the most well-known introduction of an internal market was in the case of the UK National Health Service (NHS) between 1991 and 1999 (and arguably part of the Labour government's proposals following the general election of 2005). A key part of this internal market was the relationship between the general practitioner who, on behalf of the patient, was to offer treatments at competing hospitals.

As research on the NHS has shown, internal markets have been open to the same unintended consequences as other mechanisms of competition, in particular the goal displacement and collective action problems in providing public goods of the organization as a whole.

Internal markets are viewed as an essential part of marketization for research on governance. This highlights a research tradition that emphasizes the importance of incentives for individual behavior. More broadly, internal markets relate to wider questions regarding the transaction costs of particular organizational and institutional designs.