Market Magic

Internal markets can solve thorny allocation problems and predict the future.

“Man is an animal that makes bargains,” observed the great 18th-century economist Adam Smith. Today, this instinct is given free rein in markets around the globe. Most Americans — and certainly most public-company CFOs — take it as an article of faith that markets eventually lead to the fairest prices and most efficient distribution of goods.

Why, then, don’t more companies resort to markets when it comes to making decisions about corporate resources? Market-based systems that let employees express preference and need through price have proven accurate, efficient, and technologically simple. “In principle, almost any company could use some kind of internal market,” says Thomas Malone, a professor at Massachusetts Institute of Technology’s Sloan School of Business.

But so far, few companies have large-scale internal markets under construction, according to Malone and others who consult in this area. NewsFutures Inc., one of the primary technology providers for such markets, says its client base has grown to 12 companies this year, up from 1 in 2003, and could hit a maximum of 50 over the next year. “I wouldn’t call it a bandwagon yet,” NewsFutures CEO Emile Servan-Schreiber says wryly.

Using internal markets within corporations is hardly an untested concept. One of the classic examples is the market BP Amoco set up in the late 1990s to reduce the oil giant’s greenhouse-gas emissions. Each business unit was granted the right to generate one ton of carbon-dioxide emissions and given access to an electronic trading system that allowed it to buy more capacity or sell excess to other units. By 2001 — nine years ahead of schedule — the company had hit its targeted reductions after more than 4.5 million tons had been traded.

Researchers who work on such markets say there are still many allocation applications to be explored, from the mundane to the sublime. Bernardo Huberman and his group at HP Labs, the central research organization for Hewlett-Packard, has designed systems to let people buy and sell rights to computing power and even conference rooms. Malone has recently done extensive research for Intel on the use of a market for manufacturing capacity (as yet unimplemented), in which plant managers and salespeople could gain information from each other in order to minimize production costs and maximize profit margin. In theoretical runs, the allocations have come within 10 percentage points of perfection.

Predictive Power

Another common use of internal markets is for eliciting predictions from employees about which product designs, prices, and sales strategies will be most effective. Hewlett-Packard, for example, gave salespeople 20 shares each and told them to buy and sell futures contracts based on how many printers they expected customers to buy at given prices. The results showed their expectations to be as close, if not closer, to actual sales as HP’s official predictions had been.

Likewise, at Eli Lilly and Co.’s research labs, about 50 employees involved in drug development used an internal market to buy and sell shares of six mock drug candidates. In the end, traders had bid up the highest prices for the three drugs that ended up being the most popular on the market. Web-search firm Google, too, recently set up a system to let employees bid on likely launch dates for new products, with similar results.

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