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The Economics of Internal Organization



Business environment is divided into 2-

1. Internal- Internal Environment identifies the firm's internal elements, which are frequently constitutional in character.

2. External- External environment, on the other hand, is made up of elements that are not outside of the company.


What is Internal Environment/ Internal Organization?

Internal Organization can be phrased as the ‘Structural Unit' of the company. It involves all the internal working, in-house models that constitute the soul of the business. Every business has different Structural Units.

For example, a manufacturing company’s structure will be based on its production lines.



The Economics of Internal Organization has sparked a surge of interest in the recent decade, but,

What does the ‘economics’ of ‘internal organization’ refer to?

It refers to the financial outcomes that result because of the presence, or the lack of a well-oiled structure within the business.


Not all economic activity is fueled by prices and market.


Existing theories on Internal Organization-

1. Beckman (1960) -“The span of control in an organization is constant and concludes that the marginal cost of administration is bounded and cannot explain rising costs”.


2. Williamson (1967)- He examines the consequences of a lack of coordination and control. He concludes that average costs will actually be U-shaped under specific situations, which are dependent on the values of his parameters. New research in organization economics has mostly focused on other areas of the business.


Internal Organization can be approached two ways-

1. Allocation of non- human resources



Non-human resources refer to the production units or services offered by the firm.

Capital market is of immense importance to a business.


2. Allocation of human resources



Human resources refer to the hierarchy that takes decisions in order for the non-human resources to function.

Both categories are functionally connected.

The firm's production is inversely proportional to the time it takes to create a new plan. As a result, the hierarchy must be structured in such a way that the production plan may be completed as quickly as feasible.


The sub-units of Internal Organization-

a. Function- refers to the hierarchy of workers within the company

b. Product- Applies to businesses that deal with multiple products

c. Process- The events that lead up to the production or service.

d. Customer- Structures set up to deal with individual needs of customers



Factors that lead to a robust Internal Organizational Economy


1. Internal capital market-

Internal capital market is the single-most important factor of Internal organization.

It refers to the capital allocation and the subsequent dispersal of capital among the different sections of the company.


How does it help with the economics?-

· The advantage of dealing with internal capital is that the hierarchy controls who gets how much money.

· It is also easier to track the capital when it is divided rather than when the sections withdraw from the office lump sum.

· It decreases the chances of fraud and every bit can be accounted for.

· Any surplus money can be re-invested in ideas that need more capital. It helps in determining which department is performing what standards. If a department is not doing well, the flow of cash can be stopped and given to a department that is doing well, or open a new departmental venture.



Internal capital market has been observed to thrive when a business has investments in diverse markets. Firms engage in internal growth from investments and mergers. Companies must hold on to products that have a balance in the generation and absorption of cash.

This factor is entwined with the human resources part of internal organization. An equally diverse workforce is required for the ventures to see light of the day. When it is said that the human resources are functionally inseparable from non-human resources, this is what they meant.


2. Internal labor market-

An internal labor market is an administrative unit that deals with the allocation of human resources within the company, bounded by company rules.


Many Marxist theorists believe that Internal Labor Market divides the labor into hierarchies, akin to a Marxian social structure. It tends to make them more docile and the company less prone to disturbances of whichever manner. Duty-bound workers equate with effective production and lesser time wasted by the Labor market dealing with unproductive issues.

The labor market is based on qualification attributes. Each human resource is allocated a task/ tasks that fit(s) his temperament the best.



The kinds of Internal Labor Market-

· Locational

Involves off-site and on-site workers. On-site workers cost differently than off-site workers.




While off-site workers save on the aspect of not using company resources, they need to be compensated for everything they have spent on while on company business, for the company business.




On-site workers use company resources but do not have additional expenses like that of travel costs like off-site workers do.

The company needs perspective on what kind of workers they need more, depending on what kind of company it is.





· Temporal

Involves part-time human capital and short-time human capital. Part-time workers work every day for a shorter number of hours than the regular worker. Whereas, short-time workers work every day for the full number of hours but for a limited span, or until a target number of projects have been completed.



Companies manage the economics of the company in a way that these workers often cost less than regular employees. The company can hire fresh people for every project undertaken. Besides the advantage of capital saving, it contributed to a fresh perspective every time something new is explored.


A lot of economic activity in a company is governed by differentially informed people. Interactions between these differentially informed people are mediated mostly by company business.

In a setting where decision-making is decentralized, the potential divergence of individual incentives and corporate goals instantly establishes a link between people management and the fulfilment of organizational goals.


Every company is centralized and hierarchical. Collective mini decisions are made and they are piled into one big decision that keeps afloat the company’s Internal Organization.


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