Competing for innovation: internalising the free market

As inter-company competition grows in western markets, how can internal innovation keep pace? Arraz Makhzani of UnWork looks at the benefits and detriments of fierce competition within an organisation

Markets have been the perennial battleground of political ideologies ever since Adam Smith’s The Wealth of Nations set out the core principles of how economies function. Smith laid the foundations for the study of economics, outlining many of the concepts that help us understand how business works. Competition, productivity and the division of labour are all important principles for businesses. While we generally accept that most modern countries have a mixed economy made up of mostly free markets with some regulation, there is an interesting point at which this breaks down.

The race to innovate

Consider that companies exist to make money. In mixed and free market economies they do this by competing with one another to provide services at high quality and low cost. The opposite to this is a centrally planned, Soviet style economic model in which there is no competition, only instructions to produce and distribute a given amount of a resource and a timeline to do it. There is no real incentive for organisations to innovate, reduce prices or increase quality in this latter model. This was one of the major factors that led to the collapse of a world superpower and cemented the importance of market freedom for most of the world.

‘Why do we expect companies to compete in free markets yet run them like planned economies?’

Companies therefore must compete and this competition results in lower prices, greater innovation and more choice. What is interesting is that while we apply this to our economy, companies themselves still function without competition. If you need a task done, you find the relevant team or individual and you ask them to do something. They do it (or don’t do it) according to their workload or their whim but with no real incentive beyond the vague and ephemeral idea that it is part of the job they are going to be paid for at the end of the month.

The internal free market

Why do we expect companies to compete in free markets yet run them like planned economies? This is a key question that some organisations have been asking themselves recently. One high profile example of a company that has asked themselves this question and decided that the reason was not good enough is Disco. Disco is a Japanese company that makes precision cutting equipment and has decided to drastically alter the way the company works; now there are internal markets for everything. They even have their own internal currency. This is an aim to make the company a lot more efficient by making teams compete with each other.

‘Teams bill each other for their work…’

Teams are given a budget and managers decide how this is allocated. Every employee gets a base salary which is then augmented by completing tasks; this is aided by a complex tracking system that tracks staff contributions. Staff are charged for everything from meeting room time and desks to colleague’s time assisting them. Teams bill each other for their work and it’s possible for individuals to even function as start-ups. Work assignments are auctioned and teams bid on them to complete them for the lowest price or in the fastest time. This has created a complex internal market at Disco, driving efficiency – the faster and better teams and individuals complete their tasks, the more money they make. This has also reduced other inefficiencies from tedious, long meetings; an hour in a meeting room can cost $100.

Furthermore, Disco found that many tasks that attracted few or no bids were actually not that important. This free market approached enabled them to focus on the activities that actually make money and reduce all of the bureaucracy that was getting in the way of people doing their jobs.

Disco have reported that their share price has quadrupled in the time this free market experiment has been running and their operating margin has increased by 10 per cent. Overtime hours have also dropped by 9 per cent as this is seen as an inefficient behaviour and penalised under the system. Of course, while we cannot entirely put these great results down to the management system, it seems likely that at least part of the results are down to the radical changes in the operation of the company.

Is this model sustainable?

What Disco have done is to effectively use the benefits of markets and competition to greatly enhance the efficiency of their workplace, cutting waste and using the market to determine what teams should focus on. While letting the market decide may have benefits in terms of efficiency however, this ignores some key weaknesses of totally free markets. The main reason that no economy in the world is totally free is that this would create a whole host of negative externalities that would have a severe impact on consumers and the world. Negative externalities include things like environmental damage, stress from insecure employment and burnout from constant pressure to achieve goals. While Disco focus on the good outcomes for obvious reasons, it is likely that they are experiencing some negative eventualities as well. There is also the question of how well this short-term, highly individualistic thinking will play out at a strategic company level: there is so far no evidence to support that individual trying to do what’s best for them will translate into long-term benefits for the company as a whole.

It also seems likely that while this system may work for some, it will not work for others. In the short to medium term, there may be some efficiency benefits and natural selection of projects and goals, but a totally free market encourages individuals to do what is best for them and the company may find this working against it in the long-run. Take for instance the fact that an unrestrained free market tends to concentrate wealth in the hands of very few people. While in the short-run, this may show that the system is successfully incentivising employees to perform well, what happens in the long-run when the average employees see that their peers are earning so much more than they are? They will undoubtedly leave for a more equal company where they feel that their skills are better compensated. This may shrink the company to the point where there are too few employees to actually do all of the work, causing it to collapse.

Another important point to consider is what effect this will have on siloes at the organisation. If, for example, a team develops a macro that automates a process and cuts down the processing time for an activity, they have little incentive to share this. Instead, they will sell it, or hire it out to other teams. However, if the team have already developed it, it belongs to the company so the company is effectively paying for it twice. These kinds of perverse incentives should be considered as well.

Effective team clusters

While they have probably gone further than most, Disco is not the only company looking at the possibility that smaller, more flexible units of employees may be beneficial to the company. Amoeba Management is a little-known management technique that encourages the use of small, 5-50 person teams which are supposed to have the flexibility and narrow focus to quickly make the best decisions at a low level of the hierarchy. This is essentially the basis of the Disco management style, going further than some other adopters such as Kyocera, Japanese Airlines and Capcom.

‘Decentralised, autonomy teams to improve efficiency…’

Another convergent system that has some parallels with this approach is the ‘team of teams’ idea developed by General McChrystal while on operations in Iraq in 2003. The basis of this approach is that when fighting a large, decentralised network (al-Qaeda in Iraq), the clunky top-down hierarchy of the US military was failing to respond quickly enough to events. While effective at fighting a similar structure, such a large and ungainly unit could simply not match the flexibility and rapid decision making of the al-Qaeda cells. The team of teams approach therefore emphasises decentralised control to small, manageable units that are empowered to make their own decisions. While not exactly a free market approach, there are echoes of this approach in Disco.

‘Using competition to do what competition is good at’

Market forces can be very powerful if used correctly. In the political theatre they are generally driven by ideology and the flaws of this approach are obvious. There should be a greater acceptance of the fact that more freedom in some markets is desirable and less freedom in others is equally desirable. Competition lies at the heart of this. That is why some market freedom has been a resounding success and some has been an abysmal failure. In the UK, more competition in the mobile phone sector has massively reduced consumer costs while enhancing customer service and offerings. Opening up a market in train provision, however, has resulted in plummeting satisfaction and soaring prices. The key difference between these markets is the ability of suppliers to compete with one another effectively. More companies should be open to the idea of using competition to do what competition is good at (e.g. increasing efficiency, reducing waste) but equally mindful of the drawbacks of too much competition (e.g. inequality, siloes). What is needed most is an experimental approach like that of Disco: come up with an idea, carefully test it, gather data and decide whether this is a good thing or not for the organisation. Only through constant experimentation and openness to new ideas will companies remain successful in an increasingly competitive and mutable world.

Arraz Makhzani is a workplace analyst at UnWork
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