While there are certainly some similarities between CE and other systems, there are a number of unique features as well. This page was prepared to point out the differences. I'll discuss how CE differs from traditional business structures, other market-based systems, and democratic or cooperative systems. I'll also describe how it is different from the perspective of employees working within a CE structured business.

How is CE different from traditional business structures?

The most important difference between CE and traditional businesses is the presence of an internal market system. It's like the difference between the backward economy of the Soviet state and the dynamic economies of free countries. An internal market system is the engine of CE—the source of its power and efficiency.

Traditionally structured businesses are organized like a series of mini-monopolies; each with a sole-supplier relationship to the other business units in the company. Each handles its own portion of the production process without any choice of who to deal with and how much it should cost. By contrast, in market-based firms each business unit buys from and sells to other business units, or if they so choose, other companies.

Understanding why a market-based approach promotes efficiency begins with understanding exchange value and competition. The exchange value of something is exactly what someone is willing to exchange for it. In the process of exchange people naturally strive to maximize the value they receive for a given price. If they can't make an equitable exchange with one source they seek out another. If competing sources are available they usually choose the most efficient one. [1] Those of lesser efficiency must either improve, or change their line of work.

In addition to regulating goods and services a true market-based system regulates investment capital as well. Competition for the available reserves naturally channels capital to its most productive use. (This is explained more in the description of the CE Profit System and the section on democratic or cooperative systems.)

Thus, in the CE approach, production is totally controlled by market forces. This concept strikes the traditionally minded as being risky. They usually feel that a management structure is necessary to maintain discipline. On the contrary, those business units which are poor at serving their customers are disciplined by the market far more severely than any management hierarchy could do.

This brings us to the most readily perceived difference between CE and traditional businesses—the lack of a top-down authority structure. No CEOs, directors, managers, or supervisors are necessary. Of the functions they would typically perform many have been eliminated and the rest are performed by either individual business units or elected representatives.

Practically all other business models have tried to preserve centralized control in the company by a hierarchy of executives and managers. They may have proposed flattening the hierarchy, but CE is the only one that proposes inverting the hierarchy. The constitutional system results in an inverted hierarchy, where employees delegate authority up the hierarchy, instead of the reverse. [2]

CE still provides for a chief financial officer—an executive who represents the investors interests in the financial branch of the company. This executive has no control over production, but acts more like a bank manager within the company. Even the president of the executive branch, who is elected by the employees, has no control over production. Production, in the CE model, is governed totally by market demand—the only true internal market approach.

When designing the features of CE I did not begin with the goal of eliminating managers, but once the design was largely complete there was simply no need for them. I do not mean to imply that managers are merely useless or even harmless. In fact, I discovered the conflicting roles held by them work against the efficient functioning of a business—their presence is harmful.

The world view, which holds that a management structure is necessary, assumes that certain things are knowable, which simply cannot be known. Frederick Taylor's "scientific management" was based upon improving efficiency of knowable processes. Much of traditional management theory is still based on Taylor's attempts to maximize the efficiency of routine tasks. If the world were static, Taylorism would be a perfect solution for optimizing efficiency, but that is not the case. Instead, a process of "creative destruction" is constantly at work, changing the rules at every turn. And the rate of change is increasing, which makes it even more vital that we develop systems to rapidly adapt. This ultimately requires driving decision-making down to its lowest possible level—a single individual.

A top-down authority structure is poison to a business system. It focuses the goals of employees on the desires of management instead of customers. To the extent there is no divergence between the desires of managers and customers the business is likely to do well. However, in the absence of an internal market system divergence is the rule.

The best example of the myriad problems created by a large top-down control system is the Soviet experiment. For many years all production was directed by the Soviet government—all factories were owned by them and all decisions over the supply of goods were mandated from above. They assumed the needs of consumers could be guided by administrators. Consequently, the consumers were subjected to shortages of needed goods and overages of unneeded ones. People stood in long lines to acquire goods of short supply while other unwanted goods rotted in warehouses. Rationing became the way to deal with consumer demand. Time and again it was the black market that actually supplied the goods the people needed.

The Soviet system was management-driven instead of consumer-driven. It could not respond adequately to market demands because the consumer was isolated from production decisions—they could not duplicate the self-organizing character of the free market. Attempting to bring order to industry they institutionalized methods to suit existing conditions. Then when conditions changed, as they always do, the methods were inappropriate.

One of the major sources of inefficiency in a management-driven system is the psychological effects the hierarchy has upon its participants. As shown in Exhibit 1, below, management's authority to reward and punish is the primary influence over employee actions. It imposes fear where there should simply be a business relationship. By contrast, in a consumer-driven system, where employees do not receive conflicting signals, they simply serve customers.

Exhibit 1 A hierarchy naturally imposes downward pressure on subordinates to comply with the wishes of their superiors. Whether it is a Soviet government or a business hierarchy inefficiency is the rule when commands are imposed from above. It is the combined roles of lawgiver, judge, and executioner that causes the problem. Fear is the natural result when the same person issuing commands has the power to punish for non-compliance. Regarding governments, James Madison said it this way:

The accumulation of all powers, legislative, executive, and judiciary, in the same hands, whether of one or a few, or many, and whether hereditary, self-appointed, or elective, may justly be pronounced the very definition of tyranny. [3]

How is CE different from other market-based business systems?

Some treat ownership too metaphorically [5] to support a real market system—referring to roles and responsibilities as being similar to property ownership, but do not provide for exchange to take place. Supposedly, in this approach, workers "own" their responsibilities. But how do you establish the market value of something you cannot sell? Without the possibility of buying and selling a market system does not really exist.

Some try to blend an internal market approach with concepts that are traditionally a part of a top-down authority system. In this respect they are no better than traditional business structures. They have not come to see that a market system is incompatible with a centrally controlled system.

What makes CE different is the presence of a real internal market system, along with the realization that a market system cannot function efficiently without certain supporting conditions in the environment. CE is the only business model that utilizes a constitutional system, including a written constitution with a real separation of powers and check and balances. Without these safeguards the internal market system is at risk and cannot function efficiently. I group these supporting conditions into three categories: legitimacy, equity, and opportunity. Their relationships to the Constitutional System of the CE model are explained below. (Or you can read a sample CE constitution .)

Legitimacy

Throughout human history progress has followed the incremental development of ownership rights and the corresponding recognition of the free market. The natural rights of life, liberty, and property—aspects of ownership themselves—were central to the 17th and 18th century revolution of thought known as The Enlightenment. The enforcement of contract rights also received early recognition as essential to the orderly exchange of ownership in property. The rights of privacy, speech, association, and intellectual ownership rights, such as copyrights and patents, have a more recent history, but are no less important to the creation of prosperity. And future frontiers of ownership, such as the purity of air, water, and the neighborhood effects of the visual environment are yet to be clearly defined. But, to the degree individuals perceive any of these rights to be secure, market exchange spontaneously occurs. The key point is recognizing that efficient market exchange cannot exist without legitimate ownership.

The Peruvian economist Hernando de Soto has identified the formalization of property rights as critically important toward developing the lesser developed countries. He convincingly argues that a market system is woefully deficient without a formal method for defining, securing, and exchanging property rights. Without such legal measures ownership in third-world countries is uncertain and market exchange is fraught with risks. Such markets suffer from their illegitimate status and are never very efficient. Informal property can be lost and no appeal to government is possible. Rather than accept these risks entrepreneurs and investors will pursue more formalized and secure environments elsewhere; the country remains underdeveloped. [6]

Equity

This next market support—equity—can be thought of as just reward. It is the assurance that people are rewarded justly for their actions, whether good or bad. The market system itself provides for just reward through voluntary exchange. Those who best meet the needs of customers are rewarded more than those who do not. But there are also more active measures needed to ensure justice in a market system.

Imagine what society would be like if people could violate laws without penalty, or if there were no means of enforcing contracts. How would you feel about investing all your savings in a new business venture in this environment? What guarantee would you have of your investment being secure? And if the business owners decided to keep your investment, and not recognize your claim, what recourse would you have for justice?

There must be a means of providing remedies when people fail to uphold contracts or choose to ignore laws. In our society the judicial system stands behind all contracts and laws. Anyone violating them knows they will have to face the prospect of a trial and the potential of punishment.

In CE the Judicial branch of the Constitutional System provides a means of adjudicating violations and disputes. Just the presence of such a system removes much of the risk from an internal market system, even if it never has occasion to use its powers.

Opportunity

Opportunities exist whenever there is a possibility of making choices between alternatives. Opportunity is directly related to freedom—as long as people are free to use their talents, opportunity exists. But those who are willing to improperly use force against others can take freedom away. Insofar as they limit people's choices, they limit opportunities. The protection of freedom, therefore, is the protection of opportunities.

In any society there are usually three categories of threats to freedom: threats from outside the society by persons outside of the law, threats by persons inside the society who choose to violate the law, and threats by bad laws. The role of the company Executive Branch is to protect against all three threats to freedom.

Imagine what would happen to our country if we had no military to protect us from aggressive take-over by foreign powers? Or what would happen if we had no police force to protect us from internal criminal activity? Or what if one branch of our government had unlimited power, without being checked by another? Any society, if it is to last, must protect its members from all three threats. Without these protections freedom and opportunity are at risk.

To better understand the correlation between freedom and opportunity consider what would happen if government outlawed a particular commodity. Those people who traded in that commodity would lose an opportunity they previously possessed—the freedom to trade in that commodity. Now let's suppose instead of entirely outlawing the commodity they merely imposed a new body of regulations making it more costly to produce and distribute. To the extent the new regulations made trade in that commodity more costly they would also diminish opportunity. People would no longer be as free to produce as they had been. If people do not perceive an opportunity to engage in market exchange, they won't even try. Restrictions to freedom diminish opportunities.

CE Profit System

The reason a market system functions efficiently is because people are using their own resources to make exchanges. When people spend their own money you don't have to ask them to spend it wisely. While it is true some people make frivolous purchases, it usually doesn't persist for very long before they must face the reality of being more thoughtful and discerning.

The difficulty in an internal market system is providing for those who make spending decisions to feel the consequences of their decisions the way an owner does. Many have tried to accomplish this by making employees owners, or part owners, of the business. But this is not always possible, or even preferable. (See also the section on democratic or cooperative systems below.)

In CE the perception of ownership is created by a metaphor of property. Ownership, or rather internal ownership in this sense, is not the same as ownership in the external society because the employees cannot use this property for purely self-benefiting purposes. Rather, their role is more like custodians or stewards over the property; applying it to its most productive use for the benefit of both themselves, the stockholders, and the customers. This is achieved through a profit system, which includes sharing of profits between shareholders and employees, and a capital reinvestment fund, also generated from the profits.

While the CE approach is closely modeled after the external free-market, with respect to the profit sharing system, it is markedly dissimilar. No direct counterpart to profit sharing exists in the external society. Nevertheless, this system is essential to compensate for the metaphorical nature of property rights in a CE business. Profit sharing extends the benefits of internal ownership beyond the metaphor—it makes them real.

Each business unit functions independently, handling their own income and outgo, paying their own employees, buying their own equipment and supplies, etc. At the end of each accounting period (perhaps monthly or quarterly) the group looks at their revenue and determines if it is sufficiently large to declare a portion of it as profit. The profit that is declared by the group is then split into three parts. The relative proportion of the three may vary, but for the sake of discussion, lets say it is divided evenly into thirds—an owner dividend portion, a capital investment portion, and profit sharing portion.

The owner dividend portion is distributed to the owners of the company. It could be considered stock dividends, if the business is a corporation, or simply special bonuses if the business is a partnership or sole-proprietorship.

The capital investment portion is deposited in a special fund to lend to the various business units for expansion, modernization, etc. Employees or business units request loans from this pool of money to invest in capital goods or other acquisitions which increases the material holdings of the company and therefore increases value to the shareholders. These loans, however, are unlike any loans in the external market. Interest on these loans would be used by the financial business unit managing the funds. But the returning principal would not go back into the fund for reinvestment, but rather, would be placed in a special fund to be distributed to the employees of the whole company as additional profit sharing.

The business unit managing the capital investment fund analyzes all business units requesting funds and determines which should be extended loans (a loan officer function). The criteria for deciding between them is not simply their ability to repay the loan, but also their ability to produce a profit.

The profit sharing portion is distributed directly to the employees of the business unit that generated the profit. [7] For this first tier of profit sharing all business units share only in the profits they generate themselves.

How is CE different from systems of democratic control or cooperative systems?

There are several differences between CE and democratic or cooperative systems, but most salient is the presence of an internal market system for investment capital. This difference stems from an appreciation for the different roles of employees and owners. Usually democratic systems try to merge the two roles by making employees into owners. CE draws a sharp distinction between owners and employees, but redefines their roles so that owners behave like investors and employees behave like owners.

1. Employee involvement on the board of directors,
2. Employee ownership of company stock, or
3. Worker control—actual administration of the business by the employees.

Proponents of democratic systems have various reasons for employing these methods. Some people feel the unequal power of workers and owners is unjust, and hence pursue methods for leveling this power. Others simply desire to improve worker performance by making them owners.

Before continuing with this discussion I need to point out that my sentiments are in agreement with the proponents of democratic and cooperative systems. Indeed, employee owned corporations are probably the most likely to adopt the CE model. Generally speaking, their goals are honorable; however, I disagree with many of the tactics they employ to solve perceived problems. While there are some significant employee ownership success stories there are also some colossal tragedies. Indeed, the socialist and communist movements were trying to solve the same perceptions of injustice as democratic and cooperative systems. (See The Origin Of Socialism for more discussion.)

Cooperatives and employee-owned companies often fall victim to a common error. Assuming a better system for businesses would be a democratic system, democracy is regarded as an end in itself. In their mind, if it's democratic it must be good. Often they call their system Workplace Democracy and to them no other justification is necessary except "majority rule." [8]

The proponents of Workplace Democracy often fail to understand the employment relationship is literally a contract. Employees agree to sell their labor to the employer, as deemed appropriate by the employer, in exchange for a wage. In short, they obey the employer for money. If they do not want to provide what the employer desires, they can legitimately negotiate with the employer for a change, even withhold their labor in the form of a strike (provided they are peaceful), but if the employer does not like the nature of the change then he or she does not have to accept it. It is, after all, the employer's money to spend as he or she pleases. In this case the employee has two choices, to stay and work according to the employer's expectations, or to leave and seek employment elsewhere. But they have no right to force the employer to use his or her capital in a way the employer doesn't want to. In this respect, when workers try to force measures of Workplace Democracy, their attempts are socialistic—they try to promote equality at the expense of justice. [9]

Another problem exists with respect to Employee Stock Ownership. In the free market owners and investors want the greatest possible return on their investment with the least potential for risk. Consequently, money tends to flow toward its most productive use. However, employee-owners and employee-directors have divided interests. While they have some interest in providing a good return for investors, they are more likely to be interested in preserving their own jobs. Because of this a vital source of market information may be missing or distorted—information that would prompt investors to move their money toward a more efficient use. [10]

It is critically important to draw a clear distinction between ownership of capital, and custodianship of capital. A person who has a custodial responsibility over capital can use that capital only within the context of his or her responsibility. If, for instance, an individual chooses to use capital for personal use when it is intended for the functioning of a business, he or she has misappropriated company funds. When people use company funds to provide for themselves lavish furnishings or even to donate to charitable causes, it is likewise a misappropriation of funds. [11] There is a fiduciary responsibility which exists between an employee and the owners of the company to use the resources of the company appropriately. But when an employee confuses the roles of owner and custodian, he or she can very easily commit misappropriation without the slightest pangs of guilt. "After all," they tell themselves, "isn't it mine anyway?"

How is CE different from the perspective of employees working within a CE company?

To employees working in a CE business things will be radically different. They will choose their own line of work, choose their own hours, and even choose their own salary. They will know if they choose too high a salary they will be unable to compete with other business units or meet expenses. They will also know that if they take too high a salary, they will be unable to declare a profit and will not have funds available for capital expenditures and profit sharing.

Authority will be delegated up the hierarchy, instead of down. Company officers will serve those who elect them. No one will be any better than anyone else by virtue of position. Instead, the value placed on people will be governed by the service they provide in the internal market system. When particular employees are not earning enough to satisfy their desires they need only change the value of their product or service, not bargain for higher wages.

There will be no need for managers, or for that matter, labor unions. There will be no need for labor negotiations, strikes, walkouts, or lockouts. Employees will have far more power within the structure of the organization than a union could possibly offer from without.

Some employees will be uncomfortable controlling so much of their own destinies. Some may choose to work in more traditionally structured businesses, but then their income is likely to be much lower. It would be like comparing life in the Soviet Union to life in the United States. Some people simply prefer being taken care of instead of being self-reliant. But look at the difference in life style and standard of living.

	Notes Of course, many factors besides price can have a great influence on their decision to exchange—reliability, quality, delivery schedule, etc. Return An inverted hierarchy is not the same as a democratic control of production. An inverted hierarchy merely provides for the rule making function, but production is still controlled by market demand. Return See, Alexander Hamilton, James Madison, and John Jay, The Federalist Papers, originally published 1777–1788, © 1961, The New American Library, New York. Paper No 47, by Madison, p. 301. Return The books below also propose internal markets systems for businesses. (See the Related Web Pages for links.) Wayne Gable and Jerry Ellig, Introduction to Market-Based Management, 1993, The Center for the Study of Market Processes, George Mason University, Fairfax Virginia. William Halal, Ali Geranmayeh, and John Pourdehnad, Internal Markets, 1993, John Wiley and Sons, New York. Return Ownership promotes responsible actions. The challenge is to provide for employees (non-owners) to behave like owners. Since stockholders are actually the only true owners in a firm, ownership by anyone else is at best "metaphorical." However, the closer a sense of ownership is felt by employees the more responsibly they perform. In CE the metaphor is designed to yield a close sense of ownership. In other internal market systems, if they address ownership at all, they treat it more metaphorically than in CE. See the CE Profit System for more discussion on this topic.Return Soto, Hernando de, The Other Path: The Invisible Revolution in the Third World, 1989, Harper and Row, New York. (Most significant to this theme are chapters 1, 5, 6, 7, and 8.)Return The distribution between the employees should probably be in proportion to the relative size of their wages; since, at least theoretically, their wages represent the relative value of their contribution to the business unit. They may choose among themselves to distribute it according to any other formula, as long as the formula is clearly understood and agreed to by the parties concerned. If the proportion appears to be based on preferential bias or whims the perceived injustice will create harmful contention. Return Zwerdling, Daniel, Workplace Democracy, 1978, 1980, Harper Colophon Books, New York. In this book Zwerdling details a variety of different examples of Workplace Democracy.Return What has greatly complicated this situation is the fact that governments have routinely taken the side of the workers in enforcing their claim for equal status. Unfortunately, this has increased the adversarial nature of the relationship. While I sympathize with the difficulties of workers, the solution is not to wield government as a club to beat employers into submission. Workers have the expertise needed to make a business successful. Employers do not. So instead of combining to force employers to use their money in a way they don't want to, combine to form another company and beat them at their own game. Compete with them in the open market and they will be punished far more severely than by using government—they will lose their wealth. Meanwhile, the former employees will benefit far more than by attempting to pry funds from an intractable business owner.Return While there is really nothing wrong with preserving jobs, it should not come at the expense of serving customers. If your only goal is to preserve jobs non-productive activities are likely to creep in. Then efficiency will suffer and eventually jobs will still be lost. But if your goal is to serve customers, and produce products and services they are willing to buy, you also preserve jobs. (Actually, the term "preserve jobs" implies a stagnant environment. Jobs should not really be "preserved," but continually "remade" to meet customer expectations. A true market system adapts to meet customer demand.) Return It is good to be generous with one's own wealth for the benefit of those who are less fortunate, sick, or oppressed, but to be "generous" with the wealth of others is a euphemism for theft. Let people donate their own money to worthwhile causes. Anything else isn't really giving, and cheapens the act of charity. Return

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