Internalization is described as a transaction that is handled by an entity itself without transferring or routing it via an external source.
Meaning of internalization
Internalization is defined as the process of conducting something internally. It is specific to the field to which it is related.
In business, the process applies to the corporate world or investment and business transactions. In the corporate world, it refers to the transaction that happens inside the corporation instead of the open market.
In the investment world, it refers to the buy order for shares which is filled by a brokerage firm from its inventory of shares instead of using outside inventory for executing the trade.
The process of internalization applies to Multinational Corporation when it transfers assets between its subsidiaries in various countries.
Several companies have followed the concept of internalization while producing specific material rather than outsourcing it from another manufacturer to cut down their cost prices. This is known as internal sourcing because the organization itself has manufactured it.
Internalization is thus also referred to the process where products are delivered to customers through the channels of the business itself instead of taking the help of any outside company. This process has proved beneficial to an organization as it helps in cutting down the cost price considerably.
Internalization is advantageous to a business entity as it results in a reduction of costs that would have normally been applicable if you had outsourced it. The cost of the manufacturing process or selling services and products is reduced to a greater degree with the help of internalization.
Internalized trading takes place when a trade occurs within the brokerage firm for the investor. The process seems cost-effective as it is not necessary to take help of an outside firm for the transaction.
The process of internalization is beneficial to brokers as they can make money on the spread that is the difference between the price of purchase and sale.
This transaction proves beneficial to a brokerage firm as it earns better profits than it would normally have earned if the shares were sold in the open market. It also does not have a hand in influencing the prices of the shares because the deal has not been brokerage in the open market.
Internal sourcing is a part of internalization that describes the concept of purchasing required material, service, or an asset from within the business instead of acquiring it from an external source.
The company decides to start manufacturing its products itself instead of depending it on outside company. Internal sourcing is also applicable in hiring for a top position from inside its own company.
The preference is given to a current employee rather than hiring someone from the outside. In some cases, a business organization prefers to internalize its source of finance by putting its onus on re-investment of specific assets back into the business instead of preferring investment or finance from outside sources.
Examples of internalization
#1. Example of internalized trading is-
Jalan & Company is a brokerage firm that decides to sell 1000 shares of its own company to its subsidiary XYZ Company. It does not sell in the open market, but straightaway transfers it to its subsidiary XYZ Company.
It will not have to pay any brokerage that one normally pays while both buying and selling the shares, nor will it influence the market prices as the shares are not sold in the open market. This process is known as internalization and is conducted internally without the help of an outside party.
#2. Example of internalized sourcing is-
Raj has been with the marketing division of his entity Shyam & Co since last three years. The marketing head had to retire suddenly because of health issues. The company, instead of hiring someone else appointed Raj as the next head.
It was beneficial for the company to promote Raj rather than hire someone else because they felt that he was capable of doing his job admirably and moreover the company did not want to waste any more of its resources like money, time and effort on finding and appointing a new worker. Everyone was happy with the deal.
3 Benefits of internalization
There are several benefits of internalization. It is one of the most popular concepts in the world, and its benefits are as follows-
- It is cost-effective as it reduces the cost that would have normally included for outsourcing
- It is beneficial for brokers as they can make money through the difference between the price of purchase and sale
- Internalization helps in delivering products to customers with the help of its resources without the help of outside shipping company
Limitations of internalization
One of the important limitations of internalization is-
- Internalization is not always cost-effective because in some cases, the organization may be required to buy extra resources or facilities that can increase its costs.