What is Internalization?
Internalization occurs when a business decides to handle a transaction internally rather than route it out-of-house to another entity to handle.
All kinds of businesses, including multinational corporations, practice internalization. So do investment firms and brokerages. Some individuals even put internalization to use when they decide to, for example, fix an appliance rather than pay someone else to do so.
Key Takeaways
- The term “internalization” refers to handling transactions or projects internally instead of paying an outside entity to do so.
- Internalization occurs at a brokerage when an order to buy securities such as stocks is filled using the brokerage’s own inventory.
- Company internalization occurs when some project or transaction is completed in-house, not by an outside vendor.
- Multinational internalization can occur when a corporation transfers assets to one of its subsidiaries in need of them.
- A benefit of internalization is cost savings.
Embracing Internalization in Your Business
Internalization can occur when an individual or business decides to handle an issue internally instead of outsourcing it to an unrelated third-party.
Companies may decide to internalize the production of a particular material—doing the work in-house with its own employees—rather than having another manufacturer produce it.
Where delivery of products is concerned, a company may find that it’s more efficient or effective to handle the distribution itself using its own channels rather than hire an external shipping company.
Internalization can also apply to a multinational corporation. It’s seen when a corporation decides to shift assets between its own subsidiaries in different countries.
Benefits and Limitations
Internalization can be beneficial to a company when it reduces outsourcing costs. It can be disadvantageous when it ends up costing the company more than expected to do a job itself.
For example, companies may unexpectedly need to purchase additional resources and/or facilities to handle processes themselves. They may have to assign more employees to the job than initially planned, or they may have to spend more on training employees than originally projected. A company should carefully consider internalizing tasks with which it lacks expertise. If necessary resources, facilities, or trained employees are not in place, internalization may not be worth pursuing.
Mastering Internalized Trading
When you place an order with your broker, the broker may route it to a market maker to be filled. Or, it might send it to an electronic communications network (ECN). Alternatively, it can decide to fill the order itself if it has the required securities in its own inventory.
Real-World Examples
When a client places an order with their broker to buy certain shares of stock, the broker has to source those shares to fill the order. If the broker completes the order using shares from its own inventory, this is known as internalization.
Internalized trading can often be less expensive than using external firms to complete transactions. Brokerage firms that internalize orders can also profit from the spread—the difference between their purchase price and the sale price to the investor.
Additionally, because such transactions are not conducted on the open market, the brokerage firm is less likely to influence prices if it sells a large portion of its own shares.
The Value of Internal Sourcing
Internal sourcing refers to acquiring needed assets, services, or materials from within a business rather than from an external source. This commonly denotes a business’s choice to produce goods internally instead of relying on an outside supplier.
Real-World Examples
Internal sourcing can also refer to the hiring practice that gives preference to current employees when recruiting for a vacancy. It involves maintaining certain activities, like marketing, within the company structure rather than outsourcing.
A business may also keep its financing source internalized. For example, it may focus on reinvesting assets in the business instead of seeking external borrowing or new investors.
Does a Brokerage Always Internalize Trading?
No, brokers have various options for fulfilling trade orders and must strive to achieve the best execution available for their customers. However, if filling an order with securities from its inventory is optimal, the broker may choose to internalize to save costs and potentially profit from the spread.
How Does Internalization Benefit Businesses?
The primary benefit of internalization is often cost reduction. If a company can save money by producing a product or completing a project in-house compared to hiring an outside vendor, internalization is advantageous.
Is Internal Sourcing Different From Internalization?
Internal sourcing is simply a form of internalization. It involves finding resources for a job or business need internally rather than externally. Broadly speaking, it implies using internal employees, materials, a department, or a division to complete a task instead of outsourcing.
The Bottom Line
Internalization refers to the process of taking a job or project in-house when it makes financial sense. While outsourcing processes can often make sense, especially when internal resources or expertise are lacking, companies should analyze potential savings and efficiency gains before deciding to internalize tasks.
Related Terms: internal sourcing, multinational corporations, cost savings, brokerage trade, in-house operations.
