Internalization: Definition in Business and Investing and Example

What Is Internalization?

Internalization occurs when a transaction is handled by an entity itself rather than routing it out to someone else. This process may apply to business and investment transactions, or to the corporate world.

In business, internalization is a transaction conducted within a corporation rather than in the open market. Internalization also occurs in the investment world, when a brokerage firm fills a buy order for shares from its own inventory of shares instead of executing the trade using outside inventory.

Internalization can also apply to a multinational corporation. This happens when the company decides to shift assets between its own subsidiaries in different countries.

Understanding Internalization

Internalization can occur when an individual, business, or firm decides to handle an issue in-house instead of outsourcing it to a third-party.

Companies may decide to internalize the production of a particular material on its own rather than having another manufacturer do so. This process is called internal sourcing, or delivering products to customers through the business’s own channels instead of using an outside shipping company.

Internalization is beneficial to a company as it cuts down the costs of outsourcing certain process such as manufacturing or selling products and services. The process also provides benefits to brokers, who can make money on the spread, or on the difference between the purchase and sale price.

Internalizing certain processes may not necessarily be cost-effective, as companies may be required to purchase additional resources and/or facilities.

Internalized Trading

A trade may be internalized when the trade is completed for an investor within their brokerage firm. The process is often less expensive than alternatives as it is not necessary to work with an outside firm to complete the transaction.

Brokerage firms that internalize securities orders can also take advantage of the difference between what they purchased shares for and what they sell them for, known as the spread. For example, a firm may see a greater spread by selling its own shares than by selling them on the open market. Additionally, because share sales are not conducted on the open market, the brokerage firm is less likely to influence prices if it sells a large portion of shares.

Internal Sourcing

Internal sourcing refers to the process of acquiring any needed asset, service, or material from within the business instead of from an external source. This commonly refers to a business’s decision to produce goods internally instead of retaining an outside supplier.

Internal sourcing can also refer to internal hiring practices where preference is given to current employees when recruiting for a vacancy, as well as choosing to keep certain business activities within the business structure, such as with marketing activities.

A business may work to keep its financing source internalized, focusing on the reinvestment of certain assets back into the business instead of acquiring outside financing or investment.