Organizations with decentralized operations structures typically divide their operations into cost or profit centers. It is a management and strategic decision for companies to decide which divisions should be cost centers and which ones should be profit centers. .
A cost center may actually provide services that could generate a profit if they were offered on the open market. But in most corporate environments, cost centers are not expected to generate a profit and operation costs are treated as overhead. Departments that are typically cost centers include information technology, human resources, accounting, and others.
Both cost and profit centers would add something to the bottom line of companies. Profit centers could generate profits for companies. Cost centers would reduce costs therefore increase profits for companies. Sometimes, a cost center in one company may be a profit center in some other company. Thus, a center that directly relates to the core competence of the company is usually a profit center and all other centers that do not have directly related to core business would be cost centers.
However, in recent year, more and more companies which have operated with cost centers in the past decide to change some or all of those cost centers to profit centers. They feel that these changes may generate more benefits for the organization in the long-run. This paper will discuss the difference between cost center and profit center and the reasons for conversion. It will introduce a success story; examine the considerations which must be taken into account when making this determination.
In business, an operating unit is either making money or it's detracting from a company's profits. Simply, this is the difference between a profit center and a cost center.
A cost center is a unit of an organization that generates expenses and has no responsibility for generating revenue. The only expectation a cost center has is to lower expenses whenever possible while staying with a specific budget that is determined at the corporate level. For example, the human resources department doesn’t earn revenue or profit and it should expense within the budget. As a result, the department is viewed as a cost center. IT department is another example of cost center for most companies.
In contrast, a profit center is a unit of an organization that generates both revenue and expenses. It is expected that, through the sale of goods or services, the unit will turn a profit. The goal for profit center is to have revenue exceed expenses. In other words, a business unit is regarded as a profit center when it has its own revenue and profit targets. Based on the definition above, profit centers should have following characterizes: oFocus on market that are generating higher profits
oCreate a portfolio of products and services driven by market demand. oPrice products and services at maximize profits.
oQuickly respond to market opportunity.
Reasons for conversion
Why do companies want to convert their cost centers to profit centers? Different companies may have different reasons.
Some companies want to keep their cost centers remain competitive with outside vendors providing same services. Normally, a cost center within a company provides service to other business units for free or only at cost. After the cost center converts into a profit center, the former cost center may be allowed to sell its services to other companies. Meanwhile, the company's other business units are then required to pay for the services they used to get for free or at lower cost. But in return, they are allowed to go outside the company and contract with another firm to provide those services. The expectation for this kind of conversion is that companies want this free market system will improve performance through increased competition.
Some companies want to reduce cost through conversions. When a...