Profit Centres

A concept originated in the 1940s by the great management guru, Peter Druker, profit centers divide a company into smaller entities allowing entrepreneurs to measure results more easily. Based on the nature of the financial input and/or output that are measured for control purposes, four basic types of responsibility centres, Revenue, Cost, Profit and Investment, are generally distinguished (Anthony and Govindarajan, 2004) Meaning of profit centre Distinctly identifiable department or unit that contributes to the overall financial results of a firm is called a profit centre. Where adequate cost accounting systems are in place, profit centers are given responsibility to target certain percentages of the total revenue and are given adequate authority to control their costs to achieve those targets. When using profit centers, costs and revenues should be allocated to each center. While revenues are easy to allocate, costs are a tad bit harder. Application of Profit Centre in Business Jensen and Meckling (1999) have presented the outlines of a theory that attempts to explain in which circumstances each of the four types of responsibility centres is likely to be the most efficient. In circumstances in which managers of business units have significant informational advantages over headquarters (information asymmetry), profit and investment centres seem to work best. Eccles and White (1988) described cases in which profit centers in multidivisional corporations prefer relationships with independent suppliers to in-house relationships because the latter are more difficult to manage. Profit centres encourage entrepreneurial thinking within business organizations.

Concept in Action

Nokia Corporation faced a considerable slowdown in sales in 2001. As part of turnaround strategy, Nokia Corporation split its $21 billion mobile phone unit into nine profit centres, each with responsibility for a specific market segment. Profit centres helped the company to break itself into smaller and accountable units each of which had an entrepreneurial thrust. ABB(Asea Brown Bovery), a European multinational in the business of power generation, transmission and distribution, was organized into 4500 profit centreseach with profit. loss responsibility and meaningful autonomy. While profit centres help businesses to improve quality of decision and speed, they may also result in friction within organization and focus on short run decisions. Today there are worldwide business solutions available to convert expense centres into profit centres and also to help profit centre management. Businesses would benefit greatly if they went in for optimum solutions in creation of profit centres.

References Anthony and Vijay Govindarajan, Management Control Systems, Tata McGraw Hill Publications Eccles, Robert H., and Harrison White 1988 "Price and authority in inter profit center transactions."American Journal of Sociology Supplement, 94: S17-S51. Jensen, M.C. and Meckling, W.H. (1999), Specific Knowledge and Divisional Performance Measurement, Journal of Applied Corporate Finance, 12 (2), pp. 817.