Responsibility Center

Presented By: Dipak Kumar Bhagat (1064) Jitesh Shrivas (1069)

Responsibility Center
A responsibility center is an organization unit that is headed by a manager who is responsible for its activities. A company is a collection of responsibility centers, each of which is represented by a box on the organization chart. These responsibility form a hierarchy. From the standpoint of senior management and the board of directors, the entire company is a responsibility center, though the term is usually used to units within the company.

Responsibility Center (continued)

A responsibility centre is a segment of a larger organisation and is placed under the control of a manager A segment could take the form of a department or a division or function or unit or product or even an individual item of equipment Examples: A specific store in a chain of grocery stores. A work-station in a production line manufacturing automobile batteries. HR department, administrative department, R&D, marketing, production line etc.

Nature of Responsibility Center

A responsibility center exists to accomplish one or more purpose, termed its objectives. The company as a whole has goals and senior management decides on a set of strategies to accomplish these goals. The objective of company s various responsibility centers are to help implement these strategies. Because if each responsibility center meet its objective, the goal of the organization will have been achieved.

Attributes of Responsibility Center

It is like a small business, and its manager is Asked to run that small business and preserve the interests of the larger organization. Goals for the center should be specific and measurable, and Should promote the long terms interests of the organization and should be compatible with other responsibility center activities.

In an Organization
Responsibility center receive inputs, in the form of materials, labor and services. Using working capital (e.g., inventory, receivables), equipment and other assets, the responsibility center performs its particular function with the ultimate objective of transforming its input into output. The products produced by a responsibility center may be furnished either to another responsibility center, where they are inputs, or to the outside market place, where they are outputs of the organization as a whole.

Example: A Courier Service (DHL)

Courier operations dispatch trucks to pick up or deliver shipments from local terminals. It could be sent to one or more central terminals and then sorted and redirected. Success of this service would depend on:
Service commitment to customers (on time, without damage) and Controlling costs

Let us suppose that each terminal is treated as a responsibility center. How should the company measure the performance of each terminal, its mangers, and its employees?

Why organise in terms of centres?

Improved accountability - costs/revenue can be monitored They facilitates delegation by allowing autonomy for managers in the centre Greater autonomy and empowerment of managers improves motivation Greater autonomy aids decision making The performance of the individual unit can be evaluated By analysing the performance of individual units it means there is no hiding place for weak performing units Senior management is able to trace problems Centres are an aspect of budgetary control. By dividing the business up in terms of centres a named post holder is identified as being responsible

Measuring the performance of the courier-terminal responsibility center

To focus on efficiency: we could measure no. of parcels picked up, sorted or delivered, per route, per employee, per vehicle, per hour or per shift. To focus on customer service, we could measure each group s contribution to customers: proportion of the time the terminal met its deadlines, when terminals are required to sort shipments, what the sorting error rate was. We could also measure customer service by: no. of complaints operations group receives, average time taken by the operation group to respond to complaints, and no. of complaints of poor, or impolite service.

Measuring inputs and outputs

In the courier example, the inputs are causal and direct: e.g. no. of packets received to time taken to deliver them. But, such causal and direct relationships are not always possible. For example, how does advertising contribute to increase in revenues? Or, how would you measure the contribution of R & D to product innovation, revenue generation, or cost reduction?

Converting the inputs into monetary units

Most organizations would convert the physical inputs into monetary units when evaluating a responsibility center. No. of units x cost of production, labor hours x per hour rate, etc.

Measuring outputs
Measuring outputs is more difficult. This is because: Input may be extended this year but outputs (benefits) may be received over several years (e.g. employee training). It would be difficult to make the causal relationship e.g. marketing expenses, IT investments, accountants and generation of revenue and profits.

Why does an organization relate input to outputs?

Because they inherently measure efficiency and effectiveness. Efficiency: ratio of output to inputs; Caution: Do not use ratio of output to input in an absolute sense; but, only in a comparative sense. If Dept. A is more efficient than Dept. B, do not rush to conclusions; examine why Dept. B is less efficient and what can be done about it. Also, comparisons are possible only if Dept. B and Dept. A use comparable outputs and comparable inputs. You cannot compare advertising to accounting.

Efficiency
Efficiency is generally measured by comparing actual costs to standard costs. Ratio of outputs to inputs, or the amount of output per unit of input. Issues:
Standard costs do not remain stationery. Recorded costs are often different from actual resources (costs) consumption.

Lesson: Establishing a responsibility center is easy; Measuring its efficiency in a reasonable manner is difficult.

Effectiveness
Relationship between a responsibility center s output and its objectives (what it was intended to do or perform or deliver). If the output contributes to satisfying the objectives, the more effective it is. The new advertising and marketing efforts has increased awareness and recognition of our product. Advertising and marketing has been effective.

Efficiency-Effectiveness Not a compromise

A responsibility center must both be efficient and effective. It must use the least amount of inputs to get the maximum amount of output and yet deliver on the goals. A sales department was efficient in growing the sales by 10% without adding additional sales people or marketing expenses (efficient); however, many of the credit sales could not be collected (bad debts). It is ineffective.

Role of Profit
The goal of every for-profit organization is earn profits (effectiveness). If the organization could use the least input to get the maximum earnings, profits will be high (efficiency). Therefore, profit is an indicator of both efficiency and effectiveness. However, not every unit within an organization earns profit and therefore, this measure cannot be used for all responsibility centers. Therefore, an organization must establish various types of responsibility centers.

4 types of responsibility centre

Cost centre - manager responsible for costs incurred Revenue centre - manager responsible for revenue raised Profit centre - manager responsible for both costs and revenue Investment centre - manager responsible for profit, capital investment and financing

The unit manager s responsibility

Costs Cost centre Revenue centre Profit centre Investment Y Y Y Y Y Y Y Y Y Revenue Profits Investment

Example - A level Business Studies

Within a school or college A level Business Studies can be treated as a cost centre It is possible to calculate the cost of offering this A level subject - salary of teaching staff concerned, cost of materials used plus an allocated share of the fixed overhead costs If the college finance manager calculated the revenue generated by A level Business Studies then the course could be treated as a profit centre The examination awarding bodies do treat A level Business Studies (and every other subject) as a profit centre. Data is collected on the cost of offering the subject and the revenue received from examination fees.

Revenue Centers
Responsibility Centers whose members control revenues but, Not the manufacturing or acquisition cost of the products or service they sell, or the level of investment in the responsibility center. In other words, you cannot link the input to the output.

Revenue Centers (continued)

Output (i.e., revenue) is measured in monetary terms, but no formal attempt is made to relate input (i.e., expense or cost). If expense is matched with revenue, the unit would be profit center. Typically revenue centers are marketing/sales units that do not have authority to set selling prices and are not charged for the cost of the goods they market.

Revenue Centers (continued)

Most revenue centers may not set selling prices They definitely have no control over the costs of input acquired (service manager of an automobile workshop does not control gasoline costs) These centers are generally not allocated costs of the goods that they market (there are exceptions). Manager is responsible only for costs directly incurred by his/her unit. They are evaluated on the basis of actual sales or orders booked against budgets or quotas and Example: a unit of a chain store in a mall.

Expense/Cost Centers
Responsibility centers whose employees control costs, but Do not control their revenues or investment level. Input are measured in monetary terms, but whose output are not Examples: Production department in a manufacturing unit, a dry cleaning business Two types of costs:
Engineered: those costs that can be reasonably associated with a cost center direct labor, direct materials, telephone/electricity consumed, office supplies. Discretionary: where a direct relationship between a cost unit and expenses cannot be reasonably made; Management allocates them on a discretionary basis (e.g. depreciation expenses for machines utilized).

Examples of cost centres

Personnel/HRM department Finance department R and D department Transport department Warehouse & stock control department Buying department In all the above cases the department incurs costs but does not earn revenue A item of equipment (such as an office photocopier) can also be regarded as a cost centre

Engineered costs
Should be measurable in monetary terms, outputs in physical quantities. Works well in units such as production, distribution, accounting receivables, payables where repetitive tasks are performed. Developing standard costs for such activities is more reliable than in other cases. Multiply standard cost per unit x no. of units produced or processed = this is the ideal cost. Compare it to actual costs and the difference is indicative of efficiency or lack thereof.

Engineered costs Important to remember The fundamental purpose of all responsibility centers is accountability; evaluating performance. And a engineered cost center, Does not merely compare costs but also Holds the managers accountable for obtaining/producing right quality of product Volume of production, speed of processing.

Discretionary costs
Mostly administrative and support service costs More difficult to measure in physical quantities or precisely on monetary terms (e.g. customer relations or even R & D). Discretionary means, management allocates them based on established polices (not arbitrarily). More caution is required while using discretion cost numbers. Difference between budgeted expenses and actual expenses does not indicate efficiency. Suppose if the actual cost is less than budget, does it mean good or bad? Suppose if the actual cost is higher than budget, does it mean good or bad?

Profit Centers
When a responsibility center s financial performance is measured in terms of profit (i.e., by the difference between the revenues and expenses), the center is called as profit center. A functional organization is one in which each principal manufacturing or marketing function is performed by a separate organization unit. When such an organization is converted to one in which each major unit is responsible for both the manufacture and the marketing, the process is termed divisionalization.

Profit Centers (continued)

Managers of profit centers control both the revenues and costs of the product or service they deliver. It is like an independent business except it is part of a larger organization (e.g. departmental stores of larger chains Wal Mart, restaurants, corporate hotels such as Hilton, Holiday Inn). The store manager would have responsibility for pricing, product selection, and promotion.

Profit Centers (continued)

Cost for these units vary depending on ability to control labor, waste, and hours. Revenues also will vary depending on the unit s service level, location, etc. In other words, local discretion would affect revenues and costs. Investments and some costs (e.g. centralized purchasing). Therefore, profits represent a broader index of both corporate and local decisions.

Profit Centers (continued)

If performance is poor, it may reflect poor conditions that no one in the organization could control as well as poor local conditions. For this reason, organizations should not evaluate performance only based on costs and profits, but Perform detailed evaluations that include quality, material use, labor use, and service measures that the local unit can control.

Advantage of Profit Center

The quality of decisions may improve The speed of operating decisions may be increased Headquarters management, relieved of day-to-day decision-making, can concentrate on broader issues Managers are free to use their imagination and initiative Because profit centers are similar to independent companies, they provide an excellent training ground for general management. Profit consciousness is enhanced Provide top management with ready made information Particularly responsive to pressures to improve their competitive performance

Difficulties with Profit Center

Decentralized decision-making will force top management to rely more on management control reports than on personal knowledge of an operation. Quality of decisions made at unit level may be reduced. Friction may increase Divisionalization may impose additional cost There may be too much emphasis on short-run profitability

Investment Centers
Responsibility centers whose managers and employees control revenues, costs, and the level of investment. It is also like an independent business (common when an organization acquires another organization).

Investment Centre (continued)

This takes responsibility to a greater depth An investment centre is a responsibility centre in which the manager responsible for all aspects of finance - costs, revenue, profit and investment Example: division of a large multinational company The division is assessed in terms of its contribution to overall profits

Administrative Centers (support centers)

One of the most difficult to evaluate because neither the input nor the output is easy to measure (e.g. accounting services, marketing), and Linking unit s input and output to organizational objectives. But, with a little careful approach, the costs of such centers can be reasonably computed. Since most of these centers are treated somewhat like cost centers, an approach based on costs would be helpful.

Advantages of organising in terms of responsibility centres

Decentralised decision making: faster and more responsive to local conditions Responsibility centres facilitate delegation Motivation is improved Results in improved monitoring of budgets, targets and performance Leads to greater accountability Facilitates budgetary control Prevents the performance of weak elements being hidden within the larger organisation

Problems and disadvantages

There is a danger that individual centres become too narrowly focussed Managers of responsibility centres tend to be more concerned with unit objectives than corporate objectives Rivalry between centres breaks out Creates problems of co-ordination Creates communications problems The allocation of costs is complex. Any unfairness in the way costs are allocated can lead to be demotivating

Types of Profitability Measures

Contribution margin Direct profit Controllable profit Income before taxes Net income

A simple summary of the responsibility centers

Revenue Center
Output measured in monetary terms

Expense/Cost Centers

Input measured in monetary terms

Profit Centers

Output measured in monetary terms

Investment Centers

Output measured in monetary terms

What did we learn from these control system illustrations?

All responsibility centers evolve from the concept of controllability. Controllability principle states a manager should be assigned responsibility for the revenue, costs, or investment that he/she could control. Revenues, costs, or investments that do not fall under a manager s control must be excluded when evaluating the manager or his/her center. Problem with this concept: In most organizations, many revenues and costs are jointly earned or incurred and differentiation the controllable from the uncontrollable is difficult.

An alternative to Controllability
Some argue that performance measures should be chosen to influence decision-making behavior. For example, if market prices for raw material is increasing, what can a manager do? Perhaps, enter into long term contract for fixed prices for raw materials. If electricity consumption cost is going up, find out how consumption can be economized (better machines, lighting, reduce waste).

Division President Investment center

Vice President - Restaurants

Vice President

Food Products

Vice President - Administration

Profit center

Cost center

Discretionary Cost center

TRENTON RESTAURANT

OTHER RESTAURANT

CENTRAL KITCHEN

HUMAN RESOURCE

PHYSICAL RESOURCE

Profit center

Profit center

Cost Center

Discretionary Cost Center

FINANCIAL RESOURCE

Discretionary Cost Center

DELIVERY SALES CENTER

REVENUE center

Discretionary Cost Center

THANK YOU