The Demise of Cost and Profit Centers

The Balanced Scorecard offers a previously unrecognized benefit: a new way of looking at the traditional organizational structure of cost and profit centers. Every unit, by contributing to effective strategy execution, has the opportunity to support and create profit. This capability has important implications for specifying objectives and evaluating the performance of all organizational units. In the mid-1960s, three Harvard Business School faculty members, Robert Anthony, John Dearden, and Richard Vancil, authored a classic contribution to management control, Management Control Systems (MCS). The MCS book, among many insights, contained an important taxonomy to describe the structure and systems used by different decentralized organization units. The taxonomy explored the relationship between the design of decentralized organizations and the motivations of and incentives for those who manage them. MCS identified five different types of decentralized organizational units. 1. The Profit Center. Many operating unit managers have responsibility and authority for both production and sales. They make decisions about what products and services to produce, how to produce them, their quality level, price, sales and distribution systems. But these managers may not have the authority to determine the level of capital investment in their facilities. In these cases, operating profit may be the single best (shortterm) performance measure for how well the managers are creating value from the resources the company has put at their disposal. Such a unit, in which the manager has almost complete operational decision-making responsibility and is evaluated by a straightforward profit measure, is called a profit center. 2. The Investment Center. When a local manager has all the responsibilities described above as well as the responsibility and authority for his or her center’s working capital and physical assets, the manager is running an investment center. The performance of such a unit is best measured with a metric that relates profits earned to the level of physical and financial assets employed in the center. Investment center managers are evaluated with metrics as return on investment (ROI) and economic value-added. 3. The Standard Cost Center. A standard cost center is a production or operating unit in which someone other than the local manager determines the outputs that will be produced as well as the expected inputs required to produce each unit of output. Industrial engineers and cost accountants specify the quantity and price standards for the materials, labor, energy, and machine time required to produce each widget, the generic term for a manufactured good, . The cost center manager’s job is to produce the 1 Authors, Management Control Systems, Richard D. Irwin publishing, 1965. The book, with new authors, is now in its 12 edition.