management control systems chapter 5: Profit Centers

2 criteria that need to be met to consider a unit as a profit center

1. has to be sufficient information from managers to be able to cost tradeoff decisions 2. have to have some valid measure of if tradeoff decision was made in an effective manner

advantages of profit centers

1. improved quality of decisions 2. improved speed of decisions 3. HQ is relieved of day-to-day decision making and can concentrate on broader issues 4. managers have less constraints and can use their imagination and intiative 5. training ground for general management (experience managing all functional areas) 6. profit consciousness (managers who are responsible for profits will constantly seek ways to improve them) 7. provide top management with ready-made information on the profitability of the company's individual components 8. improved competitive performance because output is readily measured; responsive to pressures to improve competitiveness

When should a marketing activity be given profit responsibility?

When the marketing manager is in the best position to make the principal cost/revenue trade-offs

what are most business units created as?

profit centers Managers are held accountable for bottom line and have access to both revenues and costs

sudo-profit center

profit centers that sell internally to company

pseudo profit centers

sell primarily to other businesses

examples of service and support units

units for maintenance, IT, transportation, engineering, consulting, customer service, etc.

profit center

when a responsibility center's financial performance is measured in terms of profit (not the same as a business unit)

divisionalization

when such an organization is converted to one in which each major unit is responsible for both the manufacture and marketing. Its about pushing decision making authority down

difficulties with profit centers

1. loss of control because of decentralized decision making (top management has to rely on control reports) 2. quality reduction in decisions made (if HQ is more capable or better informed) 3. friction may increase because of arguments over appropriate transfer price, assignment of common costs, credit for revenues that were formerly generated jointly 4. competition between organizational units 5. imposed additional costs because of additional management, personnel, record keeping, etc. required 6. competent general managers may not exist in a functional organization because there may not have been sufficient opportunities for them to develop general management competence 7. too much emphasis on short-run profitability at expense of long-run profitability 8. no completely satisfactory system for ensuring that optimizing the profits of each individual profit center will *optimize the profits of the company as a whole*

2 conditions before delegating trade-off decisions

1. manager should have access to the relevant information needed to making an expense/revenue trade-off decision 2. some way to measure the effectiveness of the trade-off must exist *major step in creating profit centers is to determine the lowest point in an organization where these two conditions exist*

2 types of profitability measurements used to evaluate profit center (as with evaluating organization as a whole)

1. measure of management performance (how well is the manager doing, used for planning, coordinating, controlling day-to-day activities, device for providing motivation for manager) 2. economic performance (how well profit center is doing as economic entity)

3 types of decisions for thinking of managing control over a profit center

1. product decision (what goods/services to make/sell) 2. marketing decision (how, where and for how much are the goods or services being sold) 3. procurement/sourcing decision (how to obtain/manufacture)

3 groups of constraints from corporate management

1. resulting from strategic operations 2. resulting because uniformity is required 3. resulting from the economies of centralization (almost like economies of scale)

constraints from other business units

1. think of managing control over a profit center in terms of 3 types of decisions 2. if the profit manager controls all 3 activities, there is no difficulties in assigning profit center responsibility and measuring performance

trade-off that business unit structures represent

business unit autonomy and corporate constraints effectiveness of business unit depends on how well these trade-offs are made

service and support units

charge customers for services rendered financial objective = generating enough business so that revenues=expenses

uniformity at a corporate level

conform to corporate accounting/management control systems - uniform pay and other personnel policies - uniform policies on ethics, vendor selection, computers, and communication equipment, design of letterhead??

functional organization

each principal manufacturing or marketing function is performed by a separate organization unit

manufacturing is usually what kind of center?

expense center

What makes assigning responsibility to a single profit center for all 3 product activities difficult?

integration

Why is profit a good measure of performance?

it allows management to use one comprehensive indicator rather than several

some functional unit examples

marketing, manufacturing, service/support, other (companies with branches) operations within business units

branch operations

natural profit center = a company with branch operations that are responsible for marketing the company's products in a particular geographic area profitability is usually the best single measure of their performance managers have no manufacturing or procurement responsibilities