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GENERAL CONSIDERATION

PROFIT CENTERS

Divisionalization
Making business unit
Delegating more authority (with certain degree of authority)

CHAPTER 5

ZUNI BAROKAH, PH.D.

MAGISTER MANAJEMEN
F A K U LTA S E K O N O M I K A D A N B I S N I S U G M
2014

Conditions For Delegating Profit Responsibility

Trade-off decisions
Involving expense/revenue trade-offs in the making process.
Conditions before delegating trade-off decision:
Manager has access to relevant information
There are some ways to measure the effectiveness of the
decision
Major

Prevalence Of Profit Centers

Divisionalization and decentralization developed

after the end of World War II in United States.

Fortunes survey:

step in creating profit centers

93% companies have two or

more profit centers
(of 638 usable responses)

Do the advantages of giving profit responsibility

offset the disadvantages?

Advantages of Profit Centers (I)

May improve quality of decisions
May increase speed of operating decisions
Headquarters management are relieved of day-to-

day decision making

Managers are freer to use their imagination and

initiative

Advantages of Profit Centers (II)

An excellent training ground for general

management

Enhanced profit consciousness

Ready made information of companys components

profitability for top management

Improved competitive performance by

responsiveness of profit centers

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Difficulties with Profit Centers (I)

Difficulties with Profit Centers (II)

Loss of control due to decentralized decision making

May impose additional costs

The quality of decision may be reduced if headquarter

Competent general managers may not exist

management is more capable or better informed

Friction may increase
May create competition between organizational unit

BUSINESS UNITS AS PROFIT CENTERS

Most business units are created as profit centers
Constraints on business unit authority
Trade-offs between business unit autonomy and corporate
constraints

Emphasizing on short-run profitability

Optimizing individual profit centers profit doesnt

always equal optimizing the profits of company as a

whole

Constraints from Corporate Management

1. Resulting from strategic considerations

Corporate control over new investment: competition

between business units for a share of funds

Business units must refrain from operating beyond its

charter even though they see profit opportunities

Constraints from other business units

The greater the degree of integration, the more difficult it is
to assign responsibility to a profit center for its activities
(production, procurement, and marketing decision)

Constraints from Corporate Management

2. Resulting because uniformity is required

Business units must conform to corporate accounting and

management control systems

especially troublesome for a new acquired business units

3. Resulting from the economies of centralization

OTHER PROFIT CENTERS: Functional Units

Marketing

Manufacturing

Generally corporate constraints wont cause big

problems if they are dealt with explicitly

Pre-condition as a profit center: marketing manager is in the best

position to make principal cost/revenue trade-offs
Could be established by charging activity with the cost of
products sold what would be the best costs? Standard vs
actual

Problems in manufacturing as an expense center: skimp on quality

control, less flexible in accommodating customers needs, lack of
incentive in producing difficult products
Could be established by giving it credit for the selling price of the
products minus estimated marketing price
Pseudo-profit center?

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OTHER PROFIT CENTERS: Functional Units

Service and support units
Could be established by charging the receiving units for
service rendered
Benefit: motivate managers to control costs to maintain
customers loyalty
Example: Singapore Airlines? Swissair?

MEASURING PROFITABILITY
Types of profitability measurement:

A measure of management performance

How

well is the manager doing?

A measure of economic performance

How

well is the profit center doing as an economic entity?

Other organizations
Ex: branch operation

Types of Profitability Measures

1) Contribution margin

Types of Profitability Measures

1) Contribution margin

2) Direct profit
3) Controllable profit
4) Income before taxes
5) Net income

Revenue variable expenses

Pros:
fixed

expenses are beyond managers control

Cons:
almost

all fixed costs are either entirely or partially controllable

by managers

Types of Profitability Measures

2) Direct profit

Revenue all expenses incurred by or directly traceable to

the profit centers (profit centers expenses)
(except expenses incurred at headquarters (HQs))
Weakness: lack of motivational benefit of charging
headquarters costs

Types of Profitability Measures

3) Controllable profit

Revenue profit centers expenses controllable HQs costs

Controllable HQs costs = HQs costs that are controllable by

profit center manager

Weakness:
cannot

be compared with other companies profits in the

industry

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Types of Profitability Measures

Income before taxes

4)

Types of Profitability Measures

5) Net income
Income after taxes

Revenue profit centers expenses allocated HQs costs

Allocated HQs costs = all HQs costs that are allocated to profit
centers

Cons:

No

additional advantage in incorporating income after taxes

(income after tax is often a constant percentage of pretax
income)
Not appropriate to judge profit center managers on the
consequences of tax relating decisions that are often made at HQ

Managers are held accountable for costs that are uncontrollable by

them
Difficulties in properly allocating HQs services

Pros:

Cons:

Keeping head office spending in check (by the questions from profit
center managers)
Realistic and readily comparable
Managers are motivated to make optimum long-term marketing
decisions

Pros:
Sometimes

effective income tax rate does vary among profit

centers, motivating managers to minimize tax

Exhibit 5.3

Revenue
Profitability Measure

Revenue

1000

Cost of sales

600

Variable expenses

180

Contribution margin

220

Fixed expenses incurred in the profit centers

130

Controllable corporate charges

(1)
(2)

Problems: situations in which two or more profit

centers participate in a successful sales effort

10

Controllable profit

120

Other corporate allocations

(3)

20

Income before taxes

100

Taxes
Net income

recognition?

90

Direct profit

What is the most appropriate method for revenue

(4)

40
$

60

(5)

Management Considerations
Issues:
Separating the measurement of the manager from the
economic measurement of the profit centers
Degree of managers influence vs real control
Eliminate items that a manager has no influence