• functional organization is one in which each principal manufacturing or marketing function is performed by a separate org unit

• many management decisions involve proposals to increase expenses with the expectation of increasing sales revenue
• expense/revenue trade off (revenue v. cost)

• Manager should have access to relevant information to make the decision
• must be some way to measure effectiveness of the trade-off

major step in creating profit center is to determine the lowest point in an organization where these two conditions occur

• most companies were functionally organized until the end of WWII.
• Since then many major corporations have divisionalized and decentralized profit responsibility at the business unit leel
• of 638 responses of Fortune 1000 companies, 93% were from companies that had two or more profit centers

• quality of decisions may improve (being made by managers closest to the point of decision)
• speed of operating decisions may increase (not referred to corporate HQ)
• Managers are freer to use their imagination and initiative (fewer corporate restraints)
• excellent training ground for general management (gain experience in managing all functional areas and management can evaluate potential for higher jobs)
• profit consciousness is enhanced since managers who are responsible for profits will seek ways to increase them
• provide top management with ready-made information on profitabilty of comapny's individual components
• responsive to pressure to improve competitive performance (output is easily measured)

• Decentralized decision making will force top management to rely more on management control reports than on personal knowledge of an operation (loss of control)
• quality of decisions may be reduced(headquarters is more capable or better informed)
• friction may increase because of arguments over appropriate transfer price, assignment of costs, and credit for revenues
• organization units that once cooperated may be in competition
• divisionalization may impose additional costs because of additional management, personnel, etc
• competent general managers may not exist in a functional organization because they may not have been sufficient opportunities for them to develop general management competence
• too much emphasis on short-run profitability at the expense of long-run profitability (skimp on R&D, training programs, maintenance, etc)
• no completely satisfactory system for ensuring that optimizing the profits of each individual profit center will optimize profits as whole

• most business units are created as profit centers since managers in charge control product development, manufacturing, and marketing resources
• managers in a position to influence revenues and costs held accountable for "bottom line"
• business unit autonomy v. business unit constraints trade-off

• Business unit manager would have to be as autonomous as the president of a company to realize the full benefits of the profit center
• if a comapny were in completely independent units, organization would lose advantages of size and synergy
• business unit structures represent trade-offs between business unit autonomy and corporate constraints (effective based on how well these trade-offs are made)

• main problem occurs when business units must deal with one another

• Product Decisions
• Marketing Decisions
• Procurement or Sourcing Decisions

If a business unit manager controls all three, therei s usually no difficulty in assigning profit responsibility and measuring performance

• those resulting from strategic considerations
• those resulting because uniformity is required (uniform accounting system, uniform bid process)
• those resulting from economies of centralization

• Marketing
• Manufacturing
• Service and Support Units
• Branches

• Marketing activity can be turned into a profit center by charging it with the cost of the product sold
• transfer price provides marketing manager with relative information to make optimum revenue/cost trade-offs
• transfer price charged to the profit center should be based on the standard cost rather than actual cost of the product being sold.
• marketing activities should be given profit responsibility when the marketing manager is in the best position to make the principal cost/revenue trade-offs.

• Manufacturing is usually an expense center (management is judged on performance v. standard cost and overhead budgets)
• can be a problem because it dosen't necessarily indicate how well the manager is performing all aspects of his job
• measured against standard costs (make a separate evaluation of activities like quality control, production scheduling, make-or-buy decisions)
• one way to measure activitiy is to turn it into a profit center and give credit for the selling price of the producst minus estimated marketing expenses
• marketing activities should be given profit responsibility when the marketing manager is in the best position to make the principal cost/revenue tradeoff

• Might operate out of HQ and service corporate divisions or fulfill similar funcitons within business units
• Charge customers for services rendered with the financial objective of generating enough business so their revenues equal expenses
• when service units are organized as profit centers, their managers are motivated to control costs in orde to prevent customers from going else where and managers o the receiving units are motivated to make decisions about whether using the service is worth the price

• responsible for maketing the company's products in a geographical area are usually natural for profit centers
• profitability is often the best single measure of their performance
• excellent motivation device

• Management performance
• Economic Performance

• contribution margin
• direct profit
• controllable profit
• income before income taxes
• net income

• reflects spread between revenue and variable expenses
• argument in favor: since fixed expenses are beyond control, managers should focus on maximizing contribution
• problem: almost all fixed expenses are at least partially controllable and some are entirely controllable

• reflects a profit center's contribution to general overhad and profit of the corporation
• incorporates all expenses either incurred by or directly traceable to the profit center regardless of whether or not these items are within the profit center manager's control
• expenses occured at headquarters aren't counted
• weakness: doesn't recognize motivational benefits of charging headquarters costs

• Controllable
• Noncontrollable

• If these costs are included in the measurement system, profit will be what remains after the deduction of all expenses that may be influenced by a profit center manager
• Major disadvantage: can't be directly compared with either published data or trade association data reporting the profit of other companies in the industry

• Taxes are part of income
• most decisions are made at corporate level

• since costs incurred by corporate staff (finance, accounting, etc) are not controllable by profit center managers, these managers should not be held accountable for them
• it may be difficult to allocate corporate staff services in a manner that would properly reflect the amount of costs incurred by each profit center

• corporate service units have a tendency to increase power base and to enhance their own excellence without regard to effect on the company as a whole.
• performance of each profit center will become more realistic and readily comparable to the performance of competititors who pay for similar services
• when managers know that their respective centers will not show a profit unless all costs are recovered, they are motivated to make optimum long-term marketing decisions (pricing, product mix, etc) that will ultimately benefit the company as a whole

• After tax income is often a constant percentage of pre-tax income, so there will be no advantage in incorporating income taxes
• since many of the decisions that affect income taxes are made at headquarters, it isn't appropriate to judge profit center managers on the consequences of these decisions.

• choosing appropriate revenue recognition is important
• should revenues be recorded when an order is made, shipped or when cash is received?
• two or more profit centers can participate in a successful sales effort, so each center shoul be given appropriate credit (how is that determined?)
• many companies take position that identification of a precise responsibility is too complicated to be practical and sales persnonel must recognize that they work not only for their own profit center but for the good of the whole company

• most confusion in measuring profit centers results from failing to separate the measurement of the manager from the economic measurement of the profit center
• managers should be measured against thosei tems that can influence, even if they don't have total control over those items.