In
business, an operating unit is either making money or it's
detracting from a company's profits. In simple terms, it's the
difference between a profit center and a cost center.
Conceptually, a business unit is considered a profit center when
"it's set up as a small business -- it has its own revenue and
profit targets," says Haim Mendelson, the James Irvin Miller
professor of information systems and management at the Stanford
Business School in Stanford, Calif.
On the flip side, a company unit such as the human resources
department doesn't earn revenue or turn a profit. Its objective is
to hire, train and support the company's employees, and there's a
cost to the company to run the unit. As such, human resources is
typically viewed as a cost center.
It's important for information technology professionals to
understand and differentiate between the two concepts in order to
"know how your [IT] organization is viewed by the rest of the
company," says Jim Jones, managing director of the Information
Management Forum, an Atlanta-based user group for IT executives.
IT departments traditionally were set up as cost centers. An IT
organization would charge back costs to a business unit. For
example, IT would charge a commercial loan division of a bank for
monthly transaction processing costs or mainframe use costs. But it
wouldn't bring in a profit because the division would be charged at
cost. In some cases, those costs may be absorbed by the company or
as part of a business unit's overhead.
If an IT department is a cost center, "the rest of the business
views you as a burden," Jones says. The onus is on the group "to
prove that you're providing value for the money that's being spent
on information technology."
Some CIOs think their IT departments should remain cost centers.
"Our core competency [in IT] is to help our company build aircraft
structures, not to code [enterprise resource planning] systems, so I
could not see us as a profit center," says Julie Peeler, corporate
vice president of manufacturing and information systems at The
Aerostructures Corp. in Nashville.
So where does the cost center approach work best? "That is like
asking a doctor if tetracycline is a good drug. It depends what your
illness is," says Eileen Birge, vice president of research at The
Concours Group in Houston.
For companies that have a "bloated" IT organization and end users
who are "poorly disciplined," a cost center-type approach "isn't
going to help you," Birge says.
However, it's common for IT organizations to be set up as cost
centers in highly-regulated industries, such as financial services
or electric utilities, "to show regulators where the costs are" by
charging IT costs to individual business units, Birge says.
Other companies, such as The Hartford Financial Services Group in
Hartford, Conn., have elected to set up their IT organizations as
profit centers with a goal of generating zero profit.
The idea here is to help the company run more efficiently by
making the IT organization compete with external consultants and
systems integrators for work from the business units, Birge says.
Because the IT organization is often the biggest cost center in
most companies, there's a growing trend to set up IT as a profit
center, Birge says. That is especially true in companies where
there's a competitive market for IT services.
That means the IT department typically bills other business units
for its services. The revenue generated by the IT department should
exceed the expenses for delivering the services.
Some organizations believe that approach keeps IT expenses
competitive and reduces unnecessary demand for IT services from the
business units. It often allows business units to shop for IT
services outside the company and, in some cases, permits the IT
department to market its services to other companies.
One example of an IT department making money outside the company
is at AMR Corp., the parent company of American Airlines, which in
1986 set up its Sabre computing unit as a profit center after seeing
how much demand there was for its information services from other
airlines, Mendelson says. It was so successful that it spun off into
its own company in 1996.
Other companies that have set apart their IT organizations as
profit centers include Shell Oil Co. in Houston and United Services
Auto Association in San Antonio, Birge says.
Teamwork
Ideally, IT profit centers should be closely aligned with other
parts of the company to reach organizational goals. Mendelson points
to Charles Schwab & Co. in San Francisco, which set up a
separate electronic brokerage division a few years ago. The success
of that initiative "has been a joint product of the IT and business
people," Mendelson says.
But setting up IT as a profit center has risks. In some
organizations, IT managers and staffers are eligible for bonuses if
they meet or exceed profit targets. In those instances, the IT
organization "has lost some alignment of interests" with the
businesses they cater to, Birge says.
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