Chapter 4 and 5

Responsibility Centers

An important component of Management Controls Assigning responsibility for executing strategy

Implementing strategies is not adequate if individuals who must execute them fall short.

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Therefore, management controls must include

How

responsibility is assigned and measured How tasks are measured (not necessarily tasks done by humans but also by machines; e.g. units produced) Task controls such as when to order inventory, why the actual differ from budgeted (the causes) And, not easy to measure or quantify items such as impact on behaviors, intangible assets, and so on.

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Responsibility Centers

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What is a responsibility center?

In

simple words: an organizational unit for which a manager is made responsible. Examples: A specific store in a chain of grocery stores. A work-station in a production line manufacturing automobile batteries. The payroll data processing center within a firm.

Attributes of a responsibility center

It

is like a small business, and its manager is Asked to run that small business and preserve the interests of the larger organization. Goals for the center should be specific and measurable, and Should promote the long terms interests of the organization and should be compatible with other responsibility center activities.

Example: A courier service (DHL)

Courier operations dispatch trucks to pick up or deliver shipments from local terminals. It could be sent to one or more central terminals and then sorted and redirected. Success of this service would depend on:
Service commitment to customers (on time, without damage) and Controlling costs

Let us suppose that each terminal is treated as a responsibility center. How should the company measure the performance of each terminal, its mangers, and its employees?

Measuring the performance of the courier-terminal responsibility center

To focus on efficiency: we could measure no. of parcels picked up, sorted or delivered, per route, per employee, per vehicle, per hour or per shift. To focus on customer service, we could measure each groups contribution to customers: proportion of the time the terminal met its deadlines, when terminals are required to sort shipments, what the sorting error rate was. We could also measure customer service by: no. of complaints operations group receives, average time taken by the operation group to respond to complaints, and no. of complaints of poor, or impolite service.

Measuring inputs and outputs

In

the courier example, the inputs are causal and direct: e.g. no. of packets received to time taken to deliver them. But, such causal and direct relationships are not always possible. For example, how does advertising contribute to increase in revenues? Or, how would you measure the contribution of R & D to product innovation, revenue generation, or cost reduction?

Converting the inputs into monetary units

Most

organizations would convert the physical inputs into monetary units when evaluating a responsibility center. No. of units x cost of production, labor hours x per hour rate, etc.

Measuring outputs
Measuring

outputs is more difficult. This is

because: Input may be extended this year but outputs (benefits) may be received over several years (e.g. employee training). It would be difficult to make the causal relationship e.g. marketing expenses, IT investments, accountants and generation of revenue and profits.

The input-output attributes

organizations use financial controls cost, revenue, and profits, etc. However, such measures are not applicable to all units within an organization. For example, how would you measure the contribution of a production department? It can only be done on a cost measurement basis. How would you measure the contribution of a sales department only by revenue generated.
Most

Why does an organization relate input to outputs?

Because they inherently measure efficiency and effectiveness. Efficiency: ratio of output to inputs; Caution: Do not use ratio of output to input in an absolute sense; but, only in a comparative sense. If Dept. A is more efficient than Dept. B, do not rush to conclusions; examine why Dept. B is less efficient and what can be done about it. Also, comparisons are possible only if Dept. B and Dept. A use comparable outputs and comparable inputs. You cannot compare advertising to accounting.

Efficiency
Efficiency

is generally measured by comparing actual costs to standard costs. Issues:

Standard costs do not remain stationery. Recorded costs are often different from actual resources (costs) consumption.
Lesson:

Establishing a responsibility center is easy; Measuring its efficiency in a reasonable manner is difficult.

Effectiveness
Relationship

between a responsibility centers output and its objectives (what it was intended to do or perform or deliver). If the output contributes to satisfying the objectives, the more effective it is. The new advertising and marketing efforts has increased awareness and recognition of our product. Advertising and marketing has been effective.

Efficiency-Effectiveness Not a compromise

A

responsibility center must both be efficient and effective. It must use the least amount of inputs to get the maximum amount of output and yet deliver on the goals. A sales department was efficient in growing the sales by 10% without adding additional sales people or marketing expenses (efficient); however, many of the credit sales could not be collected (bad debts). It is ineffective.

Role of Profit

The goal of every for-profit organization is earn profits (effectiveness). If the organization could use the least input to get the maximum earnings, profits will be high (efficiency). Therefore, profit is an indicator of both efficiency and effectiveness. However, not every unit within an organization earns profit and therefore, this measure cannot be used for all responsibility centers. Therefore, an organization must establish various types of responsibility centers.

Types of Responsibility Centers

Revenue

Centers Cost Centers or Expense Centers Profit Centers and Investment Centers

Revenue Centers
Responsibility

Centers whose members control

revenues but, Not the manufacturing or acquisition cost of the products or service they sell, or The level of investment in the responsibility center. In other words, you cannot link the input to the output.

Revenue Centers (continued)

Most

revenue centers may not set selling prices They definitely have no control over the costs of input acquired (service manager of an automobile workshop does not control gasoline costs) These centers are generally not allocated costs of the goods that they market (there are exceptions). Manager is responsible only for costs directly incurred by his/her unit. They are evaluated on the basis of actual sales or orders booked against budgets or quotas and Example: a unit of a chain store in a mall.

Expense/Cost Centers

Responsibility centers whose employees control costs, but Do not control their revenues or investment level. Examples: Production department in a manufacturing unit, a dry cleaning business Two types of costs:
Engineered: those costs that can be reasonably associated with a cost center direct labor, direct materials, telephone/electricity consumed, office supplies. Discretionary: where a direct relationship between a cost unit and expenses cannot be reasonably made; Management allocates them on a discretionary basis (e.g. depreciation expenses for machines utilized).

Expense centers (continued) Comparing Budgeted and Actual Costs

Budgeted costs are target estimates. It points to a goal to be achieved. But, it is not written in concrete. Actual costs are that were incurred during a given period. The difference between the two could be either positive or negative variances. However, making conclusions on the basis of positive or negative variances must be done carefully. See the next set slides and the example.

Profit Centers
Managers

of profit centers control both the revenues and costs of the product or service they deliver. It is like an independent business except it is part of a larger organization (e.g. departmental stores of larger chains Wal Mart, restaurants, corporate hotels such as Hilton, Holiday Inn). The store manager would have responsibility for pricing, product selection, and promotion.

Profit Centers (continued)

Cost

for these units vary depending on ability to control labor, waste, and hours. Revenues also will vary depending on the units service level, location, etc. In other words, local discretion would affect revenues and costs. Investments and some costs (e.g. centralized purchasing). Therefore, profits represent a broader index of both corporate and local decisions.

Profit Centers (continued)

If

performance is poor, it may reflect poor conditions that no one in the organization could control as well as poor local conditions. For this reason, organizations should not evaluate performance only based on costs and profits, but Perform detailed evaluations that include quality, material use, labor use, and service measures that the local unit can control.

Investment Centers
Responsibility

centers whose managers and employees control revenues, costs, and the level of investment. It is also like an independent business (common when an organization acquires another organization e.g. Sears financial centers).

Administrative Centers (support centers)

One

of the most difficult to evaluate because neither the input nor the output is easy to measure (e.g. accounting services, marketing), and Linking units input and output to organizational objectives. But, with a little careful approach, the costs of such centers can be reasonably computed. Since most of these centers are treated somewhat like cost centers, an approach based on costs would be helpful.

A simple summary of the responsibility centers

Revenue Center
Output measured in monetary terms

Expense/Cost Centers

Input measured in monetary terms

Profit Centers

Output measured in monetary terms

Investment Centers

Output measured in monetary terms

What did we learn from these control system illustrations?

All responsibility centers evolve from the concept of controllability. Controllability principle states a manager should be assigned responsibility for the revenue, costs, or investment that he/she could control. Revenues, costs, or investments that do not fall under a managers control must be excluded when evaluating the manager or his/her center. Problem with this concept: In most organizations, many revenues and costs are jointly earned or incurred and differentiation the controllable from the uncontrollable is difficult.

An alternative to Controllability
Some

argue that performance measures should be chosen to influence decision-making behavior. For example, if market prices for raw material is increasing, what can a manager do? Perhaps, enter into long term contract for fixed prices for raw materials. If electricity consumption cost is going up, find out how consumption can be economized (better machines, lighting, reduce waste).