What is a Profit Center?
A profit center is a sector within a company that is expected to be profitable, with earnings that outstrip its expenses. Some profit centers can be a sizable source of revenue for the parent company and may be an anchor or mainstay of its business. The profits they generate can be used to finance other areas of the business, as well as to pay for expansion into new areas of the market and other activities that a company may want to engage in.
By contrast, a cost center is a unit that is not necessarily expected to generate revenues. Cost centers focus on sticking within a set budget to accomplish their work. Profit centers are expected to use as many means as possible to reduce costs and increase their profit margin. This requires innovative and aggressive management. In cost centers, by contrast, managers can focus on developing and maintaining budgets without being worried about how much money their departments are bringing in.
Accounts for a profit center are processed separately and it is treated almost like an independent entity within the larger company. Profit centers are responsible for constant development of new products and services to appeal to customers and increase revenues. They are also the core of the business, and may provide the services it is most well known for. Operations in the profit center sustain lesser-known aspects of the business that can play an important role in customer loyalty.
Pharmaceutical companies are an excellent example of the profit center and cost center model. Most companies have several highly profitable divisions that market and sell popular medications. These departments are leaders for the company, keeping profits high. The research and development division, on the other hand, is a cost center. It does not generate revenues directly and can in fact be very expensive to run. However, without the cost center, the business would fail to thrive in the long term.
Not all companies break themselves up into divisions this way. However, if a company has several key flagship products that it relies upon for revenues, considering some divisions profit centers while viewing others as cost centers can be an efficient management approach. Cost centers can be tasked with development and customer retention without worrying about bringing in enough profit to be sustainable, while a profit center can focus on selling high volumes of products and services to provide the company with a steady flow of income.
@Charred - Well, it’s not always the United States doing the R&D however. Since you mention Asia, the reality is that there are a lot of technologies they produce that are at least six months ahead of what we have here.
I know, because I’ve toured their massive commercial districts where they sell electronic gizmos, and I was amazed at what I saw. The only difference between cost center and profit center in the Asian model is that I think they are raking in a lot more money in their profit centers, because the cost of labor is so low, and because it seems like they export their stuff to the whole world.
But the fact is many companies have a cost and a profit center. It’s part of the price of doing business. I would call the profit center your “bread and butter” items, things you can turn around quickly for profits and which help generate a continual revenue stream.
I think that the cost center vs profit center split is something that is useful in understanding why we sometimes lose our edge in competing with foreign markets. In short, we spend more money on research and development in some sectors than they do.
This is not universally true of course but I can think of one major industry where this is the case. In computers, the United States spent a lot of money on research and development.
Companies like IBM, which had profit centers with other products that they had been selling to the business market, were engaged in research and development in the personal computer front. Once they did that, they churned out personal computers.
Guess what the Asian markets did with that technology? They reverse engineered it, and began churning out computers, for less than we could.
Were they spending money on research and development? No, it was all copy and paste.
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