cost center

Cost centers are a necessary evil in companies, departments that don't contribute to the bottom line but are essential to the everyday maintenance of business processes.

A cost center is part of an organization that does not produce direct profit and adds to the cost of running a company. Employees and cost center management are responsible for its costs but not for the revenues or investment decisions. Examples of cost centers include research and development departments, marketing departments, human resources department, the IT department, the accounting department, help desks and customer service/contact centers.

Typically, companies classify business units as either cost centers, profit centers or investment centers. While the cost of running a particular department is easy to measure, cost centers create incentives for managers to underfund their units in order to benefit the cost center. This might have a negative effect on other departments within the company.

Despite their reputation as departments that don't have an impact on profits,, removing any one cost center from an organization could, consequently, have a detrimental effect on the profit margin of that organization. For example, if an HR department were to be completely cut, key staffing functions and basic business processes couldn't be performed, which would negatively affect the organization's profits. Cost centers often try to streamline processes, be more efficient and generally save money in order to lessen the cost it takes to run them. By cutting overhead and generating unexpected revenue, cost centers can try to cover all of their costs with offsetting revenue, thus creating no profit but also no loss and ceasing to be a cost center.

One manager or a group of managers run each cost center and have responsibilities for its financial performance, mainly relating to keeping the costs of the particular department as low as possible to keep business running. Typical responsibilities of these managers include keeping the center within budget, accounting for all expenditures and reviewing those expenditures on budget reports. The company usually accounts for each cost center separately, giving managers authority, responsibility and credit for which costs are slashed and which ones grow.

Although not always demonstrably profitable, a cost center typically adds to revenue indirectly or fulfills some other corporate mandate. Money spent on research and development, for example, may yield innovations that will be profitable in the future. Investments in public relations and customer service may result in more customers and increased customer loyalty.

Because the cost center has a negative impact on profit (at least on the surface) it is a likely target for rollbacks and layoffs when budgets are cut. Operational decisions in a contact center, for example, are typically driven by cost considerations. Financial investments in new equipment, technology and staff are often difficult to justify to management because indirect profitability is hard to translate to bottom-line figures.

Business metrics are sometimes employed to quantify the benefits of a cost center and relate costs and benefits to those of the organization as a whole. In a contact center, for example, metrics such as average handle timeservice level and cost per call are used in conjunction with other calculations to justify current or improved funding.

This was first published in May 2015

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