Using the Profit Center Model in Information Technologies. IT Departments worldwide face the difficult task of demonstrating the ROI that they

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1 Using the Profit Center Model in Information Technologies Introduction IT Departments worldwide face the difficult task of demonstrating the ROI that they provide to their parent companies. IT Departments provide essential support services to other departments within a company, however; these contributions are often not easily quantified into dollar amounts. IT Departments traditionally function as cost centers, a business model in which funds are invested but an obvious return on investment is not easily visible. The primary objective of this article is to evaluate whether a profit center model is a suitable means through which IT Departments can show ROI. Objectives covered will include an exploration of the underlying ideas behind the profit center and cost center model, opinions from industry analyst discussing the applicability of the profit center model and a culminating summary providing a recommendation on the viability of the profit center model in IT Departments. Return on Investment (ROI) ROI is an indicator of how well a department within a company or the company on a whole is being run. Return On Investment is a representation of the worth of a project or procurement in terms meaningful to decision makers. ROI is often stated as a monetary value (e.g., Net Present Value), a percentage (e.g., Internal Rate of Return), a time period (e.g., Payback Period), or a ratio (e.g., Benefit/Cost Ratio). Standard financial metrics are most common [1]. The concept of ROI applies to all departments of a business. Modern businesses are in the process of transforming as many internal departments as possible into revenue generators. IT departments have not been spared from this initiative.

2 InformationWeek provides an example of such a transition that has occurred at Cigna Corp. During the last year, Cigna Corp. changed the way its IT group operates. It morphed from an inefficient, decentralized operation with dispersed resources that were costly and underutilized into a centralized unit that maximizes the return on every piece of technology and human capital [2]. In today s business world the rules that once applied to all profit making departments in a company are applied to IT. IT no longer enjoys exemption from the justification of expense that is ROI. Many organizations are beginning to look at the IT organization as a line of business within their overall enterprise, thus making ROI calculations appear a new trend. MetLife has been using ROI calculations for the IT portfolio for a considerable amount of time. By treating IT as another line of business, IT professionals are constantly looking at ways to increase efficiencies, share best practices and, of course, maintain a strict adherence to ROI [3]. In earlier days, before the arrival of rigid fiscal accountability for IT Projects, IT was most commonly run as a cost center. Cost Center Cost centers are generally departments within a business which are not required to generate revenue. Cost centers typically operate within a set budget and are required to provide business services for internal departments while not exceeding their budget. Examples of cost centers are internal IT departments and marketing departments. As can be inferred from the given description of a cost center, the departments that run within the cost center construct are often viewed as fiscal liabilities due to their non-revenue generating status. IT departments operating as cost centers are not able to generate revenue and are thus viewed as non-performers in terms of adding to the bottom line.

3 Despite the invaluable support services that IT provides to its sister departments, business leaders now require evidence of IT s overall effect on the bottom line. And yet for all that technology has enabled for all that it has done to streamline supply chains, automate and speed production lines, reduce time-to-market, boost quality, reduce headcount, and shed more light on key business drivers many corporate executives and board members continue to view IT as a necessary evil. IT is regarded as an enormous cost center whose contribution and value to the bottom line, to the extent that it makes one, is largely unknowable and immeasurable, and therefore suspect [4]. The need for proof of ROI has forced CIO s and businesses to consider the possibility of running IT departments as profit centers. Profit Center Profit centers are departments within a business that are expected to turn a profit. A profit center is a unit of a company that generates revenue in excess of its expenses. It is expected that, through the sale of goods or services, the unit will turn a profit [5]. According to the Small Business Encyclopedia, there are typically two types of profit center models that can be used in business. Zero Cost Profit Center The zero cost profit center model is an option in which the IT department would be allowed to charge its sister departments a price for the services that IT provides and the recipient department would have the alternative of buying IT services from outside sellers if the outside sellers cost were cheaper than the internal IT departments.

4 This method would force other departments within the company to become more efficient in their use of money and would also force the internal IT department to become more efficient in order to compete with outside sellers. This quote summarizes the zero cost concept Thus, the IT department does not really take in any revenue, but neither does it cost the company any money because the divisions that utilized its services would have had to spend money to hire an outside vendor [5]. This arrangement between IT and its sister divisions creates a zero cost profit center. The efficient relationship that would result from a zero cost profit center is described in the following quotation When a business firm becomes a corporate community of entrepreneurs who buy, sell, and launch new products and services internally as well as externally, it gains the same creative interplay that makes market economies so advantageous [6]. Alternative to Zero Cost Profit Center The Small Business Encyclopedia describes another form of a profit center where IT runs as a cost center when interacting with departments within the company, but acts as a profit center by selling its services to outside companies. In this arrangement, IT manages to serve its sister departments as well as provide added revenue streams to the business. It is easily recognizable why business executives are encouraging of the profit center model for all departments. Logically if all areas of a business are geared towards creating revenue, it follows that the overall company balance sheet should reflect this trend. Cost Center to Profit Center Transition (Gap Analysis) The process of transforming a cost center to a profit center is not a simple one. The Robert Francis Group (RFG), a business consulting firm, believes the transition from cost center to profit center can be undertaken by using a series of steps.

5 The first step in transitioning to a profit center is performing a gap analysis. A gap analysis is defined as The difference between what is needed and what is available and the difference between where you are and where you want to be [7]. A gap analysis is a formal analysis done to judge what the current position and the eventual goal of the department is. Gap analyses are of significant importance because they serve as the starting point from which all other actions will originate. During a gap analysis IT leaders must be certain to ensure that they identify and assess all barriers to transforming the IT department as well as discover what variety of the profit center model is most suitable to the company s needs. Questions that could be asked during the gap analysis are the following: is there a market for the IT department to sell its products to outside companies; are IT department personnel likely to be encouraging of such a transition; is the business culture accepting of the proposed change? Business Plan Formulation The second step as detailed by the RFG group is to develop a business plan. The business plan is the blueprint detailing how exactly the newly created profit center is going to generate revenue. Issues such as employee compensation, profit creating models and all other relevant business concerns should be documented and addressed during this phase. This phase of the transition is essentially what puts the profit in profit center. It naturally follows that the business plan should include policies on selling products to the business s competition and the formulation of methods designed to align the IT profit centers goals with the goals of sister departments.

6 Charge back method Implementation The third step detailed by the RFG group is imposing a charge back method. A charge back method would strive to frame and describe the means in which an IT department s sister departments would compensate IT for services delivered. Creating a charge back method requires participation from all of IT s internal business partners. RFG concedes developing a compensation method would cause great controversy within a corporation. While this has the potential to be politically explosive, the benefit to IT is that it can help dispel the notion that it is a cost center by enabling IT to prove that it can break even. [8] By charging internal business partners for IT services, IT would be able to clearly show the benefits their services provide. RFG also suggests that IT departments need to determine competitive differentiation. Competitive differentiation in this context means that IT should realize that they are not guaranteed to win all contracts put up for bid by internal departments. IT departments must ensure that they are competitive with their outside competition and must display this competitive advantage by completing projects in an efficient and timely manner. Creation of a Value benefit model The last step as outlined by RFG is to complete a value benefit model. A value benefit model as described by RFG means that IT and its parent company must look beyond the role of ROI. RFG states The return on value perspective takes a systematic view of IT and examines more than just the financial return on investment. This method can be used to create a framework, which could then be applied to specific projects, or used to inform IT in anything it plans to do including reinventing itself and recasting its value proposition to upper management [7].

7 Essentially IT must seek to show value added to its business partners. RFG intimates that a positive balance sheet is not the most accurate means of finding out value. In the article The New ROI Spells Return on Value RFG states that IT executives who rely on return on investment (ROI) algorithms to communicate the business value of proposed projects to upper management may find themselves constrained in proving project benefits. This is because ROI is singularly focused on financial calculations and therefore limiting. Instead, there are other tangible and intangible factors as well as secondary information, which transcend the classic meaning of ROI and display return on value. IT executives should expand the scope and depth of the factors they use when making the business case for potential and continuing projects to demonstrate ROV to line of business (LOB) executives and the enterprise?[9] Industry Opinions The professional opinions of industry experts vary on whether the profit center model or the cost center model is the suitable model in which to manage an IT department. CIO.com columnist Sourabh Hajela states that IT cannot work as a profit center because it fails to meet the requirements for a department to function as a profit center: Revenues and costs: Accurately quantifying revenues and costs. Market: A focus on customer relationships that are generating higher profits and either discontinue or deemphasize those that aren't. Product Mix: The creation of a portfolio of products and services driven by market demand. Product pricing: Price products and services to maximize profits.

8 Timing: It is often said that, in business, timing is everything. Profit centers are profitable when they can quickly respond to a market opportunity[10]. Mr. Hajela general surmises that IT departments cannot work as profit centers because of its close alignment with other business departments. An ITO cannot work as a profit center because it has a captive relationship with its "customers," the other business units [10]. This suggestion by Mr. Hajela and his reasoning for the incompatibility of IT departments with the profit center model seems to be in direct contrast with the zero center and non zero center approach to the creation of a profit center. As was previously stated in the non zero and zero profit center approach, IT would still be able to maintain its close relationship with its sister business departments while completing all the tasks required of a profit center listed by Mr. Hajela. There have been other industry analysts who have openly embraced the transformation of IT from cost center to profit center, one such backer is Mike Hugos from CIO.com. Mike Hugos states For years now, we CIO s have been hard at work consolidating data centers, systems and software licenses. We ve saved our companies millions. But as the saying goes, you can t save your way to greatness [11]. Mr. Hugos believes that the next step in IT development is the profit center. In his article Mr. Hugos implies that the function of IT should not be limited to streamlining or saving money but also in generating revenue. This attitude of profit generation as evidence of productivity is the impetus behind the growing clamor for IT to demonstrate ROI by adding directly to the bottom-line.

9 Conclusion Business needs now mandate that every department provide justification for its existence. IT is now required to justify its existence by streamlining company operations through a direct application of technology as well as serving as a generator of income. The progression from cost center to profit center is simply a method in which to bring IT and business in harmony. IT must now work as a profit center.

10 Works Cited [1] Return on investment (ROI). Retrieved April 20, 2008, from Resource Management Systems Inc. Web site: [2] Cuneo, Eileen (2004). Measure up or Move Out. InformationWeek, Retrieved 03/12/2008, from [3] MacSweeny, Greg (2002). Executives Reveal ROI Tricks of the Trade. Insurance and Technology, Retrieved 03/12/2007, from [4] (2004). It Moves From Cost Center To Business Contributor. CFO Publishing Corporation, Retrieved 3/12/2008, from [5] Profit Center-Turning a Cost Center into a Profit Center. Small Business Encyclopedia [Web]. Retrieved 03/2008, from [6] Internal competition makes firms stronger. USA Today (Society for the Advancement of Education). Dec FindArticles.com. 20 Apr [7] Data Warehouse Glossary. Retrieved April 20, 2008, Web site: [8] (2001). Transforming IT: From Cost Center to Value Center. Retrieved April 20, 2008, from Robert Francis Group Web site: [9] (2001). The New ROI Spells Return on Value. Retrieved April 20, 2008, from Robert Francis Group Web site: [10] Hajela, Sourabh (2005/02/15). IT cannot be a Profit Center. CIO Update, Retrieved 03/12/2008, from [11] Hugos, Mike (2006/08/16). Show Them the Money: Position Your IT Organization as a Profit Center. CIO, Retrieved 3/12/2008, from tion_as_a_profit_center