A responsibility centre is an organisational unit with a manager accountable for its results. How it is classified determines what that manager is measured by.
1 Types of responsibility centre
| Centre | The manager is responsible for | Performance measure | Example |
|---|---|---|---|
| Cost centre | Costs only | Variance from budget | Maintenance · human resources |
| Revenue centre | Revenue only | Meeting the sales target | A regional sales department |
| Profit centre | Revenue and costs | The unit’s net profit | A branch · a product line |
| Investment centre | Profit and the assets invested | Return on investment | A subsidiary · a business segment |
The controllability principle
A manager is evaluated only on what they can influence. Charging a branch with a share of head-office salaries and then holding its manager to account for it strips the evaluation of its fairness — such costs are presented, but they do not enter the measurement of that manager’s performance.
2 The segmented performance report
| Item | Amount | Is the manager accountable? |
|---|---|---|
| Revenue | 900,000 | Yes |
| Variable costs | (500,000) | Yes |
| Contribution margin | 400,000 | — |
| Fixed costs the manager controls | (180,000) | Yes |
| Controllable margin | 220,000 | The manager’s performance measure |
| Branch fixed costs outside the manager’s control | (90,000) | No |
| Branch profit | 130,000 | The measure of the branch’s viability |
| Share of head-office expenses | (70,000) | No |
| Net profit | 60,000 | — |
The benefit: the report separates evaluating the manager (controllable margin) from evaluating the branch itself (branch profit). A manager may be excellent while the branch is not viable — or the other way round.
3 Return on investment and residual income
Two measures for an investment centre
- Return on investment = operating profit ÷ operating assets
- Residual income = operating profit − (operating assets × required rate of return)
- The first is a ratio, which makes units of different sizes comparable
- The second is an amount, which encourages accepting any investment above the required minimum
Behaviour created by the measure
A manager currently earning 20% may reject a project returning 16% because it would pull the average down — even though the business only requires 12%. Residual income fixes that distortion because it measures the amount above the required threshold rather than the ratio.
4 Beyond the financial numbers
Financial indicators measure the result of the past. To complete the picture you add indicators that drive the future — the idea behind the balanced scorecard and its four perspectives:
Financial
Profitability, growth and return
Customer
Satisfaction, retention and market share
Internal processes
Quality, cycle time and efficiency
Learning and growth
Skills, systems and culture
A causal chain: building capability → better processes → satisfied customers → a financial result
A rule for designing indicators
What you measure improves — and what you do not measure may be sacrificed to improve what you do. So balance the indicators: measuring speed alone hurts quality, and measuring cost alone hurts maintenance.
Chapter 1 summary
- There are four responsibility centres: cost, revenue, profit and investment.
- The manager is evaluated on what they control; the branch on its overall result.
- Return on investment is a ratio for comparison; residual income is an amount that prevents good opportunities being turned down.
- Financial indicators alone are lagging, and need operating indicators to drive them.
- Balance the indicators so that one measure does not improve at the expense of another.
5 Test yourself
Three quick questions
Choose the answer you think is correct — the result appears immediately.
1. A branch manager is responsible for revenue and costs but not investment decisions. What kind of centre is it?
Responsibility for both sides of the equation but not for the assets makes it a profit centre, not an investment centre.
2. A branch was charged with a share of head-office salaries and its manager held to account for it. What is wrong?
The cost is real and belongs in the report, but it does not belong in measuring the performance of someone who cannot control it.
3. Why might a manager reject a project returning 16% when the business requires only 12%?
This is a well-known distortion of the ratio measure, and it is remedied by using residual income alongside it.