IT Cannot be a Profit Center - Page 1

Feb 16, 2005

Sourabh Hajela

Of late, there is a lot of emphasis on IT ROI. While this is commendable, extending this argument to convert the ITO into a profit center is taking it to another extreme. Are HR, finance, and marketing profit centers?

No, but they are still necessary for running the business. IT is a similar, necessary evil and therefore the model of the internal ITO as a profit center just does not work.

The concept of profit centers is built around profitability, which in turn requires an unwavering focus on the business model. Consequently, profit centers must meet certain minimum criteria:

  • 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.
  • Timing: It is often said that, in business, timing is everything. Profit centers are profitable when they can quickly respond to a market opportunity.
  • This is by no means an exhaustive list but it should be sufficient to provide an idea of the general focus and direction of "profit-driven" enterprise.

    But, since companies also expect IT to work, hand-in-glove, with the business to create shareholder value the more closely an IT capability is aligned with business requirements the more shareholder value generated by the enterprise. But this is at odds with the ideal of being a profit center as I will explain later.

    Based on the example above, this discussion boils down to answering two key questions: Does an ITO meet the criteria of a profit center? And, if it were to operate as one, can it still meet the expectations of alignment and shareholder value?

    For starters, we cannot determine the revenues and cost associated with the IT department with a high degree of certainty or accuracy. How do we allocate the company's revenues to a department, say Marketing or HR? In what proportion did they contribute to creating those revenues?

    Some have approached this problem from the other end, i.e. determining the value generated by IT. Theoretically, each IT project creates value in some form, say, increased revenues, increased productivity, or cost savings.

    In theory, adding all these up would give us the value generated by the ITO as a whole. However, there are obvious flaws in this approach. Can IT generate this value without the other business units? If not, then, how do we separate IT's revenue contribution from theirs?

    Having been involved in many project portfolio rationalization efforts, I have learned that adding the projected value generated by individual IT projects often exceeds the total value generated by the entire organization!

    The bottom line is we just do not have an accurate way of allocating enterprise revenues to individual functions.

    The cost side of this equation is somewhat easier because we have departmental budgets. However, budgets do not account for all the costs associated with a function nor do they accurately reflect the cost of doing business.

    Held Captive

    The revenue and cost allocation issue is just the tip of the iceberg. An ITO cannot work as a profit center because it has a captive relationship with its "customers," the other business units.

    Since IT's customers cannot generally bid the work out to other providers and IT cannot focus on its more profitable customers over unprofitable ones, how can IT be viewed as a profit center when free market forces are not at play?

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