To attain the goals described in the master budget, top managers must coordinate the efforts of all of the firm’s employees—from senior executives through middle levels of management to every supervised worker. To coordinate the company’s efforts, top managers assign a certain amount of responsibility to lower-level managers and then hold them accountable for how they perform. Consequently, how each company structures its organization significantly shapes how it coordinates its actions.
Organization structure is an arrangement of lines of responsibility within an organization. A company such as Exxon Mobil is organized by business function—refining, marketing, and so on—with the president of each business function having decision-making authority over his or her function. Functional organizations develop strong competencies within each function but are generally less focused on particular markets or customers. To respond to this concern, other companies, such as Procter & Gamble, the household-products giant, are organized primarily by product line or brand. The managers of the individual divisions (toothpaste, soap, and so on) have decision-making authority concerning all the business functions (manufacturing, marketing, and so on) within that division. This results in some inefficiencies as support functions get duplicated in different divisions without sufficient scale or competence. Some companies, such as Swiss pharmaceutical firm Novartis, combine functional and divisional structures, for example leaving marketing within divisions but having manufacturing organized as a business function to supply products to different divisions. There is no perfect organization structure. Companies choose the structure that best meets their needs at that time, making the tradeoff between efficiency and end-to-end business authority.
Each manager, regardless of level, is in charge of a responsibility center. A responsibility center is a part, segment, or subunit of an organization whose manager is accountable for a specified set of activities. Higher-level managers supervise centers with broader responsibility and larger numbers of subordinates. Responsibility accounting is a system that measures the plans, budgets, actions, and actual results of each responsibility center. There are four types of responsibility centers:
The maintenance department of a Marriott hotel is a cost center because the maintenance manager is responsible only for costs and the budget is based only on costs. The sales department is a revenue center because the sales manager is responsible primarily for revenues, and the department’s budget is primarily based on revenues. The hotel manager is in charge of a profit center because the manager is accountable for both revenues and costs, and the hotel’s budget is based on revenues and costs. The regional manager responsible for determining the amount to be invested in new hotel projects and for revenues and costs generated from these investments is in charge of an investment center. So, this center’s budget is based on revenues, costs, and the investment base.
A responsibility center can be structured to promote better alignment of individual and company goals. For example, until recently, OPD, an office products distributor, operated its sales department solely as a revenue center. Each salesperson received a commission of 3% of the revenues per order, regardless of its size, the cost of processing it, or the cost of delivering the office products. Upon analyzing customer profitability, OPD found that many customers were unprofitable. The main reason was the high ordering and delivery costs of small orders. OPD’s managers decided to make the sales department a profit center, accountable for revenues and costs, and to change the incentive system for salespeople to 15% of the monthly profits of their customers. The costs for each customer included the manufacturing, ordering, and delivery costs. The effect of this change was immediate. The sales department began charging customers for ordering and delivery, and salespeople at OPD actively encouraged customers to consolidate their purchases into fewer orders. As a result, each order began producing larger revenues. The profitability of customers increased because of a 40% reduction in ordering and delivery costs in 1 year.