Application of the TOC thinking processes to challenging assumptions of profit and cost centre performance measurement

Abstract

The interaction of the measurement criteria of cost centres and profit centres, and the resultant effect on organizational profit is examined by applying the Theory of Constraints thinking processes. Three cases are described based on the assumptions that a profit centre should maximize profit and a cost centre should at least recover its costs. These cases illustrate that there will exist conflict between profit centres and cost centres due to disagreement about transfer pricing and hourly tariffs; that some outsourcing decisions taken in isolation can lead to a spiral of declining competitiveness; and that the attempts by a cost centre to maximize cost recovery leads to a lower profit for the organization. The thinking process logic trees show that these negative effects are caused by the application of wrong measurement criteria.