Oil and Water; RA and Profit

Every now and then I happen upon a new RA website that I have not seen before. Most of them aim to promote a consulting or software firm; on one of these sites I recently found the following emphatic statement:

Revenue Assurance as a Profit Centre

Revenue Assurance should not be considered a cost centre. A good RA function can provide positive benefits to the organisation.

Hmmm. Sometimes I sit on the fence when others instigate debate about whether the Revenue Assurance Department should be a cost centre or a profit centre. I well remember how Hugh Roberts asserted at one conference that RA should never be a profit centre. My response then was to offer counter-arguments about why execs should have the freedom to set meaningful targets for any function, and if the primary role of the RA function is to improve the bottom line, then RA should be given a relevant target and measured against it. But in truth, it goes against my nature to give dogmatic answers to questions like this. My golden rule is to be pragmatic and to select an approach that best suits the business and its objectives. So when I hear arguments that the RA Department should always be a profit centre, or always be a cost centre, I recoil from both. However, if forced to choose a rule of thumb to apply generally, I know which side is right. Hugh Roberts is correct – in general, making the RA Department a profit centre causes more harm than good.

To boil the argument down to its essentials, we should quickly clarify what is a cost centre and what is a profit centre. According to Wikipedia, a cost centre is

… a division that adds to the cost of an organization, but only indirectly adds to its profit.

and Wikipedia gives the following description for profit centres:

a part of a corporation that directly adds to its profit.

A profit centre is like a business in its own right – it has revenues and costs. A cost centre could not exist in its own right, because it only generates costs. For this distinction to be useful on a management basis, it means a profit centre must sell something in order to generate its revenues. It could sell to outside customers, or it could sell its services to other parts of the business. For me, the key notion here is that there must be a sense in which profit centres sell something that its customers want, and would voluntarily pay for. So it is meaningless to describe a unit as a profit centre if its ‘revenues’ are really a form of ‘tax’ i.e. if internal customers are forced to pay for the service, whether they want the service or not. Hence, a function like R&D would naturally be a cost centre, whilst a sales function would naturally be considered a profit centre.

Having established our context, the next question is straightforward. What service could RA sell? It could sell the ability to prevent, find and/or fix mistakes. And therein lies the problem. That is not the kind of service people willingly choose to buy, at least not in the amounts that would be healthy for the organization as a whole. The benefits of the service provided by RA are not easily correlated to the costs of the service. As with R&D, RA exhibits no straightforward and predictable relationship between the amount you spend on it and the value you generate from it. Yes, you need R&D if you want your business to innovate. Yes, you need RA if you want to reduce leakages. But no, spending twice as much on R&D will not generate twice the return, and nor will that equation work for RA. You can spend a lot on R&D and get nothing of value. You can spend a little on R&D and get lucky, generating a lot of value with a breakthrough that comes along at just the right time. The same is true for RA. You can spend a lot on discovering there are no issues and that your business makes few mistakes. You can spend a little and discover there are plenty of easy pickings. But if RA is ‘profitable’ that rather implies your business is rotten and full of holes, allowing leakages to pour through it. In such circumstances, would it be reasonable to expect other profit centre managers to be willing customers of RA? From their perspective, RA creates a lose-lose scenario for the internal customer. Either RA generates less return than it costs, or it finds and reports all the shortcomings and faults of the customer. That means there is no natural selfish motivation for the managers of other business units to buy the services of RA on an ongoing basis. Their only motivation would be to buy RA services because it is in the best interests of the company of a whole – defying the original logic of splitting the business into profit centres and cost centres. The thinking behind profit centres and cost centres is that there can be internal markets and exchanges of value within a business. This pushes RA into the realm of a necessary cost that individual units would not willingly pay for unless they are compelled to do so. Even if a unit did want to employ the services of RA to find issues and clean things up, they would want to do so on a temporary basis only. Eventually there has to be reckoning where the issues are resolved and the RA service can be terminated because it is no longer profitable – hence still pushing RA to be a cost centre in the long run, even if it did generate a profit in the short run.

When creating internal markets for RA, there is a temptation to confuse two economic essentials: the value of mistakes and the cost of preventing and addressing them. It is flawed to assume that the value of mistakes found by RA must be higher than the cost of the work done by RA. Even if it is often true that RA generates more value than it costs, this is not a logical or practical necessity. Indeed, the very fact that RA can generate more value than it costs shows the imperfection of how we run businesses in real life. A perfect business would suffer no leakage – and would know this without needing the checks done by an RA team. Error-free processing would be built in to processing; perfect design would eliminate the costs associated with errors. An RA function could never be a profit centre in a perfect world, because it would generate no revenue. Of course, the world is far from perfect. This is why it can pay off to invest in RA over a finite timescale. The key point here is that the timescale should be finite. Eventually the business should have cleaned up its historic mistakes, and get better at avoiding new ones. A mature RA function helps the business to evolve, and get to a stage of maturity where it makes fewer and fewer mistakes. To repeat an oft-used phrase, RA should aim to put itself out of business, and that means it cannot survive as a profit centre. A profit centre is a kind of internal business, and for RA to keep profiting, the rest of the business must keep leaking. But this is unhealthy for the organization as a whole, as money is spent on the never-ending fixing of leakages, instead of preventing them.

The job of RA is like separating oil and water. A shaky business can create an impression that oil always needs to be extracted from the mix with the water. But in the steady business, the oil and water separate naturally. The RA function can help the bottom line on a permanent basis, as well as in the short term. It does this by helping the business to run smoothly, not by encouraging a violently messed-up mix where managers cannot tell good from bad. Seeing the business a whole, and not from the perspective of a profit centre, RA can find the sources of pollutants within the revenue stream, so it can stop them at source. But if RA has to generate profit, it has no incentive to behave like this, so will not behave like this. That is why, as a rule of thumb, Revenue Assurance functions should be treated as cost centres in the long run, even if they can generate profits in the short run. Without the freedom to think of the business a whole, the RA team becomes another cause of sub-optimal business performance. To think of the business a whole, RA practitioners have to be released from the obligation to generate a measurable internal profit.

Whilst my thinking on RA is long-established, I recognize the organizational and motivational reasons to be pragmatic. I would never say ‘never’ with respect to making the RA Department a profit centre. If I believed a business could treat it as a temporary stage in its evolution, then the RA unit could be a profit centre. The question here is whether we could rely upon this temporary compromise. Once RA is established as a profit centre, it will be easy to forget, and hard to motivate, the later transition of RA to a cost centre with a truly holistic perspective that embraces prevention as well as detection of leakage. Nevertheless, I am heartened that greater minds have already realized this difficulty, in a much more universal way than I have. This point about RA is really a specific example of a general problem: whether it is appropriate to conceive of a business as a series of units with an internal market and internal flows of revenues. Answers to this general question can illuminate our perspective on whether the RA function is a profit centre or cost centre. With that in mind, I turn to the wisdom of management guru Peter Drucker. Drucker was thinking of the interests of the business as a whole when he asserted his ultimate answer:

The only profit center is a customer whose cheque hasn’t bounced.