Organizational Structure for the IT Department: Profit Center or Cost Center?

Abstract

Why do some firms organize their IT departments as profit centers whereas other firms organize IT as a cost center? These commonly employed organizational structures are characterized by information asymmetry and decision rights afforded to the IT department. The complexity of IT and its ongoing rapid evolution lead to information asymmetry where the IT department has private information about technology and cost, and the consuming departments have private information about demand. Under the cost center organizational structure, the firm sets the quality and number of IT services offered by the IT department. Whereas under a profit center structure, the IT department makes decisions on quality, price and variety of IT services. We find that the quality of IT services under the cost center decreases with greater uncertainty in demand for IT services. We also find that the cost center structure can offer higher quality IT services than the profit center structure, and consumption of IT services can be higher under the profit center structure. The preferred organizational structure does not always provide greater variety of IT services than the alternate structure. The cost center is preferred when the marginal cost of IT services is sufficiently low, or the fixed cost of quality is sufficiently high.