Analyzing Your Internal Value Centers

A corporate IVC - internal value center (or internal service center as it is sometimes called) is also sort if a business within a business, albeit of a fundamentally different nature compared to a regional branch or retail outlet.

The latter satisfy the needs of your clients and consumers by providing them with your products while your IVC satisfies the needs of your SBU, functional units, regional branches, retail outlets and individual employees by providing them with products and services that they need.

The fundamental attribute of an IVC that it occupies a distinct location (distinct from corporate headquarters or any other premises). Examples are training facility, data center, manufacturing plant, auto garage, warehouse, service center, and a distribution hub. And many others.

Traditional financial management paradigm distinguishes between profit centers and cost centers. Which is quite misleading and not actually useful, because shareholders who pay the salaries and bonuses of employees of both profit and cost centers, are not really concerned about profits or costs per se.

They are concerned about free cash flows and financial value; and to create it you need both ‘profit’ and ‘cost’ center. This distinction is even harmful, because it creates and illusion that the former are somehow superior to the latter, which offends employees of ‘cost centers’ and lowers their productivity. Which, in turn, immediately and negatively affects the amount of financial value generated by the company for its shareholders.

In reality, there are no ‘profit’ or ‘cost’ centers. There are only value centers that participate in value-generating corporate projects and processes. If the center is not involved in any of these processes, it has no right to exist in the corporate structure at all. Period.

The fundamental objective of IVC analysis is to choose between placing (or keeping) this center in-house or outsourcing it. Naturally, from the financial value perspective. Which requires development of a comprehensive financial model by a highly competent financial analyst. The model supported by all necessary corporate documentation.

Actually, you almost always have this choice – with both ‘cost’ centers (IT or accounting services, transportation, logistic, personnel training, etc.) and ‘profit’ centers (franchising or enlisting the services of a distributor, dealer, exporter or retailer).

If you see that the outsourcing option is clearly superior to the in-house option, you must obviously go with it. Establishing the harmonious relationship with your new supplier. If you see that the in-house option is superior (or comes very close), you will need to thoroughly analyze your IVC to maximize its aggregate performance.

You analyze IVC almost as you would analyze any other business (or an SBU, for that matter). ‘Almost’ because there is a fundamental difference between IVC and the ‘normal’ business. The latter sells its products at market prices, while the former ‘sells’ them at internal or so called ‘transfer’ prices.

Which must be determined very thoroughly and competently to accurately reflect true economics of IVC-related internal transactions. Hence, you will need the services of a very competent transfer pricing professional.

Obviously, your corporate objects map for your IVC is much more limited than the one for the ‘normal’ business. IVC has its own history, strategic objectives and plans (which need to be closely coordinated with corporate ones), its own risk management system, stakeholders (strictly internal), projects, processes, tools, obviously a functional organizational chart and personnel.

In addition, it has its own UVP, core competencies and competitive advantages (over the outsourcing option). Everything else is provided by headquarters (at their transfer prices).