A cost center is a part of a business that adds to the overall cost of the organization but does not directly generate any profit. There are a number of divisions within an organization that can act as cost centers, such as research and development, customer service and marketing. These cost center divisions do not directly generate profit, so they often are some of the first divisions to suffer cutbacks and layoffs. However, although they do not generate profit directly, they often are crucial to the long-term profitability of a company, so cutting them can be detrimental to the long-term health of the company.
In contrast to a profit center or investment center, a cost center does not directly generate revenue. A customer service call center, for instance, only helps existing customers who have already paid for a company's products or services. Such a call center would add to the company's overall costs but would not directly create sales.
Nevertheless, a cost center still contributes to the overall profit of a company. A customer service call center might not bring in sales directly, but having a reputation for excellent customer service might increase a company's sales. So, even though the call center is not directly bringing in revenue, it is making it easier for the sales department, which is a profit center, to increase its earnings.
The same would be true for other common cost center divisions within a company as well. Research and development can often be a very expensive cost center. Without this division, though, a company's products might become outdated and this will result in lower sales. Similarly, even though marketing does not generate direct revenue, without effective marketing, it can be very difficult for sales departments to reach potential customers and convince them to purchase a company's products and/or services. The marketing division, then, does improve the company's overall profitability.
When a company is not reaching its target earnings, cost centers often are one of the first areas of a company to experience cutbacks. Many cost centers do increase the company's profitability, but it can often be very difficult to measure exactly how a cost center improves overall profit. There are ways to measure the overall efficiency of most cost centers, but it often is very difficult to correlate that efficiency to an increase in overall revenue. For instance, measuring call time in a customer service center can provide metrics for the cost of the center, and surveys can measure customer satisfaction, but it is difficult to determine how those measurements correlate to repeat customers and word-of-mouth advertising.