As the world’s major economies have matured, they have become dominated by service-focused businesses. But many of the management tools and techniques service managers use, were designed to tackle the challenges of product companies. Are these sufficient, or do we need new ones? Let me submit that some new tools are necessary. When a business takes a product to market, whether it’s a basic commodity like corn or a highly engineered offering like a digital camera, the company must make the product itself compelling and also field a workforce capable of producing it at an attractive price. To be sure, neither job is easy to do well; enormous amounts of management attention and academic research have been devoted to these challenges. But delivering a service entails something else as well: The management of customers who are not simply consumers of the service, but can also be integral to its production. And because customers’ involvement as producers can wreak havoc on costs, service companies must also develop creative ways to fund their distinctive advantages.
Any of these elements — the offering or its funding mechanism, the employee management system or the customer management system — can be the undoing of a service business. This is amply demonstrated by my analysis of service companies that have struggled over the past decade. What is just as clear, however, is that there is no “right” way to combine the elements. The appropriate design of any one of them depends upon the other three. When we look at service businesses that have grown and prospered — companies like Wal-Mart in retail, Commerce Bank in banking and the Cleveland Clinic in health care — it is their effective integration of the elements that stands out more than the cleverness of any element in isolation.
This article outlines an approach for crafting a profitable service business based on four critical elements (collectively called the “service model”). Developed as a core teaching module at Harvard Business School, this approach recognises the differences between service businesses and product businesses.
• The service offering
The challenge of service-business management begins with design. As with product companies, a service business can’t last long if the offering itself is fatally flawed. It must effectively meet the needs and desires of an attractive group of customers. In thinking about the design of a service, however, managers must undergo an important shift in perspective: Whereas product designers focus on the characteristics buyers will value, service designers do better to focus on the experiences customers want to have. For example, customers may attribute convenience or friendly interaction to your service brand. They may compare your offering favourably with competitors’ because of extended hours, closer proximity, greater scope or lower prices. Your management team must be absolutely clear about which attributes of service the business will compete on.
Strategy is often defined as what a business chooses not to do. Similarly, service excellence can be defined as what a business chooses not to do well. If this sounds odd, it should. Rarely do we advise that the path to excellence is through inferior performance. But since service businesses usually don’t have the luxury of simply failing to deliver some aspects of their service — every physical store must have employees on-site, for example, even if they’re not particularly skilled or plentiful — most successful companies choose to deliver a subset of that package poorly. They don’t make this choice casually. Instead, my research has shown, they perform badly at some things in order to excel at others. This can be considered a hard-coded trade-off. Think about the company that can afford to stay open for longer hours because it charges more than the competition. This business is excelling on convenience and has relatively inferior performance on price. The price dimension fuels the service dimension.
To create a successful service offering, managers need to determine which attributes to target for excellence and which to target for inferior performance. These choices should be heavily informed by the needs of customers. Managers should discover the relative importance customers place on attributes and then match the investment in excellence with those priorities. At Wal-Mart, for example, ambience and sales help are least valued by its customers, whereas low prices and wide selection are most valued, and several other attributes rank at points in-between. The trade-offs Wal-Mart makes are deliberately informed by these preferences. The company optimises specific aspects of its service offering to cater to its customers’ priorities, and it refuses to over-invest in underappreciated attributes. The fact that Wal-Mart takes a drubbing from competitors on things its customers care little about, drives its overall performance.
The phenomenon, of course, has a circular aspect. Shoppers whose preferences match Wal-Mart’s strengths self-select into its customer base. Meanwhile, those who don’t prefer Wal-Mart’s attributes buy elsewhere. It is important therefore to identify customer segments in terms of attribute preferences — or as some marketers prefer, in terms of customer needs. Identifying what might be called customer operating segments is not the same exercise as traditional psychographic segmentation. Rather than stressing differences that enable increasingly targeted and potent messaging, this type of segmentation aims to find populations of customers who share a notion of what constitutes excellent service.
Once an attractive customer operating segment is found, the mission is clear: Management should design a new offering or tweak an existing one to line up with that segment’s preferences. Look, for example, at the fit achieved by Commerce Bank, which has been able to grow its retail customer base dramatically even though its rates are among the worst in its markets and the bank has made limited acquisitions. Commerce Bank focuses on the set of customers who care about the experience of visiting a physical branch. These customers come in all shapes and sizes — from young, first-time banking clients to time-strapped urban professionals to elderly retirees. As an operating segment, however, they all believe convenience is a bank’s most important attribute and choose Commerce Bank because of its evening and weekend hours. Second most important to them is the friendliness of interactions with employees, and so the promise of a cheerful, familiar teller has become part of the bank’s core offering. Commerce has added to its branch ambience with interior elements both lovely (high ceilings and natural light) and fun (an amusing contraption for redeeming loose change). When it comes to attributes less important to the bank’s customers — price and product range — management is willing to cede the battle to competitors.
It is tempting to think, “If I’m a really good manager, then I don’t have to cede anything to the competition.” This well-intentioned logic can lead, ironically, to not excelling at anything. The only organisations I have seen that are superior at most service attributes, demand a price premium of 50 percent over their competitors. Most industries don’t support this type of premium and so trade-offs are necessary.
• The funding mechanism
All managers, and even most customers, agree there is no such thing as a free lunch. Excellence comes at a cost, and the cost must ultimately be covered. With a tangible product, a company’s mechanism for funding superior performance is usually relatively simple: The price tag. Only the customers who forfeit the extra cash can avail themselves of the premium offering. In a service business, developing a way to fund excellence can be more complicated. Pricing is often not transaction-based, but involves the bundling of various elements of value or entails some kind of subscription, such as a monthly fee. In these cases, buyers can extract uneven amounts of value for their money. Indeed, even non-buyers may derive value in certain service environments. For example, a shopper might spend time learning from a knowledgeable salesperson, only to leave the store empty-handed.
In a service business, therefore, management must give careful thought to how excellence will be paid for. There must be a funding mechanism in place to allow the company to outshine competitors in the attributes it has chosen. In my study of successful service businesses, I’ve seen the funding mechanism take four basic forms. Two are ways of having the customer pay, and two cover the cost of excellence with operational savings.
Charge the customer in a palatable way. The classic approach to funding something of value is simply to have the customer pay for it, but often it is possible to make the form payment takes less objectionable to customers. Rarely is that done with a la carte pricing for the niceties. A large part of Starbucks’s appeal is that a customer can linger almost indefinitely in a coffeehouse setting. It’s unthinkable Starbucks would place meters next to its overstuffed chairs; a better way to fund the atmosphere is to charge more for the coffee. Commerce Bank is open late and on weekends — earning it high marks on extended hours — and it pays for that service by giving a half percentage point less in interest on deposits. Could it fund the extra labour hours by charging for evening and weekend visits? Perhaps, but a slightly lower interest rate is more palatable. Management in any setting would do well to creatively consider what feels fair to its customers. Often, the least creative solution is to charge more for the particular service feature you are funding.
Create a win-win between operational savings and value-added services. Very clever management teams discover ways to enhance the customer experience even while spending less (finding, in other words, that there can be such a thing as a free lunch). Many of these innovations provide only a temporary competitive advantage, as they are quickly recognised and copied. Some are surprisingly durable, however.
How can your management team find win-win solutions of its own? When I pose this question to managers, their impulse is to imagine what new value could be created for customers and then to ponder how that could be funded through cost savings. I suggest beginning instead by asking, “Where are our biggest cost buckets?” With these in mind, managers can then simultaneously determine how to reduce costs and create a value-added service. What’s a good first place to look? Anywhere that time is a large component of cost. Removing time is often fruitful, since it can directly improve service even as it cuts costs.
Spend now to save later. Often it is possible, if somewhat painful, to make operational investments that will pay off eventually by reducing customers’ needs for auxiliary service in the future. A classic example is Intuit’s decision to provide free customer support, in defiance of the software industry norm. Call centres are expensive to staff because of the combination of technical knowledge and sociability required to field inquiries effectively. Customers meanwhile are extremely uneven in their neediness vis-a-vis information technology. For most software makers this adds up to the obvious conclusion that customers should be charged for support.
Intuit founder Scott Cook sees the matter differently. Those needy calls, he believes, are a useful form of input to continued product development — the engine of future revenues — and that justifies an even greater expense outlay. Intuit has its higher salaried product-development people, not solely customer service people, fielding calls so that subsequent versions of its offerings will be informed by direct knowledge of what users are trying to accomplish and how they are being frustrated. This is part of a broader commitment to feedback-driven improvement that Cook refers to as “DIRST” — for “do it right the second time”. The investment has paid off in better software, which means a lower call volume. “Our competition thinks we’re crazy,” Cook says, and he understands why. “If we got as many calls as they do, we’d be out of business.”
Have the customer do the work. One other type of funding mechanism for enhanced service puts the cost back in the customers’ court, but in the form of labour. Offering self-service, from pump-your-own gas to self-managed brokerage accounts, is a well-established way to keep costs low. If the goal is service excellence, though, you must create a situation in which the customer will prefer the do-it-yourself capability over a readily available full-service alternative.
Airlines have achieved this, at last, with flight check-in kiosks, although the value proposition they initially presented was dubious. At first, passengers felt compelled to use the relatively unappealing kiosks only because carriers had allowed the lines in front of manned desks to become intolerable.
Today, however, frequent fliers prefer the kiosks because they provide readier access to useful tools like seat maps. Businesses looking to achieve service excellence in other settings should not take such an indirect route. They should set themselves the challenge of creating self-service capabilities customers will welcome. Indeed, if a self-service option is truly preferable, customers should be willing to take on the work for nothing or even pay for the privilege. When managers designing self-service solutions are not permitted to add the inducement of price discounts, they are forced to focus on improving the customer experience.
• The employee management system
Companies often live or die on the quality of their workforces, but because service businesses are typically people intensive, a relative advantage in employee management has all the more impact there. Top management must give careful attention to recruiting and selection processes, training, job design, performance management and other components making up the employee management system. More to the point, the decisions made in these areas should reflect the service attributes the company aims to be known for.
To design a well-integrated employee management system, start with two simple diagnostic questions. First: What makes our employees reasonably able to achieve excellence? And then: What makes our employees reasonably motivated to achieve excellence? Thoughtfully considered, the answers will translate into company-specific policies and programmes. Companies that neglect to connect the dots between their employee management approaches and customers’ service preferences, will find it hard to honour their service promises.
At one large international retail bank I studied, a senior manager had come to a depressing realisation. “Our service stinks,” she told me. Under her guidance the bank took various measures, mainly focussing on incentives and training, but the problem persisted. Customer experience in the branch did not improve. Perplexed but determined, the executive decided to become a frontline employee herself for a month.
She thought it would take that much time to experience a typical range of service interactions and see the roots of the problem. In fact, it took one day. “From the time the doors opened, customers were yelling at me,” she reported. “By the end of the day, I was yelling back.” What became clear was that employees were set up to fail. Recent cross-selling initiatives had created a set of customers with more complex needs and higher expectations for their relationship with the bank, but employees had not been equipped to respond. As a result of decisions made by the management team (all individually sensible), the typical employee did not have a reasonable chance of succeeding. The bank’s employee management system was broken.
If your business requires heroism by your employees to keep customers happy, then you have bad service by design. Employee self-sacrifice is rarely a sustainable resource. Instead, design a system that allows the average employee to thrive. This is part of Commerce Bank’s competitive formula. Recall that the bank chooses to compete on extended hours and friendly interactions and not on low price and product breadth. Now think how that strategy could inform employee management; the implications are not hard to imagine. For instance, Commerce concluded that it didn’t require straight-A students to master its limited product set; it could hire for attitude and train for service. In job interviews, its managers could use simple weed-out criteria — like “Does this person smile in a resting state?” — rather than trying to maximise across a wide range of positive characteristics.
It’s a simple reality that employees who are above average in both attitude and aptitude are expensive to employ. They are not only attractive to you, but also attractive to your competitors and that drives up wages. A business that wants to maintain a competitive cost structure will probably need to compromise on one quality or the other (or, if it insists on having both, find a way to fund that luxury). If, as Commerce Bank does, you choose to hire for attitude, then you must engineer things so even lower-aptitude employees will reliably deliver great service. Like managers who don’t want to admit their service is designed to be inferior on some attributes, many people are reluctant to acknowledge a trade-off between aptitude and attitude. Yet, a failure to accommodate this economic reality in the design of the employee management system is a common culprit in flawed service.
• The customer management system
In a service environment, employees aren’t the only people affecting the cost and quality of service delivered. The customers themselves can be involved in operational processes, sometimes to a large extent, and their input influences their experiences (and often other customers’ too). For example, an architectural firm’s client may explain the purpose of a new facility well or poorly, and that will affect the efficiency of the design process and the quality of the end product. Customer involvement in operations has profound implications for management, because it alters the traditional role of the business in value creation. The classic product-based business buys materials and adds value to them in some way. The enhanced-value product is then delivered to customers, who pay to receive it. In a service business, however, employees and customers are both part of the value-creation process. A main benefit is that customer labour can be far less expensive than employee labour. It can also lead to better service experiences. When students participate more in a classroom environment, for example, they learn more. But there are challenges, as well. Designing a system that explicitly manages these challenges is essential to service success.
Consider the issue of customer selection. Service designs may call for customers to perform important tasks, but for the most part customers have no interview, no background check and no personality profile. In addition, despite many organisations’ best efforts, customers are not as easy to train as employees. There are usually many times more customers than employees, and creating effective training materials for such a large, dispersed, unpaid, and often irrelevantly-skilled workforce is difficult. When this holds true, firms must accommodate the limited training in the design of the service experience. If tasks are shifted from employees to customers — from higher-skilled to lower-skilled people — then they must be adjusted accordingly. Customers also have a great deal of discretion in their operational activities, usually far more than employees. When a company introduces a new process that it wants employees to use, it can simply issue a mandate. When customers are involved, transitions like this can be significantly more complicated. In managing customers in your operations, then, you’ll need to address a few key questions: Which customers are you focusing on? Which behaviours do you want? And which techniques will most effectively influence behaviour? For example, a company whose business model depends on customers’ timeliness — whether it’s a dental office packing its appointment calendar or a video store circulating hit films — may use more or less-heavy-handed tactics to ensure compliance.
In a previous article for Harvard Business Review, I related lessons from several companies that have used a range of techniques to modify customer behaviour. These techniques can be divided into two basic categories: Instrumental (the carrots and sticks we commonly see play out as discounts and late fees) and normative (the use of shame, blame, and pride to motivate us to return shopping carts and pick up trash even when no one is looking). The important thing is to manage customers in a way that is consistent with the service attributes you’ve chosen to emphasise overall.
Integrating the elements
Successful service companies have a working plan that incorporates all four elements of service design. Within each of those areas, however, it is hard to spot any best practice. This is because the whole business depends more on the interconnection of the four than on any one element.
A standout example of effective overall integration is the Cleveland Clinic, which is consistently ranked among America’s most eminent hospitals and has been a leader in pioneering cardiac care for decades. It’s hard to put a finger on the source of that advantage. The fact the clinic has specialty centres focusing on diabetes, for example, or cardiac care is not exceptional in itself. Its refusal to attach financial rewards to doctors’ productivity is unusual, but might not be effective elsewhere. Step back from the details, however, and the bigger picture emerges. Attracting the highest-severity patients means doctors will always face a challenging environment in need of innovative solutions. Organising into disease centres rather than narrower, more traditional lines of specialisation (such as kidneys or blood) sets the stage for cross-disciplinary collaboration — and thus for novel perspectives — within those centres. Removing productivity incentives gives doctors license to spend time on innovation, which is enhanced by their close work with specialists from other fields.
Any service company, no matter how long established, can benefit from a review of its operations using the framework laid out in this article. Bringing the four elements of service design into tighter alignment can be an ongoing process of small tweaks and experiments in change. A management team planning to launch a new service will find the framework particularly helpful. It flags the decisions that should be made early and in tandem, so they don’t clash down the road. And at the highest level it underscores two important principles of service design. First, there is no such thing as a good idea in isolation; there is only a good idea in the context of a specific service model. Second, it is folly to attempt to be all things to all customers.
The first point notes the importance of fit, mentioned earlier as a key strength of the Cleveland Clinic. At the clinic, management knows extensions to its core business must be examined closely for their fit with its existing service model. The organisation recently abandoned the concept of a high-end wellness and spa offering, because it didn’t build on the hospital’s core operational strengths. In some ways this seems like an obvious point, but managers often stray into areas of relative weakness, particularly when they see a firm they consider to be a direct competitor succeeding with a service they don’t yet offer. Just as common a failing is the misguided desire to be all things to all people. In today’s service economy, it is nearly impossible to design a service model to cover a huge range of customers and remain competitive across them. Instead, firms should design their service models for more targeted excellence by being specific things to specific people.
Great service companies are, almost without exception, clever about selecting their customers.
Becoming a multi-focused firm
Inevitably, companies that attempt to be all things to all people begin to struggle when upstart competitors start picking off profitable niches. Often, the decline is not taken seriously until it’s too late.
However, some incumbents have managed to compete effectively with their more-focused rivals, and there is much to learn from their experience. The common thread in their competitive responses to upstarts is the capacity to become “multi-focused”. In other words, they stopped trying to cover the entire waterfront with a single-service model. Instead they pursued multiple niches with optimised-service models — each designed to achieve excellence on some dimensions at the expense of inferior performance on others. The secret to success in a multi-focused firm is the ability to benefit from having various service models under one house umbrella. This benefit often comes in the form of shared services (that is, internal service providers), which enable a firm to generate economies of scale and economies of experience across its service models. Effectiveness at utilising shared services to the advantage of the individual service models can determine the success of a multi-focused firm.
The shared services architecture can be seen in multi-focused corporations across industries — from Yum Brands, a collection of five fast-food companies, to Omnicom, which consists of hundreds of companies in the interactive marketing space, to GE, which seems to have no limit on the markets it can enter. Each corporation has created distinct service models for distinct customer operating segments, along with gauging the overall benefit of the models by assessing how much they gain from one another.
What determines whether a company has assembled the right portfolio of service models? It comes down to a critical test: Is each of the firm’s distinct service models better off as a result of the others? If the answer is no, it signals that performance is about to decline or the company may want to spin off some service models. If the answer is yes, it’s almost always thanks to superior management of shared services, with the incumbent thriving.
The services shared in multi-focused companies typically include business functions like finance, purchasing, information technology, human resources and executive training. The scale advantages they provide are straightforward and include pooled purchasing, preferred access to credit and other cost-related benefits. Economies of experience are more difficult to realise, but can also be more valuable. Here, the challenge is to use knowledge gained in one service model to strengthen the performance of the others. To a limited extent, this kind of knowledge transfer occurs informally; this has always been the hope and promise of diversified companies. The important difference in successful multi-focused firms is they formalise the process, designing explicit ways of leveraging experience across service models.
My research convinces me that the best means of sustaining growth in a service business is to employ the multi-focused model, yet it is also evident this model requires concentrated effort to defend. Leaders of individual service models constantly assert that dedicated resources, rather than shared, would do more to strengthen their own businesses. Operation managers, meanwhile, raise a chorus of complaint that shared services require more vigilant control “below the line”, if they are to deliver the necessary economies of scope and experience. Given the perpetual assault on the model, it may not be surprising that another common characteristic of successful multi-focused firms is directive (even autocratic) leadership. This leadership style accommodates different personalities, but it always relies on senior managers who are able and willing to exert strong influence on subordinates. They must be, in order to balance the competitive autonomy of individual service models with the collective value of shared services. Without strong, centralised leadership, revenue-generating line managers typically overrule shared-services managers, particularly in moments of strategic distress.
The management-practice frontier
Management scholars, and not a few practitioners, have taken up an interesting debate in recent years: Is the discipline of management fundamentally different in service businesses than in product businesses? The way in which management is studied and taught in graduate business schools was forged in the context of the industrial economy. Are the approaches that worked for manufacturing companies equally applicable to services?
As service businesses continue to innovate, succeed and be studied, the answers are becoming clearer. The framework presented here suggests why the traditional techniques have proved as durable as they have and why they still leave sophisticated managers wanting more. Much of what determines the health of a product business — the soundness of its offering and the management of its people — is just as indispensable in a service business and can be addressed with a similar tool kit. New areas involving customers have opened up and their tool kits are being assembled.
Harvard Business Review
Frances X Frei is an associate professor of business administration in the technology and operations management unit at Harvard Business School in Boston.Tony Darby is the chief information officer of Excell Corporation and was named Computerworld CIO of the Year in 2001 when working at the Auckland Regional Council. He explains why this Harvard Business Review article should be at the top of reading lists for ICT executives.
“IT is usually a mix of service and product delivery. Most management tools have been designed to accommodate product delivery and the author Frances Frei asks the question if these are sufficient while offering some interesting concepts:
“Four elements of service delivery are evaluated and strategies to achieve excellence are explored. I would hate to tell my CEO that service excellence in one category needs to be at the expense of service excellence in another, or even that trying to be excellent at everything is the recipe for mediocrity. It’s an interesting concept that service excellence is defined by what we choose not to do well.”
He says the key themes in the article are: Focus more on the experiences customers want; Choose between service excellence paired with inferior performance, or mediocricty across all service delivery dimensions; Put in place the incentives that allow and motivate people to achieve; The old adage is ‘hire on skill, fire on behaviour’. It’s the behaviour that drives and reinforces the service excellence; Many IT departments are
effectively multi-focused service delivery firms servicing the organisation.
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