| By: By Paul Mulligan

Services represent an increasingly large proportion of both gross domestic product and labor force of most developed economies. Proponents of service sector growth cite these statistics as evidence of a robust economic sector, while critics contend these statistics arise due to poor productivity growth rates and inefficiencies inherent in services.

For practicing managers, this argument is specious at best. Their challenge is more direct: How best to foster growth and profitability within their service environment. Services are incredibly diverse nowadays, so one size does not fit all in the pursuit of growth and profits. Researchers previously differentiated among services based upon the degree of direct customer contact. The pervasive use of technology to support virtual service markets renders this perspective obsolete. Below, I show how companies can reconceive the way they differentiate their service offerings, and then suggest why this impacts their service quality and profitability.

The New Continuum

Differentiation in today’s service environments depends upon less tangible factors, such as the degree of reliance on provider expertise, richness of information transfers, and the degree of customization required to complete a service interaction. At one end of the resulting continuum are highly standardized transaction-based services that require limited levels of provider expertise and judgment. These services involve limited provider discretion and are typically characterized by relatively brief exchanges of explicit information. At the other end are relationship-based services defined by high levels of customization, significant reliance on provider expertise and rich, contextual information exchanges that may extend beyond the time of service delivery.

The financial services industry provides compelling examples of superior operating capability along this continuum. Northwestern Mutual, the “quiet company,” relies heavily on lasting relationships with both agents and clients. Northwestern continues to be the leader in their industry in employee-agent-insured retention and profitability. By contrast, companies such as ING and Capital One rely on higher volumes of smaller dollar transactions to drive growth and profitability. These organizations developed superior transaction-based operating capabilities as a source of competitive advantage. Many local and regional banks focus on mid-continuum fulfillment processes to support lending and local banking services. These smaller organizations lack the scale necessary to profit from transaction services and the depth of expertise expected by customers of higher dollar relationship services. The scale and diversity of giants such as Bank of America dictates that they develop capabilities throughout the continuum from relationship-based to transactional service offerings.

The Importance of Loyalty

Service leaders might question why the elements of service differentiation are important to them. The answer is simple: service quality is a function of customer experience, and organizations cannot improve customer experience unless they fully understand the factors that drive service excellence in their environments. Furthermore, customer experience is the primary driver of customer loyalty, which ultimately drives profitability.

How does this relationship work between customer experience, loyalty, and profitability? For starters, customer loyalty is a powerful driver of market share. Marketers often state that the repurchase decision is a buying decision not unlike the initial customer acquisition. However, truly loyal customers do not consider competitive options when repurchasing. This lowers provider costs, and increases margin for these repeat customers. Resources previously consumed in customer acquisition can now be redirected to further improving customer experience and developing improved or expanded service offerings. As noted by Fred Reichheld,1 these loyal customers become effective sales agents by referring the provider to potential new customers.

Most managers intuitively understand that customers evaluate their experience based upon the gap that exists between pre-encounter expectations and post-encounter perceptions of service quality. However, managers often don’t know the factors that influence that gap and, therefore, are unsure of where to focus capability development in order to improve customer experience. Achieving superior performance requires consistent, targeted investment in the critical attributes that drive service quality within your service environment. For transaction-based services, investments in cost dampening information technology and lean process development can enhance performance. Relationship-based services require deeper commitments to developing employees, processes, and control systems that encourage and reward customer-centric behaviors.

How do we train managers to recognize the variability in service and make the right investments in human and organizational capability development, particularly when economic conditions predispose them to focus on the bottom line only? First, we need to refocus their attention on managing top-line growth as well. Then, we need to get them to focus more holistically on the interdependence between their service delivery system operating capabilities and customer experience.

One way to put the focus on this interdependence is simulation. In simulation-based executive education, management teams compete with one another, while also working collaboratively with team members to effect consistent, aligned decisions to development organizational capabilities. Our service simulation, First Service, rewards consistent, strategically aligned decisions, and penalizes misdirected or inconsistent decision making. First Service also requires managers to make goal-congruent decisions while managing a significant number of decision inputs and performance metrics. We customize First Service for our clients, creating a balanced set of performance measurement criteria that are consistent with the competitive landscape of the host company. The simulation requires that all competitive and market variables be addressed simultaneously and each round of decision making creates a new set of financial and comparative market reports.

Peter Drucker once advised that “checking the results of a decision against its expectations shows executives what their strengths are, where they need to improve, and where they lack knowledge or information.” This is just what participating managers do as they see the impact of their decisions reflected in cash flow, income statements, and balance sheets.

For more information about First Service or First Service training programs, please email Paul Mulligan or call 781 239-4595.

  1. Reichheld, Fred: Loyalty Based Management: The Hidden Force Behind Growth, Profits and Lasting Value, HBS Press, 1996; The Ultimate Question: Driving Good Profits and True Growth, Harvard Business Review Press, 2006.