CHAPTER 8
MANAGING PRODUCTIVITY IN SERVICE ORGANIZATIONS

“The productivity of service operations is not an internal affair. In service customers decide what is high productivity and what is not.”

INTRODUCTION

The productivity concept as it has been developed for manufacturing firms cannot readily be used in service contexts. In this chapter the problem is discussed in detail. The shortcomings of a traditional manufacturing-based productivity concept are analysed, and a service productivity concept is developed. It is observed that in service organizations decisions based on traditional productivity measurements will almost always lead in the wrong direction. Internal and external consequences have to be taken into account simultaneously if productivity is to provide management with meaningful guidance. In the final sections of this chapter the possibility of creating measurement instruments is explored. No final calculation models can yet be offered. The theoretical understanding of service productivity has to be developed further before robust measurement models can be developed. After reading this chapter the reader should understand the problems of a traditional manufacturing-oriented productivity concept in service contexts and the pitfalls of using productivity measurements based on such a concept. The reader should also understand the nature of service productivity and how service productivity measurements could be made and, finally, know how continuous learning in a relationship contributes to productivity.

PRODUCTIVITY: MANAGING PROFITS, NOT COSTS

In many organizations managers seem to misunderstand the meaning of productivity. Frequently, productivity is more or less seen as cost efficiency, and productivity management only or predominantly as the management of internal efficiency. Productivity as a concept comes from product manufacturing and from a closed system without external interference. Customers are not influencing the manufacturing processes, and moreover, are not exposed to such processes and influenced by how they are organized and function.

In conventional productivity models, the objective is to ensure effective management of profits. In practice, it is assumed that when input resources into the processes are changed, and for example, less expensive resources or production processes are introduced, the quality of the production output, the products, can be controlled. Therefore, in situations where more cost-efficient resources or processes are used, revenues generated by production outputs can be expected to remain unchanged but unit costs of production go down. Costs are variable, revenues are fixed. In conventional manufacturing this means that by managing cost efficiency, productivity is managed at the same time. Productivity management becomes a shortcut to profit management, and internal efficiency of the firm’s processes becomes a proxy for profit effectiveness.

Problems occur when this shortcut to profit management is used in business environments where production is not a system closed to customers. What functions well in a closed system does not function in an open system, as a service organization is. When new input resources and processes are introduced in service operations, the production outcome, and its technical quality dimension, and the service process, and its functional quality dimension, do not remain unchanged. When managers in service operations mistake cost efficiency for productivity, and concentrate on managing internal efficiency only, disaster is around the corner. In service, it is imperative to realize that productivity management indeed is profit management, and no shortcuts exist. This creates a need for new knowledge and new productivity models.

THE PRODUCTIVITY DILEMMA: BALANCING REVENUES AND COSTS

Although some publications on service productivity have been published during the past decade or so, productivity as a concept has been largely neglected in service research.¹ It is often claimed that productivity is low in many service organizations and that service is produced using excess resources and at unnecessarily high cost. With another resource structure the service provider could cut costs and still produce as much as before. For example, banks are urging their customers to use ATMs, PCs and the Internet to take care of regular bank affairs instead of visiting a bank and occupying the bank employees’ time. Insurance companies have established websites on the Internet and call centres for customer service, so that customers can interact over the Internet or telephone instead of by visiting customer service employees. Airlines are forcing their customers to turn to self-service check-in systems. The reason for these changes in resource structures is of course to shift from expensive resources in the service process to cheaper resources. If customers perceive that they receive the same quality as before, or perhaps even better quality, these changes have been successful.² They have been cost-effective and at the same time maintained or improved the firm’s revenue-generating capability.

However, cost-cutting changes in the resources used may well have the opposite effect. Perceived quality may deteriorate and customers may become dissatisfied and start to look for other options. The service provider’s revenue-generating capability thus declines.

The problem with being an effective service organization is that productivity and perceived quality are inseparable phenomena.³ Therefore, managers in service organizations must never revert to cost efficiency management only. As Anderson et al.⁴ observe, improving customer satisfaction and productivity may turn out to be incompatible goals. Improving productivity may have a neutral or positive impact on quality, but equally it may damage perceived quality. If the latter happens, satisfaction with quality declines and the risk that the firm will lose customers increases. Revenues go down, and this may have a negative effect on the firm’s overall financial results, even though costs may also have been reduced. As productivity is a proxy for profitability, or profit, this development is in reality not a productivity improvement.

This is the dilemma in service processes. Improved internal efficiency following the introduction of more cost-effective production resources and processes does not necessarily lead to better economic results. In fact, while using a traditional productivity terminology, what is considered to bring about an increase in productivity – that is, improved internal efficiency – often has the opposite effect in service organizations. This leads to decreasing service quality and, as a consequence, to lost revenues. The obvious conclusion is that in service contexts productivity cannot be understood without simultaneously considering the interrelationship between internal efficiency and perceived quality (external effectiveness).⁵ Hence, internal efficiency, which equates to cost efficiency, cannot be managed separately from external effectiveness, that is a firm’s capability of producing a certain level of perceived service quality with a given resource structure.⁶ Especially in service processes where the role of the employees is essential, ‘if a firm improves productivity by “downsizing”, it may achieve an increase in productivity in the short term, but future profitability may be threatened if customer satisfaction is highly dependent on the efforts of personnel’.⁷

Because the quality of the production output in manufacturing is not impacted by cost-saving changes in the production system, the revenue side can be neglected in the productivity equation. In service the quality level is impacted by such actions and therefore revenues are influenced as well. Both costs and revenues are variable. Hence, effects on revenues of cost-saving actions must always be included in productivity models and measurements.

In conclusion, following a traditional productivity concept firms are used to treating the management of productivity as an internal issue where revenue effects can be omitted from the calculations. They measure the level of productivity from an internal efficiency perspective and, because of a constant-quality assumption, take for granted that the external effects on quality are under control. The constant-quality assumption implies that production inputs can be changed without a negative impact on the quality produced. However, in service the situation is the opposite. Productivity is not evaluated internally by managers, but externally by the customers, who make external judgements of the productivity of a service operation. This, of course, does not exclude the importance of taking into account the internal efficiency aspects of service productivity as well. However, because the constant-quality assumption does not apply in service, the customers have the last word.

To clarify the discussion of service productivity, Table 8.1 describes central concepts and terms as they are used here. Some have been discussed and defined in previous chapters.

SHORTCOMINGS OF MANUFACTURING-BASED PRODUCTIVITY CONCEPTS AND REQUIREMENTS OF A SERVICE-BASED CONCEPT

The goal of productivity management is to create profit effectiveness – in other words, to manage the economic results. Because, by increasing productivity, an unchanged or even improved customer perceived quality is produced using fewer resources or using resources in a more efficient way, the economic results are assumed to improve. As long as this is the case, managing productivity makes sense. If improved productivity does not lead to better economic results, there is no profit effectiveness, and in that case increasing productivity does not make sense.

Existing productivity models and productivity measurement instruments are based on assumptions of closed systems, where consumption and production are separate processes and customers do not participate in the production process as co-producers. In traditional manufacturing,⁸ these assumptions make sense of course. In service contexts, where the service production process is largely an open system, they create confusion, give rise to misleading measurements and guide decision-making in the wrong direction. In Table 8.2 assumptions underpinning the traditional manufacturing-oriented productivity concept and characteristics of service are summarized.⁹

TABLE 8.1

Definition and description of central concepts and terms used.

Concept/term	Definition and/or description
Productivity	Efficiency and effectiveness in the process of transforming input resources in a service or manufacturing process into customer value and hence also into profitable operations. Productivity is profit management.
Traditional productivity concept	The conversion of production resources into output, or the ratio between output from the production process and input into that process, given a constant quality level (the constant-quality assumption).
Internal efficiency	How efficiently outputs can be produced using a given amount of production resources and a given production process.
Cost efficiency	Synonym for internal efficiency; capability to manage costs.
External effectiveness	How effectively perceived service quality can be produced using a given amount of production resources.
Revenue effectiveness	Synonym for external effectiveness; capability to manage revenues.
Revenue-generating capability	The degree to which the perceived service quality capability enables the service provider to generate sales and revenues.
Capacity efficiency	How efficiently the production capacity is used for serving customers (excess supply lowers capacity efficiency; excess demand may affect perceived service quality negatively).
Profit effectiveness	How efficiently and effectively production resources are used, blending external effectiveness and internal efficiency, and capacity utilized, to produce economic results. Profit effectiveness is the ultimate internal goal for productivity-improving actions and programmes; value for customers is the ultimate external goal.

The characteristics of service and the assumption underlying the traditional productivity concept make traditional productivity models and measurement instruments less useful as such for service organizations. For example, how raw materials are used in a restaurant to produce a given number of meals can be calculated using manufacturing-oriented productivity methods, and this information is undoubtedly valuable for the restaurant. However, it has nothing to do with the productivity of the total restaurant operation. A totally different approach to productivity has to be taken to measure how well a service provider uses resources to create output in the form of acceptable perceived quality and support to customers’ value creation, and hence to create profitable operations and an improved economic result. In service processes, where a firm provides customers with a highly standardized infrastructure, such as a telephone receptionist or a fast-food cash register, the service provider comes close to a closed production system resembling manufacturing. As long as the infrastructure functions without problems and the customers know how to operate it, traditional assumptions for understanding and measuring productivity apply to a large extent. However, in most service processes, even in high-tech services, the characteristics of service in Table 8.2¹⁰ apply. There, traditional productivity models and measurement instruments are more misleading than valuable.

TABLE 8.2

The service productivity dilemma.

Assumptions included in the manufacturing-oriented productivity concept	Characteristics of service affecting productivity in service contexts
Production and consumption are separate; productivity measured in a closed system → perceived quality is dependent on outcome only (technical quality).	Production and consumption are partly simultaneous processes with quality-influencing interactions, i.e. an open system. → perceived quality is dependent on both outcome and process (technical and functional quality). → difficulties in separating production input from output.
Customers do not participate in the production process (closed system) → perceived quality is not influenced by the production process.	Customers participate in the service process (open system). → uncertainty of customer-induced input in the service process; their effects vary from situation to situation. → customer-induced input affects the efficiency of firm-induced input in the process. → perceived quality is also influenced by the service (production) process (the functional quality dimension).

Source: Adapted from Ojasalo, K., Conceptualizing Productivity in Services. Helsinki, Helsingfors: Hanken Swedish School of Economics, Finland/CERS, 1999, p. 59. Reproduced by permission.

Because the service production process and consumption are partly simultaneous processes, where customers actively participate as co-producers, the resources used to produce service cannot be totally standardized. It is difficult to relate a given number of inputs, in volume or value terms, to a given number of outputs. Frequently, it is even difficult to define ‘one unit of service’. The traditional manufacturing-based productivity concept can be described with the following formula:

In traditional manufacturing inputs used can be measured in monetary terms as cost of production, and because of the constant quality assumption, a decrease of the cost level equals improved productivity. Because the output quality can be kept constant, revenues will not be affected by changes in input resources and processes. Therefore, from a commercial point of view, in traditional product manufacturing, the productivity formula takes the following form:

Only if the quality of the production output is constant can productivity be measured using traditional methods. This constant-quality assumption is normally taken for granted and, therefore, not explicitly expressed. As an unfortunate consequence, the critical importance of this assumption is easily forgotten. However, traditional productivity measurements only make sense in service contexts when the constant-quality assumption applies. In most service processes it does not apply. Consequently in service the productivity formula takes the following form:

In situations where the constant-quality assumption can be taken for granted in productivity management, revenue effectiveness is not an issue. A stable quality level is a guarantee of stable revenue streams. For service providers, however, revenue effectiveness considerations cannot be omitted, and therefore they become an integral part of productivity management. If they are not taken into account, productivity as profit effectiveness is not managed, only internal cost efficiency. From a commercial standpoint, service productivity can be illustrated with the following formula:

In service, it is not only the input that is difficult to calculate, it is also difficult to measure output. Output measured as a volume is only useful if customers are willing to buy this output. Unlike in manufacturing, in service we do not know whether customers will purchase the output produced using a different input structure or not. It depends on the effects on perceived process-related functional and outcome-related technical quality of the new inputs used. Hence, the interrelationship between the use of input or production resources and the perceived quality of the output produced with these resources has to be taken into account in service productivity.¹¹ In other words, the interrelationship between internal efficiency (cost efficiency) and external effectiveness (revenue effectiveness) is critical for service productivity.

In the limited number of publications on productivity in service that exist, the authors normally suggest that service productivity is managed as internal efficiency only, and somehow related to the management of service quality.¹² However, this is not according to the fundamental idea of the productivity concept as an instrument for managing profit effectiveness. Moreover, such an approach does not guarantee that perceived quality effects are properly taken into account. In a recently published article, Parasuraman concluded that strategies to improve productivity and service quality, and also innovation, are likely to be suboptimal, if they are pursued in isolation. Instead integrated strategies should be developed.¹³ Therefore, we present a service productivity concept which incorporates both internal efficiency (costs) and external effectiveness (perceived quality, revenues) and strives to integrate them into one model.

THE INTERRELATIONSHIP BETWEEN PRODUCTIVITY, QUALITY, CUSTOMER PARTICIPATION AND DEMAND

Because customers participate as co-producers in the service process and influence the process and its outcome, the customer’s role in productivity is also different in service contexts to that in manufacturing (see Table 8.2). We can distinguish between:

• Provider-induced contribution to productivity.

• Customer-induced contribution to productivity.

• Interaction-induced contribution to productivity.

The first contribution is provider participation in the service process. For example, for a hair stylist, his professional and communication skills, time available, the equipment, physical products used in the process, enhancing services and goods such as coffee, tea and magazines form the provider participation in the process.

The customer and fellow customers provide customer-induced contributions to productivity, such as information, self-service activities, inquiries and complaints. In the hair stylist example, the accuracy of the customer’s requests and her ability to provide correct information to guide the hair stylist in cutting her hair are customer-induced contributions to the process. The customers’ actions do not only give the input needed to produce the service, they also influence the way the employees and technologies in the service process function. Depending on how well the hair stylist and the customer can relate to and communicate with each other, the interactions that occur will contribute more or less to the perceived quality of the process, and sometimes also to the internal efficiency. This is an interaction-induced contribution to productivity.

The provider-induced, customer-induced and interaction-induced contributions do not only influence service productivity but quality as well.¹⁴ Quality and productivity are thus two sides of the same coin.

In addition, productivity is influenced by demand. If demand is low, the service provider’s resources will be underutilized, which means that internal cost efficiency decreases, with a negative effect on productivity. A given cost level produces fewer revenues and the operation turns less profitable. In manufacturing, inventories can be used to offset this effect. In service, this is not possible. When there is a demand that meets the provider-induced resources in the service process, internal efficiency improves and a positive effect on productivity is created. When demand starts to exceed what can be managed with existing resources, external effectiveness decreases, which has a negative effect on perceived service quality and on revenues and profits. Hence, demand is also a critical productivity factor in service. In Figure 8.1¹⁵ the interrelated factors in service productivity are illustrated schematically.

FIGURE 8.1

Productivity, quality, customer and provider participation and demand as productivity factors in service contexts.
Source: Gummesson, E., Productivity, quality and relationship marketing in service operations. International Journal of Contemporary Hospitality Management, 10(1); 1998: p. 9. Reproduced by permission of Emerald Insight.

The shaded areas of the provider participation and customer participation boxes depict the parts of the provider’s resources and the customer’s resources that are used in interaction with each other (in service encounters). Part of provider participation takes place in a back office, where internal service is produced. On the other hand, customer participation sometimes also takes place outside the interactions with the service provider. For example, when making a telephone call the service is produced by two customers who are interacting with each other. The telephone operator only indirectly supports the service process by providing the telephone infrastructure. For example, IKEA, the Swedish furniture chain, provides its customers with packaged furniture in a box which includes parts, bolts and tools and instructions for assembly. The customer is then expected to continue the service process which started in the shop by assembling the furniture at home. Here again the service provider only indirectly supports the service process in the customer’s home by providing tools and instructions.

From a managerial point of view, the following aspects are important in productivity management in service organizations:

• When the service provider designs its input into the process, an optimal balance between perceived service quality and the firm’s revenue-generating capability (external effectiveness) on the one hand and cost efficiency of resources used (internal efficiency) on the other hand must be maintained.

• The service provider’s resources (provider participation) must contribute to interactions with customers in the service process in a way that creates an optimal balance between perceived quality and internal efficiency.

• Customers must be chosen, educated, motivated and informed in such a way that they, through their participation in the service process, contribute positively to customer-induced quality and productivity as well as to interaction-induced quality and productivity.

• Demand must be managed so that a balance can be maintained between perceived quality and internal efficiency and thus also between revenues and costs.

The crucial point here is to pay attention to how changes in internal efficiency affect perceived service quality (external effectiveness). Longer waiting times and less customer attention from personnel may be the results of a change which increases cost efficiency in the resource structure. These effects can easily have a negative impact on the functional quality of the service process and perhaps also on the technical quality of the outcome. If this is the case, customers may be lost, revenues decline, and in the end the profit effectiveness of the service provider deteriorates. Then the ultimate goal for productivity improvements, a better economic result and improved profitability, is not achieved.¹⁶

On the other hand, actions that improve cost efficiency may have a neutral or even positive effect on perceived service quality. New configurations of inputs and a move to a new technology level may improve cost efficiency and have a positive effect on perceived quality as well. For example, a restaurant may offer a salad bar instead of serving salad at the table, to decrease its input resources. For those customers who appreciate this alternative the perceived quality is maintained or perhaps even improved. For the restaurant this shift has probably led to a more cost-efficient use of resources. In this case, both internal efficiency and external effectiveness, and hence also profit effectiveness, have improved, which is the ultimate internal goal for productivity-improving actions.

In conclusion, cost efficiency and managing costs form an important part of the management of productivity in service, as they do in manufacturing. However, because of the characteristics of service, cost efficiency is a more complicated issue in service contexts. In the next section we shall turn to the management of costs in service as one aspect of productivity management.

MANAGING COSTS IN A SERVICE CONTEXT

In a turnaround process in the 1980s that received a lot of international publicity in service industries and in service management literature, SAS (Scandinavian Airlines System), using a non-accounting language, introduced a useful division of costs. The costs of operating and administrating the firm were divided into good costs and bad costs.¹⁷ These cost concepts are not related to conventional terminology, such as fixed and variable costs, but they are managerially relevant and helpful tools for calculating cost efficiency and for service productivity management.¹⁸

Good costs are productive costs, because they improve an organization’s capability to produce high-quality service and thus enhance revenue. The costs of maintaining service encounters and back-office operations are mostly good costs. Also, the costs of training personnel, goods and service development, are examples of good costs. The connection between such costs and the enhancement of external effectiveness is obvious. Bad costs are costs that follow from unnecessary bureaucracy, heavy middle and top management layers, overstaffed departments and unnecessarily complicated and time-consuming operational and administrative routines. Changes in resource structure that decrease bad costs will have a positive effect on internal efficiency and at the same time either a neutral or sometimes even a positive effect on customer perceived quality and external effectiveness.

If management wants to improve productivity, achieve better results, or just cut costs as a means of enhancing the competitiveness of the firm, what is usually done? Far too often the main actions are to save costs of service encounter operations or back-office operations. Other staff and the management layers are left untouched. It is much easier to cut costs in operations than costs in other parts of the organization. If a firm is facing hard times with poor financial results, personnel training, product development efforts and external marketing activities are also often affected by cutbacks. What management does is to cut good costs leaving bad costs untouched. From this it follows that internal efficiency may or may not improve, but external effectiveness and customer perceived quality may be damaged, and the net effect is all too often negative. The firm’s situation is not improved, and the competitive position of the firm is worsened. The firm becomes a victim of the strategic management trap discussed in Chapter 3.

A clear distinction between good costs, bad costs and mandatory costs has to be made before any cost-saving actions are considered. Even if the firm is suffering from financial hardship, good costs, following from efforts such as improving the skills of customer contact employees or investing in new technology in service encounters, may have to be increased so that its competitiveness is improved or at least not damaged. Good costs should not be cut. Instead, bad costs should be focused on by management. Bad costs, not good costs destroy profits. First, bad costs and the sources of such costs have to be identified. Second, actions to eliminate or decrease bad costs should be taken.

The point is that all costs are not equal wherever they occur. Until a particular cost is identified as good or bad, action must not be taken to eliminate or decrease it.

PITFALLS WHEN USING A PRODUCTIVITY MODEL FROM MANUFACTURING

As mentioned, using a productivity model from manufacturing with its constant-quality assumption and concentrating on the cost side only may cause problems for a service organization and even lead to the opposite effect to what was intended. In Figure 8.2 the effects of using a manufacturing productivity model in product manufacturing and in service, respectively, are illustrated.

To the left in Figure 8.2, the manufacturing case is depicted. When increasing productivity is measured as internal efficiency only, due to the constant-quality assumption the quality of the outcome, the physical products, can be expected to remain unchanged. Therefore, the level of revenues is maintained and, because of the internal efficiency gains, costs go down and profit goes up. The right part of the figure illustrates what typically happens in a service organization. When productivity gains are sought through internal efficiency increases without paying attention to quality effects, perceived service quality tends to deteriorate. Because lower quality probably leads to lost revenues, the expected profit increase due to cost savings is not achieved. Lost revenues offset the cost savings, and in the end instead of going up, profit goes down.

In reality the development is not always as bad as illustrated above. Especially in situations where service firms operate in a bureaucratic manner, both the internal efficiency and customer perceived quality (external effectiveness) may be improved by streamlining the way the firm operates. Then bad costs are found in the service encounters as well. In a situation like this, using a manufacturing-based productivity model may very well at the same time benefit the firm as well as its customers, and hence also lead to improved profits. Also, in situations where new technology to be used in service processes is available, both internal efficiency gains and improved perceived service quality can be achieved. Using the Internet and IT technologies and other digital means may be ways of rising to a new and more cost-efficient technology level. As in the case of Internet banking, customers may not always immediately appreciate the new service processes, but in the end the service quality advantages of the introduction of new technologies are normally accepted by most, if not always all, customer segments. However, when the old-fashioned or bureaucratic service processes have been streamlined and/or the new technology has been adopted, and if the firm continues to cut costs, the problems with using a manufacturing model to achieve additional productivity gains demonstrated in Figure 8.2 will start to occur.

FIGURE 8.2

The relationship between manufacturing productivity (internal efficiency only), product and service quality and profitability.

In Figure 8.3 the challenge for a service firm looking for improved profits through productivity improvements is illustrated. As long as the service processes are unclear and bureaucratic or a new technology has not yet been adopted, a manufacturing productivity model may very well be effective. Internal efficiency is improved and because the streamlined service process or the new technology is appreciated by the firm’s customers, perceived service quality increases as well. Hence, costs go down and revenues go up, resulting in improved profit. However, eventually a turning point is reached. This breaking point, illustrated by the vertical dotted line in the figure, means that the manufacturing-like situation no longer exists and further developments require new, service-oriented productivity concepts and models. If the firm attempts to achieve further cost savings through internal efficiency improvement without paying due attention to how the quality of its service develops, the economic result and profitability easily starts to decrease. The actions that lead to a positive development before the turning point was reached become counterproductive. As illustrated in the right part of Figure 8.3, after the turning point perceived quality starts to deteriorate. The service process and the functional quality perception are probably hurt first, but eventually the outcome and the technical quality perception may also be impacted. When this happens, as was illustrated on the right side of Figure 8.2, the additional cost savings sought after the turning point are soon offset by the lost revenues that follow from a deteriorating service quality.

It is important for management in a service organization to realize that even if traditional manufacturing-oriented productivity models work at first, inevitably at some stage a turning point is reached. When this occurs, one must turn to new productivity concepts that are based on characteristics of service and service processes. Otherwise, what started as a favourable productivity and profit improvement process soon turns into a disaster. A problem exists in that there seem to be no models indicating when the turning point is reached – and managers are easily blinded by the initially occurring good results. Only by following how customers perceive the service process and the technical and functional quality of the service can one find out when the turning point has been passed and new approaches to productivity management are needed. Moreover, increasing turnover in the customer base and growing dissatisfaction among customer contact employees may be other signs indicated that the turning point has been passed.

FIGURE 8.3

Effects of using a manufacturing productivity model in service organizations.

In the following sections of this chapter a service-oriented approach to understanding productivity in service organizations will be explored and discussed.

A SERVICE PRODUCTIVITY MODEL

The discussion so far in this chapter has demonstrated that it is meaningless to develop a productivity concept for service organizations based on the management of internal efficiency (cost efficiency) and quantity of output only. Because of the characteristics of service and the service process, the management of external effectiveness (perceived service quality) of the quality of output has to be an integral part of a service productivity concept. Managing external effectiveness and perceived service quality is a matter of revenue effectiveness, because better quality normally means more sales and increased revenues, and vice versa. A third element of a service productivity model is the management of demand or capacity efficiency. This is because service providers cannot use inventories to cope with excess capacity or excess demand, as goods manufacturers can.

Hence, a service productivity concept can be described in the following way:

1. Service productivity = f (internal efficiency, external effectiveness, capacity utilization) or

2. Service productivity = f (cost efficiency, revenue effectiveness, capacity efficiency).

As we have seen, because in manufacturing quality is considered to remain constant and therefore no revenue effects of changes in input will occur in product manufacturing, external or revenue effectiveness can be eliminated from the productivity function. Because firms can use inventories as a buffer between excess demand and excess supply, within limits even capacity efficiency can be eliminated. In service this does not work. The service productivity model is illustrated in Figure 8.4.¹⁹

FIGURE 8.4

A service productivity model.
Source: Based on Ojasalo, K., Conceptualizing Productivity in Services. Helsinki: Hanken Swedish School of Economics, Finland/CERS, 1999, p. 71. Reproduced by permission.

From a productivity perspective the service process can be divided into three separate processes:

1. The service provider produces service in isolation from the customer.

2. The service provider and the customer produce service in interactions (service encounters).

3. The customer produces service in isolation from the service provider.

The service provider-induced inputs into the service process (personnel, technology, systems, information, use of time, etc.) influence the first two processes directly and, for example by providing the infrastructure for service consumption as in telephone communication, the third process indirectly (as illustrated by the black and dotted arrows, respectively). The customer-induced inputs (customer’s own participation and fellow customers’ participation as co-producers) directly affect the second and third processes, and indirectly affect the first, for example by providing information to back-office processes.

The more efficiently the service organization uses its own resources as input into the processes and the better the organization can educate and guide customers to provide process-supporting input to produce a given amount of output, the better the internal or cost efficiency of the service process will be. From the provider’s point of view, how customers produce service in isolation from the service provider has no direct effect on internal efficiency, but has a decisive impact on service productivity through customers’ perceptions of service quality and their corresponding willingness to contribute to the firm’s revenues.

Finally, the service provider and the customer influence the interactive part of the service process, leading to an interaction-induced contribution to productivity.

The output of the service process is twofold: quantity of output (volume) and quality of output (outcome and process).

The quantity produced is dependent on demand. If demand meets supply, the utilization of capacity or capacity efficiency is optimal. If there is excess demand, capacity is utilized to the full extent, but there may be a negative effect on the quality of the output. If demand is lower than potential output, the capacity is underutilized and capacity efficiency will be lower than optimal. For example, if the call centre staff is underutilized, the perceived quality of the service that is produced is good, but internal efficiency is low. On the other hand, if the call centre is understaffed, internal efficiency may be high but perceived service quality is probably low, because customers will have to wait for their calls to be answered and the employees will have a limited time for each call (low functional quality of the process). In addition, they may not have the time required to solve customers’ problems or give good advice, resulting in low technical quality as well.

Because of the characteristics of service, the quality of the output is partly manifested in the process (interaction-induced quality) and partly in the outcome of the process. As shown in Chapter 4, customers experience quality as the functional quality of the service process and the technical quality of the outcome, and filter the experiences of these two quality dimensions through the image of the company, resulting in customer perceived quality. The more effectively perceived quality is produced using a given amount of input (service provider’s input and customers’ input), the better external or revenue effectiveness will be, resulting in improved service productivity. On the other hand, if the perceived service quality goes down, because the available input is functioning in a less service-oriented way or the resource structure is altered in a way that decreases quality, external effectiveness is reduced and the firm’s revenue-generating capability is lowered. This has a negative impact on service productivity.

In conclusion, internal efficiency and the cost-efficient use of resources is one side of service productivity, and external effectiveness (perceived service quality) and the revenue-generating capability following the use of resources is another. In addition, the efficient utilization of resources so that demand and supply meet as much as possible has a positive impact on service productivity. As the service productivity functions shown at the start of this section illustrate, high service productivity requires that the three efficiency and effectiveness factors are blended in an optimal way. Increasing (internal) cost efficiency may have the opposite effect on (external) revenue effectiveness. On the other hand, improved internal efficiency following new ways of producing a service (for example, using the scenario at the beginning of this chapter, going from performing everyday bank services in bank offices to customers using ATMs, home banking, the Internet and mobile devices), may very well lead to an improved quality perception and thus to improved revenue-generating capability and external effectiveness at the same time as it lowers costs. In addition, how capacity is utilized (capacity efficiency) has to be taken into account.

This blending of the three types of efficiency is illustrated in Figure 8.5. The highest possible service productivity is achieved in the shaded area of the figure. However, achieving this may not always be possible, because higher external effectiveness and revenue-generating capabilities may require lower internal efficiency and cost efficiency. The optimal combination is dependent on the blend of revenue-generating capability and cost efficiency that optimizes the firm’s economic result, also taking into account the effect of the capacity efficiency that can be achieved.

In conclusion, to manage productivity in service organizations, an integrated service productivity concept, and realizing that a constant-quality assumption does not apply, is the only meaningful productivity concept. How to measure productivity based on a service productivity concept is another issue, which we shall turn to in the last section of this chapter.

FIGURE 8.5

Service productivity as a function of internal efficiency, external effectiveness and capacity efficiency.
Source: Ojasalo, K., Conceptualizing Productivity in Services. Helsinki: Hanken Swedish School of Economics, Finland/CERS, 1999, p. 161. Reproduced by permission.

LONG-TERM PRODUCTIVITY COUNTS

In order to produce acceptable quality, the service provider may have to invest in new technology and in training its personnel to be more customer-oriented. In the short run, say, for the first 12 to 36 months, this may increase costs more than it will generate additional revenue. However, this short-term perspective must not guide management decisions. In Western companies there is an established inclination to demand quick results and to reject actions that only pay off in the long term and show no short-term benefits. This is a devastating approach, the negative effects of which should be avoided as much as possible.

By such a strategy the long-term profitability of a firm could be sacrificed in the pursuit of quick revenues, often without management and shareholders even realizing it. However, a short-sighted outlook can easily lead to deteriorating customer perceived quality, which in turn leads to dissatisfied customers and lost business. If a firm’s market share is to be maintained, huge increases in its budget for traditional external marketing are then required, and in the long run even this may not help. A long-term perspective should, therefore, guide management decisions. If there is ever a conflict between short-term revenue and quality, quality considerations should come first. Focusing too narrowly on finances makes managers lose their long-term perspective and quality improvements that may be needed will not be achieved. By focusing first on quality, better financial results will follow. As Patrick Mene, Corporate Director of Quality and TQM co-ordinator of the Malcom Baldrige Quality Award-winning Ritz Carlton Hotel Company, once said: ‘You cannot improve a company’s financial performance merely by focusing on finances.’²⁰

An investment programme such as the one illustrated in this section will probably pay off in more internally efficient operations after, say 12 to 36 months. Applying a service productivity concept to improve productivity requires a long-term approach. Managers who do not realize this easily revert to a manufacturer-oriented productivity concept, which carries a high risk of making the wrong decisions for the long-term survival of the firm.

APPLYING THE SERVICE PRODUCTIVITY CONCEPT: IMPROVING PRODUCTIVITY AND QUALITY AT THE SAME TIME

As has been shown here, contrary to what is commonly thought, it is a mistake to believe that improving productivity and increasing service quality cannot be done simultaneously. All steps taken to improve service productivity should be based on (1) a thorough understanding of what constitutes good service quality, as perceived by customers, and (2) an equally thorough analysis of the firm’s processes and customer interfaces, and of how the firm operates to produce that quality; which resources (human, physical, technological and customer) are needed and which are unnecessary, and how effective or ineffective the systems and routines used. Good costs and bad costs have to be identified and kept separate. When these two pieces of research (external and internal) are compared, a strong basis will be established for improving productivity and quality simultaneously in a service organization. Next, ways of simultaneously improving service quality and service productivity will be discussed.

IMPROVING EMPLOYEES’ TECHNICAL SKILLS

High-quality service means, among other things, that employees know how to do things correctly. If they have inadequate skills, the technical quality of the outcome of the service process will be damaged. However, at the same time, customers will probably have to wait longer, and be more proactive themselves, to receive an acceptable technical quality. Moreover, they will perceive the lack of skills on the part of the employees. All these aspects of interactions with the firm lower the perception of the functional quality of the interaction process. At the same time, this lack of skills and the need for corrective action and the repetition of activities affect productivity. Consequently, improving the technical skills of a firm’s personnel may be a means of simultaneously improving quality and productivity.

SERVICE ORIENTATION OF ATTITUDES AND EMPLOYEE BEHAVIOUR

Unfriendly and negative attitudes and behaviour by personnel has a significant negative impact on the functional aspect of perceived service quality. Moreover, this has a backlash effect on productivity. Angry customers, by their reaction, tend to create problems for employees, which slows down the service process. Moreover, angry and dissatisfied customers may complain either on the spot or later, which creates extra work and lowers productivity. Service-oriented employees, on the other hand, enhance quality perception and thus enhance productivity. Of course, if, for example, employees spend an unnecessarily long time with each customer, which does not pay off even in the long run, a productivity problem may occur.

INTERNAL VALUES SUPPORTIVE TO GOOD SERVICE PRODUCTIVITY

Internal value systems in organizations that honour conventionality, risk aversion and behaviour inhibition may have an unfavourable impact on service productivity.²¹ The development of internal values that support good service, on the one hand, and make employees aware of the need to use resources intelligently, on the other, is a means of improving service productivity. At the same time, employees will have to understand the interplay between internal efficiency (costs) and external effectiveness (revenues) of their actions and behaviour in the service processes. Managers and supervisors have a decisive role in this process of forming internal values and culture (see Chapter 14 on internal marketing and Chapter 15 on service culture).

MAKING SYSTEMS AND TECHNOLOGY MORE SUPPORTIVE TO EMPLOYEE AND/OR CUSTOMER CO-PRODUCTION

If the operational systems and routines used are considered complicated, or difficult to handle or to understand, this may create problems for employees, customers or both. For example, if a customer service helpdesk receives too many inappropriate phone calls – for example, requests for general information – productivity and quality problems occur. For employees, this creates barriers to meeting customer service specifications and thus they are unable to care enough for the customers. For customers, it often means a long waiting time for help. Productivity and service quality are damaged. In this situation, a front-end automated device using modern call-centre technology that directs phone calls to the correct destination could be an appropriate solution. Thus, both service quality and productivity could be influenced favourably. Moreover, self-service technologies which customers find complicated and/or which do not consistently function properly also damage productivity (and perceived service quality). Self-service check-in at airports currently seems to be an example of this.

INDUSTRIALIZING THE SERVICE OPERATION

Applying manufacturing-like methods of operations as a means of improving service had already been suggested in the 1970s.²² Generally, industrializing a service means to substitute technology and automation for people. ATMs, insurance vending machines, Internet banking and Internet shops and automatic check-in machines in airports are examples of such an approach. In some cases industrialization is an appropriate way of improving both service quality and productivity. Today, when retail banks offer ATMs to customers who want to withdraw cash from their accounts with the convenience this provides but offer personal service when they want to discuss financial problems and opportunities, this way of industrializing the service works well. However, problems can arise if industrialization is offered for all types of service to all segments of customers in all situations, which is often the case. Productivity measured by internal measurements may increase, but service quality may decrease, and this may have a negative effect on the firm’s economic result, both in the short term and the long term. Hence, industrialization as a means of improving productivity and quality always demands extremely careful internal as well as external quality impact-oriented analyses to avoid errors.

USING THE INTERNET, DIGITAL SOLUTIONS AND INFORMATION TECHNOLOGY

The Internet and other digital means and information technology offer many opportunities for creating service processes which demand fewer resources from the service provider and at the same time are perceived as improved service quality by customers. Electronic commerce, Internet shopping and banking are examples of service processes with a different input configuration that lower costs and for many customers provide a high quality service. TV shopping is another example of how an information technology-based resource structure can be used to decrease costs and at the same time provide high-quality service to customers who appreciate this form of shopping. Mobile commerce-based telecommunication and digital TV have enormous potential to offer similar opportunities.

INCREASING CUSTOMER PARTICIPATION IN THE SERVICE PRODUCTION PROCESS

Another way of improving productivity and quality is to look at customer impact on the service process. There are, in principle, two ways of doing this. First, more self-service elements can be introduced. However, it is extremely important that this is not done simply for internal efficiency reasons. Customers have to see that benefits arise from participating in self-service processes. If they do not find those benefits, perceived quality suffers. Customers have to be rewarded for taking part in self-service elements, and they have to be motivated to do so. The other aspect of improving productivity and quality by paying attention to customer participation is to improve the participation skills of customers. Sometimes customers do not know exactly what they are supposed to do or say, how documents are to be filled out, and so on. This has a negative impact on the functional quality aspect; it may also affect the technical quality of the outcome. In addition to this, more of the employee’s time is required to ensure that customers fulfil their role in the service process. Thus, productivity is affected. Better-informed customers feel more secure, make fewer mistakes and need less unnecessary attention from employees. Consequently, they are more satisfied with the service. At the same time, there is a twofold effect on productivity. The customers speed up the service production process – by their input into the process they improve productivity, and employees can serve more customers, which also enhances productivity.

REDUCING THE MISMATCH BETWEEN SUPPLY AND DEMAND

Physical goods can be kept in stock, if demand is low; service cannot. If the demand curve has high peaks and corresponding troughs, service quality will probably be good in the latter situations, but at peak times too many customers present at the same time will lead to long queues, longer waiting times, less personal attention, and so on. At the same time, productivity is low, because too often the firm will have idle resources and low capacity efficiency. Hence, reducing the mismatch between supply and demand is a way of making quality more consistent and of simultaneously improving productivity. Using part-time employees may be one way of doing this, but it is not always successful. For example, when retailers replace professional sales clerks with part-time personnel without sufficient training, motivation and supervision, service quality suffers permanently, at slow times as well as at peak times. Another way of matching supply and demand is to attempt to manage the flow of customers. Offering better prices during slow periods and making customers change their consumption habits by means of communication are ways of doing this using traditional marketing activities.

In addition to these means of simultaneously improving service quality and productivity, there are other methods that can sometimes be used. Reducing the service level (quantity or quality), introducing new services (smartcards instead of credit cards or bus tickets) and substituting goods for services (new data transfer equipment replacing cable and mail services) are examples.

SERVICE PRODUCTIVITY AS A LEARNING RELATIONSHIP

Individual customers as well as organizations frequently engage in ongoing relationships with service firms, and manufacturers who face service competition also engage in relationships with customers where a range of services are included in a total offering to them. Hence, service productivity is frequently dependent on how the relationship proceeds. Relationships are learning experiences where both parties get used to each other and learn how to interact with each other so that errors, service failures, quality problems, information problems, etc. can be minimized. In other words, both the service provider and the customer gradually learn how to avoid errors and problems that create unnecessary costs for both parties, and have a negative impact on perceived service quality.²³ These effects of learning relationships on service productivity are illustrated in Figure 8.6.

Figure 8.6 demonstrates how the customer (in the upper part of the figure) gains experience of a service provider and the service process (or processes) as the relationship continues. It also shows how this has effects in two directions, on the ability to participate more effectively in the service process, thus improving internal efficiency (to the left in the figure) and on the perception of service quality, thus improving external effectiveness (to the right in the figure).

Following the upper part of the figure to the left, one can see an internal efficiency-improving learning process. More knowledgeable customers have what could be called a narrower competence gap than customers in earlier stages of the relationship, because their knowledge of how to act and, for example, what information input to provide, make the service process quicker and smoother. This enables more intense customer participation and co-production, which in turn results in higher internal efficiency (cost efficiency) and may also lead to improved external effectiveness (perceived quality and revenue effectiveness). Following the upper part of the figure to the right, one can see external effectiveness-improving effects of the same learning process. Customers become more aware of exactly what to expect and this creates a better match between expectations and experiences, which in turn improves external effectiveness (perceived quality and revenue effectiveness). It may also have a positive effect on internal efficiency (cost efficiency).

FIGURE 8.6

Effects of learning relationships on service productivity.
Source: Based on Ojasalo, K., Conceptualizing Productivity in Services. Helsinki: Hanken Swedish School of Economics, Finland/CERS, 1999, p. 194. See also Grönroos, C. and Ojasalo, K., Service productivity as mutual learning. International Journal of Quality and Service Sciences, Vol. 7, 2015 (forthcoming). Reproduced by permission.

In the lower part of Figure 8.6 one can see how the service provider, when it learns more about a customer, becomes more aware of the customer’s competence and can allow more intensive customer participation, and learns more about the their specific needs, wishes and expectations, and therefore can better tailor service for the customer. These processes make it possible for the service provider to adjust to the customer and take actions that improve both internal efficiency and external effectiveness. At the same time, due to this learning process, the service provider can try to persuade its customers to use its service in a way that levels out demand peaks and troughs, and can adjust its resources to account for customer demand so that capacity better meets demand. In this way the utilization of capacity (capacity efficiency) improves as well. The end result is improved service productivity.

From a productivity point of view, longer customer relationships are preferable, because they allow for mutual learning. Due to the learning effect, the more often relationships are broken and lost customers have to be replaced by new ones, the lower service productivity will be. Hence, customer retention is important for service productivity, and productivity in service is a learning experience.²⁴

MANAGING SERVICE PRODUCTIVITY

Service productivity theory has been developed only to a very limited extent. However, some guidelines for productivity management in service businesses can be presented. These guidelines are still quite rudimentary, but nevertheless helpful for management:

1. The first step is to distinguish between quality-enhancing good costs and bureaucracy-maintaining bad costs in the service processes. This information provides a starting point for making decisions about how to improve service productivity. Resources and processes which include good costs must be treated differently to bureaucracy-maintaining resources and processes.

2. Then clarify and systematize processes which include overlapping activities and unclear purposes, such that these processes are streamlined and double-work is avoided. In this way unnecessary cost-creating work can be avoided, and at the same time customers probably perceive the change as quality-enhancing. The customers’ experiences with streamlined service processes especially have a positive impact on the functional quality perception.

3. If possible, move to a new technology level. Introduction of more advanced technologies in service processes may have a positive effect on the customers’ perception of service quality (e.g. Internet banking) and at the same time improves the firm’s internal efficiency and lowers the cost level.

4. Also if possible, move activities which customers consider interesting and are willing to perform to the customers’ sphere. Self-service processes increase customers’ quality perception provided that they do not create unnecessary perceived sacrifice for them (increase relationship costs). Moving to self-service enables the firm to be more cost efficient. However, the customers must accept the self-service requirement and find it quality-enhancing, otherwise it does not work.

All these service productivity-improving actions aim at simultaneously increasing the internal efficiency (cost efficiency) as well as the external effectiveness (perceived service quality) of the service provider, which is at the heart of service productivity. However, one should remember that especially those actions which require customers to change their behaviour are not necessarily immediately accepted. Customers may have to be educated. However, if the customers do not eventually accept a suggested new role for them in the service process, this new self-service process will not be productivity-enhancing. It may lower the cost level, but may also hurt the firm’s revenue-generating capability even more, and may also have a negative impact on the firm’s image.

MEASURING SERVICE PRODUCTIVITY

In the final sections of this chapter, approaches to developing instruments for measuring service productivity will be discussed. As Parasuraman notes, metrics for measuring service productivity as an integrated concept are largely lacking.²⁵ No final solutions are provided, because there is not yet enough research available on how to measure service productivity to make this possible. However, suggestions for how to think and in which direction to go will be made.²⁶

In traditional manufacturing the constant-quality assumption makes it relatively easy to measure productivity. A measure of output is compared with a measure of input. If the ratio grows following alterations in the resources or resource structure used in production, productivity improves. Parts of the total service production process can be measured in a similar way. For example, the number of delivery trucks loaded in a warehouse per day, the number of phone calls that a call centre can handle in an hour or the percentage of seats in a restaurant occupied at any given point in time are examples of such partial productivity measures. They give management an idea of how efficiently these processes function from an internal perspective, which may sometimes be a useful piece of information. However, such measures must never be used to judge the overall productivity of these processes. Instead, measures of, for example, the number of calls received must always be accompanied by measures of the time spent with customers and the quality of the outcome of the call.²⁷ In service, productivity measurements must always include a measure of how a given input in the form of resources and resource structures affects perceived service quality and the revenue-generating capability of the organization. In addition, considerations of how well capacity is utilized must also be taken into account.

Because service productivity includes both cost efficiency and revenue effectiveness, the development of a global or total productivity measure has to incorporate both phenomena. A concept which includes both revenues and costs is, of course, profit. When capacity efficiency is included we get close to the profitability of the service operations. Capacity efficiency influences costs but also revenues where excess demand has a negative impact on quality. The interrelationship between quality, productivity and profit is complicated, but clear. In a previous chapter we discussed the relationship cost concept, which demonstrates how improved service quality as perceived by customers can decrease the cost level of the service provider, thus having a positive effect on both revenues and costs. In Figure 8.7 the complicated interrelationship between quality, profit and productivity is illustrated.

FIGURE 8.7

The interrelationship between quality, productivity and profit.
Source: Gummesson, E., Productivity, quality and relationship marketing in service operations. International Journal of Contemporary Hospitality Management, 10(1); 1998: p. 6. Reproduced by permission of Emerald Insight.

The figure is based on the fact that goods and service activities almost always appear in a symbiotic relationship. As the figure indicates, improved quality can be expected to have a number of internal and external effects, all of which have a positive impact on productivity. The same positive effects of improved quality also lead to a higher profit level. The effects of improved quality on revenues are shown in the left section of the figure, on cost in the middle section and on capital employed in the right section. As Evert Gummesson observes, quality, productivity and profitability form ‘triplets’, the parts of which are all related to the same phenomenon, the welfare of the organization, although they approach this from different perspectives.²⁸

Figure 8.7 demonstrates how the effects of quality and productivity improvements eventually lead to improved profit. As was concluded previously, as productivity is a proxy for profit the ultimate goal of productivity management is to achieve better profit effectiveness and economic results. Theoretically, the correct way of measuring global productivity is to measure how changes in production inputs impact on the level of perceived quality and how this, in turn, affects profits. In traditional manufacturing, due to the constant quality assumption, effects on revenue generation can be excluded from productivity measurement instruments. Therefore, measurements are reduced to cost-efficiency calculations. In service, where the constant quality assumption does not apply, effects on revenues have to be included. Hence, measuring service productivity becomes more complicated.

The next section will discuss various ways to measure service productivity and will suggest ways to develop service productivity measurement instruments.

HOW TO DEVELOP SERVICE PRODUCTIVITY MEASUREMENT INSTRUMENTS

Because external effects on perceived quality have to be taken into account in service productivity, a measurement instrument has to include the customer’s perspective as well. Taking an internal organizational perspective is not enough. This, of course, makes the development of measurement models much more complicated in service contexts than in traditional manufacturing, where paying attention to internal efficiency is sufficient.

As was said before, it can sometimes be useful to measure partial productivity, but only global or total productivity measurements give real information on how a service provider is performing. Table 8.3 gives three basic alternatives for productivity measurements.

TABLE 8.3

Alternative ways of measuring service productivity.

Physical measures are the traditional way of measuring productivity in general. The normal way of measuring service productivity has been to also use physical measures. This is natural, but misleading, because there was in the past no theory of service productivity and firms therefore had to borrow the manufacturing productivity concept. In an attempt to cope with the obvious problems of using physical measures in service operations, combinations of physical and financial measures have also been used. For example, in a restaurant the revenue per service employee or restaurant seat has been used to calculate partial productivity of personnel or physical outlets. The ratio between the number of customers served per period and the costs of operating the restaurant have also been used to find total productivity.

Using physical measures by themselves is misleading, because neither cost nor revenue effects are included. Using combination measures is also misleading, because they either omit cost considerations or exclude revenue effects. Other types of combination measures have also been suggested; one proposed measure that comes close to a pure financial measure is calculating ‘process value productivity’, which is the market value of what is produced minus the costs of the resources purchased, divided by the number of employee-hours per period used in the service process.²⁹

Purely financial measures are not normally used for measuring service productivity. This is probably because it seems difficult to calculate the value of the output of the service process. First, because of the heterogeneity of production inputs and customer participation in the service process, it is difficult to standardize output and assess a market value. Second, price fluctuations make it harder to use financial measures of output.³⁰ Table 8.4 shows the pros and cons of physical, financial and combined measures of service productivity.

Regardless of the problems involved, the only theoretically correct and seemingly practically relevant approach to measuring service productivity is to base productivity calculations on financial measures. In principle, the correct way of measuring service productivity as a function of cost efficiency (internal), revenue effectiveness (external) and capacity efficiency is the following measure:

As a global or total productivity measure of the operations of a service provider, the following measure can be used:

Hence, service productivity more or less equals the economic profit and profitability, and whenever possible productivity in a service organization is best assessed by measuring profitability or the economic result of an operation.

The perceived service quality following from a given resource structure as an input in the service process creates sales at a certain level. If the resource structure is changed, the cost level changes along with perceived quality and the revenue-generating capability of the service provider. A change in cost efficiency leads to a change in revenue effectiveness, and the result of this can be measured as the ratio between revenues and costs. This is a true measurement of productivity in service organizations. If revenues increase more than costs, productivity goes up. On the other hand, if a cost reduction leads to lost revenues, but the decline in revenues is less than the cost savings that have been achieved, productivity still improves. However, this may be a dangerous strategy, because in the long term it may lead to a negative image and unfavourable word of mouth, which in turn can have a further negative effect on revenues. Finally, cost reductions may lead to a bigger drop in revenues than is made up for by cost savings. If this is the case, service productivity declines.

TABLE 8.4

Characteristics of alternatives for measuring service productivity.

Physical measures	• Heterogeneity and intangibility aspects of services make physical measures inappropriate. • Physical measures ignore variations in quality. • Total productivity is difficult to measure because it is problematic to combine quantities of input resources. • Difficult to get precise information on quantities.
Financial measures	• Financial measures signal heterogeneity and intangibility aspects of services. • No price indices are needed because both the numerator and denominator of the productivity measure are monetary values of the same period.
Combinations of physical and financial measures	• The same problems are experienced as with physical measures. • Price indices are needed because neither numerator nor denominator is expressed in monetary values.

Source: Ojasalo, K., Conceptualizing Productivity in Services. Helsinki/Helsingfors: Hanken Swedish School of Economics Finland/CERS, 1999, p. 137. Reproduced by permission.

Service-oriented productivity measures should be derived from the two formulae above. However, one should bear in mind that there are problems with financial measures that should be observed. Revenue is not always a good measure of output, since price does not always reflect perceived service quality. It may also be difficult to assign capital costs correctly to respective revenues. Table 8.5 summarizes the advantages and limitations of revenue to cost ratios for measuring service productivity.

In conclusion, service productivity is much more complicated than traditional manufacturing productivity, because the constant quality assumption does not apply to service. In service, it is not possible to make use of the shortcuts for measuring productivity that can typically be used in traditional manufacturing. Examples of such shortcuts are excluding revenue measures from the productivity formula and using physical and combined measures. Service organizations have to take the long route to understanding and measuring productivity.

TABLE 8.5

Advantages and limitations of using the revenue/cost ratio for measuring service productivity.

Advantages

Limitations

Easy to compute and understand. Data from company records are easy to obtain. Takes into account all quantifiable output and input factors, and provides an accurate representation of the real economic picture of a service firm on an aggregate level. Output quality tends to be better taken into account than in volume-based measures (cf. point 2 in the right column). Reflects the level of capacity utilization, since all costs are incorporated in the denominator. Shows changes in productivity directly; no price indices are needed for comparisons. Easy to compare a firm’s productivity at any given moment with its past performance and objectives; and easy to compare separate units of a firm with each other.

Cannot be used in non-profit service sector. Revenues do not always provide a reliable illustration of output quality (cf. point 4 in left column), since prices do not always tend to reflect the perceived quality, especially for services which have been paid for in advance. Also, if the business is subsidized by government, if prices are regulated, or if competition is monopolistic, revenues may be a poor measure of output quality. Does not have the ability to explain reasons for changes in productivity or to show bottlenecks in performance. Assigning costs of capital correctly to respective revenues may be difficult, particularly at a detailed level. Data for computations are relatively difficult to obtain on service and customer levels, unless data collection systems are designed for this purpose.

Source: Ojasalo, K., Conceptualizing Productivity in Services. Helsinki/Helsingfors: Hanken Swedish School of Economics, Finland/CERS, 1999, p. 143. Reproduced by permission.

NOTES

1.  Grönroos, C., Service Management and Marketing. Managing the Moments of Truth in Service Competition. Lexington, MA: Lexington Books, 1990; Filitrault, P., Harvey J. & Chebat, J.C., Service quality and service productivity management practice. Industrial Marketing Management, 25(3), 1996, 243–255. Publications from the last 10 to 15 years include Parasuraman, A. Service quality and productivity: a synergistic perspective. Managing Service Quality, 12(1), 2002, 6–9; Grönroos, C. & Ojasalo, K., Service productivity: toward a conceptualization of the transformation of inputs into economic results in services. Journal of Business Research, 57(4), 2004, 414–423; Rust, R.T. & Huang, M-H., Optimizing service productivity. Journal of Marketing, 76(2), 2012, 47–66; Calabrese, A., Service productivity and service quality: a necessary trade-off? Internal Journal of Production Economics, 135, 2012, 800–812; Rust, R.T. & Huang, M-H., Optimizing service productivity. Journal of Marketing, 76(2), 2012, 47–66; Grönroos, C. Service Productivity. In Dahlgaard-Park, S.M. (ed.), Encyclopedia of Quality and the Service Economy, New York: Sage, 2015. See also Carlborg, P., Kindström, D. & Kowalkowski, C., A lean approach for service productivity investments: synergy or oxymoron. Managing Service Quality, 23(4), 2013, 291–304, where the authors discuss how a lean approach could improve service productivity without hurting customer value.

2.  It is often said that quality and productivity cannot be improved at the same time. This may sometimes be the case, but as a general rule this is not true. Quite frequently new technology, a new production system using resources in a new way or an altered customer participation pattern can contribute to better productivity and improved service quality at the same time. For one example, see Truitt, L.J. & Haynes, R., Evaluating service quality and productivity in the regional airline industry. Transportation Journal, 33(4), 1994, 21–32. For a more recent discussion, see Calabrese, op. cit.

3.  Grönroos & Ojasalo, op. cit. See also, for example, Parasuraman, op. cit., and Calabrese, op. cit. Johnston, R. & Jones, P., Service productivity. Towards understanding the relationship between operational and customer productivity. International Journal of Productivity and Performance Management, 53(3), 2004, 201–213.

4.  Anderson, E.W., Fornell, C. & Rust, R.T., Customer satisfaction, productivity, and profitability: differences between goods and services. Marketing Science, 16(2), 1997, 129–149: ‘if a firm improves productivity by “downsizing”, it may achieve an increase in productivity in the short-term, but future profitability may be threatened if customer satisfaction is highly dependent on the efforts of personnel’ (p. 129).

5.  Anderson, Fornell & Rust, op. cit., 129.

6.  Grönroos, C., op. cit.

7.  Anderson, Fornell & Rust, op. cit., 129.

8.  The phrase ‘traditional manufacturing’, is used because in modern manufacturing, through CAD/CAM techniques and Internet-mediated solutions, the customer is often involved in design and production. In such cases the manufacturing processes become partly open processes and start to resemble service processes. However, the existing productivity concept and measurement instruments are based on a traditional manufacturing context.

9.  The table is based on Ojasalo, K., Conceptualizing Productivity in Services. Helsinki/Helsingfors: Swedish School of Economics, Finland/CERS Centre for Relationship Marketing and Service Management, 1999; Sumanth, D.J., Total Productivity Management: A Systematic and Quantitative Approach to Compete in Quality, Price and Time. Boca Raton, FL: St. Lucie Press, 1997; Grönroos, 1990, op. cit.

10.  In modern manufacturing processes this does not always hold anymore.

11.  Grönroos, 1990, op. cit. See also Haynes, R.M. & DuVall, P.K., Service quality management: a process control approach. International Journal of Service Industry Management, 3(1), 1992, 14–24; Chase, R.B. & Haynes, R.M., Service operations management: a field guide. In Swartz, T.A. & Iacobucci, D. (eds), Handbook of Services Marketing & Management. Thousand Oaks, CA: Sage Publications, 2000, pp. 455–471, where the authors demonstrate the interrelationship between productivity and service quality, although they use a traditional manufacturing-oriented productivity concept. See also Vuorinen, I., Jarvinen, R. & Lehtinen, U., Content and measurement of productivity in the service sector. A conceptual analysis with an illustrative case from the insurance business. Internal Journal of Service Industry Management, 9(4), 1998, 377–386; Parasuraman, A., op. cit.; Rust & Huang, op. cit.; and Calabrese, op.cit., where the author discusses the need to combine the company-oriented and customer-oriented perspectives on productivity.

12.  See, for example, Parasuraman, op. cit.; Calabrese, op. cit.; and Rust & Huang, op. cit.

13.  Parasuraman, A., Service productivity, quality and innovation: implications for service-design practice and research. International Journal of Quality and Service Sciences, 2(3), 2010, 277–286. The challenge to integrate productivity and quality strategies in service has also been observed within the area of service science. See Maglio, P.P. & Spohrer, J., Fundamentals of service science. Journal of the Academy of Marketing Science, 36(1), 2008, 18–20. See also Luria, D., Yagil, G. & Gal, I., Quality and productivity: role conflict in the service context. The Service Industries Journal, 34(11–12), 2014, 955–973, which discusses employees’ ways of coping with the double messages that decisions about quality on one hand and productivity on the other hand send.

14.  See Gummesson, E., Productivity, quality and relationship marketing in service operations. International Journal of Contemporary Hospitality Management, 10(1), 1998, 4–15.

15.  Figure 8.1 is influenced by a figure in Gummesson, op. cit., 9.

16.  See Kontoghiorges, C., Examining the associations between quality and productivity performance in a service organization. The Quality Management Journal, 10(1), 2003, 32–43 and Dobni, D., A marketing-relevant framework for understanding service worker productivity. Journal of Services Marketing, 18(4–5), 2004, 303–312, where the authors analyse the relationship beween quality and productivity in service organizations from different angles.

17.  See Grönroos, op. cit.

18.  In a study of service productivity Katri Ojasalo added mandatory costs as a third category. Mandatory costs are unavoidable, even though they may not have an effect on external effectiveness and customers’ service experiences. Insurance is an example of such costs. See Ojasalo, 1999, op. cit.

19.  This Service Productivity model is slightly modified and further developed from a service productivity concept developed in a large study of the productivity in services by Katri Ojasalo. See Ojasalo, 1999, op. cit. Her study of service productivity is the largest and most innovative and thoughtful contribution to this field published so far. See also Grönroos, C. & Ojasalo, K., op. cit.

20.  Partlow, C.G., How Ritz-Carlton applies ‘TQM’. The Cornell H.R.A.: Quarterly, Aug, 1993, 22.

21.  Dobni, D., Ritchie, J.R.B. & Zerbe, W., Organizational values: the inside view of service productivity. Journal of Business Research, 47(1), 2000, 91–107.

22.  Levitt, T., A production-line approach to service. Harvard Business Review, Sept/Oct, 1972. See also Bowen, D.E. & Youngdahl, W.E., ‘Lean’ service: in defense of a production-line approach. International Journal of Service Industry Management, 9(2), 1998, 207–225.

23.  Ojasalo, 1999, op. cit. See also Grönroos, C. & Ojasalo, K, Service productivity as mutual learning. International Journal of Quality and Service Sciences, 7(2-3), 2015.

24.  Compare Reichheld, F.F., The Loyalty Effect. The Hidden Force Behind Growth, Profits and Lasting Value. Boston, MA: Harvard Business School Press, 1996. More generally the relationship between learning and productivity in product and service contexts is discussed in Argote, L. & Miron-Spektor, E., Organizational learning: from experience to knowledge. Organization Science, 22(5), 2011, 1123–1137.

25.  Parasuraman, 2010, op. cit.

26.  Typically, attempts to study productivity in services take only partial productivity into account, and usually only measure internal variables. See, for example, Dobni & Zerbe, op. cit., whoina very interesting study of the productivity impact of employees measure perceived role behaviour, organizational commitment and employee affect.

27.  See Coates, R., Measuring service productivity. Small Business Reports, 16(3), 1991, 22–25, where the interrelationships of quantity and quality in measuring productivity in services is discussed.

28.  Gummesson, 1998, op. cit. This proposition was originally put forward in a seminal paper on service productivity presented by Evert Gummesson at the 2nd International Research Seminar in Service Management arranged by l’Institut d’Administration des Enterprises d’Université d’Aix-Marseille in France in June 1992. See Gummesson, E., Service productivity: a blasphemous approach. In Gummesson, E. (ed.), Quality, Productivity & Profitability in Service Operations. Conference Papers from the QP&P Research Program 1992–1994. Stockholm University/Marketing Technique Centre, 1995, pp. 8–22.

29.  Edvardsson, B., Thomasson, B. & Øvretveit, J., Quality of Service. Cambridge: McGraw-Hill, 1994.

30.  For example, in Jones, P., Quality, capacity and productivity in service industries. In Johnston, R. (ed.), The Management of Service Operations. London: IFS Publications, 1988, pp. 309–321, the author argues against the use of financial measures.

FURTHER READING

Anderson, E.W., Fornell, C. & Rust, R.T. (1997) Customer satisfaction, productivity, and profitability: differences between goods and services. Marketing Science, 16(2), 129–149.

Argote, L. & Miron-Spektor, E. (2011) Organizational learning: from experience to knowledge. Organization Science, 22(5), 1123–1137.

Bowen, D.E. & Youngdahl, W.E. (1998) ‘Lean’ service: in defense of a production-line approach. International Journal of Service Industry Management, 9(2), 207–225.

Calabrese, A. (2012) Service productivity and service quality: A necessary trade-off? Internal Journal of Production Economics, 135, 800–812.

Carlborg, P., Kindström, D. & Kowalkowski, C. (2013) A lean approach for service productivity investments: synergy or oxymoron. Managing Service Quality, 23(4), 291–304.

Chase, R.B. & Haynes, R.M. (2000) Service operations management: a field guide. In Swartz, T.A. & Iacobucci, D. (eds), Handbook of Services Marketing & Management. Thousand Oaks, CA: Sage Publications, pp. 455–471.

Coates, R. (1991) Measuring service productivity. Small Business Reports, 16(3), 22–25.

Dobni, D. (2004) A marketing-relevant framework for understanding service worker productivity. Journal of Services Marketing, 18(4–5), 303–312.

Dobni, D., Ritchie, J.R.B. & Zerbe, W. (2000) Organizational values: the inside view of service productivity. Journal of Business Research, 47(1), 91–107.

Edvardsson, B., Thomasson, B. & Ovretveit, J. (1994) Quality of Service. Cambridge: McGraw-Hill.

Filitrault, P., Harvey, J. & Chebat, J.C. (1996) Service quality and service productivity management practice. Industrial Marketing Management, 25(3), 243–255.

Grönroos, C. (1990) Service Management and Marketing. Managing the Moments of Truth in Service Competition. Lexington, MA: Lexington Books.

Grönroos, C. (2015) Service Productivity. In Park-Dahlgaard, S.M. (ed.), Encyclopedia in Quality and the Service Economy. New York: Sage.

Grönroos, C. & Ojasalo, K. (2004) Service productivity: toward a conceptualization of the transformation of inputs into economic results in services. Journal of Business Research, 57(4), 414–423.

Grönroos, C. & Ojasalo, K. (2015) Service productivity as mutual learning. International Journal of Quality and Service Sciences, 7(2-3).

Gummesson, E. (1995) Service productivity: a blasphemous approach. In Gummesson, E. (ed.), Quality, Productivity & Profitability in Service Operations. Conference Papers from the QP&P Research Program 1992–1994. Stockholm University/Marketing Technique Centre, pp. 8–22.

Gummesson, E. (1998) Productivity, quality and relationship marketing in service operations. International Journal of Contemporary Hospitality Management, 10(1), 4–15.

Haynes, R.M. & DuVall, P.K. (1992) Service quality management: a process control approach. International Journal of Service Industry Management, 3(1), 14–24.

Johnston, R. & Jones, P. (2004) Service productivity. Towards understanding the relationship between operational and customer productivity. International Journal of Productivity and Performance Management, 53(3), 201–213.

Jones, P. (1988) Quality, capacity and productivity in service industries. In Johnston, R. (ed.), The Management of Service Operations. London: IFS Publications, pp. 309–321.

Kontoghiorges, C. (2003) Examining the associations between quality and productivity performance in a service organization. The Quality Management Journal, 10(1), 32–42.

Levitt, T. (1972) A production-line approach to service. Harvard Business Review, Sept–Oct.

Luria, D., Yagil, G. & Gal, I. (2014) Quality and productivity: role conflict in the service context. The Service Industries Journal, 34(11–12), 955–973.

Maglio, P.P. & Spohrer, J. (2008) Fundamentals of service science. Journal of the Academy of Marketing Science, 36(1), 18–20.

Ojasalo, K. (1999) Conceptualizing Productivity in Services. Helsinki/Helsingfors: Hanken Swedish School of Economics, Finland/CERS Centre for Relationship Marketing and Service Management.

Parasuraman, A. (2002) Service quality and productivity: a synergistic perspective. Managing Service Quality, 12(1), 6–9.

Parasuraman, A. (2010) Service productivity, quality and innovation: implications for service-design practice and research. International Journal of Quality and Service Sciences, 2(3), 277–286.

Partlow, C.G. (1993) How Ritz-Carlton applies ‘TQM’. The Cornell H.R.A.: Quarterly, August, 16–24.

Reichheld, F.F. (1996) The Loyalty Effect. The Hidden Force Behind Growth, Profits, and Lasting Value. Boston, MA: Harvard Business School Press.

Rust, R.T. & Huang, M-H. (2012) Optimizing service productivity. Journal of Marketing, 76(2), 47–66.

Sumanth, D.J. (1997) Total Productivity Management: A Systematic and Quantitative Approach to Compete in Quality, Price and Time. Boca Raton, FL: St. Lucie Press.

Truitt, L.J. & Haynes, R. (1994) Evaluating service quality and productivity in the regional airline industry. Transportation Journal, 33(4), 21–32.

Vuorinen, I., Jarvinen, R. & Lehtinen, U. (1998) Content and measurement of productivity in the service sector. A conceptual analysis with an illustrative case from the insurance business. International Journal of Service Industry Management, 9(4), 377–386.