CHAPTER 3
THE SERVICE PROFIT LOGIC AND SERVICE MANAGEMENT PRINCIPLES

“In service, costs and revenues are inseparable. The same resources, activities and processes drive both costs and revenues – and ultimately profits.”

INTRODUCTION

This chapter will discuss the nature of a service strategy, based on the service profit logic, and the importance of customer perceived quality. This includes a discussion of the pitfalls for service organizations of strategic management from a traditional manufacturing perspective, and the development of a service-oriented view of the business logic. Thus, the importance of a service-oriented approach to strategy and management is emphasized. Finally, service management as a management philosophy is defined and principles of this approach to management are discussed. After having read this chapter the reader should understand the Service Profit Logic and how it differs from a conventional manufacturing profit logic, and be familiar with the pitfalls of a traditional management approach in service contexts. Finally the reader should know how to apply a service logic to management and service management principles.

SOME TRADITIONAL AND POTENTIALLY DANGEROUS STRATEGY LESSONS FROM MANUFACTURING

For a manufacturer of goods, conventional managerial thinking generally includes, among other elements, three rules of thumb to follow in order to strengthen or maintain the competitive edge of a firm:

1. Decrease production and administration costs, to decrease the unit cost of products.

2. If needed, increase the budget for traditional marketing efforts such as advertising, sales and sales promotion in order to make the market buy the goods produced.

3. Strengthen product development efforts.

For conventional product manufacturing, these rules of thumb usually make sense. If production costs can be decreased, lower prices can be offered, or higher margins can be obtained. The consumption of physical goods can be characterized as outcome consumption – the customer consumes the outcome of the production process – and, regardless of the new, more effective and efficient production technologies and methods used, the outcome and the product quality remains the same. Economies of scale normally pay off. Moreover, sales and marketing efforts usually have a positive effect on demand. Continuous product development is of vital importance to manufacturing.

Assuming that the management of capital is sound, the long-term business success of any business is to manage revenues and costs successfully, such that a positive economic outcome is achieved. It is simplistic to say that profit equals revenues minus costs, but the business implications of this are far from simplistic. Misunderstanding these implications may turn out to be fatal. For conventional product manufacturing the business implications can be illustrated as the Manufacturing Profit Logic in Figure 3.1.

As illustrated by the Manufacturing Profit Logic, and the ground rules for product management outlined earlier, revenues are driven by sales and conventional external marketing mix activities – traditional marketing such as product design and packaging, advertising and other means of marketing communication, pricing and distribution. Marketing and sales are given the responsibility for successful external impact in the marketplace and marketspace. Production and a whole host of production-related and administrative processes, such as R&D, product development, manufacturing, logistics, order-taking, invoicing, complaints handling, human resource management, accounting and budgeting processes, and general administration are considered cost driving. Their immediate impact on revenues is thought to be minimal, and mostly only indirect through the manufactured products. This is due the fact the most of the manufacturing firm’s processes are closed to the customer. In other words, the internal efficiency of the firm’s processes, how the firm’s production and many administrative functions work, are considered to drive costs only, but not revenues, other than indirectly through the quality of the goods produced. The firm’s external effectiveness, how customers perceive the quality of products and why they are willing to purchase them, is mainly considered the responsibility of traditional marketing and sales.

FIGURE 3.1

The Manufacturing Profit Logic.

Internal efficiency and external effectiveness can be defined and described in the following way:

• Internal efficiency: efficient use of production (and administrative) resources; what traditionally, but not totally accurately, is called ‘productivity’.

• External effectiveness: the external effectiveness of the firm’s operations as perceived by its customers (in the form of customer perceived quality and customers’ willingness to pay a given price for an offering).

Internal efficiency is related to the way a firm operates and the productivity of labour and capital. It can, for example, be measured by the unit cost of the production output. External effectiveness, on the other hand, is the way customers perceive the processes and the process outcomes of the firm, or in other words, how customers perceive quality.

In conventional product manufacturing, internal efficiency and external effectiveness are treated as separate management issues, and cost drivers are not considered revenue drivers. Conventional management models are based on the situation described by the manufacturing profit logic. In conventional product manufacturing it works.

To sum up, according to this profit logic, sales and marketing are expected to be promise making, and therefore to acquire paying customers, as indicated by the thick arrow in Figure 3.1. By producing products for sales and marketing, business function other than these functions create costs and determine the firm’s level of internal efficiency (indicated by the dotted arrow in the figure).

Profit orientation is needed in service, too. However, if lessons from the manufacturing sector, and the Manufacturing Profit Logic, are followed unchanged, there is a risk that the firm will fall into a strategic management trap, or what Richard Normann called a vicious circle.¹ Before we discuss the strategic management trap further, it is important to define the commercial foundation of service, or the Service Profit Logic.

THE SERVICE PROFIT LOGIC

According to the characteristics of service and the service quality models (see Chapters 4 and 5 where perceived service quality is discussed in detail), resources and activities that have an impact on customer perceived quality and future buying and consumption behaviour can be found in most departments of the service firm. Production and other business functions traditionally considered internal to the firm affect customers’ behaviour. In service, operations management, management of human resources and marketing management are interrelated. Peter Drucker’s view that marketing, from the customer’s point of view, is too important to the firm’s economic result to be treated as a separate function is very valid indeed.²

As a consequence, other than partly, the profit and cost drivers in service are not the same as in product manufacturing. Because of this, managers in service business must consider the Service Profit Logic as a starting point for any strategies and business decisions. As Figure 3.2 shows, the Service Profit Logic is dramatically different from the corresponding Manufacturing Profit Logic.

We demonstrate in Figure 3.2 that decisions concerning business functions other than traditional marketing and sales, such as production and those functions responsible for a variety of customer contacts and what, in the previous chapter, was labelled recognized and hidden services, not only affect internal efficiency and costs, but also have a decisive impact on external effectiveness and revenues. Recognized services such as repair and maintenance, as well as hidden services, such as invoicing and recovering failures and quality problems, not only drive costs but often have a major impact on the firm’s power to generate revenues. Thus, the profit logic and how profit is formed through revenue and cost drivers change altogether. Decisions regarding internal efficiency and costs are to a large extent intertwined with external effectiveness decisions affecting the firm’s ability to generate revenues. In strategic management and in strategic as well as tactical planning processes, the revenue-generating effects of business processes other than conventional marketing and sales must be included.

FIGURE 3.2

The Service Profit Logic.

As further shown by the Service Profit Logic, decisions that simultaneously influence internal efficiency and external effectiveness should not be made before both the revenue-generating effects (external effectiveness) and the cost-generating effects (internal efficiency) of such decisions have been taken into consideration and analysed.

Because revenue-generating costs are needed to maintain a level of perceived service quality which makes customers willing to become and remain customers, revenue-generating costs and costs which predominantly enhance bureaucracy should be kept apart and treated in different ways. Moreover, from a business point of view, in relative terms, the effects on external effectiveness of planning the firm’s many processes is more important than the cost efficiency aspect, which of course must not be neglected either. In the long run at least, revenue generation is more important than cost consideration. Of course, in the short run, a firm’s situation may at times require more attention to costs. However, in the final analysis, external effectiveness and customer perceived quality drives revenues and profit. Costs have to be adjusted to meet this level of external effectiveness.

In other words, strategic planning and management should begin with the revenue-generating implications of a given decision, but of course, as an integrated process, cost implications should be considered. This is not to say that costs are of minor importance. Although perceived quality drives revenues, profits suffer if the service is produced with too high costs. Saving costs, in particular costs that do not contribute to the generation of revenues, is necessary in most firms, and monitoring costs is always of crucial importance. Sometimes the cost level can be reduced by encouraging customers to change their consumption habits. For example, banks have persuaded customers to use ATMs, and computer-based and Internet-based payment of bills instead of withdrawing money at bank counters, which costs more for the bank to administer. Airlines and airports are persuading travellers to use check-in machines instead of going to check-in encounters. And as research into the use of information technology in service shows, customers often appreciate the freedom from time and space restriction offered by Internet and mobile technologies.³ However if, for example, a cost-saving decision can be expected to have a negative impact on quality and revenues which is bigger than the cost reduction, it should probably not be made.

TABLE 3.1

The profit logic in manufacturing and in service organizations.

Manufacturing	Service
Internal efficiency and external effectiveness are separable.	Internal efficiency and external effectiveness cannot be separated other than partly.
Revenues and costs are driven by different processes.	Revenues and costs are largely driven by the same processes.
Decisions regarding internal efficiency and external effectiveness can be taken separately, i.e. they can be managed as different processes by different business functions.	Decisions regarding internal efficiency and external effectiveness cannot be taken separately, i.e. they have to be managed in an integrated process.

Not all production and administration resources and processes can be expected to have effects on revenue. As shown in Figure 3.1, there are interactive functions, with which customers have direct contact, and supporting functions, such as warehousing, information processing and other back-office activities, that through internal service indirectly influence perceived quality. Such functions are critical because they drive both revenues and costs. However, there are functions that, from the customer’s point of view, are totally invisible – such as some back-office and general administration processes. These functions are only cost-generating.

The differences in the profit logic between traditional manufacturing and service organizations are summarized in Table 3.1.

Standardization of service production, industrialization in a manufacturer-like manner, can be done in the truly invisible part of the organization. In the other parts of the organization, industrialization has to be implemented much more carefully if one wants to make cost savings without damaging perceived quality and the generation of revenue, and avoid destroying the competitive advantage of service (flexibility and adaptability; see Chapter 2).

Traditionally, external marketing activities and sales are considered to be more or less solely responsible for revenues. However, this is not true as far as service is concerned, and firms offering projects and any manufacturers of goods with extensive customer contacts by non-marketing persons face a new service-based reality as well. If the organization produces bad service quality, marketing communicaton and selling will not satisfy customers and make them buy again from that organization. The scope of marketing will have to be broadened. If the firm has to increase its traditional marketing and sales budget to maintain revenues and profit, this causes additional costs, as indicated in Figure 3.2.

To sum up, in addition to creating costs and influencing internal efficiency, as the thick arrow in Figure 3.2 indicates, other business functions than sales and marketing have an impact on the customers’ quality perception and willingness to pay a given price (external effectiveness), and thereby contribute to the firm’s revenue-generating capability in a decisive way. Sales and marketing make promises (the thin arrow) about the potential quality and value-creating support the firm intends to provide.

The Service Profit Logic has much more far-reaching management implications than for marketing only. The interconnectedness of revenue and cost drivers – external effectiveness and internal efficiency intertwined – influences, often even to a dramatic extent, at least the following management areas, which will be discussed in separate chapters in this book:

• Quality management (Chapters 4 and 5).

• Offering management (Chapter 7).

• Productivity management (Chapter 8).

• Marketing management (Chapter 9).

• Marketing communication management (Chapter 10).

• Brand management (Chapter 11).

• Human resource management (Chapters 14 and 15).

In the following sections we will first demonstrate the pitfalls of following a goods profit logic in service organizations (the strategic management trap), and then discuss how to avoid falling into this trap by implementing a service-oriented strategy based on the Service Profit Logic.

THE STRATEGIC MANAGEMENT TRAP

When the goods profit logic and manufacturing-based rules of thumb for management are followed, the consequences for a service provider may be those illustrated in Figure 3.3. We may assume, for example, that the service firm or any service organization, for example in the public sector, either has financial problems or foresees such problems, or is facing increasing competition, or both. Or the firm may for some other reason, for example in order to please shareholders, want to improve its internal efficiency. Irrespective of the impact of technology, labour costs are high in most service operations. In order to control costs, strategic decisions concerning personnel are often made: personnel reductions, a hiring freeze, full-time employees replaced by temporary staff, a greater degree of customer self-service, people being replaced by machines, and so on.

In manufacturing, such decisions should improve production efficiency, lower costs, yet have no effect on the output. They may even improve the quality of the goods produced. A favourable effect on productivity could be expected. In a service context some of this may happen. However, far too often none of these effects will occur, at least not in the long run.

As we have noted, in traditional manufacturing, the interrelationship between internal efficiency and external effectiveness is less important. Customers only perceive the physical output of the production process. In service organizations the situation is different. The consumption of service is process consumption and, according to the basic characteristics of service, the customer as a co-producer is involved in the production process and perceives not only the output of the process but parts of the process itself. In a service process an efficient manufacturing orientation, focusing primarily on internal efficiency, may easily alienate the customers, make the customers’ perception of quality deteriorate and in the end chase customers away. Hence, opportunities are missed to sell more and obtain repeat business in ongoing customer relationships. However, in back-office processes, where customers are not involved and which are not visible to them, a manufacturer-oriented approach to developing the processes may pay off.⁴ On the other hand, improved back-office efficiency may make the internal support to those who serve external customers deteriorate. In that case the effect on external effectiveness and customer perceived quality is probably negative.

FIGURE 3.3

The strategic management trap.
Source: Grönroos, C., Strategic Management and Marketing in the Service Sector.
Cambridge, MA: Marketing Science Institute, 1983, p. 41. Reproduced by permission of the Marketing Science Institute.

Management decisions concerning the production process in a service context are too often thought of as having an impact only on internal efficiency. This often leads to operations and reward systems supporting the wrong actions. For example, restaurant managers are frequently rewarded for low food costs, which are of no interest to customers, who are looking for good food and attentive service. Doing what is important to customers and means value for them should be rewarded instead.

In reality, the external effectiveness issue is highly relevant. If only internal efficiency goals are pursued, the perceived service quality changes; too often it deteriorates. Thus, an improved internal efficiency may in service operations lead to a negative shift in perceived quality. Personnel have less time for a single customer, or for paying attention to the customer, and solving the customer’s problems are not rewarded. This may increase waiting times, decrease the employee’s likelihood of penetrating to the problems of a given customer, and leave less time for employee flexibility. Self-service procedures and technology, which may be introduced as a substitute for personal service, may help the customer. Information technology may also improve the service. However, often this unfavourably changes the perceived quality, because the customer either does not accept the new system or is not prepared, trained or motivated to operate it.

When the perceived quality of the service starts to deteriorate, the outcome of the service process is usually not the most critical aspect, but the impact on the quality perception of the process has a more immediate effect and is immediately critical. Customers may feel that they get the same outcome as before, but that the manner in which the service is provided has deteriorated.

If customers are dissatisfied, they normally show it to the employees and to fellow customers. Employees in contact with such customers are easily affected by such feedback. The result may be a deteriorating work atmosphere, where the employees no longer feel satisfied with their jobs or as motivated to provide service to the customers as they may have been initially. Moreover, the direction of decisions taken in the organization, where people are treated mainly as a cost-generating burden, also has a demotivating impact on performance. The decision-making of management has a negative effect on the employees. The service employees become under a negative pressure from both customers and management.

This process may be fatal to the service operation and the whole service organization. As the atmosphere in the workplace is affected, the customer perceived quality of the service may continue to deteriorate. Employees may have less time to perform well, but they may also be less motivated to do so. Such negative sequences of management decisions easily lead to a vicious circle.⁵ Once a firm has entered into such a circle, its growth potential may be seriously affected.

The destructive process illustrated here and in Figure 3.3 seems to be caused by a lack of understanding of how the service profit logic differs from the traditional goods logic, and of the interrelationship between internal efficiency and external effectiveness in service organizations. Decisions made to help cost savings have an unexpected external effect. The output of the service operation, the service and the quality of the service are not the same as they were, or as they are supposed to be according to traditional management thinking from manufacturing.

At this point the firm sometimes turns to traditional external marketing in order to keep its customers. A temporary boom may be achieved by, for example, heavy advertising, but in the long term the new customers as well as the old ones will observe the decrease in quality and become dissatisfied with what they receive. If external marketing campaigns make unrealistic promises, which in situations like this are not uncommon, disappointment will be severe among newcomers who wanted to give the firm’s service a try. Furthermore, unrealistic promise-making has a negative and discouraging internal effect as well.

Consequently, in spite of traditional marketing efforts, in the long term one often ends up with dissatisfied customers. At the same time the firm’s corporate image will change. Decreasing perceived quality and unrealistic promises by external marketing efforts have a negative impact on image. Moreover, a growing number of dissatisfied customers and ex-customers creates a substantial negative word-of-mouth effect on image, as well as on purchase decisions.

In the end one will probably find that the decisions taken may have caused varying degrees of damage. In the worst case, service quality has decreased, the work atmosphere has deteriorated, word of mouth has become a problem instead of a support, negative comments in social media explode, the corporate image has been affected, and finally, the problems caused by the financial problem or increased competition have not been solved. In summary, a bad situation has become even worse.

A VICIOUS CIRCLE: AN EXAMPLE

What is going on in many hospitals with their for-profit service providers seems to be an example of a bad situation becoming worse, caused, to a greater or lesser extent, by the wrong management approach and a lack of understanding of the characteristics of service. If there are financial problems, doctors are urged to concentrate on professional and technical issues, which they do, and nurses are requested not to interact too much with patients and maybe not at all with family members. The intention here is, of course, to achieve a more effective use of time and, as a consequence, to cut costs.

The consequences of these actions are a lower level of service quality as perceived by the customers – the patients and their relatives and friends. But this approach from management has a much more severe internal effect, which is eventually perceived by the customers as well. The employees, probably the nurses and staff personnel first, start to feel a role conflict. Patients and relatives demand more, but management says no. They are not encouraged or authorized to give good service. This quickly affects the working atmosphere, which in turn leads to a deterioration of the customer perceived quality of the service. At this point, external marketing communication and PR activities communicating a ‘we care’ image have no significant positive effect on customers or potential customers. They know better, or will soon find out what the truth is. Moreover, they will create a substantial amount of bad word of mouth.

However, in one respect, such promotional campaigns clearly have an effect. This effect is not normally recognized by managers, or by communications people. It is an internal effect, and it is negative. Employees realize that management has deliberately attempted to fool customers and potential customers. It may, in reality, not be deliberate, it may just be a result of bad and thoughtless management, but it is easily perceived as deliberate. For example, nurses know that they cannot fulfil the promise ‘we care’. They just do not have the time, and they are encouraged not to do so. This, of course, by itself hurts morale and damages the internal atmosphere even more. Second, nobody wants to deliberately take part in lies and cheating, which such promotional efforts are in this situation. It goes against the ethics of most people, and increasingly damages the working atmosphere. Consequently, good employees start looking for another job and eventually quit; they have no interest in helping the employer, and quality continues to deteriorate. If the financial problems were initially minor, they grow as the internal crisis deepens and the service quality (the reason for the external crisis) decreases. A few wrong management decisions can easily lead to a downward spiral, a negative trend which gains momentum once it has started.

COST EFFICIENCY AND THE RISK OF FALLING INTO THE TRAP

Initial cost savings often turn out to be marginal in the long run. Employee absence due to illness or other reasons such as job dissatisfaction tends to increase. Extra personnel, without proper training, have to be hired. The work surroundings and the technology used may not be handled with appropriate care by less motivated and temporary personnel.

The process illustrated in Figure 3.3, and in a sketchy way by the hospital example above, is a true and real strategic management trap. By making the wrong decisions based only on product manufacturing know-how and models, the organization may be thrown into a vicious circle⁶ or negative downward spiral, which weakens the competitiveness of its operations and causes or intensifies the financial problems that are often the reason for making inappropriate decisions in the first place.

Why does it go wrong? Why do conventional wisdom and guidelines from manufacturing not help? The main reason is the fact that a service organization is not a traditional manufacturing firm. Instead it is an organization with characteristics of its own where a different profit logic forms the commercial basis of management and a different service-based management logic should, therefore, be adopted. Service consumption is process consumption, not outcome consumption. The service production process is a partly open system, where at the same time as he perceives and consumes a service the customer also participates in the process as a co-producer. The nature of service and service competition requires a different approach to strategic thinking and management.

In traditional management thinking the productivity of capital and labour, and internal efficiency considerations, are the factors that predominantly drive profit. However, a service firm, or any service operation, is different in some vital aspects. As noted earlier in this chapter, external effectiveness, how the organization performs and the output of its operations – in short, the perceived service quality with both its process- and outcome-related features – is what customers experience and evaluate. Actions to improve internal efficiency and productivity as traditionally measured can easily have a negative external impact on perceived quality. For service organizations, external effectiveness and customer perceived service quality drives profit, provided of course that customers consume the service in such a way that the cost of producing the service does not exceed revenues from that service.⁷ Conceptually and operationally, productivity has to be treated differently in service than in manufacturing. We shall return to this issue in Chapter 8.

However, this does not mean that decisions which are only or predominantly related to internal efficiency always lead to negative consequences. This also does not mean that cost savings and the more effective use of resources are wrong and should not be attempted. On the contrary, improved productivity of resources – labour as well as capital, and information – and better internal efficiency should always be an objective, and new technology and production processes that save costs should be used. Moving from one technology level to another, for example from traditional face-to-face bank service to Internet banking, often improves internal efficiency and external effectiveness and customers’ quality perception at the same time. However, there may be a time lag before customers learn to appreciate a new technology. The main point here is that internal developments aimed at improving internal efficiency should be based on the characteristics of service, so that the interrelationships between the internal and external effects are taken into account. It should be emphasized that all costs are not equal. There is a difference between various types of costs which has to be taken into account. Some costs are revenue-generating, some are not.

A SERVICE-ORIENTED STRATEGY

Figure 3.4 illustrates schematically a favourable process which may occur if a service strategy, and a service-based management approach, is followed.⁸ Figure 3.4 can be compared with Figure 3.3, which demonstrates the strategic management trap. To give an example, if financial problems or problems with increased competition make it necessary to change the strategies of, say, an airline company, cost considerations and internal efficiency should not govern the strategic thinking in the firm. Instead, management should focus upon the interactions with customers and customer relationships. Effects on external effectiveness and customer relationships should primarily guide the decisions to be made. Of course, cost considerations and the implications for internal efficiency must not be overlooked. Concern for internal efficiency can be given priority in the part of the organization invisible to customers. Moreover, a distinction between revenue-enhancing costs and bureaucracy-caused costs should always be made.

External effectiveness and service quality concerns should be given top priority in the interactive functions. In an airline, for example, improving buyer–seller interactions in the service encounters, for instance, by increasing seat size in planes, paying attention to in-flight services, and offering the employees appropriate customer contact training, to mention a few possibilities, would probably lead to improved perceived quality from the customers’ point of view.

Such decisions may or may not necessitate more personnel, or more advanced technology, but if the effects on revenues make up for the additional costs, such revenue-creating cost increases should obviously be allowed. Here, difficulties in calculating the effects on revenue are no excuse for ignoring the effects on external effectiveness. It should be noted that improved service quality often does not require additional costs. The only thing that is needed, in many cases, is a better understanding of customer relationships, how quality is perceived, and finally, the importance of the process-related quality dimension. Once these points are made clear, internal arrangements for using existing resources in a more systematic and market-oriented way can usually be made. Service quality management will be discussed in detail in Chapters 4 and 5.

FIGURE 3.4

A service-oriented approach.
Source: Grönroos, C., Strategic Management and Marketing in the Service Sector. Cambridge, MA: Marketing Science Institute, 1983, p. 58. Reproduced by permission of the Marketing Science Institute.

To return to Figure 3.4, improved quality usually means greater customer satisfaction, which in turn has a twofold effect. Internally, the work atmosphere will probably improve. Increased customer satisfaction is noticed by the employees. The positive effects are often very obvious. This favourable trend is supported by the service-oriented strategic direction that is chosen by management. Decisions directed towards improving the service encounters and service quality imply that management is prepared to accept the revenue-generating power of the employees and to support it. Such a strategic attitude has a considerable positive effect on the internal environment of the firm and on employee motivation. Employees are encouraged by both management and customers. Again, this results in increased internal efficiency. In some situations the service process can of course be improved by introducing technology-based solutions, in which cases fewer personnel may be needed and/or the role of employees may change. Customers of insurance companies are often requested to ask routine questions over the phone or to use the Internet instead of visiting an office in person, whereas service employees are supposed to provide customers with more knowledge-intensive service, such as financial advice. In such situations a critical challenge for management is to maintain and even improve the work atmosphere for personnel.⁹

Improved customer satisfaction also has other external effects. Favourable word of mouth is created. Existing customers may increase their business with the service provider and new customers will be attracted to the organization. The corporate image and/or local image are enhanced by positive customer experience and by favourable word of mouth and positive comments in social media.

Finally, sales volume will probably increase. If internal efficiency, external effectiveness and service quality are controlled simultaneously, a larger volume of sales can be expected to have a sound financial effect and to improve the firm’s competitive position. Such a positive trend may well continue. The improved atmosphere in the company makes the buyer–seller interactions even better, and the firm will generate more financial resources to be used to back up this trend.

CUSTOMER BENEFITS OF A SERVICE STRATEGY

Good service means certain benefits for the customer. Especially in business-to-business markets, customers may be able to calculate these benefits and see the results on the bottom line. For example, reliable and timely repair and maintenance service may reduce downtime costs, which otherwise could amount to considerable sums. Such costs can easily be calculated. Individual consumers may sense these benefits more than see them. Such cost effects will be discussed in Chapter 6.

The better the total customer relationship is taken care of, the better the quality impact of the service process will be, and the less complicated it is for the customer to maintain the relationship with the service provider. Co-operation between the two parties becomes easier. For example, the buyer can rely on the seller that deliveries will always be made on time, technical service will be good and personal contacts will be accessible when needed, claims will be handled promptly and with the buyer’s interest in mind, and social contacts will be satisfactory. Not only is it more convenient for the buyer to do business with a service provider who can be trusted in all respects, in many situations such a relationship equals a cost reduction for the buyer as well.

If the level of perceived quality is high and co-operation between the two parties is smooth, three sources of cost reduction for the customer can be distinguished:

1. Fewer resources/personnel are needed to maintain contact with the service provider.

2. The person involved in contacts with the provider will need less of their time for handling these contacts.

3. It is psychologically less demanding to maintain contact with the provider, which in turn increases the mental capacity of personnel to be used for other tasks.

In many cases the cost reductions that can thus be achieved are easy to calculate. The psychological effects of good service may be less so, but the other effects can easily be transformed into euros, pounds sterling or dollars – money that, for the buyer/customer, can be used productively elsewhere. The service provider, in turn, can transfer some of this cost reduction to the price. The benefits of improved customer relationships by a service strategy can thus be shared between the buyer and the seller. This should have a favourable impact on profitability.

THE BUSINESS MISSION AND SERVICE CONCEPT

Every service provider needs some performance guidelines. Overall, the concept of a business mission is used to determine in which markets the firm should operate and what kinds of problems it should try to solve. In generic terms a business mission, or service vision, for any firm that wishes to be a true service organization can be formulated as follows:

The firm’s business mission is to provide target customers with service that supports their everyday activities and processes, thereby contributing to their goals in life or business in a value-enhancing way.

The expression ‘supports . . . in a value enhancing way’ means that the service provided should impact a customer’s activities and processes so that value emerges for the customer, i.e. the customer is better off than before the service had been produced and used. A firm can develop a service-focused, and customer-focused, business mission based on this generic formulation by specifying:

1. Which process or processes in a customer’s everyday activities it aims to support.

2. How this support is intended to enable and enhance value creation in the customer’s life or business.

3. With what resources, processes and interactions the customer’s process should be supported.

4. What should be achieved for the customer (value-in-use; goal achievement) and service provider (value capture) respectively.

In Figure 3.5 a business mission formulation based on service logic is schematically illustrated. In the figure an example from car rental, further discussed in Chapter 7, is also included.

Within the framework of the business mission, concrete guidelines for developing service offerings have to be developed. These can be called service concepts. The service concept is a way of expressing the notion that the organization intends to solve certain types of problems in a certain manner. This means that the service concept has to include information about what the firm intends to do for a certain customer segment, how this should be achieved, and with what kinds of resources. If there is no service concept agreed upon and accepted, the risk of inconsistent behaviour is high. Supervisors do not know what should be achieved and what priorities to set. The same goes for other personnel. A situation would develop in which different parts of the organization perform inconsistently. This, of course, adds to confusion. And in an Internet-based virtual organizational setting with more or less loosely connected network partners, a clear and easily communicated service concept is of utmost importance.

FIGURE 3.5

Service logic-based business mission.

The service concept should be as concrete as possible so that it can be understood by everybody. To give an example, in a car rental company case discussed in Chapter 7, the firm stated their service concept as follows: ‘To offer immediately accessible solutions to temporary transportation problems.’ This service concept states that since problems are immediate and temporary, therefore the solutions to them must be quick and easy to obtain. This firm became very successful.

Depending on how differentiated the operations are and how many different customer segments exist, there can be one or several service concepts. It is, however, important that they all fit the overall service vision or business mission. Before a service concept can be determined, careful market research must be carried out, otherwise there is always a risk that there will be an insufficient market for service produced according to the service concept.

INCREASING THE SERVICE IMPACT IN CUSTOMER RELATIONSHIPS

Implementing a service strategy requires appropriate action at the operational level. Here one should notice that a service strategy can be pursued by actions of many kinds. However, what is often needed is a new way of thinking, i.e. adopting a new logic. Old rules and ways of thinking may misguide management and leave opportunities unexploited.

The service impact on customer relationships can be increased in three ways:

1. Developing new services to offer to the customer.

2. Activating existing but hidden services or service elements in a business relationship.

3. Turning the goods component into a service element in the customer relationship.

Too often only the first possibility is taken into account, but there are many additional opportunities for strengthening customer relationships through a better service impact.

Increasing the service impact by adding new services. The first category of activities literally means that new services are added to the offering. New services are typically various consultancy services, information services, repair and maintenance services, software development, websites, logistical services, customer training or joint R&D activities. Clearly, this may be a powerful means of differentiating one firm’s offering from that of the competition. Such efforts should be used whenever appropriate. However, such new services require new investments and increase the cost level. These must be justified by expected additional revenue.

Increasing the service impact by activating existing but hidden services. The second type of activity seems much less dramatic and is therefore frequently not thought of as a strategic issue that should initiate major changes in the customer relationship. It may, nevertheless, have a dramatic impact on the offering, perhaps even more of an impact than the first type. It is a matter of actively using existing but hidden, often non-billable, service elements in the relationship between the buyer and the seller in order to differentiate the offering and increase the support provided to the customers’ processes, and thus make use of these services as a means of competition.

Such service elements in customer relations are, for instance, casual advice, order taking, deliveries, claims handling, invoicing, demonstration of manufacturing processes, technical quality control, call centres, help desks and telephone reception services, and frequently asked questions on a website. Customers do pay for these services, too, although one seldom thinks about it. However, such service elements are far too often perceived as nuisances rather than as services by most customers. The reason for this is, of course, that they are frequently handled as mere administrative routines and not as actively rendered services. If these service elements are thought of as service and the value support that can be provided by them is recognized, the firm may improve its position and strengthen its competitive edge.

It is important to realize that these potential services already exist in the customer relationships – they only have to be managed in a different way so that their value-supporting possibilities are utilized, and customers start to experience them as service. For example, complaints handling is far too often managed as an administrative task with the seller’s interest as the top priority. Instead a complaint could be taken care of in a service recovery fashion, quickly, preferably even before a formal complaint has been made by the customer, with the customer’s interest as the first priority. In the former situation, customers consider the complaints-handling process a nuisance, which in addition may cause considerable sacrifice for them. In the latter situation, the quality problem or service breakdown is recovered in a way that the customer perceives as quality-enhancing and most often also cost-saving. Changed invoicing systems may also have similar effects.

Many of the services that are managed as administrative routines, or in some other way without taking the customer’s interests into account, are truly hidden services. On the one hand, service firms or manufacturers do not see them as potential value-creating service. On the other hand, customers often do not think of them as anything other than a necessary evil. Hence, the firm that manages to turn such hidden services or ‘non-services’ into real service to its customers can easily provide them with a series of positive surprises, and enhance perceived quality in the minds of the customers. From this should follow strengthened customer relationships.

Developing hidden services often does not demand big investments or extra costs. Rearranging existing resources and routines may frequently be all that is needed. In fact, more service-oriented invoicing and complaints handling may ensure that these activities are more effectively dealt with internally as well, and operating costs can thus be saved. The customer benefits that can be achieved frequently exceed the additional efforts. Furthermore, hidden services, which are managed as non-service – for example, invoices including mistakes or failures managed with delays – cause costs for the customer and the firm alike. If they are not activated and turned into true value-supporting service for customers, they remain a cost burden for both parties, and the service provider loses the revenue potential of improved overall service.

Increasing the service impact by turning goods components into service. If the goods component is offered in a flexible manner and tailor-made to fit the needs and wishes of the customer, or made easy to install, maintain and upgrade, it is turned into service for the customer. Consequently, it is turned into a service element in the customer relationship. A good salesperson uses such a sales strategy. However, turning the goods component into a service goes far beyond sales. In production, logistics, installation, IT applications, and so on the same approach is required.

A manufacturer of industrial equipment may try to tailor its goods as much as possible to the specific needs of its customers and make them easy to understand and easy to maintain. A restaurant may cook meals and even add seasoning according to the wishes of a specific customer. In both cases, the goods component is transformed from being a physical thing to customized service.

SERVICE MANAGEMENT: ADOPTING A SERVICE LOGIC IN MANAGEMENT

Having demonstrated the nature and characteristics of a service strategy, we now turn to the principles of management which guide decision-making and managerial behaviour in service competition. This approach to management has been labelled service management.¹⁰ It is a methodology in which management procedures are geared to the characteristics of service and the nature of service competition. Service management is also very much a customer-oriented approach. Often the term ‘service management’ is used instead of the term ‘service marketing’. Sometimes the phrase ‘service marketing and management’ is also used in the literature to describe this field.¹¹ The use of the term ‘service management’ indicates the cross-functional nature of marketing in service contexts. Marketing is not a separate function, but in the management of all business functions the interests of the customer, i.e. a customer focus, has to be taken into account. It is a matter of customer-oriented or market-oriented management. Chapter 9 discusses marketing in service competition and the relationship between marketing and customer-oriented management.

Service management is understanding how to manage a business in service competition, that is, in a competitive situation where service is the key to success in the marketplace, regardless of whether the core of the offering is a service or a manufactured product.

Service management can be described as follows:¹²

1. Understanding the value that emerges for customers by consuming or using the offerings of an organization and knowing how service, provided through goods, service activities, information, and other resources, and combinations of such resources, contributes to this value.

2. Understanding how total quality is perceived in customer relationships to facilitate such value and how it changes over time.

3. Understanding how an organization (people, technology and physical resources, systems and customers) will be able to produce and deliver this perceived quality and support customers’ value-creation, and during direct interactions also co-create value with customers.

4. Understanding how an organization should be developed and managed so that the intended perceived quality and value are achieved.

5. Making an organization function so that this perceived quality and value are achieved and the objectives of the parties involved (the organization, the customers, other parties, etc.) are met.

This means that the firm has to understand the following:

1. The perceived quality and value in their everyday activities and processes customers are looking for in service competition.

2. How to create that value support for customers.

3. How to manage the resources available to the organization to be able to support such service-based value creation.¹³

This description of service management is rather exhaustive. Shorter definitions lose some of the information content, but may still be clear to readers, and they are easier to remember. According to another definition in the literature, ‘service management is a total organizational approach that makes quality of service, as perceived by the customer, the number one driving force for the operation of the business’.¹⁴ Applying service management principles means that service is considered the organizational imperative.¹⁵

‘Organization’ in these contexts, of course, refers to the bundle of quality-supporting resources involved in producing the service, that is, people (personnel and customers alike) as well as technology and physical resources, and information and operating systems, and administration. As organizations increasingly move towards being network organizations, many of these resources are outside the boundaries of traditional organizational constructs. It is also important to observe that the definition of service management requires a dynamic approach to management. It is not enough to understand which values or benefits customers are seeking; one must also understand that the benefits customers are looking for will change over time, and that the customer perceived quality and value which is produced has to change accordingly.

A service management perspective changes the general focus of management in service firms as well as in manufacturing firms adopting a service logic in the following ways:¹⁶

1. From product-based value (‘value-in-exchange’) to total value emerging in customers’ processes (‘value-in-use’).

2. From short-term transactions to long-term relationships.

3. From core product (goods or services) quality (the quality of the outcome only) to total customer perceived quality in customer relationships.

4. From production of the technical solution (of a product or service) as the key process in the organization to developing total perceived quality and supporting customer value as the key process.

The expression value-in-exchange refers to the view that value for a customer is embedded in a pre-produced product. Value-in-use means that value for a customer evolves in the customer’s activities and processes.

SERVICE MANAGEMENT: A SHIFT IN MANAGEMENT FOCUS

Two basic shifts in focus are implicit in the service management principles when compared with the traditional management approach used in manufacturing. These are:

1. A shift from an interest in the internal consequences for the firm of performance to an interest in the external consequences for customers and other parties.

2. A shift from a focus on structure to a focus on process.

These two shifts imply a shift of focus from inside-out management to outside-in management, as discussed in Chapter 1, and they are of paramount importance. A service strategy, to be successfully implemented, requires both. As a management philosophy, service management is predominantly related to managing processes in which the underlying structures are of less importance. If the structures take over, the flexibility of operations and the handling of customer contacts suffer. The encouragement and support of managers and supervisors decreases, and thus motivation among personnel suffers as well. In the following phase, the perceived service quality starts to deteriorate and customers are probably lost. The new emphasis on process and external consequences changes the focus on (1) the profit logic as the driving force of a business, (2) decision-making authority, (3) organizational structure, (4) supervisory control and (5) reward systems; and when there is a shift in the focus on reward systems, other tasks and types of achievement have to be (6) monitored and measured. These six principles of service management are summarized in Table 3.2 and discussed below.

TABLE 3.2

Principles of service management: a summary.

Principle		Remarks
1.  The service profit logic as business driver	Customer perceived service quality drives profit.	Decisions on external efficiency and internal efficiency (customer satisfaction and productivity of capital and labour) have to be totally integrated.
2.  Decision-making authority	Decision-making has to be decentralized as close as possible to the organization–customer interface.	Some strategically important decisions have to be made centrally.
3.  Organizational structure	The organization has to be structured and functioning so that its main goal is the mobilization of resources to support frontline operations.	This may often require a ‘flat’ organization with no unnecessary layers.
4.  Supervisory control	Managers and supervisors focus on the encouragement and support of employees.	As few legislative control procedures as possible, although some may be required.
5.  Reward systems	Producing customer perceived quality should be the focus of reward systems.	All relevant facets of service quality should be considered, although they cannot always all be built into a reward system.
6.  Measurement focus	Customer satisfaction with service quality should be the focus of measuring achievements.	To monitor productivity and internal efficiency, internal measurement criteria may have to be used as well.

The service profit logic as the driver of business. As discussed in some detail in this chapter, the general economic focus or the business logic is shifted from managing internal efficiency and the productivity of capital and labour to managing total business effectiveness, including both internal efficiency and external effectiveness considerations, where customer perceived quality drives profit. However, there are several interrelated factors influencing how, and indeed if, perceived quality leads to sound economic results. Service management appreciates the importance to success of managing external effectiveness and customer relationships. Internal efficiency needed to function profitably is an inevitable issue, but it is not a top priority in itself. It must be totally integrated with external effectiveness issues and geared to managing customer perceived quality. As soon as the internal perspective begins to dominate, an interest in costs and managing internal efficiency will take over, but without a simultaneous consideration of the quality implications. Inside-out management starts to dominate at the expense of outside-in management. Issues related to creating and maintaining excellence and revenue generation will then become secondary and receive less or no management attention.

Decision-making authority. Because of the characteristics of service (e.g. the inseparability of critical parts of production and consumption) and the facets of customer perceived service quality (e.g. a demand for flexibility and recovery capabilities), decisions concerning how a service operation should function have to be made as close as possible to the interface between the organization and its customers. Ideally, customer contact employees who are involved in service encounters should have the authority to make prompt decisions. Otherwise sales opportunities and opportunities for service recovery, correcting quality mistakes and problems will not be used intelligently. If the moments of truth in the service encounters go unmanaged, service quality deteriorates quickly. Of course, a contact employee, for example a bank clerk or a service technician, cannot always have the professional knowledge required if a customer wants, for example, a sophisticated financial solution for his international business or an estimate of expected future repair costs. However, the customer contact employee should nevertheless have the decision-making authority, for example, to ask for assistance from the back office and support staff professionals.

If the employees in customer contacts are not given authority to think and make decisions for themselves, they become victims of a rigid system. Customer contact employees may be demotivated by rigid rules and systems which hamper them instead of empowering them to handle deviations from standard operational procedures. ‘Empowering’ personnel is a powerful way of motivating people (empowerment will be discussed in Chapter 14 on internal marketing). It means that employees are encouraged, and trained, to recognize the diversity of customer contact situations and to use their judgement in handling situations and solving problems following on from deviations from standard procedures so that customer satisfaction is created.

Thus, operational decision-making needs to be decentralized. However, some strategically important decisions have to be kept centralized; for example, decisions concerning overall strategies, business missions and service concepts. The unique knowledge among contact personnel of aspects of the business that are vital to making such strategic decisions should, however, always be used in central decision-making. First, this improves the quality of decisions, and second, it creates a stronger commitment to these decisions among those who will have to live with them and carry them out.

The ‘local’ manager, whether he is the head of a branch of a multi-outlet organization, such as a bank or hotel chain, or the head of a department in a firm which produces service has, of course, the overall responsibility for his team. The manager is also responsible for the total operation, service consciousness and profitability of his ‘local’ organization. One can say that the manager has dual responsibility: responsibility towards the customers and towards the corporation. Svenska Handelsbanken, a nationwide and internationalizing retail and commercial bank based in Sweden, has formulated the following ground rule for their local branch managers: ‘The local manager is responsible for perceived service quality and value for the customers and for profitability for the corporation.’ This bank is probably the most decentralized and customer-oriented bank in Scandinavia. It is also one of the most profitable banks and has invariably been rated highest by customers in satisfaction studies.

Organizational structure. Traditionally, the organizational focus is geared to building up and maintaining a structure in which management decisions are cascaded through processes involving legislative control. This often creates a lack of flexibility, fuels centralization tendencies, and can be a hindrance to the vertical flow of information in the organization. Service management shifts management focus away from structure and control procedures towards improved external efficiency with acceptable internal efficiency. This requires a more flexible organizational solution, where the mobilization of resources – management, staff, systems – to support customer contact activities is imperative. The organizational structure that suits this requirement may differ from situation to situation, but some common principles can be identified. Organization for service will be discussed in more detail in Chapter 13.

Supervisory control. In traditional management approaches, supervisory systems are closely related to monitoring the capability of the organization and its various departments in performing their tasks according to predetermined standards. If such standards are met, the employee, or a group of employees, has performed satisfactorily, and may be rewarded.

However, such a supervisory control system does not fit the nature of service and service production very well. By its very nature, service cannot often be completely standardized. Moreover, for employees to deliver quality service, some degree of flexibility is needed to meet the special wishes of customers or to successfully recover negative situations in service encounters. Here, guidelines and visions are better than rigidly defined standards. Only the technical quality aspects of service can be monitored by standards; whereas, from a competitive standpoint, the highly important process-related quality aspects are not well suited for the development of traditional standards. Process-related quality-creating performance cannot easily, if at all, be monitored by comparing it with predetermined standards. Instead, service management requires that the supervisory focus be on the support and encouragement of employees. This may require new management and leadership methods. Subsequent chapters on service culture and internal marketing will touch upon this issue to some extent.

Reward systems. Normally, reward systems are geared to the focus of supervisory control. What is monitored can be measured, and what is measured can be controlled and rewarded. Of course, not all, if any, of the tasks and factors that are controlled are geared to reward systems. However, a shift in supervisory focus requires a corresponding shift of focus on rewarding. Generally speaking, service management requires that producing perceived service quality and supporting customers’ value creation at some level – excellent or otherwise acceptable – should be rewarded, not just compliance with predetermined, easily measurable standards.

Measurement focus. What is controlled and rewarded has first to be measured. The focus here must of course also be shifted, or at least expanded. The ultimate signs of success are customer satisfaction with total perceived quality, loyal customers and improved profits. Thus, according to service management principles, for service-oriented supervisory approaches and reward systems, customer satisfaction with service quality as well as tasks that boost satisfaction and loyalty has to be measured. Measuring how standards are met and the bottom line are not enough. Internal efficiency criteria may have to be used as well, so that internal efficiency is kept under control. However, the external effectiveness criteria always dominate.

NOTES

1.  Grönroos, C., Strategic Management and Marketing in the Service Sector. Cambridge, MA: Marketing Science Institute, 1983 (first published in 1982 as a research report by Hanken Swedish School of Economics, Finland). Compare Richard Normann’s discussion of how it is possible to get into a good circle and avoid falling into such a trap. See Normann, R., Service Management. New York: John Wiley & Sons, 1984, where he uses the expression vicious circle for this trap.

2.  Drucker, P., Management: Tasks, Responsibilities, Practices. New York: Harper & Row, 1973.

3.  Heinonen, K., Temporal and spatial e-service value. International Journal of Service Industry Management, 17(4), 2006, 380–400.

4.  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. The classic article on the manufacturing orientation of service processes is Levitt, T., Production-line approach to service. Harvard Business Review, 50(Sept–Oct), 1972, 41–52.

5.  See Normann, op. cit., where the existence of – and internal effects of – such vicious circles are discussed extensively.

6.  Normann, op. cit.

7.  In a major study in the financial services sector in Scandinavia, Kaj Storbacka has demonstrated that 20% of the customers do not stand for 80% of profits but for 180% to 200% of profits. Other customers do not contribute to total profits or are directly unprofitable, thus eroding the total profitability accumulated by the group of profitable customers. Moreover, many of the unprofitable customers or customers who do not contribute to profits are what he calls ‘satisfied small customers’ and sometimes also big customers, that is customers who are satisfied with the perceived service quality but who consume the services in such a way that the cost of producing them exceeds the revenues from those services. See Storbacka, K., The Nature of Customer Relationship Profitability – Analysis of Relationships and Customer Bases in Retail Banking. Helsinki/Helsingfors, Finland: Hanken Swedish School of Economics, Finland/CERS, 1994.

8.  Compare Richard Normann’s discussion of how, by strengthening peripheral services, it is possible to get into a good circle and avoid a vicious circle. See Normann, op. cit.

9.  This effect is discussed and pointed out by Heskett, J., Guru’s View. Notes from the search for deep indicators in services. Journal of Service Management, 25(3), 2014, 298–309.

10.  Grönroos, C., Service management: a management focus for service competition. International Journal of Service Industry Management, 1(1), 1990a, 6–14. This service management concept should not be mixed up with the concept of service management, which is used to denote the management of service operations. See, for example, Fitzsimmons, J.A. & Fitzsimmons, M.J., Service Management. San Francisco, CA: McGraw-Hill, 2006.

11.  The title of the handbook in the field, Handbook of Services Marketing and Management, is a good example.

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

13.  Grönroos, 1990a, op. cit.

14.  Albrecht, K., At America’s Service. Homewood, IL: Dow Jones-Irwin, 1988.

15.  Schneider, B. & Rentsch, J., The management of climate and culture: a futures perspective. In Hage, J. (ed.), Futures of Organizations. Lexington, MA: Lexington Books, 1987.

16.  See Grönroos, 1990b, op. cit.

FURTHER READING

Albrecht, K. (1988) At America’s Service. Homewood, IL: Dow Jones-Irwin.

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.

Drucker, P. (1973) Management: Tasks, Responsibilities, Practices. New York: Harper & Row.

Fitzsimmons, J.A. & Fitzsimmons, M.J. (2006) Service Management. San Francisco, CA: McGraw-Hill.

Grönroos, C. (1983) Strategic Management and Marketing in the Service Sector. Cambridge, MA: Marketing Science Institute.

Grönroos, C. (1990a) Service management: a management focus for service competition. International Journal of Service Industry Management, 1(1), 6–14.

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

Heinonen, K. (2006) Temporal and spatial e-service value. International Journal of Service Industry Management, 17(4), 2006, 380–400.

Heskett, J. (2014) Guru’s view. Notes from the search for deep indicators in services. Journal of Service Management, 25(3), 298–309.

Levitt, T. (1972) Production-line approach to service. Harvard Business Review, 50(Sept–Oct), 41–52.

Normann, R. (1984) Service Management, 2nd edn. New York: John Wiley & Sons.

Schneider, B. & Rentsch, J. (1987) The management of climate and culture: a futures perspective. In Hage, J. (ed.), Futures of Organizations. Lexington, MA: Lexington Books.

Storbacka, K. (1994) The Nature of Customer Relationship Profitability – Analysis of Relationships and Customer Bases in Retail Banking. Helsinki/Helsingfors: Hanken Swedish School of Economics, Finland/CERS Centre for Relationship Marketing and Service Management.