In the movie “Field of Dreams,” Kevin Costner’s character takes on the job of building a ballpark because of a promise: If you build it, they will come. Does the same kind of thinking – if you achieve growth, you will be profitable – hold true for service businesses?
Not always, say two Wharton faculty members. They claim it is not by chance that organizations with a heavy emphasis on service such as Starbucks, Dell Computer, IBM, Southwest Airlines, and the University of Phoenix have managed to successfully combine growth and profitability while other companies have not. Successful service companies are able to design and implement the right strategies to keep costs low, strengthen customer loyalty and gain competitive advantage.
Service firms – as well as the service function in all companies – face a difficult challenge in transforming growth into profitability. Perhaps the chief obstacle is that service companies in the 21st century mistakenly continue to adhere to a fundamental tenet of the product-sector manufacturing businesses of the 19th and 20th centuries: that profitability is a function of scale, and scale can only be attained by an emphasis on growth. Since service businesses are often more labor intensive than production firms, growth typically adds to costs but may not produce the benefits of scale.
“It’s important that managers understand the best ways to go about growing service businesses,” says Paul Tiffany, an adjunct professor of management. “In the usual manufacturing environment, growth has long been seen as the key to success because typically there is a huge economic benefit to expanding production. When you expand production, economies of scale kick in. The more you produce, the lower your unit costs. If you do that, then you presumably have a strong strategic advantage over competitors. This was the major focus of [former General Electric CEO] Jack Welch – to be number one or two in every business GE was in. And the data backed him up: The market share leader was usually the leader in profitability.”
Service businesses differ in several ways, however, from companies that make tangible products, as marketing professor David Reibstein notes. “Perhaps the most prominent difference is that it is hard, if not impossible, to standardize service from one customer experience to the next,” Reibstein says. “Services do not come with a set of specifications of the kind that a widget-maker uses to stamp out identical products. Because the service function is delivered by individuals, standardization is not easy to achieve. As a result, branding becomes more difficult than it is with a product-sector business.”
Moreover, he adds, service companies cannot erect shelves in a warehouse and hold services in inventory. Service firms must be smart in the way they anticipate demand; any excess capacity that they have will perish, producing nothing that enhances the bottom line.
Starbucks: More than Coffee
One example of this phenomenon is the airline industry, which is getting killed by decreased demand for its services, says Reibstein. “They have capacity that’s hard for them to reduce. If a flight takes off [with empty seats], the airline can’t refill those seats. The same thing is true of hotels. You build capacity based on your expectations of demand. But when demand eases, you’re stuck with excess capacity.”
Reibstein also points out that excess capacity can pose problems for other kinds of service firms. One example: the consulting industry. Firms can hire a lot of high-priced talent only to see them become idle if demand for their expertise falls off, as it has for many consultancies in the last few years.
Reibstein and Tiffany – who are offering a Wharton Executive Education program titled Strategic Growth for the Service Function: Building Value Through Customer Focus – have identified several companies that have succeeded in turning growth into profitability.
One such company is Starbucks, which has grown by adding products and aggressively opening new locations in the United States and abroad – all the while paying close attention to creating a unique experience in its stores and forging close links with customers. Starbucks opened 572 stores during the six-month period that ended March 30, 2003, bringing to 6,458 the number of outlets worldwide. By contrast, Starbucks had only 125 stores at the end of its 1991 fiscal year.
“Starbucks is about much more than coffee,” Reibstein says. “In my classes, I have people draw a picture of what Starbucks is. Everybody initially draws a picture of a cup of coffee. But they also draw pictures of people sitting at tables with other people. What Starbucks offers is a personal experience with like-minded people.”
Dunkin’ Donuts also sells coffee, Reibstein points out, but its customers and its experience differ markedly from the high-end atmosphere of a Starbucks. “Retailing means service and Starbucks is a leader in the service industry. Part of what sets Starbucks apart from the competition is its set of customers.”
One of the important steps to building a brand is achieving standardization, Reibstein adds. “Part of what has been key for Starbucks as it has expanded – or, for that matter, Disney when that company adds amusement parks – is intense employee training to achieve a consistent level of quality. Human resources is a crucial component of success in services. Some companies may say, ‘Starbucks is a different kind of company from ours. It may be an interesting story, but we can’t transfer any of its lessons to us.’ I disagree. Other firms can learn a lot from Starbucks.”
Another successful company is Southwest Airlines. Reibstein says the task of keeping costs to a minimum is one of the main stumbling blocks to profitability among service firms. But Southwest manages to do so. The airline has one of the lowest cost structures in its industry and has significantly wider profit margins than other carriers, according to a research report by Standard & Poor’s. Southwest has been one of the few carriers to consistently earn profits in recent years, and it has achieved this without cutting its schedule or eliminating jobs.
S&P calls Southwest “an outstanding company with 30 consecutive years of profitable operations. By eschewing the hub-and-spoke structure favored by other major airlines … [Southwest] can keep aircraft turnaround times low. In addition, by serving mainly short-haul markets, it holds down food costs” and ground service fees. Despite its low costs, Southwest “delivers consistently high levels of service, and ranks high in on-time performance, baggage handling, and customer satisfaction,” according to S&P.
Reibstein says Southwest “has done a good job building a corporate structure that allows the company to have significantly lower costs” when compared to its peers. “The fact that it is a younger company than many of its competitors means that it didn’t inherit [unprofitable] routes. So it has been able to be selective about its routes.”
Computers, Cars and On-line Courses
With intense competition in the cutthroat PC business, where the machines are increasingly viewed as commodities, companies have had to find ways to differentiate themselves. Dell opted to focus on service.
“Dell doesn’t make anything,” says Tiffany. “Dell simply outsources all the physical components of the PC and focuses on providing world-class service. Dell was brilliant in realizing it should be a service firm, not a manufacturer.”
IBM in recent years also decided to reinvent itself to a large extent in order to shed its flat-footed image as a mainframe manufacturer. Says Tiffany: “When Lou Gerstner took over as CEO at IBM he turned the company into a service firm. IBM’s consulting services unit now generates by far the most profits for that company. IBM realized that customers want solutions.”
In the auto industry, when Toyota decided to enter the market for luxury cars, it realized that its brand name connoted reliability, not opulence. With the Lexus, the company decided to make its move to capture a chunk of the expensive-car market by taking service to another level, says Tiffany.
“Toyota was the first car company to institute a policy that when you brought your car in for service, the dealer would wash and clean that car inside and out,” he adds. “If you were busy, the dealer would go to your office to pick your car up and deliver another Lexus for you to use for the day. Toyota, in fact, forced the luxury end of the market to increasingly rely on service for differentiation. Lexus has set the standard for service in that end of the car market.”
One of General Motors’ businesses is another example. According to Reibstein, OnStar – GM’s safety, security and information service for motorists – offers an example of how a service can be in such demand that its owner decides it is worthwhile to make it available to competitors.
When it was launched in 1996, OnStar only came with certain GM cars. But GM later made the decision to expand the in-vehicle communications service to competitors’ vehicles. As of 2003, OnStar is available on more than 60 models from six manufacturers in addition to GM. They include Acura, Audi, Isuzu, Subaru and Volkswagen. OnStar services are also available on select Lexus models under the Lexus Link name. In addition, GM has announced that OnStar will be available to owners of recreational vehicles.
“It was a major strategic decision for GM to offer OnStar outside the company,” Reibstein says. “OnStar contributed to sales of GM cars and the company had to decide whether expanding OnStar would be worth it.” Reibstein notes that GM is working to establish OnStar as a strong, stand-alone brand name. OnStar’s website, for example, does not mention that it is owned by GM.
The two professors also cite the University of Phoenix as a successful service company. This university offers people the opportunity to earn degrees by retrieving course material online, studying at home and interacting with faculty via the Internet. All customers need is an Internet service provider.
Management guru Peter Drucker has said that education is the second biggest business in America after health care, with education approaching 10% of GDP. Schools like Phoenix, which also offers traditional classroom education, have realized that education costs are soaring and that many potential students do not want to pay those costs, according to Tiffany. “Phoenix realized that if you can capture knowledge and put it into software-based modules, you can reduce costs.”
To enhance customer service, Phoenix offers chat rooms for students to discuss their coursework. In addition, students experiencing difficulty with a certain concept have the ability to use the university’s online software to delve deeper into that concept, obtain some remedial training and then rejoin their classes.
“Certain types of courses lend themselves to online training and the University of Phoenix has caught on to that far more quickly than other schools,” says Tiffany. “Phoenix is the fastest growing university in the world. Tuition costs at other schools are sky high and those schools are pricing themselves out of the market. The Phoenix approach is bound to grow. Traditional bricks-and-mortar universities are coming to realize they have to offer online components to stay in the game.”
Looked at broadly, overcoming the challenges facing services is critical because the service sector dominates the economies of the United States and other advanced nations. And more and more service companies are learning that they have to accept that ideas about what drives value generation based on manufacturing have their limitations when applied to the services business. “Services account for more than 80% of all jobs in America, and more than 70% of GDP,” notes Tiffany. “There is a growing realization among managers in service firms that they can’t approach their businesses like companies that make physical products, but there still is a way to go.”