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Many managers of service businesses are enlightened that the strategic management (past which I mean the full procedure of selecting and implementing a corporate strategy) of service businesses is different from that of manufacturing businesses. This article discusses how pure service businesses are different from product-oriented businesses and why they require different strategic thinking. A pure service business is one in which the service is the principal entity that is sold.

That stardom is important considering everyone in every type of business sells some element of service. In pure service businesses any transfer of a physical or concrete production is incidental to the service—for example, the written report of a management consultant. Examples of pure service businesses include airlines, banks, computer service bureaus, police firms, plumbing repair companies, movement film theaters, and management consulting firms.

Meridian managers should ask themselves six questions about strategic direction. The questions are fairly common, but the answers for service businesses are oft unique. Each question will be raised hither and discussed in depth later.

1. Do we fully understand the specific type of service concern we are in? Although service-oriented businesses are different from product-oriented businesses, the nature of the difference depends a great deal on the specific type of service business organization. I volition present a classification scheme to help distinguish between service businesses forth some of import strategic dimensions.

two. How can nosotros defend our business from competitors? Every concern must consider how information technology can build and protect a stiff competitive position. To practice this, the economics of the business must be advisedly analyzed. Service businesses often require different competitive strategies from those of production-oriented companies. If an enduring institution is to be created, some attending must be given to the management of economies of scale, proprietary engineering, and reputation of the company.

3. How can we obtain more cost-efficient operations? Manufacturing companies can improve operating leverage by, for example, purchasing faster and more reliable mechanism. But most service businesses are not able to follow this arroyo. Other methods must be explored.

4. What is the rationale for our pricing strategy? The pricing of services is a nebulous area. Cost-based pricing is often hard to decide, and there are few formulas for effective value-based pricing. It is important to await at pricing strategy and remember about the economic and psychological furnishings of a change in that strategy.

5. What process are we using to develop and test new services? Every company depends on an ability to renew its franchise in the marketplace. The service-oriented visitor must pay particular attention to this surface area because of the difficulty of developing protectable competitive positions. The process of new-service development and testing must recognize the abstruse, perishable nature of services.

half dozen. What acquisitions, if any, would make sense for our company? Once the nature of the current business is understood, the conquering question can be faced. The acquisition game in the service sector tin be dangerous. More than than 1 visitor has acquired a service business using but criteria that would exist used in the acquisition of a product-oriented visitor. Every bit several of these companies accept learned, this blazon of assay, although necessary, is insufficient.

Describing Services

In product-oriented businesses, the physical reality of the product provides a simple merely powerful base on which to build a business description. The question is far more than hard for service-oriented businesses to answer because services are more abstruse than products. For example, it may be hard to depict management consulting as a business to someone who has never experienced the consulting relationship. What does a consultant practise?

One way to bargain with the difficulty of describing services has been to talk nearly them as if they were products. 1000. Lynn Shostack, a vice president in charge of business planning and analysis at Citibank, has noted:

"Banks oft devote significant resources to an activity they call 'new product evolution.' The phrase is so alluring that groups are regularly prepare up to create these 'new products.' The realization seldom seems to occur to such banks that they are not in the production development concern at all. In fact, many banks practice non seem to have arrived at the insight that things are non the ground for their industry. Even marketers in such banks obviously do not understand that they are engaged in possibly the about hard and dimly understood realm of business organisation endeavor—the development and marketing of financial services." ane

The predominant mental image about "the way things work" in business concern is a product-based image. This epitome leads to a product-oriented language, and the linguistic communication in turn constrains communication in such a way that one cannot develop really innovative approaches to managing the service business.

Because they are oft lumped together, service businesses tin can be misunderstood. As we shall run across later, they differ greatly, and an understanding of their differences tin can help the thoughtful manager to empathise the nature of the strategic opportunities in each.

The traditional image of the service business is that the service is "invariably and undeviatingly personal, as something performed by individuals for other individuals."2 This perspective is erroneous. Automated machine washes, automated banking services, and calculator time-sharing are just iii of the many examples of service businesses in which the service is provided by automated equipment. The strategic requirements for these businesses are evidently quite different from those in which individuals perform services for other individuals.

The Exhibit shows 1 mode to separate service businesses into general types, with different strategic management requirements. At the tiptop of the pyramid is the service that is provided by the business. To place a specific business on the spectrum in the showroom, information technology is necessary to answer two questions: (1) How is the service rendered? (2) What type of equipment or people return the service?

Exhibit A Spectrum of Types of Service Businesses

Placement of a specific service business along the spectrum may be difficult, but two general observations may ease the difficulty: (1) equally service businesses evolve, they oft move along the spectrum from people-based to equipment-based or vice versa, and (two) many companies are in more than one type of service business concern. Virtually all banks, for case, operate multiple-service businesses. Some of these are equipment-based, every bit in the transfer and storage of funds. Others are people-based, as in the financing of a home, car, or business, because they require judgment nigh the financial management of funds.

Edifice Barriers

In production-oriented companies, capital is the most commonly used barrier to the entry of competition. As a product-oriented company grows, it tin take reward of economies of scale in producing the product, invest in engineering that volition get proprietary, and offer a differentiated product through product development and marketing. These efforts pay off largely because they are centered on a uniform product that has concrete dimensions and is sold every bit a package. They are fabricated possible by the fact that the production, distribution, and sale of the product can be uncoupled, often being achieved by different companies.

Service businesses rarely have this luxury. The service, because information technology is an abstract, perishable quantity, must be produced and delivered past a single company, often by a single unit of measurement of equipment or people. The effect is a decentralization of the service production process to the local level and a reduction in the opportunity for developing economies of scale. As a result, location decisions are frequently very important and multiple locations can serve as a barrier to entry. One example is the car rental business, where a large number of drome locations is very of import.

Economies of Scale

Managers of service businesses should not conclude that they have no opportunities for scale economies and the resulting capital barriers to entry. On the contrary, at that place are many examples of calibration economies, peculiarly in equipment-based service businesses. The introduction of wide-bodied jets by the airlines enabled them to fly twice as many passengers with the same number of high-salaried pilots and flight engineers. Although not on the same scale, other reductions in maintenance and ground handling personnel were possible.3

A 2nd example of economies of scale is the multiple-unit of measurement motion picture show theater that can be institute in almost suburban locations in the United States. These facilities may have iv or five theaters, some of which may exist fairly small. The refreshment stand and the ticket selling booths are centralized, thus requiring both less flooring space and fewer people to operate them. In some cases, there is a single projection room for more than one theater, and the equipment is almost completely automated. Central heating and ac are provided for the entire edifice. Obviously, the cost to operate this type of facility is much lower than the price for an equal number of dissever theaters.

Advertising clout is the 3rd example of an economy of scale that service businesses can utilise as a barrier to entry. Once it achieves a size that makes regional and/or national advertizing economically feasible, a service business can use advertising as a competitive weapon to build and maintain market share. O.J. Simpson's advertisements for Hertz are an obvious case, just other companies such as Orkin, John Hancock, and FinanceAmerica as well use advertising effectively. Smaller companies but do not have the capital required to mount a competitive advertising campaign.

With the probable exception of advertising ascendancy, the economies of calibration that may provide a barrier to entry exist primarily in equipment-based, and not in people-based, service businesses. Where economies of calibration cannot be developed easily, ii other barriers to entry can be used: proprietary engineering science, and/or service differentiation.

Proprietary Technology

In equipment-based service businesses, proprietary technology is perchance most commonly used every bit a bulwark to entry. In the computer services industry the set up of "canned" programs that a fourth dimension-sharing company offers is crucial to the sales try for the company'due south services. So-called raw computer time is a article product supplied by many vendors. The purchaser of time-sharing services is interested in knowing what other services the company has which are technologically advanced over the competition. The software provided past the time-sharing company must exist technologically advanced in both what it will do and how efficient it is.

Less commonly, proprietary technologies accept been developed by people-based service businesses, peculiarly those that provide professional services. The Boston Consulting Group has developed several proprietary technologies around its experience bend concept, including market division and strategic portfolio analyses.

Service Differentiation

Product differentiation, or as I accept called information technology, service differentiation, is some other barrier to entry. In product-oriented companies, the production is developed and marketed in such a mode that it attains a brand name identification in the market place place. In the more than successful efforts, the product's brand becomes an almost generic proper name for the class of products—Bic, Coke, and Xerox, for example. Very few services accept developed a brand proper name identification. Instead, a service business develops a reputation for the type and quality of service it produces. The more abstruse and complex the service is, the greater the need and potential for developing a reputation that volition serve as a barrier to entry.

Consulting firms illustrate how a reputation can be a bulwark to entry. There are many direction problems that any one consulting firm could solve finer. However, the large ones take unique reputations and thus each tends to be chosen in on unlike kinds of issues. Such reputations provide some bulwark to the entrance of other consulting firms.

Historically, the executive recruiting business, or "headhunting" as it is oft called, has had a terrible reputation as a business organization. There are nigh no capital letter barriers to entry. All that is needed is a desk and a telephone. Recruiters work on a fee plus expenses basis, with the fee to the employer based on a percent of the first twelvemonth's total compensation to the person recruited. As a result, the business organization is highly fragmented and somewhat specialized by industry.

Building barriers to entry in service businesses is generally more hard, or at to the lowest degree must exist done in less traditional ways, than in product-oriented businesses. Managers must think less almost brand identification and more nearly the reputation of the visitor. They must look for areas in which the advantages of economies of scale are available. Finally, they must seek ways to develop and protect proprietary engineering.

Cut Costs

A common misconception virtually service businesses is that it is near incommunicable to obtain operating leverage and thus to better profit margins. Operating leverage exists in a business concern when, through a modify in operations, the relative cost per unit of the product or service decreases.

Substitution of uppercase for labor is the classic method of obtaining operating leverage in both product- and service-oriented businesses. Capital is used to purchase machinery which tin produce a product or service at a faster rate with more consistent quality. Many service businesses have followed this path of development. Twenty years ago, virtually all car washes used unskilled labor; today, nearly are automated.

When the tasks cannot be automated because human judgment must be exercised, cheap labor can often be substituted for expensive labor as a means of obtaining operating leverage. This is often the case in people-based service businesses, and police force firms are practiced in the practise. A big percent of the tasks are routine and crave little legal expertise. For example, routine and time-consuming research and the preparation of briefs can, in many cases, be done past recent graduates of police force schoolhouse or by paralegal assistants, whose time is less expensive, while partners in the firm piece of work on client relationships, develop legal strategies, and so on.

Other service businesses utilise the same basic technique in different ways. Consulting firms utilize teams of consultants who perform unlike tasks, depending on their skills. Many insurance companies break the sales task into its component parts of initial contact, presentation, and endmost the deal, and accept different people perform each function. In each case, the service is further cleaved down, and the aspects that can be performed by less expensive labor are identified. The expensive labor is then free to practice those crucial tasks that bring profits to the company.

Value Applied science

The process of value engineering has become pop in many manufacturing companies in the last decade to determine what changes in pattern and/or manufacturing procedure tin exist made to reduce the cost of manufacturing a product without reducing its utility.

A similar procedure can be used for services. Again, the service provided must exist broken into its component parts. This time, notwithstanding, the purpose is not to determine how the service is rendered, but rather what service is provided. The goals are to determine what parts of the service are essential, what parts can be eliminated, and what minor additions could greatly heighten the service.

Although they have non called it value engineering science, a number of service businesses have used the technique. Perchance the all-time current example is provided by Vacation Inns. This visitor has promoted the service as ane that has no surprises. The quality of service has been gear up at a level that does non provide the extras that one would find at an expensive hotel. The service is guaranteed to be of consistent quality throughout the country. The company believes that consistent quality with no surprises is more important to its customers than pond pools and other added services; therefore, the emphasis is on maintaining the quality of the main service.

A second instance is provided by first-class service on the airlines. The quality difference between excellent and motorbus service was significant ten years ago. Today, although the incremental fare is in excess of fifty% for beginning grade, the traveler receives a slightly larger seat, two free drinks, and marginally better nutrient. Yet beginning-class seats still sell. Excellent customers are apparently ownership status, not personal service.

Value engineering science is somewhat more difficult for a service than for a product, since the concrete nature of a product allows a checking of its continued appearance and role. For a service, it is ofttimes difficult to know which attribute is almost important to the customer'southward purchase decision.

In sum, it is probably more difficult to obtain operating leverage in service businesses, especially those that are people-based. The opportunities for finding operating leverage are there, but they require different means of thinking nigh operations.

Competing on Price

Virtually all product-oriented companies take means of determining their product's cost per unit at various volumes. Part of their strategic game is to go the low-toll producer and use this position every bit a competitive weapon.4 Other pricing strategies are of grade available, such every bit the premium-price strategy for a premium-quality product.

In service-oriented businesses it is often difficult to decide what a unit of a given service is, much less its price. In full general, it is easier to determine costs in equipment-based service businesses than in people-based businesses. To be converted to an equipment-based service in the first place, the service usually has some routine character that can be analyzed. People-based service businesses, however, are much more complex. Until the theorists and practitioners who work with human resource accounting can refine the fine art sufficiently, it will be difficult to determine the cost of people-based services accurately on anything simply an amass basis.

The pricing of services is thus frequently based on value rather than on toll. Value is mostly adamant by the customer and to some extent by contest. Customers tend to become a full general feel for what they will have to pay for a particular service, only the source of this feeling is oftentimes unclear, because comparison shopping is frequently hard. Customers will pay whatever they think the service is worth; thus pricing in many service businesses is based on whatever the market will bear.

An interesting game is played in the pricing arena. I have never heard a businessman brag that he had just hired the least expensive consultant available. People-based service businesses that rely on professionals to provide the service tin, past pricing the service too low, create an image that is counter to that necessary for a professional functioning that expects to remain competitive. Whatsoever expert consultant knows that it is easier to sell a recommendation for which the client has paid a significant corporeality than when the fee was quite low.

Prices tin exist prepare as well depression in equipment-based service businesses every bit well. At virtually every airdrome, i can find a fixed based operator (FBO) who performs one or several functions necessary to the operation of general aviation aircraft. I FBO at a decorated municipal aerodrome tried to increment the usage on the aircraft that he rented to local pilots past reducing prices past five% to 7% throughout his armada. The outcome was a subtract in volume. Somehow a rumor had started that the FBO had been able to reduce prices because he had cut back on the maintenance on the airplanes.

Probably less is known about the utilise of price equally a strategic weapon in service businesses than about any of the other strategic variables. Ane fact, however, is clear. The general manager of a service business must use marketing methods that will enhance the perceived value of the service.

Developing New Services

Virtually all product-oriented companies have some form of research and evolution effort that is responsible for designing and testing new products and/or modifications to electric current products. The R&D chore in service-oriented companies is different considering it is complicated past the lack of a physical product. A service, specially in people-based businesses, can be a niggling bit dissimilar each time it is rendered.

The entire process of creating such services deals with concepts rather than concrete objects. The testing procedure varies depending on whether the service is equipment-based or people-based, but in either case it is difficult to practice test marketing or other types of marketplace research on the new service. Customers must be enticed into experiencing the service, and this often requires major marketing efforts. Thus the cost of introducing a successful new service may be quite high because it is hard to predict what service concepts will be understandable and attractive to the customer.

An example of a new-service development that most observers agree has stalled—at least for the adjacent several years—is that of electronic funds transfer. Why has it faltered? The reasons are obviously complex and include political, legal, and economical factors. Perchance most of import, however, is consumer resistance rooted in fears about computer errors, invasion of privacy, and changes in lifestyles. It should be made clear that the failure is not one of engineering science. The engineering science is bachelor to create the then-chosen cashless lodge, but consumers do not desire the service.

The example illustrates a major difference between R&D in production-oriented and in service-oriented companies. A product tin can be shown to a customer who can make some crucial decisions about whether he or she is interested in trying the product. Just how practise you test-market the concept of a cashless social club?

The difficulty of test marketing can, nevertheless, be turned into an advantage. Service concepts, particularly in people-based service businesses, are malleable and tin can exist inverse fifty-fifty after they accept been introduced in the marketplace, and the price of such a change is oftentimes quite low.

Whatever business must develop new services if information technology is to survive. This task is quite unlike from new-product development. It is highly abstract, and the services that are developed crave difficult and expensive testing in the market. Thus there is petty existent innovation and a cracking deal of imitation of services. For example, airlines and banks are well known for their imitative practices.

Growing Through Acquisition

What is bought when a service business organisation is acquired? In that location are several answers to this question, depending on the blazon of service business that is under consideration.

Many managers, particularly those with production-oriented experience, feel most comfortable when acquiring an equipment-based service business. So the acquisition includes physical assets that can be quite valuable if bought for less than comparable new avails, if there is a limited supply of the assets, or if the business is in strategic locations (for example, a car rental business, or a cord of self-service laundries). Unless ane of these weather condition exists, it is often less expensive to buy new avails than to buy those of an existing service business.

In people-based service businesses, the acquisition is more risky because people and their skills are the major purchase detail. Regardless of the employment contracts and benefits that may exist offered, there is always the hazard that people volition leave and accept their skills with them. When concrete assets are purchased, they are owned when the papers are signed. Decisions about their use and disposition can be made by the acquiring company. The same is not true of people; they may decide to depart at whatever fourth dimension subsequently the purchase is completed.

This lesson was learned by a well-known consulting house. The firm had been quite successful in the northeastern United States. Being an acute observer of current trends, its president noted that business activeness was increasing quickly in the southern half of the state. Rather than spend several years and a significant amount of coin developing a field role, he decided to acquire a pocket-sized consulting firm in Dallas that had an excellent client list. The acquisition was made, and the president and two vice presidents of the smaller firm were given employment contracts. Unfortunately, four of the ameliorate young consultants regarded the president of the new parent business firm equally a "Yankee carpetbagger." They left, formed their own firm, and inside 18 months had acquired 40% of their erstwhile employer'southward clients every bit their ain.

Whenever acquisition of a people-based service business is existence contemplated, it is important to enquire: "What is the business worth without the cardinal people?" In that location are some instances where the "franchise" in a market place is worth the price of the business concern. In other instances, the services provided take some proprietary characteristic that is valuable fifty-fifty without the people in the visitor. Often, even so, the respond to the question is that all i is buying are people. When this is the case, information technology is usually less expensive simply to hire away the best of these people.

Growth through acquisition in service businesses is a risky suggestion, but the risk varies. It is generally riskier every bit one moves down the spectrum toward people-based businesses, and within people-based businesses the risk increases when the service is provided by professionals or highly skilled persons. Any visitor that wants to larn service businesses must make certain that it can concenter and keep skilled service-oriented managers to run them.

Last Comment

Because manufacturing has been the dominant economic force of the concluding century, almost managers take been educated through experience and/or formal education to think about strategic management in product-oriented terms. Unfortunately, a big part of this feel is irrelevant to the direction of many service businesses. The general manager of a service business must develop a healthy skepticism about his and others' approaches to strategy.

Ane of the best means to change managers' thinking patterns and thus to avoid the trap of forcefulness-fitting product-oriented direction techniques into a service-oriented business is to alter the language system in the company. If managers talk about services instead of products, they likewise think about services and those characteristics that make services unique.

1. G. Lynn Shostack, "Banks Sell Services—Non Things," The Broker's Magazine, Winter, 1977, p. twoscore.

ii. Theodore Levitt, "Production-Line Arroyo to Service," HBR September–Oct, 1972, p. 43.

3. See West. Earl Sasser, "Matching Supply and Demand in Service Industries," HBR November–Dec, 1976, p. 133.

four. Encounter Patrick Conley, "Experience Curves as a Planning Tool" in Corporate Strategy and Production Innovation, ed. Robert R. Rothberg (New York: Free Press, 1976), p. 307.

A version of this article appeared in the July 1978 issue of Harvard Business Review.