Service Logic: Transforming Product- Focused Businesses*

Stephen W. Brown Anders Gustafsson Lars Witell

2011
P.O. Box 874106 Tempe, AZ 85287-4106 Phone: 480-965-6201 Fax: 480-965-2180 wpcarey.asu.edu/csl Twitter.com/WPCCSL
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An excellent product no longer guarantees business success. Ubiquitous information and inexpensive networks for its global dissemination have created an international marketplace in which products become commoditized almost as soon as they are announced. Finding new sources of income and growth has become a matter of competitive necessity for traditionally product-oriented companies in this environment. Many have improved customer satisfaction and increased revenues and market share by shifting their focus from selling products to building customer relationships and providing service solutions. Those that have been the most successful realized early on that services require their own logic. The transition from a Goods Logic (a product focus) to a Service Logic (a customer focus) is a time and resource-intensive process that requires committed leadership and a significant organizationwide cultural shift. Otherwise, internal resistance, difficult conversations with customers, and the dangers inherent in any sort of large-scale corporate restructuring may divert resources and people from important tasks, weakening the company rather than promoting growth. Though there is no sure-fire way of guaranteeing a successful transition from a Goods Logic to a Service Logic, by surveying hundreds of manufacturers in a range of industries and conducting more than twenty in-depth case studies of product-focused companies developing service offerings, weve identified the major benefits of providing services, located the most frequent challenges, and underlined the most important success factors.

problems which it solves, using its products if appropriate or competitors products if not. The transition from a Goods Logic to a Service Logic not only revitalized IBMs business but also fundamentally changed its approach to the market. Successful services have one thing in common: they directly solve a customer problem. Product companies that have developed a services business have managed customers perceptions of the companys core capabilities. Consider a simple example. Say a customer knows that company A makes high-quality buttons, and that company B gives good advice about fasteners of all types. The customer has a product that needs a high-quality button, so he calls company A. The customer is also developing a product that requires a fastener, but hes not sure which type would work best, so he calls company B. After understanding the customers needs, Company B recommends a Velcro fastener that it can manufacture and offers to assess the rest of the customers fastener needs. The customer is so pleased with the custom Velcro solution that he agrees. Soon, company B is producing all of the customers fasteners, including the buttons company A used to provide. In addition, having established a relationship with the customer, company B is helping streamline the customers design process using principles company B developed when developing its own. Even though company A has the exact same product capabilities as company B, the customer thinks of company A as a button manufacturer because thats how company A presents itself. Company B presents itself as a one-stop solutions provider to all of the customers design challenges. The customer comes to consider company B a trusted advisor and partner. Seeing its business grow, company B fully embraces a Service Logic.

From Goods to Service: A Change in Logic

Adopting a Service Logic does not mean abandoning selling products; it means changing how a company identifies its own role within the market. CASE STORY Twenty years ago, IBM was a struggling computer manufacturer. As computing was becoming more affordable, smaller and nimbler firms were able to chip away larger pieces of IBMs B2B and consumer businesses, sending the company into a funk that threatened to tear it apart. CEO Louis V. Gerstner, Jr., appointed in 1993, is widely credited with saving the company with his prediction that IBMs greatest and most valuable asset in the coming internet age he foresaw would be its operational and organizational expertise. Capitalizing on this expertise, Gerstner repositioned the company as a provider of information technology services. IBM went from selling computer equipment to selling solutions to its customers IT challenges, building on decades of experience developing, installing and maintaining huge information infrastructures for governments and corporations. Despite the much-commented sale of its PC division to Chinese computer manufacturer Lenovo in 2005, IBM has not stopped selling computer hardware; rather, it has changed why it sells that hardware. Customers bring IBM
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Benefits of a Service Logic

Greater income stability Services are generally less expensive to develop and deliver than products and frequently enjoy much higher margins, especially in commoditized markets. And unlike products, which tend to deliver income only at the time of purchase, service offerings are often purchased more frequently, or as part of a multi-year service agreement, often providing an annuity stream of income. This is particularly important during economic downturns, when sales product income can fall drastically. Consider Scania, a leading global truck, bus, and industrial engine manufacturer. The companys sales suffered considerably in the recent downturn, with truck orders dropping by 91% in the last quarter of 2008. But when customers stop buying new trucks, they have to take better care of their existing fleets, and because Scania has invested heavily in developing comprehensive repair and maintenance agreements as well as transportation-related financial services, its service sales actually increased as its product sales declined.

Competitive differentiation Thanks to advances in communications technologies, customers considering a purchase have access not only to the full variety of options the market offers, but also to the experiences of other customers, often in near real time. And because competitors also have access to the same information, many markets are saturated with nearly identical products. Services, however, are much harder to copy and can be used to build on and reinforce existing brands, cutting through the competitive din to help a company really stand out. As more and more goods companies turn to services, customers increasingly use these firms as a benchmark for their innovativeness and reliability. In October 2002, IBM acquired the consulting arm of PricewaterhouseCoopers. Over the next decade, Big Blue shed much of its traditional hardware business in favor of services and software. Hardware accounted for 24% of its revenue in 2000 but only 7% by the end of 2009. During that time, IBM sold its PC business and became a service solutions provider. A decade later, IBM is the worlds preeminent IT services provider. Improved responsiveness and adaptability to changing market conditions Becoming a service provider forces a company to adopt a much greater level of flexibility because changing or turbulent market conditions more rapidly affect customers service needs. It takes months and often years to tweak goods, but services can be updated in real time and thus assist in keeping abreast of technological and product developments. This added closeness to the customeras well as to supply chains and the market itselfallows product-dominant companies to operate in turbulent markets that would previously have moved too quickly for them. CASE STORY In 1986 Jim and Janice Dougherty applied the big box superstore concept to the pet industry, opening two PetFood Warehouse stores in Arizona. Over the next 11 years, the company that has become PetSmart expanded nationally, building a brand that meant low prices and variety. Then in 1997, PetSmart hit what its own company history calls a bump. Inventory problems and an off-target marketing plan were followed by a drop in the stock price from $23 to $6 per share. Phil Francis, who took over as CEO in 1998, commented later that the business model didnt become wrong, but it wore out. PetSmart saw the large pet-owner market and sought to leverage it by offering pet food and supplies at a low price. It was that bump in the road that led the companys new leadership to take a good look at the contribution services made to the bottom line. The company began revising its thinking, refocusing on the pet owner as the customer. Since these owners perceive themselves as pet parents, the company developed services to help them parent their pets better. Quoting that company history again, in 1999: Weve

realized just how important services are to our business and our customers, so weve rethought our strategy. Now were focused more on providing the lifetime needs of pets and their parents, which is more than just having the most products at the best prices. Beginning the next year, training and grooming grew 21 percent, a trajectory that continued through 2006. In 2003 the company launched its pet lodging concept, called PETsHOTEL. Today, grooming, training, medical care, hotel and doggie day camp are PetSmarts featured services. Francis told an audience of business leaders in 2005 that services were twice as profitable as products. In recent down times, revenues from those popular services helped keep the company stable. Improved and expanded customer relationships The greatest benefit service providers enjoy is a far closer relationship to their customers than they would if they were only product suppliers. Services require much more frequent and deeper contact, often in the customers space, which results in more intimate relationships that can also lead to a larger share of the lifecycle value of goodsvalue that competitors captured previously. Increased familiarity with customers operations gives service providers direct insight into what new products and services to develop as well as an audience likely to respond to such tailored offerings receptively and with increased loyalty. In 2008, Xerox rolled out a redesigned logo, reflecting a new emphasis on document management and solutions, and when CEO Ursula Burns took the helm a year ago she announced that The Document Company would continue its shift to a services focus. The acquisition of Affiliated Computer Services, completed in September, 2009, was a game changer, she said. At the time of the takeover, Xerox stated that nearly 80 percent of the revenue of the combined company would come from recurring revenue based on services and equipment contracts. With technology investments ranging into the millions, Xerox clients are realizing that knowing how to make it all work is worth a price. And in uncertain economic times, when a big hardware purchase might be postponed, Xerox is hoping that the services business will provide a more reliable stream of revenue.

Initiating a Service Revolution

In practice, the transition from a Goods Logic to a Service Logic often begins at a customers behest, but even in the absence of such organic development, a company not steeped in offered services can begin to do so credibly by applying its existing expertise to creating services of the three following types. 1. Product-related, value-added services These are by far the easiest services for a product-centric company to offerin fact, many give them away with their products as a deal sweetener. Often referred to as
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entitlement services, they are expected by customers when they purchase a product. Repairs, maintenance, and extended warranties, all fall under this category, as do more specific services such as priority technical support for proprietary software platforms and printing supplies for photocopiers and printers. Such services are an excellent entry point into understanding a customers key concerns throughout the entire business and require the least amount of organizational change on the part of the provider. In many capital-intensive process industries such as pulp and paper, the pace of investment in new equipment has slowed. To ensure continued growth, Finnish paper giant Metso Paper began supplementing its product equipment sales with maintenance services. As the companys understanding of its customers grew, it was able to expand beyond equipmentspecific after-sales maintenance services and into nonproduct-related services such as taking over the management of all maintenance functions for entire paper mills. Service sales, which grew 500% between 2002 and 2008, now represent roughly one-third of the companys net revenue, and that proportion continues to grow. 2. Non-product-related services Many successful manufacturers and other productcentric businesses grow thanks to an expertise in certain organizational or operational capabilities which they can in turn offer as a service to their customers, as in the Metso Paper example. HR, logistics management, IT, transportation, and customer service are all examples of services that many customers do not have as core competencies and are thus willing to outsource to service-providing suppliers. For instance, Fenwick, a French manufacturer of fork lift trucks, parlayed its understanding of materials handling into safety, energy and other management services valued by its customers. Over half of Fenwicks sales now comes from services and these revenues helped the company weather the economic downturn. Having a product company offer revenue generating services requires numerous organizational adjustments and can strain an unprepared providers resources. 3. Service-led solutions This is the most advanced type of services and requires a full remaking of a product firms business model and organization. By working closely with its customers, a company gains insight into its customers real needs and becomes a trusted advisor in streamlining their businesses. New solutions are often developed together with a specific customer. The services are then tested and brought back to the company and subsequently modularized for potential sale and use with other customers. Delivering enlightened services that support the customer requires firm commitment to working in their best interests. IBM has become famous for its so-called offering-agnosticism, even recommending competitors products and services to its customers when its in their best interest. Take Volvo Trucks as an example. Volvo has leveraged knowledge of customers fleet efficiency issues into its new
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services offering -- Fuelwatch -- that enables owners to get more miles per gallon, reduce environmental impact and reduce down time. The program, whose top tier is a pay-toplay IT service, is based on a deep partnering relationship between Volvo and its customers. At its foundation, Fuelwatch is part of the sales and routine maintenance parts of Volvos business. Prior to a sale, Volvo works with potential buyers to assemble the right specifications for the customers business. Volvos customers share information about their routes, terrain covered and load. Volvo analyzes these factors to recommend trucks that will perform efficiently. Post purchase, Volvo offers maintenance tips and products to maximize efficiency, all delivered as part of their legacy customer service encounters. Because Volvo has been at the customers side since before purchase, it has a relationship with them that allows it to offer premium services that help customers at the very core of their businesses: operational efficiencies. VolvoLink in the U.S. and Dynafleet in Europe are information technology solutions that give fleet operators enhanced capability to track and monitor vehicles, deliveries and drivers. According to Volvo, the benefits for its customers are huge: The bottom-line is increased revenue through improved utilization, and lower operating expenses through fuel control and optimized administration. The company also offers training that teaches drivers ways to improve their skills to maximize fuel efficiency.

Innovating in Services: Co-creating Value with Customers

A strategy some companies use to develop service innovations is to pilot them within their own organizations. Not only does this allow the companies to debug the service and work out the kinks, but it also gives them a first-hand experience of the services value, which makes it much easier to price. Companies that enjoy especially close relationships with their customers increasingly begin the process with their customers and essentially co-create innovations. Co-creation is an on-going process, one that involves the customer and firm working hand-in-hand to co-create value. Often this process has the positive effect of expanding the customers connections and transactions with the company, expanding revenue at the same time. Eastman Kodak Co. faced diminishing demand for its film and film-related products as photography -- especially consumer photography -- migrated to digital technologies. By carefully listening to and working with customers, Kodak responded by offering new services to these digital shutterbugs, in the process increasing the amount of time and money the customer spends interacting with the company. Kodaks Consumer Digital Imaging Group seeks to enhance peoples lives and social interactions with service offerings

that extend Kodaks legendary heritage in ease of use. Kodaks acquisition of Ophoto Inc., one of the first online printing services, gave Kodak a service that customers use to generate reprints, albums and share photos. The web service also sells picture frames and accessories. Kodak augmented these online offering with an easy, fast way for customers to work with their images in person. Kiosks in retail locations enable customers to co-create their own reprints and photo gifts -- books, albums, posters -- instantly and in their neighborhoods. These co-creation services greatly expanded Kodaks customer touch points. In MIT Sloan Management Review, researchers estimated that digital services have increased to about a dozen the opportunities for Kodaks customers to interact with the company. The expansion was possible because Kodaks mission -- to enhance lives with easy-to-use products -- was based on an understanding of the customers needs for new services.

anticipated customer benefits and costs again requires an intimacy with a customers business that most goods companies simply dont have.

Key Success Factors

Despite the challenges noted, numerous product-dominant firms have begun providing and selling services successfully. Most have found that when customers see the value in a service, they do not object to paying a fair price for it. The key to getting customers to see that value is to understand what it is they valuewhich is only possible after an organization adopts a Service Logic. These are some of the most important steps in moving from a Goods Logic to a Service Logic. Creating a dedicated service organization Companies beginning the transition to services will often initially incorporate their creation and delivery within the rest of the organization. Problems of coordination, integration and performance metrics arise within this product-based model, especially as soon as service sales reach a certain volume. Companies that create a separate organizational unit for services, such as Ericsson for instance, tend to be more successful over time. Their autonomous service units develop a distinct organizational culture and much stronger relationships with their customers. Reducing intrafirm competition Close customer relationships within a specialized service business unit are pointless if the firm as a whole does not capitalize on them. Siloed business units competing with each other for talent or financial targets do not encourage the level of multi-functional collaboration necessary to deliver innovative services and solutions. At one successful products and services company, managers incentives are contingent on multi-business unit collaboration. To discourage internal competition, 45% of each managers bonus is based on his business units performance, 45% is based on the firms performance, and 10% is based on customers assessment of their total experience with the firm. Fostering a service culture Not everyone thrives in a collaborative atmosphere. HR policies that attract and retain smart, adaptable, lifelong learners and mentors with a team ethic and a service mentality play a big role in determining the success of a companys service offerings. Not only are such employees better collaborators, they also are more likely to ask questions and spot new opportunities within their customers businesses. Retaining, as well as recruiting, these employees allows a company to develop deep relationships with its customers and helps to model desirable behaviors within its organization.

Selling Challenges
Selling services requires new hiring policies, sales training, incentives, and performance assessments. Salespeople have to become experts in their customers businesses and need proper support and encouragement. Selling services also requires new invoicing and billing procedures, systems for managing the implementation of services, as well as financial structures and strategies for dealing with service revenues. Product-dominant companies attempting to offer services without recognizing the necessity of an underlying shift from a Goods Logic to a Service Logic and the corresponding organizational change it requires fall into many of the same traps. A company that asks its sales force to sell a service without first investing in new sales training and restructuring its organization to support and incentivize the much more intensive customer contact that selling and delivering services requires will quickly run into significant resistance from its own salespeople, especially when they have relied for years on free or discounted maintenance plans and training courses to secure product sales. They will claim that customers are sure to abandon them for the competition if they try to charge for services that they use to give away for free. Its also often much harder to sell a complex service than a product. Countless companies, including IBM and Xerox, have learned this lesson. Service sales are usually relationship-based in a way that product sales are not, and may require salespeople to deal with managers much farther up in the customers organization. Salespeople focused on products often dont have the deep knowledge of a customers operation needed to create and market services. There is also the problem of pricing. For a company used to selling tangible goods, a service presents the challenge of having to account for what is important to the customer beyond pure product reliability and longevity. Assessing

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CASE STORY Marriott practices what it preaches. To ensure consistently excellent service, Marriott treats its employees as it wants its customers to be treated, beginning from the day it hires them. Marriotts vetting process was developed by behavioral scientists to screen applicants based on their natural inclination to help others and their sense of internal responsibility. The reasoning is simple: if employees are not service-oriented, then no amount of other skills will make them useful. While prioritizing attitudes over skills might translate into more training, carefully vetted employees respond better to training and adapt more quickly than applicants chosen only based on skill. All employees receive ongoing companywide and departmental training courses both in operations and in career development. Many companies shy away from substantial training programs in fear of the cost and that once experienced and knowledgeable, trained staff will take a better job in another company, but an attractive company culture and benefits packages help retain trained staff. Marriott, a world leader in consumer tracking and satisfaction measurements, takes employee satisfaction very seriously. Marriott managers are held accountable for low employee satisfaction, though not many are being penalized. Marriott also remains the only non-unionized international hotel chain in the world. Goods-dominant firms hoping to instill service cultures among their employees would do well to learn from Marriotts philosophy: the only way to achieve customer loyalty is first to achieve employee loyalty. Cultivating a customer-orientation Service-oriented employees are half the battle. The other half is identifying those areas in which services will simplify and/or enhance customers experiences, allowing them to concentrate on developing the resources and capabilities they needed to compete more effectively in their chosen line of business. Some companies that have moved further along the goodsservices continuum have actually taken over some of their customers processes within the customers own facilities, manufacturing firms managing customers inventories or providing maintenance services for instance. Developing capabilities to perform this sort of service requires companies to establish systems for managing processes within the customers operations, and become more responsive to customer needs by making organizational adjustments. These adjustments might include decentralizing decision making so that managers working closely with the customer can make appropriate decisions without having to wait for approval from less-connected, more senior managers.

CASE STORY A product-oriented company is focused on its internal organization while a service-oriented company focuses on its customers business processes and value-creation strategies. As a senior executive with Ford observed: If you go back to even a very short while ago, our whole idea of a customer was that we would wholesale a car to a dealer, the dealer would then sell the car to the customer, and we hoped we never heard from the customerbecause, if we did, it meant something was wrong. Today, we want to establish a dialogue with the customer throughout the entire ownership experience. We want to talk to and touch our customers at every step of the way. We want to be a consumer products and services company that just happens to be in the automotive business. Balancing customization and modularity Services need to address specific customer needs, but customizing service offerings for every customer is inefficient, and given a certain service volume, untenable. Ericsson, for example, bases three-quarters of its service on pre-defined service modules. Ericsson can then rely on a majority of pre-defined service modules that can be combined with customized services to meet a customers individual needs. This allows customers to tailor service packages to their needs without overwhelming a companys service capacity. Selling downstream Services are harder to sell than products. While outsourcing maintenance might in fact reduce overhead costs, a sales strategy that has proved as successful as a cost-savings argument for numerous companies is the promise of benefits that can be passed on to customers customers thereby boosting business. Nokia, for instance, helps network operators develop networks that can accommodate greater numbers of users and services which eventually translate into more mobile service contracts for the providers and more handset sales for Nokia. Everybody wins. CASE STORY Demonstrating value for money. After discovering that 20 percent of its customers accounted for 80 percent of its service costs, Abbott Diagnostics decided to unbundle its service offerings from its instrument sales. Its salespeople initially balked, but Abbott created a tiered service plan and trained them to sell it. Many customers were thrilled that paying entitled them to higher priority service.

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Economic development is often visualized along a continuum that starts with agriculture, passes through manufacturing, and evolves into services. Thanks to the proliferation of information systems that manage hugely complex business processes, facilitate design, coordinate global logistics networks, and promote almost instant global communication, the whole world is moving into the services part of the continuum. Companies that traditionally equated superior products and superlative markets are finding increased competition and market saturation make it necessary to offer services as a way of maintaining their differentiation.

Related Reading Auguste, Byron G. Eric P. Harmon and Vivek Pandit (2006), The Right Services Strategies for Product Companies, The McKinsey Quarterly. 1, 1-8. Bitner, Mary Jo and Stephen W. Brown (2008), The Service Imperative, Business Horizons, 51 (1), 39-46. Bitner, Mary Jo, Amy L. Ostrom and Felicia N. Morgan (2008), Service Blueprinting: A Practical Technique for Service Innovation, California Management Review, 50, (3), 66-94. Brown, Stephen W., Anders Gustafsson and Lars Witell (2009), Beyond Products: More Manufacturers are Branching out into Service Business, The Wall Street Journal, June 22, R7. Davies, Andrew, Tim Brady, and Michael Hobday (2006), Charting a Path Toward Integrated Solutions, Sloan Management Review, 47 (Spring), 39-48. Fang, Eric (Er), Robert W. Palmatier, and Jan-Benedict E.M. Steenkamp (2008), Effect of Service Transition Strategies on Firm Value, Journal of Marketing, 72 (September), 1-14. Gebauer, Heiko and Thomas Friedli (2005), Behavioral impliations of the transition process from products to services, Journal of Business & Industrial Marketing, 20 (2), 70-78.

Source: Adapted with permission from James C. Spohrer, IBM University Programs World Wide The best information acted on appropriately has almost always translated into the best performance. Now that most information is ubiquitous, companies have to get closer than ever to their customers to ensure they know something their competitors dont, often becoming so intimately involved with many aspects of their customers businesses that the nature of their own businesses changes from a Goods Logic to a Service Logic. The benefits of this change make its desirability seem incontestable, and while no single approach guarantees success, the experiences of goods-dominant firms developing services outlines a general approach and does point in the right direction.

Neu, Wayne A. and Stephen Brown (2008), Manufacturers forming successful complex business services: Designing an organization to fit the market, International Journal of Service Industry Management, 19 (2), 232-51. Oliva, Rogelio and Robert Kallenberg (2003), Managing the transition from products to services, International Journal of Service Industry Management, 14 (2), 160-72. Ostrom, Amy L., Mary Jo Bitner, Stephen W. Brown, Michael Goul, Vicki Smith-Daniels, and Kevin A. Burkhard (2009), Moving Forward and Making a Difference: Research Priorities for the Science of Service. Sawhney, Mohanbir, Sridhar Balasubramanian, and Vish V. Krishnan (2004), Creating Growth With Services, Sloan Management Review, 45 (2), 34-43. Tuli, Kapil R., Ajay K. Kohli, and Sundar G. Bharadwaj (2007), Rethinking Customer Solutions: From Product Bundles to Relational Processes, Journal of Marketing, 71 (July), 1-17. Young, Laurie (2008), From Products to Services. Chichester: John Wiley & Sons Ltd

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About the Center for Services Leadership at Arizona State University

The Center for Services Leadership (CSL) is a research center within the W. P. Carey School of Business at Arizona State University (ASU) and an outreach arm from ASU to the business community and the global academic community. The CSL was founded in 1985 to pioneer the study of services when business schools were focusing primarily on products and manufacturing enterprises. Since then, the CSL has established itself as a globally recognized authority on how to compete strategically through the profitable use of services. For more information, please visit wpcarey.asu.edu/csl

* Stephen W. Brown, Ph.D. holds the Edward M. Carson Chair in Services Marketing, and is Professor of Marketing and Executive Director of the Center for Services Leadership at the W. P. Carey School of Business, Arizona State University, Tempe, Arizona USA, Anders Gustafsson, Ph.D. is Professor of Business Administration at the Center for Service Research, Karlstad University, Karlstad, Sweden; and Lars Witell, Ph.D., is Professor of Business Administration at the Center for Service Research, Karlstad University and Associate Professor of Quality and Service Development at Linkping University, Linkping, Sweden.