The Competitive Advantage of Business Service Firms: A Matched Pairs Analysis of the Relationship Between Generic Strategy and

Performance
p . N. O ' F A R R E L L , D. M. HITCHENS AND L.A.R. MOFFAT
This article reviews the literature on sources of competitive advantage in husiness services with an emphasis upon the rote of reputation as a means of differentiation and then considers the rclalionship between generic strategy and performance. Matched samples of business service firms in Scotland and the South East of England are classified into Porter's generic strategy groups and tests are carried out for differences in performance between the groups derived. Until quite recently research has not been undertaken on differences in strategic phenomena between the manufacturing and service sectors; there has been a tendency to generalise findings from the manufacturing sector across all industries. Yet there are important strategic and operational differences between business service and traditional product firms. Our principal concern in this article is with btisiness services, which may be defined as those intermediate demand functions that service as inputs into the production of goods or of other services (increasing their utility or value) and that, as such, are perhaps more correctly characterised as indirect elements of the production process, i.e., services such as product design, advertising, marketing, management consultancy, graphic design, market research, accotintancy, and so on. In the following section we shall briefly review the literature on soutccs of competitive advantage in business service companies emphasising, where relevant, differences between such firms and
p. N. OTurreli unci I.. A. Mollal aif in Itic Dcpiirimcnl ol FconomLLs. Tin- ULIMFICSS Sclmol. Hcriol-Wall Lliiivcrsily, P.O. IJox H07, RicL-arton. Ftiinburgh E n i 4 4AT, UK. n . M. HiSdiCiis is in tlic Dcparlmeni (it Fx-onnmics. Queen's Univcrsily. BcH;isl B'lT INN, UK.

The Service Indtistries JmirTial. Vol. 13. No. 1 (January 1993), pp. 4(Mv4 i m m i s n i - n HY I R A N K C A S S . L O N H O N

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manufacturers. We then consider the literature on generic strategy and performance and, in particular, focus attention upon Porter's four generic strategies. We report the results of the empirical analysis which involves testing, within a matched pairs framework, the relationship between generic strategy and various performance measures for a sample of 41 business service firms in Scotland matched with 42 similar companies in the South East of England.
SOURCES OF COMPETITIVE ADVANTAGE IN BUSINESS SERVICES ECONOMIES OF SCALE

Services in general, and business services in particular, present less scope for achieving economies of scale than in manufacturing, although significant economies may be realised in other types of services such as airlines and multiple fast food outlets. To the extent that scale economies are important in business service organisations, they are more likely to be realised at company level rather than at the operating unit (office) level. For example, advertising is a scale economy that service companies can exploit as an entry barrier to maintain market share once the firm achieves a size that makes regional and national advertising economically feasible. Similarly, organisations which operate a network of offices within the UK and abroad can realise scale economies at company level in recruiting and training staff (by creating central training schools and developing standardised training manuals). The multi-office firm can also spread the cost of support activities, such as accounting, over its many offices. It can afford to systematise the service delivery process and introduce more specialised technology. Scale economy and the task specialisation that accompanies it permits professionals to gain significant advantages by specialising. Specialisation also helps to create image (reputation) in the market. A client rents the reputation of, for example, a major management consultancy firm to lend credibility. Since the consultancy firm may rent Its reputation frequently, there are economies of specialisation realised by the supplier. Haywood-Farmer and Nollet [1985: 173] also assert that scale economies can make it easier to maintain an appropriate level of quality. Our evidence contradicts this. At the office level many business service firms reported that problems of maintaining quality are exacerbated in large operating units. Economies of scale are a major factor influencing the process of concentration which tends to be low in business services, although there is a discernible trend towards increasing concentration. For example, of the 6,250 design consultancies in the United States, fewer than 100 employ more than 20 people. Of the British market research firms listed in the

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Market Research Society's Organisation Book. 83 per cent employ 12 people or fewer, 12 per cent employ between 13 and 30, and only 5 per cent have a payroll of 31 or more employees [Bryson el al., 1990: 36-7J. During the last decade the process of concentration has intensified, as witnessed by the emergence of very large firms in accountancy and management consultancy, sui-veying and advertising; much of this growth has occurred through mergers and acquisitions. The evidence for scale economy effects in business services is meagre, in part because the issue has seldom been thoroughly investigated. The benefits of increasing size in business service firms may be illusory: there is scanl evidence of a relationship between scale and profitability; but there is, as expected, a positive association between growth and profitability [Doorley etal., I988J. However, professional business services have difficulty in maintaining higher than average growth rates over time and in gaining significantly in relative market share [Doorley ei al.. 1988: IS]. Economies of Scope When the costs of providing the services of a sharable input to two or more production hnes or services are sub-additive, that is, less than the total costs of providing these services for each production line or service separately, the multi-service cost function exhibits economies of scope [Panzar and Willig, 1981: 268-72|. Three major types of scope economies may be exploited by the service firms. First, it may share physica! assets such as an office, IT, or its reputation or brand names across different services and markets. The American Express 'blue box" logo, For example, gives brand acceptability to financial planning programmes, travel agencies, travel management services, banking and credit facilities, all derived from the global brand dominance of its charge card and travel cheques. A second important source of scope eeonomies is shared external relations: with customers, suppliers, distributors and other institutions. The relationship with customers based upon reputation and trust is a priceless asset that can be built upon by offering new services [Edvinsson and Richardson, 1989: 37). Also a firm may market a range of services through the same distribution channel. Finally, shared learning - such as the pooling of knowledge developed in different markets is the third important component of scope economies. The firm may also realise economies of geographic scope in activities such as marketing, billing and logistics from having several units in a particular region [Porter, 1990: 245]. However, the mere existence of sub-additive ctist functions is a necessary but not sufficient condition in order to generate a competitive advantage for any one firm. The presence of market failure in the underlying resource that exhibits economies of seope i^

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also necessary before such economies result in any competitive advantage. Some firms attempt to take advantages of economies of scope, as in the case of the major accountancy firms, by cross-seUing other services such as consulting, through leveraging strong relationships with existing clients. Although these may seem logical strategies from the market perspective, many such attempts fail. Service delivery systems and the prevailing culture may become confused between the various businesses so that, ultimately, companies provide poor consultancy services while also lowering the quality of their own original core business [Norman, 1984: 98]. Hence, failure may be due to both limited (if any) scale effects and the difficulties of actually realising seope economies by capturing synergies qf ross multiple activities. Proprietary Technology Certain proprietary-based technologies have been developed by service businesses; the Boston Consulting Group has marketed several proprietary technologies around its experience curve concept, including market segmentation and strategic portfolio analysis; PIMs and Associates introduced their unique database of companies; and certain market research firms have developed various proprietary technologies such as electronic scanner equipment computer-aided telephone interviewing and lap-top computers for personal interviewing. The substantial costs of investing in electronic data-capture equipment can only be afforded by the larger market research companies, so creating a capital barrier to entry at least in the short term and, therefore, a source of competitive advantage. Service Differentiation Competitive positions may be easier to sustain in services than in manufacturing. Services provide intangible outputs which are more difficult to evaluate. Established firms have brand identification, reputation and persona! customer-client relationships which stem from past advertising, word-of-mouth recommendation, previous good service, or first-mover advantage. These are socially complex phenomena which are typically more diffieult to imitate than product differences. Such differentiation creates a barrier by forcing entrants to spend heavily to overcome existing loyalties [Porter, 1980]. Best practice business service organisations constantly search for ways in which to enhance a service by adding value to it and thereby differentiating it (at least temporarily) and creating a greater margin. Such differentiation, if defensible, may permit the service organisation to earn economic rents by eharging a price premium

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well in excess of the additional marginal cost of supplying the service increment. Differentiation primarily affects the revenue side of the net profit equation, but may also influence the cost side as the firm may incur additional costs in order to differentiate. Differentiation by quality insulates a business from competitive rivalry by creating customer loyalty, lowering customer sensitivity to price, and protecting the business from competitive forces that reduce price-cost margins. Reputation as a Source of Differentiation Who steals my purse steals trash; 'tis something- nothing: Twas mine, 'tis his. and has been slave to thousands; But he that filches from me my good name Robs me of that which not enriches him. And makes me poor indeed, lago in Othello Many firms manage to build a quality reputation and to extract an economic rent for that reputation which is apparently impervious io new entrants. In Scotland, for example, our empirical evidence shows that the average charge out rate for senior consultants in the branch ofliees of the major management consultancy firms is 1,100 per day. whereas for indigenous Scottish consultancies the equivalent rate is 500 pei day.' If adopting a quality position was an easy route to high profits, new firms would be expected to enter the quality end of the market and erode charges and profits down to normal levels. Why does this not occur? First, creating quality in services or products and delivering it is difficult [O'Farrell and Hitchens, 1989 and I99O[. Second, even if a new entrant can aehieve high quality, it faces problems in persuading customers that this quahty matches that of incumbents | Davis. 1990: 51_75]. Buyer uncertainty is a significant transaction eost in services due to information asymmetries in buyer-seller relationships. High-quality items with low-quality images will incur the eosts of high-quality producers but reap only the returns of low-quality producers jDavis, 1990: b2\. Third, the intangible nature of business services and their credence quality (characteristics whieh the customer may find difficult to evaluate even after consumption) reinforces the importance ol" reputation as it competitive criterion. So the established reputation of some suppliers generates returns in excess of those that would accrue to those ot equal ability. The entry barrier and source of competitive advantage that maintains high returns at this level, therefore, is the cost ot creating and of signalling quality to customers. Consequently, the market in a region

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such as Scotland is segmented: the indigenous consultancies service predominantly small and medium-sized clients, while the large consultants sell to major corporations. Hence there is little or no competition between them. Furthermore, reputation is difficult to imitate. Many service companies have developed brand identification similar to Coke, Xerox or Guinness. Numerous retailers, insurance companies, banks, universities, restaurant chains and hotels enjoy exceptional brand identity. Within the context of business serviees, many accounting, consulting, advertising, design and law firms attain distinctive and valuable brand images which are largely founded upon building a reputation for the quality of service provided. For most business services, therefore, it is the customer's perception of the organisation whieh is the most important type of branding available. Reputation is often referred to as the goodwill value of the firm's name or loyal customer patronage. The idea of reputation makes sense only in an imperfect information world [Shapiro, 1983: 659]. Buyers face a complex and costly task in determining the attributes of services before purchase due to information asymmetries in buyer-seller relationships. Where information asymmetries exist between buyers and sellers, high- and low-quality services and goods can co-exist in the market place [Akerlof, 1970: 488-500]. This coexistence requires buyers, ex ante, to determine the quality of services they buy and this is an inherently problematic and costly task. Problems resulting from incomplete or asymmetric information may be classified as either moral hazard or adverse selection problems [Nayyar, 1990: 514]. Moral hazard refers to difficulties associated with the buyer's inability to observe actions taken by the seller: it is important for the buyer of services to evaluate whether the seller's actions were proper and adequate. Adverse selection may arise when the buyer is unable to observe either the seller's characteristics or the contingencies under whieh the seller operates. A firm has a good reputation if consumers believe its products/ services to be of high quality. Since service attributes cannot be observed prior to purchase, consumers use the perceived quality of services produced by the firm in the past as an indicator of present or future quality. In such cases a firm's decision to produce high-quality services is a dynamic one: the benefits of doing so accrue in the future via the effect of building up a reputation [Shapiro, 1983: 659]. Therefore, reputation formation is a type of signalling activity: the quality of services produced in previous periods serves as a signal of the quality of those produced during the current period. A business service firm which chooses to enter a high-quality segment

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THE S E R V I C E INDUSl RIES J O U R N A L

of the market must initially invest in building a reputation via the production of quality services. During this investment period a seller must seil his service at less than cost because he cannot eommand those prices (and economic rents) associated with high-quality items until his reputation is established. Even if a new entrant to a quality segment can achieve high quahty, it faces problems in persuading customers that its quality matches that of incumbents [Davis, 1990]. The premiums that reputable firms earn serve as a crucial role in inducing such sellers to maintain their reputations. Without premiums for high-quality items, sellers would find that a fiy-by-night strategy of quahty reduction would be profit maximising [Shapiro, 1983: 660]. This is beeause in markets with reputations sellers can always increase profits in the short run by reducing the quality of their services: quality reduction will yield immediate cost savings, while the adverse effect on reputation will arise only in the longer run. A firm will find that it is not in its interests to behave opportunistically if it has a stock of reputation capita! ^goodwill') built up, on which it is earning a return [Klein and Leffler, 1981: 6I5-41[. Klein and Leffler [1981] observed that firms producing high-quality items or serviees must earn an economic rent to prevent them from being tempted to reduce quality. The opportunity eost of earning profits through quality reductions must be included in the price of high-quality serviees. This price premium ean be viewed either as a return to reputation or as an incentive payment to induce quahty maintenance. Furthermore, maintaining a reputation for quality results in fewer customers becoming dissatisfied and leaving, and increases the probability that present customers will provide positive word-of-mouth advertising [Rogerson, 1983: 508-16]. Therefore, in a competitive market high prices may act as signals of high quality [Shapiro, 1983]. The reputation developed by a business service firm may be an umbrella concept manifest at the level of the eorporation and, therefore, any service supplied is associated with the corporate reputation. The Big-Six auditing and consultancy firms have reputations of this type. Alternatively a reputation may be created for a specialised type of service provision: the Boston Consuhing Group concentrate upon strategy consultancy while Bain and Co. is a strategy specialist with an implementation focus. At another level, a reputation may be speeifie to an individual within a service organisation, such as a key creative director in an advertising agency. Finally, firms which hire well-known directors could be renting the director's reputation [Weigcit and Camerer, 1988: 450). A director may also use his position to build a personal reputation.

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Reputation performs as an implicit contract and is likely to exhibit characteristics of a public good [Nayyar, 1990: 516]. Once acquired, a firm may rent its reputation repeatedly in the context of other services or markets. However, lapses in quality in these other services could reflect poorly on the original core service and destroy the reputation built up. Nayyar [1990] has argued that a firm that diversifies into services that its existing customers may buy from it could create a source of competitive advantage by exploiting the reduction in information asymmetry. This assumes that customers of services will economise on information acquisition costs by transferring reputation effects to other goods or services offered by a firm [Nayyar, 1990]. However, there are limits to the transferability of reputation effects that constrain the diversification opportunities for a service firm. Potential buyers must believe that the expected quality will be delivered in the new service, as in the provision of management consultancy serviees by accountancyfirms.By contrast, potential customers may not believe that an accountancy firm eould also run a travel firm. Hence, the limits to the transferability of reputation implies that it should be confined to related diversification based upon some interrelationships between the services. If a business service firm has a reputation for competing on price at lower levels of quality, it is difficult to move to a high-quality position because of its entrenched reputation in the market place. The additional training and scarce resources (new staff) needed to produce quality and the marketing expertise required to communicate it to customers may not be reflected in the price of those scarce inputs which could be rationed so the cost of moving to a quality position may be higher than it appears from examining what is spent by quality companies [Davis, 1990: 65]. Companies competing in the same market segment may differentiate along a variety of different dimensions. In strategic management consultancy, for example, some firms differentiate themselves on content that is the formulation of strategy, while others emphasise implementation. A further dimension along which strategy firms have differentiated themselves is whether they are generalists (e.g.. Coopers and Lybrand, Deloitte) or specialists in strategy only (e.g., Boston Consulting Group, PIMS, Bain & Co.). Hence, the different means to aehieve differentiation creates opportunities in the market for small specialised consultancies to sustain a competitive position against the targe multinational firms at comparable charge-out rates by building a competitive advantage and exploiting it through a focus differentiation or niche strategy. Similarly, in market research, smaller agencies with high-calibre staff may challenge the large full service consultancies by a

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focus differentiation strategy which might involve a narrow service offering - qualitative market research only or a narrow market focus, business to business only or a sectoral specialisation, or both. A key factor in successfully competing against the large consultancies and earning similar rents is their ability to persuade the customer that their delivered quahty is as good if not superior to that of larger firms. Pricing The need to maintain a reputation or image for quality ol service creates pricing problems. The pricing of services is a nebulous area. Most business service firms follow flexible pricing policies depending upon the firm's perception of its market segment, its competitive position, and the size of its clients; there is a tendency to charge what the market will bear rather than use eost-plus pricing in part because it is diffieult to calculate costs where more than one service is being offered. Other types of service - notably airlines, insurance, banks and hotels - do not necessarily adopt flexible pricing policies. Also, within some business services - executive search consultancy, for example - fees are based on a formula which uses the remuneration to be paid to the person selected as a basis to set fees. It is almost impossible to draw accurate priee-quality comparisons in business services and using price cuts as a means to gain competitive advantage carries the danger of creating a bad-quality image that is counter to that necessary for a professional operation. It is easier to sell a recommendation for which the customer has paid a significant sum than one where the fee was low. Corporations expect to pay substantial rates for high perceived quality and price cutting will seldom be successful in such relatively price-insensitive market segments where competition is more likely to be based upon factors such as reputation, problem solving eapability, and so on. Life Cycle, Experience, and Market Share Effects upon Performance Certain determinants of performance in product markets, such as product life cycle, experience curve and market share effects, have reduced usefulness when applied to services [Carman and Langeard. 1980: ll[. Consumer goods manufacturers use the life-cycle concept balancing different products by stage of life cycle, a process which is not helpful to the service firm. Most of the latter cannot achieve the synergies necessary in combining delivery systems for more than one eore service. Similarly, a large market share is in general thought desirable because of the increased profitability due to the economies of scale and the dominant position that may follow. However, we have already noted the lack of scale economy effects in business services and the problems t>f quality

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maintenance at larger size. Thus, high market share, even if It can be achieved with all the problems of deterring entry, may be a mixed blessing. The effect of learning and experience on total unit cost has seldom been demonstrated in a service context. Most service organisations probably enjoy some economies from learning both in the operation of a single facility and the development of multi-site facilities [Sasser et al., 1978: 556]. Network Effects Another potential source of competitive advantage is network effects. There is a need to distinguish between scale effects and lower costs caused directly by the network organisation, as in the case of McDonald's, and those situations in which some value accrues to other members of the network when a new member is added. For example, a new international office may make it easier through extension of the office network for other offiees to acquire large multinational clients interested in globalisation. Such international networks may be composed of independent firms in several countries or of a number of business units under the control of one company. Therefore, large-scale network effects are a source of positive externalities, more important in services than in manufacturing, since additional offices increase attractiveness to the customer. Having examined the literature on sources of competitive advantage in business services and the differences between these and those occurring in manufacturing firms, we now discuss theories of generic business strategy in order to derive hypotheses for the empirical analysis. Generic Strategy and Competitive Performance There is a general consensus on distinguishing between the cognitive aspects of strategy (formulation) and the action component (implementation), although this does not necessarily imply that strategy is developed consciously [Snow and Hambieh, 1980]. It may frequently emerge unintentionally. The field of business strategy has shown a noticeable shift away from an atomistic view, in which each firm is considered unique towards a perspective that recognises communalities among firms [Dess and Davis, 1984: 468]. Thus, strategic groups provide an intermediate frame of reference between viewing the industry as a whole and considering each firm separately. The assumption that strategic groups exist is implicit in the two best known business strategies due to Miles and Snow [1978] and Porter [1980]; and it is the latter with which we are concerned in this article. Porter's [1980] strategy

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framework is academically widely accepted and has been shown by Dess and Davis [1984] to be internally consistent. The generic strategies of Porter [1980, 1985] and those of Hofer and Schendel [1978] are based on the underlying notion of maximising efficiency rents of the resources available to the firm. Porter [19K0, 1985] argues that there are two basic types of competitive advantage: lower costs and differentiation. Lower cost, although not neglecting quality, service and other areas, emphasises the ability of the firm to design, produce and sell a standardised product or service more efficiently than its competitors with an emphasis upon reaping cost advantages trom all sources. Differentiation, conversely, is the ability to provide unique and superior value to the buyer in terms of the service (product) itself (i.e. design, quality), marketing approach, delivery system, or after-sales service. Therefore, it permits a firm to command a premium price, which leads to superior profitability provided a differentiator's cost position is not so far above that of competitors so as to offset its price premium. The other important variable in positioning is competitive scope or the breadth of the firm's target within its industry. Competitive scope is important because industries are segmented and serving different segments requires different capabilities and strategies. Included in the business scope decisions are those involving: (i) the range of market segments targeted; (ii) the number and type of services/products offered in the market segments selected; and (iii) the geographical parameters of the service-market strategy. Firms in the same industry can choose a different competitive focus, since the notionof positioning is used in both a narrow and broad sense. In its narrow sense, positioning is eoncerned with where a firm locates its product relative to its competitors in a particular market: a Lada is positioned differently from a Mercedes Bcnz, the News of the World is positioned differently from the Observer [Cronshaw et al., 1990: I]. In its broad sense, positioning relates to a firm s overall approach to competing, to its strategy taken as a whole: Ford is positioned differently from BMW; Marks and Spencer is positioned differently from C & A. Porter combined the concepts of eost leadership, differentiation and focus (the breadth of scope) to give a typology ot four generic strategies: cost leadership, cost focus, differentiation and focused differentiation. Therefore, firms with a narrow breadth or scope -concentrating, for example, upon one market segment, such as financial services - may try to compete either on the basis of cost (eost locus) or differentiation (focused differentiation). Different strategics may coexist successfully in many industries. Porter [1990: 40[ also warns that

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'the worst strategic error is to be stuck in the middle or to try simultaneously to pursue all strategies. This is a recipe for strategic mediocrity and below-average performance'. We shall test this assertion using the sample of business serviee firms. Cronshaw et al. [1990: 2] have argued that there are at least three possible interpretations of the 'stuck in the middle' hypothesis depending upon whether positioning is to be interpreted narrowly or broadly, and, if a broad view is adopted, whether it is to be taken descriptively or prescriptively. It is clear that Porter intended his taxonomy to relate to a broad concept of positioning which would encompass all aspects of a company's strategy and that is the principal focus of this analysis. The two versions of the 'stuck in the middle' hypothesis relevant to a broad positioning specified by Cronshaw et al. [1990: 8] are: 1. It is important to establish strategic clarity, and companies with multiple strategic objectives are generally less successful than those with a single goal. In particular, it is necessary to choose between the objectives of cost reduction and product differentiation. 2. Companies which do not establish lower costs or differentiated products rarely succeed. Hence, the first version suggests that it is unwise to attempt both cost reduction and differentiation, while the second implies that firms are unlikely to prosper if they do not succeed in at least one. Ideally, to test the first version would require an analysis of companies which have performed both unitary and multiple goals; data does not permit us to clearly differentiate such firms. Regarding version 2. our sample contains too few firms competing on the basis of lower costs to test this version. Porter [1985: 17] argued that cost leadership and differentiation represent opposite ends of a eontinuum and that each strategy is a 'fundamentally different approach to creating and sustaining competitive advantage', although he eoneeded that it is difficult, though not impossible, to be both lower cost and differentiated relative to competitors. Each type of generic strategy is some combination of cost, differentiation and scale. Successful differentiation does not necessarily preclude a business from having a low-cost position. A combination of cost and differentiation strategies may be eftective in certain conditions. The real underlying dimension according to Jones and Butler [1988: 203] is cost (low to high) not low cost versus differentiation. Thus the Porter strategies are not totally mutually exclusive but are dimensions along which firms may score high or low. While the complexity of strategy makes it dangerous to push any classification scheme too far, a basic taxonomy is helpful in establishing starting points for deeper analysis.

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Therefore, our approaeh has been to partition the firms into the generic categories while recognising that these are differences of degree rather than of kind; categorising business strategy into a limited number of types necessarily involves simplification. A critical aspect of management's task is to match organisational competences with the opportunities and risk created by environmental change in ways that will be both effective (to do the right things) and efficient (to do things right), Hofer and Schendel |1978: 4| defined an organisation's strategy as "the tundamental pattern of present and planned resource deployments and environmental interactions that indicates how the organisation will achieve its objectives". Henee there are four components to any organisation's strategy: seope - present and planned interactions with the environment; distinctive competences: competitive advantages; and synergy, the joint effects that are sought from the organisation's distinctive competences and/or scope decisions. The fundamental concept of competitive advantage ean be traced back to the seminal work of Chamberlin [1939] but Hofer and Schendel [1978] were the first formally to suggest a direct relationship between (distinctive) competency and competitive advantages through the abilitv of the firm to use sueh competences to create major competitive advantages. They described competitive advantage as 'the unique position an organisation develops vis-a-vis its competitors through its patterns of resource deployments', while they defined competence as the 'patterns ol . . . resource and skill deployments that will help it (the tirm) achieve its goals and objectives" [Hofer and Schendel. 1978: 25]. The literature is consistent in two important aspects: the souree of eompetency is always internal to the Hrms: and competency is produced by the way a iirm utilises its internal skills and resources, relative to the competition [Reed and De Fillippi, 1990: 89]. We concur with Hofer and Schendel's [1978: 26[ argument that competitive advantages ean stem trom either distinctive competences or produet/market positioning but that the former is more important to business level strategy. Therefore, strategy links what the firm aspires to aehieve (its goals) with what its non-coiitrollable environment and resources will permit. The eoncepts of competency and competitive advantage are not syn onymous; although competences are the major source of competitive advantage, they do not inevitably generate one; and an advantage docs not necessarily emanate Irom competences. Competences, being within the firm's eontrol, can be manipulated to generate competitive advantage and high performance. Competitive advantage ean also be ilic result of some manifestation of luck. Industrial economists argue ihal industrial structure influences conduct (i.e. strategy) [Porter. I98()[: hui

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there is also freedom for the firm to select its strategy. Both paths of causation interact in an iterative dynamic process: strategy defines particular niches in the market environment, and the environment, through customer needs and competitors' responses, induces strategic adaptation. If a firm's current strategy is incongruent with its distinctive competences and competitive advantage, then it is likely to perform less well than other firms pursuing a similar strategy but with a good fit between their strategy and their underlying competitive advantages. Members of a particular strategic group may also not realise similar returns to the extent that important differences exist in their competences [Cool and Schendel, 1988: 209]. Also, Chandler observed that strategy will have a profound effect upon organisational structure while structure can constrain and influence strategy. Strategy is related to both environment and structure and many of these relationships have implications for performance. However, neither strategies nor structures alone, nor a suitable match between environment and structure is sufficient to ensure good performance [Miller, 1988: 282]. For example, a strategy of product innovation may be unrewarding in a stagnant price-sensitive environment, no matter what the structure. Complementarities of strategy with both environment and structure may be needed for good performance. Mintzberg and Waters [1985: 257-272] offer an alternative perspective on strategy by drawing an important distinction between deliberate strategies realised as intended from emergent strategies - patterns realised despite, or in the absence of, intentions. They argue that we would expect to observe tendencies in the direction of deliberate and emergent strategies; in effect these two form ends of a continuum along which real world strategies fall [Mintzberg and Waters. 1985: 259]. The authors go on to speculate whether strategies will tend to be more deliberate in centrally controlled organisations and more emergent in decentralised loosely complex ones? Will the cost leadership strategies of Porter prove more deliberate and differentiation strategies more emergent? Hence Mintzberg conceptualises strategy as a pattern of activities over time which include observations of what actually occurred; not that planning is irrelevant but that actions are more important than intentions. It is a bottom-up view of conceiving how new strategy emerges beginning with a plethora of micro strategies, spontaneous initiatives, and successful adaptations at the grass roots [Hampden Turner, 1990: 69]. It is crucial to emphasise that there is no simplistic relationship between generic strategy and performance. A firm such as the Rover Group, for example, which had cars in each segment of the volume car market and a product-positioning strategy no different from that of Ford

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of G.M., was consistently less successful during the 1970s or early 1980s. This related not to Rover's strategy but to its inability to manufacture and deliver the product to competitive levels of quality, price,finishand rehability. In short. Rover failed to match the competition in various manufacturing-related competences and not necessarily because it pursued the wrong strategy, although they have recently moved up into higher price segments. In short, the strategy-performance relationship may be complicated by differences in implementation ability. Henee, high returns associated with, for example, a focused differentiation position may not be returns to that market position per se but rather returns to some underlying competitive advantage whieh is best exploited in that market position; while, in turn, the eompetitive advantage is predominantly a consequence of deploying the firm's competences. Firms may select a market position consistent with their competitive advantage rather than deriving competitive advantage from their market position; the latter is the most appropriate means of exploiting their competitive advantage rather than the competitive advantage itself [Cronshaw et al.., 1990: 14]. Positioning and competitive advantage, therefore, are distinct concepts. Empirical Tests of the Relationship Between Generic Strategies and Performance For some, competitiveness is the ability to perform well; for others it is the generation and maintenanee of competitive advantage. The concept of competitiveness incorporates both efficiency (achieving goals at the least possible cost) and effectiveness (defining the right goals). Competitiveness is also a relative concept which, therefore, needs to be defined with respect to some other state of the world [Buckley, ei al.. 1988: 175-200]. This might be relative to a eomparator firm, as in this analysis, or to a different time, or relative to a defined counter-factual position. In this analysis, we use both measures of competitive performance (including export dependency, profitability, and percentage repeat business) and of eompetitive potential (charge our rates and value added per person). These represent different stages in the competitive process. Potential measures describe the inputs into the operations while performance measured the outcome of the operation. The analysis is based on a sample of firms from Scotland and the South East of England drawn from market research, graphic design, product design, advertising and marketing, and management consultancy. It is sometimes diffieult to determine whether an organisation has a strategy in part because managers seldom conceive of strategy in the same terms as researchers [Snow and Hambrick. 1980: 530]. We

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asked the organisations top manager to characterise their strategy which is feasible given the elarity of Porter's model. Most managers know if they are trying to be a high quality supplier or to undercut their competitors on price of if they occupy an intermediate position. This in part involved the use of certain objective indicators for which we had collected data: number of customers and their characteristics; proportion of total sales to each market segment; pricing; the mix of core and peripheral services supplied; new serviee innovation; and perceived price competitiveness relative to rival companies. The authors classified the firms separately and then compared the taxonomies derived. Some 90 per cent of companies were allocated to the same group and the classifieation of the remaining 10 per cent was determined after further detailed consideration of characteristics of the relevant companies. Furthermore, there was a high correlation between the authors categories and those reported by firm managers. This suggests that to the greatest possible extent it is valuable to use investigators' inferences, objective measures and self-typing in combination to determine strategy in preference to exclusive reliance on a single measurement method. The outcome of the classification procedures resulted in only five firms being categorised as adopting a eost focus strategy and only three competing on the basis of cost leadership. Henee, neither of these categories could be tested against the other generic strategies. However, 28 businesses were implementing a focus differentiation strategy, 27 were competing on the basis of differentiation and 20 were 'stuck in the middle'; not competing on the basis of low eost or specialising in terms of either services offered or market segments targeted. Therefore, only a minority of companies in the sample were trying to compete on costs; most were attempting to differentiate or were stuck in the middle. This tendency is, perhaps, a function of the industries being analysed in this study and the fact that one- or two-person businesses, which are more likely to compete on price, are under-represented because of our aim to include firms potentially eapable of trading between regions. Therefore, we tested differences in competitive potential and performance measures between: Focus Differentiation and Differentiation; Focus Differentiation and 'Stuck in the Middle'; and Differentiation and 'Stuck in the Middle'. We have already argued that strategic groups may consist of members who have different capabilities in terms of resources and skills to execute a similar strategy. The fundamental question, therefore, is: having allowed for the effects of variation between firms within groups, does performance differ between strategic groups? Does formulating and implementing a strategy make a difference? Since the early 1970s a

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THE SERVICE INDUSTRIES JOURNAL

number of research studies have indicated that strategic planning does result in superior performance.^ We hypothesise that there will be no difference in performance between firms implementing a focus differentiation or differentiation strategy; but we expect that both of these groups of firms will display superior performance to those stuck in the middle, as Porter suggested. Firms were sampled first in Scotland; they represented cither a subsample of the respondents to a postal questionnaire survey; or the population of firms in the case of market research and product design. The Scottish sample was derived from relevant professional directories supplemented by regional directories. At the next stage the Scottish firms were matched with a sample of London firms also drawn from professional directories. The companies were matched by age group, size category and type of core service provided. In many cases there were a number of South East firms which matched against a Scottish company and in these instances they were selected at random. This raises the interesting question as to whether there are any systematic differences in performance within generic strategy categories between areas. We hypothesise that demand side differences between the South East and Scotland - both in terms of volume, sophistication and segmentation of demand, the existence of a highly diversified and competitive sub-supply industry in London and the more competitive environment within which firms have to operate in the capital - will remove below-average companies and result in a higher level of overall performance. This test could be conducted only for those firms adopting a differentiation policy due to an insufficient number of matched pairs of firms within the other strategic categories in both regions.
TABLti I SIZE AND AGh OF FIRMS BY GFNtKK" STRATEtiV Median employment size (IWOI 12 11.
12 14 16 14

Generic Stralegy Focus dilterenliation Differentiation hbciis differentiation Stuck in the middle Differentialiiin Stuck in the middle

Median

Wilcoxon

-[^M

N.S.

10,? ').()
10.,S 'J li

N=27 1=68 N.S. N^20 T=66 N.S. N--20

1 - H I p<0,l)7 M^-27 r-.^,s N.s. N-21)

["- rifi N.S N :ii

'. Wilcoxon Matched Pairs Signed Ranks Test.

Table 1 shows the median age and employment size of the companies

THE ADVANTAGE OF BUSINESS SERVICE FIRMS

57

sampled. Wilcoxon Matched Pairs Signed Ranks Tests applied to both age and size for each matched pair of observations for three combinations of generic strategies (focus differentiation and differentiation; differentiation and stuck in the middle; and focus differentiation and stuck in the middle) show that the differences in each case are not statistically significant at P<0.05. Thus, the companies sampled in each generic category are sufficiently well matched by size and age for these factors to have little or no independent effect. It is very important to note when interpreting the empirical findings that we have not used simple two-way tests. The pair-wise matching has introduced successful controls for type of .service provided, size, age - thereby eliminating any effects due to economies of scale, learning, and first mover advantages. Consequently, the tests summarise the effect of the relationship between generic strategy and performance holding these three variables constant, while acknowledgeing that differences in implementation abilities may complicate the analysis. In order to test for performance differences between categories of generic strategy, the Wilcoxon Matched Pairs Signed Ranks Test, which ties intermediate between the test and the sign test in power efficiency, is the appropriate one to use when data is in the form of matched pairs. The results summarised in Table 2 show that focus differentiators generate higher levels of export penetration than firms stuck in the middle; their median value added per person is 45 per cent greater, and the median charge out rate they command is some 63 per cent higher. The Wilcoxon test applied to these measures of competitiveness for each matched pair of observations indicated a significant result and the null hypothesis (Ho) of no difference between the two populations is rejected in all three cases. The proportion of repeat business recorded, however, is not significantly different. Whilst there are an insufficient number of paired observations to test for a statistical difference in profitability since partnership organisations are fee income rather than profit-oriented, the focus differentiators recorded a higher average figure, 14.3 per cent net profit on turnover, than those firms stuck in the middle, 11.2 per cent. Table 3 presents the results of testing matched pairs of differentiators in all sectors against firms stuck in the middle. Firms pursuing differentiation strategies export significantly more (P<0.01) than companies of similar size, age and service type implementing a stuck in the middle policy. Also, their median value added per person is some 56 per cent greater and their median charge out rate is 20 per cent higher. The Wiicoxon test applied to these two measures of performance for each matched pair yielded statistically significant results. The two

58

THH SERVICF INDUSTRIHS .KJURNAI

groups of firms generate similar proportions of repeat business, while the differentiators achieved an average net profit on turnover of ] I per cent compared with 10.3 per cent.
TABLF 2

PERFORMANCE MEASURES FOR MATCHED PAIRS OF FIRMS CLASSIFIED BV GENERIC STRATEGIES FOCUS DIFFERENTIATION AND STUCK IN THl": MIDDLE'
Export dependency: percentage exports Median 5 0 Mean 26 1.5 Ciiarge oui rate Senior siaff (.t per day) Median 570 3511 Mean 636 40 i

Genericstrategy

Value added per person ()

PtrcLntagi huMness Median Sll 75 Mean 7i 62

Focus differentialion Stuck in the middle Wilcoxon Matehed Pairs Signed Ranks Tesi

Median 4L(S(K) 38.7(10 I 4

Mean 4(1,93(1 3 i,56(1 I <0.0.

%)

' ^ " '

'. Means and medians caiciilaled tor malched lirms only.

I AHLE 3

PERFORMANCE MEASURES FOR MATCHED PAIRS OF I-IRMS CLASSIHliD BY CiFNERlC STRATEGIES DIFFERENTIATION AND STUCK IN THE
Expori Generic strategy dependency: percentage exports Median iO 0 Mean 12.5 4.i Vaiue added per person () Ciiarge oul rate Senior staff ( t per day) Median
>Uf>

ige

repeat

Differentiation Stuck in the middle Pairs Signed Ranks Test

Median 42,Sim 27,4(10 T=^3S N=--IS

Mean 47.9X6 37.566 P<0.n2

Mean
61S

Median 70
7-1

Mean 70 6.* N.S.

42li 1=26 N-- 17

455 P<I1.O2

N = l')

i -64 N - IS

'. Means and medians Luicuiated for niaielied ilrins only.

Next, we matched companies pursuing a focus differentiation strategy against those following one of differentiation. Both generic categories recorded similar mean levels of export percentages; hence, we cannot reject the null hypothesis of no difference between the two populations at the PanO.O5 level (Table 4). Median value added per person is 17 per cent higher for the differentiators; but the Wilcoxon test for all matched pairs shows that the differences are not statistically significant. Conversely, the charge out rate commanded by focus differentiators is 22 per cent greater and their proportion of repeat business is also higher.

THE ADVANTAGE OF BUSINESS SERVICE FIRMS

59

However, neither relationship is significant. Finally, average net profit on turnover achieved by differentiators, at 13.8 per cent is slightly greater than that of the focus differentiators, 10.8 per cent, but there are
TABLE 4 PERFORMANCE MEASURES FOR MATCHED PAIRS OF FIRMS CLASSIFIED BY GENERIC STRATEGIES FOCUS DIFFERENTIATION AND DIFFERENTIATION Export dependency: percentage exports
Median 1 5 T=136 N=23 Mean 13 11.5 N.S.

Generic strategy

Value added per person ()

Median 39,9(H) 45.750 1=64 Mean 45.437 54.174 N-S-

Charge out rate Senior staff ( per day)

Median 640 525 Mean 707 567 N.S.

Percentage repeat business

Median 79.5 72.5 T=64 N=2I M 79 73 N

Focus differentiation Differentiation Wilcoxon Matched Pairs Signed Ranks Test

r-69
N = 19

N-21

'. Means and medians calculated for matehed tirms only.

too few matched observations to justify a statistical test. Thus, it is quite clear that there are no systematic differences between differentiators and focus differentiators across the range of performance measures analysed. Tt is equally apparent that firms, which in terms of their generic strategy are stuck in the middle, display an inferior performance on the majority of indices when matched with similar companies adopting either differentiation or focus differentiation strategies.
Performance of Differentiated Firms in Scotland and the South East

We have hypothesised that service businesses in the South East pursuing a differentiation strategy will record higher levels of performance than matched Scottish companies. Table 5 presents the results of these tests.
1 ABLE 5 PERFORMANCE MEASURES FOR MATCHED PAIRS OF FIRMS ADOPTING A DIFFERENTIATION STRATEGY CLASSFIED BY REGIONAL LOCATION' Export dependency: percentage exports
Median 10 0 T=3 N=I2 Mean IS 4 P<0.OI

Region strategy

Value added per person ()

Median 46,8(K) 35.IH) T=5 N-ll Mean 53.500 42,467 P<0,02

Charge out rate Senior staff ( per day)

Median 770 438 T= N-ll Mean 73fi 565 P<().05

Percentage repeat business

Median 75 77 T=ll N=ll Mean 73 71 N.S,

South-Fast Scotland Wilcoxon Matched Pairs Signed Ranks Test

Means and medians calcidated for malched tirms oniy.

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THE SERVICE INDUSTRIES .lOURNAI

The matched differentiators in the South East export more than their matched Scottish counterparts and the difference is statistically significant (P<0.01). Median value added per person of the South East companies is 34 per cent greater; and their median charge-out rate is also substantially higher. The null hypothesis of no difference between the two populations is rejected in both cases on the basis of an application of the Wilcoxon Matched Pairs Signed Ranks Test. The proportion of repeat businesses recorded is not significantly different. This is noi unexpected. Fast-growing firms adding new clients to their core list will generate lower levels of repeat business as a proportion of their total revenue. The South East businesses achieved a higher net profit on turnover, 14.2 per cent, than the Scottish ones, 10.4 per cent although there are too few matched observations to test for a statistical difference. Hence, the business service firms in the South East implementing a differentiation strategy have recorded a superior performance to their matched Scottish counterparts.
DISCUSSION AND CONCLUSIONS

The present cross-sectional research design inhibits the ability Io do more than infer causal relationships. The viability of inferences drawn from a cross-sectional analysis depends upon assumptions concerning the persistence of strategies over time; many organisations are conservative and resistant to change jDess and Davis, 1984: 484], while others may be prepared to alter their strategy in response to environmental or other infiuences. However, there is no substitute for longitudinal research to explore the dynamic causal connections and performance implications of the relationships between competences, competitive advantage, generic strategy and environment. To our knowledge, no such research has been conducted on any industry in the business service sector. Yet successful strategics generally consist of a planned sequence of moves from one position lo another ai the right time. The dynamic nature of successful strategics is reflected in their description by Gilbert and Strebel [19881 'i^ outpacing strategies which can be either pre-emptive or proactive. The research findings are generally consistent with Porters contention that commitment to at least one of the three generic strategics will result in higher performance than if the firm fails to develop a generic strategy (i.e. becomes stuck in the middle). The empirical evidence of performance differences between strategic groups lends credibility to the notion of a strategy - performance relationship. We conclude that strategic group membership is one element that can have

THE ADVANTAGE OF BUSINESS SERVICE FIRMS

61

a differential performance impact. These results appear to be at variance with those reported by Cronshaw et al. [1990], whose analysis provided little support for the stuck in the middle hypothesis. However, there are some important differences between these analyses: different measures of competitiveness have been used; the firms have been classified using a different methodology; and we have concentrated upon business service firms only which were not included in the Cronshaw et al. study. Business service companies are probably less able to adopt a high-quality/low-cost position; high quality is perhaps more likely to be associated with higher costs than in many other industries since the production of high quality is more dependent upon very skilled (expensive) staff. The observation that firms which are stuck in the middle do not perform as well as those companies adopting a focus differentiation or differentiation strategy does not imply that such firms should reposition their services, leave the middle of the market, and adopt either aggressive price competition or, more likely, product differentiation. Prescription should only follow a careful analysis of the competences, competitive advantages and structure of each firm, and an assessment of whether its generic strategy and broad positioning is consistent both with its structure, its competitive advantages, and its environment, especially the nature of demand in its markets. Indeed, business service companies competing on the basis of cost leadership, cost focus or being stuck in the middle may underestimate the cost of attempting to develop the competences and resultant competitive strengths to move up-market to a differentiation or focus differentiation strategy. To develop a reputation for scarce skills requires large investments in human capital and time [Davis, 1990]. It cannot be emphasised strongly enough that selection of an appropriate generic strategy does not guarantee success. It is a necessary but not sufficient condition: the business needs to develop the competences that it will use to establish competitive advantage over rivals that are necessary to realise the potential of the chosen strategy. This is the most creative and difficult aspect of the business-level strategy-formulation process. In terms of implications for practice, managers need to pay particular attention to building complementarities between business strategy and its structural and environmental contexts. Furthermore, we have scant knowledge concerning what organizational characteristics facilitate the achievement of a cost leadership position or meaningful differentiation. [White, 1986|. Firms pursuing differentiation strategies may do better to seek out dynamic and sophisticated environments; while firms competing on price should remain in predictable and stable

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T H E S E R V I C E I N D U S l RIHS .lOURNAl

environments. Other important, as yet unresolved, questions remain: dofirmshave one reputation or many; how resilient are reputations and how much are they an asset? To identify the effect of reputation upon eompetitiveness and performance remains a rewarding research challenge and will require a model that also acknowledges the effects of market, product and structure variables. One of the most interesting results of this study is the finding that having controlled for age. size, and type of core service, firms located in the South East pursuing a differentiation strategy arc more competitive than matched Scottish firms adopting a similar strategy. To what extent this is due to inferior competences and competitive strengths, poorer positioning, or demand side factors is the subject of our on-going research.

NOI ES Thcst; figures should be interpreted as of an order of magnitude rather ihan precise indicators: management eonsultancy firms subcontract work and, frt)m lime lo time. may carry out more days' work than were originally budgeted. Hofer and Sehcndel [1978. p,7] cite five such studies, while Bu/zeil and (Sale il987| present evidence from the PIMS database on the links between strategy and pert'urm-

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