S-Business: Defining the Services Industry
Authored by Stephen W. Brown, Fred Van Bennekom, Keith Goffin, Al Hahn, and James A. Alexander

Most everyone has heard quite a bit about the "service economy." The average person would probably identify this with hotels, banks, and large franchises such as McDonalds. But, as noted by Dr. Stephen W. Brown of Arizona State University in his article entitled "The Move To Solutions Providers" published by Marketing Management magazine this spring, the world’s largest service providers are IBM and General Electric. Services are playing an increasingly important role among manufacturers in general and high technology companies in particular. IBM Global Services recently generated over $37 billion, has a backlog of over $60 billion, is growing at approximately 17% annually and employs well over half of IBM’s employees. As stated by Dr, Brown, "Today, IBM regards services as a business in its own right."

GE’s highly respected leader, Jack Welch, has led the company into services such as engineering, media, medical, financial and consulting. Mr. Welch was quoted in USA Today as saying "Services is so great an opportunity for the company that our vision for the next century is that GE is a global service company that also sells high quality products." Similar changes are taking place at Hewlett-Packard and other high tech firms. Pitney Bowes Inc., perhaps not considered as high tech as some, is not only transforming its products into software and Internet-based services, but also consulting with businesses to manage their mailroom operations.

Driving Forces
What is driving these transformations? Two of the most important elements in any business are at the core of this movement: customers and competitors. In an increasingly complex world customers are demanding more help to use the products that they have invested in. They are also looking to outsource important functions that are not part of their core competency. The combination means a huge demand for services that vendors are struggling to meet.

The competitive element is another consideration. Even with rapidly changing technology, it gets ever more difficult to differentiate with product innovation alone.

Commoditization is always just around the corner. This puts tremendous stress on margins. Given the customer demand just described, services offer a welcome alternate source of better margins. As opposed to tangible goods, they also do not require large capital investments before revenues begin. For investment-weary technology firms this is immeasurably good news.

Of course, this transformation to a goods and services business requires a substantial shift in thinking. Unilever, a very large food company based in Europe recently launched a food safety consulting business. Serhan Teodoresco, vice president for their consulting in the Netherlands noted "My biggest challenge is educating the product-dominant board members of Unilever on the differences between investing in goods versus services businesses." This report is aimed at educating and affecting the mindset of those contemplating this kind of transformation. We will be specifically focusing on high technology companies, although much of this report may apply elsewhere.

The Battles of Services in High Tech
Having served on the board of directors of the Association For Services Management International (AFSM International) from 1980 to 1987, including a year as international chairman and president, the author was in an excellent position to observe and participate in the struggles during that time as many high technology companies began the transition to services as a separate business. Often this was manifested as a change in accounting from a cost center to a profit center. The transitions are, in fact, more profound than just the accounting, but this was seen as the tangible manifestation of the decision to begin the journey to a somewhat different destination.

Internal battles raged during those years, culminating in the eventual consensus movement in favor of services. By the end of the decade, Andersen Consulting reported that 87% of high technology service organizations surveyed were organized as profit centers. Estimates today range from a low of 75% in some markets to over 95% in more mature sectors. The battle, however, seems to be largely over. While the eighties were full of commentaries in the trade press, a recent Internet search found only one mention of profit center transitions. That was over a year ago and was merely a matter-of-fact mention that it was an important transition that needed to be made for online support providers, a relatively new segment. Such assertions are virtually unchallenged in the media today. The overwhelming industry practice is to organize service as a profit center.

So, what was the controversy about? Like most such issues, it was largely about change. Accounting departments were concerned the about extra work required to perform the tracking and reporting. Their opposition usually faded easily when the benefits of profit center organization were understood. A more formidable obstacle was usually represented by the sales function. Sales people have a strong preference to control as much of their environment as possible. Since services are often present in field offices and actually touch customers, sales people want to control them. If they are not adequately compensated for selling services, they will typically give them away to help sell the product. Independent service organizations resist such notions, guarding the opportunity to sell their services. They also resist long warranties that exacerbate costs and may eliminate service contracts. One memorable example of this is Compaq Computer whose weak service organization years ago failed to head off the PC "warranty wars" when Compaq introduced a 3-year warranty. Veterans of this experience still regret the decisions that led to other vendors feeling required to match the long warranties and suffering through years of increased costs and lost service revenues. In the end, the supposed competitive advantage was never realized but the disadvantages linger today. Strong service organizations certainly don’t eliminate poor decisions. They do, however, perform a better job of representing service issues including costs and revenues in decisions affecting them.

In contrast to Compaq, Cisco Systems, with a strong Internet-oriented service organization, provides much shorter warranties than its direct competitors. Cisco typically prices its products and services higher and discounts far less. These are typical hallmarks of a market leader and assist them in maintaining their dominance. The company’s understanding of the importance of services is such that its own salespeople are penalized if they fail to sell services and its resellers are required to sell its services to end-users.

Profit Centers versus Cost Centers
First of all, one might wonder what the fuss is about. After all, other organizations such as manufacturing, accounting, and product development or engineering are all usually cost centers. Most companies don’t sell the services of their manufacturing or accounting departments, however. While that is certainly a possibility, it is not ordinary. When it does happen, the profit center issue will also become an issue for that department. So, the issue usually comes up as a result of the potential to sell services.

Organizations that sell services will always want to pay attention to certain things. They will want to track their revenues and costs and try to improve their margins. They will want to protect and enhance their revenue opportunities. They will want to control their own costs and transfer other department’s expenses to their source so that their margins can be fairly calculated. They will want marketing and sales activities directed at selling their services. They will begin to make investments for future economies of scale and other benefits. If they are selling their services, this will be the same whether the department is called accounting, manufacturing, or service.

Being characterized as a cost center has its hazards. Within companies, costs are items to be controlled or even attacked. If costs can be reduced, margins can be improved. Service organizations that are cost centers tend to become weaker over time. Investments are often postponed or avoided altogether. They are under constant cost reduction pressure and do not sustain robust service delivery. Quality of customer services is tightly tied to customer satisfaction and brand loyalty. Companies with strong service have more satisfied customers and enjoy more repeat business. Prognostics, of Palo Alto, California are widely regarded as the leader in high technology customer satisfaction studies. They established the correlation between customer satisfaction and repeat buying in studies conducted worldwide beginning around 1980 and continuing today. Indeed even the Internet has discovered the connection between service and customer loyalty. BizRate.com recently disclosed that one of their Internet studies rated customer service as the number one element in driving "e-loyalty." Numerous studies of high technology services sponsored by AFSM International and conducted by such firms as Coopers & Lybrand, Andersen Consulting, and Dataquest have concluded that robust, high quality services, while usually more expensive, are much more successful than low-cost services. These successful examples are the types of services typically provided by strong service organizations organized as profit centers.

Many companies have also entrusted the sale of accessories, remanufactured products, and consumables to service organizations. Frequently these items are regarded as too small to command much attention from product sales teams. Since service organizations are more frequently in touch with existing customers, they are in a perfect position to sell these items as customers need them. Most companies find that revenues of these items increase significantly when sold by service profit centers. They are also better served by focusing their more experienced and expensive product sellers on higher ticket items and new opportunities.

The Bottom Line
What is the result of the profit center movement and the more recent trend to service as a separate business? In the computer industry, 35% of revenues are now flowing from services and they are growing at a faster rate than most products. The prediction is for the service share of revenues to continue increasing. On the profit side, 60% of computer industry profits come from services today, and that trend is also expected to continue. Jack Welch, on announcing that nearly 60% of GE’s profits came from services commented, "I wish it was 80%." While many industry segments may lag the computer industry today, we believe that the same issue of customers and competition will drive the need for and growth of services in most markets, particularly high technology.