Creating Growth With Services

Faced with saturation of their core product markets, companies in search of growth are increasingly turning to services.1 A few companies have enjoyed success with this approach — General Electric Co., IBM Corp., Siemens AG and Hewlett-Packard Co., for example. GE’s Transportation Systems division had stable revenues and operating profits between 1999 and 2002, despite absorbing a drop of more than 60% in the number of locomotives it sold. Between 1996 and 2002, revenue from services climbed from $500 million to about $1.5 billion, a trend that the division expects will continue.

Not all product manufacturers are so fortunate. Intel Corp., for instance, spent $150 million to launch a unit whose function was to set up data centers to host Web sites for companies. After three years, Intel shut down the unit and announced that it was refocusing on its core microprocessor business.2 Similarly, Boeing Capital Corp., the financial services subsidiary of Boeing Co., recently reined in its efforts to provide financial services to other industries.3

A systematic approach to creating services-led growth can help managers of product companies improve the odds of success. Companies must begin by redefining their markets in terms of customer activities and customer outcomes instead of products and services. By mapping the customer-activity chain and relating the map to a service-opportunity matrix, managers can systematically explore opportunities for new services in four directions.4 Equally important, they must assess the pitfalls and risks that these opportunities represent, and another matrix — on risk mitigation — serves as a tool for that task.

The Customer-Activity Chain

Companies traditionally think about markets in terms of the offerings they sell. But as Peter Drucker has pointed out, “What the customer buys and considers value is never a product. It is always utility — that is, what a product does for him.”5 Customers seek particular outcomes, and they engage in activities to achieve them.

These activities can be mapped along a customer-activity chain, a concept that has been discussed by several authors in different but broadly consistent ways.6 A customer-activity chain has the following characteristics:

• It must represent an end-to-end temporal sequence of logically related activities. For consumers, these activities can center on a stage of life (education, career, parenting), the pursuit of a specific interest (fishing, golf) or the ownership of a specific asset (home, automobile, camera). For businesses, it can center on a process (logistics management, human resource management) or a set of assets (computer systems, machinery).
• It must lead to defined customer outcomes. For instance, retirees may want “financial independence” and “peace of mind.” Purchasers of computer systems may desire “higher employee productivity.” Business travelers may seek “to get to a meeting on time and in a positive frame of mind.” These outcomes become the basis for defining the quality of the customer experience.
• It must be defined at the segment level, not at the aggregate market level. For instance, it makes no sense to talk about the customer-activity chain for information workers when analyzing productivity. Activities should be mapped according to segments — lawyers, sales executives, health care practitioners and so on.
• It will often cross industry and product-market boundaries. For example, in the home ownership customer-activity cycle, customers might engage with contractors, insurance companies, realtors, banks, telecom companies and many other service providers. In fact, services are often the glue that holds the activity sequence together.

The customer-activity chain is the foundation for exploring services-led growth opportunities. Analogous to product-centric growth strategies like product line extension, product line filling and brand extensions, customer-activity chains can be extended, filled, expanded or reconfigured with new services. To structure the investigation of these opportunities, it is useful to categorize them on the basis of the impact they have on the customer-activity chain. The service-opportunity matrix provides the necessary framework.

The Service-Opportunity Matrix

Once companies are thinking in terms of the customer-activity chain, they can classify new services along two dimensions: the focus of growth (where does growth occur?) and the type of growth (how does growth occur?). The “where” question can be answered by thinking about primary and complementary, or adjacent, activity chains. For example, visiting a dealership is a primary activity on the auto ownership chain, whereas seeking insurance quotes is a complementary activity that falls on an adjacent chain. Service growth opportunities can be found on both chains and in two ways (the “how” question): first by adding new activities and second by reconfiguring existing activities.

Merging the focus of growth with the type of growth results in the two-by-two service-opportunity matrix. The four elements of the framework include

• Temporal expansion: growth from services that add new activities to a primary activity chain
• Spatial expansion: growth from services that add new activities to an adjacent chain

• Temporal reconfiguration: growth from services that change the structure and control of activities within a primary chain
• Spatial reconfiguration: growth from services that change the structure and control of activities within an adjacent chain (See “The Service Opportunity Matrix.”)

Temporal Expansion

An activity chain can be thought of in terms of time — the time it takes a customer to perform all the various tasks he or she needs to reach a specific outcome. And companies can expand the temporal nature of the chain, or fill in gaps within it, by adding new services that help people perform activities at every stage of the process.

Eastman Kodak Co. has created new services designed to help consumers “manage and share memories” using digital photography. Until the advent of digital technology, Kodak’s involvement with customers ended when they ordered prints. The company has since found ways to add significantly to its interaction with customers. (See “Temporal Expansion by Kodak.”)

Kodak acquired a startup called Ofoto Inc., for example, which offers an online printing service that makes it easy for customers to order prints (because it is expensive and inconvenient, only 2% of analog photographs are ever reprinted). Consumers also can create online albums, order greeting cards, archive their photos on a CD, and buy frames and other merchandise. Ofoto has had more than 2 million customers in two years, and its customer base is growing at a rate of 13% per month. Most of that growth is organic — 59% of new members come through referrals from other Ofoto members. Almost 12% of all prints ordered on Ofoto are from shared albums.

In addition to the Ofoto acquisition, Kodak has installed 30,000 kiosks in retail locations, where customers can take film or memory cards from digital cameras to make prints. In the future, the company plans to develop a new generation of XML Web services centered on digital photography.7 While Kodak is struggling as its analog film business declines rapidly, it is the second-largest seller of digital cameras, and its digital camera business turned profitable two years after launch.8 A big part of the reason for Kodak’s success is its deeper presence within the customer’s activity chain.

To identify temporal expansion opportunities, managers should create a blueprint that maps the customer-activity chain from one end to another. The blueprint should reveal the outcomes that customers seek, detail the sequence of activities they currently engage in and could potentially engage in, and demarcate the gaps and problems in the existing activity chain. The following questions and examples can guide the exploration for expansion opportunities:

Can Services Be Added That Precede the Sale of the Core Product?

Noble House Custom Tailors is based in Hong Kong, where relatively cheap labor allows the company to produce fine clothing at competitive prices. But the clothes really are custom-tailored because the company’s master tailor frequently visits dozens of cities across the United States and Europe. During those visits, which are widely advertised locally, he meets scores of customers by appointment, taking their measurements and helping them choose fabrics. People who might normally buy off the rack in order to save money are thus able to enjoy the services of a professional tailor.

Can Services Be Added That Follow the Sale of the Core Product?

When a customer selects a casket from Batesville Casket Co. in Batesville, Indiana, the company arranges for a tree to be planted in memory of the deceased. The business thus maintains a connection to people far beyond the primary activity of casket selection. Each year, Batesville Casket receives thousands of letters of appreciation from families for planting the memorial trees.

Can Services Be Added To Accompany the Product?

For example, online florists and gift companies could offer to take a digital picture or video clip of the person receiving the flowers or opening the gift and then e-mail the picture or clip to the sender. The gift giver would virtually have the experience of delivering the gift in person.

Can the Product Be Augmented With Network-Based Services?

Sewing-machine manufacturer Bernina offers a range of software for its machines that facilitates complex and creative embroidery and stitching projects. The software is thus a platform for supporting customer relationships over time, as users progress from stitching novices to experts.

Can the Product Be Updated With Services?

Computer security specialist McAfee.com offers packaged versions of its VirusScan antivirus software in retail stores. But new computer viruses emerge frequently, so the virus-definition files quickly become outdated. To deal with that problem, McAfee provides an online service that allows VirusScan buyers to update their virus-definition files frequently.

Spatial Expansion

Temporal expansion focuses on the primary activity chain, but companies can also introduce new services into adjacent opportunity spaces. While temporally linked services deepen relationships with customers, spatially linked services broaden them.9

To uncover opportunities for spatial expansion, managers need to think about the following questions: Are there activities that are not typically part of the primary chain but are closely associated with it? Can existing products or service platforms anchor the introduction of services in another context? Can the company’s reputation related to the primary activity chain be extended to other contexts? The connection between primary and adjacent chains need not be a matter of shared activities. Chains that appear to be unconnected by overlapping activities may be tightly linked along the dimensions of capability or reputation.

General Motors Corp. has leveraged its core automotive business to offer new service platforms for adjacent activity chains. Like most automobile manufacturers, GM offers a comprehensive set of temporally linked services for the primary activity chain of car ownership. Its OnStar platform, however, helps customers with related tasks: emergency services dispatch, stolen vehicle location, roadside assistance, remote diagnostics, route support, convenience and concierge services. Every month, OnStar unlocks about 28,000 doors, dispatches 13,000 roadside assistance vehicles, responds to 700 air-bag deployments and locates 700 lost vehicles.

By the end of 2001, there were almost 2 million OnStar subscribers and the product was offered on more than 40 GM models. While GM offers the first year’s OnStar service for free, it claims renewal rates as high as 80%, at annual subscription fees ranging from about $200 to more than $800. In addition, GM has become the country’s largest reseller of cellular service thanks to OnStar’s Personal Calling service. According to some projections, OnStar may bring in more than $2 billion by 2005.

New services that emerge from spatial linkages can in turn be linked to each other and can themselves become platforms for other services. GMAC Mortgage Corp., another expansion on an adjacent activity chain, is now the fifth-largest mortgage company in the United States. GM is creating an extension of OnStar for the home that will extend its remote monitoring, diagnostics and emergency response services. The company’s goal is to be a comprehensive services provider, covering automobile and home ownership, financial services, communications and entertainment. (See “Spatial Expansion by GM.”)

The search for spatial expansion opportunities begins with the identification of promising “pivot points” in current activities and capabilities that can lead to involvement with customers in other areas and continues with the identification of platforms or brands that can support new services. Managers must ask the following questions to identify opportunities in this dimension:

Can Products Become Platforms for Embedded Services?

Treadmill manufacturers, for example, have transformed treadmills into platforms for fitness services. Using computers and video equipment, treadmill buyers can log on to iFIT.com for basic workouts (in which the treadmill’s speed and incline are remotely controlled), music workouts (which include heart-rate-paced music and verbal encouragements from a trainer) and scenic workouts (which combine virtual landscapes delivered online using streaming video with music, the trainer’s voice and treadmill control signals).

Can the Existing Customer Base Be “Rented”?

Costco Wholesale Corp. has leveraged the collective bargaining power of its 35 million individual and business members to expand beyond its customers’ primary activity chain. The wholesale discounter now contracts with many vendors to provide services and special deals that cover auto and real estate sales, financing, insurance, online software training, communications packages and small-business loans.

Can the Existing Customer Interface Be Leveraged?

Recognizing that millions of users are familiar and comfortable with its online interface, eBay Inc. has teamed with Elance Inc. to offer the services of more than 300,000 professionals who work on Web-delivered projects, including software development and Web and graphic design. Customers post projects online, and service professionals make bids. In addition to receiving the bids, customers can review service providers’ profiles, portfolios of sample work and feedback ratings before choosing someone to do the job.

Temporal Reconfiguration

Opportunities for temporal reconfiguration arise again on the primary activity chain. Companies do not add new services in this part of the matrix; they shift the boundary between the activities they perform and those done by customers. Their motivations for undertaking such a shift are threefold. First, companies are better at managing assets or performing business processes that are closely related to their core competencies but not to those of customers. Second, they can aggregate demand across customers to create economies of scale that they can pass on to customers. Third, they can apply knowledge about best practices from the industries in which they provide such services.

United Parcel Service of America Inc., for example, used to focus on a narrow set of activities involved in the package delivery business — picking up, shipping, tracking and dropping off packages. It now takes ownership of the much broader set of activities performed by customers in managing their supply chain, logistics and customer-care operations. Many of the activities performed by UPS for its customers are not new individually, but UPS adds value by integrating them. (See “Temporal Reconfiguration by UPS.”)

The UPS Logistics Group has designed transportation networks for customers such as Ford Motor Co. The redesigned network reduced the time Ford needed to deliver vehicles from its plants to dealers by up to 40%. The group also designed and operates a dedicated global distribution center in Singapore for National Semiconductor Corp. The center manages the movement of National Semiconductor’s products from its manufacturing plants in Malaysia and Singapore to customers around the world. UPS expects to ship 450,000 orders annually, with an average delivery time of 48 hours. National Semiconductor estimates it will save 15% in shipping and inventory costs with this arrangement. UPS has also partnered with Nike Inc., taking responsibility for managing all the back-end processes for direct selling, including order management, shipping, delivery, returns management, inventory management and customer support.

The search for temporal reconfiguration opportunities often begins inside the company with an evaluation of its capabilities. Specifically, the company’s managers must understand which capabilities are central to their own business but peripheral to those of their customers; they must also decide what the firm can do better than its customers in terms of cost, speed, quality or agility.10 Managers should ask the following questions to identify opportunities for temporal reconfiguration:

Can Customer Burdens Involving Customization Be Reduced?

By taking over activities related to product customization, Dell Inc. embeds itself deeper into the IT operations of its enterprise customers and creates additional revenues from services. For example, Dell provides services related to hardware and software image development, migration and recovery, custom configuration and installation of software, asset tagging, and parts replacement.

Can Customer Burdens Involving Product Storage Be Reduced?

Gadue’s Dry Cleaning of Burlington, Vermont, stores customers’ winter clothes during the summer and vice versa. The clothes are laundered and readied for pickup at a week’s notice.

Can Process Expertise Be Leveraged?

DuPont is an expert on the application of paint and the minimization of waste and harmful emissions. After DuPont contracted with Ford to run its paint shops, Ford’s painting costs were reduced by 35% to 40%, while its emissions of volatile organic compounds declined by 50%. DuPont, which is paid on the basis of the number of painted vehicles, actually sells less paint than before because it has an incentive to paint cars with the least amount of waste. But the company makes more money as a result of the improved efficiency.

Can Customers’ Inventory-Control and Stocking Processes Be Replaced?

With vendor-managed inventory systems, many manufacturers now track inventory electronically and take charge of ordering, delivery and stocking processes for retailers — a well-known example is Procter & Gamble Co. handling these activities for Wal-Mart Stores Inc.

Can Processes Unrelated to Customers’ Core Competencies or Strategic Objectives Be Taken Over?

Contract manufacturers such as Solectron Corp. provide manufacturing and assembly services for companies such as Cisco Systems Inc. Over time, Solectron has added services related to product prototyping, customer support, call-center management and repair — freeing customers to focus on innovation, product design and demand creation.

Spatial Reconfiguration

Opportunities for spatial reconfiguration arise when a company that is already present in a customer’s primary activity chain can take charge of activities in an adjacent chain.

Nike identified an opportunity to get involved in a secondary customer-activity chain — that of training to play a sport better. Customers often engage coaches or attend sports camps to improve their game. Building on its reputation, Nike entered into a branding arrangement with U.S. Sports Camps; many camps run by the latter are now labeled Nike camps. The camps are held at many locations nationwide and offer mental and physical training for more than a dozen sports. The Nike brand is a vehicle to position and sell the camps; in turn, the camps reinforce the brand and enhance participant loyalty to Nike products.11

Spatial reconfiguration calls for a careful analysis of how the relationship between a company and its customers in the primary activity chain can be applied in other contexts. The linkage between the chains may be based on a brand image, a bundling of hitherto distinct activities or the clever design of the value proposition so that it addresses the objectives of an adjacent activity chain. Managers should ask the following questions to identify opportunities for spatial reconfiguration:

Can Services Be Added To Integrate Complementary Customer Activities?

Many people think about ordering a pizza to eat while watching a rental movie, but the activity chains associated with eating and viewing are distinct. Movie-rental company Flixrunner.com, however, has teamed up with pizza outlets to offer a “movie plus pizza” delivery service.

Can Services Be Added To Leverage the Brand?

While maintaining its focus on manufacturing and marketing farm and garden equipment, Deere & Co. has entered the adjacent activity chain of financial services. John Deere’s brand, forged over 160 years, allows the company to sell credit-card and operating-loan services to farmers and ranchers.

Can Services Be Shifted From Grounded to Mobile Assets?

Building expensive, grounded assets in developing nations is risky owing to economic and political uncertainty. To supply power to the Dominican Republic, Smith Cogeneration Management Inc. built a 185-megawatt floating power plant and ran power lines onshore. The plant is a flexible and mobile service platform that can be repositioned on short notice. Smith Cogeneration thus supplies power (the primary activity chain) and has taken responsibility for risk management, an adjacent activity chain.

Can Services Change the Way Customers Acquire Products?

Most people buy coffee (ground or beans) at a store when they need to restock, and coffee companies usually limit themselves to production and branding. But Gevalia Kaffe of Clifton, New Jersey, sells coffee via direct marketing. Coffees are delivered on a regular schedule and deliveries may be automatically charged to a credit card. Gevalia has built a successful service by questioning and modifying traditional patterns of coffee procurement.

Managing the Risks

The process of migration to services can be difficult and risky. To improve the chances of success, managers must be conscious of the risks involved and be well prepared to manage them. There are three major categories of risk: capability risk (the internal perspective), market risk (the customer perspective) and financial risk (the business model perspective). There are also three categories of risk mitigation strategy: organizational strategies (related to culture, people and organizational design), design strategies (related to design and architecture of the offering) and development strategies (related to the process of developing and testing new services). In combination, these categories form the service risk mitigation matrix, a tool for managers to understand and manage the risks of services-led growth opportunities. (See “The Service Risk Mitigation Matrix.”)

Capability Risk: Can We Execute?

Companies need to question continually whether expansion into new service arenas will take them outside the logical scope of their capabilities and organizational culture. For instance, Kodak has to determine to what extent a company with a background in technology products should be involved in online photo-printing services or the greeting card business. Significant risks are involved as Kodak’s traditional culture and competencies, built on volume production and distribution of cameras and films, adjust to this new perspective.

An organizational strategy for managing such risk is to incubate new service businesses separately until they mature and can be rolled into the parent organization. For example, while OnStar benefits from GM’s customer relationships and manufacturing expertise, it operates in a relatively autonomous manner and has created a culture that is distinct from GM’s. Almost 80% of OnStar employees are from outside GM. While such separation may be important in the early phases, connections between the core and the services businesses must be maintained — if they are not, opportunities for mutual leverage may be lost.

Another organizational strategy for mitigating capability risk is to leverage partners’ capabilities. The company may need to partner with or acquire other firms that possess the required competencies, as illustrated by Kodak’s acquisition of Ofoto. Outsourcing new service development can also mitigate capability risks.12 The pattern of growth is also important. Companies must carefully decide on the timing, sequence and size of the steps they take as they move away from their core competencies.13

Besides organizational adjustments, execution risk can be managed through clever product and process design. Companies can choose product architectures to ease the introduction of new services. For example, the EASYSHARE feature of Kodak’s digital cameras provides easy access to its online services. Further, as is the case with product development, the service development process can be augmented with structured tasks and gates that discipline the development process and ensure that key issues are addressed at particular stages.14 Companies that are new to the services arena must take particular care to document and inventory the tacit knowledge gained during the development process. Those that do so will be better prepared to develop other service offerings in the future.

Market Risk: Will They Come?

It’s also necessary to address the possibility that customers may not adopt the service or that the service may take so long to reach critical mass of customer adoption that the company cannot continue to fund it. Companies can adopt several strategies to mitigate market risk.

From an organizational viewpoint, selling services can be more challenging than selling a product because the functionality and benefits associated with services are not as clear. A separate organization dedicated to selling services is therefore useful. Selling strategies may include basing the sales pitch on successful, well-documented adoption stories; clarifying the return on investment supported by a detailed statement of expected cost savings, revenue enhancements, and product or process quality improvements; and carefully managing customer expectations.

Market risk is high, particularly when the business is expanding into activity chains where it does not have a proven track record or brand image. In such cases, the company can gain credibility by partnering with, or acquiring, other firms that are trusted names in the adjacent activity chains. For instance, GMAC entered the residential real estate business by acquiring small but well-regarded real estate companies like Koenig & Strey. GMAC employs the brands of these firms in its marketing communications.

To further reduce customer risk and encourage referrals, trial periods and referral bonuses for the new service should be considered. In addition, innovative arrangements in which service providers are paid from the savings realized when a customer adopts the service can dramatically reduce customer risk and encourage adoption. Of course, to support such arrangements, the service providers themselves must be convinced of the value added by the service.15

In terms of development, new services should be designed jointly with prospective customers — especially lead users —both to ensure that they have the right features and to prime the pump for adoption. As with products, a company can mitigate market risk during development through carefully planned iterations and test marketing.

Financial Risk: Can We Make Money?

Some growth opportunities may offer attractive revenues but not profits. Service margins are sometimes thinner than those for products, especially when the labor-intensive nature of a service makes it difficult to scale. Managers of the core business may question whether services can ever “move the needle” to a sufficient extent and within a reasonable time to justify the use of resources.

Companies can mitigate financial risk by “productizing” their services into standardized offerings that can be cost-effectively replicated and scaled. For instance, Gartner Inc., an information technology consulting firm, has distilled the knowledge of its consultants into industry reports, designed for prospective clients who might not otherwise engage its services. Once knowledge is so embodied, it can be replicated without additional skilled labor. This productized service is much more scalable than the consulting business and is well suited for smaller clients.

Organizations can also leverage Internet-enabled customer connections and resource arbitrage to reduce the cost of services. For example, with its “sure supply” technology for printers, Hewlett-Packard aims to reduce competition from third-party replacement-cartridge sellers and build a customer relationship that extends beyond product purchase. The technology has a sensor that detects when the ink supply is low, and the networked printer automatically orders a new cartridge. By building an automated cartridge-supply service into the printer, Hewlett-Packard not only enhances its revenues but also reduces its costs (for processing a customer’s phone order, for example) as well as those of its customers.16

Finally, as with any initiative, the economic case for the new service must be rigorously evaluated before embarking on the development process. Managers should keep three points in mind. First, it is incorrect to evaluate the economic case for the service independently of the company’s other offerings. Managers must compare the current net present value of the firm with the projected net present value once the service is added. This approach accounts for potential enhancements or cannibalization of revenue across the portfolio of offerings and accommodates the possibility that the new service may intentionally serve as a loss leader.

Second, while existing products may offer high margins and appear more attractive than services, managers must consider whether increased competition and commoditization will reduce that attractiveness in the near future.

Third, the initial costs of service development and launch may be high, but such costs can be reduced substantially as companies learn from experience. For example, management-consulting firms create practice areas and tools that are replicable and reusable by codifying the knowledge gained from service engagements.

Finally, while the issue of time to payoff is important, it must be recognized that new service platforms often have significant option value. Correspondingly, the payoff from new service-related platforms should not be assessed just in terms of discounted cash flows. For example, although OnStar generates limited revenues for General Motors today, it has significant option value if it can become the standard for in-vehicle services and a gatekeeper for delivering interactive services to automobiles.

AN OLD ADAGE IN marketing says “There are no mature markets; there are only mature marketers.” In difficult economic times, companies often find themselves stumped as they look for growth in their core businesses. And they are intimidated by the high rate of failure of services-led growth initiatives. But those that systematically employ the frameworks for exploring opportunities and managing risks in services-led growth should find that success is less elusive.