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Figure 3.8 Resources and capabilities are the basis for value creation

Capabilities are developed over time. The development of distinctive capabilities is enhanced by the breadth and depth of experience gained from the number and variety of customers, market spaces, contracts, and services. Experience is similarly enriched from solving problems, handling situations, managing risks, and analysing failures. For example, the combination of experience in a market space, reputation among customers, long-term contracts, subject matter experts, mature processes, and infrastructure in key locations, results in distinctive capabilities difficult for alternatives to offer. This assumes the organization captures knowledge and feeds it back into its management systems and processes. Investments in learning capabilities are particularly important for service providers for the development of strategic assets (See Section 4.3).

Service providers need to develop distinctive capabilities to retain customers with value propositions that are hard for competitors to duplicate. For example, two service providers may have similar resources such as applications, infrastructure, and access to finance. Their capabilities, however, differ in terms of management systems, organization structure, processes, and knowledge assets. This difference is reflected in actual performance.

Capabilities by themselves cannot produce value without adequate and appropriate resources. The productive capacity of a service provider is dependent on the resources under its control. Capabilities are used to develop, deploy and coordinate this productive capacity. For example, capabilities such as Capacity Management and Availability Management are used to manage the performance and utilization of processes, applications and infrastructure, ensuring service levels are effectively delivered.

3.2.2 Business units and service units

3.2.2.1 The business unit

A business unit is simply a bundle of assets meant to create value for customers in the form of goods and services (Figure 3.9). Customers pay for the value they receive, which ensures that the business unit maintains an adequate return on assets. The relationship is good as long as the customer receives value and the business unit recovers costs and receives some form of compensation or profit.

Figure 3.9 Business units are coordinated goal-driven collections of assets

The business unit’s capabilities coordinate, control, and deploy its resources to create value. Value is always defined in the context of customers. Some services simply increase the resources available to the customer. For example, a storage service may assure that a customer’s business systems can achieve a particular level of throughput in transaction processing with the availability of adequate, error-free and secure storage of transaction data. The storage service simply increases the capacity of the system, although one might argue that it actually enables the capability of high-volume transaction processing. Other services increase the performance of customer’s management, organization, people and processes. For example, a news-feed service provides real-time market data to be used by traders to make better and quicker decisions on trades.

The relationship with customers becomes strong when there is a balance between value created and returns generated. The catalogue of goods and services amplifies the effect and strengthens the capabilities and resources of the business unit. Better returns or cost recovery allow for greater investments in capabilities and resources. The resources and capabilities complement each other.

The business unit could be part of an organization in the public or private sectors. Instead of revenue from sales there could be revenue from taxes collected. Instead of profits there could be surpluses. The customers of the business unit could be internal or external to the organization.

Understanding the customer’s business

Back at the office

Pick a customer and carefully analyse their business to understand the ecosystem in which they operate. What conditions make the customer’s business grow? How do your services create or sustain such conditions? What challenges and opportunities does their business face? How do your services help your customer address them?

Suggestion: Visualize the ecosystem diagram with the various boxes and connectors that constitute the closed-loop system for creating and sustaining value.

3.2.2.2 The service unit

Service units are like business units, a bundle of service assets that specializes in creating value in the form of services (Figure 3.10). Services define the relationship between business units and service units. In many instances, business units (customers) and service units are part of the same organization. In other instances service units are separate legal entities.

Figure 3.10 Customer assets are the basis for defining value

There are many possible relationships between business units and service units (Figure 3.11). In the example below, Service X is provided to Business Unit A by Enterprise 2. It is hosted by Service Unit 1 and Service Unit 2. Service Y is provided to Enterprise 1 by Service Unit 2. It is shared by Business Units A, B and C. Demand for Service Y is consolidated across Enterprise 1. By pooling demand across the business units, Enterprise 1 negotiates better terms and conditions for Service Y, including pricing discounts. Enterprise 2 is willing to accept those terms and conditions because consolidated demand represents a lower risk of poor return on assets for Service Unit 2 – thereby reaching the break-even point sooner.

Service Z is provided to Business Unit D by Service Unit 3, both of which exist within Enterprise 3. Service Unit 3 commercially offers Service Z to the business units of Enterprise 1. This increases the return on assets required for the service and potentially reduces the unit costs of providing the service internally to Business Unit D.

Figure 3.11 Common relationships between business units and service units

Customers and service providers are usually a part of a larger value chain or value network. Customers have their own customers to serve, and service providers are in turn served by their service providers

3.3 Service provider types

‘There is no such thing as a service industry. There are only industries whose service components are greater or less than those of other industries. Everybody is in service.’

Professor Emeritus Theodore Levitt, Harvard Business School

Case example 4: Infrastructure services

Some time in the late 1990s, the internal IT Service Provider for a global conglomerate decided to source all data centre operations to external service providers. The primary driver was lower costs. Five years and several mergers and acquisitions later, and despite having achieved its cost reductions, the internal provider is considering in-sourcing all data centre operations.

What do you suspect is the reason?

(Answer at the end of Section 3.3)

It is necessary to distinguish between different types of service providers. While most aspects of service management apply equally to all types of service providers, others such as customers, contracts, competition, market spaces, revenue and strategy take on different meanings depending on the type. There are three archetypes of businessmodels service providers:

 Type I – internal service provider

 Type II – Shared Services Unit

 Type III – external service provider

3.3.1 Type I (internal service provider)

Type I providers are typically business functions embedded within the business units they serve. The business units themselves may be part of a larger enterprise or parent organization. Business functions such as finance, administration, logistics, human resources, and IT provide services required by various parts of the business. They are funded by overheads and are required to operate strictly within the mandates of the business. Type I providers have the benefit of tight coupling with their owner-customers, avoiding certain costs and risks associated with conducting business with external parties.

The primary objectives of Type I providers are to achieve functional excellence and cost-effectiveness for their business units.11 They specialize to serve a relatively narrow set of business needs. Services can be highly customized and resources are dedicated to provide relatively high service levels. The governance and administration of business functions are relatively straightforward. The decision rights are restricted in terms of strategies and operating models. The general managers of business units make all key decisions such as the portfolio of services to offer, the investments in capabilities and resources, and the metrics for measuring performance and outcomes.

Type I providers operate within internal market spaces. Their growth is limited by the growth of the business unit they belong to. Each business unit (BU) may have its own Type I provider (Figure 3.12). The success of Type I providers is not measured in terms of revenues or profits because they tend to operate on a cost-recovery basis with internal funding. All costs are borne by the owning business unit or enterprise.

Figure 3.12 Type I providers

Competition for Type I providers is from providers outside the business unit, such as corporate business functions, who wield advantages such as scale, scope, and autonomy. In general, service providers serving more than one customer face much lower risk of market failure. With multiple sources of demand, peak demand from one source can be offset by low demand from another. There is duplication and waste when Type I providers are replicated within the enterprise.

To leverage economies of scale and scope, Type I providers are often consolidated into a corporate business function when there is a high degree of similarity in their capabilities and resources. At this level of aggregation Type I providers balance enterprise needs with those at the business unit level. The trade-offs can be complex and require a significant amount of attention and control by senior executives. As such, consolidated Type I providers are more appropriate where classes of assets such as IT, R&D, marketing or manufacturing are at the core of the organization’s competitive advantage and therefore need careful control.

3.3.2 Type II (shared services unit)

Functions such as finance, IT, human resources, and logistics are not always at the core of an organization’s competitive advantage. Hence, they need not be maintained at the corporate level where they demand the attention of the chief executive’s team.11 Instead, the services of such shared functions are consolidated into an autonomous special unit called a shared services unit (SSU) (Figure 3.13). This model allows a more devolved governing structure under which SSU can focus on serving business units as direct customers. SSU can create, grow, and sustain an internal market for their services and model themselves along the lines of service providers in the open market. Like corporate business functions, they can leverage opportunities across the enterprise and spread their costs and risks across a wider base. Unlike corporate business functions, they have fewer protections under the banner of strategic value and core competence. They are subject to comparisons with external service providers whose business practices, operating models and strategies they must emulate and whose performance they should approximate if not exceed. Performance gaps are justified through benefits received through services within their domain of control.

Figure 3.13 Common Type II providers

Customers of Type II are business units under a corporate parent, common stakeholders, and an enterprise-level strategy. What may be sub-optimal for a particular business unit may be justified by advantages reaped at the corporate level for which the business unit may be compensated. Type II can offer lower prices compared to external service providers by leveraging corporate advantage, internal agreements and accounting policies. With the autonomy to function like a business unit, Type II providers can make decisions outside the constraints of business unit level policies. They can standardize their service offerings across business units and use market-based pricing to influence demand patterns.

Market-based pricing

With market-based pricing there is minimal need for complex discussions and negotiations over specific requirements, technologies, resource allocations, architectures, and designs (that would be necessary with Type I arrangements) because the prices would drive adjustments, self-corrections and optimization on both sides of the value equation.

While Type II providers benefit from a relatively captive internal market for their services, their customers may still evaluate them in comparison with external service providers. This balance is crucial to the effectiveness of the shared services model. It also means that poorly performing Type II providers face the threat of substitution. This puts pressure on the leadership to adopt industry best practices, cultivate market spaces, formulate business strategies, strive for operationaleffectiveness, and develop distinctive capabilities. Industry-leading shared services units have successfully been spun off by their parents as independent businesses competing in the external market. They become a source of revenues from the initial charter of simply providing a cost advantage.

3.3.3 Type III (external service provider)

The business strategies of customers sometimes require capabilities readily available from a Type III provider. The additional risks that Type III providers assume over Type I and Type II are justified by increased flexibility and freedom to pursue opportunities. Type III providers can offer competitive prices and drive down unit costs by consolidating demand. Certain business strategies are not adequately served by internal service providers such as Type I and Type II. Customers may pursue sourcing strategies requiring services from external providers. The motivation may be access to knowledge, experience, scale, scope, capabilities, and resources that are either beyond the reach of the organization or outside the scope of a carefully considered investment portfolio. Business strategies often require reductions in the asset base, fixed costs, operational risks, or the redeployment of financial assets. Competitive business environments often require customers to have flexible and lean structures. In such cases it is better to buy services rather than own and operate the assets necessary to execute certain businessfunctions and processes. For such customers, Type III is the best choice for a given set of services (Figure 3.14). The experience of such providers is not limited to any one enterprise or market. The breadth and depth of such experience is often the single most distinctive source of value for customers. The breadth comes from serving multiple types of customers or markets. The depth comes from serving multiples of the same type.

From a certain perspective, Type III providers are operating under an extended large-scale shared services model. They assume a greater level of risk from their customers compared to Type I and Type II. But their capabilities and resources are shared by their customers – some of whom may be rivals. This means that rival customers have access to the same bundle of assets, thereby diminishing any competitive advantage those assets bestowed.

Security is always an issue in shared services environments. But when the environment is shared with competitors, security becomes a larger concern. This is a driver of additional costs for Type III providers. As a counter-balance, Type III providers mitigate a type of risk inherent to Types I and II: business functions and shared service units are subject to the same system of risks as their business unit or enterprise parent. This sets up a vicious cycle, whereby risks faced by the business units or the enterprise are transferred to the service units and then fed back with amplification through the services utilized. Customers may reduce systemic risks by transferring them to external service providers who spread those risks across a larger value network.