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Figure 3.14 Type III providers3.3.4 How do customers choose between types?
From a customer’s perspective there are merits and demerits with each type of provider. Services may be sourced from each type of service provider with decisions based on transaction costs, strategic industry factors, core competence, and the risk management capabilities of the customer. The principles of specialization and coordination costs apply.
The principle of transaction costs is useful for explaining why customers may prefer one type of provider to another. Transaction costs are overall costs of conducting a business with a service provider. Over and above the purchasing cost of services sold, they include but are not limited to the cost of finding and selecting qualified providers, defining requirements, negotiating agreements, measuring performance, managing the relationship with suppliers, cost of resolving disputes, and making changes or amends to agreements.
Additionally, whether customers keep a business activity in-house (aggregate) or decide to source it from outside (disaggregate) depends on answers to the following questions.15
Does the activity require assets that are highly specialized? Will those assets be idle or obsolete if that activity is no longer performed? (If yes, then disaggregate.)
How frequently is the activity performed within a period or business cycle? Is it infrequent or sporadic? (If yes then disaggregate.)
How complex is the activity? Is it simple and routine? Is it stable over time with few changes? (If yes, then disaggregate.)
Is it hard to define good performance? (If yes, then aggregate.)
Is it hard to measure good performance? (If yes, then aggregate.)
Is it tightly coupled with other activities or assets in the business? Would separating it increase complexity and cause problems of coordination? (If yes, then aggregate.)
Based on the answers to those questions, customers may decide to switch between types of service providers (Figure 3.15). Answers to the questions themselves may change over time depending on new economic conditions, regulations, and technological innovation. Transaction costs are discussed further under the topics of Strategy, tactics and operations (Chapter 7), Service structures (Section 3.4) and Challenges and opportunities (Chapter 9).
Figure 3.15 Customer decisions on service provider types
Customers may adopt a sourcing strategy that combines the advantages and mitigates the risks of all three types. In such cases, the value network supporting a customer cuts across the boundaries of more than one organization. As part of a carefully considered sourcing strategy, customers may allocate their needs across the different types of service providers based on whichever type best provides the business outcomes they desire. Core services are sought from Type I or Type II providers, while supplementary services enhancing core services are sought from Type II or Type III providers.
In a multi-sourced environment, the centre of gravity of a value network rests with the type of service provider dominating the sourcing portfolio. Figure 3.15 shows the range of sourcing options available to customers based on the types of service providers between which controls are transferred. Outsourcing or disaggregating decisions move the centre of gravity away from corporate core. Aggregation or in-sourcing decisions move the centre of gravity closer to the corporate core and are driven by the need to maintain firm-specific advantages unavailable to competitors. Certain decisions do not shift the centre of gravity but rather reallocate services between service units of the same type.
The sourcing structure may be altered due to changes in the business fundamentals of the customer, making one type of service provider more desirable than the other. For example, a customer merger or acquisition may dramatically alter the economics that underpin a hitherto sound sourcing strategy; see Case Example 4. The customer decides to in-source an entire portfolio of services now to be offered by a newly acquired Type I or Type II.
3.3.5 The relative advantage of incumbency
Lasting relationships with customers allow organizations to learn and improve. Fewer errors are made, investments are recovered, and the resulting cost advantage can be leveraged to increase the gap with competition (Figure 3.16).
Figure 3.16 Advantage of being a well-performing incumbent
Customers find it less attractive to turn away from well-performing incumbents because of switching costs. Experience can be used to improve assets such as processes, knowledge, and the competencies that are strategic in nature.
Service providers must therefore focus on providing the basis for a lasting relationship with customers. It requires them to exercise strategic planning and control to ensure that common objectives drive everything, knowledge is shared effectively between units, and experience is fed back into future plans and actions for a steeper learning curve.
Case example 4 (solution): Newly acquired service provider types
The Type II provider for the conglomerate had achieved its cost reductions through a relationship with a Type III. As a result of mergers and acquisitions activity, however, the company grew to include additional Type I providers.
When the company re-examined its service strategy, it realized it could in-source and consolidate all service providers into a single Type II – at a lower cost and with an enhanced technological distinctiveness unavailable from any Type III.
3.4 Service structures
‘All models are wrong, but some of them are useful.’
George Box, statistician
Case example 5: Commerce services
A web-commerce company thrives despite a severe economic slowdown. The businessmodel, based on online auctions, is profitable. However, the business model does not explain why its services succeed in creating sustainable value as other sites fail.
Process flows fail to provide insight. A value net analysis, however, reveals the distinctiveness between the auctioneer and its competitors.
What did the value net reveal about the services that a process flow could not?
(Answer in Section 3.4.1)
3.4.1 From value chains to value networks
Business executives have long described the process of creating value as links in a value chain. This model is based on the industrial age production line: a series of value-adding activities connecting an organization’s supply side with its demand side. Each service provides value through a sequence of events leading to the delivery, consumption and maintenance of that particular service. By analysing each stage in the chain, senior executives presumably find opportunities for improvements.
Much of the value of service management, however, is intangible and complex. It includes knowledge and benefits such as technical expertise, strategic information, process knowledge and collaborative design. Often the value lies in how these intangibles are combined, packaged, and exchanged. Linear models have shown themselves to be inadequate for describing and understanding the complexities of value for service management, often treating information as a supporting element rather than as a source of value. Information is used to monitor and control rather than to create new value.
Case example 5 (solution):Commerce services
Most services focus on making a profit or performing social benefits. A value net analysis revealed the online auctioneer did both.
The value net revealed a hidden participant and their intangible exchanges: hobbyists. Hobbyists discovered they could take part in the auctioneer’s micro-economy. They became professional participants with their own value capture. They created a sense of community, loyalty, feedback mechanisms and referrals.
By indirectly creating prosperity for the hobbyists, the auctioneer created prosperity for itself. The auctioneer used this insight to create a new class of services directed at hobbyists.
Value chains remain an important tool. They provide a strategy for vertically integrating and coordinating the dedicated assets required for product development. The framework focuses on a linear model but as discussed throughout this publication, linear models are seldom ideal for the complexities of service management. In this case, it is the assembly line metaphor. Upstream suppliers add value and then pass it down to the next actor downstream. This approach assumes that definitions and needs are stable and well understood. If there was a problem or delay, it was because of a weak or missing link in the chain. In this traditional service model, there are three roles: the business, the service provider and the supplier. The service provider acquires goods and services from its suppliers and assembles them to produce new services to meet the needs of the business. The business, or customer, is the last link in the chain.
The economics for linear models is based on the law of averages. If the aggregate cost of a service is competitive, then seeking a cost advantage at every link in the chain is not required or even feasible. In the day-to-day practice of manufacturing, for example, it is not practical to break down processes into independently negotiated transactions. Tight coupling is the nature of the chain.
Global sourcing and modern distribution technologies, however, have undermined this logic. A service provider no longer has the luxury of compensating for weak performance in one area with the strength of another. Further, there are often many actors performing intermediary and complementary functions who are not reflected. Also, most important in a service strategy, the focus must be on the value creating system itself, rather than the fixed set of activities along a chain.
It is important to understand the most powerful force to disrupt conventional value chains: the low cost of information. Information was the glue that held the vertical integration. Getting the necessary information to suppliers and service providers has historically been expensive, requiring dedicated assets and proprietary systems. These barriers to entry gave value chains their competitive advantage. Through the exchange of open and inexpensive information, however, businesses can now make use of resources and capabilities without owning them.
Lower transaction costs allow organizations to control and track information that would have been too costly to capture and process just years ago. Transaction costs still exist, but are increasingly more burdensome within the organization than without. This in turn has created new opportunities for collaboration between service providers and suppliers. The end result is a flexible mix of mechanisms that undermine the rigid vertical integration. New strategies are now available to service providers:
Marshal external talent – no single organization can organically produce all the resources and capabilities required within an industry. Most innovation occurs outside the organization.
Reduce costs – produce more robust services in less time and for less expense than possible through conventional value-chain approaches. If it is less expensive to perform a transaction within the organization, keep it there. If it is cheaper to source externally, take a second look. An organization should contract until the cost of an internal transaction no longer exceeds the cost of performing the transaction externally. This is a corollary to ‘Coase’s Law’: a firm tends to expand until the costs of organizing an extra transaction within the firm become equal to the costs of carrying out the same transaction on the open market. The concept of Coase’s law was first developed by Tapscott.16
Change the focal point of distinctiveness – by harnessing external talent, an organization can redeploy its own resources and capabilities to enhance services better suited to its customer or market space. Take the case of a popular North American sports league and its Type I service provider. By harnessing the capabilities of Type III infrastructure service providers, the Type I is free to redeploy its capabilities to enhance its new media services, namely, web-based services with state-of-the-art streaming video, ticket sales, statistics, fantasy leagues and promotions.
Increase demand for complementary services – an organization, particularly a Type I, may lack the breadth of services offered by Type II and Type III service providers. By acting as a service integrator, such organizations not only remedy the gap but boost demand through complementary offerings.
Collaborate – as transaction costs drop, collaboration is less optional. There are always more smart people outside an organization than inside.
Value network
A value network is a web of relationships that generates tangible and intangible value through complex dynamic exchanges through two or more organizations.
Once we view service management as patterns of collaborative exchanges, rather than an assembly line, it is apparent that our idea of value creation is due for revision. From a systems thinking perspective it is more useful to think of service management as a value network or net. Any group of organizations engaged in both tangible and intangible exchanges is viewed as a value network (Figures 3.17 and 3.18), whether or not they are in the same self-contained enterprise, whether private industry or public sector.