CHAPTER 2

SERVICE STRATEGY

TEACHING NOTE
This chapter sets forth the strategic theme of the book that the operations function is central to
the competitive strength of a service firm. The chapter begins with the strategic service vision
that relates the service delivery system to the target market segments via an operating strategy
and service concept using Southwest Airlines as an example. The application of the three generic
competitive strategies — cost leadership, differentiation, and focus — to service firms is
explored with examples. Porter’s five forces model and SWOT analysis are applied to service
firms. Taking a page from manufacturing strategy, we apply the concept of service winners,
qualifiers, and service losers to the dimensions of service competition. Sustainability in discussed
with the application of Triple Bottom Line to services. The important role that information plays
in a firm's competitive strategy is captured in a two-by-two matrix that uses the dimensions of
strategic focus (external or internal) and competitive use of information (online or offline). In
keeping with the latest innovations, we discuss the impact of Internet of Things (IoT) and data
analytics on services. The concept of a virtual value chain that can create competitive advantage
in the "marketspace" is illustrated with examples from USAA. Privacy questions and
anticompetitive behavior are issues that limit the use of information. The chapter concludes with
a discussion of the stages in service firm competitiveness and a “whodunit” Case about two
niche-market banks.

SUPPLEMENTARY MATERIALS
James L. Heskett, W. Earl Sasser, Jr. and Christopher W.L. Hart, Service Breakthroughs,
Free Press, New York, 1990.
The authors describe how breakthrough managers develop counterintuitive strategic service
visions and a service concept that focuses on achieving results for their customers.

Case: The Priceline Group: Booking a Place for the Future (HBS: 316177-PDF-ENG)
The Chairman of the Priceline Group is considering the actions he must take to confront an
evolving external environment, new direct competition, disintermediation and substitute
offerings. Does his response require an increased coordination of each historically autonomous
division or some other approach? (competitive advantage, strategy)
Case: Southwest Airlines (A) (HBS case 575-060)
Southwest Airlines began as a small intrastate Texas airline, operating commuter-length routes
between Dallas (Love Field), Houston, and San Antonio. In June 1971, having overcome legal
hurdles raised by entrenched Braniff and Texas International, Southwest inaugurated service with
a massive promotional campaign and many innovations designed to attract passengers. On
February 1, 1973, Southwest must decide how to respond to Braniff's "Half Price Sale."

Case: Monster.com: Success Beyond the Bubble (HBS: 802024-PDF-ENG)

In 2001, Monster.com was an Internet site that, among other things, connected individuals
seeking jobs with organizations wanting to hire. Its substitutes included help wanted classified
advertising in newspapers. Monster was one of the few Internet companies that had weathered

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the bursting of the dot-com bubble and continued to grow both its revenues and profits at rates
above 50% per year in 2001. This case examines why the company was able to prosper and
discusses options for future growth. (business growth, economies of scale, IT)
Case: Zipcar: Refining the Business Model (HBS Case: 9-803-096)
The expense of owning or leasing a modest car in urban locations can exceed $500 per month
when insurance and parking expenses are included. Using a website for reservations and wireless
communication, the concept of car sharing has become a reality with Zipcar and its tag line,
“wheels when you want.”

Case: British Airways: Using Information Systems to Better Serve the Customer (HBS case
9-395-065)
British Airways developed an information system, Customer Analysis and Retention System
(CARESS) to ensure rapid response to customer complaints. The case explores how this system
is able to melt the complaint iceberg in order to resolve customer complaints quickly and
improve retention as well as to provide data for root-cause-analysis of problems.

Case: Ritz Carlton: Using Information Systems to Better Serve the Customer (HBS Case
9-395-064)
Ritz-Carlton, a Malcolm Baldrige National Quality Award winner, relies on two information
systems to promote customer loyalty: COVIA to handle centralized reservations and Encore, a
local system that keeps track of guest preferences.

Note: Service in E-Commerce: Findings from Exploratory Research (HBS Module Note N9-
800-418).
This note explores the concept of scalability in the context of customer support and logistics.
The authors also discuss the E-commerce customer experience cycle that includes navigation,
information, customer support, and logistics leading to loyalty when well executed.

LECTURE OUTLINE
1. The Strategic Service Vision (Table 2.1 and 2.2)

2. Understanding the Competitive Environment of Services

3. Competitive Service Strategies

Overall cost leadership, Differentiation, Focus

4. Strategic Analysis

Porter’s Five Forces Analysis (Figure 2.1)

SWOT Analysis: Strengths, Weaknesses, Opportunities, Threats (Table 2.3)

5. Winning Customers in the Marketplace

Qualifiers, Service winners, Service losers

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6. Sustainability (Figure 2.2)

7. The Competitive Role of Information in Services (Figure 2.3)

Creation of Barriers to Entry, Revenue Generation, Database Asset, Productivity

Enhancement
8. Internet of Things (IoT) (Figure 2.4)
9. Data Analytics in Services (Figure 2.5 and Table 2.4)
10. The Virtual Value Chain (Figure 2.6)

11. Economics of Scalability (Table 2.5 and 2.6)

12. Limits in the Use of Information

Anticompetitive, Fairness, Invasion of Privacy, Data Security, Reliability

13. Using Information to Categorize Customers

14. Stages in Service Firm Competitiveness (Table 2.7)

Available for Service, Journeyman, Distinctive Competence, World-Class
Service Delivery

TOPICS FOR DISCUSSION

1. Give examples of service firms that use the strategy of focus and differentiation and the
strategy of focus and overall cost leadership.

Reed College in Portland, Oregon, is a small private college that is focused primarily on an
undergraduate education in liberal arts and sciences. The school differentiates itself from most
other higher education institutions in such areas as the selectivity of its admissions requirements,
the rigorousness of its courses, and the requirement of a research thesis for an undergraduate
degree. Another firm that exemplifies the strategies of focus and differentiation is Amy's Ice
Cream in Austin, Texas. Amy's is focused on kneading various condiments into the ice cream, a
service that also is provided by a number of other firms. But, the servers at Amy's are accorded
extraordinary freedom to interact with customers and it is the nature of this service encounter that
differentiates Amy's from other ice creameries.

Southwest Airlines is an example of firms that employ the strategies of focus and overall cost
leadership. Southwest concentrates on serving a select geographic region at low cost. The
airline achieves low cost by providing “no-frills” service, and it maximizes utilization of its
assets by maintaining a quick turnaround practice at airports. United Services Automobile
Association (USAA) is another example of an organization that has a well-defined focus,
primarily that of providing insurance and financial services for American military officers and
their families. The company is able to provide the lowest possible rates in the industry to its
customers, in part, by doing business over the phone instead of using field agents.

2. What ethical issues are associated with micromarketing?

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The ethical issue associated with micromarketing involves the customer's right to privacy.
Scanner data and other personal information that target specific customers might be very
beneficial for businesses, but the inappropriate use of the information can allow businesses to
mislead or manipulate their customers. From an ethical standpoint, there must be some limits to
the nature and amount of information a business can obtain from its customers.

3. For each of the three generic strategies (i.e., cost leadership, differentiation, and focus),
which of the four competitive uses of information is most powerful?

Productivity enhancement is the most powerful use of information for achieving cost leadership,
because it allows firms to reduce inventory, reduce waste, and eliminate paperwork, all of which
save money. Improved productivity allows companies to make more efficient use of their assets,
such as retail shelf space.

Creating barriers to entry is the most powerful use of information for protecting a differentiation
strategy. When customer loyalty is high, cost cutting by competitors is less effective. Switching
costs can also create barriers to entry, for example, when suppliers use a computer order-entry
network to establish a direct link to customers.

Database assets are the most powerful use of information for building a focus strategy. These
assets allow a company to develop profiles of their customers and their buying habits. This
information allows the firm to develop new services and to be seen as responsive to its
customers' needs. Advertising and distribution economies can be realized.

4. Give an example of a firm that began as world-class and has remained in that category.
Federal Express and Disney come to mind.

5. Could firms in the “world-class service delivery” stage of competitiveness be described as

“learning organizations’?
Learning in organizations means the continuous testing of experience and the transformation of
that experience into knowledge that is accessible to the whole organization and relevant to its
purpose (see Senge, et.al., The Fifth Discipline Field Book, Doubleday, New York, pg. 49).
Table 2.6 in the text confirms this definition as illustrated by the world-class service delivery
category. Consider the following example comments:
 Learning organizations raise customer expectations, seek challenges, and improve
continuously.
 A learning organization is proactive, develops its own capabilities, and generates
opportunities
 The learning organization regards the customer as a source of stimulation, ideas, and
opportunities.
 The workforce of a learning organization is innovative and creates new procedures.
 Top management of a learning organization looks to front-line management as a source of
ideas.
6. Compare and contrast sustainability efforts in service operations and manufacturing.

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At the outset, certain environmental wastes such as pollution generated by manufacturing

plants are glaring problems in industrialized nations. Therefore, it is easy for most people to
relate the physical nature of sustainability efforts to manufacturing. Such efforts include
emission control and other measures to protect our air and water from contamination.
Waste reduction through lean management and value recovery apply to service and
manufacturing firms alike, however. Regulations by agencies such as EPA, WEEE, and
RoHS apply equally to service firms. Beyond those regulations, service firms must build an
image of responsible organizations that are committed to sustainability by cultivating a culture
that eliminates negative impacts on environmental and social issues. Service firms have a
responsibility equal to that of the manufacturing sector in achieving sustainability, especially
for long-term viability of the firm.

7. Conduct a triple bottom line evaluation for a hospital by identifying its social,
economic, and environmental attributes that enhance the sustainability movement.

Social:
 Proper health education for all constituencies.
 Free screening for essential medical issues.
 Appropriate medical outsourcing.
 Linking health and wellness programs for a holistic approach to health care.
Economic:
 Use of lean management for cost savings – e.g., process control, better materials
management, better record-keeping, elimination of unnecessary tests.
 Cost-efficient payment structure for medical access and health insurance
Environmental:
 Managing medical wastes – e.g., biodegradable products such as contaminated
dressings.
 Responsible medical disposals – e.g., used syringes.

Overall, in promoting health, hospitals need to use fewer resources (economic), provide
support for employee self esteem (social), and become better stewards of their medical resources
and products (environmental).

INTERACTIVE CLASS EXERCISE

The class divides and debates the proposition “Frequent flyer award programs are or are not
anticompetitive.”

The statement “Frequent flyer award programs are anticompetitive” was voiced following airline
deregulation. The frequent flyer award is an attempt by airlines to create customer loyalty in a
commodity market and to avoid price competition. Priceline.com and other Internet ticket sellers
have reintroduced price competition making frequent flyer awards less effective.

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CASE 2.1: UNITED COMMERCIAL BANK AND EL BANCO

1. Compare and contrast the strategic vision of El Banco and United Commercial Bank.

Service Delivery Operating Strategy Service Concept Target Market

System Segments

El Banco Spanish spoken Franchise Fee based services Latinos

Hispanic physical Low cost informal Attract first time

setting store fronts bank customers

United Chinese spoken Branches in Loans to Chinese-

Commercial Chinese-American businesses Americans
Bank Conservative communities
High interest CDs
Import-export Offices in China,
services Taiwan, Hong Kong Low fees

2. Identify the service winners, qualifiers, and service losers for El Banco and United
Commercial Bank.

Service Winners Qualifiers Service Losers

El Banco Check cashing Spanish spoken Lack of sophisticated

services
Money transfers Informal location

United Commercial Low fees Chinese spoken Lowering interest rate

Bank on CDs
Import-export services Soundness and safety

3. What are the differentiating features of banks that target ethnic communities?

 Products that match unique customer needs (trade finance, check cashing)

 Well articulated cultural focus on target community (language, physical setting)

 Convenient location accessible to community (ethnic population centers, places

frequently visited by community members)

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CASE 2.2: THE ALAMO DRAFTHOUSE

1. Marketing analysts use market position maps to display visually the customers’ perceptions of
a firm in relation to its competitors regarding two attributes. Prepare a market position map for
Alamo Drafthouse using “food quality” and “movie selection” as axes.

Movie Selection (+)

Multiplex

(-) Food Quality (+)

Alamo

(-)

2. Use the “Strategic Service Vision” framework to describe Alamo Drafthouse in terms of
target market segments, service concept, operating strategy, and service delivery system.

Target Market Service Concept Operating Strategy Service Delivery

· 18-30 year old, · Meal and 2nd run or · Low cost old theater · Unobtrusive wait
male, alcohol cult films people
consumers, cult film · Inexpensive 2nd run
appeal · Single screen theater movies · Acceptable sound
with every other row and projection
· 25-40 year olds with replaced with narrow · Food made to order equipment
sophisticated taste in tables with less waste
films · Excess capacity
mid-day

3. Identify the service qualifiers, winners, and service losers for Alamo Drafthouse. Are
the Alamo purchase decision criteria appropriate for the multiplex movie theater
market? What do you conclude?

Qualifiers include good sound system, reasonable prices for the meals, availability of beer
and wine, and menu selection. A service winner is the unique “date” experience including
the special events and film showing. Service losers include movie projection and sound that
do not meeting minimal standards. For the multiplex movie theater market the qualifier is
the desired movie showing, a winner would be convenient location and available time of
showing, and the loser would be a long waiting line at the box office. The difference in the
criteria would lead us to conclude that Alamo does not compete in the multiplex movie
market.

4. Use Porter’s Five Forces Model to assess the strategic position of Alamo Drafthouse in
the “entertainment industry.”

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Porter’s Five Forces Assessment of Alamo Drafthouse

Potential
New Entrants
- Availability of small
theaters
- First mover brand equity

Competitive Rivalry
Bargaining Power within Industry
of Suppliers - Restaurants, bars, Bargaining Power of
- Second-run movies live theater, live music Customers
easy to obtain - Only existing - Price sensitivity
- Low volume food theater/restaurant - Movie selection
needs - Food selection

Threat of Substitutes
- Netflix and pizza delivered
to home
- All other entertainment
options

5. Conduct a SWOT analysis to identify internal strengths and weaknesses as well as

threats and opportunities in the external environment.

Strengths Weaknesses

 Small theater with kitchen is unique.  Projection and sound quality could be

 People in your market see dinning and movie improved.

combination as your strength.  Attracting mid-week audience.

Opportunities Threats

 Expand by purchasing small movie theaters.  Cash-flow problem.

 Business meeting could be a market niche.  Concept copied by competitor.

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CHAPTER QUIZ QUESTIONS

True/False
1. A characteristic of the overall cost leadership strategy is the incurring of start-up losses
to build market share. (T)
2. On-line networks between suppliers and their customers create a barrier to entry. (T)
3. When pursuing a differentiation strategy, a service firm should work to ensure that the
service being offered is standardized. (F)
4. Service winners are the competitive dimensions used by customers to decide among
qualified service providers. (T)
5. Quality is considered to be a structural element of the strategic service concept. (F)
6. Service industries have low entry barriers because economy-of-scale opportunities are
limited. (F)
7. The use of micromarketing has the potential to create customer concerns about invasion
of privacy. (T)
8. Implementing a low-cost strategy can sometimes revolutionize an industry. (T)
9. A cost-leadership strategy often involves customizing a standard service. (F)
10. The competitive dimension of dependability is a likely candidate for becoming a service
loser. (T)
11. Selling information and developing new services are examples of the role that
information technology plays in generating revenue. (F)
12. Information technology can be used to promote customer loyalty. (T)
13. The IRS has identified frequent-user programs as anti-competitive. (F)
14. American Airlines' early development of the SABRE reservation system became the
foundation for its yield management innovation. (T)
15. Information databases are an asset, because they represent a source of revenue. (T)
16. Information is a substitute for inventory. (T)
17. Focus is a competitive strategy that creates a service perceived as being unique. (F)
18. Service encounter, quality, information, and capacity planning are all managerial
elements of a strategic service concept. (F)
19. Ordering from L.L. Bean by telephone is an example of a service firm maximizing
opportunities for economies of scale. (T)
20. A firm facing serious competition for the first time is in the journeyman stage of a
service firm's competitiveness. (T)

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21. World-class service operations strive to replace workers with enhanced automation. (F)
22. Firms classified as "available for service" view quality improvement efforts with disdain.
(T)
23. For a firm achieving "journeyman" competitive status, the back-office function is
considered an activity that plays an important role in service delivery. (F)
24. In a world-class service firm, the front-line management controls the process. (F)
25. The job design premise in a world-class service organization is division of labor. (F)
26. Porter’s five forces analysis is used at the industry level to determine competitive
intensity. (T)
27. SWOT analysis is objective with easily agreed upon results. (F)
28. Scalability is a measure of how unit variable cost relates to transaction volume. (T)
29. Infinite scalability can occur only when the variable cost is zero. (T)
30. Healthcare is an example of a service that exhibits high scalability. (F)
31. A highly scalable firm such as Kelly Blue Book (kkb.com) requires a call center. (F)
32. Scalability is enhanced with self-service. (T)
33. Customers seldom take note of firms that are leaders in the sustainability movement. (F)
34. Recycling paper and reducing energy usage often is the first step towards sustainability.
(T)
35. Data analytics and Big Data are associated terms. (T)
36. Widsom is the last layer of the five layer data analytic model. (F)
37. The idea of IoT is to create “swarm intelligence”. (T)
38. Adopting IoT raises privacy concerns. (T)
Multiple Choice
1. The qualifier for an airline offering short commuter flights is:
a. quality of the meals.
b. safety record.*
c. politeness of the crew.
d. on-time performance.
2. Place the McDonald's fast food chain within the following matrix:

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3. A difficult economic environment exists for service industries for all but one of the following
reasons.
a. Relatively high overall entry barriers*
b. Product substitution
c. Minimal opportunities for economies of scale
d. Exit barriers.
4. A personal training facility that is located in the exclusive Beverly Hills area with only one
other competitor could adopt a service strategy that emphasizes ________.
a. overall cost leadership
b. differentiation*
c. focus
d. personalization
5. Of the nine dimensions of service competition, three are regarded as most likely to become
service losers. Which of the following is not one of those three vulnerable dimensions?
a. Speed
b. Price*
c. Dependability
d. Personalization
6. Which of the following is not identified as a strategy common to many successful service
providers?
a. Close coordination between the marketing and operations
b. The exploitation of information to generate new business
c. A project-oriented organizational structure*
d. Redirection of the strategic service vision inward to focus on employees

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7. Which of the following usually is not a good idea with respect to an overall cost leadership
strategy?
a. Offer as many different services as possible to spread overhead costs.*
b. Concentrate on routine/standardized services.
c. Replace labor with capital where possible.
d. Perform some service activities off-line at a centralized site.
8. The nature of the service act depends on to whom or to what the service is directed and the
degree of "tangibility" of the service provided. An example of a tangible service directed to
the possessions of a customer would be:
a. a stay in a hotel.
b. an investment advising session.
c. a fortune telling session.
d. a full-service car wash.*
9. Which one of the following is not a key characteristic that leads to a difficult competitive
environment for service industries?
a. Low barriers to entry
b. Lack of sustainable competitive advantage
c. Lack of government regulation and oversight*
d. Low switching costs for customers
10. In which of the following cases does the use of information raise ethical issues?
a. Yield management
b. Selling information
c. Micromarketing
d. All of the above*
11. American Airlines' SABRE reservation system fills the following strategic role of
information:
a. Revenue generation
b. Productivity enhancement
c. Creation of barriers to entry*
d. Data base asset
12. Services can create barriers to entry by __________
a. using economies of scale.

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b. creating switching costs.

c. using databases and information technology.
d. all of the above.*
13. Which of the following is an example of the competitive use of information in generating
revenue?
a. Reservation systems
b. Data envelopment analysis
c. Micromarketing*
d. Expert systems
14. Which of the following is not a role of information technology?
a. Creating a barrier to entry for competitors
b. Generating revenues
c. Displacing workers*
d. Managing multisite operations
15. Using the dimensions of strategic focus and competitive use of information can identify four
strategic roles of information. Which of the following is not a strategic role of information?
a. Create barriers to entry.
b. Generate revenue.
c. Create a data base asset.
d. Provide global communications.*
16. Real-time information technologies that have a focus on internal operations can play a
competitive role in increasing revenue opportunities. Which one of the following uses of
information does not play a role in generating revenue?
a. Yield management
b. Point of sale
c. Expert systems*
d. Sale of information
17. Bar coding and checkout scanner technology have created a wealth of consumer buying
information that can be used to target customers with precision. This process is an example
of:
a. service development.
b. micromarketing.*

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c. data envelopment analysis.

d. point of sale.
18. ________ is not a component of big data.
a. Value*
b. Volume
c. Velocity
d. Variety
19. Which one the following is not a subordinate areas of data analytics?
a. Descriptive analytics
b. Diagnostic analytics
c. Predictive analytics
d. Disruptive analytics*

20. Which one the following is not a subordinate areas of data analytics?
a. Descriptive analytics
b. Diagnostic analytics
c. Predictive analytics
d. Disruptive analytics*
21. The Internet of Things (IoT) trajectory begins with ________.
a. surveillance
b. RFID tags*
c. monitoring
d. location

22. Internet of Things (IoT) involves a convergence of multiple technologies but not _______.
a. GPS positioning*
b. wireless communications
c. commodity sensors
d. machine learning

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23. Kraft targeted its cream cheese flavors to match the tastes of a store’s customers using off-
line analysis of POS (point-of-sale) data. This is an example of:
a. yield management
b. expert systems
c. data envelopment analysis
d. micromarketing*
24. Service firms use information technology to create barriers to entry, generate revenue,
enhance productivity, and serve as data base assets. Which cell below is productivity
enhancement?

20. Which of the following service quality descriptions would be considered "World Class?"
a. It raises the customer's expectations and improves continuously.*
b. It exceeds the customer's expectations and is consistent on many dimensions.
c. It is less important than cost and is highly variable.
d. It contributes to service and plays an important role in total service.
21. Not satisfied with just meeting customer expectations, this category of service firms expands
upon the expectations to levels that competitors find difficult to meet.
a. Available-for-service
b. Journeyman
c. Distinctive competence achieved
d. World class service delivery*
22. The innovation of moving from a "country" store where the proprietor fills the shopper's list
with items from behind the counter to a self-service supermarket where the shopper fills a
cart with items represents a move between which of the following pairs of competitive
stages?
a. From available-for-service to journeyman
b. From available-for-service to distinctive competence achieved*
c. From journeyman to distinctive competence achieved

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d. From distinctive competence achieved to world class service delivery

23. Which of the following stages of a firm's competitiveness describes customers who seek out
a firm based upon its sustained reputation for meeting customer expectations?
a. Available-for-service
b. Journeyman
c. Distinctive competence achieved*
d. World class service delivery
24. Which one of the following does SWOT analysis not have as its aim?
a. Reveal competitive advantages
b. Determine the competitive intensity*
c. Analyze prospects
d. Development of contingency plans
25. Porter’s five forces analysis does not include which one of the following considerations.
e. Pricing power*
f. Potential new entrants
g. Threat of substitutes
h. Bargaining power of suppliers
26. Which one of the following is not a dimension of scalability?
a. Information vs. goods content
b. Degree of self-service*
c. Cost of after-sales service
d. Shipping and handling costs
27. Which of the following is not considered a criterion for evaluating the triple bottom line?
a. social progress
b. economic growth
c. environmental stewardship
d. market share*
28. Service innovation is driven by which factor listed below?
a. New product technology
b. Customer needs
c. Observant contact employee

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d. All of the above*

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