Putting the Service-Profit Chain to Work
by James L. Heskett, Thomas O. Jones, Gary W. Loveman,
W. Earl Sasser, Jr., and Leonard A. Schlesinger
Top-level executives of outstanding service organizations spend little time setting profit goals or focusing on market share, the management mantra of the 1970s and 1980s. Instead, they understand that in the new economics of service, frontline workers and customers need to be the center of management concern. Successful service managers pay attention to the factors that drive profitability in this new service paradigm: investment in people, technology that supports frontline workers, revamped recruiting and training practices, and compensation linked to performance for employees at every level. And they express a vision of leadership in terms rarely heard in corporate America: an organization’s "patina of spirituality," the "importance of the mundane."
A growing number of companies that includes Banc One, Intuit Corporation, Southwest Airlines, ServiceMaster, USAA, Taco Bell, and MCI know that when they make employees and customers paramount, a radical shift occurs in the way they manage and measure success. The new economics of service requires innovative measurement techniques. These techniques calibrate the impact of employee satisfaction, loyalty, and productivity on the value of products and services delivered so that managers can build customer satisfaction and loyalty and assess the corresponding impact on profitability and growth. In fact, the lifetime value of a loyal customer can be astronomical, especially when referrals are added to the economics of customer retention and repeat purchases of related products. For example, the lifetime revenue stream from a loyal pizza eater can be $8,000, a Cadillac owner $332,000, and a corporate purchaser of commercial aircraft literally billions of dollars.
The service-profit chain, developed from analyses of successful service organizations, puts "hard" values on "soft" measures. It helps managers target new investments to develop service and satisfaction levels for maximum competitive impact, widening the gap between service leaders and their merely good competitors.
The Service-Profit Chain
The service-profit chain establishes relationships between profitability, customer loyalty, and employee satisfaction, loyalty, and productivity. The links in the chain (which should be regarded as propositions) are as follows: Profit and growth are stimulated primarily by customer loyalty. Loyalty is a direct result of customer satisfaction. Satisfaction is largely influenced by the value of services provided to customers. Value is created by satisfied, loyal, and productive employees. Employee satisfaction, in turn, results primarily from high-quality support services and policies that enable employees to deliver results to customers.
The service-profit chain is also defined by a special kind of leadership. CEOs of exemplary service companies emphasize the importance of each employee and customer. For these CEOs, the focus on customers and employees is no empty slogan tailored to an annual management meeting. For example, Herbert Kelleher, CEO of Southwest Airlines, can be found aboard airplanes, on tarmacs, and in terminals, interacting with employees and customers. Kelleher believes that hiring employees that have the right attitude is so important that the hiring process takes on a "patina of spirituality." In addition, he believes that "anyone who looks at things solely in terms of factors that can easily be quantified is missing the heart of business, which is people." William Pollard, the chairman of ServiceMaster, continually underscores the importance of "teacher-learner" managers, who have what he calls "a servant’s heart." And John McCoy, CEO of Banc One, stresses the "uncommon partnership," a system of support that provides maximum latitude to individual bank presidents while supplying information systems and common measurements of customer satisfaction and financial measures.
A closer look at each link reveals how the service-profit chain functions as a whole
Customer Loyalty Drives Profitability and Growth
To maximize profit, managers have pursued the Holy Grail of becoming number one or two in their industries for nearly two decades. Recently, however, new measures of service industries like software and banking suggest that customer loyalty is a more important determinant of profit. (See Frederick F. Reichheld and W. Earl Sasser, Jr., "Zero Defections: Quality Comes to Services," HBR September–October 1990.) Reichheld and Sasser estimate that a 5% increase in customer loyalty can produce profit increases from 25% to 85%. They conclude that quality of market share, measured in terms of customer loyalty, deserves as much attention as quantity of share.
Banc One, based in Columbus, Ohio, has developed a sophisticated system to track several factors involved in customer loyalty and satisfaction. Once driven strictly by financial measures, Banc One now conducts quarterly measures of customer retention; the number of services used by each customer, or depth of relationship; and the level of customer satisfaction. The strategies derived from this information help explain why Banc One has achieved a return on assets more than double that of its competitors in recent years.
Customer Satisfaction Drives Customer Loyalty
Leading service companies are currently trying to quantify customer satisfaction. For example, for several years, Xerox has polled 480,000 customers per year regarding product and service satisfaction using a five-point scale from 5 (high) to 1 (low). Until two years ago, Xerox’s goal was to achieve 100% 4s (satisfied) and 5s (very satisfied) by the end of 1993. But in 1991, an analysis of customers who gave Xerox 4s and 5s on satisfaction found that the relationships between the scores and actual loyalty differed greatly depending on whether the customers were very satisfied or satisfied. Customers giving Xerox 5s were six times more likely to repurchase Xerox equipment than those giving 4s.
This analysis led Xerox to extend its efforts to create apostles—a term coined by Scott D. Cook, CEO of software producer and distributor, Intuit Corporation, describing customers so satisfied that they convert the uninitiated to a product or service. Xerox’s management currently wants to achieve 100% apostles, or 5s, by the end of 1996 by upgrading service levels and guaranteeing customer satisfaction. But just as important for Xerox’s profitability is to avoid creating terrorists: customers so unhappy that they speak out against a poorly delivered service at every opportunity. Terrorists can reach hundreds of potential customers. In some instances, they can even discourage acquaintances from trying a service or product.
Value Drives Customer Satisfaction
Customers today are strongly value oriented. But just what does that mean? Customers tell us that value means the results they receive in relation to the total costs (both the price and other costs to customers incurred in acquiring the service). The insurance company, Progressive Corporation, is creating just this kind of value for its customers by processing and paying claims quickly and with little policyholder effort. Members of the company’s CAT (catastrophe) team fly to the scene of major accidents, providing support services like transportation and housing and handling claims rapidly. By reducing legal costs and actually placing more money in the hands of the injured parties, the CAT team more than makes up for the added expenses the organization incurs by maintaining the team. In addition, the CAT team delivers value to customers, which helps explain why Progressive has one of the highest margins in the property-and-casualty insurance industry.
Employee Productivity Drives Value
At Southwest Airlines, the seventh-largest U.S. domestic carrier, an astonishing story of employee productivity occurs daily. Eighty-six percent of the company’s 14,000 employees are unionized. Positions are designed so that employees can perform several jobs if necessary. Schedules, routes, and company practices—such as open seating and the use of simple, color-coded, reusable boarding passes—enable the boarding of three and four times more passengers per day than competing airlines. In fact, Southwest deplanes and reloads two-thirds of its flights in 15 minutes or less. Because of aircraft availability and shorthaul routes that don’t require long layovers for flight crews, Southwest has roughly 40% more pilot and aircraft utilization than its major competitors: its pilots fly on average 70 hours per month versus 50 hours at other airlines. These factors explain how the company can charge fares from 60% to 70% lower than existing fares in markets it enters.
At Southwest, customer perceptions of value are very high, even though the airline does not assign seats, offer meals, or integrate its reservation system with other airlines. Customers place high value on Southwest’s frequent departures, ontime service, friendly employees, and very low fares. Southwest’s management knows this because its major marketing research unit—its 14,000 employees—is in daily contact with customers and reports its findings back to management. In addition, the Federal Aviation Administration’s performance measures show that Southwest, of all the major airlines, regularly achieves the highest level of ontime arrivals, the lowest number of complaints, and the fewest lost-baggage claims per 1,000 passengers. When combined with Southwest’s low fares per seat-mile, these indicators show the higher value delivered by Southwest’s employees compared with most domestic competitors. Southwest has been profitable for 21 consecutive years and was the only major airline to realize a profit in 1992.
Employee Loyalty Drives Productivity
Traditional measures of the losses incurred by employee turnover concentrate only on the cost of recruiting, hiring, and training replacements. In most service jobs, the real cost of turnover is the loss of productivity and decreased customer satisfaction. One recent study of an automobile dealer’s sales personnel by Abt Associates concluded that the average monthly cost of replacing a sales representative who had five to eight years of experience with an employee who had less than one year of experience was as much as $36,000 in sales. And the costs of losing a valued broker at a securities firm can be still more dire. Conservatively estimated, it takes nearly five years for a broker to rebuild relationships with customers that can return $1 million per year in commissions to the brokerage house—a cumulative loss of at least $2.5 million in commissions.
Employee Satisfaction Drives Loyalty
In one 1991 proprietary study of a property-and-casualty insurance company’s employees, 30% of all dissatisfied employees registered an intention to leave the company, a potential turnover rate three times higher than that for satisfied employees. In this same case, low employee turnover was found to be linked closely to high customer satisfaction. In contrast, Southwest Airlines, recently named one of the country’s ten best places to work, experiences the highest rate of employee retention in the airline industry. Satisfaction levels are so high that at some of its operating locations, employee turnover rates are less than 5% per year. USAA, a major provider of insurance and other financial services by direct mail and phone, also achieves low levels of employee turnover by ensuring that its employees are highly satisfied. But what drives employee satisfaction? Is it compensation, perks, or plush workplaces?
Internal Quality Drives Employee Satisfaction
What we call the internal quality of a working environment contributes most to employee satisfaction. Internal quality is measured by the feelings that employees have toward their jobs, colleagues, and companies. What do service employees value most on the job? Although our data are preliminary at best, they point increasingly to the ability and authority of service workers to achieve results for customers. At USAA, for example, telephone sales and service representatives are backed by a sophisticated information system that puts complete customer information files at their fingertips the instant they receive a customer’s call. In addition, state-of-the-art, job-related training is made available to USAA employees. And the curriculum goes still further, with 200 courses in 75 classrooms on a wide range of subjects.
Internal quality is also characterized by the attitudes that people have toward one another and the way people serve each other inside the organization. For example, ServiceMaster, a provider of a range of cleaning and maintenance services, aims to maximize the dignity of the individual service worker. Each year, it analyzes in depth a part of the maintenance process, such as cleaning a floor, in order to reduce the time and effort needed to complete the task. The "importance of the mundane" is stressed repeatedly in ServiceMaster’s management training—for example, in the seven-step process devised for cleaning a hospital room: from the first step, greeting the patient, to the last step, asking patients whether or not they need anything else done. Using this process, service workers develop communication skills and learn to interact with patients in ways that add depth and dimension to their jobs.
Leadership Underlies the Chain’s Success
Leaders who understand the service-profit chain develop and maintain a corporate culture centered around service to customers and fellow employees. They display a willingness and ability to listen. Successful CEOs like John Martin of Taco Bell, John McCoy of Banc One, Herb Kelleher of Southwest, and Bill Pollard of ServiceMaster spend a great deal of time with customers and employees, experiencing their companies’ service processes while listening to employees for suggestions for improvement. They care about their employees and spend a great deal of time selecting, tracking, and recognizing them.
For example, Brigadier General Robert McDermott, until recently chairman and CEO of USAA, reflected, "Public recognition of outstanding employees flows naturally from our corporate culture. That culture is talked about all the time, and we live it." According to Scott Cook at Intuit, "Most people take culture as a given. It is around you, the thinking goes, and you can’t do anything about it. However, when you run a company, you have the opportunity to determine the culture. I find that when you champion the most noble values—including service, analysis, and database decision making—employees rise to the challenge, and you forever change their lives."
Relating Links in the Chain for Management Action
While many organizations are beginning to measure relationships between individual links in the service-profit chain, only a few have related the links in meaningful ways—ways that can lead to comprehensive strategies for achieving lasting competitive advantage.
The 1991 proprietary study of a property-and-casualty insurance company, cited earlier, not only identified the links between employee satisfaction and loyalty but also established that a primary source of job satisfaction was the service workers’ perceptions of their ability to meet customer needs. Those who felt they did meet customer needs registered job satisfaction levels more than twice as high as those who felt they didn’t. But even more important, the same study found that when a service worker left the company, customer satisfaction levels dropped sharply from 75% to 55%. As a result of this analysis, management is trying to reduce turnover among customer-contact employees and to enhance their job skills.
Similarly, in a study of its seven telephone customer service centers, MCI found clear relationships between employees’ perceptions of the quality of MCI service and employee satisfaction. The study also linked employee satisfaction directly to customer satisfaction and intentions to continue to use MCI services. Identifying these relationships motivated MCI’s management to probe deeper and determine what affected job satisfaction at the service centers. The factors they uncovered, in order of importance, were satisfaction with the job itself, training, pay, advancement fairness, treatment with respect and dignity, teamwork, and the company’s interest in employees’ well-being. Armed with this information, MCI’s management began examining its policies concerning those items valued most by employees at its service centers. MCI has incorporated information about its service capabilities into training and communications efforts and television advertising.
No organization has made a more comprehensive effort to measure relationships in the service-profit chain and fashion a strategy around them than the fast-food company, Taco Bell, a subsidiary of PepsiCo. Taco Bell’s management tracks profits daily by unit, market manager, zone, and country. By integrating this information with the results of exit interviews that Taco Bell conducts with 800,000 customers annually, management has found that stores in the top quadrant of customer satisfaction ratings outperform the others by all measures. As a result, it has linked no less than 20% of all operations managers’ compensation in company-owned stores to customer satisfaction ratings, realizing a subsequent increase in both customer satisfaction ratings and profits.
However, Taco Bell’s efforts don’t stop there. By examining employee turnover records for individual stores, Taco Bell has discovered that the 20% of the stores with the lowest turnover rates enjoy double the sales and 55% higher profits than the 20% of stores with the highest employee turnover rates. As a result of this self-examination, Taco Bell has instituted financial and other incentives in order to reverse the cycle of failure that is associated with poor employee selection, subpar training, low pay, and high turnover.
In addition, Taco Bell monitors internal quality through a network of 800 numbers created to answer employees’ questions, field their complaints, remedy situations, and alert top-level management to potential trouble spots. It also conducts periodic employee roundtable meetings, interviews, as well as a comprehensive companywide survey every two or three years in order to measure satisfaction. As a result of all this work, Taco Bell’s employee satisfaction program features a new selection process, improved skill building, increased latitude for decision making on the job, further automation of unpleasant "back room" labor.
Relating all the links in the service-profit chain may seem to be a tall order. But profitability depends not only on placing hard values on soft measures but also on linking those individual measures together into a comprehensive service picture. Service organizations need to quantify their investments in people—both customers and employees. The service-profit chain provides the framework for this critical task.