Posted
Sep 2008
Firm Size and Service Level
When is it advantageous for a service-oriented firm to differentiate itself along service quality dimensions?
Based on the Research of Gad Allon And Itay Gurvich
Both Ameritrade and E-Trade, small online brokerage firms, tout their guaranteed transaction times as part of their service to customers. However, capable large-scale competitors such as Merrill Lynch Direct make no such guarantee. Why do some firms choose to promote a customer service guarantee as one of their benefits while others are content to conform to the customer service standard set by their industry?
Customers often select service providers—ranging from mobile phone service to fast food chains—based on three attributes: service level, price, or another attribute of the firm (such as coverage areas for mobile phones or ingredient quality for fast food). Service level can be measured by customer wait time. Customers place value on shorter wait times and factor this into their selection of service providers. Customers dissatisfied with any attribute of a firm may transfer their business to a competitor. Conversely, satisfied customers are more open to cross-selling, which results in increased revenues for the firm.
Professors Gad Allon and Itay Gurvich from the Kellogg School’s Managerial Economics and Decision Sciences department used cutting-edge game theory and queuing theory research to show that regardless of the firm’s cost structure, large-scale service providers generally provide service at a level considered the industry standard. It is much easier for large firms to achieve a high level of service by leveraging their economies of scale through service investments—ranging from training to technology systems to streamlining the customer service experience. However, since only minimal investments are necessary for large firms to improve their wait times, it would be easy for other large firms to make similar investments and match their competitors’ wait times. Consequently, deviating from industry service standards provides very small diminishing returns for large firms. These firms benefit more by investing resources to better compete on price or another attribute.
In contrast, small-scale firms must make significant investments to achieve or exceed industry service standards as set by large-scale firms and thus should include their desirable service level as one of their competitive attributes. Of course, any small-scale firm is free to compete via shorter wait times or along other dimensions, but generally it must make tradeoffs when deciding how to position itself within the market. The following chart of customer wait times in the fast food industry illustrates this point:
Figure 1: Average customer wait time (seconds)
Source: QSR Magazine, “The Best in Drive-Thru ‘07: Building a Better Drive-Thru.”
As the chart shows, there is a significant difference in average customer wait time between small-scale players both when compared with one another and with large-scale firms. Indeed, some small-scale players such as Checkers compete aggressively across service level with an average customer wait time that is significantly shorter than either their large-scale or small-scale competitors. Large-scale firms, on the other hand, fall within a few seconds of one another and, presumably, compete on price or another attribute.
The Effect of Market Size
Allon and Gurvich also measured the impact of market size on service-level differentiation. They found an interesting difference in the effect of market size on large-scale firms versus small-scale firms. As market size increases, the already narrow level of differentiation between large-scale firms becomes even narrower. Yet the opposite occurs with small-scale firms. As market size increases, the level of differentiation between small-scale firms ranges far more widely. The following graph illustrates the effect of market size on the percentage of service-level differentiation between firms:
Figure 2: Service-level differentiation: Large-scale vs. small-scale firms
Managerial Implications
This research shows the potential significance for a firm, based on its size, when selecting a service level. Managers of large-scale firms can leverage their economies of scale not only to meet the industry standard for service but also to compete more aggressively across price or another attribute. Conversely, managers of small-scale firms face a more complex decision. They can use their resources to compete either on service level or on another attribute (such as price). Because they do not share the same economies of scale as large firms, small firms may also benefit by outsourcing their service functions. By outsourcing, smaller firms across any market scale can potentially reap the same benefits of scale as their larger counterparts.
2 Comments
Sep 9 2008
That’s really cool. Can you apply these findings across different “markets”? For example, in foreign affairs, in order for a small country (e.g., Israel) to compete against larger countries (say, the USA or the EU or Russia) to establish relationships with a potential “client”-nation (a market for goods and services), would that smaller nation have to find unique ways to establish a competitive advantage? Does it work that way? In individual relationships, would an unattractive man competing with ostensibly more desirable men for a pretty mate improve his chances by establishing, and advertising, some unique attribute or service? (This is in fact sort of the plot of one of the nerd movies where the nerds and the jocks compete for the sorority babes.) How do you determine from research about potential clients the least costly attribute you can tout in order to compete effectively? (And, no, my nerd days were over some 40 years ago.)
Nov 29 2008
It is an interesting insight. In any market, there are some factors seen as order-qualifiers and others seen as Order-winners, but it is interesting to see how the classification may vary for a large scale and a small scale firm.
What I was curious was about the fact that the service level here has been defined as waiting time.What if we consider it as a function of various factors, say waiting time, availability of desired material and say politeness of staff. Now what I mean is, perhaps a small scale firm would work hard to cut down service time, but maybe the overall service level is still comparable to a large-scale firm. On the other hand, as you have pointed out, a large scale firm doesn’t bother to cut down just waiting time, as it is maintaining level of the function.
Another interesting aspect I like, especially so because I always believed in it, the firms on their own would not improve any standard. It is only when the customers expect them todo something that firms would take steps to meet expectations. Like you said, if all large scale firms serve with a fixed waiting time, customer doesn’t expect lower waiting time, and thus firm will not take steps to reduce this waiting time. On the other hand, if a big foreign major enters with reduced waiting time, customers begin to expect that and everyone has to comply. Very good example of this is entry of Domino’s in India, and the 30minutes delivery promise.
A really insightful, and thought provoking work. Thank You.