Firm Size and Service Level
Skip to content
Podcast | Insight Unpacked Season 1: Extraordinary Brands and How to Build Them
Operations Strategy Economics Sep 1, 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

Itai Gurvich

Listening: Interview with Gad Allon and Itay Gurvich
download
0:00 Skip back button Play Skip forward button 12:22

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)
image
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

image

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.

Featured Faculty

Member of the Department of Managerial Economics & Decision Sciences from 2005-2016

About the Writer
Matt Krehbiel, Kellogg MBA '08
About the Research

Allon, Gad and Itay Gurvich (2007). “Competition in Large-Scale Service Systems: Do Waiting Time Standards Matter?” Kellogg School of Management.

Read the original

Most Popular This Week
  1. What Went Wrong with FTX—and What’s Next for Crypto?
    One key issue will be introducing regulation without strangling innovation, a fintech expert explains.
    stock trader surrounded by computer monitors
  2. How Experts Make Complex Decisions
    By studying 200 million chess moves, researchers shed light on what gives players an advantage—and what trips them up.
    two people playing chess
  3. What Donors Need to Hear to Open the Checkbook
    Insights from marketing on how charities can grow by appealing to different kinds of donors.
  4. The Complicated Logic Behind Donating to a Food Pantry Rather than Giving a Hungry Person Cash
    If we were in need, we’d likely want money. So what accounts for that difference?
    Donating food is paternalistic aid
  5. To Improve Fundraising, Give Donors a Local Connection
    Research offers concrete strategies for appealing to donors who want to make an impact.
    Charity appeals that frame the message around local connection tend to be more successful as a result of the proximity effect
  6. Which Form of Government Is Best?
    Democracies may not outlast dictatorships, but they adapt better.
    Is democracy the best form of government?
  7. How You Can Make a More Positive Social Impact
    A 3-step guide to becoming a more thoughtful consumer and donor.
    person with money deciding which box to put it in.
  8. Podcast: What the FTX Meltdown Means for the Future of Crypto
    The implosion of the crypto exchange has sent the industry reeling. We dig into what happened and whether cryptocurrency, as a concept, can weather the storm.
  9. What Went Wrong at AIG?
    Unpacking the insurance giant's collapse during the 2008 financial crisis.
    What went wrong during the AIG financial crisis?
  10. How Much Do Campaign Ads Matter?
    Tone is key, according to new research, which found that a change in TV ad strategy could have altered the results of the 2000 presidential election.
    Political advertisements on television next to polling place
  11. What’s the Secret to Successful Innovation?
    Hint: it’s not the product itself.
    standing woman speaking with man seated on stool
  12. Immigrants to the U.S. Create More Jobs than They Take
    A new study finds that immigrants are far more likely to found companies—both large and small—than native-born Americans.
    Immigrant CEO welcomes new hires
  13. How Are Black–White Biracial People Perceived in Terms of Race?
    Understanding the answer—and why black and white Americans may percieve biracial people differently—is increasingly important in a multiracial society.
    How are biracial people perceived in terms of race
  14. Why Well-Meaning NGOs Sometimes Do More Harm than Good
    Studies of aid groups in Ghana and Uganda show why it’s so important to coordinate with local governments and institutions.
    To succeed, foreign aid and health programs need buy-in and coordination with local partners.
  15. How Has Marketing Changed over the Past Half-Century?
    Phil Kotler’s groundbreaking textbook came out 55 years ago. Sixteen editions later, he and coauthor Alexander Chernev discuss how big data, social media, and purpose-driven branding are moving the field forward.
    people in 1967 and 2022 react to advertising
  16. Why Are So Many Politicians Embracing Conspiracy Theories?
    Conspiratorial thinking has always been attractive in times of uncertainty—but it’s become more mainstream. An expert explains why, and whether anything can be done.
    Voting machine in a spider web
  17. What the New Climate Bill Means for the U.S.—and the World
    The Inflation Reduction Act won’t reverse inflation or halt climate change, but it's still a big deal.
    energy bill with solar panels wind turbines and pipelines
More in Operations