Firm Size and Service Level

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.