Effect of Service Transition Strategies on Firm Value
Published 9/1/2008
Author: Eric (Er) Fang, Robert W. Palmatier, Jan-Benedict E.M. Steenkamp
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Executive Summary
In the past few decades, many leading firms have added services to their existing product offerings in an attempt to provide total customer solutions and thus improve their competitiveness and performance. The resultant service-based initiatives have been successful in many cases, but there also are noticeable failures. The authors investigate the effectiveness of service transition strategies for generating shareholder value by evaluating 477 publicly traded manufacturing firms during 1990–2005. Specifically, they capture a firm’s progress in implementing a service-based strategy by using the portion of a firm’s total sales revenue that results from the sale of services. The average service ratio in their sample increases steadily from 9% in 1990 to 42% in 2005.
The results support the notion that transitioning to services positively affects firm value, but there are two important caveats. First, the effects on firm value become pronounced only after the level of services sales reaches a critical mass, which averages approximately 20%–30% of total firm sales. Shifting to services typically requires managers to allocate their limited resources from existing product opportunities to new service initiatives, even though they have little prior experience evaluating or managing service-based projects. These new service initiatives also demand different and possibly conflicting organizational elements, which can undermine motivation and productivity. These negative mechanisms become less salient as managers and employees gain more experience or more service-minded replacements join the organization. In addition, as service sales increase to a meaningful level, organizational elements can be optimized for service offerings (e.g., separate business units), which reduces product–service conflicts. Thus, until the service ratio reaches a critical mass, its effects on firm value remain minimal or negative, but after that point, the synergistic benefits of offering products and services and the inherent benefits of services become more dominant, such that the service ratio provides an accelerating positive effect on firm value.
The second important caveat to the received wisdom regarding the value-enhancing qualities of service transition strategies is that the effects of service sales on firm value are highly contingent on the firm and industry. Transitioning to services is substantially more effective for firms that offer services related to their core product business. Sales of unrelated services have little impact on firm value over the full range of meaningful service ratios, which suggests that without some spillover from existing products, any benefits of the inherent characteristics of services cannot overcome the costs of launching and maintaining a new service business. Without these spillover or synergistic benefits, product-centric firms likely find themselves hard pressed to compete against more focused, service-only firms.
Generating firm value from service transition strategies also depends heavily on the characteristics of the firm’s core product industry. Adding services to a core product offering is most effective for firms in slow-growth and turbulent industries, but in other conditions, service transition strategies may decrease firm value. Firms in high-growth industries can destroy firm value by shifting focus and the resources needed to cater to the persistent growth in the core product markets to services initiatives. In stable industries, adding services also has a negative effect on firm value because product suppliers have minimal insider’s knowledge to arbitrage into spillover benefits, cannot offer substantial advantages by bundling products and services, and achieve little advantage from the reduced volatility of service compared with product sales.
Biography
Eric (Er) Fang is Assistant Professor of Marketing at University of Illinois at Urbana–Champaign. He obtained his PhD from the University of Missouri. His research interest focuses on relationship marketing theory and strategy, innovation, and marketing strategy. His research has appeared in Journal of Marketing, Journal of International Business Studies, and Journal of the Academy of Marketing Science, among other outlets.
Robert W. Palmatier is the Evert McCabe Faculty Fellow at the University of Washington. He holds a Bachelors and Masters in Electrical Engineering from Georgia Institute of Technology, an MBA from Georgia State University, and a PhD from the University of Missouri. His research interest focuses on relationship marketing theory and strategy with an emphasis on multilevel and multichannel customer relationships in the business-to-business and retail markets. His research has appeared in Journal of Marketing, Journal of Marketing Research, Marketing Science, Journal of the Academy of Marketing Science, and International Journal of Research in Marketing. Before academia, he held numerous positions in industry, including president and chief operating officer of C&K Components, and European general manager, director of worldwide marketing, director of worldwide strategic planning, and North American sales and marketing manager at multiple divisions of Tyco-Raychem Corporation. He has also served as a lieutenant onboard nuclear submarines in the United States Navy. He teaches executive MBA and MBA classes, including sales management and marketing strategy.
Jan-Benedict E.M. Steenkamp is C. Knox Massey Professor of Marketing and Marketing Area Chair in the Kenan-Flagler Business School at the University of North Carolina at Chapel Hill. His work has been published in journals such Academy of Management Journal, International Journal of Research in Marketing, Journal of Consumer Research, Journal of Marketing, Journal of Marketing Research, and Marketing Science. He serves on the editorial boards of International Journal of Research in Marketing, Journal of Consumer Research, Journal of Marketing, Journal of Marketing Research, and Marketing Science and is a past editor of International Journal of Research in Marketing. His most recent book is Private Label Strategy: How to Meet the Store Brand Challenge (with Nirmalya Kumar), published in 2007 by Harvard Business School Press. The book has already been translated into Chinese and Portuguese. He has won the Hendrik Muller lifetime award for the social and behavioral sciences awarded by the Royal Netherlands Academy of Sciences for “exceptional achievements in the area of the behavioral and social sciences” (the first time the prize has been awarded to a researcher in any area of business administration). He has also received the O’Dell, Little, Bass, and International Journal of Research in Marketing Best Article Awards, as well as the AMA Global Marketing SIG Excellence in Research Award (twice). His current research focuses on private labels and branding, global marketing, and international marketing research techniques.
Journal of Marketing, Volume 72, Number 5, September 2008
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