Productivity, quality and relationship
marketing in service operations
The Authors
Evert Gummesson, Professor of Service Management and Marketing, School of Business,
Stockholm University, Sweden
Acknowledgements
Also published in the book, Service Management: Basics, Concepts, Experiences, Manfred
Bruhn and Heribert Meffert (Editors), Gabler Verlag, Wiesbaden, 1998 © Evert Gummesson.
Abstract
The purpose of this article is to draw the reader’s attention to service productivity and its
connection to service quality and eventually to profits. In service operations the customer
plays an active role in influencing productivity and quality. Furthermore, contemporary
companies are networks, not delimited hierarchies, and the productivity and quality issues
affect all members of a network, not just the provider and the customer. This is clear from the
new developments in relationship marketing and imaginary (virtual) organizations. In order to
assess the financial outcome, the concept of return on relationships is introduced based on the
notions of intellectual capital and the balanced scorecard. The article ends with challenging
questions as well as recommendations for practising managers.
Article Type:
Research paper
Keyword(s):
Relationship marketing; Service improvements; Service quality.
Journal:
International Journal of Contemporary Hospitality Management
Volume:
10
Number:
1
Year:
1998
pp:
4-15
ISSN:
0959-6119
Introduction
This article addresses service productivity and its connection to service quality and
profitability. Compared to service quality, service productivity as well as the joint qualityproductivity consequences for profitability have received little attention. It has become
obvious that profitable service operations and the service quality and productivity concepts
require new mindsets and deeper insights into the nature of services, relationships, and
measurement. Here, profitability will be represented by relationship marketing (RM) which
stresses loyalty, customer retention, and long-term relationships as keys to profitability. The
article is particularly focused on the relationships between service providers and customers as
these stand out in the service encounter and the service production process. The customers’
role in creating both quality and productivity is crucial in services, whereas it is less salient in
goods manufacturing.
RM puts emphasis not only on relationships and interaction between suppliers and customers,
but also on relationships between suppliers and other parties. The modern corporation turns
into a network of relationships in which all members of the network influence quality and
productivity. This view is endorsed by new organization theory, particularly the notion of
imaginary (or virtual) organizations. It is further supported by the new accounting practices of
the balanced scorecard and the growing interest in intellectual capital. The article is focused
on the micro level of service operations, and on what to measure rather than on how to
measure.
The article draws on long-term, basic research[1]. The research currently provides more
questions than answers - but if we cannot ask the germane questions, the answers do not
matter.
Triplets, tribes and financial factors
The following proposition forms the vantage point for the article: “Quality, productivity and
profitability are triplets; separating one from the other creates an unhappy family”
(Gummesson, 1991, p. 6). The “triplets” all serve the purpose of making service operations
efficient. This view is underscored by the criteria of the quality prizes that are now common
on international, national, local, industry, and company levels. As an example, the first of the
original goals of the Malcolm Baldrige National Quality Award in the USA is “Helping to
stimulate the American companies to improve quality and productivity for the pride of
recognition while obtaining a competitive edge through increased profits” (quoted from Hart
and Bogan, 1992, p. 13).
The quality thinking represented by the awards is usually referred to as total quality
management, TQM. The awards are the closest we have come so far to an empirically-based,
general quality theory. They embrace internal, technology-related quality dimensions as well
as external, customer-related dimensions. They include both goods and services and some of
them include both private for-profit corporations, and not-for-profit government and voluntary
organizations.
TQM and the awards criteria also serve to instil certain values and modes of operation. A
main purpose is to implant the strategy of “continuous improvements”, which like the
Japanese kaizen, covers all activities in an organization to improve both quality and
productivity as an everyday activity, involving each and every one (Imai, 1986, pp. 3-4).
Another purpose is evaluation of outcomes: how well did we succeed with regard to quality,
productivity, and financial outcomes? By measuring the triplets we get a health reading of an
organization’s financial status, in private companies traditionally referred to as return on
investment, in the public sector referred to as the ability to fulfil societal goals within a budget.
Each triplet is the object of definition difficulties. The difficulties include the selection of
indicators of success or failure, the application of measurement techniques, the ways of
reporting and communicating outcomes, and the performance of activities that lead to
improvements. This article will highlight aspects of the triplets and their interconnections that
are part of the author’s perception of an ongoing paradigm shift in management and
marketing. Technicalities of measuring the triplets will not be treated.
Service productivity
Service productivity has been sparsely treated in the literature with a few exceptions
(Gummesson, 1992a; Lovelock and Young, 1979; McLaughlin and Coffey, 1990).
Productivity is a ratio between output and input. The more we can reduce the input keeping up
output, the better is our productivity. This is the guideline for the current trend - maybe even
craze - to downsize organizations both in the private and in the public sector. In a futureoriented and offensive spirit, the focus is on revenue enhancement rather than cost reduction.
Productivity in this sense can also be increased by increasing output at a faster rate than input
and consequently offer improved profitability at the same time as cost goes up.
There is a widespread notion that service productivity has not improved over the years while
the productivity of manufacturing has improved steadily. There is also a political and
ideological debate on the productivity of the government sector compared with the private
service sector.
Before we start measuring service productivity, we need to know what to measure, whether
this is possible to measure, what techniques to apply, and whether the measurements can be of
any genuine assistance to us. An even more basic question is whether service productivity is a
viable concept at all (Adam and Gravesen, 1996; Bylund and Thoresson-Hallgren, 1994).
Measurements of productivity are often ambiguous and inadequate, especially on an industry
and national level. As a consequence, comparisons between service industries and nations are
difficult, maybe even impossible, to make with meaningful accuracy (see e.g. McKinsey,
1992).
Service quality
The second triplet, service quality, is in the centre of attention for services marketing
literature; sometimes services marketing is made synonymous with service quality
management.
Beginning in the late 1970s, quality thinking has gone through a metamorphosis. The product
sector in the Western hemisphere neglected its quality development, resting on the laurels of
past performance. The driving force for quality came from Japan, ironically based on the
knowledge of Americans who got no response for quality improvements in their home
country. After having lost market share to the Japanese in product areas where Europe and the
USA traditionally dominated, there was a slow awakening.
For service quality the tradition is different. Japanese competition has not yet been
particularly noted for productivity and quality in services. The driving force was rather that
service quality got under heavy fire from dissatisfied customers and citizens. Service
researchers found that there was little on service quality in the literature; when the author first
looked into this in 1976 nothing was found. Whereas systematic approaches to quality
management in goods manufacturing started to develop in the 1920s by people in operations
management, systematic approaches in service quality lingered until the 1980s and came from
marketers (Edvardsson et al., 1994; Grönroos, 1990; Gummesson, 1993; Meffert and Bruhn,
1995). Although goods and services always appear in some kind of dependency in a customer
offering, the understanding of the similarities and differences between goods and services is
rarely found among the same people. There is need for “holistic quality” embracing
simultaneous consideration of services and goods quality dimensions, as well as quality
dimensions of computer software (Gummesson, 1992b).
There is usually an assumed causal connection between customer perceived quality and
profitability. This connection is supported by evidence from the PIMS research programme
(Buzzell and Gale, 1987). It is, however, increasingly being questioned, for example by Rust
et al. (1994) who calculate “return on quality” and by Reichheld’s (1996) studies of the
connection between profits and customer loyalty.
Profitability of service operations
The third triplet, profitability, is always at the centre of attention. Stock exchanges and the
media continuously report on the price of shares and companies are assessed by short-term
results. Within companies there are financial reports that may in some service businesses even
be daily, for example, in restaurant and retailing operations. However, accounting practices,
which are closely allied with corporate law, tax legislation, banking traditions, and methods of
assessing the value of a company, primarily emerged with manufacturing in mind. There is,
however, growing opposition against the limitation to report only short-term financial and
historical data. The balanced scorecard is a current experiment to include other indicators
such as the customer base, employee turnover, and development rate, thus measuring the
intellectual capital of an organization.
The triplets are related to financial factors which constitute the result of a company: cost,
revenue, and capital employed. The profile of the triplets, with consideration of these factors
as they are applied on the micro level, is summarized in Table I.
The interconnection between productivity, quality, and profitability - the “triplets at play” - is
graphically shown in Figure 1. The figure starts with quality, defined as doing things right
from the beginning and doing the things that customers need and want. If quality in this sense
improves, it can have a positive impact on revenue (left section of the figure), cost (middle
section), and capital employed (right section). When function and reliability improve, they
boost the image in the market, customer retention, and share of customer (i.e. the percentage
of a customer’s purchase of a certain product which is made from a specific supplier). These
changes stimulate sales volume growth, differentiate a provider from the competition and
make the provider less dependent on price competition. Service costs for machinery go down,
and so do the costs of inspection, testing, rework, scrap, complaints, and warranties. The
capital employed is reduced as less stock needs to be kept; accounts receivable go down
because payment comes earlier and less payment is delayed because of complaints; and
reduced processing time requires fewer resources. As the cash flow becomes faster, the
money can be used elsewhere and capital costs are reduced. Improved productivity becomes
an antecedent to profitability and some factors directly affect profitability through enhanced
revenue.
The figure is general as there are no “pure” service companies nor any “pure” goods
companies. Goods and services always appear in a symbiotic relationship; all providers
combine momentary activities (services) with things (goods).
Organizational aspects: triplets and tribes
The triplets are all concerned with the same phenomenon, the welfare of an organization, but
from different perspectives. These perspectives have given rise to “tribes” within
organizations. The tribes represent different traditions and cultures; each tribe’s awareness of
the total welfare of the company is limited. The three tribes are the productivity tribe, the
quality tribe and the accounting tribe.
Members of the productivity tribe (PT) are cost-obsessed and devote themselves to internal
operations. The members may be engineers, statisticians, accountants, or economists.
The quality tribe (QT) used to be internally oriented and complacent in its own expert
knowledge of design and manufacturing, and rarely customer-oriented. The past two decades
have gradually changed that; its members are now oriented towards revenue and customer
satisfaction.
The accounting tribe (AT) is the most institutionalized of the tribes. Its existence is partially
secured by law, and its members are dedicated to measurement. Still accounting is primarily
restrained to reporting short-term and historical financial data.
The three tribes could all contribute valuable expertise, but they each see things differently.
Unfortunately, they have also contributed to erect functional silos that obstruct collaboration
and coherent processes. The crucial matter is to see the contribution from all functions and
utilize their concerted knowledge. This is the task of top management, the big chiefs.
Unfortunately big chiefs all too often do not overview the whole or favour one perspective at
the expense of another. The QT has made the most far-reaching progress to break down
barriers and territory protection. The quality awards have already been mentioned; they
provide total company audits with quality in focus but they also embrace productivity and
profitability.
The PT has not often taken the customer and services to its heart but rather treated customers
and services as residuals. Productivity statistics face a gargantuan problem as definitions of
goods, services, and the combined offerings continually change through innovation and
change of customer preferences. This makes comparisons and time-series difficult. “Hedonic
price functions” constitute an effort to include quality changes by using a specification of
product characteristics and consider the changes in each item of the specification (Assarsson,
1991). This is, however, a resource consuming process and the still very few applications of
hedonic functions are confined to goods, primarily durable goods such as household
appliances and computers.
The elusiveness of services
A recurrent statement in the service literature claims that service quality is more difficult than
goods quality, both to manage and to assess. The author strongly disagrees with this statement;
managing and measuring goods quality is not easier. But service
quality is different, and we have to recognize how and why it is different. An equally
misleading but recurrent statement claims that service productivity is lagging behind goods
and manufacturing productivity. The statement is based on lack of understanding for service
productivity, trying to manage and measure it on the terms of manufacturing.
Goods and services not only appear in tandem, but the distinction between them is vague and
confusing. They are sometimes supplements, sometimes substitutes. Services may even be the
leftovers, those bits and pieces of production whose productivity cannot be increased.
Services have been named residuals, invisibles, and intangibles in statistics. For example, the
washing machine increased productivity and replaced the heaviest parts of manual work
performed by housewives, maids, and workers in laundries. Using a term from Abbott (1955),
the washing machine is a child of innovative quality. The term refers to a step forward in
quality, a novel solution to a problem, which will gradually make an extant product obsolete.
A washing machine is ten to 15 years of built-in washing services, but its contribution to an
increase in productivity of washing services will never be credited to the service sector. By
the same token the car replaced the horse, and when the car became easier to operate, there
was no need for a professional chauffeur. It is reputed that, around 1900, Mercedes made a
forecast of the world market growth for private cars and considered the lack of professional
chauffeurs as the limiting factor. But the chauffeur’s job was taken over by the passenger,
driving became do-it-yourself and never entered productivity statistics.
Mechanical and electronic components can be manufactured and assembled at an increasing
speed and at lowered cost until they reach a maturity level. In Sweden, in the 1950s, a car cost
the same as two TV sets (black and white), in the 1960s, three TV sets (colour), and in the
1980s, 30 TV sets. Already, in the 1950s, the car was a mature product while the TV was not.
The experience curve pattern of continuous cost reduction through learning enhances
productivity. A classic example (in two senses) of service productivity is Wolfgang Amadeus
Mozart. He composed 600 pieces of music although he died at the age of 35 (Johnson, 1986, p.
84). The productivity in the composer industry has probably not yet surpassed this eighteenth
century record. Nor can orchestras and singers perform the Magic Flute faster now than at its
opening night in 1791. So service productivity has not improved. On the other hand, we can
buy a CD player and a disc that will give us access to any world class orchestra and singer at
our convenience in our homes. But CD players and discs are classified as goods, not as
services. As Norris wrote in 1941: “Goods are wanted because they can perform services”
(quoted from Abbott, 1955, p. 29).
The list can be expanded. A hotel room cannot become smaller, nor can a bed. We cannot do
away with teachers and nurses just because we have computers and sedatives, but the
configuration of services and products in an offering may change.
The increase in manufacturing productivity is attributable to more use of technology and
robotization, better systems, and more skilled workers. However, internal services in
organizations are also conditional for manufacturing to be productive. They include
production planning, computer software maintenance, installation of Internet and Intranet,
education and training of employees, secretarial services, etc. These services make it possible
for employees in the factory to specialize and concentrate on their core task and for machinery
to function; they become necessary support for productivity in manufacturing.
This is not to say that service productivity per se cannot be enhanced. It is not unusual that
employees who are urged to increase productivity protest that quality will go down. This may
be true, but it may also not be true. Each case has to be tried on its own terms. Pauli (1991)
claims that 75 per cent of a manufacturing company is actually services, but it is still the
productivity of the remaining 25 per cent that is the object of attention; the greater potential of
productivity improvements is thus underutilized. Services are also increasingly deploying
technology and automation to improve their productivity. But Pauli also stresses that low-tech
is essential, perfecting services through “organisational technologies”: “There is no high-tech
implicit in copying keys or cleaning factory floors. How much information technology is
needed to prepare a Big Mac?”
In assessing service productivity, the distinction between the monetarized and nonmonetarized sectors is essential (Giarini and Stahel, 1989). The first sector is reported in
official statistics, the second is not. The non-monetarized sector mainly consists of services
performed in voluntary organizations and households, including all kinds of do-it-yourself
activities such as driving your car, repairing your home, and lately, doing your banking via
the Internet, thus taking over the job of the bank teller. In service production, the provider’s
input and output are measured as monetarized, the customer’s are not. The balance of the
roles in service production and delivery, where the customer can do more or do less, is thus
crucial for the official measurements of service productivity.
The service encounter and co-produced value
A look at service production and delivery systems reveals a number of sources of service
productivity and quality. Not only is the distinction between goods and services blurred but
service production is different from goods manufacturing. The most crucial operational
characteristic of service management and marketing - which differentiates it from goods - is
the service encounter. It holds that in service production and delivery, the customer enters the
stage during the production process, starts the consumption of the service during the
production, and continues to benefit from the service in the future (Gummesson, 1997). In
goods manufacturing, the customer enters the stage only when the manufacturing of the goods
is finished. This leads to a different buying and consumption behaviour pattern for services
from that for goods. The customers’ contributions to the production of the service have a
significant impact on productivity and quality. The customer is a co-producer of value.
Two basic types of relationships and interactions of the service encounter will be analysed
here: those between the service provider’s contact personnel (the front line) and the customer;
and customer-to-customer interaction, that is, interactions between customers.
Interaction between the service provider’s contact personnel and the customer
A passenger interacts with a flight attendant, a patient with nurses and doctors at a hospital, a
product manager with the account manager, the art director, and the copywriter of an
advertising agency. The customer becomes a co-producer; productivity and quality of the
service are dependent on the contributions from both the customer and the service provider.
The interaction is sometimes extremely intense and intimate and includes enormous stakes for
the customer, such as in surgery or counsel in a divorce case. The shared experience can
cement or prevent long-lasting relationships. Other service encounters can be trivial but
regular, such as taxi and postal services, but because of the repeated need for the services,
they are important to the customer.
In this context, service productivity and quality emerge from three sources:



part of the provider’s work being done independently of the customer;
part of the customer’s work being done independently of the provider; and
work the two parties do in interaction.
Figure 2 shows three concepts of service quality and three of service productivity. The terms
customer induced productivity and customer induced quality denote the customer’s
contribution to quality and productivity. Today, quality is usually seen as customer perceived
quality based on the individuals’ assessments of the value of the service for them - their
satisfaction - but their contribution to quality is not measured. The provider’s contribution is
defined as provider induced productivity and provider induced quality. Measures of
productivity traditionally refer to provider induced productivity. These measures are internally
oriented and related to the provider’s cost; the customer is treated as a free utility and not as a
production factor.
The concepts of interactive productivity and interactive quality emphasize the
interdependence and mutual benefit from interaction between the provider and the customer.
Interactive quality and productivity are generated not only by labour and capital as in
traditional, internally oriented measurements, but also by customers and their knowledge and
willingness to participate in the service production and delivery process.
Examples of combinations of these three sources of productivity and quality are:



Skandia AFS (Assurance and Financial Services) sells “unit linked insurance”. The
customers of this particular type of insurance have the option to decide where their
pension money should be invested and thus take on the responsibility for the yield. A
customer can have the investment portfolio changed overday through a phone call to
Skandia, but can also consult its staff on alternative investments.
Accounting firms and management consultants do much of their work in the offices of
their clients and in interaction with client personnel.
Customers of Oriflame (suppliers of cosmetics for home party selling) allow the
provider to open up a store for a few hours in their living rooms, while the provider
offers a system for delivery of its retailing services.

IKEA’s packaged furniture - including nuts and bolts, tools for assembly and an
instruction - is collected and transported by the customer and unpacked and assembled
in the customer’s home.
There are, however, exceptions to the interactive production of services. Examples are the
courts, the defence, and road maintenance. We only interact with these service providers in
rare cases, but they provide ongoing services and long-term benefits to all citizens. Goods
manufacturing can also be interactive and is increasingly so through outsourcing and the
building of the networks of imaginary organizations. In business-to-business marketing,
companies may develop, produce, and finance products in joint ventures. In consumer goods
marketing, RM encourages the involvement of the consumer and a closer dialogue with the
provider. In the IKEA case, the consumer participates both in the production of the furniture,
by assembling the parts, and its delivery.
Based on the interaction and relationships between suppliers and customers, there is a need to
rethink the meaning of value (Wikström and Normann, 1994). In the accounting tradition the
term “value added” is synonymous with cost added. Productivity means the opposite, lowered
cost, which could sometimes mean reduced quality, sometimes that quality remains
unchanged, and sometimes that it goes up. Whereas production is traditionally considered to
add value, consumption is considered to destroy value. From a consumer point of view it
could be argued that only when a product or service is consumed has it contributed value.
Furthermore, waste and scrap are increasingly being recycled and the recycling capability of a
service production and consumption process, such as the waste from a restaurant, is being
designed into a production-consumption system. Hence it is no longer correct to call the
consumer an “end-user”. Instead, the consumer is an agent in an ongoing value-adding circle.
Customer-to-customer interaction
Customers sometimes produce a service between themselves if the seller provides a service
arena: the right systems, the right staff, the right environment, and the right products. An
obvious example is a dance restaurant; if the customers refuse to dance with each other, the
core service will not be produced. The choice of segmentation variables therefore becomes
important, to get customers together that share a lifestyle or form an affinity group with
common interests and values. A concert or a sports game draws crowds because the customers
create an atmosphere together which cannot be created by a lonely TV-watcher. A negative
side of the customer-to-customer relationship is queues, they are usually disliked by
customers. Queues consist of customers blocking each other from access to a service because
they all want the service at the same moment.
Again, customer performance is critical for productivity and quality through each customer’s
independent input, as well as through the interactive customer-to-customer input (Figure 3).
In conclusion, customers play a pivotal role in the emergence of service productivity, service
quality and hence also in the profitability of the provider. We have yet to learn how to manage
and measure the triplets and the effects on them caused by customers and the co-production of
value. This calls for novel approaches to management.
Novel management approaches
Current management theory and practices are not sufficiently sensitive to the customer’s role
in services. Novel approaches in four areas of management will be treated here: relationship
marketing, imaginary organizations, the balanced scorecard approach to accounting and
measurement, and intellectual capital. The areas are chosen because of their relevance to the
triplets, but they all offer an exciting rejuvenation in management thinking in general.
Relationship marketing
Increasingly, relationships and interactions between suppliers, customers, competitors, and
others are being considered in marketing under the label of relationship marketing, RM. RM
is not only highly applicable to services, but services marketing has also provided input to the
general RM paradigm. Other significant contributions to RM come from the network
approach to industrial marketing (see e.g. Gemünden and Walter, 1995; Turnball and Valla,
1986 ) but also from TQM.
RM is a new term for an ancient phenomenon, but its domain is not yet well laid out. The
author’s definition of RM is general to all types of marketing: “Relationship marketing is
marketing seen as relationships, networks and interaction”. The “parent relationship” of
marketing is that between a supplier and a customer. Networks are sets of relationships and in
the relationships, the parties enter into interaction with each other.
This definition offers a perspective and a broad view of RM and translates into a
recommendation: “Put on the relationship eye-glasses!” These eye-glasses allow you to focus
on relationships, networks, and interaction and help you to see these core variables more
distinctly and in more detail. There are other definitions of RM, most of them within the spirit
of the relationship eye-glasses but phrased differently. For example, to Ballantyne (1994, p. 3)
RM is “An emergent disciplinary framework for creating, developing and sustaining
exchanges of value, between the parties involved, whereby exchange relationships evolve to
provide continuous and stable links in the supply chain”. (See also Berry, 1995; Bund Jackson,
1985, p. 165; Morgan and Hunt, 1994, p. 22; Porter, 1993, p. 14).
The broader view of RM includes all types of marketing, both business-to-business marketing
to few buyers and consumer marketing to thousands or millions of consumers; both services
marketing and goods marketing; and both distant contact through information technology and
other media, and face-to-face contact.
The Gummesson approach to RM identifies 30 business relationships, the 30Rs (Gummesson,
1997). In the 30R approach, a distinction is made between three types of relationships. The
first is market relationships which are relationships between suppliers, customers, competitors,
and others who operate directly in the market. The service encounter belongs to this type, and
among the others are the supplier-customer dyad; the triad of supplier-customer-competitor;
the physical distribution network; and the customer as member of a loyalty programme.
The next two types are non-market relationships which indirectly influence the quality,
productivity, and profitability of market relationships. One is mega relationships which exist
above the market relationships; they concern the economy and society in general. Among
these are mega-marketing (lobbying to influence public opinion and political decisions);
mega-alliances (such as the European Union setting a new stage for marketing); and social
relationships (such as friendship and ethnic bonds). The other is nano relationships which
exist below the market relationships; they concern the internal operations of an organization.
Examples are the relationships between internal customers, and the relationships between
internal markets that arise as a consequence of the increasing use of independent profit centres,
divisions, and business areas inside corporations.
RM sets the spotlight on collaboration and in the author’s view this is its most important
contribution to marketing. RM belongs to the triplet family and will be used here to stress that
profitability in service operations is highly dependent on collaboration between parties such
as in the service encounter.
It has been a widespread postulation that improvement in customer perceived quality will
increase customer satisfaction, loyalty, and profitability. A number of authors have suggested
customer relationship lifecycles with virtuous circles or profit chains, all following a similar
pattern: good internal service quality → satisfied employees → employees stay → good
external service quality → satisfied customers → customers stay → high profitability
(Grönroos, 1990; Normann, 1991; Schlesinger and Hallowell, 1994; Schlesinger and Heskett,
1991).
The logic seems indisputable but the outcome is not automatic; satisfaction does not by itself
lead to retention and profits. The provider must actively maintain the customer relationship to
make it sustaining and provide incentives for repurchase loyalty. Of particular interest here is
the conclusion that customer retention and repurchase is a key, maybe even the key, to
profitability (Reichheld, 1996). The longer the customer stays with a supplier, the better the
profitability (provided of course that the customer is contributing to profits in the first place).
RM has a series of profound consequences for the triplets:
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The rationale for RM is usually presented to be increased customer loyalty and
customer retention. Focus has shifted from investing the major marketing resources
into attracting new customers, to caring for existing customers and providing them
with incentives for repurchase. It can be expressed by the slogan: “Court your own
customers before you start courting your competitors’ customers!”
In caring for existing customers, the interest in customer share - in contrast to market
share - is growing. It means that you want existing customers to fill more of their
needs of a product or service from you, thus exploiting the customer base for more
sales.
Increased customer retention and duration of a relationship will lower marketing costs
and consequently enhance marketing productivity. Maintaining existing customers is
usually less costly than attracting new ones.
The relationship must be win-win if it is going to be a long-term and constructive
relationship; all parties involved co-produce value and must derive individual value
out of the relationship. No happy marriage is based on a win-lose relationship.
In a relationship, it is not just one party that takes initiatives, it is an interaction on
equal and respectful terms. Suppliers, customers and all others involved in a network
of relationships have a responsibility to be active parties.
Increased customer retention and duration, as well as the building of more stable
relationships with other parties, increase security and help to establish trust and
commitment over a longer period. This facilitates marketing and makes the outcome
more predictable.
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
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Long-term service customers become better co-producers, which facilitates production
and delivery. Quality defects go down and it becomes easier to clear up
misunderstandings and complaints.
Service providers can gradually build up knowledge about their customers and target
their offerings to individual customer needs.
Within limits, customers become less price-sensitive.
As RM offers a fundamental focus shift in marketing, it cannot just be pasted on existing
organizational structures. RM must join forces with an organization theory that corresponds to
its requirements and recognizes networks of relationships and interactions as the foundation
for business. The new theory of imaginary organizations provides such a partner.
Imaginary organizations
According to Hedberg et al. (1997), the imaginary organization is a system where crucial
resources, processes, and actors are found and managed not only inside but also outside of a
company’s legal boundaries, official accounting reports, and organizational charts. The
imaginary organization is a network of relationships. It has a core consisting of a leader
company and an “imaginator” (the leader, the entrepreneur) and his/her strategic map; a
customer base which is tied to the leader company through production, delivery, market
communications, and payment systems; partnering companies and others that contribute
resources; and shared interests and a mission that keeps the network together.
Because of the extensive use of outside resources (resourcing or outsourcing), an imaginary
organization is larger than it seems from the organizational chart and more resourceful than
the balance sheet indicates. It is an inclusive organization, not exclusive as the tradition
prescribes as it involves customers in co-production of value, treating customers as part-time
and temporary members of the organization. Furthermore, it dissolves tribal territories and
knocks down walls erected by functional specialists as well as walls between hierarchical tiers.
It is based on processes rather than functional structures. Information technology often helps
to create totally new and imaginary organizational designs. The imaginary organization is a
pulsating network that continuously changes shape and is perceived differently by each and
everyone, depending on where and how the participant is engaged in the network
The aforementioned Skandia AFS is an imaginary organization consisting of 1,207,000
customers; 70,000 contracts with independent brokers and banks; 2,237 employees spread
globally in “competence centres”; and a central core competence of 60 people (Skandia,
1997). It co-produces services with its customers and grows through alliances with customers
and distributors. Allies, not own personnel, constitute the majority of those engaged in the
company.
In order to make RM and its organizational base - the imaginary organization - manageable,
suitable key indicators of success and failure are needed. We have to find out how to measure
return on relationships (Gummesson, 1997). The balanced scorecard and the notion of
intellectual capital are conducive to that very task.
Return on relationships: applying the balanced scorecard and intellectual capital
Traditionally, the balance sheet consists of tangible assets: money, inventory, machines, and
buildings. It is not particularly informative about service companies and knowledge-intensive
companies. In the jargon of the balance sheet, the human being is worthless, while the chair
on which she sits represents a value which is only slowly depreciated according to some
accounting principle. The customer represents no official value. However, when a company is
sold or its stock is traded on an exchange, buyers pay for intangible assets (“goodwill”) and
expected future earnings.
Accounting systems do not measure the profitability of relationships (Storbacka, 1994). There
is, however, growing dissatisfaction with the accounting tribe and its preoccupation with
short-term return on investment and tangible assets. In order to make RM and the imaginary
organization work, there is a need to rethink the financial indicators and broaden them. This is
done in the balanced scorecard, which registers not only financial capital but also other types
of capital. Its original version contains indicators in four groups of capital (Kaplan and Norton,
1996): financial, customer, internal business process, and learning and growth. These added
groups of capital are named intellectual capital (Edvinsson and Malone, 1997; Sveiby, 1997).
Intellectual capital can also be divided into individual and structural capital.
Individual capital consists of employees and their qualities. It includes knowledge, skills,
behaviour and motivation, but also an individuals’ network of market, mega, and nano
relationships. These relationships are personal and have been established over a long period
when an employee has gained the trust and confidence of customers and other network parties.
The power and prestige of individual capital is evident for an advertising agency or a
partnership of lawyers who thrive on their personal interaction with clients. There is also
capital built into an employee who has the ability to gain a customer’s confidence quickly, a
personality trait which is particularly precious in a salesperson. For example, the top
performing Electrolux door-to-door vacuum cleaner salesman of all times says that knocking
on doors gave him only 20 seconds to gain the confidence of the consumer.
If an employee leaves a company, the individual capital vanishes; the employer borrowed the
employee from nine to five, one day at a time. Individual capital is migratory, it can be
transported. Structural capital on the other hand is embedded in a company or network and is
inseparable from its environment. In an RM sense, structural capital consists of relationships
which have been established by a company as such and are tied to culture, systems, contracts,
image, and the network to which the company belongs. The more successfully a company ties
its relationships to the structure, the less dependent it is on an individual employee. The
European computer consultant WM-data, which has been exceptionally successful with
sustainable profits and growth over a long period of years, says that “Our structural capital
embraces the ability of our employees to use their professional and personal qualities to create
and maintain superior relationships to the environment. Therefore, it is prestigious for a WM
consultant to establish and maintain customer relationships” (WM-data, 1992).
For many years, Skandia has been experimenting with its own special variant of the balanced
scorecard and intellectual capital indicators. Among indicators that are now reported in a
supplement to the official annual report are availability on the telephone; an index of
customer satisfaction; number of customers; retention rate; the ratio between cost for business
development and total cost; the ratio between number of employees and information
technology investment; number of ideas for improvements; and revenue from new services
(Skandia, 1997). After some years, time-series can be developed and trends be discerned.
Reichheld (1996) convincingly outlines the connection between the triplets and the need for
new indicators. According to his findings, companies who stimulate customer, employee, and
investor loyalty are amply rewarded. For example, the advertising agency Leo Burnett only
loses 2 per cent of its customers per year and its productivity is 15-20 per cent higher than that
of its principal competitors. Chick-fil-A, a chain of 600 quick service restaurants has a
turnover of store operator of 4-6 per cent per year while the industry average is 40-50 per cent.
Moreover, the store operators earn 50 per cent more than those of competing restaurants.
Compared to industry average, State Farm Insurance agents stay twice as long, it has a
productivity which is 40 per cent higher, and the customer retention rate is 95 per cent. Lexus,
Toyota’s luxury car, has the highest repurchase rate in the premium car bracket; it is 2 per
cent of Toyota sales but accounts for 33 per cent of Toyota profits. In a comparison between
nine industries - among them credit card services, industry laundry, and auto repair - in which
the defection rate was reduced by 5 per cent, the profits grew by 25 to 85 per cent. Credit card
company MBNA America reduced the defection rate from 10 per cent to 5 per cent which
was half of the industry average and profitability was dramatically improved. An average
cardholder who stays one year causes a loss of $51, one who stays for five years a profit of
$55, and one who stays for 20 years a profit of $525. For industry laundry, the profit for year
one was $144 and for year five $256; for auto repair, $25 for year one and $88 for year five. If
defection rates go down from 20 per cent to 10 per cent per annum and further to 5 per cent,
the duration of the customer will increase from five to ten to 20 years with a consequent
increase in customer lifetime profits. If a customer is lost, the whole of the future profit
potential goes down the drain.
Getting it all together and asking the difficult questions
Figures 2 and 3 showed simple, dyadic and interactive relationship between providers and
customers. RM requires the building of strategic networks including customers but also
competitors, research institutes, government agencies and others. These are both market
relationships and mega relationships. But RM also requires the building of nano relationships,
those “inside” the organization, to make sure that these internal customer relationships end up
in external customer relationships. We have then left the dyad for more complex networks of
relationships which expand into imaginary organizations. Figure 4 shows the principle of a
network of relationships. It is perhaps a bewildering picture - but it is a realistic one. In such
networks, all parties affect each other and consequently the evolution of productivity and
quality becomes much more intriguing than today’s simplistic models suggest.
Within the theme of this article, a series of challenging questions arises:
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How should service productivity and quality be defined in a complex network of
relationships?
How should we manage service productivity and quality when so many independent
parties are involved and influence the outcome?
What indicators should we use to monitor service productivity and quality in a
network?
How should we measure return on relationships and how should we evaluate the
contributions to profits from the various actors in a network?
We are struggling with these questions in our research. The appearance of a series of novel
approaches to management indicates a growing interest in providing answers. The notions of
the service encounter, relationship marketing, imaginary organizations, the balanced
scorecard, and intellectual capital may currently provide more confusion than solution.
However, we need to deal with them, they attempt to capture phenomena that do exist whether we approve of their existence or not.
Recommendations
Although we only partially know the answers to the questions that have been raised in this
article, we venture to present some recommendations for service business:
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both at independent provider and customer contributions to the triplets and at
interactive contributions.
if more of a service can be produced by the customer, thus unloading costs - but not at
the expense of service quality. When customers do more, sometimes the quality is
enhanced at the same time as service productivity goes up.
how customer-to-customer interaction can enhance productivity and quality.
service production and marketing as interactive events where relationships are
established with the customer, and work on the reinforcement of these relationships.
Loyal customers contribute more to profits and cost less than temporary customers.
service production we need both technology and the human touch to maintain and
improve service productivity and quality. Although information technology will exert
a major influence on service businesses, it is not a panacea.
a company, its customers, and all others in the company’s network as allies and
partners. They are all parents to the triplets.
Note
1 Quality, productivity, and profitability in service operations (The QP&P Research
Programme) as well as RM and new organization theory - imaginary organizations - are
themes for ongoing research at Stockholm University, Sweden.
Table IProfile of the triplets
Figure 1The triplets at play
Figure 2Service productivity and service quality induced by the provider and the customer as
well as by the interaction between the two
Figure 3Customer-to-customer interaction in which service productivity and service quality
are induced by customers individually and in interaction with each other