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SM

Profitability and Service-

Profit Chain

McGraw-Hill © 2000 The McGraw-Hill Companies

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Objectives of the Session:
SM
• Examine the direct effects of service on profits

• Consider the impact of service on getting new

customers

• Discuss what is know about the key service drivers

of overall service quality, customer retention and
profitability

• Discuss the balanced performance scorecard to

focus on strategic measurement other than
financials

McGraw-Hill © 2000 The McGraw-Hill Companies

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SM
Links in the Service-Profit Chain
• Internal quality drives employee satisfaction
• Employee satisfaction drives retention and
productivity
• Employee retention and productivity drives
service value.
• Service value drives customer satisfaction.
• Customer satisfaction drives customer loyalty.
• Customer loyalty drives profitability and growth.

McGraw-Hill © 2000 The McGraw-Hill Companies

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SM The Direct Relationship between

Service and Profits

Service
Quality ? Profits

McGraw-Hill © 2000 The McGraw-Hill Companies

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SM How Quality Generates

Profits

• Is it always worthwhile to spend more on

improving the quality of one’s goods and
services?

McGraw-Hill © 2000 The McGraw-Hill Companies

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SM Evidence of relationship
between quality and profits
• Lower costs due to efficiencies achieved
• Increased sales from current customers
• Greater attraction of new customers
• Possible ability to charge higher prices
• PIMS data (Profit Impact of Marketing
Strategy)

McGraw-Hill © 2000 The McGraw-Hill Companies

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SM What is ROSQ?
• Looks at investments in services as a chain
of effects
– improvement leads to satisfaction leads to
behavioral intentions leads to behavioral impact
leads to profit
• Assumptions
– quality is an investment
– quality efforts must be financially accountable
– it is possible to spend too much on quality
– not all quality expenditures are equally valid
McGraw-Hill © 2000 The McGraw-Hill Companies
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SM Measuring the Effects of

Quality

• Can/should it be measured
• Must manage limited resources and direct
spending where it most counts

McGraw-Hill © 2000 The McGraw-Hill Companies

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Offensive and Defensive
SM Marketing

• Offensive --- marketing used to attract more and

better customers

• Defensive---marketing used to prevent customer

defection

McGraw-Hill © 2000 The McGraw-Hill Companies

 The Value of New 10

SM Customers (Offensive
Marketing)
• Quality attracts new customers
• W-O-M
• Personal referrals
• “Willingness to recommend”
• Enthusiastic testimonial

McGraw-Hill © 2000 The McGraw-Hill Companies

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SM Offensive Marketing Effects of

Service on Profits

Service
Quality
Profits
Market
Share

Reputation Sales

Price
Premium
McGraw-Hill © 2000 The McGraw-Hill Companies
 Why Improved Retention 12

SM (Defensive Marketing)
Increases Profits
• It’s about 5 times more expensive to win a
new customer than to keep an old one.
• Longer-term customers tend to purchase
more.
• Familiar customers may be more efficient to
deal with.

McGraw-Hill © 2000 The McGraw-Hill Companies

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Defensive Marketing Effects of
SM Service on Profit

Costs

Volume of Margins
Service Customer
Purchases

Quality Retention Price

Premium

Word of
Mouth
Profits

McGraw-Hill © 2000 The McGraw-Hill Companies

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Perceptions of Service,
SM Behavioral
Intentions and Profits

Costs

Volume of Margins
Purchases
Customer
Retention Price
Behavioral Premium
Service Intentions
Word of
Mouth
Profits

Sales

McGraw-Hill © 2000 The McGraw-Hill Companies

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SM The “80/20” Customer Pyramid

Most Profitable
What segment spends more with
Customers us over time, costs less to maintain,
Best
Customers spreads positive word of mouth?

Other
Customers What segment costs us in
time, effort and money yet
does not provide the return
Least Profitable we want? What segment is
Customers difficult to do business with?

McGraw-Hill © 2000 The McGraw-Hill Companies

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SM The Expanded Customer Pyramid

Most Profitable
What segment spends more with
Customers Platinum us over time, costs less to maintain,
spreads positive word of mouth?
Gold

Iron

What segment costs us in

Lead time, effort and money yet
does not provide the return
Least Profitable we want? What segment is
difficult to do business with?
Customers

McGraw-Hill © 2000 The McGraw-Hill Companies

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SM Service Elements

• Key drivers of service quality, customer

retention, and profits are service encounters

• Relative importance of various service

dimensions will differ but reliability is
usually the most critical

McGraw-Hill © 2000 The McGraw-Hill Companies

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The Key Drivers of Service Quality,
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Customer Retention, and Profits

Key Drivers Service Encounters

Service
Encounter

Service
Encounter
Service Behavioral Customer
Quality Intentions Retention Profits
Service
Encounter

Service
Encounter

McGraw-Hill © 2000 The McGraw-Hill Companies

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SM
Measurement Issues

• Traditional measures relied on profit, sales,

and return on investment
– must look at both costs of quality and returns
on quality

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SM The Balanced Scorecard

• Financial Measures
– lifetime value of customers, lost revenue, value of price
premium, volume increases, cross sales, etc.
• Customer Perceptual Measures
– leading indicators
• Operational Measures
– linked to customer expectations

• Innovation and Learning Measures

– innovate, improve, and learn

McGraw-Hill © 2000 The McGraw-Hill Companies

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Sample Measurements for the
SM Balanced Scorecard
Financial Measures

Price Premium
Volume Increases
Value of Customer
Referrals
Customer Value of Cross Sales
Perspective Operational
Long-term Value of Perspective:
Customer
Service Perceptions
Service Expectations Right first time (% hits)
Right on time (% hits)
Perceived Value
Responsiveness (% on
Behavioral Intentions: Innovation and time)
% Loyalty Learning Perspective Transaction time (hours,
% Intent to Switch days)
# Customer Number of new products Throughput time
Referrals Return on innovation Reduction in waste
# Cross Sales Employee skills Process quality
# of Defections Time to market
Time spent talking to
customers

Adapted from Kaplan and Norton

McGraw-Hill © 2000 The McGraw-Hill Companies
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Service Quality Spells Profits
SM
Costs

Defensive Volume of Margins

Marketing Purchases

Price
Premium
Service Customer
Quality Retention
Word of
Mouth Profits
Market
Share
Sales
Offensive
Marketing Reputation

Price
Premium
McGraw-Hill © 2000 The McGraw-Hill Companies
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SM The Measures that Matter

Most

• A causal model for a fast-food company

shows the critical drivers of performance
and the concepts that lead to shareholder
value.

• The study found that fewer than 30 percent

of the firms surveyed used this causal
modeling approach.
McGraw-Hill © 2000 The McGraw-Hill Companies
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The Measures that Matter Most
SM

Source: Christopher D. Ittner and David F. Larcker, “Coming Up Short on Nonfinancial Performance Measurement,” Harvard Business Review,
November 2003, pp. 88–95.
McGraw-Hill © 2000 The McGraw-Hill Companies