In today's economy, it is impossible to completely separate service-producing industries (traditionally known as “services”) from product-producing businesses (traditionally known as “manufacturers”). Successful firms have recognized that potential customers do not compartmentalize value that way. Customers look at the total package, which includes aspects of both services and products. Failure to recognize this greatly reduces a firm's ability to compete. Studies by the American Society for Quality (ASQ) confirm this perspective. Since 1994, despite significant improvement in product quality, overall customer satisfaction has continued to drop, leaving no doubt that the service aspects of doing business are not meeting expectations. From a competitive standpoint, it means that providing a high-quality product is necessary, but not sufficient, to effectively compete.⁴

Despite the integrated nature of business outputs and the difficulty in defining a business as a service or a manufacturer, it is important to understand that business outputs can be defined distinctly as either a service or a product. Even though these components are perceived by the customer as one entity, they are often produced separately.

Products

Products are things. They're tangible. They can be seen, they can be touched, they can be counted, they can be measured, and they can be stored for later use. They are produced by manufacturers. The fact that products are tangible has many management implications, most of them advantageous to managers.

Because a product is tangible, its quality can be measured in a relatively straightforward manner before a customer has a chance to examine it. The function of the product can be measured and actually tested to make sure it works properly, allowing management to avoid exposing customers to poor quality. Electronic products are tested upon completion. Automobiles are examined for defects. Clothing is inspected for flaws in the fabric. The defective product is separated from the good products and is either fixed or destroyed.

A completed product can be stored in finished-goods inventory until needed, or it can be shipped anywhere in the world for use. Some products are stored for only a short time before being consumed (some food, pharmaceuticals, stylish clothing, and newspapers, for example), but others have an extremely long shelf life (furniture, books, and toys, for example). When products can be stored for later use, their actual rate of production does not have to match the rate of demand in the short term. Matching output rate to a fluctuating demand is difficult, particularly when materials have to be ordered in advance and employees have to be hired and trained in advance. The ability to store products is important to production management.

When a product is purchased, the customer typically has no idea of the conditions associated with its production. She doesn't care if processes are noisy, if they smell bad, or if the machines are dirty. It's the outcome of those processes that matters. The finished product is evaluated in terms of quality, but the process used to create it isn't. As consumers become more aware of production, however, they have also become more concerned. Consumers were shocked, for example, when they found out that certain clothing items they wore were being manufactured by children and in unacceptable conditions. In some cases, the companies that purchased the goods weren't even aware of the conditions in which they were manufactured. Issues such as employee exploitation and impact on environment have begun to interest consumers. Attributes such as the friendliness of the employees or the ambiance of the factory, however, make no difference.

Services

Services are intangible. They can't be touched or counted or examined the way a product can. They can't be stored for later use. Services are tasks that are done for the customer or done to the customer. They can't be examined or tested for quality before the customer gets them. In fact, they are often produced in a process that the customer is actually a part of. Sometimes it is the customer that is actually processed. The intangibility and customer involvement create a situation that can be quite difficult to manage. In a service, the customer does care about the production process because he spends time in it. The process can be as important as the outcome. The process utilized to entertain a customer at a theme park matters a great deal. The process a retailer uses to sell products defines the quality of service a customer perceives. The process a financial consultant uses to plan investments for a client matters because she is a player in that process.

A close match between the output rate and the demand rate is critical for services because people aren't willing to wait for a process to catch up with them. Access to an online retailer, for example, must be immediate or the customer will click on an alternative. A seat on an airplane must be available when a customer wants it or he'll simply buy a ticket on a competing airline. If either business has idle server capacity or empty seats at a particular time, it can't store that capacity for later use.

Unfortunately for managers of services, service quality cannot be determined until after the fact. For customers, this means that they're exposed to poor quality service more often than they're exposed to poor quality products. Unlike manufacturing managers, who can “scrap” or “rework” defective products, service managers must attempt a “recovery” when customers are exposed to quality failures. When a restaurant finds out that a customer is dissatisfied, management attempts the recovery by providing complimentary drinks or a gift certificate for free meals at a later date.

Customers place higher expectations on the employees in services because they are often face to face with them. When the customer watches a service production process and is involved in it, expectations for “special treatment” are common. A rule of thumb is that the greater the customer contact, the greater the expectation for customization, and the more difficult it is to maintain efficient processes. Banking by ATM, phone, and online removes customers from direct contact with bank personnel. For students, online registration has improved the efficiency of that process by removing direct student contact. The need to meet varied expectations and customize the service can make the management of a service more difficult and customer expectations harder to meet. Many services have removed service processes from customer access to increase productivity. Exhibit 1.4 summarizes the characteristics of products and services.

EXHIBIT 1.4 Summary of Product and Service Output Differences

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As can be seen in Exhibit 1.5, business outputs often blend product and service components. For example, you might order a product directly from a manufacturer, but along with that product comes a lot of services. Dell Computer Corporation provides an excellent example of a manufacturer that has blended products and services. A customer buys a computer directly from Dell and receives services as well. One is fast delivery. The second is on-site support. The customer can also buy additional services, such as extended support. Dell's success, particularly in quantity purchases for businesses and schools, is not dependent solely on the quality of its products but can also be traced directly to its reputation for after-the-sale support.

EXHIBIT 1.5 Continuum of Service and Product Producers

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For many traditional product-oriented companies, managers are finding that good service not only helps sell products but can also be profitable. Auto companies dramatically increased incentives to buyers in 2001 in response to declining sales during the economic downturn, resulting in record sales. They expected a sharp decline in 2002 and hoped to balance that decline by improved used car sales, which actually have higher margins than new cars. The economic slowdown resulted in customers keeping cars longer. Those older cars needed more service. At large dealer chains, repairs and service part sales made up 10 to 12 percent of revenues but created up to 35 percent of the net profits.⁵

Service management tends to follow manufacturing management in adopting new management approaches. Productivity and quality improvement efforts initiated in manufacturing often move to the service sector. In the past decade it has become increasingly common for manufacturers to outsource labor-intensive aspects of production to countries with cheaper labor. That has been made possible by the ease of transporting products, compared to the difficulty in transporting services. Services have begun to follow suit. Labor markets in the United States have increased the incentive for U.S. services to seek labor from outside the country.

An excellent example of this trend is the maquiladorasForeign-owned (typically U.S.-owned) manufacturing plants in Mexico.. Maquiladoras have traditionally been known as foreign-owned manufacturing (usually assembly) plants in Mexico. A company establishes a plant in Mexico, usually just across the border from the United States. Since the plant is company-owned, the company could import the components into Mexico duty-free and then export finished products back to the United States. Maquiladoras have been very popular as a means of lowering labor expenses in a variety of manufacturing industries, including automotive, electronics, and garment manufacturing. They have also been controversial in that some companies' primary motivation to manufacture in Mexico has been to avoid Environmental Protection Agency (EPA) requirements. The use of maquiladoras extended into the service sector and by early 2000, approximately 50,000 Mexican workers were employed by service maquiladoras. Outsourcing of services has sinced moved to India and the Philippines, and even to China. Providing back-office support services such as call center management and other services for retailers, financial services, telecom, and software companies is commonplace.⁶