Title: Transferring service operations to the customer: an outsourcing perspective.

Transcription

1 POMS, College of Service Operations Conference July 2007 Student paper Title: Transferring service operations to the customer: an outsourcing perspective. Marlene Amorim, PhD Student IESE Business School Av. Pearson, Barcelona, Spain Phone: Fax: Ph.D Supervisor: Alejandro Lago Assistant Professor of Production, Technology and Operations Management IESE Business School Av. Pearson, Barcelona, Spain

2 Transferring service operations to the customer: an outsourcing perspective. Abstract This paper addresses the participation of customers in service operations, through an extended supply chain management perspective. The purpose is to develop a framework for optimal allocation of service value chain process parts among service firms and their customers. Customer involvement is regarded differently depending on the value that providers can assign to this participation: it can be seen as a source of either unwanted variability of results or, of productivity gains. Furthermore, it is not clear which level of customer participation is needed and in what activities. In practice, wide variety of scopes and purposes are observed. Most service literature assumes that processes have to cope with some degree of predefined customer participation. They focus on adapting the existing knowledge from operations and human resources to address the physical participation of the customer. Concepts of process design and control have been applied to adapt the service process to participation for maximizing efficiency and minimizing customer failure in production. Also, knowledge about selection, incentives and employee retention has been applied to motivate, monitor and improve customer performance, considering customers as quasi employees. This paper addresses a question which is prior to those concerns about customer operational management: when shall service operations be transferred to the customer rather than be conducted integrally by the firm? For that purpose, I address customers as suppliers, who may partially, or totally, embrace some process parts. I formulate service production as a combination of operations which can be performed either by customers or employees. However any of those alternatives require input exchanges, which have associated some transaction costs. Therefore, 1

3 understanding the transaction cost sources associated to those service input exchanges, is used to derive criteria for an efficient allocation of operations in service process design. Overview and motivation One of the most challenging current concerns in service management research is to investigate how customer participation should be integrated along a service production process, while improving its performance. Although reality shows that service processes can be permeated by a wide variety of customer contributions, no consensual set of criteria is available to support the managerial decision about the optimal extent and scope for that participation. Additional motivation for this research derives from the fact that information and communication technologies have amplified the available alternatives for processes decoupling, automation and delegation and, consequentially, that this has broadened the possibilities for integrating customer contributions along the corridor of service production and delivery. One way to formulate these changes is to think of service firms no longer as providers, but rather, as enablers of service experiences, which will result from a selection and combination of alternative delivery modes of production of the successive process parts. Each of this alternative delivery modes can be performed by the firm - either directly or trough its suppliers - or by the customer itself. According to this approach, customer participation can be addressed trough the lenses of an outsourcing decision which enables the formulation of customer participation as a firm boundaries issue. Therefore, reviewing the outsourcing literature, and in particular transaction cost considerations, can be a useful exercise to derive knowledge for guiding an efficient allocation of tasks, between the firm and the customers. The argument developed in this paper is inspired by the stream of service definitions which acknowledge the requirement of customer inputs as the distinguishing characteristic. However, I 2

4 argue that - in order to gain further understanding about the consequences of customer participation for production performance - it is necessary to take into account that distinct operational purposes may underlie the request for customer contributions. Customers may be asked to infuse the production process with specific inputs, with the objective of enabling an appropriate customization of the service experience. But, rather differently, customers can also be required participate for substituting firms employees in some operations. The argument which supports the relevance of this distinction is that it is likely that the consequences of customer participation associated with each one of these types of contributions will also be distinct. This paper proposes a contribution inspired by transaction cost economics, for explaining why these differences might occur. The main argument developed in this paper departs from the assumption that every service operation requires both customer and firms inputs, which will have some degree of specificity. According to transaction costs reasoning, higher degrees of specificity will result in higher transaction costs. Therefore those operations which are very demanding in terms of customization, and because of that require a lot of customer specific inputs, can gain in performance if they are transferred to the customer, while those operations which are very demanding in terms of firm specific inputs, will better be kept in the hands of firms employees. The paper is organized in three main sections, followed by a concluding part where a research agenda is drafted. In the first section of the paper I present a review of the literature about customer involvement in service production. The objective is to provide an overview of the different types of inputs that customers may be invited to place in service production, and to understand the associated performance consequences of those contributions. The argument developed there is that a service production process can be formulated as a combination of tasks and decisions that will performed either by customers or employees. However, the allocation of operations to one or other of those actors will require bi-directional input exchanges. In the 3

5 second section, I review the transaction costs reasoning and apply it to the exchanges involved in service production processes. The argument developed here is the input exchanges found in service production have associated transaction costs, which will be stronger if the inputs to be transferred are very specific or complex. Section three integrates the arguments exposed in the former two parts, and formulates propositions to guide the allocation of service process parts. In the final section I draw some considerations the implications of the proposed arguments and I draft a research agenda. 1. Customer contributions for service production 1.1. Customer contributions for service production Service firms frequently require their customers to provide some inputs to the production process. Customers can be asked to be present in the service production facilities (Chase, 1978, 1981), to interact with service employees (Mills, Chase, & Margulies, 1983), to provide information and personal belongings (Scott, 2000), or even be invited to perform some of the operations themselves, therefore replacing the firms personnel (Larsson & Bowen, 1989; Mills & Morris, 1986). In practice, a wide variety of scope and extent for customer participation in different service business has been observed (Bitner, Faranda, Hubbert, & Zeithaml, 1997). Not surprisingly customer participation in service production has been pointed out as one of the key distinguishing characteristics of services (Sampson & Froehle, 2006). But, further than distinguishing, this characteristic has soon been perceived as rather challenging, because it raised management issues for which satisfactory answers could not be derived from the existent knowledge from manufacturing contexts (Fitzsimmons & Fitzsimmons, 1999; Nambisan, 2001). To a large extent, those emergent concerns had to do with the impacts that customer 4

6 involvement would have in terms of heterogeneity of service processes performance and outcomes (Michael, 1994; Mills et al., 1983; Ojasalo, 2003; Soteriou & Chase, 1998). 1.2 Impacts of customer participation in production performance and quality The main contributions provided by service management research have been twofold: on the one hand the development of some categorization to distinguish different kinds of customer participation (Bitner et al., 1997; Lengnick-Hall, Claycomb, & Inks, 2000) and, on the other hand an effort of reviewing and transferring knowledge form the fields of human resources and operations in order to apply it to the management customer participation (Bowen, 1986; Chase & Dasu, 2001). Because customer involvement can have both positive and negative impacts on service production performance different prescriptions about where to draw the borderline have emerged. On the one hand customer participation has been described as troubling. Its inputs were labeled as source uncertainty (Frei, 2006; Larsson et al., 1989) - in the sense that they are hold by the customers and only clearly known for the service organization when the service performance effectively takes place - and as a source of variability (Frei, 2006) for the production process, due to the diversity of their skills and effort profiles. Authors like Chase (Chase & Stewart, 1994) highlighted the higher proneness of customers to fail and prescribed a service firm model which would have a back office setting, where the pursuit of efficiency would be based on standardization knowledge derived from manufacturing contexts, and a front office in charge of buffering the production from customer variability and of building on the emotional and perceptual elements of the quality of the service experience (Mills et al., 1983). There have been several sources of inspiration to prescribe tools to solve this. From the human resources literature perspective, customers were labeled as quasi employees and the effort has been to apply to the 5

7 management of their performance some of the existing knowledge about selection, incentives and employee retention (Bowen, 1986). From the operations management literature there have been inputs about process design and control in order to maximize the efficiency of the participation and minimize customer failure in production (Chase et al., 1994). But, positive consequences of customer involvement have been also acknowledged, such as the gains from organizational socialization in improving customers perception of service quality (Kelley, Donnelly Jr, & Skinner, 1990), or the benefits that customers derive from higher control of the service experience (Bendapudi & Leone, 2003), and also the value derived from a more adjusted customization (Bettencourt, 1997; Prahalad & Ramaswamy, 2000; Prahalad & Ramaswamy, 2004). One practical way to capture the counteracting consequences that customer involvement can have for value is captured by the value equation formulation (Heskett, Sasser, & Schlesinger, 2003). Value equations capture the positive and negative dimensions of value in a production process. In the formulation proposed by Heskett (2003), customer value equation encompasses four dimensions: results, process quality, price and customer access costs. This equation captures the conflicting arguments of customer participation: on the one hand, he might derive additional benefits from being embedded and having higher discretionary power in the service production, but, on the other hand, this increases the effort, or access costs, that he will have to support to get the service. The optimality of the decision will be conditioned by these tradeoffs. An analogous reasoning is proposed to understand the value impacts from the firm s perspective. There is potential for value creation either because of the attainment of increased customization and eventually cost savings in terms of personnel, but the likelihood of customers to fail might compromise outcome quality. 6

8 The two dimensional formulation of service quality proposed by (Anderson, Fornell, & Rust, 1997) is also illustrative of the performance tradeoffs derived form customer involvement. These authors propose that service quality can be appropriately captured by two distinct categories: quality that meets customers need and quality that consists of freedom from deficiencies, which they respectively label as customization and standardization quality. From a customer participation point of view, the challenge is to infuse customer inputs to increase customization quality without hurting standardization quality. In summary, what can be read from all these concerns is that some customer contributions are required to appropriately customize the service experience, and additional ones can be further requested to replace employees inputs, and improve process productivity. The difficulties emerge either because it is hard to extract the necessary customization specific inputs form the customer, or because when they are asked to act as substitutes for employees, it s hard to ensure that they have the knowledge or motivation to do it properly. A service production process can therefore be formulated as a combination of tasks and decisions that in some extent can be performed either by customers or employees. Having the firm entirely taking care of it or, rather, passing it to the hands of the customers will always involve some input exchanges. If the firm does it, it will have to extract knowledge about customer needs and feedback info about the effectiveness of the operations. If the tasks and decisions are passed to the customers, they will have to be provided with some production specific knowledge, which typically is embedded in employees. Because these exchanges can be complex and costly, I argue that they should be considered in the set of criteria which would guide the decision about where to draw the borderline for customer involvement in production. 7

9 This approach is consistent with the formulation of service delivery as result of customersupplier duality (Fitzsimmons, Anderson, Morrice, & Powell, 2004; Scott, 2000). According to this perspective, service production is a by-directional system where the customer is integrated in the knowledge management strategy of the firm. As a consequence, value creation in this system requires also a bi-directional optimization: doing what is best from the customer perspective while doing the best for the service enterprise. Or, putting it in other words, combining the contributions of both, in order to achieve the most efficient value creation alternative. The guiding idea is to understand how service process design shall integrate customer contributions, by creating value in a way which can be economically efficient both for him and the firm. 2. Service operations and transaction costs Transaction cost economics is one of the approaches that can be applied to explain firms decision about whether outsourcing an activity rather than conducting it internally. This perspective postulates that there are some costs associated to conducting transactions in the market, and, because of that, before deciding to outsource some part of its production process, a firm will compare this costs with the ones it would from having to coordinate and control those activities internally. If the transaction costs associated with an outsourcing alternative exceed their internal equivalents, the likelihood increases that the firm will choose to perform the operations itself. The existence of transaction costs is explained by the assumptions made about the nature of the economic agents. Individuals, and consequently firms, are assumed to have bounded rationality and a potential for opportunistic behavior (Coase, 1937). This has two sorts of consequences: firstly as firms are not capable of perfectly codifying and transferring the knowledge required to perform some activities, there will be some performance ambiguity associated with operational outcomes; and secondly, some suppliers might take advantage of any 8

10 information or power asymmetry due to the existence of goal incongruence between them and the contracting firm. It is also observed that the presence of some transactional characteristics will tend to aggravate those costs. The characteristics of transactions that are usually mentioned to increase transaction costs are three: the need for some asset specificity in order to perform the activity; the frequency of the transaction and the uncertainty nature of the objective outcome (Williamson, 1985). In order to apply the former outsourcing reasoning to the decision making about the transference of some operations to the hands of service customers, the first question which is addressed is the identification of what kind of transaction costs can emerge in this specific customer context. In accordance with the work of Bowen and Jones (Bowen & Jones, 1986) it seems reasonable to accept that in a service production context, particularly in what concerns the decision about sourcing some operations from the customers, those assumptions of bounded rationality and opportunism still hold. This means that service operations will also have associated some performance ambiguity or even goal incongruence if they are to be performed outside firm s boundary. According to those authors this will be particularly the case the more intangible and customized is the nature of the service activity, and, also the higher information or power asymmetry between the two parts. As I explained in the first section of this paper the approach adopted in this paper is to formulate a service production process can therefore as a combination of tasks and decisions that in some extent can be performed either by customers or employees. But, that either having the firm entirely taking care of it or, rather, passing it to the hands of the customers will always involve some input exchanges. If the a firm transfers the operation to the customer it will have to provide him some operational knowledge and maybe other resources like the use of facilities or equipment, and will have to incur in costs of monitoring and controlling his performance in order 9

11 to guarantee some quality requirements both of the outcome and the process. But, the new thing, when we compare this reasoning to the manufacturing outsourcing framework, is that even if the firm decides to perform the activity internally, it will have to deal with more than its own coordination or hierarchical efforts because most probably the service firm also needs information inputs from the customer, in order to achieve he required customization level. So firms will face transaction costs in both situations either doing it or letting the customer do it himself. The derived argument is that service production will always require two-way knowledge exchanges between the service firm and the customer. These input exchanges will then have associated transaction costs, which will be stronger if the inputs to be transferred are very specific or complex. For example, if the knowledge about customer preferences, or the knowledge about how to execute the production tasks is very hard to codify, the exchanges will be hard and costly and prone to exhibit strong transaction costs. 3. Discussion and propositions Integrating the initially adopted vision of the service value creation - according to which service production process is formulated as a combination of tasks and decisions which can be performed either by customers or employees with the transaction costs considerations, inspired the formulation of some propositions to guide the allocation of service process parts. For those service operations which involve production knowledge that is relatively simple to codify, productivity gains can be achieved trough customers contributions where they replace employees roles. By their turn, for those service operations with high customization requirements associated with specific and complex customer information, the productivity 10

12 will very dependent on the ability to infuse production those specific customer inputs. Due to the transaction costs which would be associated with transferring those inputs to the firm, a more efficient alternative most likely resides in passing those tasks and decisions to the customer hands. This reasoning can be summarized in the following propositions: Proposition 1: The more complex is the nature of the knowledge involved in a service production process, the less likely the firm will transfer operations to the customer. Proposition 2: The more complex is the nature of the knowledge associated with customer customization requirements, the more likely the firm will transfer operations to the customer. The nature of customer contributions to the service production process will vary according to the associated knowledge complexity. For service process where production knowledge is relatively simple to codify, productivity gains can be achieved by enabling customers to contribute with labor letting them replace employees performance. For those service processes which demand high customization, productivity gains can achieved by making customers provide and manage their specific knowledge inputs in the process. 4. Final considerations and research agenda In this paper I have used an outsourcing lens in order to reason about the allocation of service process parts among firms and their customers. Service production was portrayed as a set of operations, whose allocation is guided by efficient value creation concerns. The bi-directional specific input requirements which characterize service operations were used to explain the occurrence transaction costs associated with each allocation decision. Finally two propositions 11

13 were formulated, about the likelihood of transferring service operations to the customer according to the complexity of the required inputs. This paper is a first draft in terms of a supplier perspective for understanding and managing customer contributions in service production. It sets the inspiration and the goals that guide the allocation reasoning. However the propositions are formulated in very broad terms at this stage. In order to progress with this perspective, preliminary work is required both in (1) what concerns a clear identification of the variables that capture customer and firms value equations, and also (2) in terms of the identification of the determinants of the referred input complexity. This operationalization of the suggested framework will enable the refinement of propositions and subsequent research work. 12

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