Service-Profit Value Chain

The service-profit value chain (SPVC) is a model of the relationship between employee productivity, service delivery, and customer satisfaction that explains the link between customer service as a broad concept and business profitability. Although the model is generally well-known, it does not seem to attract as much academic attention as other concepts in CRM. That is unfortunate because the SPVC is one of the more flexible and practical analytical models available; if understood and applied correctly, it is equally useful as a tool for external analysis of firms as well as a tool for planning.

The Basic Concept behind the SPVC: Employees Come First

The development of the SPVC is attributed to a group of Harvard Business School faculty members led by James L. Heskett, and the model was introduced in an article in the Harvard Business Review in 1994 (“Putting the Service-Profit Value Chain to Work”, Harvard Business Review, March-April 1994). The basic concept of the SPVC, the ‘links’ in the chain, is expressed as a series of propositions:

  • Profit and growth result from customer loyalty.
  • Customer loyalty results from customer satisfaction.
  • Customer satisfaction results from service value.
  • Service value results from employee loyalty and productivity.
  • Employee loyalty and productivity are results of employee satisfaction.
  • Employee satisfaction results from internal service quality.

Internal service quality refers to the working environment – working conditions, compensation and rewards, policies, and support that facilitate the delivery of service by employees. The philosophy “Take care of your employees and they will take care of your business,” expressed in different ways by management icons like Virgin’s Richard Branson, Southwest Airlines’ Herb Kelleher or Enterprise Rent-a-Car’s Jack Taylor is not just homespun wisdom, but really the fundamental idea behind the SPVC. The customer is naturally the highest priority, but the business can’t meet the customer’s needs unless it has something to deliver; and the only way the business can accomplish that is to cultivate its workforce, which makes internal service quality the first objective.

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The SPVC as an Empirical Model

One of the advantages of the SPVC as an analytical tool is that it can be configured as kind of empirical model. Heskett, et al. made the argument that customer satisfaction – and consequently, customer loyalty leading to profitability for the firm – is the result of the customer’s perception of service value. The service value perception is a judgment by the customer that compares the outcomes of the service and the quality of the process to the price of the service and other costs to the customer to obtain the service. The customer assessment can be expressed as a customer value equation:

[SO + PQ]/[P + C] = CV → CL → PROFIT

Of course, in order for this equation to be useful, some meaningful values have to be assigned to the variables, and that might present a bit of a challenge. The easiest way to approach the problem is to start with the variables that have a known value: Price (P) and Profit; profit should be expressed as a numerical value, i.e. price times profit margin. Other customer costs (C) can be estimated; factors such as the price differential between the firm’s product or service and that of a competitor, the difference in distance a customer has to travel to reach the business rather than a competitor, shipping or transfer costs, and costs in time required for the customer to obtain the product or service all account for C, and with a little research a fairly accurate estimate can be generated.

Service Outcome (SO) is a bit more difficult, but if it is generalized to represent ‘completion of a transaction’, it can be handled with a Likert Scale. For example:

1 – Transaction not completed
2 – Transaction completed, but below customer expectations
3 – Transaction completed, met customer expectations
4 – Transaction completed, exceeded customer expectations

Note that in this scale there is no ‘0’. A transaction that is not completed or is otherwise entirely unsatisfactory to the customer probably deserves a ‘0’, but that would also increase the likelihood that the left side of the equation would equal ‘0’; not only would that be mathematically incorrect (unless profit happens to equal ‘0’ as well), but it is simply not very helpful in analyzing problems with service.
Process quality (PQ) is the most subjective factor, but because this entire formula is an expression of customer perceptions, a scale similar to the one used to assign a value to SO can be used here. Here’s how it looks with real numbers plugged in:

Wacky Lube, a chain of auto service shops, has done a customer survey about their $9.99 quick oil change service, which at that price has a margin of 15%. The company has decided to focus on the time to complete the service as the key factor in other customer costs; they learn through the survey that their customers have an average income of about $30,000, and spend an average of 21 minutes waiting for the service to be completed. Overall, the customers surveyed rate the service outcome at 2.5, and the process quality at 3.1. Thus,

SO = 2.5
PQ = 3.1
P = 9.99
C = 5.25 (at $30,000 a year, a full-time worker is earning $0.25 per minute)
PROFIT = 1.50 ($9.99 x 15%)
[2.5 + 3.1]/[9.99 + 5.25] = CV → 1.50
0.3675 = CV, which corresponds to $1.50 profit for the quick-oil-change service.

This is the point where the equation becomes only “sort of” empirical. First and most noticeably, the contribution of internal service quality and employee satisfaction is completely missing from this formula. That is an omission in the research literature as well; despite the importance given to employee satisfaction, there has been very little if any scholarly work done to this point to try to model it, possibly because internal service environments differ greatly from one workplace to another. As it is, the equation only indicates that some undefined status quo in Wacky Lube’s internal service environment correlates to a CV of 0.3675, leaving Wacky Lube’s management with a bit more work to do to figure out the connections. The second problem is that the profit and the CV can be and probably are mutually exclusive; revenues are a function of customer value/customer loyalty as a sales driver, but profits are a function of costs. There are some circumstances where costs are related to customer loyalty – for instance, greater customer retention or repeat business tends to lower some costs – but caution must be exercised in applying the results of the SPVC analysis.



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