To Be or Not to Be…More Productive

Lower productivity can often lead to a better bottom line.

All other things being equal, productivity is good. The problem is, all other things are not equal. Companies want to show productivity gains, but that is not always a good strategy.

Automating customer service functions has become a popular strategy to improve service productivity and cut costs. But too much service productivity can actually cut into a company’s revenue, according to recent research from Roland Rust, Distinguished University Professor, David Bruce Smith Chair in Marketing, and executive director of the Smith School’s Center for Excellence in Service, and Ming-Hui Huang, Distinguished Faculty Fellow at the Center.

Consider Alaska Airline’s automated check-in system at Anchorage Airport. Though passengers were initially wary, by 2008, 73 percent of passengers were choosing to check in using the automated kiosks on the airline’s website. That improved Alaska Airline’s productivity by 18 percent. It also saved money: it costs the airline $3.02 cents to use an agent to perform each passenger check-in, while self-service costs between 14 and 32 cents per check-in. The airline was able to reduce its workforce by 10 percent and increase its earnings by 25 percent.

But for every success story there is a corresponding cautionary tale. United Airlines improved its labor productivity by 32 percent, and then received the lowest customer satisfaction scores in the airline industry for the next three years running. Its passenger revenues declined 17 percent over the same period, the worst decline of any US airline.

Rust, with co-author Ming-Hui Huang, National Taiwan University, gathered data from more than 700 other companies in two time periods across a variety of industries, including wholesale and retail, information and technical services, finance and insurance, education and healthcare, and food and recreation.

They found that when prices and profit margins are higher, the most profitable service productivity levels tend to be lower. Firms in highly competitive industries, with high prices and profit margins and relatively low wages, should provide higher levels of “high-touch” service, even at the expense of productivity. In industries where wages are high, prices and margins are low, and the market isn’t very competitive, higher productivity—with its correspondingly lower cost—results in a better bottom line. Each firm’s optimal level of productivity is based on those variables, and when productivity is too high or too low, profitability suffers.

The tradeoff between service quality and productivity should be considered in the same light as any strategic variable, says Rust: “Productivity is a strategic decision. Companies tend to think about the cost side exclusively—“the lower our costs are, the better our bottom line.” But that ignores the revenue side … customer satisfaction has a very large impact on revenue.”

Managers should be able to use the model Rust and his co-author created to examine the effectiveness of their own firms’ productivity levels. All the data from the study’s empirical analysis are in the public domain, so any firm could replicate it. By inserting their firm’s own data into the author’s empirical equation, managers can get a better idea about whether they are over- or under-productive.

Firms of all sizes, across all industries, should carefully consider the strategic tradeoffs between service productivity and quality, the authors find. But small companies may need to be even more careful about their productivity strategy than large companies. Small companies don’t enjoy the same economies of scale as big firms, so it is difficult for them to compete on cost and price. High-quality customer service to a niche market can help a smaller business out-compete larger firms that have a cost advantage.

The results of the study lead to some straightforward recommendations for firms’ productivity strategy. “If you have a small number of customers you have to treat them really well,” says Rust. “Any defense contractor serving the federal government understands that. Also, the more money you’re making from each customer, the more important it is to treat them well. To treat customers well, you place less emphasis on productivity.”

“All other things being equal, productivity is good. The problem is, all other things are not equal. Companies want to show productivity gains, but that is not always a good strategy. As technology improves, a higher level of productivity is justified, but at a given level of technology higher productivity can be counter-productive.”

Large companies have the hardest time finding the optimal level of productivity, according to Rust and Huang’s research. They have found that on average, large companies are about 9 percent too productive. Most of these companies, Rust and Huang conclude, would actually make more money if they were less productive. A side societal benefit is that decreasing service productivity would also put more people to work, leading to better economic conditions, which would in turn benefit the society.

“Optimizing Service Productivity” was published in the Journal of Marketing. For more information about this research, contact rrust@rhsmith.umd.edu.