Technology in Services: Rethinking Strategic Focus

SERVICE TECHNOLOGIES are not just revolutionizing internal organizational configurations. They are restructuring whole industries’—and nations’—entire competitive postures. Service technologies now provide sufficient scale economies, flexibility, efficiency, and specialization potentials that outside vendors can supply many important corporate functions at greatly enhanced value and lower cost. Thus many of these functions should often be outsourced. Strategically approached, this does not “hollow out” the corporation. Instead, it decreases internal bureaucracies, flattens the organization, gives it a heightened strategic focus, and improves its competitive responsiveness. Taking advantage of this opportunity requires a whole new approach to strategy.

Services Dominate the Value Chain

The process begins by redefining what the company really does. Most companies primarily produce a chain of services and integrate these into a form most useful to certain customers. So dominant is this consideration that one questions whether many companies—like those in pharmaceuticals, computers, clothing, oil and gas, foods, office or automation equipment—should really be classified as “manufacturers” anymore. The vast majority of their systems costs, value-added, profits, and competitive advantage grows out of service activities.

• For example, the strategies of virtually all pharmaceutical companies are critically dependent on service functions. This is especially true of the top performers like $5-billion Merck and ¥1.7-billion Glaxo, and less true for lower profit generic drug producers. The direct manufacturing cost of most patented ethical drugs is trivial relative to their sale price. Value is added primarily by service activities— discovery of a drug through R&D, a carefully constructed patent and legal defense, rapid and thorough clinical clearance through regulatory bodies, or a strong preemptive distribution system. Recognizing this, in recent years Merck’s strategy has focused on one portion of the value chain, a powerful research-based patent position. Glaxo has successfully targeted rapid clinical clearance as its key activity. Both strategies rest primarily on adding value through service activities. Merck and Glaxo outperform the industry in gross margins (71.5 percent and 79.6 percent versus an industry composite of 66.9 percent), in operating income margins (27.1 percent and 38.2 percent versus 21.2 percent), and in profits as a percentage of shareholders’ equity (48 percent and 35 percent versus an industry average of 2 3 percent).

As manufacturing becomes more universally automated, the major value added to a product increasingly moves away from the point where raw materials are converted into useful form (i.e.,