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OCR for page 9
Services Technology and
Manufacturing:
Cornerstones of the U. S. Economy
JAMES BRIAN QUINN
Now, more than ever, the United States needs a vital services sector. Some
U.S. manufacturing industries (such as basic steel, automobiles, or electronic
appliances) have suffered serious competitive reverses in recent years. Mer-
chandise trade deficits have risen to all time highs. And even services trade
balances have begun to slip seriously-from a positive balance of $37 billion
in 1982 to only $15 billion for the entire year 1987. Of the total, the selected
business services category declined by more than $8.6 billion between 1982
and 1987, when the net balance was a mere $0.8 billions The most serious
losses occurred in travel and transportation-related industries. Although U.S.
airlines have maintained a steady 38 to 41 percent of the world's revenue
passenger miles during the past decade (U.S. passengers made up nearly 46
percent of the world total), the once powerful international carriers PanAm
and TWA have fared poorly at the hands of direct foreign competitors such
as JAL, Swissair, and Singapore Airlines, which made heavy long-term
investments in their fleets and paid close attention to the quality of care given
to passengers.
MAJOR THREATS AND OPPORTUNITIES FOR THE 1990s
The threat to other services industries is real and immediate. Confrontations
will not be limited to markets abroad; U.S. markets for services are no safer
from foreign competition than were the domestic markets for manufactured
goods. Indeed, foreign direct investment in the U.S. services sector has
exploded since the mid-1970s, although the rate of increase was slowing
until the mid-1980s, when the weak dollar began to attract further foreign
9
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10
JAMES BRIAN QUINN
investments. It is sobering to realize that many of the great names in ser-
vices such as 20th Century Fox, Stouffers Hotels and Restaurants, Inter-
continental Hotels, Saks Fifth Avenue, Marshall Fields, Spiegel, A&P, Grand
Union, and Giant Food have foreign owners now. Even the great invest-
ment banks of the United States have strong new partial owners from abroad.
The United States needs to take a careful look at its services sector and
place increasing emphasis on its competitiveness and value-added potentials.
U.S.-based services will continue to offer dramatic opportunities for growth,
productivity improvement, and innovation over the next decade. Few realize
how completely technological innovations in services have already restruc-
tured the U.S. economy and its international competitive relationships in
the process antiquating many of our precepts about the roles of both man-
ufacturing and services in a modern economy.
The companion volume to this book Technology in Services: Policies
for Growth, Trade, and Employment- contains a number of research and
policy papers concerning the implications of this restructuring. In this volume
we have collected some outstanding cases about services innovations. These
can provide informative guidelines on how such innovations can be managed,
or mismanaged if we are not careful.
NEW TERMS OF COMPETITION IN SERVICES
Although the effects of deregulation complicate the picture, it is new
technologies that have most extensively altered and expanded the services
industries in recent years. Unfortunately, such technologies have also made
these industries vulnerable to the same modes of attack that earlier so rapidly
undermined segments of the nation's manufacturing economy. If executives
and policymakers understand these emerging forces, they will both exploit
some potent opportunities to boost their companies' (and the nation's) per-
formance and develop more effective responses to their foreign competition.
The attempts and frustrations of Federal Express in opening the Japanese
market provide a good example. If executives do not comprehend these
potentials or if they act with the complacency and shortsightedness that
characterized policies that affected manufacturing industries a decade ago,
they could leave major portions of the U.S. economy wide open to further
foreign incursions. What are the main patterns at work?
Concentration and Diffusion
In virtually every services industry, technological change has created vastly
increased capacities and economies of scale. The New York Stock Exchange
and Federal Express COSMOS II systems described in this volume provide
cases in point. The first-order effect in most industries has been a revised
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SERVICES TECHNOLOGY AND MANUFACTURING
11
competitive structure characterized both by increased concentration in the
industry and by increased fragmentation and market segmentation. To exploit
the new scale economies available, many intermediate and large companies
in each services industry merged to form giant enterprises. But within each
services industry smaller companies also identified local niches- or spe-
cialized services needs-and concentrated successfully on these, with in-
vestment returns following the classic V- or U-shaped distributions noted by
Porter (1985) and others (Booz Allen & Hamilton, undated).
In the rental car industry, for example, the major companies in conjunction
with the airlines initially locked up virtually all long-distance travelers with
their instantaneous guaranteed reservation systems. They rapidly extended
their scale through international subsidiaries and affiliates connected elec-
tronically. But soon, niche operators proliferated to exploit the rigidities of
the giants' more standardized services. Automated computer and telephone-
answering devices allowed both "Super-Elegant" and "Rent-A-Wreck" ex-
tremes to serve local markets with office-in-the-home operations. Only a few
midsized operations such as Alamo or Agency could grow substantially by
segmenting target groups with particular needs, such as cut-rate or conference
rentals.
As the Keith and Grody paper notes, automation in the securities handling
process has changed that industry's entire structure since the mid-1960s.
Under the old paper-based system, brokers had to document all trades by
hand, and shares had to be physically delivered from the seller's agent to
the buyer' s. As daily volumes approached 12 million shares, only the big
firms could hire and manage enough people to keep up with their securities
trades each day. Smaller firms began to fail because they could neither control
nor process their securities in a timely fashion. Finally, Wall Street filllls
formed Central Certificate Services (later the Depository Trust Company),
which brought essentially all securities certificates under one roof, where a
single set of accounting entries could change their ownership. After 5 or 6
years, the system became totally electronic and smaller brokers could tie
into the Depository. Today, such automated clearinghouses handle virtually
all private and government transactions and are key linkages enabling the
worldwide integration of financial markets.
New technology also produced important scale effects in medical care.
Some high-cost technologies, such as computerized axial tomography (CAT),
allowed much more accurate diagnoses, and other advanced technological
systems opened the way for heart, brain, general surgical, and life support
procedures never before feasible. In part because of the reimbursement system
then in use, the initial effect of these capital-intensive technologies was to
centralize treatment in the larger hospitals. Small practitioners and hospitals
had neither the patients nor the resources to buy or constantly update the
new diagnostic, surgical, and recovery equipment. This centralization led to
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12
JAIIlES BRIAN QUINN
highly specialized medical training in the medical centers, caused specialist
practices to form around the biggest hospitals, and spurred the creation of
large regional referral facilities to handle particularly difficult cases. Many
smaller hospitals suffered, closed down, or joined in cooperative networks
with the larger centers.
Overhead expenses grew and the average cost of an inpatient stay soared
from $729 in 1972 to $2,898 in 1984, when diagnosis-related group restric-
tions devised by the government medical reimbursement programs began to
shift cost patterns. With patient care becoming ever more impersonal in the
large centers, new and less costly distribution systems began to emerge along
both vertical (home care, primary care, specialty care) and horizontal (pe-
diatrics, obstetrics, dermatology, internal medicine) axes. Such complex
alternative systems as electronically linked home or outpatient care facilities,
emergency cardiac systems, and health maintenance organization networks
have grown almost 10 times in number since 1971, and the number of people
they serve grew from 3.1 million to more than 13.6 million. Ambulatory
surgical centers have exploded from 400 in 1982 to more than 1,200 in 1985.
Soon management of these complex systems became so critical a factor that
large private companies found it profitable to apply their skills to both hos-
pitals and other parts of the system thus starting another wave of consol-
idation.
Networks and Variety in Services
Beyond their important effects on scale, new services technologies often
create powerful second-order effects-economies of scope-that allow en-
tirely new service products to move through established networks or systems
with little added cost. Once debugged, communications and information-
handling technologies permit the distribution of a much wider set of services
to a more diverse and dispersed customer base. In the process they often
further decrease costs on old product lines as equipment, development, and
software investments are allocated over the broader base of applications. In
addition, new technologies frequently offer wide-ranging strategic benefits
in terms of more rapid new-product introductions or faster response to com-
petitors' moves.
An often cited but classic example is American Airlines' Sabre System,
a computerized reservation system which when combined with sophisticated
revenue management software allowed American to offer selected fares com-
parable with those of People Express, an upstart no-frills competitor, without
jeopardizing its higher fare sales base. More recently, Sabre has expanded
its services to allow customer companies to link directly into its system,
make their own reservations, and eventually handle payment of their travel
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SERVICES TECHNOLOGY AND MAIIUFACTUR1NC
13
bills. Sabre, which is reportedly often more profitable than the air travel
operation, is extending its services into telemarketing of products.
In this same vein, insurance companies first began automating their back-
office activities for greater efficiency in the mid-1960s when their industry
was stable and heavily regulated. As expected, better handling of premium
billings and collections brought dramatic productivity gains. Then when
wildly fluctuating interest rates hit the industry in the 1970s the companies
had to alter their products rapidly to attract new premiums and to offset the
effects of customers' borrowing against their policies at lower interest rates.
In such an environment, only companies with flexibly designed back-office
computer and control systems could design or deploy their products quickly
enough within days or weeks to get a competitive edge. Previously, in-
surance companies had brought out new rate books only once every 3 to 5
years. Surviving companies now note that, without effective electronic and
software systems, they could neither have conceived of the variety of new
products needed during this critical period nor could they have explained
and introduced the products to their widespread agent and customer bases.
Again, many smaller insurance companies, which could not afford the huge
costs of sophisticated electronic networks, faltered, sold out, merged, or
concentrated on localized or specialized services outside the interests of larger
companies.
International Implications
Given both their economies of scale and scope, as well as the relatively
low expense of transporting their services internationally, large technologi-
cally sophisticated U.S. services companies such as Citicorp or the dere-
gulated AT&T system (see the Glaser and Davis chapters in this volume)
should enjoy powerful international advantages. But the same is also true
for selected foreign competitors. The cellular telephone case included here
also shows how rapidly overseas competitors can seize and exploit an ad-
vanced U.S. innovation, when regulatory processes react too slowly.
In still another service arena, powerful European and Asian distribution
companies are also proving to have the scale, talent, and management systems
to acquire and upgrade poorly performing U.S. retail networks. For example,
Britain.' s well-automated food retailers boast a hefty 23.4 percent return on
capital employed. J. Sainsbury's (which is electronically automated from
checkout scanning through stock control and employee scheduling) with four
other chain stores accounts for more than half of Britain's grocery sales (The
Economist, 1987b). Now, Sainsbury's (through its acquisition of Shaw's
Supermarkets) and other big British retailers are pushing abroad both in the
United States and the European Economic Community (EEC) (The Econo-
mist, 1987a). Increasingly, technology is making global competition among
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14
JAMES BRIAN QUINN
services giants both possible and essential to success. Few areas seem im
mune.
Segmentation and Responsiveness
As the chapter by Doorley et al. suggests, technology in professional
services although not enhancing "measured productivity" much is en-
abling the management of greater levels of complexity, with higher output
quality. Law firms can in a matter of hours complete more exhaustive back-
ground searches, prepare more intricate contracts, and document resulting
settlements more thoroughly than they previously could in weeks. Computer
models and data base networks have become so powerful in some research
fields that they can identify critical relationships and pose new hypotheses,
not merely help analyze and test data. The Murillo chapter suggests the
power of computer techniques in engineering design of structures. In other
services industries, computer-based techniques are helping to find feasible
structures for complex but as yet unknown proteins, identify potential disease
causes from epidemiological or genetic models, or (as Richard Larson's
chapter demonstrates) solve inordinately complex problems in delivering
public services.
Within companies, the effects of complexity reinforce the strategic effects
of economies of both scale and scope. Companies that can.deliver better and
more varied services without increasing their marginal costs can achieve
competitive advantages through a higher degree of segmentation in their
marketing activities, increasing value added for their customers, while low-
ering their own average operating costs. The Fellowes and Frey chapter
provides an excellent example. But the technologies that make such systems
possible are having their own interesting side effects. They are undermining
established concepts of competition, strategic management, organization, and
economic policymaking at a rate never before envisioned. They have short-
ened transaction times, heightened volatility, and created entirely new forms
of internal organizations, external alliances, and industry competitive struc-
tures in both manufacturing and services.
Services technologies have created a new level of responsiveness to mar-
kets by disinte~ediating (eliminating intermediaries) between customers and
the producers of goods or services. Direct access to financial services markets
has, of course, short-circuited many traditional banker, agent, and broker
relationships; and easy direct ticketing by airlines, hotels, tours, and theaters
has cut out other intermediaries in these services fields. The entire production
process from raw materials to ultimate customer purchase can now be in-
tegrated by electronics systems, without entailing the ownership and control
patterns involved in earlier attempts at "vertical integration." Any level in
the value chain from raw material producer to retailer can drive this process.
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SERVICES TECHNOLOGY Al!iD MANUFACTURING
15
Intermediaries themselves (such as wholesalers) can simultaneously ver-
tically and horizontally integrate their markets by providing a better level of
price, quality, and service than their customers could possibly achieve alone.
For example, McKesson and Super Valu provide their retailing customers
with the benefits of vertical integration (without ownership) by helping them
locate and design their stores, advising them on increased value-added prod-
uct mixes, managing stocks and displays in key departments, processing
medical insurance claims for customers, recycling customer wastes, handling
customers' accounting and credit functions, and researching new uses for,
suppliers' products. Sears owns and controls many suppliers for its branded
lines and provides after-sales services through its own extensive financial,
credit, repair, and insurance networks.
Computerized reservation and product control systems allow airlines, au-
tomobile rental companies, and retailers to analyze their costs and customers'
buying behavior in such detail that they can optimize margins on each type
of demand and meet each competitor's response. Research indicates that the
resulting crazy quilt of prices leads customers to concentrate more on services
provided. This in turn offers attentive services companies greater opportun-
ities to segment their markets with highly personalized responses such as
Domino's Pizza recognizing customers' names, addresses, and preferences
instantly; airlines offering specialized meals, wheelchairs, luggage verifi-
cation, and even counseling for nervous passengers; and banks offering uniquely
tailored products and services to individual clients, depending on their roles
in their particular companies and their personal banking and credit histories.
Such possibilities have led to whole new approaches to designing flexible,
responsive organizations that can delegate authority with "spans of control"
as wide as 200 people and empower and motivate employees at all levels to
innovate and exploit their own creative potentials and the opportunities that
the new technologies allow (Carlzon, 19871.
Services technologies are thus breaking down the traditional boundaries
of nations, industries, and even government versus private functions. With
no element in its value chain immune to structural changes due to services
technologies, each producer must constantly reassess who its true suppliers,
competitors, and customers are and how each could enhance or subvert its
competitive posture. Just as international banks already often find that their
compatriots may be simultaneously competitors, customers, joint venture
partners, and suppliers, other manufacturing and services concerns are en-
tering a new competitive era where substantially increased cross-industry
competition is a fact of life.
The various cases in this volume offer specific and detailed examples of
major innovations that have helped restructure services companies and in-
dustries in the ways described above. The next section of this paper, however,
will focus on another set of innovations not widely recognized but also
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16
JAMES BRIAN QUINN
radically changing the country's basic economic landscape and competitive-
ness the manufactur~ng-services interface.
THE MANUFACTURING-SERVICES INTERFACE
In recent years many have expressed concerns over the decline of U.S.
manufacturing. They fear a U.S. economy dominated by services will mean
low wages, diminished real economic growth, and a society engaged in
menial personal services tasks. These perceptions are incorrect.
Total employment in manufacturing has decreased only marginally from
long-term trends (see Figure 11. Real value added attributable- to manufac-
tur~ng grew steadily until the mid-1980s (see Figure 2~; and U.S. manufac-
turers' percentage of total goods trade (including their overseas production)
has stayed between 20 and 22 percent since the 1960s. Many important U.S.
manufacturing industries (such as aircraft, pharmaceuticals, computers,
chemicals) are strong and viable, although some (such as basic steel, auto-
mobiles, or electronic appliances) have suffered real declines in employment,
output, and competitiveness over the last IS years.
Meanwhile the services sector has grown steadily in its contributions to
U.S. gross national product (GNP) and value added and in 1986 accounted
80
70
60
50
40
30
20
10
o
Services '
/
l l l
.
. ~
-
-
-
Manufacturing
Agric., Min., Constr.
_.. ~ -.
l
1950 1 960
1970 . 1980 1986
FIGURE 1 Employment trends by sector. SOURCE: Bureau
of Economic Analysis, The National Income and Product Ac-
counts of the United States; and Bureau of Labor Statistics,
Establishment Database.
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SERVICES TEClINOLOGY AND MANUFACTURING
1600
1400
In
All 1 200
o
cot
o
In
o
._
=
._
m
1 000
800
600
400
200
Services
~ Manufacturing
- O Agric., Min., Constr.
i,
1950 1960 1970 1980 1986
FIGURE 2 Real value added by sector. SOURCE: Bureau of
Economic Analysis, The National Income and Product Ac-
counts of the United States.
17
for 71 percent of the country's GNP and 75 percent of its employment (see
Table 1~. Far from being a negative development, today's services industries
actually create major markets for consumer goods, lower virtually all man-
ufacturers' costs, provide strong stable markets for capital goods producers,
and enhance overall U.S. competitiveness in world markets. New technol-
ogies in services both have improved real economic growth significantly and
offer manufacturers major new strategic opportunities and potentials for future
growth.
Hypothesizing a presumed conflict of services versus manufacturing is
counterproductive. The services and goods-producing sectors of the economy
are so intertwined that it is inappropriate to consider one as somehow sub-
ordinate or in opposition to the other.
Services Directly Substitute for Manufactures
Far from being inferior economic outputs, services are directly inter-
changeable with manufactures in a wide variety of situations. Few customers
care whether a refrigerator manufacturer implements a particular feature
through a hardware circuit or by internal software. New CAD/CAM software
can substitute for added production or design equipment, and improved trans-
portation or handling services can lower a manufacturer's costs as effectively
as cutting its direct labor or materials inputs. These "services" investments
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18
TABLE 1 U.S. GNP and Employment by Industry, 1986
JAIk1ES BRIAR! QUINN
GNP
Employment
$ billions % of total Millions To of total
Total economy$4,235 108.0
Agnculture, forestry,
fisheries93 1.7
Mining and construction293 5.7
Manufactunng825 19.1
Total goods sector$1,211 29%26.5 25%
Finance, insurance, real
estate$695 6.5
Retail trade408 18.4
Wholesale trade295 5.8
Transportation and public
utilities276 4.0
Communications115 1.3
Other services700 24.9
Total private services$2,489 59%60.8 56%
Government and
government enterprises507
20.6
Total services sector $2,996 71% 81.4 75%
Rest of world and statistical
discrepancy
SOURCE: U.S. Bureau of Economic Analysis; U.S. Bureau of Labor Statistics.
30
improve productivity or add value just like any other new investment in
physical-handling machinery or product features.
The U.S. services sector is a natural and desirable outgrowth of an in-
creasingly productive agricultural and industrial economy. People were able
to buy ever more with what they earned each hour of their working time.
But demands for products were inherently somewhat capped; people could
only consume so many washing machines, sofas, or pounds of food. Con-
sequently the relative utility of services grew apace. Simultaneously, new
technologies also vastly improved performance and opened further markets
in virtually all services industries.
From the manufacturer's viewpoint jet aircraft made long-haul passenger
and freight handling much more efficient and convenient. New containeri-
zation, loading, refrigeration, and handling techniques for volatile liquids,
by making it possible to transport virtually all goods safely and effectively,
vastly extended international trade in manufactures. And electronics, infor-
mation, and communications technologies stimulated new initiatives in vir-
tually all services areas most notably in retailing and wholesale trade,
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SERVICES TECHNOLOGY AND MANUFACTURING
19
engineering design, financial services, communications, and entertainment.
Note that virtually all these advances involve interactions between manufac-
tured products and services.
However, total interactions between services and manufacturing are much
more complex. Figure 3 suggests only some of the principal relationships.
Economic benefits flow both ways between all these activities; the fact of
trade means that each party must benefit from the presence of the other.
Although most of the structure seems self-evident once disclosed, the role
of the "service intermediary" may not be. Not all products can be used by
the ultimate user without the intermediation of a professional who can harness
its more arcane possibilities or control its potential hazards. Specialized
technical representatives or consultants are often needed to introduce or
support new product entries in high-technology fields such as nuclear energy,
computers, or medical care systems. Without these services, market access
would be prohibitively high.
Services Generate Manufacturing Markets
Many have noted that some U.S. services industries are very dependent
on manufacturing; many services companies exist primarily to provide trans-
portation, finance, advertising, repair, distribution, or communications in
support of goods manufactured here. A large number of these services would
still be provided in the United States regardless of where the product was
manufactured, for example, selling a Toyota in this country requires many
of the same U.S.-based services activities as selling a Ford. However, im-
portant design support functions and supplier linkage services might move
overseas if manufacture was not performed here.
Less recognized is the fact that a healthy manufacturing sector is probably
equally dependent on services. First, if 75 percent of all people are employed
in services, clearly they and their enterprises must be the major markets for
most consumer and commercial products. Second, although the lagging data
for U.S. input-output tables and poor definition of sectors do not allow
complete intersectoral sales calculations, some specific studies suggest that
85 percent of the communications and related information technologies equip-
ment sold in the United States in 1985 went to the information industries
(dominantly services) (Roach, 1988), and 70 percent of all installed computer
systems in Great Britain in 1984 were in services (The Economist, 19851.
In addition, services technologies can allow manufacturers to be much
more responsive to fluctuating or individual demand patterns. Proper inte-
gration of these technologies throughout manufacturing and distribution can
significantly increase the number and range of goods it pays to produce in
the United States, rather than overseas. As personal affluence or the sheer
size of markets grows, there is an increasing demand for differentiated,
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SERVICES TECHNOLOGY AND MANUFACTURING
25
services functions. Aggressively managing services activities within manu-
facturing enterprises to both improve quality and lower costs can provide a
major attack point for improving competitiveness. Successful quality pro-
grams start by analyzing quality from the customers' viewpoint and then
emphasize quality considerations in all functions from design through final
shipping and presentation, mostly services activities. Two examples will
suggest how some large companies have approached this complex problem.
· In the automobile industry, designing and introducing a new car line are major
components of overhead costs and significant contributors to the value the customer
perceives in the product. At Ford this design cycle had taken 5 to 6 years and could
cost several billion dollars. In 1980, Ford's chief executive officer Philip Caldwell
and president Donald Petersen decided to undertake a new "simultaneous design"
process for their new upper middle line, which became the Taurus/Sable cars. To
integrate design from research to marketing, they established a core group, called
Team Taurus, which had a full-time representative from all of the critical groups
within Ford product design, component engineering, manufacturing, sales, mar-
keting, purchasing, service, legal, environmental and safety engineering, and cor-
porate headquarters (virtually all "services operations". Instead of moving the
design linearly along these groups to the marketplace with numerous conflicts and
design reworks- Team Taurus involved everyone from suppliers to workers, dis-
tributors, repairmen, customers, and even insurance and media representatives from
the outset. The result: Taurus/Sable's introduction cost some $250 million less than
its design budget, and the cars were exceptionally successful in the marketplace.
Future cars will be designed with the same process in only 3 or 4 years- potentially
saving Ford hundreds of millions of dollars more and ensuring that manufacturing
design is much closer to customer desires.
· Black and Decker (B&D), faced by both U.S. inflation and strong cost com-
petition from overseas manufacturers, decided it had to radically redesign its products
for greater value added and lower cost. It focused on (1) simplifying its product
offering, (2) developing a "family" look for the 122 basic tools (with hundreds of
variations) in its line, (3) standardizing materials and components, and (4) creating
new product features specifically adapting the products to meet worldwide (non-
U.S.) product specifications. In a program that took 7 years to break even, B&D
drove labor costs down in each component to such "tnvial" levels that no competitor
could obtain a meaningful competitive edge by simply having lower labor costs.
Interestingly, however, B&D found that its simplification and automation programs
drove out about $3 of overhead for each $1 of labor saved, and its standardization
programs substantially improved the rapidity, efficiency, and effectiveness of its
future product development capabilities (Lehnerd, 1987~.
The Strategic Planning Institute's Profit Impact of Management Strategy
(PIMS) data base clearly shows that financial performance is directly related
to the perceived quality of a company's goods and services. Not surprisingly,
one of the biggest determinants of perceptions of overall quality is customer
service. As the two examples above illustrate, greater attention to product
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26
JA3IES BRIAN QUINN
design which ultimately shows up as customer service is a significant com-
ponent of improving quality. Using technology more directly, Cadillac has
vastly increased its service ratings by linking its dealers' mechanics with a
corps of 10 engineers who use a computerized data base of engineering
drawings and service bulletins to walk them through difficult repairs so that
a Cadillac gets repaired right the first time (Uttar, 1987, p. 1161. In an effort
to improve the product support so essential to sales of its aircraft engines,
Pratt & Whitney following We dictates of SAS's Jan Carlzon has slashed
layers of bureaucracy and pushed decision making down the chain of com-
mand to the people who actually deal with the customers so they can fix or
replace a part and worry about whether it is covered in the customer's support
contract later (Air Transport World, 19881.
Services Support International Manufacturing Operations
One of the areas where services technologies affect manufacturing most
markedly is in international operations. Telecommunications, air transport,
and improved surface cargo handling technologies have forced virtually all
manufacturers to consider their supply sources, markets, and competition on
a worldwide scale or to lose their competitive position. Although the figures
do not show up in merchandise trade balance statistics, the greatest impact
of U.S. manufacturing technology on world markets is probably through
multinational companies' operations inside host countries. Approximately
one-fifth of the total capital invested in U.S. manufacturing firms is in
facilities outside the United States. And some of the largest continuing fa-
vorable net balance-of-trade accounts for the United States have been the
profits, royalties, and intercorporate sales these multinationals remit to the
United States (see Table 3~.
Effective coordination of these giant enterprises-and many much smaller
companies' international transactions clearly depends on services technol
. an. . .
Ogles ant ettlc1encles.
· IBM, in bringing forth its 360 computer series in 1962-1964, is often credited
TABLE 3 Manufacturing Related Trade Balances ($ Billions)
(category 1970 19751982 19851987a
Royalties and fees, net 2.1 3.84.6 5.36.8
Direct investments, net 2.6 14.418.2 26.635.3
Merchandise, netb 2.6 8.9(36.4) (122.1)(159.2)
aPreliminary figures.
bExcluding military.
SOURCE: Bureau of Economic Analysis, U.S. International Transactions.
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SERVICES TECHNOLOGY AND MANUFACTURING
27
with the first truly simultaneous international design of a product line. Its various
laboratories became permanently linked by telecommunications for daily coordination
of the design process. Ford Motor Company has recognized the huge advantages it
can achieve by designing and engineering different sized platforms for its cars only
once (at specified "centers of excellence") to get maximum economies of scale,
then doing the styling and feature designs for its different markets within its sub-
sidiaries in individual countries. The corporation later coordinates cost comparisons
for various features, sourcing performance, market information, parts inventories,
and customer service activities through its large transborder data network (Business
Week, 1987a).
· Global information systems and data bases dealing with exchange rate fluctua-
tions, transportation alternatives, and sourcing performance have become crucial
competitive weapons in manufacturing. While labor, materials, and plant level over-
head costs tend to drop markedly with offshore manufacture, logistics costs tend to
increase by a factor of about 20 percent and tariffs can become a significant factor.
So important are these costs that before an experienced Japanese automobile man-
ufacturer would begin its joint venture in the United States, it set as its target having
"the most cost efficient inbound-outbound logistics system in the world." Since
most of the other costs of manufacture here and in Japan were essentially fixed,
logistics control technologies became We key strategic variables (Distribution, 1987b).
Recognizing the importance that cross-border data and services flows have
in foreign companies' competitive postures, many host countries are trying
to tax or regulate such activities. Since the real economies of scale multi-
national manufacturing companies most often enjoy are due to their services
capabilities i.e., technology transfer, marketing skills, financial services,
logistics-rather than plant scale economies, such restrictions on data and
services flows are as significant to manufacturers as they are to international
services providers. Worldwide integration of manufacturing operations through
services technologies is essential for producers seeking competitive advantage
in today's world.
Manufacturers Benefit from External Services Innovations
As technology creates new capabilities, economies of scale, or economies
of scope for services, manufacturers will constantly have to reassess when
to produce their own services or buy them "out of house." Many have found
that specialized services companies can handle their accounting, legal, pay-
roll, benefits, maintenance, repair, or even research and design functions
much more effectively than they can "in house." This is one of the factors
contributing to the rapid growth of the business services industry in recent
years-in 1982 business services accounted for $90.7 million of GNP and
employed 3.4 million people; by 1986 it provided $162.8 million of GNP
and 4.9 million jobs (Kutscher, 1988; Tschetter, 19871.
More than this, services companies have become major innovators on their
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JAMES BRIAN QUINN
own. Focused and imaginative technology investments by many business
and professional services providers have greatly improved the quality, range,
and flexibility of their services offerings. Although these services companies
often cannot translate such product improvements into higher margins, man-
ufacturers and other customers benefit directly. Unless manufacturers sys-
tematically and continuously cultivate the innovations services suppliers can
provide, they will miss out on important sources of competitive advantage.
For example:
~ Federal Express has been a leader in the development of package sorting,
handling, and control equipment and techniques. Based upon this expertise, Federal
Express now offers its package tracking and supporting systems as a part of a service
to help producers automate their own shipping docks and package handling activities.
· A freighter waiting at the Suez Canal or at a customs wharf in France will often
have to pay all required fees before it can pass through or unload. As an alternative
to paying an 8-day float on funds cleared through venous correspondent banks and
$10,000 per day of waiting cost for the ship, Citicorp offers a service for instant
transfer of funds to a local (Port Said or Marseilles) correspondent bank as soon as
the fee is known thus saving manufacturing customers unnecessary costs on the
(otherwise) delayed cargo (Davis, 1987, p. 181.
~ Michigan Bell has created innovative new "facilitating" services such as those
which improve communications among the Big Three automakers and their sup-
pliers coordinating hardware and software vendors in developing and exchanging
engineering drawings and specifications between job shops and factories. Although
Michigan Bell started with such large company networking projects, it should be
able to roll out this experience to other areas. It can offer a shared service (with a
standard interface system) providing state of the art design and specification coor-
dination to large and small manufacturers alike (Managing Automation, 1987~.
· Finally, services technologies offer a rich new array of channels through which
manufacturers can reach specialized segments of their markets. Electronic home
shopping and interactive video terminals located in banks, airports, hotels, airplanes,
and shopping malls allow manufacturers to contact whole new groupings of customers
in a psychological situation where they are likely to buy. Similar technologies in
retail showrooms allow customers to see a full array of a manufacturer's product
line when the retailer-for example a shoe or furniture outlet could not carry all
possible sizes and variations of the product.
With services enterprises growing rapidly in scale and technical sophis-
tication, the opportunities are expanding for manufacturers to leverage their
own internal innovation programs by exploiting those of services suppliers,
just as they do those of product vendors. Although 75 percent of a manu-
facturer's costs are in "services" activities, flexible manufacturing systems
(FMS) and computer integrated manufacturing (CIM) are likely to drive
variable costs even lower and hence the percentage of costs represented
by services support and other fixed costs higher. Consequently, there should
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SERVICES TECHNOLOGY AND MANUFACTURING
29
be enhanced incentives for more effective use of services suppliers' inno-
vative capabilities. In fact, EMS and CIM installation themselves are unlikely
to be effective if proper attention is not given to services support arrangements
such as training, cost accounting, personnel practices, organization, com-
munication, and control systems. Because internal groups are likely to be
inexperienced in such matters or biased by old ways of doing things, the
required expertise for such changeovers may often be found only in external
services groups.
MANUFACTURING'S CHANGING STRATEGIC ENVIRONMENT
Perhaps the most important structural change in international manufactur-
ing competition stems from the continuing integration (through electronics)
of the world's financial centers into a single world financial marketplace.
World financial flows have already become largely disconnected from trade
flows.2 Although world trade in goods and services aggregates only $3-4
trillion annually, financial transactions by the Clearing House for Interna-
tional Payments (CHIPS) alone totaled $105 trillion in 1986- and early 1987
transactions were running more than $200 trillion on an annualized basis.
Turnover on the 1986 Eurodollar market also amounted to $75 trillion. Any
of these sums dwarfs world merchandise trade, just as Fedwire's $125 trillion
of 1986 domestic transactions dwarfed the $4 trillion GNP of the United
States. Instead of following trade in goods, money now flows toward the
highest available real interest rates or returns in safer, more stable economic
situations.
Exchange Rates Determine Manufacturing Costs
As a result, exchange rates have fluctuated approximately +50 percent
among major trading partners within a few years, principally because of
fiscal or monetary not trade or management decisions. Comparative costs
for an international competitor are often more a function of exchange rates
than of productivity or competitive managerial decisions. Even skillful Jap-
anese manufacturers have found it difficult to compete when the rising value
of the yen pushes their relative costs up by 48 percent in 18 months against
competitors paying for wages and materials in U.S. dollars. But they appear
to be responding with dramatic productivity increases and transfers of op-
erations offshore (Business Week, 1988a).
As was recently demonstrated, the short-run volatility of securities markets
has amplified enormously because of the capacity of large investor groups
to move rapidly into or out of world securities and funds markets. The stimuli
that disrupt a nation's capital markets and relative cost structures can easily
come from outside sources. Consequently, it has become increasingly dif
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JAMES BRIAN QUINN
ficult for sovereign nations to control their economies in the short run or to
fine tune them through traditional fiscal or monetary interventions. And it
has become impossible for major manufacturers to operate effectively without
global plant location, sourcing, logistics, and financial strategies.
With freer access to world capital markets everywhere, it is becoming
very difficult for a single nation to maintain differentially low capital costs
as a policy as Japan has in recent years and as the United States once did-
in support of aggressive economic development or trade objectives. As capital
costs among nations are leveled by globalized financial markets, countries
such as the United States and Japan with high domestic labor and materials
costs-will be under ever greater pressures to move manufacturing overseas.
Among the few alternatives available is innovation, in both technical and
structural terms, at a rate others cannot match. A key element will be in-
novative utilization of the full potentials of services technologies both inter-
nally and externally. Simply targeting more reductions in direct labor and
materials costs will not be sufficient (Bleeke and Bryan, 19881.
New Power Relationships with Services Groups
The entire power relationship between manufacturing and services groups
is changing profoundly. For example:
· As the number of major airlines (services providers) declined through consol-
idation due to deregulation and the introduction of wide-bodied jets, aircraft man-
ufacturers had to modify their strategies. The number of U.S.-lead customers for a
firm such as Boeing has shrunk to a handful of large "megacarriers," each with a
more powerful bargaining position than before. The military no longer can provide
the "first order" volumes necessary to launch a commercial aircraft. Consequently,
to obtain essential economies of scale, yet satisfy each customer, companies such
as Boeing have invested heavily (more than $800 million) in flexible automation,
allowing them to modify their aircrafts' internal seating, baggage storage, mainte-
nance system, and customer convenience patterns to suit virtually any requirement
their major customers might conceive over the useful life of the aircraft. Boeing is
even proposing to restructure its overall cabin configuration (in its 7J7 aircraft) in
response to the recommendation of SAS's President J. Carlzon that airline seating
patterns would be optimized if the cabin cross section were a horizontal ellipse rather
than a circle or vertical ellipse. The coming deregulation of Europe's airlines will
Only lead to further concentration in the world's airline industry.
~ Even when buyers have not consolidated into large individual units, services
technologies allow them to achieve similar bargaining power. For example, a team
of airline and manufacturer-supplier experts, coordinated by the Air Transport As-
sociation, has created an automated parts procurement system (Spec 2000) that is
expected to save millions of dollars and can be accessed using a personal computer.
Spec 2000 is a computerized compendium of manufacturers' catalogs including more
than a million part numbers and an automated computer-to-computer ordering system.
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SERVICES TECHNOLOGY AND MANUFACTURING
31
Not only does the system allow an airline to get comparative specification and
quotation data, but it also gives information about how vendors meet their delivery
and performance criteria, thus increasing the information leverages of all potential
purchasers (Air Transport World, 1987~. Retailers with electronic point of sale sys-
tems and those that use McKinsey's Direct Product Profitability (DPP) analyses have
also found that they now have the best information and thus increased bargaining
power over their product suppliers. In response, Procter & Gamble has reorganized
itself and changed many of its long-established attitudes and ways of doing business.
· Large retailers, such as Sears (or IKEA), can offer instant distribution for any
manufacturer's consumer product (or furniture) innovations, with powerful presen-
tation and financial support for any products they accept. Thus, overseas producers
have immediate access to U.S. (or European) markets without creating the costly
distribution channels they once had to build. Access to large retail electronics chains
has provided rapid penetration for many Asian "clones" competing with U.S. man-
ufacturers. Along with the capacity of the retail and distribution system to help
manufacturers target and design their products better, such potentials call for much
more attention to carefully developed "downstream alliances" in manufacturers'
strategies.
· Services suppliers' cost leverages have also increased. Many manufacturers find
that their medical care or insurance outlays for employees are higher than their own
profits. Hence, new strategies creating "coalitions" with providers and insurers have
emerged as key elements in cost control.3 Deregulation has created more powerful
transportation companies with intermodal handling capabilities that can increase
shipping efficiencies enormously, but at the cost of much more bargaining power
against manufacturers or other shippers. And large money center banks have the
information, instant capital access, and worldwide connections to manage a com-
pany's financial assets with a knowledge base and leverage few manufacturers can
equal.
Disintermediation Builds New Industries
Disintermediation of service activities through product substitutions offers
powerful new strategic options. All "services" or "goods" are really just
means for providing satisfaction to customers. Thus, the boundary between
services and manufactures is very fluid and varies widely over time. Rec-
ognizing this, manufacturers can greatly extend the scope of their operations,
lower costs, and expand their margins by eliminating or taking over adjacent
services functions sometimes opening up entire new support industries. For
example:
· In the early days of computers, a high priesthood controlled access to huge
machines that ran only in their own special, environmentally controlled temples.
Programmers or others "submitted" punched cards or tapes for processing, often at
inconvenient times determined by the priesthood. By designing their machines and
software to be more "user friendly," manufacturers slowly eliminated the priesthood
and expanded their markets in the process. The success of Apple computers and the
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JAMES BRIAN QUINN
IBM PC was essentially due to service disintermediation, which (oddly enough) later
opened more services and product opportunities through clever use of the computers
and design of software for them.
· "Pennanent press" and crease resistant fabrics, textile and fibers manufacturing
innovations, have significantly restructured the white goods, apparel, and personal
services industries. In the past, those who could afford it sent their tablecloths, bed
linens, and dress clothing (especially men's trousers and shirts) to the laundry, getting
them back neatly ironed in a week or so. Others spent hours tediously ironing in
their own homes. Permanent press and "wash and wear" fabrics shrank the com-
mercial laundry business, increased the attractiveness of home washers, dryers, and
"touch up" irons, and freed domestic workers and homemakers for other tasks. To
fully exploit permanent press possibilities (a services disinterrnediation), new deter-
gents, whiteners, and home laundry equipment designs soon appeared, changing the
nature of competition in those fields as well.
The potentials for such substitutions of products for services abound.
Automated communications systems have eliminated tiers of banking, bro-
kerage, and insurance personnel. Increased "quality" in home appliances
and automobiles has decreased the personal time, cost, and frustrations con-
sumers expend on maintenance and repair. Prepared gourmet foods, con-
venience mixes, and microwave dinners substitute for restaurant sales and
home cooking time. And so on.
CONCLUSIONS: SERVICES INNOVATION
Discussions concerning U.S. competitiveness have tended to overlook two
major areas for innovation and productivity improvement services and the
manufacturing-services interface. Technological changes in services have
radically altered the economy and the strategic environment in ways that
offer significant new opportunities and threats for technologists and investors.
In addition to providing major innovative opportunities in their own right,
services industries have become some of the most important customers,
suppliers, and coalition partners for manufacturing concerns. In these roles,
U.S. services enterprises both are near at hand and are generally among the
most efficient performers in the world. In addition, services technologies
offer a variety of ways for manufacturers to add value or lower costs within
their own operations. This paper has merely attempted to offer a few useful
case vignettes; other cases in this volume will develop some of these in detail.
The United States painfully learned that its goods-producing industries
were vulnerable to challenges from abroad. So too are the services on which
much of the nation's economic wealth depends. It is difficult for even well-
run services establishments to maintain their competitive advantages when
everyone can buy the same hardware and software, connect into the same
networks, and exploit the offerings of suppliers with strong incentives to sell
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SERVICES TECHNOLOGY AND MANUFACTURING
33
their products as quickly and widely as possible throughout the world. It is
becoming ever more important that services companies develop their own
internal technological capacities and strategically leverage these in conjunc-
tion with manufacturing concerns and other services companies.
It will take hard and dedicated work not to dissipate the broad-based lead
that the United States enjoys in services. Seemingly secure markets may be
easy to invade. On the one hand, U.S. policies of deregulation in commu-
nications and financial markets may have given the United States a lead that,
some say, other countries' more regulated sectors will find difficult ever to
close. But those countries are deregulating, too, and there is little room for
complacency. Deregulation also opens domestic U.S. markets to foreign
competition. And many countries and foreign companies have proved that
their skills in managing services enterprises are formidable indeed.
Unfortunately, we daily encounter the same inattention to quality, emphasis
on scale economies rather than customers' concerns, and short-term financial
orientation that earlier injured manufacturing. Too many services companies
have been slow to invest in the new market opportunities and flexible tech-
nologies available to them. They have stayed with their old concepts too
long and have concentrated on cost-cutting efficiencies they can quantify,
rather than on adding to their product value by listening carefully and flexibly
providing the services their customers genuinely want. The cases and con-
cepts in this book are intended to help others avoid these errors and understand
some of the opportunities and complexities of introducing new technologies
in the services and services-manufacturing areas. The strengths of manufac-
turing and services in the United States are intimately intertwined. Increas-
ingly, success in both services and manufacturing will go to those who
understand and successfully combine the new potentials of services and
manufacturing technologies.
ACKNOWLEDGMENTS
The author gratefully acknowledges the important contributions of Dr.
Jordan J. Baruch and Penny C. Paquette in developing this paper, as well
as the generosity of Bankers Trust Company, Bell & Howell Company,
Royal Bank of Canada, Braxton Associates, and Bell Atlanticom Co. in
supporting this research.
NOTES
1. The selected business services category includes travel, passenger fares, and other trans-
portation areas where large negative balances exist today as well as fees and royalties
where positive balances have continued to grow and other private services where balances
have changed little over the S-year period from 1982 to 1987. Statistics are taken from the
U.S. International Transactions series published in Survey of Current Business.
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JAMES BRIAN QUINN
2. S. Bell and B. Kettell estimate that 95 percent of the daily volume in foreign exchange
markets in 1983 was not direct commercial business but trading between the foreign ex-
change dealers of the world's international banks (Foreign Exchange Handbook, Quorum
Books, Westport, Conn., 1983, p. 3).
3. At the national level, The Washington Business Group on Health has been attempting to
coordinate provider, payer, and government agency groups that need to cooperate on this
issue and started publishing Business and Health to bring the views of both private and
public authorities to the fore.
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Representative terms from entire chapter:
services technology
