value insights

Service Industry Efficiency- Valutrics

The information economy is driving the redefinition of work processes. We can look back   at history to get an idea about why. In the early days of industrialization, a new widely available power source—electricity— replaced manual labor or steam power in factory environments. But did management immediately employ the most optimal approaches to take advantage of this new power source? No. Management simply retrofitted the new power source into existing processes. Executives did not launch into a business process reengineering (BPR) exercise to rethink the workflows prior to implementation.
Service industry efficiency has caused transaction costs to come down a great deal. Services used to be wrapped up inside organizations so that it was hard find them in discrete bundles that could be measured. They have become much more visible in the last few decades to the benefit of entrepreneurs who always keep a lookout for good ideas. Market entrants can seize on these opportunities to form new businesses. Service outsourcing is a new growth industry. Everyday, entrepreneurs try to peel off functions that large organizations perform for themselves. These enterprising capitalists make a market in the form of outsourcing, where no market existed before.
This means that the delineation between market on the one hand, and organizational function on the other, will become very hard to map as information or service infuses every aspect of commercial interaction. The market now fulfills the same role as internal managers in many cases. Both act to synthesize information in order to ensure its accuracy. Both can increase overall productivity. Both can stimulate commerce.
Why are the rules for transaction costs different in the new economy?
Simple. Because many professions associated with service industries are transaction costs. This would cover almost every occupational category except those associated with the actual process of direct production or transportation.
Transaction-cost-oriented functions include those performed by lawyers, financial institutions, entrepreneurs, managers, clerks, police, intermediaries, federal, state, and local government. The list gets longer all the time as manufacturing becomes more efficient and sheds workers every day worldwide. New jobs will have to come from somewhere else. Where? From the service sector.

Service occupations will increase as the role of information grows in the new economy. Let us look at a real life example. The job of many salespeople is to disseminate information. Transaction costs constitute the bulk of services performed by both the public as well as private sectors.
This starts to explain their importance. Strategic management too often fails to recognize the impact of transaction costs on organization. The subject incorporates economics, management, and organizational theory in a useful way that will forever alter the rules of governance.
Transaction cost drives discussion about the following items in a more systematic manner:
• Vertical integration
• Outsourcing
• Diversification
• Joint Ventures
• Divestitures

When discussions about the scope of the enterprise or its structure get underway, management should focus on how to create effective inter- company linkages, not engage in vague discussions about synergies.   The value added (or taken away) through these linkages will become the focus of better measurement and they are easier to get your arms around than synergies. To do this, analysis will require a good understanding of the implications of transaction costs. Sound decision-making will depend on smoother interorganizational interfaces so that information can be traded more easily. Successful organizational design will reflect the realities of the new economy by capturing measurements oriented toward transaction costs.

Why do transaction costs not rate much attention yet? Traditional accounting functions combined with a preoccupation of financial treatments deserve much of the blame for this. What gets measured gets recognized.
Of course, transaction costs generate questions about the structure of organization where the boundaries should be drawn even if they do not receive systematic measurement yet. These represent important issues for management. What sort of things cause transaction costs to change? Several factors affect governance structures:
• Rate of growth of demand
• Elasticity of demand
• Technology
• Production techniques
• Complexity of a product, expected life
• Social cohesion
• Cost to borrow
• Degree of development of the stock market
The cost of a transaction on the inside, relative to the cost of one in the marketplace goes up or down as changes occur in one or more of the above areas. New technology introduced to the market often requires   outside expertise to implement, so outsourcing will be more expensive at that stage. When ERP first hit the market, expertise to implement the software was scarce and expensive. New technology developed on the inside can be managed better in-house because that is where the proprietary expertise resides. Outsourcing from a supplier will make sense only if cost is a secondary consideration. Typically this occurs because a new technology is only available from someone else and cannot realistically be developed in-house on a competitive cost basis.

Management Forecasting
Forecasting must be considered one of the key tools of good management . It provides the ability to think ahead. Otherwise competitors will see the future first to claim it for themselves.
The problem is that accurate forecasting constitutes a difficult art. Competent organizational management requires that you think multiple steps ahead. Then you must consider multiple scenarios. The most probable scenario should be laid out. Then another one, and so on and so forth until management identifies many potential futures. Competitive responses along with second-order effects must also be considered. This facet of scenario planning is a variant of game theory. The reactions of others figures into the analysis. Such an approach offers dual advantages. It appears opaque to competitors. It also does not require a great deal of complexity.
No one can say for sure what will happen in the future. Forecasts do not need to suggest that kind of certainty. The forecasting exercise serves to enable the organization to be prepared for a number of possible futures.

This helps management allow for unexpected situations that might not otherwise receive serious consideration.
Robust forecasting as well as scenario planning should include sufficient use of if-then analysis. You might be surprised to learn how much complexity can be generated from multiple iterations that start with simple programs.18We should try to understand the nature of these simple rules first, because they can weave very intricate fabrics. We can always look for more complex explanations later.
Lengthy iteration remains far too underutilized as a management tool.
The technique requires that you run extended scenarios over and over again. Each time you run it with somewhat different assumptions. While unremarkable at the outset, the final output can provide unexpected insight when run at length.
Instead, managers tend to rely too much on deduction or fundamental insight. These wicked brainstorms might perhaps result in the dramatic transformation of business models or entire industries. Often they disintegrate under scrutiny. Still, adherents abound. The mainstay of solid management technique lies elsewhere.

The best organizational strategies do not rely on staggering complexity.
They do depend on well-thought out, well-executed strategies. This basic fact alone gives other organizations trouble when they try to compete head-on.
Most people fall into a rut when they try to look ahead into the future.
The average manager does not make use of more than a few years worth of history. It is easier to remember. While secular (long-term) trends may be apparent in many ways, the near-term picture gets a whole lot harder to predict. The road to the future cuts and weaves like a bad driver.
Let us use economic growth as an example. It remains pretty steady over time-on average. Yet the cycles do not confirm to any consistent pattern from day to day or year to year. Even decade to decade.

Investment in dotcom companies created billionaires overnight in the late 1990s. The trend seemed to extend as far as the eye could see. In the year 2000, forecasts of fiber optic shortages and exponential Internet growth harkened back to events that kicked off not much earlier than 1995, with the public offering of Netscape. People can get very optimistic for a while only to then get just as pessimistic. So the route to the future will meander. It will not be a straight line.
Probabilities as well as expected outcomes for individuals or organizations also need to be better understood. Take the risk/regret tradeoff.  Were the downsides associated with Bhopal, Chernobyl, Challenger, Exxon Valdez, SARS, Barings, Long Term Capital Management, Enron, WorldCom, Columbia, and so on considered to an adequate degree? The periodic regularity of such events bears out that organizations (governments as well) do not factor in enough risk to their plans. The risk associated with a strategy or decision cannot be assessed if the worst-case scenario does not get plugged into the analysis. Mr. Wizard cannot wave a wand to get you out if the worst cases become a reality and you do not have an action plan.

Organizations also struggle to truly understand cause and effect. This holds true in particular, for second order effects. A policy change at one end of the organization will cascade down and throughout the system. Senior management sets itself up for failure when it makes command decisions without consultation or consensus. Executives must understand the issues at hand in a multilayered fashion. Otherwise they set themselves up for trouble. The law of unintended consequences often comes up in the context of government activity. It also holds for business organizations and nonprofits. Senior management still too often tends to make broad pronouncements without examining second or third order effects.

The Transition to a Service Economy
The transition to a service economy will be marked by the following realities:
• Componentization of organizations will enable greater collaboration, increased specialization, modularity, and higher efficiency.
• Organizations will develop better service process measurements and crisp points of interface inside their boundaries as well as across them.
• Roughly Right measures of meaningful outputs will be employed— even if early information is imperfect—rather than a dependence on false precision and irrelevant measures.
• Improved, more robust forecasting that incorporates a variety of well- developed scenarios will hedge against the inherent difficulty in predicting the future.
• Greater rigor will be required of executive judgment based on a thoughtful understanding of the issues at hand and an unflinching willingness to acknowledge hard realities.
• Increased accountability of senior managers, executives, and board members for long-term, sustainable performance of the organization will also be required. Greater organizational transparency will help ensure that no more Enrons will be allowed.
• Dysfunctional behaviors at all levels of organization, such as information hoarding and empire building will be exposed for the snake oil they are. Management will be focused on outputs, process interfaces, and clear rules of engagement.
• Management will come to terms with the inseparability of people, services, information/knowledge, and transaction costs.
• Structured, systematic approaches that make full use of information will be the price of admission to the management ranks in medium and large organizations.
• All managers will have to be well-versed with information technology, even those outside of traditional IT departments.
• Markets and outsourcing will impose a steady erosion of regulatory burdens as well as internal monopolies that now cause organizations to operate in an inefficient and uncompetitive manner.

In the end, organizational efficiency will have to compare itself to the market. The charter for all management will be to challenge itself as well as the organization against the discipline of the market at all levels, in all areas, with regard to all functions. The organization cannot afford submarket performance anywhere, if a chain is as strong as its weakest link. Those classified as overhead will come under particular scrutiny. Service functions will be compelled to become more efficient. This will be a growth industry in the new economy.

This means that manufacturing will not be the engine of job growth in the future. It will remain important to society for its outputs just as agriculture has. The next phase of economic development in the leading economies will be focused on people, service, information, and transaction costs. These components will take many forms. They may serve as an input to manufacturing products. They can be products in their own right. They may fuel the growth of nascent industries that have information-laden components like biotechnology. Less obvious, will be the service industries that drive the manufacture of computers, paper, printers, CDs, etc.

The information, service, and intellectual property components provide increased proportions of the value. So it remains essential that managers understand this transition. Effective management of services must ensure that multifaceted plans, combined with consequential measurement mechanisms, remain integral to the refinement of these abstract outputs. The ser- vice economy cannot be managed like the manufacturing dominated economy. More sophisticated metrics will be the price of admission.
Management will struggle with these issues. Yet they will be overcome.
The apt analogy continues to be the efforts by competent managers in the first half of the twentieth century. They reconciled the implications of unprecedented scale that came with mass industrialization. Service industry managers will reconcile the fungible nature of information.
The process is underway even now. Insightful leaders realize that the disciplined management of service outputs will determine organizational performance.