competitive advantage of business

7/28/2019 Competitive Advantage of Business

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The Competitive Advantage of BusinessService Firms: A Matched Pairs Analysis othe Relationship Between Generic Strategyand Performance

p . N. O ' F A R R E L L , D. M. H I T C H E N SA N D L . A . R . M O F F A T

This article reviews the literature on sources of competitiveadvantage in husiness services with an emphasis upon the rote ofreputation as a means o f differentiation and then co nsiders the rc-lalionship between generic strategy and performance. Matchedsamples of business service firms in Scotland and the South Eastof England are classified into Porter's generic strategy groupsand tests are carried out for differences inperformance betweenthe groups derived.

Until quite recently research has not been under taken on differencesstra tegic phenomena between the manufacturing and service sectorthere has been a tendency to generalise findings from the manufacturisector across all industries. Yet there are important strategic and opeational differences between business service and traditional produfirms. Our principal concern in this article is with btisiness servicewhich may be defined as those intermediate demand functions that sevice as inputs into the production of goods or of other servic(increasing their utility or value) and tha t , as such, are perhaps mocorrectly characterised as indirect elements of the production procei.e., services such as product design, advertising, marketing, managment consultancy, graphic design, market research , accotintancy, andon .In the following section we shall briefly review the l i terature osoutccs of competitive advantage in business service companies emphsising, where relevant, differences between such firms an


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THB ADVANTAGE OF BUSINESS SERVICE FIRMS 41manufacturers. We then consider the literature on generic strategy andperformance and, in particular, focus attention upon Porter's fourgeneric strategies. We report the results of the empirical analysis whichinvolves testing, within a matched pairs framework, the relationship be-tween generic strategy and various performance measures for a sampleof 41 business service firms inScotland matched with 42 similar com-panies in the South East of England.SOURCES OF COMPETITIVE ADVANTAGE IN BUSINESSSERVICES ECONOMIES OF SCALE

Services in general, andbusiness services in particular, present lessscope for achieving economies of scale than in manufacturing, althoughsignificant economies may be realised in other types of services such asairlines and multiple fast food outlets. To the extent that scale econo-mies are important in business service organisations, they aremorelikely to be realised at company level rather than at the operating unit(office) level. For example, advertising is a scale economy that servicecompanies can exploit as an entry barrier to m aintain m arket share oncethe firm achieves a size that makes regional and national advertisingeconomically feasible. Similarly, organisations which operate a networkof offices within the UK and abroad can realise scale economies at com-pany level in recruiting and training staff (by creating central trainingschools and developing standardised training manuals). The multi-officefirm can also spread the cost of support activities, such as accoun ting,over its many offices. It can afford tosystematise the service deliveryprocess and introduce more specialised technology. Scale economy andthe task specialisation that accompanies it permits professionals to gainsignificant advantages by specialising. Specialisation also helps to createimage (reputation) in the market. A client rents the reputation of, forexample, a major management consultancy firm to lend credibility.Since the consultancy firm may rent Its reputation frequently, there areeconomies of specialisation realised by the supplier. Haywood-Farmerand Nollet [1985: 173] also assert that scale economies can make it easierto maintain an appropriate level of quality. Our evidence contradictsthis. At the office level many business service firms reported that prob-lems ofmaintaining quality are exacerbated in large operating units.Economies of scale are amajor factor influencing the process of con-


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4 2 I H E S E R V I C E I N D U S I R I E S J O U R N AMarket Research Society's Organisation Book. 83 per cent employ 1peo ple o r fewer, 12 per cent em ploy betw een 13 and 30, and only 5 pcent have a payroll of 31 or more employees [Bryson el al., 1990: 36-7During the last decade the process of concentration has intensified, witnessed by the emergence of very large firms in accountancy anmanagement consultancy, sui-veying and advertising; much of thgrowth has occurred throug h merg ers and acqu isit ions. Th e evidence fscale econo my effects in business services is m eag re, in part beca use thissue has seldom been thoroughly investigated. The benefits of icreasing size in business service firms may be illusory: there is scaevidence of a relationship between scale and profitability; but there ias expected, a positive association between growth and profitabili[Doorley etal., I988J. However, professional business services have dificulty in maintaining higher than average growth rates over time and gaining significantly in relative market share [Doorley ei al.. 1988: ISEconomies of ScopeWhen the costs of providing the services of a sharable input to two more production hnes or services are sub-additive, that is, less than ttotal costs of providing these services for each p rod uctio n line or serviseparately, the multi-service cost function exhibits economies of sco[Panzar and W illig, 1981: 26 8-7 2|. Th ree major types of scope econmies may be exploited by the service firms. First, it may share physicassets such as an office, IT, or its reputation or brand names across dferent services and markets. The American Express 'blue box" logo, Fexa m ple, gives bra nd acceptability to financial plann ing p rog ram m etravel agencies, travel management services, banking and credit facities, all derived from the global brand dominance of its charge card antravel cheq ues. A second im portan t source of scope eeonom ies is sharexternal relations: with customers, suppliers, distr ibutors and other isti tutions. The relationship with customers based upon reputation atrust is a priceless asset that can be built upon by offering new servic[Edvinsson and R ich ard son , 1989: 37). Also a firm may m arket a ranof services through the same distribution channel. Finally, shared learing - such as the pooling of know ledge dev elop ed in different m ark etsis the third im portan t co m pon ent of scope econo m ies. The f irm may alrealise economies of geographic scope in activities such as marketinbilling and logistics from having several units in a particular regi


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THE ADV ANTA GE OF BUSINESS SERVICE FIRMS 43also necessary before such economies result in any competitive advan-tage.Some firms attempt to take advantages of economies of scope, as inthe case of the major accountancy firms, by cross-seUing other servicessuch as consulting, through leveraging strong relationships with existingclients. Although these may seem logical strategies from the market per-spective, many such attempts fail. Service delivery systems and theprevailing culture may become confused between the various businessesso that, ultimately, companies provide poor consultancy services whilealso lowering the quality of their own original core business [Norman,1984: 98]. Hence , failure may be due to both limited (if any) scale effectsand the difficulties of actually realising seope economies by capturingsynergies qf ross multiple activities.Proprietary TechnologyCertain proprietary-based technologies have been developed by servicebusinesses; the Boston Consulting Group has marketed several proprie-tary technologies around its experience curve concept, including m arketsegmentation and strategic portfolio analysis; PIMs and Associates in-troduced their unique database of companies; and certain marketresearch firms have developed various proprietary technologies such aselectronic scanner equipment computer-aided telephone interviewingand lap-top computers for personal interviewing. The substantial costsof investing in electronic data-capture equipment can only be affordedby the larger market research companies, so creating a capital barrier toentry at least in the short term and, therefore, a source of competitiveadvantage.Service DifferentiationCompetitive positions may be easier to sustain in services than in manu-facturing. Services provide intangible outputs which are more difficult toevaluate. Established firms have brand identification, reputation andpersona! customer-client relationships which stem from past advertising,word-of-mouth recommendation, previous good service, or first-moveradvantage. These are socially complex phenomena which are typicallymore diffieult to imitate than product differences. Such differentiationcreates a barrier by forcing entrants to spend heavily to overcome exist-ing loyalties [Porter, 1980]. Best practice business service organisations


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4 4 r H E S E R V I C E I N D U S l R l h S . l O U R N Awell in excess of the additional marginal cost of supplying the service increment. Differentiation primarily affects the revenue side of the nprofit equation, but may also influence the cost side as the firm may icur additional costs in order to differentiate. Differentiation by qualiinsulates a business from competitive rivalry by creating customloyalty, lowering customer sensitivity to price, and protecting the busness from competitive forces that reduce price-cost margins.Reputation as a Source of Differentiation

Who steals my purse steals trash; 'tis something- nothing:Twas mine, 'tis his. and has been slave to thousands;But he that filches from me my good nameRobs me of that which not enriches him.And makes me poor indeed, lago in Othel

Many firms manage to build a quality reputation and to extract an ecnomic rent for that reputation which is apparently impervious io neentrants. In Scotland, for example, our empirical evidence shows ththe average charge out rate for senior consultants in the branch oflieof the major management consultancy firms is 1,100 per day. wherefor indigenous Scottish consultancies the equivalent rate is 500 pday.' If adopting a quality position was an easy route to high profits, nfirms would be expected to enter the quality end of the m arket aerode charges and profits down to normal levels. Why does this noccur? First, creating quality in services or products and delivering itdifficult [O'Farrell and Hitchens, 1989 and I99O[. Second, even if a neentrant can aehieve high quality, it faces problems in persuadicustomers that this quahty matches that of incumbents | Davis. 1951_75]. Buyer uncertainty is a significant transaction eost in services dto information asymmetries in buyer-seller relationships. High-qualitems with low-quality images will incur the eosts of high-quality produers but reap only the returns of low-quality producers jDavis, 1990: bThird, the intangible nature of business services and their credenquality (characteristics whieh the customer may find difficult to evalueven after consumption) reinforces the importance ol" reputation acompetitive criterion. So the established reputation of some suppli


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THB ADV ANTA GE OF BUSINESS SERVICE FIRMS 45such as Scotland is segmented: the indigenous consultancies service pre-dominantly small and medium-sized clients, while the large consultantssell to major corporations. Hence there is little or no competition be-tween them.Furthermore, reputation is difficult to imitate. Many service com-panies have developed brand identification similar to Coke, Xerox orGuinness. Numerous retailers, insurance companies, banks, universi-ties, restaurant chains and hotels enjoy exceptional brand identity.Within the context of business serviees, many accounting, consulting,advertising, design and law firms attain distinctive and valuable brandimages which are largely founded upon building a reputation for thequality of service provided. For most business services, therefore, it isthe customer's perception of the organisation whieh is the most import-ant type of branding available. Reputation is often referred to as thegoodwill value of the firm 's name or loyal customer patronage. The ideaof reputation makes sense only in an imperfect information world [Sha-piro, 1983: 659]. Buyers face a complex and costly task in determiningthe attributes of services before purchase due to information asym-metries in buyer-seller relationships. Where information asymmetriesexist between buyers and sellers, high- and low-quality services andgoods can co-exist in the market place [Akerlof, 1970: 488-500]. This co-existence requires buyers, ex ante, to determine the quality of servicesthey buy and this is an inherently problematic and costly task. Problemsresulting from incomplete or asymmetric information may be classifiedas either moral hazard or adverse selection problems [Nayyar, 1990:514]. Moral hazard refers to difficulties associated with the buyer's in-ability to observe actions taken by the seller: it is important for thebuyer of services to evaluate whether the seller's actions were properand adequate. Adverse selection may arise when the buyer is unable toobserve either the seller's characteristics or the contingencies underwhieh the seller operates.

A firm has a good reputation if consumers believe its products/services to be of high quality. Since service attributes cannot beobserved prior to purchase, consumers use the perceived quality ofservices produced by the firm in the past as an indicator of present orfuture quality. In such cases a firm's decision to produce high-qualityservices is a dynamic one: the benefits of doing so accrue in the futurevia the effect of building up a reputation [Shapiro, 1983: 659]. There-


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4 6 T H E S E R V I C E I N D U S l R I E S J O U R N Aof the market must initially invest in building a reputation via the prduction of quality services. During this investment period a seller museil his service at less than cost because he cannot eommand those pric(and economic rents) associated with high-quality items until his reputtion is established. Even if a new entrant to a quality segment cachieve high quahty, it faces problems in persuading customers that quality matches that of incumbents [Davis, 1990].

The premiums that reputable firms earn serve as a crucial role in iducing such sellers to maintain their reputations. Without premiums fhigh-quality items, sellers would find that a fiy-by-night strategy qua hty reductio n would be profit m aximising [Sh apiro , 1983: 660]. This bee aus e in ma rke ts with re pu tatio ns sellers can always increase profin the short run by reducing the quality of their services: quality rduction will yield immediate cost savings, while the adverse effect reputation will arise only in the longer run. A firm will find that it is nin its interests to behave opportunistically if it has a stock of reputaticapita! ^goodwill') built up, on which it is earning a return [Klein aLeffler, 1981: 6I5 -41 [. Klein and Leffler [1981] ob se rve d tha t firms prducing high-quality items or serviees must earn an economic rent prevent them from being tempted to reduce quality. The opportunieost of earning profits through quality reductions must be included the price of high-quality serviees. This price premium ean be vieweither as a return to reputation or as an incentive payment to induquahty maintenance. Furthermore, maintaining a reputation for qualresults in fewer customers becoming dissatisfied and leaving, and creases the probability that present customers will provide positiwo rd-of-mo uth advertising [R og erso n, 1983: 508-16]. Th ere for e, incompetitive market high prices may act as signals of high quality [Shpiro, 1983].

The reputation developed by a business service firm may be umbrella concept manifest at the level of the eorporation and, thefore, any service supplied is associated with the corporate reputatioThe Big-Six auditing and consultancy firms have reputations of ttype. Alternatively a reputation may be created for a specialised type service provision: the Boston Consuhing Group concentrate upstrategy consultancy while Bain and Co. is a strategy specialist with implementation focus. At another level, a reputation may be speeifiean individual within a service organisation, such as a key creative dire


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THE ADVANTAGE OF BUSINESS SERVICE FIRMS 47Reputation performs asan implicit contract and is likely toexhibitcharacteristics of a public good [Nayyar, 1990: 516]. Once acquired, afirm may rent its reputation repeatedly in the context of other servicesor markets. However, lapses in quality in these other services could re-flect poorly on the original core service and destroy the reputation builtup. Nayyar [1990] has argued that a firm that diversifies into services thatits existing customers may buy from it could create a source of com-petitive advantage by exploiting the reduction in informationasymmetry. This assumes that customers of services will economise oninformation acquisition costs by transferring reputation effects to othergoods or services offered by a firm [Nayyar, 1990]. However, there are

limits to the transferability of reputation effects that constrain the diver-sification opportunities for a service firm. Potential buyers must believethat the expected quality will be delivered in the new service, as in theprovision of management consultancy serviees by accountancyfirms.Bycontrast, potential customers may not believe that an accountancy firmeould also run a travel firm. Hence, the limits to the transferability ofreputation implies that it should be confined to related diversificationbased upon some interrelationships between the services.If a business service firm has a reputation for competing on price atlower levels of quality, it is difficult to move to a high-quality positionbecause of its entrenched reputation in the m arket place. The additionaltraining and scarce resources (new staff) needed to produce quality andthe marketing expertise required tocommunicate it to customers maynot be reflected in the price of those scarce inputs which could berationed so the cost of moving to a quality position may be higher than itappears from examining what is spent byquality companies [Davis,

1990: 65].Companies competing in the same market segment may differentiatealong a variety of different dimensions. In strategic management con-sultancy, for exam ple, some firms differentiate themselves on content -that is the formulation of strategy, while others emphasise im-plementation. A further dimension along which strategy firms havedifferentiated themselves is whether they are generalists (e .g.. C oopersand Lybrand, Deloitte) or specialists in strategy only (e.g ., Boston Con-sulting Group, PIMS, Bain &Co.). Hence, the different means toaehieve differentiation creates opportunities in themarket for small


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4 8 I H E S E R V I C E I N D U S l K i E S J O U R N Afocus differentiation strategy which might involve a narrow servicoffering - qualitative market research only or a narrow market focubusiness to business only or a sectoral specialisation, or both. A key fator in successfully competing against the large consultancies and earninsimilar rents is their ability to persuade the customer that their deliverequahty is as good if not superior to that of larger firms.PricingThe need to maintain a reputation or image for quality ol service creatpricing problems. The pricing of services is a nebulous area. Most busness service firms follow flexible pricing policies depending upon thfirm's p ercep tion of its m ark et segm ent, its com petitive po sition , anthe size of its clients; there is a tendency to charge what the market wibear rather than use eost-plus pricing in part because it is diffieult to caculate costs where more than one service is being offered. Other typeof service - notably airlines, insurance, banks and hotels - do not necesarily ado pt flexible pricing policies. A lso , within so m e business servic- executive search consultancy, for example - fees are based on a fomula which uses the re m un erat ion to be paid to the person selected asbasis to set fees. It is almost impossible to draw accurate priee-qualitcomparisons in business services and using price cuts as a means to gaicompetitive advantage carries the danger of creating a bad-qualitimage that is counter to that necessary for a professional operation. It easier to sell a recommendation for which the customer has paid a significant sum than one where the fee was low. Corporations expect to pasubstantial rates for high perceived quality and price cutting will seldombe successful in such relatively price-insensitive market segments whecompetition is more likely to be based upon factors such as reputatioproblem solving eapability, and so on.Life Cycle, Experience, and Market Share Effects upon Perform anceCertain determinants of performance in product markets, such as prduct life cycle, experience curve and market share effects, have reduceusefulness when applied to services [Carman and Langeard. 1980: llConsumer goods manufacturers use the life-cycle concept balancing diferent products by stage of life cycle, a process which is not helpful the service firm. Most of the latter cannot achieve the synergies necesary in combining delivery systems for more than one eore servic


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THE ADVANTAGE OE BUSINESS SERVICE EIRMS 49maintenance at larger size. Thus, high market share, even if It can beachieved with all the problems of deterring entry, may be a mixed bless-ing. The effect of learning and experience on total unit cost has seldombeen demonstrated in a service context. Most service organisationsprobably enjoy some economies from learning both in the operation of asingle facility and the development of multi-site facilities [Sasser et al.,1978: 556].Network EffectsAnother potential source of competitive advantage is network effects.There is a need to distinguish between scale effects and lower costscaused directly by the network organisation, as in the case ofMcDo-nald's, and those situations in which some value accrues to othermembers of the network when anew m ember is added. For exam ple, anew international office may make it easier through extension of theoffice network for other offiees to acquire large multinational clients in-terested in globalisation. Such international networks may be composedof independent firms in several countries or of a number of businessunits under the control of one company. T herefore, large-scale networkeffects are a source of positive externalities, more important in servicesthan in manufacturing, since additional offices increase attractiveness tothe customer. Having examined the literature on sources of com petitiveadvantage in business services and the differences between these andthose occurring in manufacturing firms, we now discuss theories ofgeneric business strategy in order to derive hypotheses for the empiricalanalysis.Generic Strategy and Competitive PerformanceThere is a general consensus ondistinguishing between the cognitiveaspects of strategy (formulation) and the action component (im-plementation), although this does not necessarily imply that strategy isdeveloped consciously [Snow and Hambieh, 1980]. It may frequentlyemerge unintentionally. The field of business strategy has shown anoticeable shift away from an atomistic view, in which each firm is con-sidered unique towards a perspective that recognises communalitiesamong firms [Dess and D avis, 1984: 468]. Thus, strategic groups providean intermediate frame of reference between viewing the industry as a


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50 THE SERVICE INDUSTRIES JOtJRNA

framework is academically widely accepted and has been shown by Deand Davis [1984] tobe internally consistent.The generic strategies of Porter [1980, 1985] and those of Hofer aSchendel [1978] are based on the underlying notion of maximising efciency rents of the resources available to the firm. Porter [19K0, 198argues that there are two basic types of competit ive advantage: lowcosts and differentiation. Lower cost, although not neglecting qualiservice and other areas, emphasises the ability of the firm to design, prduce and sell a standardised product or service more efficiently thancompetitors with an emphasis upon reaping cost advantages trom asources. Differentiation, conversely, is the ability to provide unique asuperior value to the buyer in terms of the service (product) itself (idesign, quality) , marketing approach, delivery system, or after-saservice. Therefore, it permits a firm to c om m a nd a premium pricwhich leads to sup erior p rofitability prov ided a differentiator 's cost potion is not so far above that of competi tors so as to offset its pripremium.

The other important variable in positioning is competi t ive scopethe breadth of the firm's target within its industry. Competitive scopeimportant because industries are segmented and serving different sements requires different capabilities and strategies. Included in business scope decisions are those involving: (i) the range of market sements targeted; (ii) the number and type of services/products offered the market segments selected; and (ii i) the geographical parameters the service-market strategy. Firms in the same industry can choose a dferent competitive focus, since the notionof positioning is used in bothnarrow and broad sense. In its narrow sense, positioning is eoncernwith wh ere a firm locates its produ ct relative to its com peti tors in aparcular market: a Lada is positioned differently from a Mercedes Bcnthe News of the World is po sitio ne d differently from t he Observer [Croshaw et al., 1990: I]. In its broad sense, positioning relates to a firmoverall approach to competing, to its strategy taken as a whole: Fordposition ed differently from BM W ; Marks and Spe ncer is positioned dferently from C& A. Porter combined the concepts of eost leadershdifferentiation and focus (the breadth of scope) to give a typologyfour generic strategies: cost leadership, cost focus, differentiation anfocused differentiation. Therefore, firms with anarrow breadth or sco-concentra t ing, for example , upon one market segment , such as fin


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THE ADVANTAGE OE BUSINESS SERVICE FIRMS 51

'the worst strategic error is to be stuck in the middle or to try simulta-neously to pursue all strategies. This is a recipe for strategic mediocrityand below-average performance'. We shall test this assertion using thesample of business serviee firms.Cronshaw et al. [1990: 2] have argued that there are at least three pos-sible interpretations of the 'stuck in the middle' hypothesis dependingupon whether positioning is to be interpreted narrowly or broadly, and,if a broad view is adopted, whether it is to be taken descriptively or pre-scriptively. It is clear that Porter intended his taxonomy to relate to abroad concept of positioning which would encompass all aspects of acompany's strategy and that is the principal focus of this analysis. Thetwo versions of the 'stuck in the middle' hypothesis relevant to abroadpositioning specified by Cronshaw et al. [1990: 8] are:1. It is important to establish strategic clarity, and companies withmultiple strategic objectives are generally less successful than thosewith a single goal. In particula r, it is necessary to choose between theobjectives of cost reduction and product differentiation.2. Companies which do not establish lower costs or differentiated pro-ducts rarely succeed.

Hence, the first version suggests that it is unwise to attempt both costreduction and differentiation, while the second implies that firms are un-likely to prosper if they do not succeed in at least one . Ideally, to test thefirst version would require an analysis of companies which have per-formed both unitary and multiple goals; data does not permit us toclearly differentiate such firms. Regarding version 2. our sample con-tains too few firms competing on the basis of lower costs to test thisversion.Porter [1985: 17] argued that cost leadership and differentiation repre-sent opposite ends of a eontinuum and that each strategy is a'fundamentally different approach to creating and sustaining com-petitive advantage', although he eoneeded that it is difficult, though notimpossible, to beboth lower cost and differentiated relative tocom-petitors. Each type of generic strategy is some combination of cost,differentiation and scale. Successful differentiation does not necessarilypreclude abusiness from having a low-cost position. A combination ofcost and differentiation strategies may be eftective in certain conditions.The real underlying dimension according to Jones and Butler [1988: 203]is cost (low to high) not low cost versus differentiation. Thus the Porter


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52 THE SERVICE INDUSTRIES JOURNATherefore, our approaeh has been to partition the firms into the genecategories while recognising that these are differences of degree raththan of kind; categorising business strategy into a l imited numbertypes necessarily involves simplification.A critical aspect of management ' s task is to match organisationcompetences with the opportunities and risk created by environmenchange in ways that will be both effective (to do the right things) aefficient (to do things right), Hofer and Schendel |1978: 4| definedorganisation's strategy as "the tundamenta l pa t tern of present anplanned resource deployments and environmental interactions that idicates how the organ isation will achieve its objectives". H enee t he re afour components to anyorganisation's strategy: seope - present anplanned interactions with the environment; dis t inc t ive competenccompetitive advantages; and synergy, the joint effects that are sougfrom the organisation's distinctive competences and/or scope decisio

The fundamental concept of competit ive advantage ean be tracback to the seminal work of Ch am berlin [1939] but Ho fer and Schen[1978] were the first formally to suggest a direct relationship betwe(distinctive) competency and competitive advantages through the abilof the firm touse sueh competences to create major competit ive advatages. They described competit ive advantage as ' the unique position organisation develops vis-a-vis its competitors through its patterns ofsource deployments ' , while they defined competence as the 'patterns . . . resource and skill deployments that will help it (the tirm) achievegoals and objectives" [Hofer and S che nd el. 1978: 25]. Th e literatu reconsistent in two important aspects: the souree of eompetency is alwinternal to the Hrms: and competency is produced by the way a iirm uises its internal skills and resources, relative to the competit ion [Reand De Fillippi, 1990: 89]. We concur with Hofer and Schendel's [19726[ argument that competit ive advantages ean stem trom either dtinctive competences or produet/market positioning but that the formis more important to business level strategy. Therefore, strategy linwhat the firm aspires to aehieve (its goals) with what its non-coiitrollaenvironment and resources will permit.

The eoncepts of competency and competit ive advantage are not syonymous; a l though competences are the major source of competitadvantage, they do not inevitably generate one; and an advantage dnot necessarily emanate Irom competences. Competences, being with


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THE ADV ANTA GE OF BUSINESS SERVICE FIRMS 53there is also freedom for the firm to select its strategy. Both paths ofcausation interact in an iterative dynamic process: strategy defines parti-cular niches in the market environment, and the environment, throughcustomer needs and competitors' responses, induces strategic adaptation.If a firm's current strategy is incongruent with its distinctive com-petences and com petitive advan tage , then it is likely to perform less wellthan other firms pursuing a similar strategy but with a good fit betweentheir strategy and their underlying com petitive advantages. M embers ofa particular strategic group may also not realise similar returns to the ex-tent that important differences exist in their competences [Cool andSchendel, 1988: 209]. Also, Chandler observed that strategy will have aprofound effect upon organisational structure while structure can con-strain and influence strategy. Strategy is related to both environmentand structure and many of these relationships have implications for per-formance. However, neither strategies nor structures alone, nor asuitable match between environment and structure is sufficient to ensuregood performance [Miller, 1988: 282]. For example, a strategy of pro-duct innovation may be unrewarding in a stagnant price-sensitiveenvironment, no matter what the structure. Complementarities ofstrategy with both environment and structure may be needed for goodperformance.

Mintzberg and Waters [1985: 257-272] offer an alternative perspectiveon strategy by drawing an important distinction between deliberate stra-tegies realised as intended from emergent strategies - patterns realiseddesp ite, or in the absence of, intentions. They argue that we would ex-pect to observe tendencies in the direction of deliberate and emergentstrateg ies; in effect these two form ends of a continuum along which realworld strategies fall [Mintzberg and Waters. 1985: 259]. The authors goon to speculate whether strategies will tend to be more deliberate incentrally controlled organisations and more emergent in decentralisedloosely complex ones? Will the cost leadership strategies of Porter provemore deliberate and differentiation strategies more emergent? HenceMintzberg conceptualises strategy as a pattern of activities over timewhich include observations of what actually occurred; not that planningis irrelevant but that actions are more important than intentions. It is abottom-up view of conceiving how new strategy emerges beginning witha plethora of micro strategies, spontaneous initiatives, and successfuladaptations at the grass roots [Hampden Tu rner, 1990: 69].


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54 THE SERVICE INDUSTRIES JOURNAof G.M., was consistently less successful during the 1970s or early 198This related not to Rover's strategy but to its inability to manufactand deliver the product to competitive levels of quality, price,finisharehability. In short. Rover failed tomatch the competition in variomanufacturing-related competences and not necessarily because it psued the wrong strategy, although they have recently moved up inhigher price segm ents. In short, the strategy-performance relationshmay be complicated by differences in implementation ability. Henhigh returns associated with, for example, a focused differentiation potion may not be returns to that market position per se but rather returto some underlying competitive advantage whieh is best exploitedthat market position; while, in turn, the eompetitive advantage is prdominantly a consequence of deploying the firm's competences. Firmmay select a market position consistent with their competitive advatage rather than deriving competitive advantage from their markposition; the latter is the most appropriate means of exploiting thcompetitive advantage rather than thecompetitive advantage itse[Cronshaw et al.., 1990: 14]. Positioning and competitive advantagtherefore, are distinct concepts.Empirical Tests of the Relationship Between Generic Strategies anPerformanceFor some, competitiveness is the ability to perform well; for others itthe generation and m aintenanee of competitive advan tage. The conceof competitiveness incorporates both efficiency (achieving goals at tleast possible cost) and effectiveness (defining the right goals). Competitiveness is also a relative concept which, therefore, needs to defined with respect to some other state of the world [Buckley, ei1988: 175-200]. This might be relative to a eomparator firm, as in tanalysis, or to a different time, or relative to a defined counter-factuposition. In this analysis, we use both measures of competitive performance (including export dependency, profitability, and percentage repebusiness) and of eompetitive potential (charge our rates andvaladded per person). These represent different stages in the competitivprocess. Potential measures describe the inputs into the operatiowhile performance measured the outcome of the operation.

The analysis is based on a sample of firm s from Scotland and thSouth East of England drawn from market research, graphic desig


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THE ADV ANT AGE OF BUSINESS SERVICE FIRMS 55asked the organisations to p manager to characterise their strategy whichis feasible given the elarity of Porter's model. Most managers know ifthey are trying to be a high quality supplier or to undercut their com-petitors on price of if they occupy an intermediate position. This in partinvolved the use of certain objective indicators for which we had col-lected data: number of customers and their characteristics; proportionof total sales to each market segment; pricing; the mix of core and peri-pheral services supplied; new serviee innovation; and perceived pricecompetitiveness relative to rival companies. The authors classified thefirms separately and then com pared the taxonomies derived. Some 90per cent of companies were allocated to the same group and the classifi-eation of the remaining 10 per cent was determined after further detailedconsideration of characteristics of the relevant companies. Further-more, there was a high correlation between the authors categories andthose reported by firm managers. This suggests that to the greatest pos-sible extent it is valuable to use investigators' inferences, objectivemeasures and self-typing in combination to determine strategy in pre-ference to exclusive reliance on a single measurement method. Theoutcom e of the classification procedures resulted in only five firms beingcategorised as adopting a eost focus strategy and only three competingon the basis of cost leadership. Henee, neither of these categories couldbe tested against the other generic strategies. However, 28 businesseswere implementing a focus differentiation strategy, 27 were competingon the basis of differentiation and 20 were 'stuck in the m iddle'; notcompeting on the basis of low eost or specialising in terms of eitherservices offered or market segments targeted. Therefore, only a minor-ity of companies in the sample were trying to compete on costs; mostwere attempting to differentiate or were stuck in the middle. This ten-dency is, perhaps, a function of the industries being analysed in thisstudy and the fact that one- or two-person businesses, which are morelikely to compete on p rice, are under-represen ted because of our aim toinclude firms potentially eapable of trading between regions. Therefore ,we tested differences in competitive potential and performancemeasures between: Focus Differentiation and Differentiation; FocusDifferentiation and 'Stuck in the M iddle '; and Differentiation and'Stuck in the Middle'.

We have already argued that strategic groups may consist of m embers


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56 THE SERVICE INDUSTRIES JOURNAnumber of research studies have indicated that strategic planning doresult in superior performance.^ We hypothesise that there will be difference in performance between firms implementing a focus dferentiation or differentiation strategy; but we expect that both of thegroups of firms will display superior performance to those stuck in tmiddle, as Porter suggested.

Firms were sampled first in Scotland; they represented cither a susample of the respondents to a postal questionnaire survey; or the poplation of firms in the case of market research and product design. TScottish sample was derived from relevant professional directories suplemented by regional directories. At the next stage the Scottish firmwere matched with a sample of London firms also drawn from profesional directories. The companies were matched by age group, sicategory and type of core service provided. In many cases there werenumber of South East firms which matched against a Scottish companand in these instances they were selected at random. This raises the teresting question as to whether there are any systematic differencesperformance within generic strategy categories between areas. Whypothesise that demand side differences between the South East anScotland - both in terms of volume, sophistication and segmentationdemand, the existence of a highly diversified and competitive sub-suppindustry in London and the more competitive environment within whicfirms have to operate in the capital - will remove below-average companies and result in a higher level of overall performance. This tecould be conducted only for those firms adopting a differentiation policdue to an insufficient number of matched pairs of firms within the othstrategic categories in both regions.

TABLti ISIZE AND AGh OF FIRMS BY GFNtKK" STRATEtiV

GenericStralegy

Focus dilterenliationDif ferent iat ionhbciis differentiationStuck in the middleDif ferent ial i i in

Median

10,?').()

10.,S

W i l c o x o n

-[^M N.S.N=271=68 N.S.N^20

Medianemploymentsize (IWOI1211.1214

1 -HI p


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THE ADV ANTA GE OF BUSINESS SERVICE FIRMS 57sampled. Wilcoxon Matched Pairs Signed Ranks Tests applied to bothage and size for each matched pair of observations for three com-binations of generic strategies (focus differentiation and differentiation;differentiation and stuck in the middle; and focus differentiation andstuck in the middle) show tha t the differences in each case are not statis-tically significant at P


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58 THH SERVICF INDUSTRIHS .KJURNAgroups of firms generate similar proportions of repeat business, whthe differentiators achieved an average net profit on turnover of ] Icent compared with 10.3 per cent.

TABLF 2PERFORMANCE MEASURES FOR MATCHED PAIRS OFFIRMS CLASSIFIED BVGENERIC STRATEGIES FOCUS DIFFERENTIATION AND STUCK INTHl": MIDDLE

Generic-strategy

Focus differentialionStuck in the middleWilcoxon MatehedPairs Signed RanksTesi

Exportdependency:percentageexportsMedian Mean5 260 1.5

%) ' ^ " '

Value addedper person ()

Median Mean4L(S(K) 4(1,93(138.7(10 3 i,56(1I 4 I 61S42li 4551=26 P


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THE ADVANTAGE OF BUSINESS SERVICE FIRMS 59However, neither relationship is significant. Finally, average net profiton turnover achieved by differentiators, at 13.8 per cent is slightlygreater than that of the focus differentiators, 10.8 per cent, but there are

TABLE 4PERFORMANCE MEASURES FOR MATCHED PAIRS OF FIRMS CLASSIFIED BYGENERIC STRATEGIES FOCUS DIFFERENTIATION AND DIFFERENTIATION

GenericstrategyExportdependency:percentageexports

Value addedper person ()Charge outrateSenior staff( per day)

Percentagerepeatbusiness

Focus differentiationDifferentiationWilcoxon MatchedPairs Signed RanksTest

Median15T=136N=23

Mean1311.5N.S.

Median39,9(H)45.7501=64N-21

Mean45.43754.174N-S-

Median640525r-69N = 19

Mean707567N.S.

Median79.572.5T=64N=2I

M7973N

'. Means and medians calculated for matehed tirms only.too few matched observations to justify a statistical test. Thus, it is quiteclear that there are no systematic differences between differentiatorsand focus differentiators across the range of performance measures ana-lysed. Tt is equally apparent that firms, which in terms of their genericstrategy are stuck in themiddle, display an inferior performance on themajority of indices when matched with similar companies adoptingeither differentiation or focus differentiation strategies.Performance of Differentiated Firms in Scotland and the South EastWe have hypothesised that service businesses in the South East pursuinga differentiation strategy will record higher levels of performance thanmatched Scottish companies. Table 5 presents the results of these tests.

1 ABLE 5PERFORMANCE MEASURES FOR MATCHED PAIRS OF FIRMS ADOPTINGA DIFFERENTIATION STRATEGY CLASSFIED BY REGIONAL LOCATION'

RegionstrategyExportdependency:percentageexports

Value addedper person ()Charge outrateSenior staff( per day)

PercentagerepeatbusinessMedian Mean Median Mean53.500

Median770

Mean73fi

Median75

Mean73


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60 THE SERVICE INDUSTRIES .lOURNAThe matched differentiators in the South East export more than thmatched Scottish counterparts and the difference is statistically signicant (P


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THE ADV ANTA GE OF BUSINESS SERVICE FIRMS 61a differential performance impact. These results appea r to be at var-iance with those reported by Cronshaw et al. [1990], whose analysisprovided little support for the stuck in the m iddle hypothesis. However,there are some important differences between these analyses: differentmeasures of competitiveness have been used; the firms have been classi-fied using a different methodology; and we have concentrated uponbusiness service firms only which were not included in the Cronshaw etal. study. Business service companies are probably less able to adopt ahigh-quality/low-cost position; high quality is perhaps more likely to beassociated with higher costs than in many other industries since the pro-duction of high quality is more dependent upon very skilled (expensive)staff.The observation that firms which are stuck in the middle do not per-form as well as those companies adopting a focus differentiation ordifferentiation strategy does not imply that such firms should repositiontheir services, leave the middle of the market, and adopt either aggres-sive price com petition o r, more likely, product differentiation.Prescription should only follow a careful analysis of the competences,competitive advantages and structure of each firm, and an assessment ofwhether its generic strategy and broad positioning is consistent bothwith its structure, its competitive advan tages, and its environ ment, espe-cially the nature of demand in its markets. Indeed, business servicecompanies competing on the basis of cost leadership, cost focus or beingstuck in the middle may underestimate the cost of attempting to developthe competences and resultant competitive strengths to move up-m arketto a differentiation or focus differentiation strategy. To develop a repu-tation for scarce skills requires large investments in human capital andtime [Davis, 1990].

It cannot be emphasised strongly enough that selection of an appro-priate generic strategy does not guarantee success. It is a necessary butnot sufficient condition: the business needs to develop the competencesthat it will use to establish competitive advantage over rivals that arenecessary to realise the potential of the chosen strategy. This is the mostcreative and difficult aspect of the business-level strategy-formulationprocess. In terms of implications for practice, managers need to pay par-ticular attention to building complementarities between businessstrategy and its structural and environmental contexts. Furthermore, wehave scant knowledge concerning what organizational characteristics


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6 2 T H E S E R V I C E I N D U S l R I H S . l O U R Nenvironments. Other important, as yet unresolved, questions remadofirmshave one reputation or many; how resilient are reputations ahow much are they an asset? To identify the effect of reputation upeompetitiveness and performance remains a rewarding research chlenge and will require a model that also acknowledges the effects market, product and structure variables. One of the most interesting sults of this study is the finding that having controlled for age. size, atype of core service, firms located in the South East pursuing a dferentiation strategy arc more competitive than matched Scottish firadopting a similar strategy. To what extent this is due to inferior copetences and competitive strengths, poorer positioning, or demand sfactors is the subject of our on-going research.

NOI ESThcst; figures should be interpreted as of an order of magnitude rather ihan precindicators: management eonsultancy firms subcontract work and, frt)m lime lo timmay carry out more days' work than were originally budgeted.Hofer and Sehcndel [1978. p,7] cite five such studies, while Bu/zeil and (Sale il9present evidence from the PIMS database on the links between strategy and pert'ur

ACKNOWLEDGHMEN ISThis research was conducted with the aid ot an Economic and Social Resc;irch Coun

Grant R(XK)23 1891.

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competitive advantage of business

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