Market Oriented Value Creation in Service Firms

Transcription

1 Market Oriented Value Creation in Service Firms Rod B. McNaughton Eyton Chair in Entrepreneurship, University of Waterloo, Ontario, Canada Phil Osborne Marketing Department, School of Business, University of Otago, New Zealand Brian C. Imrie Marketing Department, School of Business, University of Otago, New Zealand Key Words: Competitive Advantage, Market Orientation, Performance, Value Address for correspondence: Professor Rod McNaughton Department of Management Sciences University of Waterloo 200 University Avenue West Waterloo, Ontario, Canada N2L 3G1 Telephone: , extension 6203 Fax:

2 Market Oriented Value Creation in Service Firms Abstract A fundamental proposition in marketing strategy is that a market orientation is positively related to firm performance. However, the mechanisms of this relationship have yet to be explored in detail, especially in service industries where intangible assets are relatively more important. This paper addresses this issue by proposing a model that identifies important intermediate variables between a market orientation and increased firm value. The model posits that a market orientation guides investment in market-based assets and other asset types, that these assets may be levered to create a competitive advantage and value for customers, and that this results in loyalty and easier customer attraction. Quicker and more extensive market penetration, shorter sales cycles, and decreased marketing and sales costs enhance the cash flow of a market-oriented firm. This may be recognised in higher valuations, which ultimately translate into higher share prices and wealth creation for the owners of the firm. Introduction A key objective of research into marketing strategy is to uncover how firms develop and sustain a competitive advantage, and how an advantage translates into superior performance. Market orientation a business culture focused on the continuous creation of customer value (Slater and Narver, 1

3 1994) is one intangible that is posited to be a source of competitive advantage that positively influences business performance (Narver and Slater, 1990; Jaworski and Kohli, 1993; Deshpande, Farley and Webster, 1993). A substantial number of studies are reported in the literature that test hypotheses relating a market orientation to firm performance as measured by financial measures such as profit, relative profit, return on investment or assets, and non-financial measures such as new product success and innovation. Empirical results generally confirm a positive relationship with measures of performance, though the strength of the association is often weak (e.g., Ruekert, 1992; Deshpande, Farley and Webster, 1993; Jaworski and Kohli, 1993; Slater and Narver, 1994; Pelham and Wilson, 1996). Most empirical studies of the market orientation performance link are set in the context of traditional manufacturing sectors. However, there is evidence of a market orientation performance link in the context of service industries (e.g., Van Egeren and O Connor, 1998; Chang and Chen, 1998; Kumar, Subramanian, and Yauger, 1998; Pitt, Caruana, and Berthon, 1996; Han, Kim and Srivastava, 1998; Voss and Voss, 2000). The often cited service characteristics of intangibility, heterogeneity, inseparability and perishability (Sasser et al., 1978) highlight both the reduced emphasis upon tangibles and the increased role that a consumer plays within the service process. Within the service industries, competitive advantage is less likely to come from tangible factors, and is more likely to be derived from intangibles that contribute to unique capabilities. Intangible assets are also important because they are increasingly considered in determining the market value of companies (Kaplan and Norton, 2001). 2

4 The integral involvement of the consumer within the service process suggests the need to develop close and trusting relationships to increase customer perceived value, and such relationships are logically fostered by a market orientation. As an active participant in the service performance the consumer interacts with personnel, the service script and supporting tangibles in a manner that does not occur in a product marketing context. The consequent transparency of the service encounter enables an impression to be formed of the firm s commitment to creating customer value. Equally the interaction that occurs with service personnel enables enhanced market sensing by the firm, a capability of a market oriented company (Day, 1994). As a result it is possible that a market orientation is even more central to the performance of services firms. The papers in this special issue are important as they reveal more detail about the relationships between the dimensions of a market orientation, the creation of value for buyers of services, and the performance implications for the producers and sellers of those services. The extant body of marketing orientation theory, no matter the sector in which it is applied, focuses on the processes whereby market orientation creates customer value. (For example, see Figure 2 in Slater and Narver, 1994.) But, the bulk of empirical studies make a substantial leap in positing a relationship between a measure of market orientation and improved financial performance. The processes that underlie the links between market orientation, customer value, and financial performance are largely treated as a black box. This paper develops a conceptual model that makes explicit the processes whereby a market orientation and emphasis on customer value can 3

5 enhance financial performance, and ultimately create wealth for the owners of a firm. It builds on and refines our model of market-based value creation, which we recently used to characterise the restructuring of British Telecom PLC s marketing activities (McNaughton, Osborne, Morgan and Kutwaroo, 2001). In particular, by drawing on the services literature relating to quality, satisfaction and loyalty, we are able to be more specific about the interface between customer value and firm performance. Our model postulates an explanation of the process whereby a market orientation is transformed into customer value and how this in turn creates value for the owners of the firm. It also contributes to management practice by providing a logical rationale for investments in market-based assets, justification for efforts to develop a market oriented organisation, and framework that can be used to both guide and analyse the strategies of market-oriented firms. Market Orientation and Service Firm Performance Despite continuous debate over the specific dimensions of the market orientation construct (for an excellent review see Lafferty and Hult, 2001), the link to organisational performance is almost universally accepted (Sheth and Sisodia, 1999). However, empirical tests of the robustness of the relationship to the unique characteristics of the services environment are a relatively recent addition to the market orientation literature. Early considerations of a market orientation in the services industries include Greenley and Matcham (1986), and Qureshi (1993). Bharadwaj, Varadarajan, and Fahy (1993) included 4

6 elements of market-oriented behaviour in their conceptual model of the drivers of sustainable competitive advantage in service industries. A number of empirical tests of the market orientation-performance relationship appeared in the literature in the late 1990s. Table 1 highlights a sample of these investigations. Most of these studies support the market orientation performance link, but there is enough contrary evidence to suggest the relationship is not as straightforward as is often perceived (Au and Tse, 1998; Caruana, Pitt, and Berthon, 1999; Sargeant and Mohamad, 1999). While these negative results are usually accompanied by study-specific reasons for the anomalous findings (e.g., Caruana, et al 1999), even supportive findings explain little of the variation in firm performance, with coefficients of determination typically being less than >>>> Take in Table 1 about here<<<< Our conclusion from the extant literature is that understanding of how a market orientation influences performance is still nascent and requires development (McNaughton, Osborne, Morgan and Kutwaroo, 2001), a view that has also been expressed by Uncles (2000), and Deshpande (1999). This is especially the case in the context of the services industries where a high degree of intangibility may confound the relationship (Sin and Tse, 2000), and intermediate variables such as service quality are also likely to significantly impact firm performance (Chang and Chen, 1998). The role of intermediate variables is key. The processes that underlie the market orientation - performance relationship are poorly identified in most 5

7 empirical studies, though the improbability of a direct causal link (e.g., as postulated by Narver and Slater, 1990 and Ruekert, 1992) is acknowledged by exploration of potential moderators (e.g., Day and Wensley, 1988; Diamantopoulos and Hart, 1993; Greenley, 1995, Jaworski and Kohli, 1993). The established logic is that a market orientation provides the basis for devising a strategy that creates value for customers, and that such a strategy provides the foundation for a sustainable competitive advantage that contributes to financial performance. (For example, see the hypotheses related to business performance developed by Jaworski and Kohli, 1993, or by Deshpandé, Farley and Webster, 1993.) However, this line of reasoning does not in itself explain why a firm can realise value for its shareholders by pursuing a strategy of creating customer value. Nor is an explanation readily apparent in the market orientation literature. Kohli and Jaworski (1990, 1993), for example, found that an emphasis on profitability was conspicuously absent as a component of a customer value-based business strategy. Chang and Chen (1998) make an important contribution to identifying the steps that fall between a market-oriented business culture and performance outcomes. These authors developed a conceptual model that postulates both a direct effect for market orientation on business performance, and an indirect effect through helping to improve service quality. (See Figure 2 in Chang and Chen, 1998.) The model is tested with a sample of retail stockbrokers in Taiwan. The results support the hypothesis that a market orientation can assist firms to achieve a higher quality level, and that quality has a positive relationship with profitability. Quality is found to explain more of the variation in profitability than does market orientation. The model including 6

8 service quality (and a number of covariates) explains 38 percent of the variation in profitability between firms, and the addition of market orientation to the model only increases this to 45 percent. Chang and Chen (1998, 257) conclude: Given that there are other potential intermediate variables unaccounted for, the pure direct effect of market orientation on profitability may be even smaller. This illustrates the importance of the identification of intermediate variables. A Model of Market Oriented Value Creation in Service Firms Figure 1 presents a model that maps a path from market orientation to changes in cash flow that can influence firm value. The model identifies a number of the intermediate variables, or steps, that fall between a market orientation and eventual performance outcomes. The performance outcome in our model is changes in the cash position of the firm rather than profitability per se. The rationale is that cash flow ultimately determines the value of the firm, and there are several mechanisms for this of which profitability is one. Increased earnings, accelerated cash cycling, increased residual value of cash, and decreased volatility of cash flow all influence firm value (Srivastava, Shervani and Fahey, 1998). Further, an emphasis on cash flow recognises the time lag between implementation of market orientation, which can have costs, and realisation of benefits in later periods (Gauzente, 2001). >>> Take in Figure 1 about here<<< 7

9 The model begins with the market orientation of a firm, which we link to the creation of market-based assets, and other asset types. Market-based assets are largely intangible, and consist of intellectual assets (knowledge about the market), relational assets (outcomes of relationships with stakeholders including channel members, customers, and other players), and the interaction between these asset forms (Srivastava, Shervani and Fahey, 1998). Market-based assets accumulate by developing knowledge, skills and resources that are unique and difficult to imitate (Barney, 1991; Hunt and Morgan, 1995). They can be built or acquired through various forms of investment, including staff time spent in relationship building, databases, advertising and promotion, and sponsorship. Market-based assets can create value for a firm by building strong barriers to entry that divert competitors to higher cost or less effective strategies (Grant, 1991, 1996), leveraging the asset (Srivastava, Shervani and Fahey, 1998), and deploying the asset to create customer value (Slater, 1997). The deployment of the asset to create customer value is of most interest to us as this is the method by which a market orientation influences the way in which a firm interacts with its customers. There is also a relationship between market-based assets and other asset types. First, a market-oriented firm may uncover through its intelligence about customers or a competitor that investment is required in a non-market asset to achieve or maintain their competitive position. This might, for example, be a new store location or technology. Second, there is potential synergy between market-based assets and other asset types. A hotel, for example, has greater potential value when 8

10 branded and managed with an international hotelier s business systems, than it does if operated by a local property developer. The unique assets of a firm, both market-based and of other forms, create the competitive advantage of a firm. This in turn can be used to create value for customers. Value is judged as part of an equation in which customers compare perceived benefits and the perceived total costs (or sacrifice) of ownership (Monroe, 1991). Market-based assets can create value for customers through a positive quality perception (Chang and Chen, 1998), lowering search costs, matching performance requirements and price (Day, 1994), improving service and trust, risk reduction, and by generating innovative new offerings (Slater and Narver, 1994). Customer perceived value is also influenced by comparisons made with offerings by competitors. Thus, the competitor intelligence gathered by a market-oriented firm can be used to improve the positioning of the offering (or the firm itself). Market orientation thus influences both the numerator and the denominator of this equation. To construct a positive value equation, a firm must define, deliver and communicate a proposition that is recognised by the target market as better than that delivered by the competition (Christopher, 1996). A positive value equation attracts customers, and if their expectations are met, they become part of a growing pool of satisfied customers. The literature postulates that firms providing customer value have more satisfied customers who demonstrate stronger brand loyalty (Aaker, 1991; Oliver, 1997). Satisfied customers also generate positive word-of-mouth, which helps to recruit new customers (Swan and Oliver, 1989; Singh and Pandya, 1991). There is a substantial body of literature that addresses these relationships in 9

11 general, and in the specific context of service industries. Interestingly, attempts to relate measures of quality or satisfaction at the firm level to profitability (or firm value) have met the same result as those testing the market orientation performance link; generally the relationship is positive but the effect is weak. Examples of this research include Yeung and Ennew (2000), Aaker and Jocobson (1994), and Anderson and Fornell (1994). These studies show a much weaker quality-performance relationship than was originally suggested by the PIMS data (Buzzell and Gale, 1987). Research into the behavioural aspects of these relationships has met with more success, by investigating the relationships between variables that are intermediate between quality and performance outcomes. Namely: quality - satisfaction, satisfaction - loyalty, satisfaction - positive word-of-mouth, loyalty - customer retention, and customer retention - performance. Examples of this literature in the context of the service industries are described in Table 2. One reason why the evidence for these individual links is stronger than that for quality - performance is the difficulty of linking micro- and macroconstructs (Yeung and Ennew, 2000). Concepts like satisfaction or loyalty are attitudes and behaviours of individuals, often associated with particular service experiences, while performance is an aggregate characteristic of an organisation. In our model we illustrate this problem by embedding customer value (the shaded box) within the broader construct of firm value. The variables which fall outside of the customer value box, loyalty and word-ofmouth, are associated with the behaviours of individuals, but have conceptual equivalents at the level of the organisation retention and referrals. 10

12 >>>Take in Table 2 about here<<< Both retention and referrals have the potential to increase incoming cash and decrease outgoing cash, and thus to influence the value of a firm (Table 3). For example, loyal customers are less likely to switch and require less ongoing marketing effort to retain (Reichheld and Sasser, 1990). The literature on both brand equity and customer satisfaction suggests that loyal or satisfied customers will pay price premiums (Farquhar, 1989), adopt line extensions more readily (Keller, 1993), try and refer products more frequently, and have lower sales and service costs (Reichheld and Sasser, 1990). The overall effect of these processes is to speed receipt of cash, widen the gap between incoming and outgoing cash (for marketing related expenditures), and reduce working capital and fixed capital requirements. All else being the same, this should help to create higher earnings, reduce the volatility of cash flow, and increase the residual value of cash flow (Srivastava, Shervani, and Fahey, 1998); effects which have the potential to increase firm value (Day and Fahey, 1988). The owners and managers of a firm also have to decide how to allocate the retained earnings associated with this higher net marketing contribution. The resulting cost advantage could be used to increase customer perceived value through price reductions, possibly stimulating demand, or it could be reinvested in the creation of further market-based or other assets. >>>Take in Table 3 about here<<< 11

13 Finally, while the construct service quality does not explicitly appear, it has an important role in our model. Chang and Chen (1998) identified quality as an outcome of managerial action, which is in turn motivated by a market orientation. However, we perceive service quality to be a ubiquitous influence. When a firm s personnel (at all levels) are marketoriented, activity focuses upon the creation of quality service through deployment of both intellectual and relational market-based assets. The Gap Model (Parasuraman et al., 1985) inventories the activities (gaps 1-4), by both managerial and front line personnel, that are required to create a consumer perception of service quality (gap 5). Service quality is considered an outcome of the successful application of market assets while also adding value to the firm and taking its place amongst the stock of market based assets (Zeithaml, 2000). Lastly, the value that service quality creates for all stakeholders establishes it as an effective competitive advantage. The service quality construct is embedded within our model as a market based asset, competitive advantage and influencer of customer perceived value. Conclusions Our model traces the theoretical effects of market orientation on firm value. The model furthers understanding of the market orientation - performance relationship by making explicit the mechanisms whereby creating value for customers can also improve the financial position of a firm. This addresses a gap in the stream of research that seeks to demonstrate a positive 12

14 empirical relationship between market orientation and measures of financial performance (e.g., Narver and Slater, 1990 and Ruekert, 1992; Day and Wensley, 1988; Diamantopoulos and Hart, 1993; Greenley, 1995, Jaworski and Kohli, 1993). The model postulates that a market orientation helps a firm to both create market-based assets and guide investment in other types of investments. These become the basis of a competitive advantage that can be deployed to create customer value. Increased customer perceived value attracts customers, and results in satisfied customers that are more loyal and who act as marketing agents by spreading positive word-of-mouth (Reichheld and Sasser, 1990). A growing pool of retained customers helps to accelerate net cash flow, increase the residual value of cash, and decrease the volatility of cash flow. The model also acknowledges that a market orientation may improve the performance of service firms by contributing to service quality. This model emphasises cash flow, which has three clear benefits. First it provides the ability to communicate the benefits of a market-oriented culture across functional areas within a firm. The language of cash flow is universal. Second, it emphasises that market-based assets are an important investment type. Valuation measures could be applied to market-based assets, providing a common framework for firms to compare the benefits of a market orientation with alternative internally focused strategies (or indeed, the complementary effect of a market orientation on other asset forms). Finally, an emphasis on cash flow impacts also clarifies that the benefits of a market orientation are not realised in the same period as the investment. This is a problem for empirical 13

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21 Figure 1 A Model of market oriented value creation Asset Creation Cost Advantage Other Asset Types Loyalty Market Orientation Competitive Advantage Perceived Customer Value Customer Attraction Satisfaction Cash Flow Impacts Market-based Assets Word of Mouth Customer Value Firm Value 20

22 Table 1 A sample of market orientation - performance relationship investigations in service industries Author Sample Country (Usable responses) Van Egeren and O Connor (1998) Kumar, Subramanian, and Yauger (1998) Pitt, Caruana, and Berthon (1996) Caruana, Ramaseshan, and Ewing (1998) Chang and Chen (1998) Au and Tse (1995) Lado, Maydeu- Olivares, and Rivera (1998) Han, Kim, and Sristava (1998) Sargeant and 70, diverse, large, individual (non-sbu), SIC Code 5000, 7000, 8000 Mid western U.S (70) Healthcare US (159) Diverse, large UK (161) and Malta (193) Universities NZ and Australia Retail Stock Taiwan (116) Broking Hotels Hong Kong (41) and NZ (148) Insurance Belgium (34) and Spain (32) Performance Relationship Direct Mediated None Banks Mid West US (134) Hotels UK (200) Mohamad (1999) Caruana, Pitt and Diverse, large UK (161) Berthon (1999) 1 1 The research reported in this paper appears to use the same data reported in Pitt, Caruana, and Berthon (1996). However, a contrary result is presented and discussed. The authors suggest problems with the conceptualisation of market orientation used, though no such qualms were expressed in the earlier paper. Further, the later paper explores a more complex model that may have confounded the identification of the earlier direct relationship. 21

23 Table 2 Research linking satisfaction, loyalty, and performance Topic Author(s) Research Finding Service Quality and Performance (Aaker and Jocobsen 1994) (Rust et al. 1995) In an analysis of 34 major U.S. brands (both services and products) a positive relationship was established between the stock price index and quality perceptions. A framework is developed for determining the impact that service quality has upon profitability. A simulation is then used to illustrate the impact of service quality on profitability. Service Qualitysatisfactionloyaltybehaviour Satisfaction and loyalty Loyalty and performance (Brady and Robertson 2001) (Singh and Sirdeshmukh 2000) (Jones et al. 2000) (Reichheld and Sasser 1990) (Anderson 1993) (Heskett et al. 1997) In a cross-national study it is found that service quality s impact upon loyalty and behavioural intentions is mediated by a consumer's level of satisfaction and that this relationship is consistent across cultures. The authors model the key mechanisms that shape satisfaction in an individual encounter, and loyalty across ongoing exchanges. Central to the model is the way in which agency theory interacts with trust to affect satisfaction in an individual encounter and loyalty in the long term. The results of this study indicate that the influences of service satisfaction on repurchase intentions decreases where high switching barriers exist. Within a services context four mediating variables (cost, increased purchases, price premiums, word of mouth) are introduced as increasing with retention and subsequently positively impacting firm performance. Evidence is presented from a cross-section of industries to illustrate this contention A model is developed to link explicitly the antecedents and consequences of customer satisfaction in a utilityoriented framework. It is found a positive relationship exists between customer retention and profitability. It is demonstrated that customer retention has a greater impact upon service firm performance than economies of scale, market share and other factors. Satisfaction and performance Satisfaction, loyalty and firm performance (Anderson 1994) (Heskett et al. 1994) Using a sample of 77 prominent Swedish firms the authors found a significant relationship between satisfaction and return on assets (ROA). The service-profit chain is introduced. The links in the chain are as follows: Profit and growth are stimulated primarily by customer loyalty. Loyalty is a direct result of customer satisfaction. Satisfaction is largely influenced by the value of services provided to customers. Satisfied, loyal, and productive employees create value. 22

24 Table 2 (Continued) Research linking satisfaction, loyalty, and performance Topic Author(s) Research Finding Satisfaction, loyalty and firm performance (Fornell 1992) Utilising the Swedish Customer Satisfaction Barometer (CSB), a national economic indicator of customer satisfaction, the authors find a significant relationship between satisfaction, loyalty, price elasticities and firm profitability. (Hallowell 1996) The service profit chain was tested in a retail bank setting. The relationship satisfaction, loyalty and firm profitability is supported. (Bo 2000) This paper finds that the satisfaction-loyaltyperformance logic has a greater positive impact upon services than products. It is reasoned that service firms must earn loyalty but product firms can lower prices to aid retention. The results suggest however that for services satisfaction is only one determinant of loyalty. It is also noted that service revenue growth is driven primarily by personal referrals and word-of-mouth. 23

25 Table 3 Possible impacts on cash flow of customer loyalty and positive wordof-mouth Increase incoming cash Decrease outgoing cash Loyalty customer retention Price premiums Adoption of line extensions Increased purchase frequency Increased purchase volume (easier to crosssell, companion sell and up-sell) Reduced switching Lower cost of recruiting customers Decreased customer servicing costs Lower selling costs Word-of-mouth customer attraction Faster trial, adoption and diffusion of products Increased market share Shortened sales cycle Reduced inventory levels Lower selling costs Lower innovation costs and fewer new product failures 24