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Managing Innovation: Cases from the Services Industries (1988)

Chapter: Services Technology and Manufacturing: Cornerstones of the U.S. Economy

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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Suggested Citation:"Services Technology and Manufacturing: Cornerstones of the U.S. Economy." National Academy of Engineering. 1988. Managing Innovation: Cases from the Services Industries. Washington, DC: The National Academies Press. doi: 10.17226/765.
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Services Technology and Manufacturing: Cornerstones of the U. S. Economy JAMES BRIAN QUINN Now, more than ever, the United States needs a vital services sector. Some U.S. manufacturing industries (such as basic steel, automobiles, or electronic appliances) have suffered serious competitive reverses in recent years. Mer- chandise trade deficits have risen to all time highs. And even services trade balances have begun to slip seriously-from a positive balance of $37 billion in 1982 to only $15 billion for the entire year 1987. Of the total, the selected business services category declined by more than $8.6 billion between 1982 and 1987, when the net balance was a mere $0.8 billions The most serious losses occurred in travel and transportation-related industries. Although U.S. airlines have maintained a steady 38 to 41 percent of the world's revenue passenger miles during the past decade (U.S. passengers made up nearly 46 percent of the world total), the once powerful international carriers PanAm and TWA have fared poorly at the hands of direct foreign competitors such as JAL, Swissair, and Singapore Airlines, which made heavy long-term investments in their fleets and paid close attention to the quality of care given to passengers. MAJOR THREATS AND OPPORTUNITIES FOR THE 1990s The threat to other services industries is real and immediate. Confrontations will not be limited to markets abroad; U.S. markets for services are no safer from foreign competition than were the domestic markets for manufactured goods. Indeed, foreign direct investment in the U.S. services sector has exploded since the mid-1970s, although the rate of increase was slowing until the mid-1980s, when the weak dollar began to attract further foreign 9

10 JAMES BRIAN QUINN investments. It is sobering to realize that many of the great names in ser- vices such as 20th Century Fox, Stouffers Hotels and Restaurants, Inter- continental Hotels, Saks Fifth Avenue, Marshall Fields, Spiegel, A&P, Grand Union, and Giant Food have foreign owners now. Even the great invest- ment banks of the United States have strong new partial owners from abroad. The United States needs to take a careful look at its services sector and place increasing emphasis on its competitiveness and value-added potentials. U.S.-based services will continue to offer dramatic opportunities for growth, productivity improvement, and innovation over the next decade. Few realize how completely technological innovations in services have already restruc- tured the U.S. economy and its international competitive relationships in the process antiquating many of our precepts about the roles of both man- ufacturing and services in a modern economy. The companion volume to this book Technology in Services: Policies for Growth, Trade, and Employment- contains a number of research and policy papers concerning the implications of this restructuring. In this volume we have collected some outstanding cases about services innovations. These can provide informative guidelines on how such innovations can be managed, or mismanaged if we are not careful. NEW TERMS OF COMPETITION IN SERVICES Although the effects of deregulation complicate the picture, it is new technologies that have most extensively altered and expanded the services industries in recent years. Unfortunately, such technologies have also made these industries vulnerable to the same modes of attack that earlier so rapidly undermined segments of the nation's manufacturing economy. If executives and policymakers understand these emerging forces, they will both exploit some potent opportunities to boost their companies' (and the nation's) per- formance and develop more effective responses to their foreign competition. The attempts and frustrations of Federal Express in opening the Japanese market provide a good example. If executives do not comprehend these potentials or if they act with the complacency and shortsightedness that characterized policies that affected manufacturing industries a decade ago, they could leave major portions of the U.S. economy wide open to further foreign incursions. What are the main patterns at work? Concentration and Diffusion In virtually every services industry, technological change has created vastly increased capacities and economies of scale. The New York Stock Exchange and Federal Express COSMOS II systems described in this volume provide cases in point. The first-order effect in most industries has been a revised

SERVICES TECHNOLOGY AND MANUFACTURING 11 competitive structure characterized both by increased concentration in the industry and by increased fragmentation and market segmentation. To exploit the new scale economies available, many intermediate and large companies in each services industry merged to form giant enterprises. But within each services industry smaller companies also identified local niches- or spe- cialized services needs-and concentrated successfully on these, with in- vestment returns following the classic V- or U-shaped distributions noted by Porter (1985) and others (Booz Allen & Hamilton, undated). In the rental car industry, for example, the major companies in conjunction with the airlines initially locked up virtually all long-distance travelers with their instantaneous guaranteed reservation systems. They rapidly extended their scale through international subsidiaries and affiliates connected elec- tronically. But soon, niche operators proliferated to exploit the rigidities of the giants' more standardized services. Automated computer and telephone- answering devices allowed both "Super-Elegant" and "Rent-A-Wreck" ex- tremes to serve local markets with office-in-the-home operations. Only a few midsized operations such as Alamo or Agency could grow substantially by segmenting target groups with particular needs, such as cut-rate or conference rentals. As the Keith and Grody paper notes, automation in the securities handling process has changed that industry's entire structure since the mid-1960s. Under the old paper-based system, brokers had to document all trades by hand, and shares had to be physically delivered from the seller's agent to the buyer' s. As daily volumes approached 12 million shares, only the big firms could hire and manage enough people to keep up with their securities trades each day. Smaller firms began to fail because they could neither control nor process their securities in a timely fashion. Finally, Wall Street filllls formed Central Certificate Services (later the Depository Trust Company), which brought essentially all securities certificates under one roof, where a single set of accounting entries could change their ownership. After 5 or 6 years, the system became totally electronic and smaller brokers could tie into the Depository. Today, such automated clearinghouses handle virtually all private and government transactions and are key linkages enabling the worldwide integration of financial markets. New technology also produced important scale effects in medical care. Some high-cost technologies, such as computerized axial tomography (CAT), allowed much more accurate diagnoses, and other advanced technological systems opened the way for heart, brain, general surgical, and life support procedures never before feasible. In part because of the reimbursement system then in use, the initial effect of these capital-intensive technologies was to centralize treatment in the larger hospitals. Small practitioners and hospitals had neither the patients nor the resources to buy or constantly update the new diagnostic, surgical, and recovery equipment. This centralization led to

12 JAIIlES BRIAN QUINN highly specialized medical training in the medical centers, caused specialist practices to form around the biggest hospitals, and spurred the creation of large regional referral facilities to handle particularly difficult cases. Many smaller hospitals suffered, closed down, or joined in cooperative networks with the larger centers. Overhead expenses grew and the average cost of an inpatient stay soared from $729 in 1972 to $2,898 in 1984, when diagnosis-related group restric- tions devised by the government medical reimbursement programs began to shift cost patterns. With patient care becoming ever more impersonal in the large centers, new and less costly distribution systems began to emerge along both vertical (home care, primary care, specialty care) and horizontal (pe- diatrics, obstetrics, dermatology, internal medicine) axes. Such complex alternative systems as electronically linked home or outpatient care facilities, emergency cardiac systems, and health maintenance organization networks have grown almost 10 times in number since 1971, and the number of people they serve grew from 3.1 million to more than 13.6 million. Ambulatory surgical centers have exploded from 400 in 1982 to more than 1,200 in 1985. Soon management of these complex systems became so critical a factor that large private companies found it profitable to apply their skills to both hos- pitals and other parts of the system thus starting another wave of consol- idation. Networks and Variety in Services Beyond their important effects on scale, new services technologies often create powerful second-order effects-economies of scope-that allow en- tirely new service products to move through established networks or systems with little added cost. Once debugged, communications and information- handling technologies permit the distribution of a much wider set of services to a more diverse and dispersed customer base. In the process they often further decrease costs on old product lines as equipment, development, and software investments are allocated over the broader base of applications. In addition, new technologies frequently offer wide-ranging strategic benefits in terms of more rapid new-product introductions or faster response to com- petitors' moves. An often cited but classic example is American Airlines' Sabre System, a computerized reservation system which when combined with sophisticated revenue management software allowed American to offer selected fares com- parable with those of People Express, an upstart no-frills competitor, without jeopardizing its higher fare sales base. More recently, Sabre has expanded its services to allow customer companies to link directly into its system, make their own reservations, and eventually handle payment of their travel

SERVICES TECHNOLOGY AND MAIIUFACTUR1NC 13 bills. Sabre, which is reportedly often more profitable than the air travel operation, is extending its services into telemarketing of products. In this same vein, insurance companies first began automating their back- office activities for greater efficiency in the mid-1960s when their industry was stable and heavily regulated. As expected, better handling of premium billings and collections brought dramatic productivity gains. Then when wildly fluctuating interest rates hit the industry in the 1970s the companies had to alter their products rapidly to attract new premiums and to offset the effects of customers' borrowing against their policies at lower interest rates. In such an environment, only companies with flexibly designed back-office computer and control systems could design or deploy their products quickly enough within days or weeks to get a competitive edge. Previously, in- surance companies had brought out new rate books only once every 3 to 5 years. Surviving companies now note that, without effective electronic and software systems, they could neither have conceived of the variety of new products needed during this critical period nor could they have explained and introduced the products to their widespread agent and customer bases. Again, many smaller insurance companies, which could not afford the huge costs of sophisticated electronic networks, faltered, sold out, merged, or concentrated on localized or specialized services outside the interests of larger companies. International Implications Given both their economies of scale and scope, as well as the relatively low expense of transporting their services internationally, large technologi- cally sophisticated U.S. services companies such as Citicorp or the dere- gulated AT&T system (see the Glaser and Davis chapters in this volume) should enjoy powerful international advantages. But the same is also true for selected foreign competitors. The cellular telephone case included here also shows how rapidly overseas competitors can seize and exploit an ad- vanced U.S. innovation, when regulatory processes react too slowly. In still another service arena, powerful European and Asian distribution companies are also proving to have the scale, talent, and management systems to acquire and upgrade poorly performing U.S. retail networks. For example, Britain.' s well-automated food retailers boast a hefty 23.4 percent return on capital employed. J. Sainsbury's (which is electronically automated from checkout scanning through stock control and employee scheduling) with four other chain stores accounts for more than half of Britain's grocery sales (The Economist, 1987b). Now, Sainsbury's (through its acquisition of Shaw's Supermarkets) and other big British retailers are pushing abroad both in the United States and the European Economic Community (EEC) (The Econo- mist, 1987a). Increasingly, technology is making global competition among

14 JAMES BRIAN QUINN services giants both possible and essential to success. Few areas seem im mune. Segmentation and Responsiveness As the chapter by Doorley et al. suggests, technology in professional services although not enhancing "measured productivity" much is en- abling the management of greater levels of complexity, with higher output quality. Law firms can in a matter of hours complete more exhaustive back- ground searches, prepare more intricate contracts, and document resulting settlements more thoroughly than they previously could in weeks. Computer models and data base networks have become so powerful in some research fields that they can identify critical relationships and pose new hypotheses, not merely help analyze and test data. The Murillo chapter suggests the power of computer techniques in engineering design of structures. In other services industries, computer-based techniques are helping to find feasible structures for complex but as yet unknown proteins, identify potential disease causes from epidemiological or genetic models, or (as Richard Larson's chapter demonstrates) solve inordinately complex problems in delivering public services. Within companies, the effects of complexity reinforce the strategic effects of economies of both scale and scope. Companies that can.deliver better and more varied services without increasing their marginal costs can achieve competitive advantages through a higher degree of segmentation in their marketing activities, increasing value added for their customers, while low- ering their own average operating costs. The Fellowes and Frey chapter provides an excellent example. But the technologies that make such systems possible are having their own interesting side effects. They are undermining established concepts of competition, strategic management, organization, and economic policymaking at a rate never before envisioned. They have short- ened transaction times, heightened volatility, and created entirely new forms of internal organizations, external alliances, and industry competitive struc- tures in both manufacturing and services. Services technologies have created a new level of responsiveness to mar- kets by disinte~ediating (eliminating intermediaries) between customers and the producers of goods or services. Direct access to financial services markets has, of course, short-circuited many traditional banker, agent, and broker relationships; and easy direct ticketing by airlines, hotels, tours, and theaters has cut out other intermediaries in these services fields. The entire production process from raw materials to ultimate customer purchase can now be in- tegrated by electronics systems, without entailing the ownership and control patterns involved in earlier attempts at "vertical integration." Any level in the value chain from raw material producer to retailer can drive this process.

SERVICES TECHNOLOGY Al!iD MANUFACTURING 15 Intermediaries themselves (such as wholesalers) can simultaneously ver- tically and horizontally integrate their markets by providing a better level of price, quality, and service than their customers could possibly achieve alone. For example, McKesson and Super Valu provide their retailing customers with the benefits of vertical integration (without ownership) by helping them locate and design their stores, advising them on increased value-added prod- uct mixes, managing stocks and displays in key departments, processing medical insurance claims for customers, recycling customer wastes, handling customers' accounting and credit functions, and researching new uses for, suppliers' products. Sears owns and controls many suppliers for its branded lines and provides after-sales services through its own extensive financial, credit, repair, and insurance networks. Computerized reservation and product control systems allow airlines, au- tomobile rental companies, and retailers to analyze their costs and customers' buying behavior in such detail that they can optimize margins on each type of demand and meet each competitor's response. Research indicates that the resulting crazy quilt of prices leads customers to concentrate more on services provided. This in turn offers attentive services companies greater opportun- ities to segment their markets with highly personalized responses such as Domino's Pizza recognizing customers' names, addresses, and preferences instantly; airlines offering specialized meals, wheelchairs, luggage verifi- cation, and even counseling for nervous passengers; and banks offering uniquely tailored products and services to individual clients, depending on their roles in their particular companies and their personal banking and credit histories. Such possibilities have led to whole new approaches to designing flexible, responsive organizations that can delegate authority with "spans of control" as wide as 200 people and empower and motivate employees at all levels to innovate and exploit their own creative potentials and the opportunities that the new technologies allow (Carlzon, 19871. Services technologies are thus breaking down the traditional boundaries of nations, industries, and even government versus private functions. With no element in its value chain immune to structural changes due to services technologies, each producer must constantly reassess who its true suppliers, competitors, and customers are and how each could enhance or subvert its competitive posture. Just as international banks already often find that their compatriots may be simultaneously competitors, customers, joint venture partners, and suppliers, other manufacturing and services concerns are en- tering a new competitive era where substantially increased cross-industry competition is a fact of life. The various cases in this volume offer specific and detailed examples of major innovations that have helped restructure services companies and in- dustries in the ways described above. The next section of this paper, however, will focus on another set of innovations not widely recognized but also

16 JAMES BRIAN QUINN radically changing the country's basic economic landscape and competitive- ness the manufactur~ng-services interface. THE MANUFACTURING-SERVICES INTERFACE In recent years many have expressed concerns over the decline of U.S. manufacturing. They fear a U.S. economy dominated by services will mean low wages, diminished real economic growth, and a society engaged in menial personal services tasks. These perceptions are incorrect. Total employment in manufacturing has decreased only marginally from long-term trends (see Figure 11. Real value added attributable- to manufac- tur~ng grew steadily until the mid-1980s (see Figure 2~; and U.S. manufac- turers' percentage of total goods trade (including their overseas production) has stayed between 20 and 22 percent since the 1960s. Many important U.S. manufacturing industries (such as aircraft, pharmaceuticals, computers, chemicals) are strong and viable, although some (such as basic steel, auto- mobiles, or electronic appliances) have suffered real declines in employment, output, and competitiveness over the last IS years. Meanwhile the services sector has grown steadily in its contributions to U.S. gross national product (GNP) and value added and in 1986 accounted 80 70 60 50 40 30 20 10 o Services ' / l l l . . ~ - - - Manufacturing Agric., Min., Constr. _.. ~ -. l 1950 1 960 1970 . 1980 1986 FIGURE 1 Employment trends by sector. SOURCE: Bureau of Economic Analysis, The National Income and Product Ac- counts of the United States; and Bureau of Labor Statistics, Establishment Database.

SERVICES TEClINOLOGY AND MANUFACTURING 1600 1400 In All 1 200 o cot o In o ._ = ._ m 1 000 800 600 400 200 Services ~ Manufacturing - O Agric., Min., Constr. i, 1950 1960 1970 1980 1986 FIGURE 2 Real value added by sector. SOURCE: Bureau of Economic Analysis, The National Income and Product Ac- counts of the United States. 17 for 71 percent of the country's GNP and 75 percent of its employment (see Table 1~. Far from being a negative development, today's services industries actually create major markets for consumer goods, lower virtually all man- ufacturers' costs, provide strong stable markets for capital goods producers, and enhance overall U.S. competitiveness in world markets. New technol- ogies in services both have improved real economic growth significantly and offer manufacturers major new strategic opportunities and potentials for future growth. Hypothesizing a presumed conflict of services versus manufacturing is counterproductive. The services and goods-producing sectors of the economy are so intertwined that it is inappropriate to consider one as somehow sub- ordinate or in opposition to the other. Services Directly Substitute for Manufactures Far from being inferior economic outputs, services are directly inter- changeable with manufactures in a wide variety of situations. Few customers care whether a refrigerator manufacturer implements a particular feature through a hardware circuit or by internal software. New CAD/CAM software can substitute for added production or design equipment, and improved trans- portation or handling services can lower a manufacturer's costs as effectively as cutting its direct labor or materials inputs. These "services" investments

18 TABLE 1 U.S. GNP and Employment by Industry, 1986 JAIk1ES BRIAR! QUINN GNP Employment $ billions % of total Millions To of total Total economy$4,235 108.0 Agnculture, forestry, fisheries93 1.7 Mining and construction293 5.7 Manufactunng825 19.1 Total goods sector$1,211 29%26.5 25% Finance, insurance, real estate$695 6.5 Retail trade408 18.4 Wholesale trade295 5.8 Transportation and public utilities276 4.0 Communications115 1.3 Other services700 24.9 Total private services$2,489 59%60.8 56% Government and government enterprises507 20.6 Total services sector $2,996 71% 81.4 75% Rest of world and statistical discrepancy SOURCE: U.S. Bureau of Economic Analysis; U.S. Bureau of Labor Statistics. 30 improve productivity or add value just like any other new investment in physical-handling machinery or product features. The U.S. services sector is a natural and desirable outgrowth of an in- creasingly productive agricultural and industrial economy. People were able to buy ever more with what they earned each hour of their working time. But demands for products were inherently somewhat capped; people could only consume so many washing machines, sofas, or pounds of food. Con- sequently the relative utility of services grew apace. Simultaneously, new technologies also vastly improved performance and opened further markets in virtually all services industries. From the manufacturer's viewpoint jet aircraft made long-haul passenger and freight handling much more efficient and convenient. New containeri- zation, loading, refrigeration, and handling techniques for volatile liquids, by making it possible to transport virtually all goods safely and effectively, vastly extended international trade in manufactures. And electronics, infor- mation, and communications technologies stimulated new initiatives in vir- tually all services areas most notably in retailing and wholesale trade,

SERVICES TECHNOLOGY AND MANUFACTURING 19 engineering design, financial services, communications, and entertainment. Note that virtually all these advances involve interactions between manufac- tured products and services. However, total interactions between services and manufacturing are much more complex. Figure 3 suggests only some of the principal relationships. Economic benefits flow both ways between all these activities; the fact of trade means that each party must benefit from the presence of the other. Although most of the structure seems self-evident once disclosed, the role of the "service intermediary" may not be. Not all products can be used by the ultimate user without the intermediation of a professional who can harness its more arcane possibilities or control its potential hazards. Specialized technical representatives or consultants are often needed to introduce or support new product entries in high-technology fields such as nuclear energy, computers, or medical care systems. Without these services, market access would be prohibitively high. Services Generate Manufacturing Markets Many have noted that some U.S. services industries are very dependent on manufacturing; many services companies exist primarily to provide trans- portation, finance, advertising, repair, distribution, or communications in support of goods manufactured here. A large number of these services would still be provided in the United States regardless of where the product was manufactured, for example, selling a Toyota in this country requires many of the same U.S.-based services activities as selling a Ford. However, im- portant design support functions and supplier linkage services might move overseas if manufacture was not performed here. Less recognized is the fact that a healthy manufacturing sector is probably equally dependent on services. First, if 75 percent of all people are employed in services, clearly they and their enterprises must be the major markets for most consumer and commercial products. Second, although the lagging data for U.S. input-output tables and poor definition of sectors do not allow complete intersectoral sales calculations, some specific studies suggest that 85 percent of the communications and related information technologies equip- ment sold in the United States in 1985 went to the information industries (dominantly services) (Roach, 1988), and 70 percent of all installed computer systems in Great Britain in 1984 were in services (The Economist, 19851. In addition, services technologies can allow manufacturers to be much more responsive to fluctuating or individual demand patterns. Proper inte- gration of these technologies throughout manufacturing and distribution can significantly increase the number and range of goods it pays to produce in the United States, rather than overseas. As personal affluence or the sheer size of markets grows, there is an increasing demand for differentiated,

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SERVICES TECHNOLOGY AND MANUFACTURING 21 individualized, or customized products. Thus, original equipment manufac- turers (OEM) and wholesale-retail customers generally want shorter or just- in-time (JIT) inventory responses and higher variability in products available. Also final consumers want delivery on products that reflect their particular tastes now, rather than in 3-12 weeks. Both flexible manufacturing and automated services technologies can help manufacturers exploit these trends and increase their markets. Services Technologies Improve Market Responsiveness Manufacturing success today often requires more rapid feedback from the marketplace, better customized products, and more accurate delivery in shorter cycle times, all of which are dependent on services integration. So important is market integration that Texas Instruments tries to place its application- specific integrated circuit technical representatives in its customers' design shops, and consumer goods producers such as Mr. Ge van Schaik of Hei- neken's sometimes note, "We are just a marketing company with a pro- duction facility." Other specific examples will suggest how new technologies help manufacturers effect better marketing-production integration: ~ Clearly, American Hospital Supply built its preeminent position by placing computer terminals right in its customers' premises and providing updated software to help users control inventories, access catalogs, and order American Hospital Supply products directly from the terminals. Similarly, by affixing uniform product code (UPC) bar-code labels on its products at the factory and offering electronic ordering systems, Levi Strauss is now able to provide extremely fast replenishment of stock for retailers who have installed bar-code scanners at their checkout registers a practice long used by supermarkets (Business Week, 1987c). · Some manufacturers are closely tied to retailers that, like The Limited, daily aggregate sales data electronically from their entire retail networks, transmit re- stocking orders by telecommunications to their manufacturer-suppliers all over the world, and expect accurate deliveries within days to their specific distribution points. "Quick response" reordering systems can allow American textile mills significant competitive advantages in the fashion apparel business, which now constitutes 40 percent of apparel sales. They make it possible to deliver fabric in one-third the time it takes from Taiwan, and CAD/CAM links between cutters on Seventh Avenue and Southeastern mills can halve the time from design to delivery (Business Month, 1987~. · When a Stratus Corporation customer's mainframe computer malfunctions, its backup system is designed to take over and send a signal to Stratus specifying the particular part the computer may need. The first time the customer may know a problem exists is when the replacement part arrives with the next morning's express delivery (Davis, 1987, p. 149. U.S.-based manufacturers able to link flexible production systems directly

22 JAMES BRIAN QUINN to their customers' market intelligence networks should have very real com- petitive advantages (in both timing and transportation costs) over foreign producers. In the early 1970s Continental Can locked in its customers by putting its Conoweld lines directly into its customers' premises offering the ultimate in supplier-customer integration. Similarly, in heavy, bulky, or complex products such as automobiles, it could become impossible for over- seas producers of more standardized lines to compete against well-developed, responsive, integrated, U.S. manufactunng-distr~bution systems. Already foreign firms investing in U.S.-based manufacturing capacity to get closer to the huge, highly variable U.S. marketplace are helping to generate a "remanufactunng" of the United States. This is noticeably under way in the automotive industry. · Such considerations seem an important factor in Honda's rapid proliferation of auto models and options, its increased emphasis on U.S. production, and the im- portation of its own suppliers to the United States (when U.S. manufacturers proved unwilling or unable to meet Honda's service and quality demands). Honda now offers a much wider variety of styles and options and faster delivery to the U. S . marketplace than it ever could have from a solely Japanese base. Increasingly, it will have to source more of its high value-added components and subassemblies from nearby U.S.-based producers to obtain the response time it needs without escalating in- ventory costs beyond economic levels. In addition, Honda will shortly be helping reduce the U.S. merchandise trade deficit by exporting American-built Accords to Europe and Japan (Business Week, 1988b). Manufacturers Become Services Producers In a variety of other ways, services technologies and their extensions as new "products" for exploitation are becoming vital competitive weapons for large "manufacturing" companies. For example: · General Motors' or Exxon's competitive positions are largely determined by their capacities to manage information worldwide about suppliers, new technolo- gies, exchange rates, swap potentials, or the changing political or market sensitivities in key countries. With crude oil resources primarily in the hands of sovereign nations, Exxon's profits depend ever more on its ability to find, track, deploy, trade, transport, finance, and distribute energy efficiently. All these "services" activities are tech- nology driven. In addition to such logistics activities (especially in worldwide sourc- ing), General Motors has found financial services to be an indispensable competitive weapon in the marketplace. General Motors Acceptance Corporation (GMAC) now manages over $75 billion in private consumer debt, has provided 1/3 to 1/2 of GM's profitability in recent years, and has allowed GM to offer 1.9 percent financing as a pricing strategy to offset competition on a "features" or production cost basis. · At IBM, software has always been a key to success, especially in the early years when it was "bundled" into product and rental prices. Now, with the hardware aspects of computing becoming extremely low cost and competitive, IBM has been

SERVICES TEClINOLOGY AND MANUFACTURING ~3 shifting its focus even more toward software, networks, and communication linkages (services) as its basis for improving value added and profits (Business Week, 1987b). Some manufacturers have initially ventured into services to support their main product offerings, then found that the service itself can become an attractive new product line. For example: · Because of the very high costs its customers incurred if their equipment went down for repair, Caterpillar Co. developed one of the largest, fastest response parts systems in existence with 23 distribution centers, 10 million square feet of storage space in 11 countnes, and 340,000 stock keeping units (SKUs) available to customers on a 24-hour-tu~naround basis for most parts. Recognizing the success of this system, around 1980 some of Caterpillars' customers began asking it to help them manage aspects of their parts control and distribution systems. Caterpillar responded and now has a lively business (Caterpillar Logistics Services) providing logistics and trans- portation services to large manufacturers (such as Land Rover) interested in efficient warehousing and delivery of their own parts on a worldwide basis (Distribution, 1987a). Similarly, foods companies, such as Pillsbury, have found that their large scale distribution and support systems (such as Davmor and Distron servicing Pillsbury's fast food chains) can provide potential new growth opportunities in industrial and institutional feeding. Manufacturers of steel and glass run short-haul railroads that deliver bulky materials to their own and other man- ufacturers' plants. One manufacturer of measurement and control devices used in nuclear power plants runs a personnel services firm with revenues of more than half the parents' supplying trained personnel to operate the complicated measurement and control devices in nuclear facilities. Creative expansions of their own services capabilities can offer other manufacturers new opportunities to share in the growing services market directly. Services Lower Costs and Increase Product Value Many aspects of a manufacturer's cost competitiveness depend intimately on services. Greater efficiencies in communications, transportation, financ- ing, distribution, health care, or waste handling (services industries) can markedly affect a manufacturer's direct costs. To the extent that these services also improve the quality of life or lower living costs in the United States, they indirectly create downward pressures on U.S. wages relative to foreign nations. That is, for any given wage level U.S. manufacturing employees can live better than foreign workers in countries with less efficient services. And in most areas the efficiency of U.S. services industries has been more than competitive, even compared with Japan (see Table 21. In fact Japan has usually suffered a large negative trade balance in services (Tanaka, 19841. It should be noted that Japan's services industries have not been standing still since 1980; the application of new technologies, deregulation, and rising

24 TABLE 2 U.S. and Japanese Productivity in Servicesa JAMES BRIAN QUINN U.S. Output per Japan U.S. Hour as a % of Japanese Output per 1970 1980 1970 1980 Hour, 1980 Private domestic business 3.59 6.01 9.40 10.06 167 Agriculture 1.37 2.38 16.53 18.36 771 Selected services Transportation and communications 3.86 5.66 9.29 13.14 232 Electricity, gas, water 14.01 19.74 21.98 25.38 129 Trade 2.88 4.53 6.88 7.92 175 Finance and insurance 6.69 12.03 8.21 8.20 68 Business services 2.29 3.60 7.69 7.59 211 Manufacturing 3.91 8.00 7.92 10.17 127 aMeasured as output per hour in 1975 dollars. SOURCE: UNIPUB, 1984. consumerism have no doubt created restructurings, innovations, and im- proved efficiencies. The following attest to that trend: (1) the rapid rise in catalog sales and the increasing use of telemarketing techniques; (2) the innovations in the household-moving business led by Art Moving and the boom in just-in-time trucking and parcel courier services; and (3) the in- stallation by deregulated insurance companies of expanded nationwide com- puter networks designed to increase the level of automation in field offices and to improve their headquarters' ability to develop new products. Given Japan's emphasis on the information industries and its proved capability to apply new technologies, one would expect the trend to grow even stronger in the future. Within manufacturing some 75 percent of all costs-and a much higher percentage of value added is generally due to services activities (Office of the United States Trade Representative, 1983; Vollman, 1986, p. 149~. The major value added to a product is typically less due to its basic commodity value (i.e., producing the "body in white" for an automobile or the grain and vegetables in a processed food) than to the styling features, perceived quality, subjective taste, distribution, marketing presentation added by "ser- vices" activities inside or outside the producing company. Except in con- tinuous process industries (such as oil refining or chemicals manufacturing), planning, accounting, inventory, quality assurance, transportation, design, advertising, and distribution costs generally outweigh direct labor costs by factors of between 3 to 1 and 10 to 1. Most companies have diligently driven out direct labor costs while only cautiously attacking the greater costs and value added potentials of their

SERVICES TECHNOLOGY AND MANUFACTURING 25 services functions. Aggressively managing services activities within manu- facturing enterprises to both improve quality and lower costs can provide a major attack point for improving competitiveness. Successful quality pro- grams start by analyzing quality from the customers' viewpoint and then emphasize quality considerations in all functions from design through final shipping and presentation, mostly services activities. Two examples will suggest how some large companies have approached this complex problem. · In the automobile industry, designing and introducing a new car line are major components of overhead costs and significant contributors to the value the customer perceives in the product. At Ford this design cycle had taken 5 to 6 years and could cost several billion dollars. In 1980, Ford's chief executive officer Philip Caldwell and president Donald Petersen decided to undertake a new "simultaneous design" process for their new upper middle line, which became the Taurus/Sable cars. To integrate design from research to marketing, they established a core group, called Team Taurus, which had a full-time representative from all of the critical groups within Ford product design, component engineering, manufacturing, sales, mar- keting, purchasing, service, legal, environmental and safety engineering, and cor- porate headquarters (virtually all "services operations". Instead of moving the design linearly along these groups to the marketplace with numerous conflicts and design reworks- Team Taurus involved everyone from suppliers to workers, dis- tributors, repairmen, customers, and even insurance and media representatives from the outset. The result: Taurus/Sable's introduction cost some $250 million less than its design budget, and the cars were exceptionally successful in the marketplace. Future cars will be designed with the same process in only 3 or 4 years- potentially saving Ford hundreds of millions of dollars more and ensuring that manufacturing design is much closer to customer desires. · Black and Decker (B&D), faced by both U.S. inflation and strong cost com- petition from overseas manufacturers, decided it had to radically redesign its products for greater value added and lower cost. It focused on (1) simplifying its product offering, (2) developing a "family" look for the 122 basic tools (with hundreds of variations) in its line, (3) standardizing materials and components, and (4) creating new product features specifically adapting the products to meet worldwide (non- U.S.) product specifications. In a program that took 7 years to break even, B&D drove labor costs down in each component to such "tnvial" levels that no competitor could obtain a meaningful competitive edge by simply having lower labor costs. Interestingly, however, B&D found that its simplification and automation programs drove out about $3 of overhead for each $1 of labor saved, and its standardization programs substantially improved the rapidity, efficiency, and effectiveness of its future product development capabilities (Lehnerd, 1987~. The Strategic Planning Institute's Profit Impact of Management Strategy (PIMS) data base clearly shows that financial performance is directly related to the perceived quality of a company's goods and services. Not surprisingly, one of the biggest determinants of perceptions of overall quality is customer service. As the two examples above illustrate, greater attention to product

26 JA3IES BRIAN QUINN design which ultimately shows up as customer service is a significant com- ponent of improving quality. Using technology more directly, Cadillac has vastly increased its service ratings by linking its dealers' mechanics with a corps of 10 engineers who use a computerized data base of engineering drawings and service bulletins to walk them through difficult repairs so that a Cadillac gets repaired right the first time (Uttar, 1987, p. 1161. In an effort to improve the product support so essential to sales of its aircraft engines, Pratt & Whitney following We dictates of SAS's Jan Carlzon has slashed layers of bureaucracy and pushed decision making down the chain of com- mand to the people who actually deal with the customers so they can fix or replace a part and worry about whether it is covered in the customer's support contract later (Air Transport World, 19881. Services Support International Manufacturing Operations One of the areas where services technologies affect manufacturing most markedly is in international operations. Telecommunications, air transport, and improved surface cargo handling technologies have forced virtually all manufacturers to consider their supply sources, markets, and competition on a worldwide scale or to lose their competitive position. Although the figures do not show up in merchandise trade balance statistics, the greatest impact of U.S. manufacturing technology on world markets is probably through multinational companies' operations inside host countries. Approximately one-fifth of the total capital invested in U.S. manufacturing firms is in facilities outside the United States. And some of the largest continuing fa- vorable net balance-of-trade accounts for the United States have been the profits, royalties, and intercorporate sales these multinationals remit to the United States (see Table 3~. Effective coordination of these giant enterprises-and many much smaller companies' international transactions clearly depends on services technol . an. . . Ogles ant ettlc1encles. · IBM, in bringing forth its 360 computer series in 1962-1964, is often credited TABLE 3 Manufacturing Related Trade Balances ($ Billions) (category 1970 19751982 19851987a Royalties and fees, net 2.1 3.84.6 5.36.8 Direct investments, net 2.6 14.418.2 26.635.3 Merchandise, netb 2.6 8.9(36.4) (122.1)(159.2) aPreliminary figures. bExcluding military. SOURCE: Bureau of Economic Analysis, U.S. International Transactions.

SERVICES TECHNOLOGY AND MANUFACTURING 27 with the first truly simultaneous international design of a product line. Its various laboratories became permanently linked by telecommunications for daily coordination of the design process. Ford Motor Company has recognized the huge advantages it can achieve by designing and engineering different sized platforms for its cars only once (at specified "centers of excellence") to get maximum economies of scale, then doing the styling and feature designs for its different markets within its sub- sidiaries in individual countries. The corporation later coordinates cost comparisons for various features, sourcing performance, market information, parts inventories, and customer service activities through its large transborder data network (Business Week, 1987a). · Global information systems and data bases dealing with exchange rate fluctua- tions, transportation alternatives, and sourcing performance have become crucial competitive weapons in manufacturing. While labor, materials, and plant level over- head costs tend to drop markedly with offshore manufacture, logistics costs tend to increase by a factor of about 20 percent and tariffs can become a significant factor. So important are these costs that before an experienced Japanese automobile man- ufacturer would begin its joint venture in the United States, it set as its target having "the most cost efficient inbound-outbound logistics system in the world." Since most of the other costs of manufacture here and in Japan were essentially fixed, logistics control technologies became We key strategic variables (Distribution, 1987b). Recognizing the importance that cross-border data and services flows have in foreign companies' competitive postures, many host countries are trying to tax or regulate such activities. Since the real economies of scale multi- national manufacturing companies most often enjoy are due to their services capabilities i.e., technology transfer, marketing skills, financial services, logistics-rather than plant scale economies, such restrictions on data and services flows are as significant to manufacturers as they are to international services providers. Worldwide integration of manufacturing operations through services technologies is essential for producers seeking competitive advantage in today's world. Manufacturers Benefit from External Services Innovations As technology creates new capabilities, economies of scale, or economies of scope for services, manufacturers will constantly have to reassess when to produce their own services or buy them "out of house." Many have found that specialized services companies can handle their accounting, legal, pay- roll, benefits, maintenance, repair, or even research and design functions much more effectively than they can "in house." This is one of the factors contributing to the rapid growth of the business services industry in recent years-in 1982 business services accounted for $90.7 million of GNP and employed 3.4 million people; by 1986 it provided $162.8 million of GNP and 4.9 million jobs (Kutscher, 1988; Tschetter, 19871. More than this, services companies have become major innovators on their

28 JAMES BRIAN QUINN own. Focused and imaginative technology investments by many business and professional services providers have greatly improved the quality, range, and flexibility of their services offerings. Although these services companies often cannot translate such product improvements into higher margins, man- ufacturers and other customers benefit directly. Unless manufacturers sys- tematically and continuously cultivate the innovations services suppliers can provide, they will miss out on important sources of competitive advantage. For example: ~ Federal Express has been a leader in the development of package sorting, handling, and control equipment and techniques. Based upon this expertise, Federal Express now offers its package tracking and supporting systems as a part of a service to help producers automate their own shipping docks and package handling activities. · A freighter waiting at the Suez Canal or at a customs wharf in France will often have to pay all required fees before it can pass through or unload. As an alternative to paying an 8-day float on funds cleared through venous correspondent banks and $10,000 per day of waiting cost for the ship, Citicorp offers a service for instant transfer of funds to a local (Port Said or Marseilles) correspondent bank as soon as the fee is known thus saving manufacturing customers unnecessary costs on the (otherwise) delayed cargo (Davis, 1987, p. 181. ~ Michigan Bell has created innovative new "facilitating" services such as those which improve communications among the Big Three automakers and their sup- pliers coordinating hardware and software vendors in developing and exchanging engineering drawings and specifications between job shops and factories. Although Michigan Bell started with such large company networking projects, it should be able to roll out this experience to other areas. It can offer a shared service (with a standard interface system) providing state of the art design and specification coor- dination to large and small manufacturers alike (Managing Automation, 1987~. · Finally, services technologies offer a rich new array of channels through which manufacturers can reach specialized segments of their markets. Electronic home shopping and interactive video terminals located in banks, airports, hotels, airplanes, and shopping malls allow manufacturers to contact whole new groupings of customers in a psychological situation where they are likely to buy. Similar technologies in retail showrooms allow customers to see a full array of a manufacturer's product line when the retailer-for example a shoe or furniture outlet could not carry all possible sizes and variations of the product. With services enterprises growing rapidly in scale and technical sophis- tication, the opportunities are expanding for manufacturers to leverage their own internal innovation programs by exploiting those of services suppliers, just as they do those of product vendors. Although 75 percent of a manu- facturer's costs are in "services" activities, flexible manufacturing systems (FMS) and computer integrated manufacturing (CIM) are likely to drive variable costs even lower and hence the percentage of costs represented by services support and other fixed costs higher. Consequently, there should

SERVICES TECHNOLOGY AND MANUFACTURING 29 be enhanced incentives for more effective use of services suppliers' inno- vative capabilities. In fact, EMS and CIM installation themselves are unlikely to be effective if proper attention is not given to services support arrangements such as training, cost accounting, personnel practices, organization, com- munication, and control systems. Because internal groups are likely to be inexperienced in such matters or biased by old ways of doing things, the required expertise for such changeovers may often be found only in external services groups. MANUFACTURING'S CHANGING STRATEGIC ENVIRONMENT Perhaps the most important structural change in international manufactur- ing competition stems from the continuing integration (through electronics) of the world's financial centers into a single world financial marketplace. World financial flows have already become largely disconnected from trade flows.2 Although world trade in goods and services aggregates only $3-4 trillion annually, financial transactions by the Clearing House for Interna- tional Payments (CHIPS) alone totaled $105 trillion in 1986- and early 1987 transactions were running more than $200 trillion on an annualized basis. Turnover on the 1986 Eurodollar market also amounted to $75 trillion. Any of these sums dwarfs world merchandise trade, just as Fedwire's $125 trillion of 1986 domestic transactions dwarfed the $4 trillion GNP of the United States. Instead of following trade in goods, money now flows toward the highest available real interest rates or returns in safer, more stable economic situations. Exchange Rates Determine Manufacturing Costs As a result, exchange rates have fluctuated approximately +50 percent among major trading partners within a few years, principally because of fiscal or monetary not trade or management decisions. Comparative costs for an international competitor are often more a function of exchange rates than of productivity or competitive managerial decisions. Even skillful Jap- anese manufacturers have found it difficult to compete when the rising value of the yen pushes their relative costs up by 48 percent in 18 months against competitors paying for wages and materials in U.S. dollars. But they appear to be responding with dramatic productivity increases and transfers of op- erations offshore (Business Week, 1988a). As was recently demonstrated, the short-run volatility of securities markets has amplified enormously because of the capacity of large investor groups to move rapidly into or out of world securities and funds markets. The stimuli that disrupt a nation's capital markets and relative cost structures can easily come from outside sources. Consequently, it has become increasingly dif

30 JAMES BRIAN QUINN ficult for sovereign nations to control their economies in the short run or to fine tune them through traditional fiscal or monetary interventions. And it has become impossible for major manufacturers to operate effectively without global plant location, sourcing, logistics, and financial strategies. With freer access to world capital markets everywhere, it is becoming very difficult for a single nation to maintain differentially low capital costs as a policy as Japan has in recent years and as the United States once did- in support of aggressive economic development or trade objectives. As capital costs among nations are leveled by globalized financial markets, countries such as the United States and Japan with high domestic labor and materials costs-will be under ever greater pressures to move manufacturing overseas. Among the few alternatives available is innovation, in both technical and structural terms, at a rate others cannot match. A key element will be in- novative utilization of the full potentials of services technologies both inter- nally and externally. Simply targeting more reductions in direct labor and materials costs will not be sufficient (Bleeke and Bryan, 19881. New Power Relationships with Services Groups The entire power relationship between manufacturing and services groups is changing profoundly. For example: · As the number of major airlines (services providers) declined through consol- idation due to deregulation and the introduction of wide-bodied jets, aircraft man- ufacturers had to modify their strategies. The number of U.S.-lead customers for a firm such as Boeing has shrunk to a handful of large "megacarriers," each with a more powerful bargaining position than before. The military no longer can provide the "first order" volumes necessary to launch a commercial aircraft. Consequently, to obtain essential economies of scale, yet satisfy each customer, companies such as Boeing have invested heavily (more than $800 million) in flexible automation, allowing them to modify their aircrafts' internal seating, baggage storage, mainte- nance system, and customer convenience patterns to suit virtually any requirement their major customers might conceive over the useful life of the aircraft. Boeing is even proposing to restructure its overall cabin configuration (in its 7J7 aircraft) in response to the recommendation of SAS's President J. Carlzon that airline seating patterns would be optimized if the cabin cross section were a horizontal ellipse rather than a circle or vertical ellipse. The coming deregulation of Europe's airlines will Only lead to further concentration in the world's airline industry. ~ Even when buyers have not consolidated into large individual units, services technologies allow them to achieve similar bargaining power. For example, a team of airline and manufacturer-supplier experts, coordinated by the Air Transport As- sociation, has created an automated parts procurement system (Spec 2000) that is expected to save millions of dollars and can be accessed using a personal computer. Spec 2000 is a computerized compendium of manufacturers' catalogs including more than a million part numbers and an automated computer-to-computer ordering system.

SERVICES TECHNOLOGY AND MANUFACTURING 31 Not only does the system allow an airline to get comparative specification and quotation data, but it also gives information about how vendors meet their delivery and performance criteria, thus increasing the information leverages of all potential purchasers (Air Transport World, 1987~. Retailers with electronic point of sale sys- tems and those that use McKinsey's Direct Product Profitability (DPP) analyses have also found that they now have the best information and thus increased bargaining power over their product suppliers. In response, Procter & Gamble has reorganized itself and changed many of its long-established attitudes and ways of doing business. · Large retailers, such as Sears (or IKEA), can offer instant distribution for any manufacturer's consumer product (or furniture) innovations, with powerful presen- tation and financial support for any products they accept. Thus, overseas producers have immediate access to U.S. (or European) markets without creating the costly distribution channels they once had to build. Access to large retail electronics chains has provided rapid penetration for many Asian "clones" competing with U.S. man- ufacturers. Along with the capacity of the retail and distribution system to help manufacturers target and design their products better, such potentials call for much more attention to carefully developed "downstream alliances" in manufacturers' strategies. · Services suppliers' cost leverages have also increased. Many manufacturers find that their medical care or insurance outlays for employees are higher than their own profits. Hence, new strategies creating "coalitions" with providers and insurers have emerged as key elements in cost control.3 Deregulation has created more powerful transportation companies with intermodal handling capabilities that can increase shipping efficiencies enormously, but at the cost of much more bargaining power against manufacturers or other shippers. And large money center banks have the information, instant capital access, and worldwide connections to manage a com- pany's financial assets with a knowledge base and leverage few manufacturers can equal. Disintermediation Builds New Industries Disintermediation of service activities through product substitutions offers powerful new strategic options. All "services" or "goods" are really just means for providing satisfaction to customers. Thus, the boundary between services and manufactures is very fluid and varies widely over time. Rec- ognizing this, manufacturers can greatly extend the scope of their operations, lower costs, and expand their margins by eliminating or taking over adjacent services functions sometimes opening up entire new support industries. For example: · In the early days of computers, a high priesthood controlled access to huge machines that ran only in their own special, environmentally controlled temples. Programmers or others "submitted" punched cards or tapes for processing, often at inconvenient times determined by the priesthood. By designing their machines and software to be more "user friendly," manufacturers slowly eliminated the priesthood and expanded their markets in the process. The success of Apple computers and the

32 JAMES BRIAN QUINN IBM PC was essentially due to service disintermediation, which (oddly enough) later opened more services and product opportunities through clever use of the computers and design of software for them. · "Pennanent press" and crease resistant fabrics, textile and fibers manufacturing innovations, have significantly restructured the white goods, apparel, and personal services industries. In the past, those who could afford it sent their tablecloths, bed linens, and dress clothing (especially men's trousers and shirts) to the laundry, getting them back neatly ironed in a week or so. Others spent hours tediously ironing in their own homes. Permanent press and "wash and wear" fabrics shrank the com- mercial laundry business, increased the attractiveness of home washers, dryers, and "touch up" irons, and freed domestic workers and homemakers for other tasks. To fully exploit permanent press possibilities (a services disinterrnediation), new deter- gents, whiteners, and home laundry equipment designs soon appeared, changing the nature of competition in those fields as well. The potentials for such substitutions of products for services abound. Automated communications systems have eliminated tiers of banking, bro- kerage, and insurance personnel. Increased "quality" in home appliances and automobiles has decreased the personal time, cost, and frustrations con- sumers expend on maintenance and repair. Prepared gourmet foods, con- venience mixes, and microwave dinners substitute for restaurant sales and home cooking time. And so on. CONCLUSIONS: SERVICES INNOVATION Discussions concerning U.S. competitiveness have tended to overlook two major areas for innovation and productivity improvement services and the manufacturing-services interface. Technological changes in services have radically altered the economy and the strategic environment in ways that offer significant new opportunities and threats for technologists and investors. In addition to providing major innovative opportunities in their own right, services industries have become some of the most important customers, suppliers, and coalition partners for manufacturing concerns. In these roles, U.S. services enterprises both are near at hand and are generally among the most efficient performers in the world. In addition, services technologies offer a variety of ways for manufacturers to add value or lower costs within their own operations. This paper has merely attempted to offer a few useful case vignettes; other cases in this volume will develop some of these in detail. The United States painfully learned that its goods-producing industries were vulnerable to challenges from abroad. So too are the services on which much of the nation's economic wealth depends. It is difficult for even well- run services establishments to maintain their competitive advantages when everyone can buy the same hardware and software, connect into the same networks, and exploit the offerings of suppliers with strong incentives to sell

SERVICES TECHNOLOGY AND MANUFACTURING 33 their products as quickly and widely as possible throughout the world. It is becoming ever more important that services companies develop their own internal technological capacities and strategically leverage these in conjunc- tion with manufacturing concerns and other services companies. It will take hard and dedicated work not to dissipate the broad-based lead that the United States enjoys in services. Seemingly secure markets may be easy to invade. On the one hand, U.S. policies of deregulation in commu- nications and financial markets may have given the United States a lead that, some say, other countries' more regulated sectors will find difficult ever to close. But those countries are deregulating, too, and there is little room for complacency. Deregulation also opens domestic U.S. markets to foreign competition. And many countries and foreign companies have proved that their skills in managing services enterprises are formidable indeed. Unfortunately, we daily encounter the same inattention to quality, emphasis on scale economies rather than customers' concerns, and short-term financial orientation that earlier injured manufacturing. Too many services companies have been slow to invest in the new market opportunities and flexible tech- nologies available to them. They have stayed with their old concepts too long and have concentrated on cost-cutting efficiencies they can quantify, rather than on adding to their product value by listening carefully and flexibly providing the services their customers genuinely want. The cases and con- cepts in this book are intended to help others avoid these errors and understand some of the opportunities and complexities of introducing new technologies in the services and services-manufacturing areas. The strengths of manufac- turing and services in the United States are intimately intertwined. Increas- ingly, success in both services and manufacturing will go to those who understand and successfully combine the new potentials of services and manufacturing technologies. ACKNOWLEDGMENTS The author gratefully acknowledges the important contributions of Dr. Jordan J. Baruch and Penny C. Paquette in developing this paper, as well as the generosity of Bankers Trust Company, Bell & Howell Company, Royal Bank of Canada, Braxton Associates, and Bell Atlanticom Co. in supporting this research. NOTES 1. The selected business services category includes travel, passenger fares, and other trans- portation areas where large negative balances exist today as well as fees and royalties where positive balances have continued to grow and other private services where balances have changed little over the S-year period from 1982 to 1987. Statistics are taken from the U.S. International Transactions series published in Survey of Current Business.

34 JAMES BRIAN QUINN 2. S. Bell and B. Kettell estimate that 95 percent of the daily volume in foreign exchange markets in 1983 was not direct commercial business but trading between the foreign ex- change dealers of the world's international banks (Foreign Exchange Handbook, Quorum Books, Westport, Conn., 1983, p. 3). 3. At the national level, The Washington Business Group on Health has been attempting to coordinate provider, payer, and government agency groups that need to cooperate on this issue and started publishing Business and Health to bring the views of both private and public authorities to the fore. REFERENCES Air Transport World. January 1987. Spec 2000 weds airline procurement systems with awto- matic technology. P. 66. Air Transport World. February 1988. Product support: Promises, promises. Pp. 25-31. Bell, S., and B. Kettell. 1983. Foreign Exchange Handbook. Westport, Conn.: Quorum Books. Bleeke, J., and L. Bryan. 1988. The globalization of financial markets. McKinsey Quarterly (Winter): 17-38. Booz Allen & Hamilton. Undated. From strategic planning to strategic performance: Closing the achievement gap. Outlook. Number 4. Business Month. April 1987. Taking Control in the Rag Trade. P. 49. Business Week. September 28, 1987(a). Can Ford stay on top. Pp. 78-86. Business Week. November 30, 1987(b). Computers: The new look. Pp. 112-122. Business Week. December 21, 1987(c). Power retailers. P. 92. Business Week. January 18, 1988(a). Japan's latest triumph: Hurdling the high yen. Pp. 36- 41. Business Week. February 29, 1988(b). U.S. exporters that aren't American. Pp. 70-71. Carlzon, J. 1987. Moments of Truth. Cambridge, Mass.: Ballinger Publishing Co. Davis, S. 1987. Future Perfect. Reading, Mass.: Addison-Wesley. Distribution. September 1987(a). CLS explores new logistics frontiers. Pp. 52-54. Distribution. October 1987(b). International logistics management. Pp. 13-20. The Economist. July 6, 1985. The other dimension: Technology and the City of London. A survey. p.6. The Economist. June 27, 1987 (a). British food retailers: Checking out. P. 73. The Economist. December 5, 1987 (b). Purveyors to all nations. P. 16. Kutscher, R. 1988. Growth of service employment in the United States. In Technology in Services: Policies for Growth, Trade, and Employment, B. R. Guile and J. B. Quinn, eds. Washington, D.C.: National Academy Press. Lehnerd, A. P. 1987. Revitalizing the manufacture and design of mature global products. Pp. 49-64 in Technology and Global Industry, B. R. Guile and H. Brooks, eds. Washington, D.C.: National Academy Press. Managing Automation. October 1987. Ameritech has promises for future manufacturing. Pp. 48-49. Office of the United States Trade Representative. December 1983. U.S. National Study on Trade in Services. Washington, D.C. Porter, M. 1985. Competitive Advantage. New York: Macmillan & Co. Roach S. 1988. Technology and the service sector: America's hidden competitive challenge. In Technology in Services: Policies for Growth, Trade, and Employment, B. R. Guile and J. B. Quinn, eds. Washington, D.C.: National Academy Press. Tanaka, M. 1984. Moving beyond merchandise: Japan's trade in services. Journal of Japanese Trade and Industry 4:12-15.

SERVICES TECHNOLOGY AND MANUFACTURING 35 Tschetter, J. 1987. Producer services industries: Why are they growing so rapidly. Monthly Labor Review (December):31-40. UNIPUB. 1984. Measuring Productivity: Trends and Comparisons from the First International Productivity Symposium, Tokyo, Japan, 1983. New York: UNIPUB. Uttal, B. 1987. Companies that serve you best. Fortune (December 7):98-116. Vollman, T. 1986. The effect of zero inventories on cost (just in time). Pp. 141-164 in Cost Accounting for the '9Os: The Challenge of Technological Change. Montvale, N.J.: National Association of Accountants.

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This book of case histories is devoted solely to service industries and the technologies that drive them, as told by those who have developed segments of these industries. The chapters cover innovations such as Federal Express's advanced system for package tracking, Citicorp's development of the Automated Teller Machine, AT&T's experience with mobile telephones, Bell & Howell's introduction of an automated automotive parts catalog, and the New York Stock Exchange's development of electronic trading. Some broader analyses discuss the interfaces between services technologies and manufacturing, operations research in services, and technology in professional services.

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