when service companies put employees and customers first, aradical shift occurs in the way they manage and measure success.

Putting the Service-ProfitChain to Work

by James L. Heskett, Thomas O. Jones, Gary W. Loveman,W. Earl Sasser, Jr., and Leonard A. Schlesinger

Top-level executives of outstanding service orga-nizations spend little time setting profit goals or fo-cusing on market share, the management mantra ofthe 1970s and 1980s. Instead, they understand thatin the new economics of service, frontline workersand customers need to be the center of manage-ment concern. Successful service managers pay at-tention to the factors that drive profitability in thisnew service paradigm: investment in people, tech-nology that supports frontline workers, revampedrecruiting and training practices, and compensa-tion linked to performance for employees at everylevel. And they express a vision of leadership interms rarely heard in corporate America: an organi-zation's "patina of spirituality," the "importance ofthe mundane."

A growing number of companies that includesBane One, Intuit Corporation, Southwest Airlines,ServiceMaster, USAA, Taco Bell, and MCI knowthat when they make employees and customersparamount, a radical shift occurs in the way theymanage and measure success. The new economicsof service requires innovative measurement tech-niques. These techniques calibrate the impact of

James L. Heskett, Thomas O. Jones, Gary VV. Loveman,W. Earl Sasser. Jr., and Leonard A. Schlesinger are mem-bers of the Harvard Business School faculty and service-management interest group.

employee satisfaction, loyalty, and productivity onthe value of products and services delivered so thatmanagers can build customer satisfaction and loy-alty and assess the corresponding impact on prof-itability and growth. In fact, the lifetime value ofa loyal customer can be astronomical, especiallywhen referrals are added to the economics of cus-tomer retention and repeat purchases of relatedproducts. For example, the lifetime revenue streamfrom a loyal pizza eater can be $8,000, a Cadillacowner $332,000, and a corporate purchaser of com-mercial aircraft literally billions of dollars.

The service-profit chain, developed from analy-ses of successful service organizations, puts "hard"values on "soft" measures. It helps managers targetnew investments to develop service and satisfac-tion levels for maximum competitive impact, wid-ening the gap between service leaders and theirmerely good competitors.

The Service-Profit Chain

The service-profit chain establishes relationshipsbetween profitability, customer loyalty, and em-ployee satisfaction, loyalty, and productivity. Thelinks in the chain (which should be regarded aspropositions) are as follows: Profit and growth arestimulated primarily by customer loyalty. Loyalty

164 DRAWINGS BY GARISON WEILAND

is a direct result of customer satisfaction. Satisfac-tion is largely influenced by the value of servicesprovided to customers. Value is created by satisfied,loyal, and productive employees. Employee satis-faction, in turn, results primarily from high-qualitysupport services and policies that enable employeesto deliver results to customers. (See the chart, "TheLinks in the Service-Profit Chain.")

The service-profit chain is also defined by a spe-cial kind of leadership. CEOs of exemplary servicecompanies emphasize the importance of each em-ployee and customer. For these CEOs, the focus oncustomers and employees is no empty slogan tai-lored to an annual management meeting. For exam-ple, Herbert Kelleher, CEO of Southwest Airlines,can be found aboard airplanes, on tarmacs, and interminals, interacting with employees and cus-tomers. Kelleher believes that hiring employeesthat have the right attitude is so important that thehiring process takes on a "patina of spirituality." Inaddition, he believes that "anyone who looks atthings solely in terms of factors that can easily bequantified is missing the heart of husiness, which ispeople." William Pollard, the chairman of Service-Master, continually underscores the importance of"teacher-learner" managers, who have what hecalls "a servant's heart." And John McCoy, CEO ofBane One, stresses the "uncommon partnership,"a system of support that providesmaximum latitude to individualbank presidents while supplying in-formation systems and commonmeasurements of customer satisfac-tion and financial measures.

A closer look at each link revealshow the service-profit chain func-tions as a whole.

Customer Loyalty DrivesProfitability and Growth

To maximize profit, managershave pursued the Holy Grail ofbecoming number-one or -two intheir industries for nearly twodecades. Recently, however, newmeasures of service industries likusoftware and banking suggest thaicustomer loyalty is a more impor-tant determinant of profit. (SeeFrederick F. Reichheld and W. EarlSasser, Jr., "Zero Defections: QualityComes to Services," HBR September-October 1990.) Reicbheld and Sasserestimate that a 5% increase in cus-

tomer loyalty can produce profit increases from25% to 85%. They conclude tbat quality of marketshare, measured in terms of customer loyalty, de-serves as much attention as cjuantity of share.

Bane One, based in Columbus, Obio, has devel-oped a sophisticated system to track several factorsinvolved in customer loyalty and satisfaction. Oncedriven strictly by financial measures. Bane Onenow conducts quarterly measures of customer re-tention; the number of services used by each cus-tomer, or depth of relationship-, and the level ofcustomer satisfaction. The strategies derived fromthis information help explain why Bane One hasachieved a return on assets more than double thatof its competitors in recent years.

Customer Satisfaction DrivesCustomer Loyally

Leading service companies are currently trying toquantify customer satisfaction. For example, forseveral years, Xerox has polled 480,000 customersper year regarding product and service satisfactionusing a five-point scale from 5 (high) to 1 (low). Un-til two years ago, Xerox's goal was to achieve 100%4s (satisfied) and 5s (very satisfied) by the end of1993. But in 1991, an analysis of customers wbogave Xerox 4s and 5s on satisfaction found that the

The lifetime value of a loyal pizza ^ater can be as much as $8,000.

HARVARD BUSINESS REVIEW M^irch April 1994 165

OperaHng Strategy andService Delivery System

iravenueGrowth

CustomerLoyalty

CustomerSatiifoction

ServiceQuality

employeeProductivity ^ Profitablity

u service concept:results for customers

n retentionD repeat businessD referral

D workplace designD job designD employee selection

and developmentD employee rewards

and recognitionD tools for serving customers

D service designed anddelivered to meettargeted customers' needs

relationships hetween the scores and actual loyaltydiffered greatly depending on whether the cus-tomers were very satisfied or satisfied. Customersgiving Xerox 5s were six times more likely to repur-chase Xerox equipment than those giving 4s.

This analysis led Xerox to extend its efforts tocreate apostles-a term coined hy Scott D. Cook,CEO of software producer and distrihutor. IntuitCorporation, describing customers so satisfied thatthey convert the uninitiated to a product or service.Xerox's management currently wants to achieve100% apostles, or 5s, by the end of 1996 by up-grading service levels and guaranteeing customersatisfaction. But just as important for Xerox'sprofitability is to avoid creating terrorists: cus-tomers so unhappy that they speak out against apoorly delivered service at every opportunity. Ter-rorists can reach hundreds of potential customers.In some instances, they can even discourage ac-quaintances from trying a service or product. (Seethe graph "A Satisfied Customer Is Loyal.")

Value Drives Customer Satisfaction

Customers today are strongly value oriented. Butjust what does that mean? Customers tell us thatvalue means the results they receive in relation to

the total costs (botb tbe price and otber costs to cus-tomers incurred in acquiring the service). The in-surance company, Progressive Corporation, is cre-ating just this kind of value for its customers hyprocessing and paying claims quickly and with lit-tle policyholder effort. Members of the company'sCAT (catastrophe) team fly to the scene of major ac-cidents, providing support services like transporta-tion and housing and handling claims rapidly. By re-ducing legal costs and actually placing more moneyin the hands of the injured parties, the CAT teammore than makes up for the added expenses the or-ganization incurs hy maintaining the team. In addi-tion, the CAT team delivers value to customers,wbicb belps explain why Progressive has one of thehighest margins in the property-and-casualty insur-ance industry.

Employee Productivity Drives Value

At Southwest Airlines, the seventh-largest U.S.domestic carrier, an astonishing story of employ-ee productivity occurs daily. Eighty-six percent ofthe company's 14,000 employees are unionized. Po-sitions are designed so that employees can per-form several johs if necessary. Schedules, routes,and company practices - such as open seating and

166 HARVARD BUSINESS REVIEW March April 1994

THE SERVICE-PROFIT CHAIN

the use of simple, color-coded, reusable boardingpasses - enahle the boarding of three and four tim.esmore passengers per day than competing airlines. Infact. Southwest deplanes and reloads two-thirds ofits flights in 15 minutes or less. Because of aircraftavailability and short-haul routes that don't requirelong layovers for flight crews. Southwest has rough-ly 40% more pilot and aircraft utilization than itsmajor competitors: its pilots fly on average 70 hoursper month versus 50 hours at other airlines. Thesefactors explain how the company can charge faresfrom 60% to 70% lower tban existing fares in mar-kets it enters.

At Soutbwest, customer perceptions of value arevery high, even though the airline does not assignseats, offer meals, or integrate its reservation sys-tem with other airlines. Customers place high val-ue on Southwest's frequent departures, on-timeservice, friendly employees, and very low fares.Southwest's management knows tbis because itsmajor marketing research unit-i ts 14,000 employ-ees-is in daily contact with customers and reportsits findings back to management. In addition, theFederal Aviation Administration's performancemeasures show that Southwest, of all the major air-lines, regularly achieves the highest level of on-time arrivals, the lowest numher of complaints,and the fewest lost-baggage claims per 1,000 pas-sengers. When comhined withSouthwest's low fares per seat-mile, these indicators show thehigher value delivered by South-west's employees compared withmost domestic competi tors .Southwest has been profitable for21 consecutive years and was theonly major airline to realize aprofit in 1992. (See the graph"How Southwest Compares withIts Competitors.")

that the average monthly cost of replacing a salesrepresentative who had five to eight years of experi-ence with an employee who had less than one yearof experience was as much as $36,000 in sales. Andthe costs of losing a valued broker at a securitiesfirm can be still more dire. Conservatively estimat-ed, it takes nearly five years for a broker to rebuildrelationships with customers that can return $1million per year in commissions to tbe brokeragehouse-a cumulative loss of at least $2.5 million incommissions.

Employee Satisfaction Drives LoyaltyIn one 1991 proprietary study of a property-and-

casualty insurance company's employees, 30% ofall dissatisfied employees registered an intention toleave the company, a potential turnover rate threetimes higher than that for satisfied employees. Inthis same case, low employee turnover was foundto be linked closely to high customer satisfaction.In contrast, Southwest Airlines, recently namedone of the country's ten best places to work, experi-ences the highest rate of employee retention in theairline industry. Satisfaction levels are so high thatat some of its operating locations, employeeturnover rates are less than 5% per year. USAA, amajor provider of insurance and other financial ser-

Employee Loyalty DrivesProductivity

Traditional measures of thelosses incurred by employeeturnover concentrate only on thecost of recruiting, hiring, andtraining replacements. In mostservice jobs, the real cost ofturnover is the loss of productivi-ty and decreased customer satis-faction. One recent study of anautomobile dealer's sales person-nel by Abt Associates concluded

A Satisfied Customer Is Loyal

100%

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60

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zone of indifference

zone of defection

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1 2 3 4extremely somewhat slightly satisfieddissatisfied dissatisfied dissatisfied

Satisfaction Measure

verysatisfied

HARVARD BUSINESS REVIEW March April 1994 167

THE SERVICE-PROFIT CHAIN

vices by direct mail and phone, also achieves lowlevels of employee turnover by ensuring that itsemployees are highly satisfied. But what drives em-ployee satisfaction: Is it compensation, perks, orplush workplaces;

Internal Quality DrivesEmployee Satisfaction

what we call the internal quality of a workingenvironment contributes most to employee satis-faction. Internal quality is measured by tbe feelingsthat employees bave toward tbeir jobs, colleagues,and companies. What do service employees valuemost on the job? Although our data arc preliminaryat best, they point increasingly to the ability andauthority of service workers to achieve results forcustomers. At USAA, for example, telephone salesand service representatives are backed by a sophis-ticated information system that puts complete cus-tomer information files at their fingertips the in-stant they receive a customer's call. In addition,state-of-the-art, job-related training is made avail-able to USAA employees. And the curriculum goesstill further, witb 200 courses in 75 classrooms ona wide range of subjects.

Internal quality is also characterized by the atti-tudes that people have toward one another and theway people serve eacb other inside the organiza-tion. For example, ServiceMaster, a provider of arange of cleaning and maintenance services, aimsto maximize the dignity of the individual serviceworker. Each year, it analyzes in deptb a part of themaintenance process, such as cleaning a floor, in or-der to reduce the time and effort needed to com-

plete the task. The "importance of the mundane" isstressed repeatedly in ServiceMaster's managementtraining-for example, in the seven-step process de-vised for cleaning a hospital room: from the firststep, greeting tbe patient, to tbe last step, askingpatients whether or not they need anything elsedone. Using tbis process, service workers developcommunication skills and learn to interact withpatients in ways that add depth and dimensionto their jobs.

Leadership Underlies theChain's Success

Leaders wbo understand the service-profit chaindevelop and maintain a corporate culture centeredaround service to customers and fellow employees.Tbey display a willingness and ability to listen.Successful CEOs like John Martin of Taco Bell,Jobn McCoy of Bane One, Herb Kelleher of South-west, and Bill Pollard of ServiceMaster spend a greatdeal of time witb customers and employees, experi-encing their companies' service processes while lis-tening to employees for suggestions for improve-ment. They care ahout their employees and spenda great deal of time selecting, tracking, and rec-ognizing tbem.

For example. Brigadier General Robert McDer-mott, until recently chairman and CEO of USAA,reflected, "Public recognition of outstanding em-ployees flows naturally from our corporate culture.That culture is talked about all tbe time, and welive it." According to Scott Cook at Intuit, "Mostpeople take culture as a given. It is around you, thethinking goes, and you can't do anything about it.

How Southvs^est Compares v/\fh Its CompetitorsRevenuein billions

Profitin millions

On-timearrival

94%

92

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88

86

84

828078

168 HARVARD BUSINESS REVIEW March-April 1994

However, wben you run a company, you have tbeopportunity to determine tbe culture. I find thatwben you champion the most noble values-in-cluding service, analysis, and database decisionmaking - employees rise to the challenge, and youforever change tbeir lives."

Relating Links in the Chain forManagement Action

while many organizations are beginning to mea-sure relationships between individual links in tbeservice-profit chain, only a few have related thelinks in meaningful ways-ways tbat can lead tocomprehensive strategies for acbieving lastingcompetitive advantage.

Tbe 1991 proprietary study of a property-and-ca-sualty insurance company, cited earlier, not onlyidentified the links between employee satisfactionand loyalty but also established that a primarysource of job satisfaction was the service workers'perceptions of their ability to meet customer needs.Tbose wbo felt tbey did meet customer needs regis-tered job satisfaction levels more tban twice as higbas those who felt they didn't. But even more impor-tant, the same study found that when a serviceworker left the company, customer satisfaction lev-els dropped sharply from 75% to 55%. As a resultof this analysis, management is trying to reduceturnover among customer-contact employees andto enhance their job skills.

Similarly, in a study of its seven telephone cus-tomer service centers, MCI found clear relation-ships hetween employees' perceptions of the quali-ty of MCI service and employee satisfaction. The

study also linked employee satisfaction directly tocustomer satisfaction and intentions to continue touse MCI services. Identifying these relationshipsmotivated MCI's management to probe deeper anddetermine what affected job satisfaction at the ser-vice centers. The factors they uncovered, in order ofimportance, were satisfaction with the joh itself,training, pay, advancement fairness, treatmentwitb respect and dignity, teamwork, and the com-pany's interest in employees' well-being. Armedwith this information, MCI's management beganexamining its policies concerning those items val-ued most by employees at its service centers. MCIhas incorporated information about its service ca-pahilities into training and communications effortsand television advertising.

No organization bas made a more comprehensiveeffort to measure relationsbips in tbe service-profitchain and fashion a strategy around them than thefast-food company, Taco Bell, a subsidiary of Pepsi-Co. Taco Bell's management tracks profits daily hyunit, market manager, zone, and country. By in-tegrating this information with the results of exitinterviews that Taco Bell conducts with 800,000customers annually, management has found thatstores in the top quadrant of customer satisfactionratings outperform tbe others hy all measures. As aresult, it has linked no less than 20% of all opera-tions managers' compensation in company-ownedstores to customer satisfaction ratings, realizing asubsequent increase in hoth customer satisfactionratings and profits.

However, Taco Bell's efforts don't stop there. Byexamining employee turnover records for individu-al stores, Taco Bell has discovered that the 20% of

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HARVARD BUSINESS REVIEW March-April 1994 169

THE SERVICE-PROFIT CHAIN

the stores with the lowest turnover rates enjoy dou-ble the sales and 55% higher profits than the 20% ofstores with the highest employee turnover rates. Asa result of this self-examination, Taco Bell has in-stituted financial and other incentives in order toreverse the cycle of failure that is associated withpoor employee selection, subpar training, low pay,and high turnover.

In addition, Taco Bell monitors internal qualitythrough a network of 800 numbers created to an-swer employees' questions, field their complaints,remedy situations, and alert top-level managementto potential trouble spots. It also conducts periodicemployee roundtable meetings, interviews, as wellas a comprehensive companywide survey everytwo or three years in order to measure satisfaction.

As a result of all this work, Taco Bell's employeesatisfaction program features a new selection pro-cess, improved skill building, increased latitude fordecision making on the joh, further automation ofunpleasant "hack room" labor, and, finally, greateropportunities for employee promotion into man-agement positions.

Relating all the links in the service-profit chainmay seem to be a tall order. But profitability de-pends not only on placing hard values on soft mea-sures but also on linking those individual measurestogether into a comprehensive service picture. Ser-vice organizations need to quantify their invest-ments in people-hoth customers and employees.The service-profit chain provides the framework forthis critical task.

Service-Profit Chain Audit

A service-profit chain audit helps companies de-termine what drives tbeir profit and suggests ac-tions that can lead to long-term profitability. Astbey review the audit, managers should ask them-selves what efforts are under way to obtain answersto the following questions and what those answersreveal about their companies.

Profit and Growth1. How do we define loyal customers^

Customers often become more profitable overtime. And loyal customers account for an unusual-ly high proportion of the sales and profit growth ofsuccessful service providers. In some organizations,loyalty is measured in terms of whether or not acustomer is on the company rolls. But several com-panies have found that their most loyal customers-the top 20% of total customers-not only provideall the profit but also cover losses incurred in deal-ing with less loyal customers.

Because of the link between loyal customers andprofit. Bane One measures depth of relationship-the number of available related financial services,such as checking, lending, and safe deposit, actual-ly used hy customers. Recognizing the same re-lationship, Taco Bell measures "share of stomach"to assess the company's sales against all otherfood purchases a customer can potentially make. Asa result, the fast-food chain is trying to reachconsumers through kiosks, carts, trucks, and theshelves of supermarkets.

2. Do measurements of customer profitability in-clude profits from referrals^

Companies that measure the stream of revenueand profits from loyal customers (retention) and re-peat sales often overlook what can be the most im-portant of the three Rs of loyalty: referrals. For ex-ample. Intuit provides higb-quality, free lifetimeservice for a personal finance software package tbatsells for as little as $30. The strategy makes sense

170 HARVARD BUSINESS REVIEW March-April 1994