Market Oriented Value Creation in Service Firms Rod B. McNaughton Eyton Chair in Entrepreneurship, University of Waterloo, Ontario, Canada Phil Osborne Marketing Department, School of Business, University of Otago, New Zealand Brian C. Imrie Marketing Department, School of Business, University of Otago, New Zealand Key Words: Competitive Advantage, Market Orientation, Performance, Value Address for correspondence: Professor Rod McNaughton Department of Management Sciences University of Waterloo 200 University Avenue West Waterloo, Ontario, Canada N2L 3G1 Telephone: 519-888-4567, extension 6203 Fax: 519-746-7252 E-mail: [email protected]
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Market Oriented Value Creation in Service Firms · A Model of Market Oriented Value Creation in Service Firms Figure 1 presents a model that maps a path from market orientation to
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Market Oriented Value Creation in Service Firms Rod B. McNaughton Eyton Chair in Entrepreneurship, University of Waterloo, Ontario, Canada Phil Osborne Marketing Department, School of Business, University of Otago, New Zealand Brian C. Imrie Marketing Department, School of Business, University of Otago, New Zealand Key Words: Competitive Advantage, Market Orientation, Performance, Value Address for correspondence: Professor Rod McNaughton Department of Management Sciences University of Waterloo 200 University Avenue West Waterloo, Ontario, Canada N2L 3G1 Telephone: 519-888-4567, extension 6203 Fax: 519-746-7252 E-mail: [email protected]
loyalty - customer retention, and customer retention - performance. Examples
of this literature in the context of the service industries are described in Table
2. One reason why the evidence for these individual links is stronger than that
for quality - performance is the difficulty of linking micro- and macro-
constructs (Yeung and Ennew, 2000). Concepts like satisfaction or loyalty are
attitudes and behaviours of individuals, often associated with particular service
experiences, while performance is an aggregate characteristic of an
organisation. In our model we illustrate this problem by embedding customer
value (the shaded box) within the broader construct of firm value. The
variables which fall outside of the customer value box, loyalty and word-of-
mouth, are associated with the behaviours of individuals, but have conceptual
equivalents at the level of the organisation – retention and referrals.
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>>>Take in Table 2 about here<<<
Both retention and referrals have the potential to increase incoming
cash and decrease outgoing cash, and thus to influence the value of a firm
(Table 3). For example, loyal customers are less likely to switch and require
less ongoing marketing effort to retain (Reichheld and Sasser, 1990). The
literature on both brand equity and customer satisfaction suggests that loyal or
satisfied customers will pay price premiums (Farquhar, 1989), adopt line
extensions more readily (Keller, 1993), try and refer products more frequently,
and have lower sales and service costs (Reichheld and Sasser, 1990). The
overall effect of these processes is to speed receipt of cash, widen the gap
between incoming and outgoing cash (for marketing related expenditures), and
reduce working capital and fixed capital requirements. All else being the same,
this should help to create higher earnings, reduce the volatility of cash flow,
and increase the residual value of cash flow (Srivastava, Shervani, and Fahey,
1998); effects which have the potential to increase firm value (Day and Fahey,
1988). The owners and managers of a firm also have to decide how to allocate
the retained earnings associated with this higher net marketing contribution.
The resulting cost advantage could be used to increase customer perceived
value through price reductions, possibly stimulating demand, or it could be
reinvested in the creation of further market-based or other assets.
>>>Take in Table 3 about here<<<
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Finally, while the construct “service quality” does not explicitly
appear, it has an important role in our model. Chang and Chen (1998)
identified quality as an outcome of managerial action, which is in turn
motivated by a market orientation. However, we perceive service quality to be
a ubiquitous influence. When a firm’s personnel (at all levels) are market-
oriented, activity focuses upon the creation of quality service through
deployment of both intellectual and relational market-based assets. The Gap
Model (Parasuraman et al., 1985) inventories the activities (gaps 1-4), by both
managerial and front line personnel, that are required to create a consumer
perception of service quality (gap 5). Service quality is considered an outcome
of the successful application of market assets while also adding value to the
firm and taking its place amongst the stock of market based assets (Zeithaml,
2000). Lastly, the value that service quality creates for all stakeholders
establishes it as an effective competitive advantage. The service quality
construct is embedded within our model as a market based asset, competitive
advantage and influencer of customer perceived value.
Conclusions
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Our model traces the theoretical effects of market orientation on firm
value. The model furthers understanding of the market orientation -
performance relationship by making explicit the mechanisms whereby creating
value for customers can also improve the financial position of a firm. This
addresses a gap in the stream of research that seeks to demonstrate a positive
empirical relationship between market orientation and measures of financial
performance (e.g., Narver and Slater, 1990 and Ruekert, 1992; Day and
Wensley, 1988; Diamantopoulos and Hart, 1993; Greenley, 1995, Jaworski
and Kohli, 1993).
The model postulates that a market orientation helps a firm to both
create market-based assets and guide investment in other types of investments.
These become the basis of a competitive advantage that can be deployed to
create customer value. Increased customer perceived value attracts customers,
and results in satisfied customers that are more loyal and who act as marketing
agents by spreading positive word-of-mouth (Reichheld and Sasser, 1990). A
growing pool of retained customers helps to accelerate net cash flow, increase
the residual value of cash, and decrease the volatility of cash flow. The model
also acknowledges that a market orientation may improve the performance of
service firms by contributing to service quality.
This model emphasises cash flow, which has three clear benefits. First
it provides the ability to communicate the benefits of a market-oriented culture
across functional areas within a firm. The language of cash flow is universal.
Second, it emphasises that market-based assets are an important investment
type. Valuation measures could be applied to market-based assets, providing a
common framework for firms to compare the benefits of a market orientation
with alternative internally focused strategies (or indeed, the complementary
effect of a market orientation on other asset forms). Finally, an emphasis on
cash flow impacts also clarifies that the benefits of a market orientation are not
realised in the same period as the investment. This is a problem for empirical
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studies that seek to correlate a market orientation with traditional measures of
financial performance, particularly profit.
The implementation of our model as a strategic framework would
require an accounting method that is able to relate changes in cash position to
specific marketing activities. Goebel, Marshall and Locander (1998) recently
addressed this issue by describing how activity-based costing can assist
analysis of the costs and benefits of a market orientation. The cost-per-
customer and revenue-per-customer metrics that are being used to both value
and track the performance of Internet-based firms are also relevant. These
metrics make a direct link between the costs of marketing activities and the
benefits derived in terms of customer retention, and the frequency and quality
of sales (Whyman, 1999).
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Figure 1 A Model of market oriented value creation
Asset Creation
Market-basedAssets
MarketOrientation
Other Asset Types
CompetitiveAdvantage
PerceivedCustomer
Value
CustomerAttraction Satisfaction Cash Flow
Impacts
Cost Advantage
Firm ValueCustomer Value
Loyalty
Word ofMouth
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Table 1 A sample of market orientation - performance relationship investigations in service industries Author Sample Country
(Usable responses)
Performance Relationship
Direct Mediated None Van Egeren and O’Connor (1998)
70, diverse, large, individual (non-SBU), SIC Code 5000, 7000, 8000
Mid western U.S (70)
Kumar, Subramanian, and Yauger (1998)
Healthcare US (159)
Pitt, Caruana, and Berthon (1996)
Diverse , large UK (161) and Malta (193)
Caruana, Ramaseshan, and Ewing (1998)
Universities NZ and Australia
Chang and Chen (1998)
Retail Stock Broking
Taiwan (116)
Au and Tse (1995)
Hotels Hong Kong (41) and NZ (148)
Lado, Maydeu-Olivares, and Rivera (1998)
Insurance Belgium (34) and Spain (32)
Han, Kim, and Sristava (1998)
Banks Mid West US (134)
Sargeant and Mohamad (1999)
Hotels UK (200)
Caruana, Pitt and Berthon (1999)1
Diverse, large UK (161)
1 The research reported in this paper appears to use the same data reported in Pitt, Caruana, and Berthon (1996). However, a contrary result is presented and discussed. The authors suggest problems with the conceptualisation of market orientation used, though no such qualms were expressed in the earlier paper. Further, the later paper explores a more complex model that may have confounded the identification of the earlier ‘direct’ relationship.
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Table 2 Research linking satisfaction, loyalty, and performance Topic Author(s) Research Finding Service Quality and Performance
(Aaker and Jocobsen 1994)
In an analysis of 34 major U.S. brands (both services and products) a positive relationship was established between the stock price index and quality perceptions.
(Rust et al. 1995) A framework is developed for determining the impact that service quality has upon profitability. A simulation is then used to illustrate the impact of service quality on profitability.
Service Quality-satisfaction-loyalty-behaviour
(Brady and Robertson 2001)
In a cross-national study it is found that service quality’s impact upon loyalty and behavioural intentions is mediated by a consumer's level of satisfaction and that this relationship is consistent across cultures.
Satisfaction and loyalty
(Singh and Sirdeshmukh 2000)
The authors model the key mechanisms that shape satisfaction in an individual encounter, and loyalty across ongoing exchanges. Central to the model is the way in which agency theory interacts with trust to affect satisfaction in an individual encounter and loyalty in the long term.
(Jones et al. 2000) The results of this study indicate that the influences of service satisfaction on repurchase intentions decreases where high switching barriers exist.
Loyalty and performance
(Reichheld and Sasser 1990)
Within a services context four mediating variables (cost, increased purchases, price premiums, word of mouth) are introduced as increasing with retention and subsequently positively impacting firm performance. Evidence is presented from a cross-section of industries to illustrate this contention
(Anderson 1993) A model is developed to link explicitly the antecedents and consequences of customer satisfaction in a utility-oriented framework. It is found a positive relationship exists between customer retention and profitability.
(Heskett et al. 1997) It is demonstrated that customer retention has a greater impact upon service firm performance than economies of scale, market share and other factors.
Satisfaction and performance
(Anderson 1994)
Using a sample of 77 prominent Swedish firms the authors found a significant relationship between satisfaction and return on assets (ROA).
Satisfaction, loyalty and firm performance
(Heskett et al. 1994)
The service-profit chain is introduced. The links in the chain are as follows: Profit and growth are stimulated primarily by customer loyalty. Loyalty is a direct result of customer satisfaction. Satisfaction is largely influenced by the value of services provided to customers. Satisfied, loyal, and productive employees create value.
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Table 2 (Continued) Research linking satisfaction, loyalty, and performance Topic Author(s) Research Finding Satisfaction, loyalty and firm performance
(Fornell 1992) Utilising the Swedish Customer Satisfaction Barometer (CSB), a national economic indicator of customer satisfaction, the authors find a significant relationship between satisfaction, loyalty, price elasticities and firm profitability.
(Hallowell 1996) The service profit chain was tested in a retail bank setting. The relationship satisfaction, loyalty and firm profitability is supported.
(Bo 2000) This paper finds that the satisfaction-loyalty-performance logic has a greater positive impact upon services than products. It is reasoned that service firms must earn loyalty but product firms can lower prices to aid retention. The results suggest however that for services satisfaction is only one determinant of loyalty. It is also noted that service revenue growth is driven primarily by personal referrals and word-of-mouth.
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Table 3 Possible impacts on cash flow of customer loyalty and positive word-of-mouth Loyalty – customer
retention Word-of-mouth – customer attraction
Increase incoming cash • Price premiums • Adoption of line
extensions • Increased purchase
frequency • Increased purchase
volume (easier to cross-sell, companion sell and up-sell)
• Reduced switching
• Faster trial, adoption and diffusion of products
• Increased market share
Decrease outgoing cash • Lower cost of recruiting customers