Creating customer value in a service-dominant environment

Introduction

Dynamic capabilities and their impact on a firm’s performance are both topics that are gaining increasing attention in business literature and in practice. The concept of dynamic capabilities refers to organizational features or practices that a firm has developed to cope with a changing and uncertain market environment in a better way than its competitors and consequently sustain its competitive advantage. This book contributes to theory and practice in several domains. Drawing on the literature about customer value, service-dominant logic and dynamic capabilities, it investigates how the absorptive capacity approach can be used to (co-)create customer value in order to achieve sustainable competitive advantage in a service-dominant environment. This book provides guidance to practitioners by building up a framework that reflects how absorptive capacity can be used to co-create value in a B2B relationship. The case of the fictional company TurboIT, an SAP service and solution provider, illustrates the practical application of this concept.

“The ability to learn faster than your competitors may be only sustainable competitive advantage.”

Arie de Geus, Shell Oil

Table of contents

1 Competitive advantage through dynamic capabilities ... 5

2 The concepts of customer value and service-dominant logic ... 7
2.1 Literature review: customer value ... 7
2.1.1 A short history of value ... 7
2.1.2 The concept of value ... 8
2.2 The concept of service-dominant logic ... 11
2.2.1 Overview of service-dominant logic ... 11
2.2.2 Value in use, exchange value and value co-creation ... 14
2.2.3 Frameworks for co-creation of value ... 17
2.2.4 Value co-creation in a B2B context ... 21

3 Strategic thinking and dynamic capabilities ... 24
3.1 The evolution of strategic thinking ... 24
3.2 The resource-based view ... 24
3.3 The concept of dynamic capabilities ... 27
3.4 Dynamic capabilities and competitive advantage ... 32
3.5 The concept of absorptive capacity ... 33

4 Strategy in action: increasing absorptive capacity to support co-creation of value at TurboIT ... 42

References ... 52

Appendix A ... 62
Appendix B ... 63
Appendix C ... 64
Appendix D ... 65
Appendix E ... 66
Appendix F ... 67
Appendix G ... 67
Appendix H ... 68

Tables and figures

Table 1. Contrasting goods- and service-dominant logic ... 12
Table 2. Routines to increase absorptive capacity (discrete events) ... 46
Table 3a. Selected definitions and contributions to value (Part 1) ... 64
Table 3b. Selected definitions and contributions to value (Part 2) ... 65
Table 4. Foundational premises of service-dominant logic ... 66
Table 5. Key definitions of dynamic capabilities ... 68
Table 6. Selected definitions and contributions to absorptive capacity ... 69
Table 7a. Routines to increase absorptive capacity (Part 1) ... 70
Table 7b. Routines to increase absorptive capacity (Part 2) ... 71

Figure 1. Overview of the concepts discussed in this book ... 7
Figure 2. Value creation from the customer and supplier perspective ... 15
Figure 3. DART – the building blocks for co-creating value ... 18
Figure 4. Marketing-decision variables of co-creation ... 19
Figure 5. Conceptual framework for value co-creation ... 20
Figure 6. A dual-process model of capability dynamization ... 28
Figure 7. Dynamic capabilities ... 31
Figure 8. A process model of absorptive capacity ... 36
Figure 9. A refined model of absorptive capacity ... 37
Figure 10. Organizational structure of TurboIT ... 44
Figure 11. Paradigms of strategy ... 67
Figure 12. Customer-delivered value ... 65
Figure 13. Model of capability formation and performance ... 69

1. Competitive advantage through dynamic capabilities

The field of strategic management is largely concerned with how firms generate and sustain competitive advantage. According to Porter’s (1996) theory on strategy, striving for operational efficiency is not enough in the highly competitive global market. Operational efficiency is something that every company can achieve and duplicate and thus does not serve as a basis for building competitive advantage. Companies need to find strategies that give them a long-term competitive advantage. This superior position reflects the capture of superior customer value, which results in market-share dominance and superior financial performance (Hunt & Morgan 1995).

In order to create superior customer value to achieve a sustainable competitive advantage, we need to understand the various dimensions of customer value. The concept of service-dominant logic sheds new light on the role of the customer in the value-creation process. It seems that the co-creation experience of the customer becomes the very basis of value. According to Lusch, Vargo and O’Brien (2007), the only true source of sustainable competitive advantage is knowledge. Section 2 gives an overview of the different value definitions and takes a closer look at the concepts of service-dominant logic and co-creation of value.

The key question here is how this superior value can be created in changing environments over a period of time. Section 3 shows how the dynamic capability perspective extends the resource-based view by addressing how valuable, rare, difficult- to-imitate and imperfectly substitutable resources can be created and how the current stock of valuable resources can be enhanced. The concept of dynamic capabilities refers to organizational features or practices that a firm has developed to cope with a changing and uncertain market environment better than its competitors and consequently sustain its competitive advantage. Dynamic capabilities include difficult-to-replicate enterprise capabilities that are required to adapt to changing customer and technological opportunities. They also embrace the enterprise’s capacity to shape the ecosystem it occupies, develop new products, services, solutions and processes, and design and implement viable business models. This section explains the ideas behind dynamic capabilities and shows the relationship between dynamic capabilities and competitive advantage. It also demonstrates how such capabilities can help to develop a high-performing company that is able to sense changes in the marketplace, seize these opportunities and reconfigure its existing assets and competencies. The dynamic capability perspective specifically focuses on how firms can change their valuable resources over time and do so persistently.

One of the most important dynamic capabilities seems to be absorptive capacity. Zahra and George (2002) conceptualize absorptive capacity as a dynamic capability required to manage knowledge for the purpose of value creation. According to them, absorptive capacity consists of acquisition, assimilation, transformation and exploitation capabilities. It seems to be one of the most influential dynamic capabilities, with a huge influence on other dynamic capabilities like R&D activities and product innovation. It directly addresses the view of service-dominant logic in which knowledge is seen as a key component of competitive advantage. This concept is explained in section 3.5. Figure 1 provides an overview of the two main streams covered in this book. One stream is concerned with the question of how value can be created, especially in terms of service-dominant logic. The second stream of thought concerns the strategic arena of the resource-based view and the hot topic of dynamic capabilities, particularly the absorptive capacity to find ways of building up and maintaining the resources that are necessary to cope with a changing environment and provide the knowledge needed for the co-creation of value.

Figure 1. Overview of the concepts discussed in this book

Figure 1 is not visible in this excerpt.

Building on the knowledge gained in the preceding theoretical sections, section 4 demonstrates how the absorptive capacity approach can be linked to value co-creation at TurboIT, an SAP consulting company. More generally speaking, the book takes a particular look at value co-creation for IT service and solution providers in a B2B relationship.

"We see our customers as invited guests to a party, and we are the hosts. It’s our job every day to make every important aspect of the customer experience a little bit better."

Jeff Bezos, Founder and CEO, Amazon

2. The concepts of customer value and service-dominant logic

2.1 Literature review: customer value

2.1.1 A short history of value

According to Ramirez, value was seen as a measurable connotation during the 13th century (Ramirez, 1999). By the 19th century, value was regarded as being based on personal judgement (Ramirez, 1999). His article about value co-production can be highlighted for all the interesting historical details given here. An overview of some of the most important definitions and contributions about value that can be found in the literature is provided in Appendix A. In order to create superior customer value to achieve sustainable competitive advantage, we need to understand the different dimensions of customer value.

2.1.2 The concept of value

Going back in history, Schumpeter discussed value creation through technological change and innovation (1934). The Organization for Economic Co-operation and Development makes a distinction between four different types of innovation: product innovation, process innovation, marketing innovation and organizational innovation (http://www.oecd.org/document/10/0,3343,en_2649_33723_40898954_1_1_1_1,00.html, accessed on 13 January 2010). The word "value", however, has a ubiquitous nature stemming from its semantic vagueness. In today’s marketing literature, value for customers is considered as an ultimate goal for marketing (e.g. Grönroos, 1997, Sheth & Uslay, 2007). However, there is no commonly accepted definition or consensus about the dimensions of value. "Customer value" is the most commonly used term (e.g. Anderson & Narus, 1998; Dodds, 1999; Woodruff, 1997), with "perceived value" (Patterson & Spreng, 1997), "value consciousness" (Lichtenstein et al., 1990) and plain "value" (e.g. Berry & Yadav, 1996; De Ruyter, Wetzels, Lemmink and Mattson (1997), 1997) being used in the literature. Interestingly, however, despite the variance in terminology, little compelling evidence has been put forward to suggest that the literature recognizes or proposes individually distinct concepts of customer value (Woodall, 2003).

A definition provided by Anderson, Jain and Chintagunta (1993: 4) goes as follows: "the perceived worth in monetary units of the set of economic, technical, service and social benefits received by the customer firm in exchange for the price paid for a product offering, taking into consideration the available suppliers’ offerings and prices". When discussing the value of a single offering, the discussion is frequently about measuring its value in terms of monetary units, as in the definition proposed by Porter (1985: 38): "the amount buyers are willing to pay for what a firm provides them". However, there is a growing interest in discussing other kinds of value besides the monetary one, and also a growing awareness of the fact that value is not produced by one party and consumed by the other, but that all the parties involved expect to get some value out of the relationship.

One definition that does not regard value purely in monetary terms is provided by Flint, Woodruff and Gardial (1997). In their view, value can be regarded as a trade-off between benefits and sacrifices. This definition is similar to Zeithaml’s (1998). A commonly used definition of the value construct is "a ratio of benefits received versus burdens endured by the customer" (Ulaga, 2001: 318). This definition does not involve the idea of money in the definition and includes two highly subjective and intangible concepts: burden and benefit.

According to marketing guru Philip Kotler (2003), total customer value is the bundle of benefits customers expect from a given product or service. Total customer cost is the bundle of costs customers expect to incur in evaluating, obtaining, and using the product or service. Customer-delivered value is the difference between total customer value and total customer cost. In his concept of customer-delivered value, he identifies six dimensions of value (see Appendix B).

Ulaga (2001) uses the term "customer value" and has three different perspectives on the concept: the buyer perspective, the supplier perspective and the buyer-seller perspective. The buyer perspective is concerned with issues such as how the supplier can create offerings that are of superior value to the customer. The supplier perspective regards customers as key assets of the firm. The buyer-seller perspective is about how buyers and sellers can create value jointly through relationships, partnering and alliances. According to Wilkinson and Young (1994), relationship value is difficult to measure because the indirect effects of the value that is created in a focal relationship are not easy to evaluate. Indirect value is the value for relationships or the wider network of relationships to which the firm is connected (Wilkinson & Young, 1994). In a paper on value creation in buyer-seller relationships, Walter, Ritter and Gemünden (2001) look at the value concept from the supplier’s perspective. They use functions of a customer relationship as a way of categorizing how the supplier perceives value. They talk about direct and indirect functions and say that a third type of function could also be added, namely social functions. They view e.g. the profit function as a direct function of a customer relationship, whereas e.g. the scout function is seen as an indirect function. Walter argues that supplier-perceived value consists of the above-mentioned functions of a customer relationship. Lado and Wilson (1994), in contrast, suggest that value can be understood as competence, market position and social rewards. Normann and Ramirez (1993) have termed the link between the customer and the supplier "offerings". An offering is of value if it provides relieving value or enabling value, so they claim. Relieving value is understood to be the labour-saving value that the offering provides, while enabling value is everything that helps the other party to work more efficiently, effectively, easily, safely and elegantly. Normann and Ramirez (1993) use the term "value constellations" where the unit of analysis is the interaction or offering, not the organization or network (Ramirez 1999). According to them, value is a combination of transforming materials, transforming information and transforming people. Although the terms "information" and "knowledge" tend to be used interchangeably in the literature, a clear distinction ought to be made here, as in Ackoff’s (1989) DIKW hierarchy, which propose four layers: data as symbols at the most basic level, information as data that is processed to be useful, knowledge as the application of data and information, and wisdom as evaluated understanding. According to Davenport and Prusak (1998), in organizations, knowledge often becomes embedded not only in documents or repositories, but also in organizational routines, processes, practices and norms.

Interestingly, Grönroos (2008) summarizes that the literature on value creation and value co-creation uses the term "value" as an abstract concept that is seldom specified in more concrete terms. He concludes that value for customers and what value a customer can create out of the support provided by a supplier can be divided into three types of value-enhancing effects, namely the effects on the customer’s growth- and revenue- generating capacity, effects on the customer’s cost level and effects on perception.

Bearing all these different value concepts in mind, the question that managers working for a service provider in a B2B relationship need to ask themselves is "What is the most important type of customer value we have to offer?" Woodruff (1997) points this out in noting that customer-value concepts can differ on the basis of the circumstances in which customers think about value. Jackson, Neidell and Lunsford (1995) found that industrial buyers felt it was more difficult to determine the quality of services than the quality of goods. Kumar and Grisaffe (2004) state that prior research that has developed models of industrial buyer behaviour suggests that buyers in B2B settings are influenced by environmental and organizational factors as well as individual buyer characteristics. An important finding of their study was that the effects of customer focus varied across the goods and service industries in B2B contexts. It was found that customer focus has a greater influence on customer value in the service industry than in the goods industry. Price and quality, the traditional antecedents of value, were indeed the strongest influencers of value. It was also found that perceptions of customer value were significantly influenced by all three extrinsic attributes, perceived industry leadership, innovativeness and customer focus. Of the three extrinsic attributes, customer focus had the most impact on quality and value. The concepts of value in use, exchange value and value co-creation are discussed in the following section on service- dominant logic.

2.2 The concept of service-dominant logic

2.2.1 Overview of service-dominant logic

In an award-winning paper, marketing researchers Stephen L. Vargo and Robert F. Lusch present a new marketing perspective they term "the service-dominant logic of marketing" (Vargo & Lusch, 2004). In this novel view, the authors present marketing in a manner whereby goods and services are no longer regarded in the same conventional sense. They define service as "the application of specialized competences (knowledge and skills) through deeds, processes, and performances for the benefit of another entity or the entity itself" (2004: 2). Along with this new definition, the authors argue that every enterprise is in the business of providing services and that those that produce goods only do so as a means of transmitting their services to the customer. In terms of service-dominant logic, all products, be they goods or services, actually provide a service (Vargo & Lusch, 2004). Hence, what is a B2B good and a B2B service is a matter of the degree of service provision through services and goods. Service-dominant logic effectively reverses the prominence of the roles of service and goods. The transitions from concepts of goods-dominant logic to concepts of service-dominant logic can be seen in Table 1:

Table 1. Contrasting goods- and service-dominant logic (Lusch, Vargo & Malter, 2006: 268)

Table 1 is not visible in this excerpt.

Appendix C provides the (revised) ten foundational premises (which they also call "FPs") of service-dominant logic (Vargo, Maglio & Akaka, 2008).

The value co-creation process is mainly linked to two of their ten foundational premises. Firstly, the customer is always a co-creator (FP6) and secondly, the firm cannot deliver value, but only offer value propositions (FP7). The co-creation of value is inherently relational in this perspective, and it is intended that "the enterprise cannot unilaterally create and/or deliver value. Both the supplier and the beneficiary of the service collaboratively create value" (Vargo and Lusch, 2004: 11). Thus, there is no value before consuming or using the offering, and value creation needs the sharing of resources, mainly in the form of skills and knowledge. The participants in the process should be seen as "dynamic operant resources" (Lusch et al., 2006; Aitken, Ballantyne, Osborne & Williams, 2006). In the debate on service-dominant logic, several works analyse value co-creation, which underlies specific aspects.

Vargo and Lusch (2004) have challenged the value-delivery sequence, pointing out the involvement of customers as co-creators of value with the same importance as the firm itself. The definition by these two researchers highlights the process nature of the service, which relates back to doing something beneficial for and in conjunction with some entity. In other words, according to service-dominant logic, one service is exchanged for another service, whereas tangible goods are mere appliances (i.e. tools or distribution mechanisms) serving as alternatives to direct the provision of a service. The entities concerned by this service-for-service exchange are also called service systems (Spohrer, Maglio, Bailey & Gruhl, 2007). Service systems are "configurations of resources (including people, information and technology) connected to other systems by value propositions" (Vargo et al., 2008: 145). As a result, firms are service systems as well as their customers, suppliers, employees and all the other partners in a firm’s network. The service-dominant logic of marketing also redefines the relationship between the organization and the customer, where the latter has been promoted to a co- producer of value who is constantly communicating with the firm to improve the quality of the offering (Vargo & Lusch, 2004: 2). In this sense, businesses are regarded as continuously learning organizations that do not create value by themselves, but rather are only able to propose offerings to the customer. The customer, on the other hand, is able to provide direct or indirect feedback regarding what it thinks of the offering, which is reflected in the company’s financial performance. Ballantyne and Varey (2006) emphasize the role of interaction and dialogue in developing customer-supplier relationships. A double perspective is also analysed by Grönroos (2008), who points out the different roles of consumers and providers of goods and services. Gummesson (2008) widens the perspective of value co-creation to a network view in which all the stakeholders have an interest in achieving benefits. Value creation in a network perspective is particularly fitting in service-dominant logic, which recognizes the need to collaborate in order to share resources and integrate them. According to Cova and Salle (2008), the concept of involving the supply network in the customer network for the co-creation of solutions is a logical consequence of service-dominant logic.

Vargo and Lusch attribute this fundamental change of perspective to many developments that have been occurring since the middle of the twentieth century when scholars gradually recognized the importance of services. Zimmerman (1951) and Penrose (1959), for example, deemed human skills and knowledge to be the most important resources, and not the natural resources to which these are applied. Vargo and Lusch have also recognized the fundamental importance of human skills, competencies and the accumulated work experiences of employees (Vargo & Lusch, 2004: 6-7). They claim that "knowledge is the fundamental source of competitive advantage". Following Nonaka and Takeuchi (1995), knowledge takes two forms, tacit and explicit. Tacit knowledge is employee know-how or competencies gained through observation, imitation and mutual experience. It operates more or less at an unconscious level of application, which means it tends to be under-recognized as a firm-based (collective) resource. The second form of knowledge, explicit knowledge, is media-based and can be digitized, duplicated and circulated. Both forms of knowledge are valued as resources, but are different. The first type is applied directly in creating value. The second one is a store of knowledge that can be accessed for creating value. The first form is an operant resource, while the second is an operand resource in the sense that Vargo and Lusch (2004: 2-3) use these terms; service-dominant logic divides resources into operant and operand resources, the operant resources being knowledge and skills and the operand resources being the appliances in the value-creation process (Vargo & Lusch, 2004). Many firms have overinvested in building up explicit forms of knowledge by using expensive data-warehousing or customer-relationship management (CRM) systems (Kelly, 2005). At the same time, they have ignored the active (operant) resource within, which is their employees’ tacit knowledge. Tacit knowledge is especially derived from learning together as employees work across functional borders to achieve cost efficiencies or from working with customers or suppliers to co-create value. However, in the relationship-marketing literature, as Storbacka and Lehtinen (2001) have noted, a firm’s tacit knowledge (or know-how) tends to expire at a faster rate than explicit (recorded) knowledge within the firm. This is especially apparent when the external business environment is changing rapidly. To activate knowledge renewal within the firm, a relationship-orientated internal marketing process can be used (Ballantyne, 2003).

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