I recently came across “Division of Labor between Firms: Business Services, Non-Ownership-Value and the Rise of the Service Economy,” Ehret and Wirtz, Service Science 2(3), pp. 136-145, © 2010 SSG 136 — a concise, but intellectually expansive, article (with a rather opaque title). I found more than I expected from the academic title and got more than I bargained for.
Within (and beyond) the scientific concepts and categories alluded to in the cryptic title, the article sets out a compelling, coherent argument connecting the evolution of services in the modern economy, the importance and value of external services, and the ways in which firms and entrepreneurs can potentially exploit these developments to expand strategic business opportunities. The article concludes by identifying three developments/emerging pathways that can expand opportunities for businesses today:
- The transformation of high-tech products into service-hubs/service platforms
- Systematic design of business-models for fostering service performance (including service-driven innovation and the transformation of R&D),
- The opening-up of business models (per Chesbrough, structures that exhibit patterns and behaviors conducive to “open innovation”).
The article starts by examining the evolution of services in the modern economy, beginning with the development of services in manufacturing in the last quarter of the 20th century:
It continues to explain the “rise of the service sector–and the hidden role of business services” (i.e., outsourcing, 3rd party service providers, ecosystem partners), concluding:The rise of the service economy is first and foremost the rise of business services. Empirical data and economic theory suggest that this is no coincidence but an inherent feature of economic development. In the early stages, economic growth is driven by vertical integration of assets and people under the roof of integrated corporations. As economies grow, competition increases and forces companies to focus their assets and competencies on areas where they enjoy competitive advantages. For doing so, companies must design organizational structures to capture entrepreneurial opportunities and draw corporate boundaries around the most promising areas [my emphasis]. As a result, many activities that used to be organized in-house are now sourced from external service providers. Strategies of redrawing corporate boundaries started on a large scale in IT-outsourcing, when globally operating companies began to hire external business providers for managing data and information operations (Lee et al. 2003). Soon this practice became common in a growing range of corporate activities (Quinn 1992, Heracleous and Wirtz 2009), including custodial services, customer contact centers, payroll operations, consulting for a growing range of expertise and even contract manufacturing. Today, there is almost no business activity one cannot source from a specialized service provider in a competitive business service market.
The reference to the importance of IT outsourcing and services is certainly still highly relevant today in 2011, as Cloud Computing continues to radically redraw firm boundaries and transform concepts of services. But the main point is that (starting in product manufacturing) a clear, unimpeded evolution has been occurring and expanding/transforming the essential role and types of services within and around firms. Traditional manufacturing long ago expanded the model of division of labor internally and externally (suppliers and distributors) to achieve productivity gains. But the service phenomenon emerging in the past decades represents a new stage of evolution.
Hence, the article states:
In contrast, productivity growth in today’s service economy relies on the division of labor between firms (Stigler 1952, Becker and Murphy 1992). As such, one salient feature of the service economy is the division of labor between organizations (Wirtz and Ehret 2009). This perspective provides service science with a number of challenges and opportunities. First, empirical research has started to take note of the role of the reorganization At this point, the article clarifies its main agenda:of business activities as part of the rise of the service economy. Second, we are just beginning to understand the theoretical underpinnings and conceptual implications of the division of labor between organizations for the growth and management of businesses. Finally, one widely neglected implication of the division of labor and outsourcing of activities is the role of services in driving innovation and resulting productivity growth.
At this point, the article clarifies its main agenda:
…we first present evidence for the central role of business services in restructuring our economies. Second, we explain the economic benefits firms enjoy by redrawing their organizational boundaries and argue the case for a non-ownership perspective. Third, we discuss the theory of the firm, division of labor and the value of business services for service innovation and growth using three related theories. They are the Property Rights Theory, Resource-Based View and the Entrepreneurial Theory of the Firm. We conclude by discussing the implications…”
The details of how the arguments are threaded through three mainstream “theories of the firm” can be found in the article itself ( Service Science 2(3)). But one excerpt from the article neatly summarizes the main thread of the argument:
a) Business services provide the means to draw efficient boundaries of the firm. Service providers generate value by acting as owners of assets, employers of people and owners of processes that have lost their central position in the investment agenda of a firm. Property Rights Theory highlights the efficiency conditions (i.e., measurement and governance costs) of an observed situation in a snap-shot mode and determines the efficient division of labor between provider and client.
b) Business service providers enhance the growth potential of their clients by freeing their management capacity to focus on the firm’s most promising growth opportunities. The Resource-Based View implies a more dynamic perspective revealing strategic shifts of a firm’s boundaries towards market opportunities.
c) The Entrepreneurial Theory of the Firm proposes the firm as a tool for entrepreneurs to explore and exploit business opportunities. To some extent it shares the dynamic perspective and core arguments of the Resource-Based View. It highlights ownership and contracts as tools for entrepreneurs to assume control (and the entrepreneurial risk and returns) through equity of their most promising projects. This theory thus provides an explanation of a firm’s shifting boundaries that are shaped in response to shifting perceptions of entrepreneurial opportunities (Dyer and Singh 1998, Ghosh and John 1999). Entrepreneurial projects are also the dynamic factors that change efficiency conditions investigated by Property Rights Theory (Nooteboom 1992, 1993). Thus, the Entrepreneurial Theory of the Firm identifies the common denominator of the diverse perspectives concerned with the boundaries of the firm. In a nutshell, business services support their clients in navigating them to the most promising business opportunities.
With empirical and theoretical rationalization established, the article concludes with a perspective on three different emerging pathways that seem to offer potential for capturing new business opportunity and value:
- The transformation of products into service-platforms: As the service-economy rises, boundaries between products and services increasingly blur. In that regard smartphones have become the signature gadgets that act as a service-platform linking users to a network of service providers via the “appeconomy” (MacMillan et al. 2009). In a similar fashion the rise of industrial services has transformed many industrial products into service-hubs such as Rolls-Royce’s shift towards selling enginepowerhour by the hour (and assuming ownership of the engine and all related service processes, Lovelock and Wirtz 2011, p. 18). One current research challenge is to re-align design processes originally devoted to product development to keep up with the challenges and needs of the emerging service-systems (Brown 2009). Thus we need design approaches that take service experiences and performances into account that are typically not reflected in the spec-sheets and performance indicators that are used to direct industrial design-processes.
- Service-driven innovation: In its infancy the service sector was associated with low growth potential. This notion is changing as we are beginning to understand the role of business services in supporting growth opportunities of firms. Business Services are crucial for opening up business models and therefore have become a powerful means for enhancing performance of existing firms, providing opportunities for new firms and thus keeping economies on a growth path. The service economy has become an innovation force in its own right. One of the most striking phenomena in this respect is the transformation of one of the hitherto core functions of the industrial corporation into a service industry: R&D. Accelerating costs and increasing volatility of innovation rents have forced companies to open up their business models. As a result, firms are increasingly building on external inventions while becoming more agile in using external partners for commercializing their own achievements (Arora et al. 2004, Chesbrough 2006). Biotech is a point in case (Pisano 2006), where in advanced economies 70 percent or more of R&D budgets are managed by specialized service providers (Beuzekom and Arundel 2009). With respect to their role as a force of organizational innovation (Bhide 2008, Callaway and Dobrzykowski 2009), business services have arrived at transforming the way innovation is generated and commercialized.
- Services contribute to the opening-up of business models: Innovation research has highlighted the potential of open business models (Chessbrough 2006). Qualcomm followed this strategy by licensing its IP for digital mobile-communication-technology to handset-makers and equipment-vendors (Mock 2005). But the same model that earned the firm respect in high-tech circles and fame on the trading floor failed in other markets such as digital cinema (Chesbrough 2006) and Biotech (Pisano 2006). While research has shown the potential of opening-up business models, it lacks a consistent theory and research framework to analyze benefits and drawbacks of these models on the same footing (Chesbrough 2006, Pisano 2006). Here, entrepreneurial contracting provides the conceptual underpinning for a research program on the performance of business-networks based on sound division of labor between firms.
The article sets out a broad, sweeping view of the long-term evolution of services in our modern economy (along with more specific, more recent developments of the same); it explains how firms and entrepreneurs may rationally behave under such conditions and reveals new pathways for capturing business opportunity and value. It makes clear that we are in the midst of a significant evolutionary leap in business structures, which is occurring before our eyes (though often invisibly, beyond our standard framework of comprehension) in the turbulent confluence of “platform business models” and “services” (as defined by the perspective of Service Science), and further turbo-charged by information technology. It is happening all around us, and this article asks us how we can better understand and harness these forces to create new business value and growth.