If you look at IBM's business last year, services revenues were roughly 55%, while systems (hardware) and software revenues were around 25% and 20% respectively. But services constituted around one-third of the company's profit, for a very simple reason. Systems and software products leverage technology assets and apply engineering principles to improve quality, scale-up capacity, and achieve higher productivity and profit margins. Services, on the other hand, have historically been significantly more labor-based, less prone to economies of scale, subject to higher quality variations, and generally less productive and profitable.
The picture is similar across most businesses around the world. Services are an increasing portion of their revenues, but they are more labor-intensive than their product-based revenues and therefore not as profitable.
Another way to appreciate the increased importance of services is to look at the three main sectors into which economies are usually grouped - the service, industrial and agriculture sectors. The service sector already accounts for more than 75% of the labor force in the US and UK, with the industrial sector being around 20% and agriculture in low single digits. In other developed countries like Japan, Germany and France, services are more than two thirds of the labor force, and in Brazil, Russia and South Korea they are well over fifty percent. While huge progress has been made in the productivity of the industrial and agricultural sectors, the service sector has lagged far behind.
A few years ago we started a major initiative across IBM's technical community to better understand the nature of services, with particular focus on how to improve their productivity at IBM and in our clients' businesses around the world. We wanted to bring to bear on services the kinds of engineering, scientific and management disciplines that have been so successful in systems and software in the IT industry, as well as in the industrial and agricultural sectors of the economy. We therefore gave our initiative the somewhat unwieldy though academically inclusive name of Services Sciences, Management and Engineering, or SSME.
A major part of our work has been to establish SSME collaborative initiatives around the world with universities, research labs and government bodies focusing on research, education and skills development. In the course of these activities we have learned that everyone seems to get the need for a higher skilled labor force, but it is not so easy to communicate why we feel the urgent need to focus on services innovation, SSME as a discipline of study, and why we are so excited about the potential for progress. So I have personally spent quite a bit of time thinking about how best to talk about services in as simple and concrete a way as possible.
Several weeks ago, a colleague sent me a pre-publication copy of an excellent new book that offers a particularly elegant explanation of services and their importance. Services Is Front Stage: We are all in Services . . . More or Less! is authored by James Teboul, Emeritus Professor of Operations Management at INSEAD. The book will be available in October of this year. Its introduction, content and index can be found here.
Professor Teboul starts the book by observing, "The service sector is the dominant part of the economy, and yet its exact nature is poorly defined. Most people will agree with the English magazine The Economist, that a service is 'anything sold in trade that cannot be dropped on your foot.' They will also agree that this sector excludes harvesting the land or manufacturing automobiles. Differences of opinion rapidly surface, however, when we try to explain what exactly a service is, rather than what it is not. Any analysis is thus confronted with the complex issue of definition."
He then proceeds to give a very simple and powerful definition of services. Every organization, whether in business, government, health care or education consists of front stage and back stage activities. Services deal with the front stage interactions; manufacturing and production with the back stage operations. People are prominent in front stage activities, providing solutions to problems and focusing on achieving a positive customer experience in a collaboration between the providers and consumers of services. Product excellence and competitive costs are key to back stage activities, which tend to focus on specialization, standardization and automation. Given this definition, every business and institution is involved in services to a greater or lesser extent, because its activities will involve front stage interactions as well as back stage operations. This is a very good operational and practical definition of services.
Professor Teboul observes, "We are all in services now, more or less, but we will be even more in services in the future, as the back end shrinks with economies of scale and outsourcing and the front end develops further with more sophisticated demands from customers. What is important is to weigh the relative importance of the back stage and the front stage and to understand how to manage those two very different worlds that are often in conflict but need to be aligned and coordinated."
Later on he adds: "The back stage and the front stage are clearly two different worlds. Lessons drawn from manufacturing do not necessarily apply to services, and vice versa. An insurance company can invest considerable amounts in its backstage activities to achieve economies of scale, but this effort may lose much of its effectiveness if the company neglects its interface with customers. However, understanding the difference between front stage and back stage does not mean that they must be separated. Our distinction, which is intentionally exaggerated, should not lead us to deform the reality. These two components are closely interwoven. They are both part of the same system, and backstage activities exist to support the front stage."
Professor Teboul's elegant arguments on services helped shape my own thinking in a number of areas. Front and back stage activities do indeed have different characteristics. For example, while variations in the front stage might be due to new customer requirements that might in fact be the seeds of future business opportunities, variations in the back stage often signify the need for better standardization and process controls to avoid lower quality and higher costs. Nevertheless, as he observes, front stage and back stage activities are closely interwoven and should be viewed as parts of a holistic system. I believe that this accounts for the rise of interdisciplinary programs that an increasing number of universities have established over the last decade focusing on complex engineering systems.
MIT's Engineering Systems Division - with which I am associated as Visiting Professor - is typical of these new interdisciplinary academic initiatives. Its objective is to "tackle the large-scale engineering challenges of the 21st century," "create and share interdisciplinary knowledge about complex engineering systems through initiatives in education, research and industry partnership," and "broaden engineering practice to include the context of each challenge as well as the consequences of technological advancement." A focus on the context and consequences of engineering and science must by necessity include expertise from other disciplines, in particular front stage kinds of disciplines that deal with business, markets and economies, as well as people, communities and their behavior.
Why is it that we can now look at engineering systems as bringing together our "hard," back stage-oriented disciplines like engineering and science with the "softer," front stage disciplines like business and the social sciences? My personal view is that as the Internet and information technologies now increasingly permeate all aspects of business, society and our personal lives, we are designing, building, managing and evolving systems "up the stack." Such systems not only include the classic back stage activities to which we traditionally applied engineering, but they now reach up to include all kinds of front stage market- and people-oriented processes which traditionally have been done in an ad-hoc way, with limited engineering tools, processes and methodologies. Such systems are not just incredibly complex because of their sheer size; they are inherently unpredictable or emergent, because they now encompass market forces and the behavior of people who are themselves unpredictable. This is what is giving rise to such an intense new focus on complex engineering systems.
In the end, front stage activities, or services, are becoming an increasingly important part of any organization. That is what accounts for the rise of services revenues in IBM and elsewhere in business. Such services are today quite labor-intensive because our study of services and their role in complex engineering systems is so new, and we are in the early stages of understanding how best to apply technology and science to them. But now that we are focused on the challenge, we look forward to significant progress in the future.