Customer Service Principles of Service Marketing and Management_6 pptx

That's why it is important for service managers to identify all the possible O T S U s asso-ciated with a particular task so they can put together a delivery system that is explicitly de

Act I: Starting the Service Experience

Act I begins with the customer making a reservation—an interaction conducted by

telephone with an unseen employee In theatrical terms, the telephone conversation

might be likened to a radio drama, with impressions being created by the speed of

response, tone of the respondent's voice, and style of the conversation O n c e the

cus-tomers arrive at the restaurant, the "stage" or servicescape includes both the exterior

and interior of the restaurant From this point on, front-stage actions take place in a very

visual environment Restaurants are often quite theatrical in their use of physical

evi-dence like furnishings, decor, uniforms, lighting, and table settings; they may also

employ background music to help create an environment that matches their market

positioning

By the time our customers reach their table in the dining room, they have been

exposed to several supplementary services, including reservations, valet parking,

coat-room, cocktails, and seating T h e y have also seen a sizeable cast of characters, including

five or more contact personnel and many other customers Standards that are based on a

good understanding of guest expectations should be set for each of these service

activi-ties Below the line of visibility, the blueprint identifies key actions that should take

place to ensure that each front-stage step is p e r f o r m e d in a m a n n e r that meets or

exceeds customer expectations These actions include recording reservations, handling

customers' coats, delivery and preparation of food, maintenance of facilities and

equip-ment, training and assignment of staff for each task, and use of information technology

to access, input, store, and transfer relevant data

Identifying the Fail Points R u n n i n g a good restaurant is a complex business and

much can go wrong T h e most serious fail points, marked by Q are those that will

result in failure to access or enjoy the core product.They involve the reservation (Could

the customer get through by phone? Was a table available at the desired time and date?

Was the reservation recorded accurately?) and seating (Was a table available w h e n

promised?) Since service delivery takes place over time, there is also the possibility of

delays between specific actions that will cause customers to wait Points at which there

is a risk of such a wait are identified by a y(^\ Excessive waits at critical steps in delivery

can be classified as fail points, because they will annoy customers and negatively impact

perceived service quality

Every step in the process has some potential for failures and delays David Maister

coined the term O T S U ("opportunity to screw up") to highlight the importance of

thinking about all the things that might go wrong in delivering a particular type of

ser-vice.10 O T S U s can be very h u m o r o u s if you're not personally involved J o h n Cleese

made millions laugh with his portrayal of an inept hotel manager in the television series

Fmt'lty Towers Chevy Chase and Steve Martin have entertained movie audiences for

years by playing customers tortured by inept, rude, or downright cruel service

employ-ees However, customers don't always see the funny side w h e n the j o k e is on them

That's why it is important for service managers to identify all the possible O T S U s

asso-ciated with a particular task so they can put together a delivery system that is explicitly

designed to avoid these problems

S e t t i n g S e r v i c e S t a n d a r d s T h r o u g h b o t h formal research and o n - t h e - j o b

experience, service managers can learn the nature of customer expectations at each

step in t h e process As discussed in o t h e r chapters, c u s t o m e r s ' expectations range

across a spectrum—referred to as the zone of tolerance—from desired service (an ideal)

to a threshold level of merely a d e q u a t e service Service providers s h o u l d design

F I G U R E 7.4

Blueprinting a Full-Service

Restaurant Experience

F I G U R E 7.4

(continued)

standards for each step that are sufficiently high to satisfy and even delight customers These standards may include time parameters for specific activities, the script for a technically correct performance, and prescriptions for appropriate employee style and demeanor

T h e initial steps of service delivery are particularly important, since customers' first impressions can affect their evaluations of quality during later stages of service delivery Perceptions of their service experiences tend to be cumulative.1 1 If things go badly at the outset, customers may simply walk out Even if they stay, they may be looking for other things that aren't quite right On the other hand, if the first steps go well, their zones of tolerance may increase so that they are more willing to overlook m i n o r mis-takes later in the service performance

Research by Marriott Hotels has found that four of the five top factors ing to customer loyalty come into play during the first 10 minutes of service delivery.12

contribut-W h i l e initial impressions are critical, performance standards should not be allowed to fall off toward the end of service delivery O t h e r research findings point to the impor-tance of a strong finish They suggest that a service encounter that starts poorly but then increases in quality will be better rated than one that starts well but declines to a poor conclusion

Act II: Delivery of the Core Product

In Act II, o u r customers are finally about to experience the core service they came for We've condensed the meal into just four scenes for simplicity's sake But review-ing the m e n u and placing the order are actually two separate activities and meal ser-vice typically proceeds on a course-by-course basis Assuming all goes well, the two guests will have an excellent meal, nicely served in a pleasant atmosphere, and perhaps

a fine w i n e to enhance it But there is always the possibility that the restaurant won't satisfy customer expectations d u r i n g Act II T h e answers to the following questions can help managers identify potential fail points: Is the m e n u information complete? Is

it intelligible? Is e v e r y t h i n g that's listed on t h e m e n u available this evening? Will employees provide explanations and advice in a friendly and n o n c o n d e s c e n d i n g m a n -ner for guests w h o have questions about specific m e n u items or are unsure about

w h i c h w i n e to order?

After o u r c u s t o m e r s decide on their meals, t h e y place their o r d e r w i t h the server, w h o m u s t t h e n pass on t h e details to p e r s o n n e l in t h e k i t c h e n , bar, and billing desk Mistakes in t r a n s m i t t i n g i n f o r m a t i o n are a frequent cause of quality failures in many organizations Bad h a n d w r i t i n g or unclear verbal requests can lead

to delivery of t h e w r o n g items a l t o g e t h e r — o r of t h e r i g h t items i n c o r r e c t l y prepared

As Act II continues, our customers evaluate n o t only the quality of food and drink—the most important dimension of all—but also h o w promptly it is served and the style of service A disinterested, ingratiating, or overly casual server can still spoil a technically correct performance

Act III: Concluding the Service Performance

T h e m e a l m a y be over, b u t m u c h activity is still t a k i n g place b o t h front stage and backstage as the service process moves to its close T h e core service has n o w

b e e n delivered, and we'll assume that o u r customers are happily digesting it Act III s h o u l d b e s h o r t T h e a c t i o n i n each o f t h e r e m a i n i n g scenes s h o u l d m o v e smoothly, quickly, and pleasantly, w i t h no shocking surprises at the end In a N o r t h

American environment, most customers' expectations w o u l d probably include the

following:

>- An accurate, intelligible bill is presented promptly as soon as customers request it

>- Payment is handled politely and expeditiously (with all major credit cards

accepted)

>• Guests are thanked for their patronage and invited to come again

>- Customers visiting the restrooms find t h e m clean and properly supplied

»- T h e right coats are promptly retrieved from the coat room

>- T h e customers' car is brought promptly to the door in the same condition as

w h e n it was left

>- T h e parking lot attendant thanks them again and bids t h e m a good evening

But how often do failures at the end of a service intervene to ruin the customers'

experience and spoil their good humor? C a n you remember situations in which the

experience of a nice meal was completely spoiled by one or more failures in

conclud-ing the service delivery? Informal research among participants in dozens of executive

programs has found that the most commonly cited source of dissatisfaction with

restau-rants is an inability to get the bill quickly w h e n customers are ready to leave! This

seem-ingly minor O T S U can sour the overall dining experience even if everything else has

gone well (For some suggestions on reducing customer waits, see the box, "In and O u t

Food Service.")

We chose a restaurant e x a m p l e to illustrate b l u e p r i n t i n g because it is a

high-contact, people-processing service that is familiar to most readers However,

many possession-processing services (like repair or maintenance) and

information-processing services (like i n s u r a n c e or a c c o u n t i n g ) involve far less c o n t a c t w i t h

customers since m u c h of t h e a c t i o n takes place backstage In these situations, a

In and Out

Food Service

When customers are on a tight time budget, making them wait

unnecessarily at any point in the process is akin to stealing their

time Restaurant Hospitality, a trade magazine for the restaurant

industry, offers the following 10 suggestions for serving customers

quickly without making them feel like they've been pushed out of the

door As you'll see, some of these tactics involve front-stage

processes while others take place backstage—but it is the

interac-tion between front stage and backstage that creates the desired

ser-vice delivery

1 Distinguish between patrons who are in a hurry, and those

who are not

2 Design specials that are quick

3 Guide hurried customers to those specials

4 Place the quickest, highest-margin menu items either first or last on the menu

5 Offer dishes that can be prepared ahead of time

6 Warn customers when they order menu items that will take a lot of time to prepare

7 Consider short-line buffets, roving carts, and more wiches

sand-8 Offer "wrap"-style sandwiches, which are a quickly prepared, filling meal

9 Use equipment built for speed, like combination ovens

10 Eliminate preparation steps that require cooks to stop cooking

failure c o m m i t t e d front stage is likely to represent a h i g h e r p r o p o r t i o n of the customer's service e n c o u n t e r s w i t h a company T h u s it may be viewed even more seriously, because t h e r e are fewer s u b s e q u e n t o p p o r t u n i t i e s to create a favorable impression

reengineering: the analysis

and redesign of business

processes to create dramatic

performance improvements

in such areas as cost, quality,

speed, and customers' service

experiences

REENGINEERING SERVICE PROCESSES

Blueprinting can provide valuable insights by suggesting opportunities to reengineer business processes, improve capacity planning, and better define employee roles T h e design of business processes has important implications for the nature and quality of the customer's e x p e r i e n c e as well as t h e cost, speed, and productivity w i t h w h i c h the desired o u t c o m e is achieved

Improving productivity in services often requires speeding up the overall process, since the cost of creating a service is usually related to h o w long it takes to deliver each step in the process (plus any dead time between each step) W h e n they are relaxing or being entertained, customers don't mind spending time But w h e n they are busy, they hate wasting time and often view time expenditures as something to be minimized Even w h e n customers aren't directly involved in the process, the elapsed time between ordering and receiving a service may be seen as burdensome (for example, waiting for repair of a broken machine, installation of a n e w c o m p u t e r system, receipt of legal advice, or delivery of a consulting report)

R e e n g i n e e r i n g involves analyzing and r e d e s i g n i n g business processes to

achieve faster and better performance To reduce t h e overall time for a process, lysts must identify each step, measure h o w long it takes, look for o p p o r t u n i t i e s to speed it up (or even eliminate it altogether), and cut o u t dead time R u n n i n g tasks in parallel rather than in sequence is a well-established approach to speed up processes (a simple h o u s e h o l d example w o u l d be to c o o k t h e vegetables for a meal while the main dish was in the oven, rather than waiting to c o o k t h e m until after the main dish was removed)

ana-Examination of business processes sometimes leads to creation of alternative ery forms that are so radically different as to constitute entirely n e w service concepts

deliv-O p t i o n s may include eliminating certain supplementary services, adding n e w ones, transforming personal service into self-service, or rethinking the location where service delivery takes place Figure 7.5 illustrates this principle with simple flowcharts of four alternative ways to deliver meal service Take a m o m e n t to compare and contrast what happens front stage at a fast-food restaurant, a drive-in restaurant, h o m e delivery, and

h o m e catering A n d now, for each alternative, think about the implications for backstage activities

Understanding Employee Roles

M a n y o f t h e benefits o f b l u e p r i n t i n g c o m e from t h e actual n a t u r e o f t h e w o r k

r e q u i r e d to create t h e charts—especially if employees themselves are directly involved in the task Participation in m a p p i n g specific processes gives employees a clearer picture of their roles and responsibilities and makes t h e m feel like part of a team that is responsible for i m p l e m e n t i n g a shared service vision Blueprints can also help managers and employees understand the service delivery process as customers experience it

Blueprinting can also be used to show backstage personnel h o w their work relates

to that of their front-stage colleagues Backstage personnel provide a series of internal services (represented by each of the vertically stacked boxes in Figure 7.4) that support

C H A P T E R S E V E N • T H E S E R V I C E P R O D U C T 163

front-stage activities If they do their jobs poorly, the employees working backstage may

create problems for their coworkers with c u s t o m e r - c o n t a c t responsibilities It's n o t

always possible to give either external or internal customers exactly the service that they

would like, but blueprinting can be a valuable tool for facilitating discussion about how

to improve service processes

F I G U R E 7.5 Flowcharts for Meal Delivery

Scenarios

Conclusion

In mature industries, the core service can b e c o m e a commodity T h e search for

compet-itive advantage often centers on improvements to the supplementary services that

sur-round this core In this chapter, we grouped supplementary services into eight

cate-gories, circling the core like the petals of a flower T h e y are categorized as either

facilitating or enhancing supplementary services Facilitating supplementary services aid

in the use of the core product or are required for service delivery, while enhancing

sup-plementary services add extra value for customers

Designing the overall service experience is a complex task that requires an u n d e r

-standing of h o w the core and s u p p l e m e n t a r y services should be c o m b i n e d and

sequenced to create a p r o d u c t offering that meets t h e needs of target customers

Blueprinting is a structured procedure for analyzing existing services and planning

new ones In particular, it enables us to define the different components of the

aug-mented service, to examine the sequence in w h i c h they are delivered, and to identify

potential fail points We also gain insights into what is happening to the customer at

each stage Supporting each front-stage action are backstage activities involving people,

supporting equipment and facilities, and information (often stored in a databank) As

we discussed, a poorly organized backstage can lead to failures that are experienced by

the customer

Study Questions and Exercises

1 Define w h a t is meant by the core product and supplementary services C a n they

be applied to goods as well as services? Explain your answer

2 W h a t service failures have you encountered recently? D i d they involve the core product or supplementary service elements? Identify possible causes and suggest

h o w such failures might be prevented in the future

3 Explain the distinction b e t w e e n enhancing and facilitating supplementary services Give several examples of each for services that you have used recently

4 R e v i e w the blueprint of the restaurant experience in this chapter (Figure 7.4) Identify and categorize each of the supplementary services described in the figure

5 Prepare detailed blueprints for the following services:

1 Thomas Brinckwirth and Stephen A Butscher,"Germany's Most Popular

Radio Station Creates Loyal Listeners," Colloquy (the Frequency Marketing,

Inc quarterly newsletter) 6, no 3 (1998); SWF3 Web site, www.swO.de,January

2001

2 G Lynn Shostack, "Breaking Free from Product Marketing," Journal of Marketing, 44

(April 1977): 73-80

3 Pierre Eiglier and Eric Langeard,"Services as Systems: Marketing Implications," in P

Eiglier, E Langeard, C H Lovelock, J.E.G Bateson, and R F Young, Marketing Consumer

Services: New Insights (Cambridge, MA: Marketing Science Institute, 1977), 83-103 Note:

An earlier version of this article was published in French in Revue Francaise de Gestion,

March-April, 1977,72-84

4 The "Flower of Service" concept presented in this section was first introduced in

Christopher H Lovelock, "Cultivating the Flower of Service: New Ways of Looking at

Core and Supplementary Services," in P Eiglier and E Langeard (eds.) Marketing,

Operations, and Human Resources: Insights into Services (Aix-en-Provence, France: IAE,

Universite d'Aix-Marseille III, 1992), 296-316

5 James C.Anderson and James A Narus, "Capturing the Value of Supplementary

Services," Harvard Business Review, 73 Qanuary-February 1995): 75-83

6 From James C.Anderson and James A Narus, Business Market Management (Upper Saddle

River, NJ: Prentice Hall, 1999), 180

7 See G Lynn Shostack,"Understanding Services through Blueprinting" i n T Schwartz et

al., Advances in Services Marketing and Management (Greenwich, CT:JAI Press, 1992),

75-90

8 G Lynn Shostack, "Designing Services That Deliver," Harvard Business Review

(January-February 1984): 133-139

9 Jane Kingman-Brundage,"The ABCs of Service System Blueprinting," in M.J Bitner and

L A Crosby (eds.), Designing a Winning Service Strategy (Chicago, IL: American Marketing

Association, 1989)

CHAPTER SEVEN • THE SERVICE PRODUCT 165

10 David Maister, now president of Maister Associates, coined the term OTSU while

teaching at Harvard Business School in the 1980s

11 See for example, Eric J Arnould and Linda L Price, "River Magic: Extraordinary

Experience and the Extended Service Encounter," Journal of Consumer Research 20

(June 1993): 24-25; Nick Johns and Phil Tyas, "Customer Perceptions of Service

Operations: Gestalt, Incident or Mythology?" The Service Industries Journal 17 (July

1997): 474-488

12 "How Marriott Makes a Great First Impression," The Service Edge 6 (May 1993): 5

13 David E Hansen and Peter J Danaher, "Inconsistent Performance during the Service

Encounter: What's a Good Start Worth!" Journal of Service Research 1 (February 1999):

227-235

"Name Your O w n Price"

w i t h Priceline.com

Priceline.com was launched in 1998 to give customers some leverage

in purchasing a variety of services.1 Using the slogan, "Name Your

Own Price," the Internet-based company invited price-conscious

con-sumers to make offers for services such as airline tickets, hotel rooms,

rental cars, long-distance phone service, and mortgages In addition to

helping customers save money, Priceline offered sellers an opportunity

to generate incremental revenue without disrupting their existing

dis-tribution channels or retail pricing structures

Priceline termed its approach a demand collection system

Through its Web site, the firm collected consumer demand (in the form

of individual bids guaranteed by a credit card) for a particular service

at prices set by those customers It then communicated that demand

directly to participating sellers or to their private databases Customers

agreed to hold their offers open for a specified period of time, during

which Priceline sought to fulfill their offers from inventory provided by

participating sellers Users of the service had to be flexible with regard

to brands, sellers, and/or product features Once fulfilled, purchases

normally couldn't be canceled

The concept of giving customers the freedom to set their own

prices initially attracted a lot of attention and enthusiasm The firm's

market value rose to $20 billion within a month after it went public in

1999 Founder (and then-CEO) Jay Walker expanded Priceline's

offer-ings to include hotel rooms, rental cars, home mortgages,

long-dis-tance telephone services, and cars He also added services like

WebHouse Club that allowed customers to bid on groceries and

gaso-line Promoted heavily through television advertising featuring actor

William Shatner (best known for his role of Captain Kirk in Star Trek),

Priceline soon became one of the most widely recognized brand names in e-commerce

But in spite of Priceline's promising start, things began to go wrong in 2000 Instead of taking a markup on the inventory that it held and resold, Priceline sometimes found itself selling rooms, tick-ets, and even gasoline at prices below its own cost There was a growing number of complaints, ranging from hidden airline charges

to shabby hotel facilities; consumer dissatisfaction was compounded

by poor customer service, eventually leading to an investigation by the attorney general in the company's home state of Connecticut and expulsion from the local Better Business Bureau The company's business model had worked best in the air travel market, where Priceline accounted for about 4 percent of all ticket sales in the United States However, new competition emerged in October 2000 when a number of airlines got together to create their own Internet service to dispose of unsold tickets at discounts of up to 40 percent Named Hotwire, this service differed from Priceline in that users specified their travel needs (but no price) and received an almost immediate fare offer; however, as with Priceline, customers didn't learn the carrier name or precise schedule until after they had pur-chased the ticket

WebHouse Club service had to be discontinued in late 2000 when it became clear that suppliers weren't eager to provide groceries

or gasoline at cut-rate prices in response to consumer bids And sumers themselves got frustrated at the conditions that sellers often

con-Pricing Strategies for Services

attached to sales, such as a requirement to sign up for trial magazine

subscriptions

In response to investigations into consumer complaints, the firm

added more customer service reps, improved its training procedures,

and instituted more consistent guidelines on problem resolution

Misleading procedures on the Web site were corrected In particular,

the full amount that customers would have to pay for an airline ticket,

including all taxes and fuel charges, was disclosed on a single page;

previously, the extras were noted on separate screens Finally, an

important phrasing change, from "Submitting my offer now" to "Buy

my ticket now" clarified that customers were committing themselves

to a purchase if their offer was accepted

Seeking to sharpen its focus, Priceline announced that it was

restructuring its operations, cutting staff, and canceling plans to add

cell phone services and insurance But Hotwire disclosed that it was

expanding service to include hotel rooms and international air travel

Further bad news for Priceline came from the departure of key

execu-tives and a plummeting stock price

All in all, the future looked very uncertain for Priceline as it

entered 2001, with promises of profits still unfulfilled and news that

the company's market valuation on Wall Street had sunk to an

all-time low of only $200 million—down more than 99 percent from its

£> appreciate ethical concerns in pricing policy

£)> identify the different outlays customers incur in purchasing and using a service

£> discuss the relationship between pricing and demand

^> understand yield management and how it relates to price elasticity

^ describe the key issues in designing

and implementing pricing strategies

PAYING FOR SERVICE:

THE CUSTOMER'S PERSPECTIVE

Have you ever noticed what a wide variety of terms service organizations use to describe

the prices they set? Universities talk about tuition, professional firms collect fees, and banks charge interest on loans or add service charges Some bridges and highways impose tolls, trans- port operators collect fares, clubs charge subscriptions, utilities set tariffs, insurance companies establish premiums, and hotels establish room rates.These diverse terms are a signal that service

industries have historically taken a different approach to pricing than manufacturers

Answering the question, What price should we charge for our service? is a task that

can't be left solely to financial managers T h e challenges of service pricing require active participation from marketers w h o understand customer needs and behavior and from operations managers w h o recognize the importance of matching demand to available capacity T h e discussion that follows in this chapter assumes a basic understanding of the economic costs—fixed, semivariable, and variable—incurred by companies, as well as the concepts of contribution and break-even analysis If you haven't previously been exposed to this material or feel you could benefit from a refresher, you may want to review the information in the b o x titled " U n d e r s t a n d i n g Costs, C o n t r i b u t i o n , and Break-Even Analysis" on page 169

What Makes Service Pricing Different?

Let's consider h o w some of the differences between goods and services marketing that

we discussed in Chapter 1 may affect pricing strategy

No O w n e r s h i p of S e r v i c e s It's usually harder for managers to calculate the

financial costs involved in creating an intangible performance for a customer than it is

to identify the labor, materials, machine time, storage, and shipping costs associated with

p r o d u c i n g a physical g o o d Yet w i t h o u t a g o o d understanding of costs, h o w can managers hope to price at levels sufficient to achieve a desired profit margin?

H i g h e r R a t i o o f F i x e d C o s t s t o Variable C o s t s Because o f the labor and

infrastructure needed to create performances, many service organizations have a m u c h higher ratio of fixed costs to variable costs than is found in manufacturing firms.2

Service businesses with high fixed costs include those with an expensive physical facility (e.g., a hotel, a hospital, a university, or a theater), or a fleet of vehicles (e.g., an airline, a bus company, or a trucking company), or a network dependent on company-owned infrastructure (e.g., a telecommunications company, an Internet provider, a railroad, or a gas pipeline).While the fixed costs may be high for such businesses, the variable costs for serving o n e extra customer may be minimal

Variability of B o t h Inputs and O u t p u t s It's not always easy to define a unit of

service, raising questions as to w h a t should be the basis for service pricing A n d seemingly similar units of service may not cost the same to produce, nor may they be of equal value to all customers T h e potential for variability in service performances (especially those that involve interactions with employees and other customers) means that customers may pay the same price for a service but receive different levels of quality and value Alternatively, they may be charged radically different prices for the same service offering, as often happens in the hotel industry Advertising byTravelscape.com, the do-it-yourself travel site, emphasizes its ability to help customers quickly find the cheapest price for a hotel r o o m (see Figure 8.1)

Many Services Are Hard to Evaluate T h e intangibility of service performances

and the invisibility of the backstage facilities and labor make it harder for customers to

know what they are getting for their m o n e y than w h e n they purchase a physical good

Consider the homeowners w h o call an electrical firm, seeking repairs to a defective

circuit.A few days later (if they are lucky) an electrician arrives with a small bag of tools

Within 20 minutes, the problem is located and a new circuit breaker installed Presto,

everything works! Subsequently, the owners are horrified to receive a bill for $65, most

of it for labor charges But they're overlooking all the fixed costs that the firm needs to

recover, such as the office, telephone, vehicles, tools, fuel, and support staff T h e variable

costs of the visit are also higher than they appear Fifteen minutes of driving back and

forth plus 5 minutes to unload (and later reload) needed tools and supplies from the van

on arrival at the house must be added to the 20 minutes spent at the customers' house

These activities effectively double the labor time devoted to this call Finally, the firm

Understanding Costs, Contribution,

and Break-Even Analysis

Fixed costs—sometimes referred to as overheads—are those

economic costs that a supplier would continue to incur (at least in

the short run) even if no services were sold These costs may

include rent, depreciation, utilities, taxes, insurance, salaries and

wages for managers and long-term employees, security, and

inter-est payments

Variable costs refer to the economic costs associated with

serving an additional customer, such as making another bank

transaction, selling an additional seat in a train or theater, serving

an extra hotel guest for the night in a hotel, or completing one

more repair job For many services, such costs are very low

There is, for instance, very little labor or fuel cost involved in

transporting an extra bus passenger Selling a hotel room for the

night has slightly higher variable costs, since the room will need

to be cleaned and the linens sent to the laundry after a guest

leaves More significant variable costs are associated with

activi-ties like serving food and beverages or installing a new part when

making repairs, since they include the provision of costly physical

products in addition to labor Just because a firm has sold a

ser-vice at a price that exceeds its variable costs does not mean that

the firm is now profitable There are still fixed and semivariable

costs to be covered

Semivariable costs fall in between fixed and variable costs

They represent expenses that rise or fall in stepwise fashion as the

volume of business increases/decreases Examples include adding

an extra flight to meet increased demand on a specific air route,

or hiring a part-time employee to work in a restaurant on busy

weekends

Contribution is the difference between the variable cost of

sell-ing an extra unit of service and the money received for that service It goes to cover fixed and semivariable costs before creating profits

Determining and allocating economic costs can be a

chal-lenging task in some service operations For example, it's difficult

to decide how to assign fixed costs in a multi-service facility like a hospital There are certain fixed costs associated with running the emergency unit Beyond that there are fixed costs for running the entire hospital How much of the hospital's fixed costs should be allocated to the emergency unit? A hospital manager might use one

of several approaches to calculate the unit's share of overheads These could include (1) the percentage of total floor space that it occupies, (2) the percentage of employee hours or payroll that it accounts for, or (3) the percentage of total patient contact hours involved Each method is likely to yield a totally different fixed-cost allocation One method might indicate that the emergency unit is very profitable, another might make it seem like a break-even operation, and a third might suggest that the unit is losing money

Break-even analysis Managers need to know at what sales

volume a service will become profitable This is called the even point The necessary analysis involves dividing the total fixed and semivariable costs by the contribution obtained on each unit of service For instance, if a 100-room hotel needs to cover fixed and semivariable costs of $2 million a year and the average contribu-tion per room-night is $100, then the hotel will need to sell 20,000 room-nights per year out of a total annual capacity of 36,500 If

break-prices are cut by an average of $20 per room night (or variable

costs rise by $20), then the contribution will drop to $80 and the hotel's break-even volume will rise to 25,000 room nights