The Colossal (and Untapped) Potential of Systematic R&D for Advancement of New Services

Systematic innovation in services could offer an enormous commercial reward for firms (and its investors). The service sector accounts for >70% of the Western economies. Yet, services innovation is globally under-appreciated and a formal framework is lacking. In the close future, it is expected that industries that traditionally have been highly product-focused, increasingly will adopt service-based business models.

Services, like products, have a shelf life. After all, customer expectations and demands evolve, and technological progress constantly generate new opportunities. Services, therefore, should be continuously assessed and refreshed, just as products are. It is surprising that not more R&D is allocated to services innovation given that there is (i) a strong advantage for pioneering innovation, (ii) low barriers of entry and (iii) a quicker break-even-time as compared with investments in manufacturing R&D.

The service trade has been around since the dawn of mankind. During the last few decades, the scale and complexity of the tertiary sector has increased considerably. Hightened competitive pressure due to increased customer-access to information, more competitors from fast growing regions outside the traditional markets, and political/regulatory changes has resulted in enhanced customer demands. These factors force firms to provide services in an increasingly effective, more efficient and sustainable manner.

What are services?

The shape and form of services is immeasurable. For this reason there is not just one clear widely accepted definition of services available. One recent attempt to define the term has been proposed by Flikkema et al., 2007:

A service is an attempt to transform a customer reality, as constructed by its service provider, at the request of the customer and frequently in cooperation with the customer

Services, which currently represent about 65% of global GDP (70% in the US and 75% in Germany), are expected to account for about three-quarters of global growth over the coming decade. Yet, the relative investment into R&D as a fraction of total revenue generated is only 30% of what is observed in the manufacturing sector (OECD, 1999). In fact, manufacturing, with just 12 percent of US GDP, accounts for some 42 percent of the country’s R&D and employs a disproportionately large number of its scientists, technicians, and engineers. The service sector, with about 70 percent of US GDP, accounts for less than 30% of the total national R&D investment in many OECD countries. Only an estimated 25% of venture capital in US is allocated for the development of new or improved ways of designing and producing services. 

Many companies think of R&D as exclusively for product development

Innovation is forward looking, anticipating the future. Solving yesterday’s problems is important, but not innovative. Replicating what others do well is often a good approach, but not innovative.

Companies that dedicate resources and management attention systematically to developing and refining their service offerings, can undoubtedly reap significant commercial benefits. The sorts of digital disruptions that began in retailing with the likes of Amazon, two decades ago, are quickly penetrating business practices of most business—if they haven’t already. Examples include Credit Acceptance in financial services, CustomInk in design and marketing support, Zipcar in transportation, Airbnb in hotels and hospitality, Castlight Health in healthcare. 

The nature of services innovation

While few organizations have mastered the new environment, the theory of services innovation is a young science. The amount of resources that are deployed at a national level towards formal research and education of scientists, is much lower than in the manufacturing field. Many key studies and investigations pertaining to services innovation have been produced and published only in the last 15 years. The economist Dirk Pilat notes (OECD, 2001):

R&D in services is often different in character from R&D in manufacturing. It is less oriented toward technological developments and more at codevelopment, of ways to apply new technology to products.

 Attempts to deconstruct the core elements of services innovation, have resulted in the identification of at least three main dimensions of service innovation (Tidd & Bessant, 2009), involving (i) process, (ii) product, or (iii) organization. New service offerings typically involve innovation in at least one of these domains. Radical new concepts often involve all three of these dimensions. 

• Process innovation: Changing the way old services are provided; it often involves improved production process, distribution methods or support activity, including new payment schemes. Examples: Long Reach Pathology Services (long-distance shipping of bodies for autopsy), Build-a-Bear (toy manufacturing with customer involvement), Ebay (online auctioning of used items)
• Product innovation: Involves the provision of a product/service that is new to its market. This umbrella category generally also includes reaching specific client groups through marketing innovations. Examples: 23andme (genetic testing for private customers); Ashley Madison (secret online dating site for married people), Cars.com (online car service and repair support)
• Organizational innovation: A headline for alterations of the value network that allow a service to be provided at a drastically lower pricepoint or at a different scale, width or reach. Examples: Skype (peer-to-peer telephony), Assay Depot (online peer-to-peer marketplace for research analysis services), Uber (taxi-service provided by private individuals in their own cars) 

The benefits of R&D aiming for new services

By tradition, a number of industries have been almost exclusively product-centric, for example the pharmaceutical, food and specialty retail sectors. It is possible, or even likely, that these branches gradually will embrace services provision as an adds-on source of revenue in the future. There are a number of reasons that would strongly argue for increased investment in R&D of services innovation: 

First-movers-advantage. First-mover firms that pioneer the commercialization of a new service may be able to acquire a reputation as an industry leader. These innovators often define the service category concept and shape buyer preferences; they can build technical standards that late entrants are forced to follow. First-entrants may move down the learning curve rapidly with consequent cost-reduction and enhanced profitability. Moreover, pioneering innovators often force followers to pay the buyer switching cost.

Low barriers of entry. Less than 5% of new services offerings are protected by patents. Variety rights are never indicated. Instead, service firms protect their innovation through rapid time-to-the-market periods in order to protect their innovations. Inversely, this means that the freedom-to-operate situation can be very favorable, with few intellectual property barriers to market entry.

Quick return-on-investment. In a recent survey of 60 Dutch firms in the services sector (Vos, 2010), two thirds report an average development time from investment-to-market of 14 months or less. This is a small fraction of the median lead-time that is typically seen in manufacturing R&D. In contrast to product innovation, services innovation can be done cost-effectively in customer-centric iterations of gradual improvement, often-times less rigidly than what is typical for new product introductions.

The national impact

More than ever, the unease of globalization troubles the Western economies. Many sorts of global interactions have gradually become more frequent, but not in a symmetric way: international trade in manufactured goods has escalated, but most services remain untraded. From a national perspective, this means that investments in services innovation, at least for time being, benefit the region where they are developed, because, in contrast to manufacturing, most services generated in any particular region are consumed there.

What is the conclusion?

In summary, around 75-80% of the working society in the Western economies is employed in the services industry. Despite the widely acknowledged importance of the service sector, it is the least studied and understood part of the economy.

In line with the prodigious growth of the services sector, new management paths need to be defined to chaperon innovation activities within services. A comprehensive innovation management model in service firms is not yet recognized. There is a steep need for a more formalistic approach; the commercial reward could be immense.

References

• Flikkema, M., Jansen, P., & Van der Sluis, L. (2007). Identifying Neo-Schumpeterian Innovation in Service Firms: A Conceptual Essay with a Novel Classification. Economics of Innovation and New Technology , 16 (7), 541-558.
• OECD Report (2001) Innovations and Productivity in Services. OECD Publication Service.
• Tidd, J., & Bessant, J. (2009). Managing Innovation Itegrating Technological, Market and Organizational Change. West Sussex: John Wiley & Sons Ltd.
• Vos AH. (2010). Service Innovation: Managing Innovation from Idea Generation to Innovative Offer. A Master's thesis at University of Twente.