Rewards Strategy: A Key Driver of Service–Profit Chain

Introduction

The service industry is one of the fastest growing sectors in developed and developing countries, experiencing increased competition and more demanding customers in recent years. Such an intense environment puts pressure on service providers to set themselves apart from their competitors, including by providing higher quality service to retain customers and drive profitability. ¹ As service industries are heavily dependent on their employees for achieving and sustaining a competitive advantage, it is important for organizations to take those actions and making those investments that best enable their employees to successfully coproduce quality service experiences. Companies are forced to focus greater attention on the quality of the service provided to customers, making frontline employees of central importance for the better customer experience. It is imperative for organizations to improve the internal customer (i.e., employee) service quality, with satisfying human resource management (HRM) policies and procedures to increase employees’ job satisfaction, which in turn help in rendering good quality external services. Thus, organizations should focus and prioritize on the needs and requirements of their employees for gaining more external customer-oriented competitive advantage. ² Various HRM practices, including employee rewards and recognition, have the ability to effectively influence employee attitudes and behaviors in ways that can improve service quality for customers and organizational performance. This research works in this direction and studies service–profit chain concept to emphasize role of effective rewards strategy in enhancing overall business performance.

The Service–Profit Chain

The service–profit chain is a well-received concept to explain the sustainable competitiveness of many service organizations. The service–profit chain establishes a series of links between business performance in terms of revenue growth and profitability, customer satisfaction and loyalty, and employee satisfaction, loyalty and productivity. ³ According to it, profit is a result of customer loyalty, driven by customer satisfaction. It is estimated that a 5% increase in customer loyalty can produce profit increases from 25% to 85%. ⁴ Satisfaction is largely a result of the customers’ perceived value of the service they receive. And this service is, in turn, dependent on, on one hand, the employees’ satisfaction and loyalty, and on the other hand, the employees’ productivity. Empirical findings have shown that employee satisfaction is positively correlated with employee loyalty. The employees’ satisfaction and loyalty also have a positive effect on productivity.

The service–profit chain postulates that higher employee satisfaction levels lead to high customer satisfaction and, ultimately, affect customer loyalty and profitability. Researchers have described the relationship between employee and customer satisfaction with their analogy of the satisfaction mirror, in which employee satisfaction is “reflected” in terms of customer satisfaction, which in turn generates business growth and profitability. ⁵ It means that employee satisfaction and customer satisfaction are highly correlated, because employee satisfaction translates into service quality, which leads to more satisfied customers and ultimately business success.

Between 40% and 80% of customer satisfaction and loyalty is determined by the customer–employee relationship, depending on the industry and market segment that is being considered. ⁶ At Sears, employee satisfaction accounts for 60% to 80% of customer satisfaction. ⁷ At the Royal Bank of Canada, 40% of the difference in how customers view its services can be directly linked to their relationships with bank staff. ⁸ Customer satisfaction is an important determinant of repeat purchasing behavior; and therefore, it is the essential component of sustainable competitive advantage. ⁹ Researchers have collected empirical evidence from 20 large service organizations, lending support to many of the linkages in the service–profit chain. ¹⁰ Customer satisfaction leads to customer loyalty because it breeds attachment to the provider and motivates repurchase intentions. There is a positive causal relationship between customer satisfaction and customer loyalty. Loyal customers amplify sales through frequent repurchases and customer referrals and also reduce service costs and marketing expenditures because they are familiar with the service provider’s processes and are reluctant to switch. Providing a satisfying work environment for employees results in employees’ job satisfaction, and this translates into good service. This, in turn, translates into satisfied and loyal customers who will continue to buy goods and services from the company and thus drives firm performance.

Financial and Nonfinancial Rewards

Organizational reward means all the benefits, which include financial and nonfinancial, that an employee receives through the employment relationship with an organization. There are three main types of rewards that individuals seek from their organization: extrinsic (provides tangible, material consequences), intrinsic (provides intangible benefits that have internal consequences) and social (refer to the extent of positive interpersonal relationships) rewards. The extrinsic rewards include pay (wages and salary), fringe benefits, promotion prospects, recognition, status symbols and praise. The intrinsic rewards are those rewards that are related directly to performing the job and include self-granted and internally experienced payoffs. This includes a sense of accomplishment, self-esteem, autonomy, personal growth and self-actualization. The social rewards arise from the interaction with other people on the job and may include having supportive relationship with supervisor and coworkers.

Reward is the basic element that indicates how much employees gain by dedicating their time and efforts toward the achievement of organizational objectives. Therefore, management have the responsibility of designing an attractive reward package to attract and retain valuable employees to the organization. With optimal reward structure, organizations anticipate returns from their investments in employee reward programs through reward value chain. ²³ Designing optimal reward strategy for employees matters for the top and bottom line of organizations. ²⁴

Effective reward programs not only emphasize financial and tangible returns but also provide value to the organization through intangible returns by signaling the behaviors and actions the organization wishes to prioritize. Although, cash rewards are often necessary to motivate employees, they must be used carefully and in combination with other reward types. A quick look at the organizations listed in many “best places to work” lists reveals a near universal adoption of a total rewards strategy, in which salary and cash bonuses constitute only a portion of reward packages otherwise brimming with tangible and intangible rewards. ²⁵ Effectively managed total reward systems will have a strong positive influence on employee attraction, motivation and retention. Incentive Research Foundation report reveals that between 80% and 90% of top performing U.S. firms use noncash rewards (e.g., travel, merchandise, gift cards) versus only 60% to 75% of their average-performing counterparts. The research revealed that top-performing companies are more likely than average-performing businesses to use noncash rewards and recognition programs to reward their salespeople (90%), employees (88%) and channel partners (81%). ²⁶

U.S. companies allocate more than one fifth of their budgets to wages and salaries, spending between $38 and $77 billion on cash rewards and incentives each year. ²⁷ In addition to cash rewards, U.S. companies spend between $46 and $90 billion each year on tangible noncash rewards, including gift cards.^28,29 Despite these enormous expenditures, more than 80% of American employees report that they do not feel recognized or rewarded, and about 40% of the employees reported that they would work harder if their contributions were more widely recognized. ³⁰

Effective rewards strategy outlines how to best satisfy employee’s psychological needs through rewards and recognition. ³¹ A good strategy offers a range of tailored cash and noncash tangible and intangible rewards that satisfy these universal psychological needs. Reward and recognition are viewed as some of the most important factors related to employee satisfaction. Firms with strong strategic recognition programs exhibit greater productivity, lower turnover and greater returns on investment than other firms in their industries. ³²

Rewards play an important role in building and sustaining the commitment among employees, which ensure a high standard of performance. Employees are certainly closer to their organizations and perform better jobs when they receive healthier reward and recognition in their organizations. Effective balance between financial and nonfinancial rewards enhances employee satisfaction and can leverage on employees to perform better at workplace, to ensure retention and to boost productivity. Motivation of employees is determined by both monetary and nonmonetary factors. As services are unique in nature, an effective reward system can motivate and retain employees in the service organization, but an ineffective reward system leads them to dissatisfaction and higher turnover. The four key characteristics of service separate them from goods or products: intangibility (not being palpable or material), heterogeneity (difficulty in standardizing services), inseparability (production and consumption occur simultaneously) and perishability (no option of storing). Intrinsic and extrinsic rewards satisfy and motivate employees in service organizations and lead to their higher satisfaction, loyalty and retention (Figure 1).

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Figure 1.

Total rewards strategy in service industry: Impact on internal service quality.

As shown in Figure 1, financial and nonfinancial rewards are major drivers of internal service quality and hence reinforce the primary message of recognition and appreciation.

Effective Rewards Strategy: A Key Driver of Service–Profit Chain

The service–profit chain concept posits that revenues are driven by service quality perceptions, which in turn are driven by operational inputs and employee efforts. ⁴² It also suggests that higher internal service quality enhances employee satisfaction, and employees who are satisfied are more likely to provide higher quality service than those who are not. Satisfaction is an employee’s evaluation of his or her rate of pay, level of benefits, level of flexibility in one’s job, etc. Organizations can choose the high road—that is, the good jobs strategy—by offering employees a living wage, better benefits and a job that motivates them to do great work. Costco (a wholesale-club chain), Trader Joe’s (an American supermarket chain) and QuickTrip (a U.S. convenience store chain) have adopted good jobs strategy. These retailers compete on offering customers low prices, but each business has chosen the high road pathway to profits. Each of these companies makes greater profits than their competitors—all the while treating their employees better. When retailers view employees not as a cost to be minimized but as a driver of sales and profits, they create a virtuous cycle as investment in employees (i.e., better wages, benefits, training, growth opportunity, etc.) allows for excellent operational execution, which boosts sales and profits, which allows for a larger labor budget and which results in even more investment in store employees. Costco, Trader Joe’s and QuikTrip operate in a virtuous cycle. ⁴³

The employee satisfaction is imperative for providing better and timely service to the customers and achieving their satisfaction and loyalty. The effects of internal service quality practices on employee satisfaction vary in part according to the type of service; and hence, HR managers should tailor internal service quality to ensure that the practices fit the particular jobs and meet the expectations of employees in various service settings. There are numerous components of employee satisfaction as it complements in enhancing internal service quality: rewards and compensation, job security, training, flexibility, meaningful work and professional growth. Training will develop the overall capabilities of service employees and improve their service delivery performance. Job insecurity is a chronic job stressor, which affects the well-being of employees and results in an increased employee turnover rate. When employees are empowered with a sense of well-being at the organization, it provides reassurance about job security. Feelings of job security can have a significant positive impact on employee engagement. Employee engagement entails willingness to invest effort in one’s work and to persevere when challenges arise. Employee engagement is influenced by job security and empowerment of employees. Empowerment means providing employees with enough autonomy to allow them to handle unforeseen situations and challenges. Empowerment motivates employees to greater service performance and creates a greater sense of accomplishment or satisfaction in their jobs. This research specifically focuses on financial and nonfinancial rewards that are contingent on an employee’s work performance.

Employee satisfaction and loyalty are seen as critical to the capability of service organizations to respond effectively to customer needs, while also driving down costs through reduced recruitment cost, reduced training expenditure and overall cost-efficiencies. Job satisfaction is a key factor to an organization because it affects employee performance and productivity, absenteeism and turnover. Organizations are competing to attract and retain employees; therefore, creating a work environment that encourages and supports employees is worthwhile. Sorting effects describe how reward systems attract, retain and sort out individuals with particular characteristics. Sorting based on reward systems is consistent with the idea of person–organization fit, which asserts that employees choose organizations based on their perceptions of the match between their own dispositions and organizational characteristics.

Loyal, high-performing employees are more likely to create a positive service experience. Researchers show that HRM practices directly influence financial outcomes through employees’ abilities and motivation and operational outcomes such as customer satisfaction. ⁴⁴ Improvements in internal service quality may also help cut costs and increase efficiency through the positive effect on employees’ citizenship behavior, such that internal service quality improves firm performance beyond the effect on external service quality. Internal service quality drives employee satisfaction through various HRM practices, including employee rewards and recognition. Extending the concept of the service–profit chain, this research emphasizes the impact of rewards mix (financial and nonfinancial rewards) on employee satisfaction, customer retention and firm performance. As shown with the service–profit chain framework (Figure 2), the research suggests that effective rewards strategy enhances employee satisfaction, and satisfied and loyal employees can deliver high-quality services to fulfil customers’ needs; satisfied customers would, in turn, become loyal to the firm, leading to improved revenue growth and profitability.

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Figure 2.

Total rewards strategy: A key driver of service–profit chain in service industry.

Following illustration explains how Zap-pos has effectively used service–profit chain concept to enhance employee satisfaction, customer retention and overall business per-formance.

Managerial Implications

Rewards provided by organizations have positive relationship with job satisfaction and hence employee’s improved performance and retention. The main purpose of reward strategy is how it can assist to attract talented people, motivate them to achieve a high level of performance, ensure their retention and boost output in the organization. Financial rewards increase employees’ feelings of satisfaction, achievement, status, control and power. The use of nonfinancial rewards serves as reminders of the commendable performance that led to their receipt. The memory of these rewards will further reinforce that the organization values the employee. Both financial and nonfinancial rewards can enhance employees’ motivation and attachment to the organization. The research highlights that with effective rewards strategy, companies should take care of their employees first, because doing so will result in employees delivering a better customer experience and creating loyal customers who generate greater profits.

Conclusions

The research emphasizes that the service–profit chain begins with internal service quality triggered by financial and nonfinancial rewards and ends with business performance in terms of revenue growth and profitability. It is becoming increasingly important for organizations to focus on customer service to create a competitive advantage. As internal service quality influences customer perceptions of external service quality, organizations need to make investments in internal service quality to signal a company’s aspiration to provide outstanding service. The internal service quality components identified in the service–profit chain model are rewards and recognition, employee selection and development, workplace design, job design and tools for serving customers. As such, internal service quality encompasses various HRM practices, work environment and supporting tools for customer service. This research extends the service–profit chain concept to specifically focus on the financial and nonfinancial rewards to understand its impact on service–profit chain.

Better HRM practices with proper design of rewards mix (financial and nonfinancial rewards) enhance internal service quality and thus lead to higher employee satisfaction and a more committed workforce, which, in turn, lead to superior services, which lead back to higher customer satisfaction. It is necessary to develop a firmwide rewards and recognition system tied to established measures. The service–profit chain concept helps managers understand the role of human capital as driver of business success in their organizations. The research deploys service–profit chain model to underscore the impact of effective rewards strategy on contribution and performance of employees in enhancing customer service and thus business performance.