Dynamic Effects of Service Transition Strategies on B2B Firm Value: Tradeoffs in Sales, Profits, and Cash Flow
Mehdi Nezami, Stefan Worm, and Robert W. Palmatier, 2016, 16-108
In the face of declining business and growing pressures from low-cost competitors, many business-to-business manufacturers are transitioning to services. Yet despite substantial investments, firms fail to understand the performance effects of adding more service offerings.
In this study, Mehdi Nezami, Stefan Worm, and Robert Palmatier identify three financial-based mediators linking service ratio (the share of a firm’s revenue generated from selling services) to firm value. With a longitudinal data set (1998–2013) of 525 manufacturers, they test a comprehensive framework that explores the effects of these mechanisms--sales growth, profitability, and cash flow volatility--on firms’ overall performance at several stages of the service transition.
They find that although providing services monotonously boosts sales growth, it has a U-shaped curvilinear relationship with profitability and linearly reduces cash flow volatility. The performance effects of moving into services also depend on industry- and firm-level factors; for example, the positive effect of services on sales growth is greater in mature industries. Increasing the scope of the service business by diversifying across different markets unfavorably moderates the effect of the transition to services on profitability.
In the early stages of service transition, managers need to expect a decrease in firm value. Although tailored offerings enhance customer satisfaction, facilitating cross-selling and repeat purchase, the substantial costs associated with such strategies reduce profitability. In later stages, the mediating roles of sales growth and cash flow volatility gain strength. In the payoff stage, all three mechanisms contribute positively to firm value
Their study also suggests that service ratio is a valuable metric that financial analysts can use to assess a firm’s potential sales growth, profitability, and cash flow volatility as well as overall effects on firm valuations.
Mehdi Nezami is a doctoral candidate in marketing at HEC Paris / Michael G. Foster School of Business, University of Washington. Stefan Worm is Assistant Professor, BI Norwegian Business School. Robert W. Palmatier is Professor of Marketing and John C. Narver Chair in Business Administration, Michael G. Foster School of Business, University of Washington.
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