Service design facilitates market transactions

New kind of offerings are possible with low transaction costs

Service design expands the market

The total cost of utilization (TCU) is the idea that customers pay over and above the price of the service, in cash and or in kind.  To make use of the service, they may incur other expenses or suffer hidden fees and penalties. Or, they pay in terms of the additional time and effort for enrolling or signing up for the service, engaging it for use, entrusting it with their demand and enforcing it in terms of getting what they paid for under the terms and conditions. These are transaction costs. When transactions costs are high, services become less attractive because of a lower net value. When the costs are low, service offerings become more attractive.

High transactions costs, which include the additional pain from lousy user experience and burdensome contracts, drive down the willingness of customers to use a service. So, the ability of a service provider isn’t just about having capabilities and resources, but also deploying them in a manner that the outcomes and experiences deliver a high net value. Transaction costs are higher when the job to be done is very complex. They are lower when it is simple or routine and stable over time with few changes. They are also higher when it is hard to define outcomes, and therefore harder to enforce if the delivery falls short of promises. Another problem is when outcomes produced by a service are dependent on other factors outside the control of the service provider.

TCU is the sum of all costs incurred by customers and users, including the price for using the service and all the extra costs they are willing to accept in the process of using the service. These costs add up, across enrollment, engagement, fulfillment, and enjoyment. They include sign-up and set up costs. Some services require costly installations, including changes that need to be made within the customer’s environment simply to make use of the service. Or, the cost could be in terms of lock-in in the form of contractual commitments.

Some services require the purchase of other enabling services, such as paying for high-quality broadband access to use Netflix or traveling to a far-off airport from where a low-fare airline flies. Other costs include the impositions of dialog and interaction due to errors and failures by the service provider. When a service is poorly functioning at degraded service levels, customers may suffer a loss of benefits from downtime and disruption for which they may not be compensated. Worse, they have to resort to temporary solutions or alternatives to get by. Enforcement costs, which include getting help and assistance to fix service disruptions are costly for customers as well, and poorly designed recovery processes place an undue burden on customers.

Some services require customers to pay with data and privacy as part of the service agreement, which is considered the cost of using the service. It is not by accident that many such services are advertised as FREE. Airlines fares include a large amount of taxes and fees which one would not find in other forms of transportation, such as buses, trains, and trams. These are attached to the airfare and cannot be unbundled and are not open to negotiation. However, justified they may be, such as the airport fee for noise isolation which prevents noise pollution for those not flying, they are part of the TCU and take away from consumer surplus. However, since passengers are now more likely to use fare comparison engines, airlines are using the framing effect to unbundle many aspects of air travel and sell them separately.

All of these costs add up. For a given price, the TCU is the ratio of price and quality of experience. The TCU is high when the quality of experience is low. It is low when the quality of experience is high.

These are the total costs customers experience from paying for and using the service, across the stages of enrollment, engagement, fulfillment, and enjoyment. That’s the sum of transaction costs and production costs. Benefits from using the service justify most of these costs but not all. The costs due to the poor quality of experience can be quite significant.

When transaction costs are high, they eat into the benefits. The totality of these costs has the effect of reducing perceived benefits and increasing real and perceived risks. From behavioral economics perspectives, perceptions matter a lot. On the other hand, what can you subtract from these costs? There could be savings from using the service versus the opportunity costs associated with do-nothing or DIY options.

Higher levels of quality assurance can also reduce unnecessary and unexpected costs. Goodwill and trust of service providers, in the form of discounts and rewards, can also reduce the TCU. For a fixed quality of outcomes, any reduction in TCU results in an economic surplus (also known as consumer surplus) that in turn generates goodwill and trust towards the service provider, thus completing the feedback loop.

Posted by:Majid Iqbal

TL;DR I bring clarity to the concept of a service.