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Enabling service innovation: A dynamic capabilities approach

Article in Journal of Business Research · August 2013

DOI: 10.1016/j.jbusres.2012.03.003

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Enabling service innovation – A dynamic capabilities approach

Daniel Kindström, Linköping University

Christian Kowalkowski, Hanken School of Economics
Erik Sandberg, Linköping University

JANUARY, 2012

The authors are indebted to Heiko Gebauer for insightful comments on earlier
versions of this paper and to Keith Crosier for his patient and invaluable editing
services. They also gratefully acknowledge the financial support of the Jan Wallander
and Tom Hedelius Foundation and Vinnova (The Swedish Governmental Agency for
Innovation Systems).

Send correspondence to Daniel Kindström, Linköping University, Department of

Management and Engineering, SE-581 83 Linköping, Sweden; telephone +46-13-
281571 ([email protected]); Christian Kowalkowski, Hanken School of
Economics, CERS - Center for Relationship Marketing and Service Management, PO
Box 479, FIN-00101 Helsinki, Finland ([email protected]); Erik
Sandberg, Linköping University, Department of Management and Engineering, SE-
581 83 Linköping, Sweden ([email protected]).
 Enabling service innovation – A dynamic capabilities approach

ABSTRACT

The point of departure for this article is the need for product-centric firms to

compete in the market by adding services to their portfolio, which requires a greater

focus on service innovation if they are to remain competitive. A major challenge

associated with the shift from product-centeredness to a product-and-service

orientation is the management of the essential dynamic capabilities of sensing,

seizing, and reconfiguring needed for service innovation. The research study reported

identifies key microfoundations forming the basis of successful realignment of a

firm’s dynamic capabilities so as to achieve a better fit with service innovation

activities. Eight qualitative case studies of product-centric firms form the basis of the

study.

The findings make three primary contributions to the body of knowledge. First,

they extend the existing literature on dynamic capabilities by specifically discussing

microfoundations related to service innovation. Second, the study extends existing

work on service innovation into the manufacturing industries by identifying the key

microfoundations in that context. Third, the research provides empirical evidence of

dynamic capabilities in practice, especially in product-centric settings in which the

service context is novel.

Keywords: Service innovation, dynamic capabilities, microfoundations, services,

service orientation, strategy.

1. Introduction

Though product-centric firms may today acknowledge the transition toward

services, many struggle to envision how they would best manage the process in

practice. That uncertainty is understandable, given that an increased service

orientation often involves a major shift to a new strategic direction, a new

organizational structure, and new skills (Gebauer, Gustafsson, and Witell, 2011; Jacob

and Ulaga, 2008; Kowalkowski, Kindström, Brashear, Brege and Biggeman, 2012;

Raddats and Easingwood, 2010). To be able to develop new services continuously and

comprehend the underlying business logic of service provision, firms must develop

dynamic capabilities (Teece, Pisano and Shuen, 1997) that can enable service

innovation (Den Hertog, van der Aa and de Jong, 2010; Fischer, Gebauer, Gregory,

Ren and Fleisch, 2010; Martin and Horne, 1992). Service innovation and its

associated dynamic capabilities are a key concern for many firms today, some

researchers citing them as key drivers of consistent high performance over time

(Gallouj and Weinstein, 1997; Sundbo, 1997). An understanding of these capabilities

is an important first step in being able to reap the benefits of future service

innovation; without it, a firm risks becoming trapped in activities delivering ever-

decreasing returns (Tallman, 2003; Teece, 2007; Winter, 2003) and erecting

increasingly rigid barriers (Leonard-Barton, 1992).

The emerging field of dynamic capabilities provides a relatively new

perspective from which to approach service innovation and strategic renewal. . The

focus on change inherent in the concept is a difference in comparison to previous

literature and a reason for why dynamic capabilities contributes to our understanding

of service innovation in this research. Based on the idea that unique bundles of

resources form the basis for competitive advantage, the dynamic capabilities
perspective views sustainable competitive advantage as the ability to create, extend,

and modify valuable resources and capabilities over time (Helfat, Finkelstein,

Mitchell, Peteraf, Singh, Teece and Winter, 2007). For analytical purposes, dynamic

capabilities can be disaggregated into three distinct activities: sensing opportunities

and threats, seizing those opportunities, and maintaining competitiveness by

reconfiguring resources (Teece, 2007). Underpinning these three generic, corporate-

level capabilities are ‘microfoundations’, defined by Teece (2007, p. 1319) as

“distinct skills, processes, procedures, organizational structures, decision rules, and

disciplines”, form the organizational basis of dynamic capabilities. Those are

consequently at the very core of understanding the creation of competitive advantage.

The purpose of the research study reported here is to identify the key

microfoundations that permit product-centric firms to build the dynamic capabilities

that can facilitate service innovation. Focusing on microfoundations enables

researchers to drill down to a level of detail that would not otherwise be possible and

thereby build a firm conceptual foundation for service innovation, and to devise

strategies for its implementation by management.

Although the concept of dynamic capabilities is relatively generic, most research

has tended to focus on its product-related and technology-related aspects. Yet

product-centric firms, which have traditionally based their competitiveness on product

leadership and protection by patents, are increasingly shifting their focus toward

services and innovation in service delivery. Consequently, it is timely to apply the

concept of dynamic capabilities and their microfoundations directly to the pressing

challenge of infusing a greater element of service, as a means to effective innovation.

The study reported here therefore aims to contribute to theory by adding a

discussion of dynamic capabilities to the service-oriented literature and introducing

the service dimension into the strategic analysis. The point of departure is a broad

view of service innovation, such as that taken by Bessant and Davies (2007), dealing

not only with the uniqueness or newness of the service, but also of innovations in

other areas of the service system (Drejer, 2004; Gallouj, 2002; Gallouj and Weinstein,

1997), such as the delivery processes, customer interfaces, and the buyer-seller

relationship (de Jong and Vermeulen, 2003). Service innovation can also be focused

on customer roles and competences in the service process (Gallouj and Weinstein,

1997; Michel, Brown and Gallan, 2008).

This remainder of this article begins with a brief overview of the concept of

service innovation, followed by a discussion of the dynamic capability framework and

its links with services and service innovation. Next, the case-study methodology is

described and discussed, before the findings are presented for the separate activities of

‘sensing’, ‘seizing’ and ‘reconfiguring’. The article concludes with a discussion of the

implications of the study for academics and practitioners.

2. The nature of service innovation

Service innovation is a broad concept that encompasses a considerable number of

distinct dimensions, discussed in the literature by Bessant and Davies (2007), de Jong

and Vermeulen (2003), Edvardsson and Olsson (1996), and Tidd, Bessant, and Pavitt

(2001). Specific examples of innovation include service development processes

(Kindström and Kowalkowski, 2009; Song, Song and Di Benedetto, 2009), capability

development (Den Hertog et al., 2010; Fischer et al., 2010), learning (Stevens and

Dimitriadis, 2004), organizational adaptation (Neu and Brown, 2008), and culture

(Gebauer and Friedl, 2005). Firms aiming to master the intricacies of service

innovation and take full advantage of the potential benefits of service innovation must

address that wide array of component parts. Yet many of the service innovation
frameworks applied in practice focus solely on changes in the firm’s view of service

or on the processes of service provision. The study reported here proceeds from the

proposition that service innovation is a multi-dimensional, organization-wide

challenge to the managers charged with its design and implementation, and that a

comprehensive conception of it is therefore essential.

Although service innovation has a catalytic role in shaping new markets and

creating new business opportunities, most product-centric firms still adhere to the

‘invention’ model, which prioritizes the conventional, structured processes and

platforms for product development that are typical of mature, product-centered firms

(Ostrom et al., 2010). Innovation is often taken to be synonymous with new

technology in the context of new product development and manufacturing processes

(Utterback, 1994). There are few insights into the means by which product-centric

firms might achieve successful service innovation, and thereby differentiate

themselves by ‘infusing’ services and solutions (Ostrom, Bitner, Brown, Burkhard,

Goul, Smith-Daniels, Demirkan and Rabinovich, 2010).

3. The nature of dynamic capabilities

The so-called resource-based view of strategy has been criticized for not

considering how to develop and maintain a firm’s resources over time (Teece et al.,

1997). The concept of dynamic capabilities, which takes the resource-based view as

one of its starting points, aims to address that problem. A widely adopted definition of

dynamic capabilities is that they are routines within the firm’s managerial and

organizational processes that aim to gain, release, integrate and reconfigure resources

(Teece et al., 1997) and are therefore change-oriented (Winter, 2003; Zollo and

Winter, 2002). They not only seek to adapt a firm’s resource base to evolving

customer demands and market trends, such as an increased demand for services, but
also allow firms to shape their environment through innovation and collaboration with

their customers and other key actors (Teece, 2007).

Given the focus on change, the original conception of dynamic capabilities was in

the context of rapidly changing environments (Teece et al., 1997). The recognized

need for firms in relatively stable environments to gain, release, integrate and

reconfigure their resources in response to the threats and opportunities of change in

the marketplace has led to a change in the traditional perspective (Eisenhardt and

Martin, 2000). Given that product-centric firms are confronted by changing markets,

new customer demands, new (often low-cost) competition, and commoditization of

products, the adoption of a dynamic capability framework is both appropriate and

timely. Some observers (Prasnikar, Lisjak, Buhovac and Stembergar, 2008; Day,

2004) feel that managers need to understand both their firms’ core technological

capabilities and its marketing capabilities, to be able to decide which capabilities

should be developed and which discontinued as irrelevant. As the business focus of

product-centric firms shifts to services, the need increases to identify the necessary

capabilities and propose means for their implementation.

The tendency to discuss capabilities in a product- and technology-development

context (e.g., Eisenhardt and Martin, 2000; Lisboa et al., 2011; Teece, 2007) often

leads to the neglect of the service component.. The increasing importance of service

innovation for many firms and the fact that changes in the external environment can

decrease the value of current dynamic capabilities, together generate the imperative to

extend discussions about the dynamic capabilities framework (Den Hertog et al.,

2010; Fischer et al., 2010). The introduction of service innovation into the scenario

does not necessarily demand modification of the overarching generic framework.

Instead, firms must extend the underlying structure – that is, the microfoundations
(Teece, 2007) – by taking the service aspect into account. A focus on those

microfoundations rather than overarching capabilities, favours deeper insights and an

analysis better attuned to initiatives and procedures that directly influence service

innovation.

There is a need to distinguish a number of distinct microfoundations geared to the

facilitation of service innovation. Identification and implementation of such

subcategories will extend the dynamic capabilities framework, rendering it more

comprehensive, well attuned to the contemporary characteristics of the industry and

its context, and better able to address the particular challenges of service innovation.

For analysis of the empirical data, the study reported here adopted the threefold

classification of firm-level dynamic capabilities proposed by Teece (2007): sensing,

seizing, and reconfiguring. The aim was to develop a more inclusive structural

framework, which would include the microfoundations at the heart of the concept of

dynamic capabilities. These three constructs are not novel. Indeed, their conceptually

relationship to the exploration-exploitation dichotomy (Lisboa et al., 2011) and

equivalent constructs in the literature of market orientation (Kohli and Jaworski,

1990) attests to the relevance and applicability of the constructs. Nevertheless, the

addition of a dynamic capabilities perspective and associated microfoundations

permits a more direct connection to underlying factors.

3.1 Sensing capabilities

‘Sensing’ refers essentially to the gathering of relevant marketing intelligence. It is

crucial for businesses in pursuit of competitive advantage to be able to scan global

and local markets, assess customers’ actual preferences, and capture ideas internally

from a wide range of employees (Day, 2004; Teece, 2007). In the context of market

orientation, Kohli and Jaworski (1990) describe a comparable process of intelligence

generation followed by the dissemination of information. Voola and O’Cass (2010)

focus on aspects relating to the sensing capability in their discussion of ‘proactive’

market orientation.

Gathering information about customers is a particularly important basis for the

development and provision of services (Edvardsson, Gustafsson, Kristensson,

Magnusson and Matthing, 2006; Gallouj and Weinstein, 1997). Developing and

delivering a service typically involves several stages, characterized by customer

involvement and continuous feedback loops of interaction and mutual adjustment

(Kindström and Kowalkowski, 2009; Stevens and Dimitriadis, 2004). The sensing of

service-related opportunities is inherently complex, because those are apt to reside

deep in customer-specific processes and activities and are typically understandable

only after the co-creation of the service in the customers’ unique contexts (Vargo and

Lusch, 2008).

3.2 Seizing capabilities

To ‘seize’ capabilities, it is not sufficient to invest in technology and

complementary assets. A business model must also exist that is capable of sustaining

and exploiting new opportunities as they present themselves (Chesbrough, 2010;

Teece, 2010). Similarly, Kohli and Jaworski (1990) and Atuahene-Gima (1996) call

for ‘responsiveness’, by which they mean the readiness to disseminate market

intelligence throughout the firm and duly take initiatives based upon it. The product-

centric business model is inappropriate, in the sense that it may cause the loss of many

previously sensed service opportunities in transit between management levels or

functions, or between resources for sensing and seizing. Firm decision-making

processes geared towards products can miss service innovation opportunities that

would be seized by a more service-oriented capability.

 Proficiency in service design and delivery is as dependent upon organizational

innovations as upon the development and implementation of particular service

innovations. The reason is at least partly that many of the challenges entailed in

changing from a product-orientation to a service-orientation and becoming more

customer-centric require are internal to the firm (Shah et al., 2006).

3.3 Reconfiguring Capabilities

It is widely recognized that successful firms often become complacent and rigid

over time (Leonard-Barton, 1992), frequently fine-tuning their current business model

by focusing on exploitation rather than exploration. A slight adjustment of the model

may be enough to sustain exploitation of the current set of opportunities but, when the

environment changes, management will need to undertake more substantial

reconfiguration (Helfat et al., 2007).

Although a firm’s business model and associated business logic may be sound

enough to benefit from current product-based opportunities, they may not be

sufficient to take advantage of emerging opportunities for service innovation, even if

those are sensed. To do so, the firm must reconfigure fundamental elements of its

business model and its current resources (Kindström, 2010) and break embedded path

dependencies that are faulty.

4. Methodology

The aim of this study was to explore key microfoundations for service innovation

in product-centric firms, a complex and context-bound process. Accordingly, the

multiple case method was chosen as the most appropriate vehicle for gathering the

necessary data, since it allows analysis of issues from different standpoints and is

considered to be an effective means of gaining new knowledge about a specific

phenomenon (Eisenhardt & Graebner, 2007). Specifically, multiple case analysis was

expected to facilitate in-depth understanding of the contextual factors and underlying

processes influencing dynamic capabilities and service innovation in product-centric

firms, and thereby develop a refined and extended conceptualization of the service-

based microfoundations of dynamic capabilities. The focus is on product-centric firms

because, to the best of our knowledge, no studies have yet explored the

microfoundations of service innovation, which is a pressing issue in industry today.

4.1 Sample

Three criteria were applied to the selection of appropriate cases from a pool of

firms taking part in two ongoing research projects on service transition in

manufacturing industry. First, a candidate firm had to have existing professional

experience of service innovation within its own organization and must have expanded

its offering beyond its core product. Second, for reasons of practicality, access to key

informants had to be readily available. Third, the case firms should yield qualitative

richness and diversity of data, rather than delivering statistical representativeness,

each one standing on its own merits as a unit of analysis (Eisenhardt and Graebner,

2007; Yin, 2003). In short, sample selection was based theoretical sampling, not

statistical sampling, in pursuit of superior generalizability of the findings (Gibbert,

Ruigrok, and Wicki, 2008).

The selection process took care to distinguish basic, product-oriented services –

such as repair, maintenance or spare parts supply – from more advanced, process-

oriented services –such as long-term service and rental agreements, process

optimization or fleet management (cf. Mathieu, 2001). While the eight firms

eventually selected for the study had all provided basic services for a long time, the

mode of provision generally lacked structure and strategic direction with respect to
development and innovation. Though the firms studied thus did deliver basic services,

to varying degrees, only a few offered a wide range of advanced services or derived a

large share of their revenue from such services.

Application of the selection criteria resulted in the sample of eight (anonymized)

firms described in Table 1. All are long-established, founded more than 60 years ago,

and successful in their fields. As the table shows, they collectively represent a good

range of industry types and product-service offerings.

Table 1 here

4.2 Data collection

Data for analysis were collected by means of: face-to-face interviews, focus group

discussions, and extraction from internal and external secondary sources. The

rationale for the focus group method, in particular, was to strengthen the findings of

the study in terms of their contribution to both academic and practitioner

understanding.

Interview respondents, drawn from the eight case-study firms, represented three

distinct organizational groupings: general business managers, service managers, and

service engineers. The rationale for this sample profile was to minimize the scope for

bias inherent in relying on answers filtered through the personal interpretation of

questions by a relatively small number of respondents. Interviews were semi-

structured, guided by a case study protocol (Gibbert et al., 2008; Yin, 2003) based on

inputs from the service innovation literature and the dynamic capability framework.

The approach of the focus group element of the research design had much in

common with what Van de Ven and Johnson (2006) call “engaged scholarship

research … a collaborative form of inquiry in which academics and practitioners

leverage their different perspectives and competencies to coproduce knowledge about

a complex problem or phenomenon” (p. 803). Participants in one group which met

several times were drawn from all eight participating firms. Discussion focused on the

continuing preliminary conclusions of the study, as an input to refinement of the

analysis and eventual validation of the results (Matthyssens and Vandenbempt, 1998;

Stewart and Shamdasani, 1990). Given that the researchers and their practitioner

partners had established mutual trust during the research projects, and that none of the

participating firms was in competition with another, the atmosphere during the

discussions was open and honest.

4.3 Data analysis

The participating researchers audio-recorded the majority of the interviews, for

subsequent transcription. Respondents reviewed the resulting write-ups, as a

precaution against misunderstandings and errors of transcription (Gibbert et al.,

2008). Analysis of the inputs from the depth interviews, focus-group discussions and

secondary sources identified a number of service innovation skills, processes and

procedures (that is, preliminary versions of microfoundations) across the sample.

Theoretical triangulation of the written-up inputs optimized their internal validity and

reliability (Yin, 2003), thereby substantiating the conclusions drawn (Gibbert et al.,

2008). The results of that process were interpreted against the background of the

literature relating to dynamic capabilities, service innovation, and the process of

transition from product-centrism to the infusion of service into the offering. A

sequence of iterations, switching sequentially between empirical results and

theoretical inputs, generated and developed the new conceptual framework. This

process has been termed “abductive” (Dubois and Gadde, 2002). The analyzed and

processed data were lastly grouped and regrouped, systematically, into discrete related
themes.

Following the methodological lead of Eisenhardt (1989) and Yin (2003), the

process of analysis and interpretation carried out within-case analyses as a prelude to

cross-case comparisons and pattern-matching procedures. This structured approach

served to extract distinct microfoundations for service innovation from the

preliminary versions identified by within-case analysis (see Table 5 for a brief

summary of the prevalence of each microfoundation in the individual cases). The

process furthermore increases the validity and robustness of the results and, among

other things, permits comparison of findings among several firms.

A minimum of two participating researchers conducted the initial analysis of the

collected data, before making a comparison and synthesis of their process notes at a

later stage (Yin, 2003). The analysis achieved ‘theoretical saturation’ before

complete analysis of all eight cases. Since all case firms fulfilled the selection criteria,

however, they were duly included in the general analysis. Furthermore, though a

larger sample of firms would have enlarged the database, eight cases constitutes a

manageable number (Eisenhardt, 1989).

Making the research method replicable by incorporating a semi-structured

interview guide increased the reliability of the findings and conclusions, as did

collating all of the collected transcripts. These procedures permit repetition of the

study with similar outcomes (Yin, 2003).

5. Findings: dynamic capabilities, microfoundations and service innovation

Innovative service delivery is an inherently dynamic process, which is more

dependent for its success than traditional product-centric marketing on continuous

adaptation to the evolving nature of customer needs and the technological aspects of
provision. The results of the study reported here demonstrate the need for an

extended, sometimes completely new, armory of underlying initiatives and processes,

if a firm offering its customers product-service solutions is to remain competitive.

This finding goes beyond the concepts and microfoundations that have previously

underpinned firms’ traditional product operations, to the innovative behaviour that is

necessary for the development of those dynamic capabilities that facilitate and support

innovation in the provision of services. The case studies demonstrate the difficulties

inherent in successfully competing in the current business arena if a firm’s dynamic

capabilities rest solely on product-based microfoundations. In short, strategists

seeking to identify and exploit the benefits to be derived from service innovation

cannot rely on capabilities geared only to product-driven and manufacturing-driven

innovation. This real-life challenge for service businesses provides a starting point for

the discussion that follows.

Tables 2 to 4 list and define the identified microfoundations of service innovation,

separately for the ‘sensing’, ‘seizing’ and ‘reconfiguring’ subsets described in Section

3. Descriptions of the microfoundations are accompanied by the critical managerial

questions associated with them. The key aspects and success factors found in the

participating firms help identify and develop these microfoundations.

5.1 Sensing: new approaches to opportunity discovery

The study found that firms seeking to increase the service content of their business

portfolios and looking to service innovation to generate opportunities for value

creation should employ new sensing activities in four main areas: customer-linked

service sensing, service system sensing, internal sensing, and technology exploration.

Table 2 summarizes the specific associated microfoundations, and the strategic

questions they suggest.

 Table 2 here

5.1.1 Customer-linked service sensing

The fact that the value of new services and their underlying customer needs can

differ from those of traditional products (Ulaga and Eggert, 2006) points to the

possible need for firms to develop new competences and resources if they are to

detect them. Given that service-oriented values tend to be intrinsic and intangible,

they are more difficult to measure, as Grönroos (2007) has observed. Furthermore,

service innovation arises more often than product innovation does from the sensing of

local customer needs and problems (Edvardsson et al., 2006; Kowalkowski et al.,

2012). Thus, in order to sense service opportunities, a firm needs to develop new

resources, roles, and processes. For instance, when OutdoorCo were designing their

first service performance contract, they discovered that their customers did not

necessarily perceive the actual value of the service in the way they had been expected

to. Instead of simply rolling out the planned service performance contract, the firm

initiated a thorough pilot study, to discover what customers valued. The case study

experience resulted in substantial changes to the design of the service as well as the

delivery.

Firms typically use traditional marketing research techniques to learn about present

customer needs, but the planning of service innovations may in practice demand

involvement of customers in more proactive, collaborative roles (Edvardsson et al.,

2006). Firms which take such initiatives will consult lead customers early in the

service development process, and shape the expectations and design of new concepts

jointly with their suppliers and customers. The enhanced linkages arising from such

co-development activities have improved customer-sensing skills in practice. They

also require, however, new intelligence-gathering processes that emphasize customer

interaction, which will in turn demand that front-line staff acquire new competencies

in the building of relationships and he stimulation of interaction. Despite the

recognition of such new directions on the part of several case firms, none has yet

developed its service sensing performance to any great extent.

5.1.2 Service system sensing

Customers are not the only source for the sensing of service innovation

opportunities. Successful firms do access the wider service system for this purpose,

but to a lesser extent than they do in pursuit of product innovation. Given that

innovative service strategies are likely to involve other actors, such as local service

delivery organizations, dealers and third-party service providers, firms tend to direct

their sensing efforts at co-suppliers and other service system partners (De Vries, 2006;

Kindström and Kowalkowski, 2009). The involvement of other parties is particularly

evident in industries in which system integrators, consultants, and contractors are

major influences on the specification of larger contracts. IndustrialPumpsCo, for

example, has required an understanding of the activities and strategies of major

consultancy firms and local contractors. The firm has seen the participation and

commitment of these other actors as a prerequisite for success, whether they are

developing new service initiatives or launching advanced versions of existing

offerings. Similarly, AircraftCo has similarly been highly dependent on an

understanding of key actors in the service system during the process of developing

new services. For instance, the sensing of key service partners and subsystem

providers was critical in the specification of its first aircraft availability contract.

5.1.3 Internal service sensing

Internal sensing for service innovation opportunities is particularly challenging for

firms providing such services as technical consulting, maintenance, and free-of-

charge extended warranty as a means of supporting product sales. WeldingCo, for

example, has found it difficult to capture new ideas and find support for an enhanced

orientation toward service.

Many firms often do not manage their service provision in a structured and formal

manner, with the result that the services concerned are not necessarily visible in

financial statements and performance measurement systems (Gebauer and Friedl,

2005). Such ‘invisible’ services tend to attract limited management attention, even

though they can have a substantial (albeit indirect) influence on turnover, profitability,

and sales. At GasCo, one of the key drivers for an increased service orientation has

been an understanding that service sales drive future product sales. An initial mapping

of such semi-invisible services can have great potential in providing the initial

impetus for service innovations and thereby instilling a sense of value and confidence

in the service innovation process among key actors in the process. Firms have been

found to derive such impetus for service-innovation projects from ideas and concepts

that local enthusiasts based in subsidiaries have initiated (Kindström and

Kowalkowski, 2009). The ability to identify and exploit such local initiatives is

noticeable in firms with a more prevalent focus on service innovation.

5.1.4 Technology exploration

Service innovation often emphasizes the sensing of external technological

opportunities (Lusch, Vargo and Tanniru, 2010). All of the case firms were well

aware of the benefits potentially arising from the adoption of technologies, especially

ICT (information and communication technology). OutdoorCo, for example, has

cooperated with specialist external experts to develop RFID-based services. At

MaterialsHandlingCo, service development had often been synonymous with ICT

development in many ways. Instead of focusing on specific individual problems that

could arise, the firm has continuously sensed technological frontiers and used that

expertise to engage with external ICT specialists, in order to internalize future

opportunities. For example, the internal technical platform has allowed the firm to

connect its installed base of products to a wireless information system, enabling it to

identify service innovation opportunities more effectively.

Technology sensing in the case firms differs from traditional product research in

that there is no explicit link between probing technological possibilities and new

product R&D. Rather, technology sensing seeks to tap into technological development

streams in order to shape the service innovation process.

5.2 Seizing: capitalizing on service innovation opportunities

The sensing of potential opportunities is only the first step toward capitalizing on

service innovation opportunities. Realizing the potential of these opportunities by

seizing and exploiting them is a vital prerequisite to the creation of value and the

accruing of profits through service innovation. The core microfoundations identified

with respect to seizing capability are service interactions, managing the service

delivery process, structuring the service development process, and adopting new

revenue mechanisms. Table 3 summarizes the specific associated microfoundations,

and the strategic questions they suggest.

Table 3 here

5.2.1 Service interactions

Firms devising ad delivering services typically need to be conscious of their

customers’ entire business processes, including those of the customers’ own

customers (Anderson et al., 2007; Normann, 2001). Successful innovation in services

implies increased interaction with customers and other actors in the service system

(Alam, 2006; Sundbo, 1997). Firms should therefore also aim to achieve an

overarching capability for interaction, as a means of increasing customer bonding.

Such interactions were found to have given the case firms a chance to sense new

opportunities for innovation and value creation, possibly including customer co-

innovation (Mannervik and Ramírez, 2006). For example, GasCo’s service

development process commonly involved both customers and internal sales staff,

which created a sense of belonging in customers and a significantly reduced resistance

to adoption of the firm’s services.

Relationship building is critical for many firms, product-centered or service-

centered and regardless of the industry. The factor that distinguishes the interaction

capability, in the study, is that the case firms have managed to seize opportunities for

innovation and competitive advantage that have arisen over repeated cycles of

interactive co-creation. Participants whose firms had exploited their interaction

capability successfully often emphasized that value creation is a mutual process that

ranges from actors in the service system to the customer. Interaction was not practiced

for its own sake, but because it created arenas for the efficient exploitation of any

associated opportunities that might arise. At GasCo, for instance, such arenas

included repeated and choreographed customer visits. Firms well positioned in this

regard are better able to seize innovation opportunities that arise, both on an ad hoc

basis, which is common in many services (Gallouj and Weinstein, 1997;

Kowalkowski et al., 2012), and to work efficiently in formal and informal

interactions during the process. Such firms are also better at converting the learning

from previous service activities into reusable components and thereby simplifying

future exploitation initiatives (Davies et al., 2006).

5.2.2 Managing the service delivery process

Most (though not yet all) firms see the management of a service delivery process

and the associated configuration of resources as an important capability. Well-

managed provision of a service also lays the groundwork for more efficient seizing of

future opportunities, for instance by facilitating interaction. GasCo had developed a

type of ‘service script’ that outlined the method for delivering certain services and

interacting with customers, which requires service technicians to look for new service

opportunities.

A service delivery process with high productivity requires the firm to use its

service capacity effectively, which includes maintaining an optimal balance between

service quality and cost efficiency (Grönroos and Ojasalo 2004). For

IndustrialPumpsCo and WeldingCo, this process also involved a continuous balancing

of the comparative strengths and weaknesses of their internal service functions and

their external service partners. This balancing act includes a control-versus-flexibility

trade-off (Kowalkowski et al., 2011), determining where in-house service units

belong (typically at headquarters versus locally) and which services should be

outsourced to external parties. Due to difficulties with knowledge transfer, technical

integration, and control, the managers at IndustrialPumpsCo, for example, felt that

offering advanced process-orientated services in-house would be beneficial. They also

determined, however, that relying on external service partners for more basic services

would be a relatively simple option. At MaterialsHandlingCo, by contrast, the in-

house service operation, comprising more than 4,000 service technicians in Europe

alone, had been a pivotal factor in its achievement of a strong position in the service

market.

5.2.3 Structuring the service development process

 In order to manage and develop the service business in a systematic manner and

fully exploit service innovation opportunities, case firms expressed the need to have a

structured service development process in place (Song et al, 2009). In many cases, the

firms develop services only on an ad-hoc basis, which often results in unplanned and

unprofitable customization. It is equally common for firms to have failed to develop

services partly because development managers have tended to apply an unsuitable

product development approach to the service development process and have

underestimated service-specific challenges, despite the many differences between the

two contexts. For example, whereas product development processes normally require

heavy investment at the outset, with strong emphasis on R&D and prototyping,

successful projects tend to require the allocation of more resources during the setting

up of a delivery organization and the launching of the service (Kindström and

Kowalkowski, 2009; Lovelock, 1984). Aware of this tendency, VehicleCo developed

a completely new service development process in parallel with the product

development process. GasCo and MaterialHandlingCo had also addressed the need

for separate processes and emphasized the later phases of service development, such

as the actual selling of services, consequently partly integrating sales training into the

development process.

5.2.4 Adopting new revenue mechanisms

Seizing on a service innovation completely requires a firm to be able to extract

revenue from the innovation. Most of the case firms struggled with this aspect of the

operation. To varying extents, they devised innovative mechanisms to increase their

service revenue, based on fixed or dynamic pricing, profit sharing, and the availability

agreements based on productivity. This finding is consistent with those of Lay,

Schroeter, and Biege (2009), and Ng, Maull and Yip (2009). The basis for these
mechanisms is often the value-in-use that the services create throughout the life cycle

of the product rather than by product ownership. The actual value-in-use is

determined in the context of a customer’s own use, and is thus uniquely determined

by the customer, who will be inherently idiosyncratic and process-oriented. Value-in-

use is a higher-order concept than value-in-exchange, the negotiated evaluation that

buyers and sellers offer and receive among themselves; it is therefore a limited part of

value creation (Kowalkowski, 2011).

VehicleCo and MiningCo both developed profit-sharing schemes with a few large

customers. Rather than charging for equipment and associated spare parts on a price-

per-unit basis, both firms’ based their earnings on the productivity that the service

stimulates across the customer’s entire operation. Similarly, AircraftCo had revised its

traditional revenue model, which based receipts on the number of spare parts sold and

the amount of time involved in maintenance, for one of its services. Revenues were

instead predicated on the availability of its product to the customer.

5.3 Reconfiguring: shifting the competitive arena

A focus on sensing and seizing current service innovation opportunities is often

sufficient to produce a short-term competitive advantage. More effort is needed,

however, if that advantage is to be sustainable (Helfat et al., 2007; Zahra et al., 2006).

In order to sustain service innovation initiatives over time and maintain appropriate

value in the face of changing markets, technologies, and customer demands, firms

must have in place processes and competencies that will allow them to transform and

reconfigure their resource base (Normann, 2001). Such challenges require a

reconfiguring capability that identifies microfoundations focused on the orchestration

of the service system, balancing product- and service-innovation related assets and

the development of a service-oriented mental model. Table 4 summarizes the specific

associated microfoundations, and the strategic questions they suggest.

Table 4 here

5.3.1 Orchestrating the service system

When a firm increases its focus on service innovation, one of the most complex

competences demanded is the ability to orchestrate the service system efficiently. In

the case firms, service innovation (especially with regard to advanced services)

frequently demanded the inclusion of external actors throughout the entire service

system (Normann, 2001). AircraftCo, for example, had to manage the behavior of

external service providers who exerted a direct influence on the performance of the

firm’s services and on their perceived quality. There was also a need to involve

second-tier suppliers, as experts on specific sub-components included in the service,

to ensure the effective performance of the final service.

Orchestration leads to increased emphasis on value creation in the broader context

of the service system, which some observers feel requires a re-evaluation of a firm’s

whole network of providers, service partners, and customers (Lusch et al., 2010;

Agarwal and Selen, 2009). When VehicleCo launched extended maintenance

contracts, it had to convince its front-end, customer-facing staff of the benefits of the

service. Firms that depend strongly on external dealers have even greater difficulty

persuading their own people of the value of service innovation. One case in point is

OutdoorCo, which sells through dealers and has neither a local service organization

nor a direct relationship with its end customers. Entering the service market to sell

such advanced services as performance-based contracts, the firm had to create an

incentive system that would benefit both dealers and users.

Several of the case firms asserted the importance of including customers in the
service system and emphasized the consequent need for orchestration of the process.

There would be a need for enhanced interaction, and orchestrating the service system

therefore has a close relationship to the interaction microfoundation discussed in sub-

section 5.2.1.

5.3.2 Balancing product- and service-innovation related assets

A constant challenge for the case firms was found to be the need to balance assets

related to product-centered and service-centered innovation, to secure the interests of

both the product and service functions. As firms increasingly offer advanced services,

often combining services and products, they typically find it necessary to add

systemic characteristics and integration aspects. Tension between product and service

interests was evident in all case firms, as previous studies have noted: for example,

Gebauer and Friedl (2005). Given that the product side of the business is a core

activity for product-centric firms, a product-oriented core of capabilities and

microfoundations (manufacturing, R&D activities, etc.) will demand ongoing parallel

management and development.

Service-related activities and their development often seem to be subservient to

product development, creating the need to establish formal service development roles

at both operational and strategic levels. GasCo’s introduction of service-focused roles

(such as service developers) at its operational level, including the appointment of

service managers to the firm’s board, was found to have contributed to the realization

of such benefits as increased service revenues and an increased market penetration.

5.3.3 Creating a service-oriented mental model

One of the most difficult and time-consuming elements of reconfiguration is the

creation of a service-oriented mental model, which will frame everything the firm
does. All the case firms acknowledged that this change of mental set was difficult to

achieve, but absolutely crucial to long-term success and continuous service innovation

(cf., Gebauer and Friedl, 2005). A new menatal model implies not only learning, but

also the willingness and ability to unlearn (Sinkula 2002) and reject obsolete routines,

which should lead in turn to the adaptation of more effective behaviors (Matthyssens

et al., 2006).

The CEO of VehicleCo emphasized the importance of services to his firm. He had

started the firm’s journey toward a service-oriented mental model by announcing his

intention that 50% of total revenue would in future be attributable to services,

including the supply of spare parts. The appointment of a vice president with

responsibility for services reinforced that increased commitment to the service

orientation. The process of changing the internal norms, values, and business logic at

Materials HandlingCo had been constantly ongoing, often characterized by long

periods of sustained effort. Across the case firms, service transition had been a time-

consuming, incremental process over several decades. Although many managers had

at first seen services as a necessary evil, the firms were today service providers in

many senses.

5.4 Implementation of the microfoundations

Although the discussed microfoundations were detectable in all participating firms,

the degree of implementation differed. Some firms were early identifiers of certain

microfoundations as being particularly important for their business, and therefore

achieved a higher degree of implementation where those microfoundations are

concerned. A number of firms were also facing a faster pace of change, increased

competition on their traditional product markets, and changing demands from

customers. These pressures forced them to implement more microfoundations and to

do so to a greater extent. Table 5 shows the level of prevalence of each

microfoundation in each case firm, defined as high, medium or low.

Table 5 here

Firms that have a high level of prevalence are actively engaged in exploiting the

microfoundation in question, have a structured process in place, commit appropriate

resources, and are widely accepting of the microfoundation at several hierarchical

levels. Firms characterized as having a medium level of prevalence commit several

resources to the microfoundation, have started to discuss processes in a formal setting,

and have some top-level support, even if only a limited number of people are directly

concerned with these service-related issues. Those found to have a low level of

prevalence with respect to a particular microfoundation exhibit a limited interest in it

and commit few resources to it (usually only operational), but have at least one

service in place in a local key market. For example, the sensing activities of firms

with the weakest technological exploration abilities tended to focus on maintaining

product leadership by adding new features and incorporating new generations of

technologies. Such firms paid minimal attention to future service opportunities. Their

overall understanding of the microfoundations was also limited, typically meaning

that that very few employees recognized the need for it in practice.

For many firms, including all of those participating in the study reported here, a

crucial starting point is endorsement by top-level management. On a more concrete

level, firms that have a well-established service delivery organization have been better

able to seize service innovation opportunities, and also to transform those

opportunities successfully into customer value.

Regarding the general phenomenon of service transition, the firms studied had
started from very different situations and market environments. The findings of the

study therefore cannot confirm a general pattern regarding the sequence of

microfoundation development.

6. Conclusions

6.1 Research contribution

This paper lays claim to three main contributions to the body of knowledge. First,

the research extends the existing literature on dynamic capabilities by specifically

addressing their application to service industries. Earlier studies exhibit a bias towards

products and technological innovation, tending to overlook many service innovations

(Michel et al., 2008). Analysis of the service transition phenomenon contributes to the

understanding of generic-level dynamic capabilities, specifically of the underlying

logic, by identifying the microfoundations that firms must develop in order to achieve

service innovation. The study reported here focuses on activities and mechanisms that

drive the development of such dynamic capabilities directly.

The list of microfoundations identified is consistent with the work of Eisenhardt

and Martin (2000) in laying no claim to being either a comprehensive or exhaustive

inventory of all possibilities. Rather, they have a solid grounding in the reality that

many firms face. Dynamic capabilities may be evaluated conceptually from two

perspectives: evolutionary and technical fitness (Teece, 2007). Evolutionary fitness

describes the ability of dynamic capabilities to enable firms to align with

environmental change, create value, and prosper in the marketplace. Technical fitness

refers to the capacity of a dynamic capability to carry out its designated task (Helfat et

al., 2007). In adding microfoundations that enable service innovation to the existing

dynamic capabilities framework, the present study focuses primarily on a firm’s

ability to increase evolutionary fitness. That enhancement can in turn be expected to

improve service performance. Furthermore, a greater emphasis on the

microfoundations should also increase the technical fitness of dynamic capabilities as

the firm becomes more skilled in their use over time. The challenge for many firms,

however, is to identify and subsequently implement the microfoundations appropriate

to external changes and demands.

The second theoretical contribution of the study is that it extends existing work on

the relatively young research field of service innovation into the manufacturing

industries. It does so by identifying the key microfoundations on which such firms

need to focus if they are to increase the service content of their business portfolio.

Since service firms are the primary empirical base of previous research into service

innovation, the focus on an industrial setting helps fill that research gap. The research

findings show that relying on product-driven and manufacturing-driven

microfoundations (and consequent capabilities) is not sufficient for success in service

innovation; a new set of microfoundations is required.

The third contribution of the research is that it provides empirical evidence of

dynamic capabilities in practice, especially in industrial settings where the service

perspective may be novel. Previous research into dynamic capabilities has been

mainly conceptual and focused on more product related issues. The point of departure

for the study reported here is the proposition that, to compete effectively in the

marketplace, product-centric firms need to focus on the concomitant service as well as

the product and place greater emphasis on service innovation. A major challenge

posed by this shift in the business model is to manage and extend the dynamic

capabilities of sensing, seizing, and reconfiguring (Teece, 2007), which are essential

to successful service innovation. The study has identified microfoundations that form

the basis of successful realignment of a firm’s dynamic capabilities, in such a way as

to achieve a better fit with service innovation initiatives. Thus, because service

innovation requires changes throughout the organization, firms must adopt a

multidimensional perspective on service innovation (Bessant and Davies, 2007; Tidd

et al., 2001).

Although the discussed microfoundations are identifiable in all firms, the extent to

which they are implemented and activated varies (see Table 5). They should therefore

be regarded more as propositions than as necessary preconditions. The findings show

that there is no single best way to become service oriented, and also hint at the path-

dependent characteristics of dynamic capabilities. Thus, firms may in practice differ

in terms of the sequence in which they develop microfoundations.

6.2. Managerial implications

The microfoundations identified and discussed in this research study are

cornerstones of a strategy for firms aiming to introduce service innovation into their

organizations. These microfoundations offer managers insights into the aspects on

which to focus in their efforts to enhance service innovation initiatives. Because they

and the subsequent dynamic capabilities are typically path-dependent and related to

the idiosyncrasies of the particular firm, managers must understand their firm’s

specific situation, the environment in which it is operating, and the pace of change, so

as to choose and develop situation-specific microfoundations. The sequence in which

those are developed may furthermore vary according to the firm’s idiosyncrasies and

to external stimuli.

Organizational challenges are present in all three classes of dynamic capability.

Two levels of the sensing capability are discernable: one at the front line, where there

is interaction with customers, and the other at a higher level in the organization, where

data are centrally aggregated and analyzed. In service innovation, these mechanisms
assume a special emphasis. Given that the discovery of opportunities often takes place

during interactions with customers, front-line personnel must have the appropriate

skills and tools for opportunity-sensing. The availability of those resources will

depend on the existence of relevant organizational processes, just as central resources

need to be available for the monitoring of macro-level technological developments

and market changes.

Challenges to the seizing capability relate to organizational arrangements and the

strategy-environment fit. A wider perspective on service systems and value creation

brings with it the need for continuous updating of areas of responsibility and

interfaces between different functions. Important tasks for management include

external coordination and prioritization of relationships, as well as their re-evaluation

and revision over time.

One of the most challenging microfoundations associated with the reconfiguring

capability is to implement a shift toward a service-oriented mental model within the

organization. In that regard, senior management must play the crucial role of

messenger and ambassador, proposing and leading change while championing

service-oriented attitudes. Creating the right culture involves a long list of tangible

management tasks, including organizational change, outsourcing, the management of

relationships within the service system, and striking the right balance between service

and product.

6.3 Further research and limitations

Though the study reported here was an exploratory attempt to identify key

microfoundations, questions arise regarding the methods by which they are generated

and implemented. As a logical extension of the current research, investigation of the

actual process of generation and the sequence of development should yield results

with interesting implications for both research and practice. Further research might

also usefully evaluate the performance of the identified microfoundations and assess

the effect on overall corporate performance. Such an analysis would imply a greater

focus on the technical fitness of the dynamic capabilities.

A second limitation of the study relates to the measurement of a firm’s

performance. The operating assumption that the microfoundations are necessary and

do indeed contribute to stronger corporate performance is matched by a strong

conviction among the participating firms, but the study did not explicitly measure that

outcome. As Helfat et al. (2007) observe, linking microfoundations to performance is

complicated, given that financial measures tend to underestimate value creation in

general and that attributable to services in particular. Furthermore, though the

research method was in-depth multiple case studies, access to primary data from

customers, service partners, and dealers was limited. Richer data would have provided

valuable additional insights capable of either confirming or modifying the findings.

Lastly, the product-centric characteristics of the firms studied limits the scope for

tends to complicate generalization to other contexts. Such future topics of study as the

dynamic capabilities and microfoundations of pure service firms could enhance

understanding of service innovation and shed new light on the context-specific issues

uncovered by the present research.

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Table 1. Case firms and typical examples of their service.

Recent key service

Firm Size Core business Typical services
innovation

Approx 12,000 employees Aircrafts and related Maintenance Availability contract

AircraftCo
Turnover approx €2.5 billion parts contracts for products

Approx 1,000 employees Industrial gases and Continuous supply

GasCo Service concept
Turnover approx €0.3 billion associated equipment of product

Rental plans and

Materials Approx 8,900 employees Materials handling Fleet management
maintenance
HandlingCo Turnover approx €1.6 billion equipment solution
contracts

Approx 8,500 employees Revenue scheme for

MiningCo Mining equipment Process consulting
Turnover approx €2 billion advanced services

Approx 15,000 employees Outdoor power products Support and service Service contracts
OutdoorCo
Turnover approx €3 billion for professional use contracts provided by dealers

Industrial Approx 4,500 employees Monitoring and

Industrial pumps Process analysis
PumpsCo Turnover approx €1 billion control services

Approx 8,000 employees Maintenance Service level

VehicleCo Heavy vehicles
Turnover approx €2 billion contracts agreement
Approx 8,000 employees Retrofits and
WeldingCo Welding equipment Upgrade of services
Turnover approx €1 billion upgrades

Note:
€1.00 = US$1.29 at January 2012 (Reuters)
Table 2. Sensing: microfoundations and key questions

Dynamic New service-innovation-oriented Critical managerial questions

capability microfoundations
Sensing Customer-linked service sensing: Building up Who interacts with the
deep customer knowledge, including customer and how do we
institutionalizing feedback loops and creating systematically capture and
organizational roles, systems, and processes that relay that information?
continuously capture and relay customer
demands.

Service system sensing: Building up an Who interacts with service

understanding of the entire service system, partners and suppliers, and
including links to partners and suppliers, and what lateral roles and processes
creating network skills. do we have in place to capture
this?
Do we have service-dedicated
roles and teams?

Internal service sensing: Building up internal What interfaces do we have

sensing: e.g. opportunities related to the between central and local
integration of products and services and the service units and between
detection of decentralized initiatives. Having a functions?
structured service development process to
address this factor.

Technology exploration: Scanning and exploring What new-to-industry

sources outside the service system, primarily technologies are emerging,
related to more radical technological changes. from which we could derive
service value in our specific
context?
Table 3. Seizing: microfoundations and key questions

Dynamic New service-innovation-oriented Critical managerial questions

capability microfoundations
Seizing Service interactions: Interacting and co-developing What are we good at and what
with customers and partners to understand, visualize, can we benefit from letting
and deliver value propositions. Involves processes, others do? Who owns the
roles, and skills to interact and change together with customer interface?
customers.

Managing the service delivery process: Having the Who assumes the risk, and the
ability to restructure internal and external resources ultimate responsibility? Do we or
swiftly, for the delivery of new or improved services, should we own our own service
including roles dedicated to services at both function? What type of services
operational and strategic levels. should we perform in-house?

How should we develop

Structuring the service development process: services (e.g., milestones,
Structuring a service development process and being gates, structure)? What are the
flexible as the process develops. linkages to the product
development process?
What value are customers
Adopting new revenue mechanisms: Rolling out new interested in? How can we
revenue mechanisms based on service value, such as communicate our value? What
availability and customer productivity. The ability to changes in the revenue streams
visualize the value of new, often intangible services can we introduce?
and solutions for a wide array of actors in the service-
delivery system.
Table 4. Reconfiguring: microfoundations and key questions

Dynamic New service-innovation-oriented Critical managerial questions

capability microfoundations
Reconfiguring Orchestrating the service system: Managing and What partners should we have?
transforming the service system, especially How much risk are we willing
managing external actors central to performance to take on? What roles and
of the service. An ability to extend the resource structures can we implement?
base into new markets and services, and to Should we, for example, create
incorporate complementary resources and co- new roles and teams focused
specialization. Reconfiguring roles, resources, purely on services?
locus of control, and power in the service system.

Balancing product and service-innovation related How do we simultaneously

assets: Maintaining a balanced relationship encourage product and service
between the service organization and the product development? What new
organization, necessitating the creation of roles reward systems can we
designed for service on all levels of the introduce?
organizational structure.

Creating service-oriented mental model: Often How do we change the mental

referred to as a service logic; implies a learning model of a primarily
dimension. production-oriented
organization?
 Table 5. Summary of identified microfoundations and their.

Micro- AircraftCo GasCo Materials MiningCo OutdoorCo Industrial VehicleCo WeldingCo

foundation HandlingCo PumpsCo
Customer- M H M M L L L L
linked
service
sensing
Service L L M M M M M L
system
linking
Internal L M H L L M M M
sensing
Technology M M H M M M H L
exploration
Service H H H M L M M M
interaction
Service L H H H L M M L
delivery
Service L H M M L L M L
development
Revenue M M H M L L H L
mechanisms
Orchestrating M M M M L M M L
Balancing L M H L L L M L
Mental L M M L L L M L
model

H = high; M = medium; L = low

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