Sunday, June 28, 2015

Service Sector Productivity

Recently I went on a diet and began ordering specific drinks ordered a specific way - generally gin with a "splash" of tonic (because tonic has carbs and I want to minimize carbs, but need something to cut against the alcohol). This order, however, has become a running joke among my friends because no matter what I order I usually get the same drink every time - which is a "standard" gin and tonic (see below, the wrong order per usual).



Unlike most people who would shrug it off or get angry, to me this is really an economics issue and not just a "bad order". When you work with bars and restaurants and other similar industries, if you do anything "outside the norm" your odds of getting it "right" are often less than 50/50. Which leads us to the title of this post...



One of the most critical and least discussed economic problems today is "service sector productivity". The world has made immense progress in manufacturing productivity - we expect zero defects or "six sigma" which is 3.4 defects per million. Entire facilities are "lights out" meaning production is automated end-to-end and delivers consistent results (generally with robots).

Not only have expectations of quality risen immensely, prices of manufactured goods have plummeted. The cost of flat screen TV's have moved from the thousands of dollars to hundreds of dollars, while features and capabilities have improved. My recent 2011 Jetta cost $17,000 and it includes safety features and technology that would have cost tens of thousands if they had been available at all 10-15 years prior. Except for bespoke or luxury goods (which intentionally trade at a high price for exclusivity), the cost of manufactured goods has plummeted while the value of those goods in terms of features and capabilities rose spectacularly.

The service economy makes up 80% (give or take) of the US economy and workforce. While manufacturing and the farm sector have enjoyed immense productivity gains over recent decades, the service sector remains woefully inefficient and ineffective. A one in four chance of getting my order right compares abysmally with 3.4 defects per million.

If you have a service work force, you expect to pay more each year, likely for the same or less productivity. The entire discussion of raising the minimum wage falls squarely onto the service sector productivity issue - how can businesses grow their profits while paying more for the same quality and quantity of output? They can't. The businesses are going to have to find another way to compete.

From my perspective, one of the key elements to improving service sector productivity is the assignment of metrics to measure outcomes, quality of outcomes, and profitability. The service sector industry components with the slimmest profit margins are generally the first to invest in these sorts of concepts (technology and processes), because they are on the razor's edge of staying in or going out of business. If you go to a restaurant where you can see the kitchen operate, a well-run restaurant is a whirl of well laid out and thoughtful productivity. Orders are received and worked on in an efficient manner, and when the meals are completed they are inspected before being rapidly delivered out to customers. I'm certain that they are also looking at scrap and leftover food at the end of the day and working to incorporate this into their menu selections and to optimize what they purchase daily. These restaurants also usually embrace some sort of online ordering system and track their customers through a reward system to lure them back for future specials.

The secret to "improving" a service sector work force, sadly, is often to automate and eliminate it entirely. Just try to reach a human at a company like Google, Amazon, or Apple. There is a large and automated set of questions to answer and then they direct you to a support forum often which are manned by non-company employees who explain to users how to get around problems with the service or product. Where possible, the scaling of humans and efficiency cannot be matched by algorithms and processes that are created "from scratch" to enable machine learning through capturing core data that can be tracked and aligned with future buying patterns.

While elements of the service sector may improve in productivity, like tax preparers who utilize online tools to process returns, they also may be overwhelmed by the increasing complexity and sometimes outright insanity of government rules which continue to grow in size and impact each year. The government does not value simplicity nor does it view its taxpayers and citizens as "customers", more like willful charges to be monitored, and thus the government influence on the service sector is often malign and increases costs, complexity, and crushes overall productivity.

The topic of service sector productivity is gigantic and can only be touched in the barest outline by this blog post. However, I would posit a few fundamental assumptions and insights:
1. Manufacturing productivity has soared over the last 3 decades. However, manufacturing makes up a small component of our overall economy
2. Service sector productivity lags far behind manufacturing, and makes up 80% of our economy
3. One common approach to increasing service sector productivity is to automate the process entirely, eliminating human contact. While this resolves the productivity issue, it will have a significant impact on employment
4. Attempts to raise wages and the cost of staffing (through laws and regulations) will increase the use of automation, exacerbating the problem of #3 above

Cross posted at Chicago Boyz

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