Companies in the US service sector are second to none. American retailers, banks, airlines, package shippers, restaurants, and hotels lead the world in productivity. They constantly innovate to attract customers. Over the past decade, they have generated tremendous wealth and created thousands of jobs. Yet this formidable record could be jeopardized by a shortage of the one thing every service business needs: employees.

Labor markets in the United States are extremely tight. Nationwide, unemployment stands at about 4.5 percent; in Atlanta, Chicago, San Francisco, and Orlando, the figure is even lower. While this state of affairs affects all employers, it puts particular pressure on service companies, since they have traditionally paid the least and attracted workers who had relatively few options. What’s more, the tightness will persist. The US Bureau of Labor Statistics estimates that the total labor force in 2005 will be between 143 and 153 million people, and the number of jobs will be between 140 and 150 million.

As a result, business models based on a steady supply of cheap labor will increasingly flounder as they fail to find people capable of executing them. To continue to grow in such an environment, service companies will need to segment and manage their workforces as deftly as they segment and manage customers. They will also have to structure their business and customer value proposition to fit the employee base they are able to attract.

Paradoxically, the root of the problem is the service sector’s success at creating jobs. Millions of new service jobs have come into being since the 1950s, and services will continue to be the primary engine of job growth in the United States (Exhibit 1).

This growth in employment is a direct result of the strategies that service companies are pursuing. Many are committed to putting outlets closer to customers. Taco Bell has declared its intention to have 20,000 outlets by the year 2000, for instance, and McDonald’s has set itself up in gas stations and Wal-Mart stores. Propelled by commitments to Wall Street and the desire to fill profitable niches while they still can, major service chains are building outlets furiously.

Because service concepts tend to be easy to replicate, service innovators have to move quickly to penetrate local markets before competitors copy or even pre-empt their innovation. Witness the "bagel wars," in which the five leading bagel chains doubled the number of outlets between 1995 and 1996. The high-end coffee business, in which companies like Starbucks and Seattle’s Best Coffee rushed to fill markets, tells a similar story. In the temporary help business, the number of agencies expanded from about 12,000 in 1989 to over 20,000 in 1994. Kinko’s Copies has grown at an annual rate of 15 to 18 percent for years, and expects to rocket from 850 outlets today to 2,000 by the turn of the century.

Until recently, the supply of labor has kept pace with demand, and service companies in particular have benefited from the equilibrium. Labor represents a large share of overall costs in most service industries (Exhibit 2). The bulk of the growth in supply has come from women and baby boomers entering the workforce. In 1950, 31 percent of women participated in the workforce, and made up 30 percent of the total; by 1994, 58 percent of women participated in the workforce, and made up 46 percent of the total.

Young people also contributed to the workforce explosion. In 1950, about 12 million 16- to 24-year-olds were in the labor force; their number peaked at 25 million in 1978, and has fallen back to about 21 million today. Many service industries with heavy frontline requirements have benefited from the influx of women and young people into the workforce (Exhibit 3). Indeed, jobs in these industries have been filled disproportionately by young people or women entering the workforce.

But the equilibrium will not last. We can predict the available workforce for the next 15 years by extrapolation, since everyone who will be of working age in 15 years’ time is already alive (although not necessarily living in the United States). While the segment of the workforce aged between 45 and 65 is set to increase, the annual rate of growth of the workforce will fall from 1.4 to 1.1 percent. Although women will continue to be an important source—over 60 percent—of labor force growth, their growth rate will also drop from 1.8 to 1.4 percent a year.

While downsizing in other businesses will release some employees, there will not be nearly enough to satisfy demand. The manufacturing sector appears to have stabilized after a long decline (Exhibit 4), and service sector productivity has not improved dramatically (Exhibit 5). While positions for bank tellers, accounting clerks, and computer operators will continue to decline (Exhibit 6), these occupations will release far fewer people than are needed.

Even if they can find enough warm bodies to fill all their positions, service companies may have trouble hiring the kind of workers they need. Customer skills—the ability to make people feel welcome, understand and respond to requests, solve problems, and deal with service failures at a practical and emotional level—are essential in service companies, for instance. Yet only 20 to 30 percent of even pre-screened applicants appear to have these skills.

Treat employees like customers

Companies in search of employees need to begin by understanding the labor markets in which they operate. Just as a marketer segments prospective customers, they can segment potential workers.

Labor markets are generally local markets. Most people are unwilling to travel long distances to work. Service sector labor markets tend to be even more local than those for other industries; this is particularly true of low-wage positions that may not support car ownership. Journey-to-work data reveal that certain industries, such as food service, tend to have especially narrow labor markets (Exhibit 7). In fact, in a recent National Restaurant Association study, the most popular reason for the job chosen by food service employees was that "the job was near my home."¹

The message for a service company is thus that the market from which its labor is drawn may be considerably smaller than the city or district in which it is located. A simple way to get a feel for the labor market of a specific store or franchise is to plot where its current employees live.

Within a locality, prospective employees can be segmented in several ways. One critical dimension is aspirations. What do prospective workers want from their jobs? How important is the quality of their everyday working environment? Are employees looking for long-term stability, career development within the organization, or the chance to acquire transferable skills? How much do they value flexible working hours?

In its study, the National Restaurant Association divided a sample of workers into three groups: those who were looking for a career in the restaurant business; those who were just passing through; and those who had no real interest in the work, and were hence misplaced. "Careerist" and "passing through" individuals clearly have quite different motives and priorities, and a restaurant would need to understand and deliver what one or both groups wanted if it was to attract and retain employees.

Prospective employees can also be segmented by what they bring to the company. The priority may be technical skills—the ability to fix cars, inject patients safely, or enter data—or customer skills. The ability to learn new skills quickly may also be vital, especially when a position requires unusual technical skills, or when customer skills are lacking in the labor market.

Once a company has identified the employee segments it is interested in, it has to get to know the other employers competing for those segments and the employee value propositions they offer. It can then develop its own employee value proposition so as to offer a competitive package.

One easy way to track the competition is to monitor where people go when they leave your employ, and where they have come from when they join you. The NRA study found that most of the employees who left restaurants went to retail jobs. Many others joined the healthcare industry.

A service company needs to know what salaries and benefits are being offered by its competitors; it must also understand what their conditions are like, and what opportunities exist for employee growth. If, say, health benefits are becoming more common (as they are in several lower-wage service industries), the company should develop a conscious approach to benefit planning.

For a multi-site company, employee segmentation and competitor analysis will have a distinctly local flavor. The mix of people will differ from site to site, even within the same city. Consider the task of recruiting fast-food workers in a college town like Ann Arbor, Michigan; in a retirement community like Sarasota, Florida; and in a major city like Chicago. The experience base, skills, and aspirations of college students, older workers, and city-center residents are quite different—and so are the factors that will appeal to them.

Competition will also differ from site to site. Needless to say, a Wal-Mart in a regional mall of 200 stores faces a different hiring challenge to one in a town with no other major retailers. Competition is also affected by the local balance of supply and demand, since in a tight market service employees will enjoy more opportunities. In San Francisco, recruitment advertisements placed by small food establishments are currently attracting only a tenth of the responses they would have received in the past. The missing people are working elsewhere.

As in marketing, a new form of segmentation can reveal previously unnoticed opportunities. One casino has identified double-income couples with children as an attractive employee segment, because the late-night hours might appeal to them. Other companies are targeting people of particular ages who may find their schedules or working conditions congenial.

One insurance company finds new salespeople by taking on teachers during the summer vacation. They are hired on a provisional basis, and most sell only a few policies before deciding to return to school. However, some work out well, and become permanent employees.

Similarly, one real estate company finds its services most in demand during the summer, so it hires college students and adjusts its workflow to allow bright but not fully trained temporary staff to perform a portion of each transaction. Permanent employees tackle the more complex tasks. When the students go back to college, the workflow is readjusted so that permanent employees complete the whole transaction themselves.

Become employer of choice

The key to success in marketing to prospective employees is to craft a distinctive value proposition designed to appeal to your target segments

The key to success in marketing to prospective employees, as in any kind of marketing, is to craft a distinctive value proposition designed to appeal to your target segments. If the target group is sufficiently large, this may be enough in itself to resolve your staffing needs. To pursue this "employer of choice" strategy, you must understand what the individuals you would like to employ really want out of their jobs.

Employers of choice possess employee value propositions that are compelling to each of their target groups. Every company’s value proposition is unique, because every company has its own particular target segments and competitors. ServiceMaster, a corporate cleaning operation, has pursued a people-based strategy committed to turning otherwise dead-end jobs into steps in a career path. Starbucks offers health benefits to attract the slightly better-educated staff it needs to fulfill its upscale value proposition. Manor Care, a nursing home and hotel company, has devised an innovative set of pension plans that increase with tenure, not just with pay, in order to retain its employees.

Airlines and hotel companies have long exploited the opportunity to use travel benefits as part of their employee value proposition. Many retail stores offer discounts on merchandise. As an employer of choice, you can preside over a virtuous circle, hiring the best frontline people from a wide range of applicants, who then deliver great service and help your business and its reputation grow, leading even more applicants to seek you out.

Find new segments

As well as attracting the most desirable employees, a company can also extend the range of employees it will accept. Segments that are underused by many service companies include:

People with disabilities. While most companies try to comply with the Americans with Disabilities Act, relatively few have pursued people with disabilities as a target group. Those that have include The Home Depot, NationsBank, Marriott, and Nordstrom.

Older people. This growing source of service workers has already been targeted by companies like McDonald’s and Wal-Mart. Temporary agencies also find older workers attractive, and are able to offer the flexible part-time schedules that many of them want.

Welfare to work. Recognizing that this untapped segment could provide part of the answer to the growing shortage of employees, service companies have been at the forefront in helping welfare recipients make the transition to work. Sears, UPS, and Marriott are among those that have taken a proactive approach to integrating people new to the workforce. Issues such as childcare provision and help with travel to work often turn out to be as important to a successful transition as employee skills. One entertainment company educates high school students who have a strong chance of dropping out and gives them after-school jobs. The vast majority graduate and stay on as permanent employees.

Companies should be aware that recruits from these segments will probably have to be handled in a different way from their traditional hires. Adjustments will be needed if the new match is to work.

Change the structure of work

In some cases, the labor market will be so tight or competition so fierce that a company will not be able to fill its vacancies with workers at current rates of pay. At this point, wages will rise. In 1996, wages in the US service sector rose faster than those in the rest of the economy. Soaring wages can be disastrous for a labor-intensive service company operating on a relatively low margin. Businesses that can thrive at labor costs of $6 per hour may collapse at $8 per hour unless something else changes.

In circumstances like these, businesses looking to grow will be forced to consider changing what they offer customers and how they deliver it. Such a redesign of the business can take place at several levels.

One option a company can pursue is simply to operate with fewer workers by providing supporting equipment and systems or helping employees extend their capabilities. The automation of interactive tasks such as data gathering may mean fewer workers are required; for example, scanners enable supermarket staff to serve more customers at the checkout. Many banks are considering increasing the number of unstaffed locations with automatic teller machines available 24 hours a day, and video links to customer service staff who can help with any problems that arise.

Another possibility is to eliminate certain elements of a process. Some hotels employ information technology to speed up check-in and check-out: guests use their credit cards as room keys and approve their final bill by switching on their TV. Similarly, car hire companies take advantage of their preferred customer programs when vehicles are dispatched or collected. In fast food, equipment suppliers are developing systems that are more automated and thus require fewer cooks.

Deskilling jobs is an option that allows a company to use a broader pool of workers. Fast-food chains are increasingly introducing point-of-sale systems that do not require operators to be able to read (or add, or subtract).

Yet another approach entails looking for work done by frontline service people that does not involve the customer, and delegating it to someone else somewhere else. Taco Bell cut out much of the food production that used to be done in its outlets in order to allow its service personnel to focus on customers. Many banks and other financial institutions have pulled their production shops out of their branches (where they were inefficient to operate), relocated them to take advantage of scale economies and more favorable labor markets, and freed branch staff to work directly with customers.

Similarly, the declining cost of telecommunications has led some companies to explore what needs to be done close to the customer and what can be done far away. Many banks, travel companies, and other service providers have set up customer service centers in regions where labor is cheap, abundant, or of high quality, even if their outlets or service delivery points still have to be located near the customer.

Large businesses often have opportunities to push work out to their suppliers. In healthcare, for example, suppliers make up prepackaged surgery kits to take a task out of the hospital and free up time for hard-to-find operating room staff.

Changing customer behavior provides another possible solution. The more customers can do for themselves, the less service employees need to do

Changing customer behavior provides another possible solution. The more customers can do for themselves, the less service employees need to do. Many fast-food restaurants allow customers to fill their own soft-drink cups. Banks encourage customers to use ATMs or online banking. Healthcare providers promote health and fitness to reduce the demand for their services. Gas stations have become almost completely self-service.

The challenge here is to avoid eliminating aspects of the service that customers value. Some customers may be happy to find out their credit card balance from a voice response unit, but others will always prefer the human touch, and may change provider if that option is no longer available.

Perhaps the most dangerous approach is simply to use fewer people to do exactly what you have always done. In most service businesses, frontline performance is critical. Fewer staff doing more work means worse service and dissatisfied customers.

Any service sector strategy is inextricably linked to the availability of the right kind of workers. If service companies want to continue to grow and maintain their present levels of service, let alone improve the value they deliver to customers, they have no choice but to think differently about employees.