by Vinay Couto [email protected] Anil Kaul [email protected] Gary Neilson [email protected] Joe Saddi [email protected] Driving Demand Management for Internal Services The Role of BehaviorChanging Pricing in Managing Demand Booz & Company is a leading global management consulting firm, helping the world’s top businesses, governments, and organizations. deep functional expertise, and a practical approach to building capabilities and delivering real impact. We work closely with our clients to create and deliver essential advantage. Our founder, Edwin Booz, defined the profession when he established the first management consulting firm in 1914. For our management magazine strategy+business, visit www.strategy-business.com. Today, with more than 3,300 people in 57 offices around the world, we bring foresight and knowledge, Visit www.booz.com to learn more about Booz & Company. CONTACT INFORMATION Beirut Chicago Senior Partner +1-961-1-336433 [email protected] Senior Partner +1-312-578-4727 [email protected] Joe Saddi Gary Neilson Vinay Couto Rio de Janeiro Sydney Tokyo Partner +1-55-21-2237-8400 [email protected] Senior Executive Advisor +1-61-2-9321-2853 [email protected] Executive Advisor +1-81-3-34360-8600 [email protected] Paolo Pigorini Ian Buchanan Partner +1-312-578-4617 [email protected] Anil Kaul Principal +1-312-578-4738 [email protected] Akira Uchida Zurich Jens Schaedler Partner +1-41-1-206-40-54 [email protected] Claudia Staub Partner +1-41-1-206-40-50 [email protected] Originally published as: Driving Demand Management for Internal Services, The Role of Behavior-changing Pricing in Managing Demand by Ian Buchanan, Vinay Couto, Anil Kaul, Paolo Pigorini, Gary Neilson, Joe Saddi, Jens Schaedler, Claudia Staub, and Akira Uchida. Booz Allen Hamilton, 2003. $RIVING$EMAND-ANAGEMENTFOR)NTERNAL 3ERVICES 4HE2OLEOF"EHAVIORCHANGING0RICINGIN-ANAGING$EMAND )NAWORDYES)TISTRUETHATINTERNALSERVICEORGANI ZATIONSHAVEBECOMENOTICEABLYMOREEFFICIENTAND MARKETORIENTEDINTHEPASTDECADETHANKSTOAHOST OFSTRATEGICINITIATIVESINCLUDINGBUSINESSPROCESSREEN GINEERINGSHAREDSERVICES%20ANDSTRATEGICOUTSOURC ING"UTTHEYHAVEALSOGAINEDUNNECESSARYWEIGHT $URINGTHESINTERNALSERVICEORGANIZATIONSGREW ATARATEDISPROPORTIONATETOTHEGROWTHOFTHEIRCOM PANIES!SMANAGEMENTFOCUSEDONMEETINGGROWING CUSTOMERDEMANDTHECOSTOFDEMANDDRIVENSUPPORT FUNCTIONSSUCHAS&INANCE(UMAN2ESOURCESAND )4DRIFTEDOFFTHERADARSCREENANDSTEADILYUPWARD (OWEVERNOWTHATGROWTHHASSTALLEDMANAGEMENT HASREDIRECTEDITSFOCUSTOCOSTREDUCTIONnTHOUGHTFUL LASTINGACROSSTHEBOARDCOSTREDUCTION4HEFIRSTPLACE COMPANIESTYPICALLYLOOKTOFORTHOSESAVINGSISTHEIR SUPPORTSERVICES 4ODATECOMPANIESHAVEATTACKEDINTERNALSERVICE COSTSFROMTHESUPPLYSIDEAPPLYINGREENGINEERING TECHNIQUESTOINCREASEEFFICIENCYANDPRODUCTIVITYOR LEVERAGINGBESTPRACTICESANDSCALE/URRECENTCLI ENTEXPERIENCEHOWEVERSUGGESTSTHATMANAGINGTHE DEMANDFORSUCHOVERHEADSERVICESYIELDSEQUIVALENT BENEFITSSEE%XHIBIT-OREOVERTHERESAGREATER OPPORTUNITYINDEMANDMANAGEMENTASTHESETECH NIQUESHAVENOTYETBEENFULLYEXPLOITED 4HE%VOLUTIONOF$EMAND-ANAGEMENT &ORYEARSSUPPORTFUNCTIONSWERETREATEDASCOSTCENTERS WHOSERESOURCESWEREALLOCATEDANDCHARGEDBACK 3ENIORCORPORATEEXECUTIVESDETERMINEDWHOGOTWHAT %XHIBIT $EMAND-ANAGEMENT$ELIVERS/VEROFTHE#OST"ENElT ""!#%& %) &ACEDWITHSTAGNANTGROWTHANDINCREASEDCOM PETITIVEPRESSURESCOMPANIESINMANYINDUSTRIES AREREEXAMININGTHEIRCOSTSTRUCTURESTOEXTRACT FURTHERSAVINGSANDSUSTAINADEQUATEMARGINS 4HISSEARCHFORSTEPCHANGEIMPROVEMENTSETSUP ANATURALCONTESTBETWEENLINEANDSERVICEORGA NIZATIONSONETHATPLAYSOUTINPREDICTABLEWAYS "USINESSUNITS"5SCOMPLAINTHATTHEYBEARTHE BRUNTOFTHEBELTTIGHTENINGANDPOINTTOSUPPORT SERVICESASADRAINONTHEIRRESOURCES3UPPORT FUNCTIONSPOINTTOBENCHMARKSTUDIESTHATSHOW THEYAREPERFORMINGATBESTINCLASSLEVELSAND HAVEALREADYSQUEEZEDOUTPOTENTIALCOSTSAVINGS #ANTHEYBOTHBERIGHT '# & !%% &%$!&# !!) !"(%) %!#!$%$ ! %#%$ 3OURCE"OOZ!LLEN(AMILTON $% #%$ % # $# #!&# %!#"&#"!$ !&%! $ SERVICESBASEDONPERCEIVEDPRIORITIESVOLUMEOFWORK ANDINTERNALPOLITICS4HE"5SHADLITTLESAYINTHEMATTER 4HESHAREDSERVICESMODELHASNOWLARGELYSUPPLANTED THECOSTCENTERMODEL!CCOUNTABILITYFORALLOCATION DECISIONSHASSHIFTEDDOWNTHELADDERTOTHEBUSI NESSUNITSANDSERVICEPROVIDERSWHONOWCONTRACTFOR SERVICESATAGREEDUPONLEVELSANDPRICES(OWEVER WHILETHESHAREDSERVICESMODELISADVERTISEDASADIS CIPLINEDMECHANISMFORENSURINGMARKETBASEDARMS LENGTHTRANSACTIONSBETWEENBUYERANDSELLERITHAS NOTALWAYSDELIVEREDONITSPROMISE-ANYCOMPANIES COMPLAINTHATITHASNOTWORKEDASEFFECTIVELYASTHEY HADHOPEDINLOWERINGTHEIRCOSTS3UPPLYANDDEMAND FORINTERNALSERVICESSTILLDONOTMEETATTHEEQUILIBRIUM PRICEPOINT4HEREASONSFORTHISIMBALANCEARESEVERAL N N N N ,ACKOFhFITFORPURPOSEv"5SDEMANDSIGNIFICANTLY HIGHERSERVICELEVELSANDORGREATERCUSTOMIZATION THANISOPTIMALFROMACOSTBENEFITSTANDPOINT 3ERVICEPROVIDERSEXACERBATETHEPROBLEMBYACCOM MODATINGTHESEREQUESTSSOASTOMAINTAINHIGHCUS TOMERSATISFACTIONRATINGS -ISALIGNEDINCENTIVESTRUCTURES3ERVICEPROVIDERSARE PULLEDINOPPOSITEDIRECTIONSBYCONFLICTINGINCENTIVE SCHEMES4HEYAREDIRECTEDTOSATISFYTHEIRDEMANDING "5CUSTOMERSWHILEALSODRIVINGDOWNOVERALLCOSTS 7EAKGOVERNANCEMECHANISMS4HEREISOFTENLITTLETO NOCOMMUNICATIONBETWEENSERVICEANDLINEORGANIZA TIONS3ERVICELEVELAGREEMENTS3,!SSERVEASAPOOR SUBSTITUTEFORAMOREACTIVEANDENGAGINGDIALOGUE )NACCURATEPRICESIGNALS4OAVOIDBEINGMICROMAN AGEDBY"5CUSTOMERSANDTOALLOWFORCOMPARISON WITHEXTERNALSERVICEPROVIDERSSERVICEORGANIZATIONS SETPRICESTHATEFFECTIVELYOBSCURETHEIRTRUECOST STRUCTURE7HILETHESEPRICESWORKFORBENCHMARKING PURPOSESTHEYDONOTFACILITATEECONOMICDECISION MAKING-OREOVERTHESEPRICINGMETHODOLOGIESARE EXPENSIVETOMANAGE 4OOVERCOMETHESEOBSTACLESANDESTABLISHTHEOPTIMAL EQUILIBRIUMBETWEENSUPPLYANDDEMANDFORSUPPORT SERVICESMANYCOMPANIESAREIMPLEMENTINGDEMAND MANAGEMENTMETHODOLOGIES%FFECTIVEDEMANDMANAGE MENTISNOTANEASYENDEAVORWHICHISWHYITHASNOT BEENEXPLOREDUNTILNOW)TIMPOSESONBUSINESSUNITS SOMEHARDCHOICES4OMANAGETHEIRBUSINESSESINTHE MOSTCOSTEFFECTIVEMANNER"5MANAGERSMUSTMAKE TOUGHTRADEOFFSINTHENATUREVOLUMEANDQUALITYLEV ELSOFTHESERVICESTHATTHEYCONSUME4HEYMUSTDIS TINGUISHBETWEENhMUSTHAVEvANDhNICETOHAVEvSER VICES4OPROMPTTHISPARADIGMSHIFTCOMPANIESNEED TOTRANSFORMTHEIRSERVICEDELIVERYMODELBYLEVERAGING THREECRITICALMECHANISMSPRICINGINCENTIVES ANDGOVERNANCESEE%XHIBIT4HEFOCUSOFTHIS 6IEWPOINTISONTHEPRIMARYMECHANISMPRICING4HE OTHERSWILLBEDEALTWITHINSUBSEQUENT6IEWPOINTS !.EW0ERSPECTIVEON0RICING)NTERNAL3ERVICES 0RICESDRIVECUSTOMERBEHAVIORANDTHEREFOREARECRITI CALTOADJUSTINGANDBALANCINGDEMAND"ASICECONOM ICTHEORYTELLSUSTHATTHEOPTIMALPRICEPOINTISWHERE MARGINALCOSTEQUALSMARGINALBENEFITIETHECOSTOF ANADDITIONALUNITOFSERVICEISEQUIVALENTTOTHEBENEFIT DERIVEDFROMTHATUNIT4OARRIVEATTHISEQUILIBRIUM HOWEVERMARKETPARTICIPANTSNEEDTOUNDERSTANDTRUE MARGINALCOSTSANDTHATISSIMPLYNOTTHECASEWHEN ITCOMESTOINTERNALSERVICEDELIVERYATMOSTCOMPA NIES(ISTORICALLYPRICESIGNALSHAVEBEENINACCURATE OBSCUREDANDDIFFICULTTODECIPHER3ERVICEORGANIZA TIONSSOUGHTTORECOVERTHEIRCOSTSANDPRICESREFLECTED %XHIBIT $EMAND-ANAGEMENT-ECHANISMS %%)& "!"'"&!& (&"&&"'& $ %) %) % % & & % !# " N "$!"" N $ !#!#% N " "% N 3OURCE"OOZ!LLEN(AMILTON !" ! N #!" N ! ! ! " %&"!'! $! N !!! $ ! N #% #! N #!" "!" N #% N ("'#" ("'#"& & "'#("'"%& "'#("'"%& " " %#!!% %#!!%%#($ %#($ "$!"# #""% N !"" ! % N ! N !! #"! N (&"&& (&"&& "'& "'& N " (&"&&"' (&"&&"' ""%& ""%& *(*%& *(*%& (&"&&"'#"'%# (&"&&"'#"'%# %& %& THATIMPERATIVERATHERTHANREVEALINGTHEUNDERLYING COSTDRIVERS-ORERECENTLYINTHEINTERESTOFMEETING ANDUNDERCUTTINGEXTERNALBENCHMARKSINTERNALSUPPORT FUNCTIONSHAVEMASSAGEDNUMBERSOFTENMERGINGFIXED ANDVARIABLECOSTS 4HERESULT"5SDONOTUNDERSTANDTRUEMARGINAL COSTSRESULTINGINPOORPRICESIGNALSANDSUBOPTIMAL RESOURCEALLOCATION0RICINGSHOULDBEADEMANDMAN AGEMENTFACILITATORNOTACOSTRECOVERYVEHICLE4HAT OBJECTIVEISPOSSIBLEONLYIFPRICESARETRANSPARENTAND PROVIDECUSTOMERSWITHTHELEVERSTHEYNEEDTOINFLU ENCESERVICEOFFERINGSCOSTSANDQUALITY$IFFERENTSER VICESHAVEANINHERENTLYDIFFERENTCOSTSTRUCTURESEE %XHIBITANDTHEIRPRICESSHOULDREFLECTTHESEDISTINC TIONS)NOTHERWORDSTHEPRICEFOREVERYSERVICEOFFER INGSHOULDREVEALTHEBREAKDOWNAMONGDIRECTFIXED COSTSDIRECTVARIABLECOSTSANDOVERHEADCOSTS $IRECT&IXED#OSTS $IRECT&IXED#OSTSARETYPICALLYINFRASTRUCTURERELATEDAND THEREFORENOTEASYOREVENPOSSIBLETOELIMINATEOR REDUCEINTHESHORTRUN)DEALLYCOMPANIESWANTTOMAX IMIZESHORTTERMDEMANDFORSUCHSERVICESTOINCREASE UTILIZATIONANDREDUCEEFFECTIVEUNITCOST&ROMA DEMANDMANAGEMENTPERSPECTIVEHOWEVERTHEREISNOT ALOTCOMPANIESCANDOWITHFIXEDCOSTS4HEBUDGETFOR THESEhLIGHTSONvNONDISCRETIONARYSERVICESEG,!. 7!.TELEPHONENETWORK(2)3INFRASTRUCTUREISGENER ALLYSETATTHECORPORATELEVELANDINDIVIDUAL"5SHAVE LIMITEDINPUTINTHATDECISIONMAKINGPROCESS 0RICESIGNALSRELATEDTODIRECTFIXEDCOSTSSHOULDNOT CONVEYTOCUSTOMERSTHEIMPRESSIONOFFLEXIBILITYOR EVENCONTROLLABILITY0RODUCTSANDSERVICESTHATHAVEA PREDOMINANTLYFIXEDCOSTSTRUCTURESHOULDBECHARGED OUTONTHEBASISOFHISTORICALUSAGE3ERVICEORGANI ZATIONSSHOULDDETERMINETHETOTALCOSTSFORTHESE SERVICESONCEAYEARANDMAINTAINTHERESULTINGPRICE LEVELSTHROUGHOUTTHEYEARSINCEFLUCTUATIONSINSHORT TERMDEMANDHAVENOIMPACTONFIXEDCOSTS4HIS APPROACHSHOULDFREEUPRESOURCESDEDICATEDTOPRIC INGSUCHSERVICES $IRECT6ARIABLE#OSTS $IRECT6ARIABLE#OSTSONTHEOTHERHANDDOFLUCTUATE WITHDEMAND4HESEAREDISCRETIONARYFLEXIBLEAND REDEPLOYABLERESOURCESANDTHEPRIMETARGETOFDEMAND MANAGEMENTEFFORTSEGHELPDESKSPRINTINGSERVICES LONGDISTANCETELEPHONEUSAGE3ERVICEORGANIZATIONS SHOULDSENDBUSINESSUNITSVERYCLEARPRICESIGNALS FORTHESESERVICESTOREFLECTTHEIRVARIABLENATUREAND ENCOURAGEAREDUCTIONINSHORTTERMDEMAND 0RODUCTSANDSERVICESTHATHAVEAPREDOMINANTLYVARI ABLECOSTSTRUCTURESHOULDBEBILLEDOUTBASEDONTHE %XHIBIT 0RICES3HOULD2EmECT5NDERLYING#OST$RIVERS Support Organization Overhead Costs N %()( $+%"+ $ #$ $)('+ %'$ /) %$ N .& "". -%()( %&" ! N $#$) N *) $&' $ ! N N N N N N N ".%$( $ $)$ ". $"- " (.()#($ " ) ( $) #'()'*)*' $ %()()%)*'$%('+ %,#' $"%())% ('+ ) %$"*$ )( )'$%()(, ) '*#$ $'()'*)*' "&%$ $'()'*)*' )),%'! N N N N N ".*&%$"- " '&"%."'(%*'( $ $'()'*)*' %()($ #&), ) $ #%$)((%$ "*)*) %$( $ #$%'('+ ( "&(! ' $) $ %$ ()$ )"&%$( 3OURCE"OOZ!LLEN(AMILTON ACTUALCOSTINCURREDTODELIVERTHATPRODUCTORSERVICE 4HISSORTOFFLEXIBLEPRICINGMECHANISMENCOURAGES BUSINESSUNITSTOOPTIMIZETHEIRSHORTTERMDEMAND WHILEFORCINGSERVICEPROVIDERSTOADJUSTSUPPLYLEVELS CONTINUALLYTOMATCHTHATDEMAND &INALLY/VERHEAD#OSTSARETHOSEINCURREDBYTHESER VICEORGANIZATIONTHATCANNOTBEDIRECTLYATTRIBUTEDTO THEDELIVERYOFASERVICE4HESECOSTSINCLUDEMANAGE MENTANDOTHERADMINISTRATIVEFUNCTIONS4HECOSTS FORTHESEACTIVITIESSHOULDBESEPARATELYIDENTIFIEDAND MONITOREDBYANINTERNALSERVICESGOVERNANCEBODY)N THESHORTRUNTHESECOSTSSHOULDBETREATEDASFIXED ANDCHARGEDOUTTHESAMEWAY /BVIOUSLYTHISDISCUSSIONOVERSIMPLIFIESTHEVARIETYOF COMPLICATEDFACTORSTHATWEIGHONTHEPRICINGOFINTER NALSERVICES(OWEVERITDOESMAKECLEARTHEIMPOR TANCEOFCONVEYINGTHETRUECOSTSTRUCTUREFORINTERNAL SERVICESTOTHECUSTOMER )NADDITIONTOEXPOSINGTHEUNDERLYINGCOSTSTRUCTURE SERVICEPROVIDERSNEEDTOCOMMUNICATETHATINFORMA TIONTOTHECUSTOMERxATALEVELWHEREITIShACTION ABLEv)FTHECUSTOMERCONTACTISNOTINAPOSITIONTO MAKEABUYINGDECISIONTHEREISLITTLEPOINTINBILLING ATTHATLEVEL3IMILARLYIFA"5MANAGERCANNOTWEIGH INONANEXPENSEBECAUSEITISMANDATEDATTHECOR PORATELEVELEGCORPORATESECURITYAUDITTHESE COSTSNEEDNOTBEBROKENDOWNATTHE"5MANAGER LEVEL$ISCUSSIONSOFTHOSECOSTSSHOULDBEHELDATTHE EXECUTIVELEVEL /THER$EMAND-ANAGEMENT$RIVERS )NCENTIVESARECLOSELYLINKEDTOPRICINGINDRIVING DEMANDMANAGEMENT!SMENTIONEDEARLIERTOOOFTEN INCENTIVESAREMISALIGNEDANDPROMPTSCHIZOPHRENIC BEHAVIORONTHEPARTOFTHESERVICEORGANIZATION -OTIVATEDTOENHANCECUSTOMERSATISFACTIONBYSERVICE LEVELAGREEMENTINCENTIVESSERVICEPROVIDERSLOSESIGHT OFTHEBIGGERPICTUREWHICHISTODECREASEOVERALLCOSTS BYRATIONALIZING"5DEMAND4OACHIEVETHATGOALINCEN TIVESNEEDTOBEDIRECTLYLINKEDTOTHEBUSINESSUNITS COSTREDUCTIONGOALS 3OASNOTTOSTRAINDAYTODAYWORKINGRELATIONSHIPSAT THELINEMANAGERLEVELTHESELINKSSHOULDBEESTAB LISHEDATSENIORLEVELSINTHESERVICEANDLINEORGANI ZATIONSWHERETHEYAREBOUNDTOBEMOREEFFECTIVE "RINGINGTHATTOPLEVELPERSPECTIVETOTHEMATTEROF INTERNALSERVICEINCENTIVESFOSTERSOPTIMIZATIONWITHIN ANDACROSS"5S 4HESEPROPOSEDCHANGESINPRICINGANDINCENTIVES CANNOTBEEFFECTIVEINTHEABSENCEOFEFFECTIVE GOVERNANCE'OODGOVERNANCEATITSCOREISAMATTER OFCOMMUNICATION"YESTABLISHINGCLEARINDEED TRANSPARENTPRICINGMECHANISMSANDBYMOTIVATING THEAPPROPRIATEBEHAVIORSACOMPANYWILLEFFECTIVELY PROVIDETHECONTEXTFORANAFFORDABILITYDIALOGUE $EMANDMANAGEMENTCANBEINSTITUTIONALIZEDONLY IFBOTH"5SANDSERVICEPROVIDERSAREHELDACCOUNT ABLE-ANYCOMPANIESSETUPBOARDSTOSERVEASA GOVERNANCEFORUMWITHPARTICIPATIONFROMBOTHLINEAND SERVICEMANAGEMENT4HESEBOARDSACTASAPRIMARY INTERFACEPROVIDINGDIRECTIONALOVERSIGHTANDCUSTOMER INPUTTOTHESERVICEORGANIZATIONANDSERVINGASA "5SOUNDINGBOARDANDPLATFORMFORSERVICEDELIVERY STANDARDIZATION4HISCROSSFUNCTIONALTEAMPROVIDES THEVEHICLETHROUGHWHICHTRUECUSTOMERSEGMENTA TIONANDFITFORPURPOSESOLUTIONSBECOMEREALITY4HE GOVERNANCEBOARDALSOSERVESASAFORUMWHERECOST ANDSERVICELEVELISSUESCANBERESOLVED!GAINGOOD GOVERNANCESETSTHESTAGEFORAGENUINEAFFORDABILITY DIALOGUEANDREINFORCESTHEALIGNMENTOFSUPPLYAND DEMANDININTERNALSERVICEDELIVERY $OWNLOADABLEDIGITALVERSIONSOFTHISARTICLEANDOTHER"OOZ!LLEN(AMILTONPUBLICATIONSAREAVAILABLEFROMWWWBOOZALLENCOM 02).4%$).53! Ú"OOZ!LLEN(AMILTON)NC BOOZ & COMPANY WORLDWIDE OFFICES Asia Europe Middle East South America Beijing Hong Kong Seoul Shanghai Taipei Tokyo Amsterdam Berlin Copenhagen Dublin Düsseldorf Frankfurt Helsinki London Madrid Milan Moscow Munich Oslo Paris Rome Stockholm Stuttgart Vienna Warsaw Zurich Abu Dhabi Beirut Cairo Dubai Riyadh Buenos Aires Rio de Janeiro Santiago São Paulo Australia, New Zealand, and Southeast Asia Adelaide Auckland Bangkok Brisbane Canberra Jakarta Kuala Lumpur Melbourne Sydney North America Atlanta Chicago Cleveland Dallas Detroit Florham Park Houston Los Angeles McLean Mexico City New York City Parsippany San Francisco The most recent list of our office addresses and telephone numbers can be found on our Web site, www.booz.com. 20030030/5/03 Printed in USA ©2003 Booz Allen Hamilton Inc.
© Copyright 2026 Paperzz