Explaining the Service-Profit Chain: How Quality Drives Profit

It’s an age-old question: How does a business generate and grow its profits?

Many business owners and entrepreneurs would argue that the answer is simple: sell more products and increase revenue. But according to the service-profit chain, that’s just one piece of a much larger framework.

Understanding the service-profit chain is crucial for business owners, entrepreneurs, and executives, as it directly impacts revenue and long-term success. Here’s a primer on its key elements.

What Is the Service-Profit Chain?

The service-profit chain is a business management framework that establishes a direct connection between profitability and employee satisfaction. It operates based on several assumptions or propositions, including:

• A business’s profit and growth are primarily driven by customer loyalty.
• Customer loyalty stems from customer satisfaction.
• Customers are more satisfied when they receive genuine value from a company’s services.
• Value is generated by employees who are satisfied with their jobs, leading to greater loyalty and productivity.
• Employee satisfaction results from strong policies and support services that empower employees to generate value for customers.

If these principles hold true, a company’s profitability is ultimately fueled by satisfied, loyal, high-performing employees.

Originally proposed by Harvard Business School professors James L. Heskett, W. Earl Sasser, and Leonard Schlesinger in a 1994 article published in the Harvard Business Review, the service-profit chain has been embraced by some of the most successful companies, including financial technology company Intuit, fast food chain Taco Bell, and Southwest Airlines.

Elements of the Service-Profit Chain Model

The service-profit chain model comprises seven interconnected elements, each crucial in linking employee satisfaction to revenue growth and profitability. These elements build upon one another, forming a continuous cycle of business success.

The first link in the chain is internal service quality—the foundation that drives employee satisfaction and sets the stage for the rest of the model.

Internal Service Quality

What Internal Service Quality Is

Internal services are resources and support an organization provides its employees. This includes training, tools, technology, organizational structure, incentives, and other factors that help your teams perform their jobs effectively. Internal service quality measures how well these internal services empower employees to deliver high-quality customer experiences.

“We need to create systems around our employees to ensure that they can thrive in the delivery of outstanding service,” says Harvard Business School Professor Ryan Buell, who teaches the online course Transforming Customer Experiences. “Internal service quality spreads to all facets of the employee management system—to how we select employees, how we train and mentor them, how we design their jobs, how we compensate them, and how we manage their performance.”

The service-profit chain framework states that strong internal service quality leads to higher employee satisfaction.

How to Measure Internal Service Quality

You can measure internal service quality through:

• Employee surveys
• Comments
• Referrals
• Exit interviews

These methods provide valuable insights into how employees perceive the quality of internal services.

Employee Satisfaction

What Employee Satisfaction Is

Employee satisfaction measures how content employees are with their roles, responsibilities, and overall workplace environment.

The service-profit chain model assumes that satisfied employees will be more loyal and productive than unsatisfied ones.

How to Measure Employee Satisfaction

Consider using key performance indicators (KPIs) to gauge employee satisfaction. Examples include:

• Employee absence rates: How often employees are absent from work
• Employee engagement: How committed employees are to their work
• Employee Net Promoter Scores (eNPS): The likelihood of employees recommending your company as a great place to work

Employee Retention and Productivity

What Employee Retention and Productivity Is

Employee retention measures how well an organization develops and retains its employees, preventing them from seeking opportunities elsewhere. Productivity refers to how efficiently employees complete their work and contribute to business outcomes.

“If we succeed in creating internal service quality, then our employees will be satisfied, and they’ll stick around longer,” Buell says in Transforming Customer Experiences. “When employees stay with us longer, they become better at their jobs.”

Loyal and productive employees enhance customer value by delivering higher external service quality.

How to Measure Employee Retention and Productivity

Important KPIs to consider for measuring employee loyalty include:

• Retention rates: How effective your business is at keeping its employees
• Turnover rates: The percentage of employees who leave the company in a given timeframe
• Internal promotion rates: The frequency of promotions, which implies employees are sticking around for longer

To measure employee productivity, consider tracking:

• Completion rates: How many tasks an employee completes in a time frame, such as by the hour, day, or week
• Time to complete tasks: Another way of understanding the number of tasks an employee is completing
• Revenue per employee: How much revenue is generated by each employee

External Service Quality

What External Service Quality Is

External services are those your company delivers to its customers. This includes everything from the products or services your customers are paying for to indirect ones, such as customer service or relations. External service quality measures how well your business meets—or exceeds—customer expectations.

“The better they are at their jobs, the more able they are to create value for our customers,” Buell says in Transforming Customer Experiences. “That is the foundation for delivering external service value. Because employees have an achievable set of service objectives, and we’ve set them up for success in their work, they’re able to deliver exceptional service to customers.”

Under the service-profit chain model, higher external service quality leads to greater customer satisfaction.

How to Measure External Service Quality

To better understand your external service quality, the following data is useful to measure:

• Customer surveys: A method of collecting consumer feedback
• Error rates: A measure of error frequency
• Complaints: Customer criticisms about a product or service
• Response times: How quickly your business responds to customer complaints

Customer Satisfaction

What Customer Satisfaction Is

Customer satisfaction measures how pleased customers are with the value they receive from your product or services.

The service-profit chain framework suggests that satisfied customers are more likely to remain loyal—choosing your business over a competitor.

How to Measure Customer Satisfaction

Customer satisfaction can be measured through qualitative feedback such as surveys, complaints, reviews, and other sources of feedback, as well as KPIs like:

• Customer satisfaction scores (CSAT): How satisfied customers are with their experience
• Customer effort scores (CES): A measure of how easy it is for customers to use your product or service
• Net Promoter Scores (NPS): How likely customers are to recommend your service to others

Customer Loyalty

What Customer Loyalty Is

Customer loyalty measures how likely your customers are to maintain and deepen their relationship with you, whether through multiple purchases, subscription renewals, or promoting your products or services to their network.

Strong customer loyalty translates into revenue growth and long-term profitability.

How to Measure Customer Loyalty

To get a sense of your customer loyalty, consider referencing KPIs like:

• Customer retention rates: The percentage of customers your business retains within a set timeframe
• Customer churn rates: The percentage of customers that stop doing business with you in a given period
• Repeat purchase rates: How often customers make repeat or additional purchases after their first
• Lifetime value (LTV): The average lifetime value of your customer
• Upsell ratio: How often you succeed in upselling your customers

Related: 3 Engagement Strategies You Can Use to Retain Customers

Revenue Growth and Profitability

What Revenue Growth and Profitability Is

Revenue growth measures how much your revenue has increased compared to previous reporting periods, while profitability reflects the earnings that remain after all expenses are accounted for.

Revenue growth doesn’t always lead to higher profitability, but both are indicators of a company’s financial health.

“When we create value for our customers, our customers are more satisfied and more loyal, which leads to revenue growth and profitability,” Buell says in Transforming Customer Experiences. “We can then reinvest some of that profitability into the business to create better internal service quality, which closes the loop on the service-profit chain and grows the business.”

A portion of your company’s profit should be dedicated to improving internal services, officially closing the loop for the model, and driving sustained growth.

How to Measure Revenue Growth and Profitability

When evaluating revenue growth and profitability, consider KPIs such as:

• Year-over-year (YoY) revenue growth: How much your revenue grows from one year to the next
• Operating cash flow: How much cash your business generates from its core operations
• Return on equity (ROE): How efficiently your business generates profits from shareholder equity
• Return on assets (ROA): How efficiently your business generates a profit from its assets
• Net profit margin: How much profit your business earned compared to revenues

Improving Your Service-Profit Chain

Each link in the service-profit chain is connected, meaning improvements in one area naturally drive positive changes in others. By strengthening internal service quality—through enhanced training, upgraded technology, or greater employee incentives—you create a ripple effect that improves employee satisfaction, retention, and productivity. These improvements will increase the quality of external services you deliver to customers, leading to higher customer satisfaction, loyalty, and, ultimately, profitability.

Are you experiencing a weakness in one part of your service-profit chain? Start by addressing the section that precedes it. If employee satisfaction lags, internal service quality may be the root cause. Strengthening that foundation can enhance engagement and, by extension, customer experiences. Apply this logic across the entire chain to drive continuous improvement.

Why the Service-Profit Chain Impacts Revenue

Because every link in the service-profit chain is interconnected, a breakdown in any one directly affects the others—ultimately impacting your business’s ability to generate revenue and profit. The service-profit chain helps business owners recognize the large-scale effects that seemingly minor problems can have.

To illustrate this point, imagine an effort to improve collaboration across teams where a business owner transitions their workplace from a closed-space floor plan with cubicles and offices to an open one with shared spaces. While this setup works well at some companies, employees at this business struggle with distractions, making it difficult to focus and perform their duties.

After months of trying to unsuccessfully adapt to the new floor plan, several top performers leave for other opportunities. This increases the stress on remaining employees, reducing external service value for customers and lowering their satisfaction. Unsatisfied customers lose loyalty and search for alternatives, stalling the business’s ability to grow.

With a lack of revenue growth, the company cuts back on office investments, further worsening the employee experience and creating a downward spiral that threatens long-term success.

While this example may seem extreme, it demonstrates the indirect impact of a poor or under-considered business decision on your company’s overarching strategy and success.

Putting the Service-Profit Chain into Action

Now that you’re familiar with the service-profit chain, how it impacts revenue, and its importance, determine how to implement the framework in your business to improve the customer experience and drive growth.

While the service-profit chain is a powerful framework, it should be just one piece of your broader business strategy. You must also consider how your business’s value proposition, pricing, and employee motivation collectively influence your customer journey.

Business owners, entrepreneurs, consultants, and service organization leaders should consider taking an online course like Transforming Customer Experiences, designed to teach you a systematic approach for delivering standout services and experiences that provide a competitive edge and build customer loyalty.

Ready to transform your customer experience and build lasting loyalty? Explore Transforming Customer Experiences—one of our online entrepreneurship and innovation courses—and download our online learning success guide to learn more about how an online program can benefit your career.