What it Takes to Improve Productivity: Smoothing service demand is the key

Vice President, RIETI

Productivity improvement of service industries has become a topic of active discussion not only in economic policy circles but also among business managers. The productivity of service industries, which account for more than 70% of overall economic activities, significantly affects the potential growth rate of the economy, so it is natural that productivity improvement should become a centerpiece of the growth strategy.

Recently, due to the serious labor shortage and working style reform, interest in this has heightened further. At one time, productivity improvement was viewed as a way of downsizing employment. However, as saving labor input has become inevitable, the current economic environment is more favorable than before for efforts to improve productivity.

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According to the employment conditions diffusion index of the Bank of Japan's Short-Term Economic Survey of Enterprises (Tankan), the state of labor shortage has continued for more than five years in the non-manufacturing sector. The sense of shortage is particularly strong in labor-intensive industries, such as lodging/food service, transportation, and personal services. The working style reform measures, particularly the correction of long working hours, that are being implemented under such circumstances may lead to productivity improvement over the medium to long term. However, shortening working hours under full employment will escalate the labor shortage in the short term.

The fundamental cause of the shift toward a service-oriented economy is the fact that the demand for services is growing faster than that for goods. According to a survey I conducted recently on how people spend money when their income increases in the future, the majority of the respondents answered their willingness to increase savings, indicating that their willingness for consumption is weak. However, among those who expressed priority for consumption, the ratio of those who preferred spending on services was triple that of those who preferred spending on goods.

The preference for spending on services was prominent particularly among people aged 60 or older, women, and individuals with high income. Against the backdrop of the ongoing aging of society and women's increasing labor participation and growing disposable income, there is no doubt that the shift in consumption to services, mainly recreational services and healthcare services, will continue to proceed.

Under the Basic Policy on Economic and Fiscal Management and Reform 2015, the government proposed a "productivity revolution in the service sector." Since then, the government has implemented concrete measures, including establishing the Act for Facilitating New Business Activities of Small and Medium-sized Enterprises, which is intended to help to raise the productivity of small and medium-sized service companies, and expanding the scope of the research and development tax credit to cover services development. The government recently established the Council on the Promotion of the National Movement to Improve Productivity, which is scheduled to formulate respective productivity improvement guidelines for individual service industries, including retail, restaurants, lodging, nursing care and cargo transportation. This initiative comes against the backdrop of the tightening of the labor market; all of those service industries are facing a serious labor shortage.

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While the growing interest in productivity improvement among business managers and policymakers are welcome, I frequently feel that there are misunderstanding about productivity. For example, it is often said that despite the high quality of services in Japan, they cannot be priced at a level commensurate with the quality level because Japanese consumers tend to think that services are something for which they do not have to pay.

However, consumers are paying for what matches the quality of service, including convenience and hospitality, so the quality of service as evaluated by consumers is reflected usually in service prices.

For example, in the case of retail services, the same products under the same brands may be sold at different prices depending on which category of store sells them: the price is more than 10% higher at convenience stores than at supermarkets. This is evidence that service in the form of convenience has market value. The fares for luxury trains such as Seven Stars in Kyushu and Mizukaze are much higher than those for ordinary trains, but demand is so high that it is difficult to book seats.

If companies provide services for which consumers are strongly willing to pay, it should be possible to set prices commensurate with the service quality. In a survey I conducted on how much premium is considered to be appropriate for prices at full-service eating establishments and gas stations over prices for self-service ones, the premium considered to be appropriate was 10%-15% on average. However, it was confirmed that the strength of preference for service quality varies widely from individual to individual.

Recently, among door-to-door parcel delivery companies, there have been moves to reform time-designated delivery service. Time-designated delivery provides a higher level of service quality than delivery whereby recipients do not know when the parcels will arrive. However, although some people are willing to pay for the difference, others are not. In this respect, unbundling—charging different fees for different services, with an extra fee required for better quality—is the pricing arrangement desirable for service businesses.

Among ways of improving the productivity of service industries are utilizing the economic effect of agglomeration through the creation of compact cities, stimulating the dynamism of service industries through the reform of restrictions on new market entry and the occupational licensing system, and promoting service innovation. In what follows, I will focus on leveling out demand over time, a challenge particular to services.

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Unlike manufacturing industries where goods can be stocked, service industries are characterized by the simultaneity of production and consumption. As a result, the capacity utilization rate strongly defines business performance. Typical examples are the ratio of occupied vehicle trips in the taxi industry and the guest room occupancy rate in the hotel industry. In the retail and food service industries as well, fluctuations in the number of visiting customers may affect productivity. That is due to the high adjustment cost with respect to both facilities and equipment, including stores, and the number of workers.

In recent years, the occupancy rate of lodging facilities has been rising due to a rapid increase in the number of foreign visitors to Japan. According to the Japan Tourism Agency, the guest room occupancy rate of lodging facilities across Japan has risen by nearly 10 percentage points over the past five years. The figure shows that the distribution of occupancy rates shifted significantly rightward, with the mode moving to around 80% from 60%. There have been significant contributions not only from an increase in the number of lodgers but also from the demand-smoothing effect due to differences between the lodging patterns of Japanese and foreign travelers (these two groups of travelers tend to use lodging facilities in different seasons and on different days of the week). On the other hand, the occupancy rate has remained low at many lodging facilities.

Figure. Distribution of the Occupancy Rate of Lodging Facilities
Figure. Distribution of the Occupancy Rate of Lodging Facilities
Source: Created by the author based on the microdata from the Accommodation Survey of the Japan Tourism Agency.

Many empirical studies have indicated that the use of IT is effective in raising the capacity utilization rate in service industries. An online booking system and flexible pricing based on demand forecasting are good examples. According to a survey I conducted, consumers intend to change the timing of their demand if there is a 10%-20% price difference on average with respect to the use of such services as restaurants, lodging, and air travel. Concerning these services, price elasticity for timing of demand is relatively high. In the future, artificial intelligence is expected to be used to match supply and demand more efficiently.

In service industries, the proportion of non-regular workers such as part-time workers is large. That is because it is impossible to avoid fluctuations in demand during the course of the day and across days of the week and seasons of the year. As a result, companies and business facilities where demand fluctuations are large seek to raise productivity by employing non-regular workers.

Meanwhile, one pillar of the working style reform is making improvements in the treatment of non-regular workers, including equal wages for equal work. However, according to my estimate, the level of wages for part-time workers is balanced with the level of their contribution to their employers' productivity. In other words, on average, we can say that Japanese companies are paying wages commensurate with the productivity level, rather than setting wages in an unfairly discriminatory manner. If so, in order to improve the wages of part-time workers, it is necessary to raise the level of their contribution to companies' productivity.

In this regard, if demand can be smoothed, it will become possible to lower the dependence on part-time workers. If there are limits to the effort to smooth demand, another option is training workers to acquire multiple skills. Assigning a non-regular worker to do a clerical or sales job in addition to handling customers in the offseason is likely to provide a greater chance to improve skills and shift to regular work.

Given that the present situation of individual companies is economically rational for them, a regulation-based approach to improving the treatment of non-regular workers in service industries will be effective only to a limited degree, so innovation of business administration and labor management is the key.

As an institutional initiative that goes beyond the individual company level, encouraging flexible use of time on the part of users is important. Expanding the application of a flexible working time system and encouraging the use of paid leave, which is being advocated under the working style reform, may result in the leveling-out of service demand, thereby contributing to productivity improvement. There are various avenues for improving the productivity of service industries.

>> Original text in Japanese

* Translated by RIETI.

August 23, 2017 Nihon Keizai Shimbun

September 20, 2017

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