(FORTUNE Magazine) – EVERY MANAGER should know by now that what the customer really wants is service. Personal service, the kind that is delivered by live bodies behind the sales counter, a human voice at the other end of the telephone, real folks in the tellers' cages at the bank. Consider this: William Wilsted, an adviser to Ernst & Young, the accounting and consulting firm, surveyed banking, high-tech, and manufacturing company customers and found that these people considered ''the personal touch'' -- which includes how committed a company representative is to a client and whether he or she remembers a customer's name -- to be the most important element of service. It is more important than convenience, speed of delivery, and how well the product works, among other factors. In April, Opinion Research Corp. of Princeton, New Jersey, surveyed 400 executives of the nation's largest companies, the vast majority of whom said that how much an airline ''cares about its customer'' is as important to them as prompt baggage delivery and efficient check-in. And fast-foodies at Burger King, who used to rank speed of service first, rank courtesy No. 1 today. Now consider the problem: How will managers deliver such personal service in the midst of a labor shortage? Just as the ranks of high-income consumers expand and push up demand, the primary hiring pool of people ages 18 to 29 will shrink by almost 10% through 1995. From now through the year 2000, 25% of the people entering the work force will be immigrants and minorities, many with language or education barriers. Only 71% of U.S. high schoolers make it to graduation, and in New York City the figure is even lower -- 40%. American Express finds that some of the people it hires today lack basic social skills -- for example, how to speak courteously to customers -- that all new employees possessed just a couple of years ago. At Super Valu Stores' Cub Food markets in Denver, managers must teach workers how to smile and walk erectly, and must even request that some of them dress for work with their shoes tied and shirts ironed. How will these workers measure up to the customer's expectations about service? Says Edwin Cooperman, president of American Express's North American Travel Related Services division: ''The work force challenge is one of the most important issues, if not the key challenge, for service providers in the Nineties.'' Listen to Super Valu's CEO Michael Wright, one of the most successful service company managers (see box): ''We're used to competing for customers, but now we'll be faced with a growing need to compete for our work force.'' Companies as diverse as PepsiCo and Maryland National Bank, Target Stores and Marriott, are grappling with the problem of providing more and better service with fewer of those precious bodies. They are revamping hiring and pay practices, looking for employees in some unusual places and compensating them on the basis of how well they have served customers. A few smart companies are training workers to focus on customer retention, something even higher-echelon executives rarely worried about. Finally, they are all accepting the reality that technology can best be used to support workers, not replace them. THERE IS a surprising payoff awaiting these and other companies that imbue their employees with the service ethic: When they make their customers happy, they make their employees happy too. Contented workers make for better-served customers, and there is also mounting evidence that improvements in customer satisfaction lead directly to higher employee retention. This is important because labor turnover hurts. Not only are employees increasingly difficult to replace, but the money spent recruiting and training them is wasted as well. Worse, high turnover creates what Harvard business school professor Leonard Schlesinger calls ''a cycle of failure'' because it results, at least temporarily, in low productivity, poor service, angry customers, and even more discontented workers. Says consultant Frederick Reichheld of Bain & Co. in Boston: ''Customer retention and employee retention feed one another.'' Roger Ballou, president of American Express's Travel Services Group, would agree. The division's customer-service center in Phoenix began a crusade in January to boost service and attract a more educated worker. Ballou is hiring as customer service representatives busy mothers who are also college graduates, enticing them with flexible hours and a richer job content. Until this year, each representative performed a separate function in the complaint- handling chain -- one person opened mail, another wrote back to the customer, still a third might track down copies of receipts on microfiche. And you wondered why it took so long to get your billing problem resolved? Now that one representative handles a card member's complaint straight through, most issues are cleared up in six days on average instead of 35, and customer satisfaction has shot up. Moreover, employee turnover has declined about 30% in just three months. Ballou lifted the idea from a Japanese manufacturing process called parallel engineering, in which products are designed simultaneously for the customer's use and for simplicity of manufacture. Says he: ''Allowing one person to complete the task is better for customers and a lot more fulfilling for employees.'' Other companies are revamping work schedules to accommodate different types of workers. Super Valu uses a computer to match the preferred work shift of each employee in its Cub markets with shopper traffic patterns. Store managers will soon be able to program one-hour shifts so a student who stocks groceries part time can work an hour, leave to take her chemistry exam, and return to work the same day. This kind of flexibility helps keep employee turnover at Cub to around 25% annually, less than half the supermarket industry average. COMPANIES are going to have to be flexible about more than hourly schedules if they want to attract qualified workers. They may have to adapt their corporate bureaucracies to some maverick ways. William Daiger, president of Maryland National Bank in Baltimore, was shocked to find that branch managers who have the best records for customer retention ''solve their problems by skating through the bureaucracy of a company as big as ours.'' For example, these rugged individualists don't use Maryland National's central hiring pool; they recruit locally to hire tellers who can swap neighborhood gossip with customers. They would rather die than encourage customers to use the company's impersonal toll-free complaint line; they want face-to-face meetings. Among the 20 branches Daiger studied, the No. 1 manager for holding on to customers turned out to be Leslie Joy, who runs the outpost in suburban Bowie and is particularly popular with customers and employees. Her secret: She never lets a customer close an account without meeting him personally. Says Daiger: ''She dresses very blue-collar, and she doesn't look like a typical manager of people. But this woman is totally committed to her customers.'' The biggest mistake that managers make in hiring is choosing only those who look as if they would fit in. Says Frank Petro, a consultant with Booz Allen & Hamilton in San Francisco: ''What you really need in a service business is people who like people.'' At Target Stores, Dayton Hudson's $7.5 billion discount chain, 5,000 of the 80,000 employees are 60 or over. Customer service specialists, assistants who roam the aisles and help shoppers find the floor polish in aisle three, include 64-year-old Evelyn Hayes. Mabel Sly, 88, is a fitting room attendant, while Vernon Basore, 76, puts price tags on the merchandise. Says Susan DeNuccio, a vice president of personnel: ''Elderly workers deal better with customers. They go out of their way to satisfy them and don't stop with simple answers.'' Each of Target's 407 stores also employs two or three mentally or physically handicapped people, who do everything from directing customers to folding towels. DeNuccio reports that turnover and absenteeism among the handicapped and older workers is below average. In addition, she says: ''Customers have been writing in and telling our managers how much they admire us for our citizenship. And they don't go out of their way to thank us very often.'' DON'T UNDERESTIMATE the power of bigger bucks to attract higher-quality workers and improve service. That approach has worked at Au Bon Pain, a fast- growing, privately held chain of sandwich shops in the Northeast that sell ham and Brie on a croissant instead of ham and Swiss on rye. Len Schlesinger took a break from teaching at Harvard business school and joined Au Bon Pain to help the company escape the cycle of failure endemic to the fast-food industry: constant employee turnover, a continual decline in worker quality, and deteriorating customer satisfaction. He and the company's co-chairmen revised Au Bon Pain's hiring and compensation system so that store managers earn from $50,000, about twice the industry average, to as much as $165,000 a year based on their contribution to sales and profits. Crew workers, the people who slap the Boursin on the / baguette, are paid up to $25,000 a year, but they must work at least 50 hours a week. The payoff for Au Bon Pain is high productivity, low absenteeism, and reduced training costs because workers stick around longer. Annual turnover of entry-level workers is about 75%, vs. over 200% industrywide. Since the luncheon crowd seems to care whether restaurant workers remember their names, a stable work force helps Au Bon Pain keep buyers loyal. Opening the door to new types of employees usually requires that companies invest heavily in worker training. The best advice for turning entry-level people into providers of first-class service comes from Japan: Grow your own trainers. Japanese companies usually don't hire professional instructors, they teach their own managers how to train the staff. Says Richard Whiteley, president of Forum Corp., a Boston consulting firm: ''Training is much more powerful if it starts at the top and sifts down.'' THAT WAS the approach that Marriott adopted to meet a remarkable challenge in opening the Warsaw Marriott, Poland's first Western-owned hotel. In late 1987, two years before it opened, the company recruited 20 Polish managers, none with lodging-industry background. Says Haile Aguilar, a 17-year Marriott veteran who is now the Warsaw Marriott's general manager: ''A sense of hospitality is not characteristic of hotels in Poland. We wanted people with no experience and a willingness to learn from us.'' The Poles flew to Boston, where Marriott managers led classroom discussions in matters such as running a smooth room-service operation and taking accurate messages for guests. Says Dorota Kowalska, the Warsaw hotel's director of human resources: ''Role-playing helped more than three hours of lectures because it made the trainees think like customers.'' When the trainees returned home, they hired and instructed a staff of 1,000. Quickly they proved that bosses don't have to be behind-closed-door dictators. Says Kowalska, 32, the daughter of a Polish diplomat and previously a teacher of English, French, and Arabic in Warsaw: ''Seeing the executive director of food and beverage actually clear tables in the breakfast room was something our people had never experienced before.'' Now her compatriots are passing up lunch breaks and working extra-long hours, for the sake of caring for the guests. And the Warsaw Marriott, which attracts mostly Westerners, has been earning even higher customer satisfaction ratings than Marriott's U.S. hotels. Besides educating their employees in the service ethic, the smartest companies train everyone in the organization to focus on retaining customers. Fred Reichheld, the Bain consultant, points out that long-established customers are the most profitable because they buy more, refer new business, and usually are willing to pay higher prices. Yet, on average, companies lose about 20% of their customers every year. Not MBNA America. The credit card operation of Baltimore-based MNC Financial, also the parent of Maryland National Bank, holds on to 95% of its customers every year, compared with about 88% for its competitors. Why MBNA thrives is obvious from the moment you set foot in its headquarters: At each of four entrances, a 9 1/2-foot-by-5 1/2-foot legend, THE CUSTOMER FIRST, is woven into plush gray and green carpeting. Above each lintel of 350 doorways is the sign THINK OF YOURSELF AS THE CUSTOMER. Charles Cawley, MBNA's president, began paying intense attention to retaining his customers seven years ago because a new card member costs him $100 to acquire, but a five-year customer brings in an average $100 in profits annually, and a ten-year cardholder produces $300. He set up a card retention department where 68 phone service agents call every customer who wants to close an account and plead with him to stay, or do whatever it takes -- waiving annual fees, perhaps -- to win him back. They typically rescue half the accounts. In the collection division, which MBNA calls customer assistance, senior vice president Craig Smith tells his 380 people that even deadbeats ''need a hugging, not a mugging.'' Over 95% of the delinquent customers say that MBNA's collection squad is polite. Though the labor market is highly competitive around Newark, Delaware, where MBNA and two dozen other credit card companies have their headquarters, MBNA was flooded with 10,700 applications for 490 job openings last year. Employee turnover is 7%, one-third the average of its competitors. Says Cawley: ''It's much easier to work at a place where customers are happy. I think that our commitment to keeping customers is the overriding reason why our employee turnover is low.'' When you make customer retention a top employee priority, it is important that you deliver the financial incentives to keep service levels up. MBNA has measured the factors that affect a cardholder's satisfaction. Two top ones: how quickly customer representatives answer a telephone or written inquiry, * and whether billing statements are error free. Management watches over every department's performance on each count. When all the groups achieve 97% of the performance standards, an allotment of the company's profits goes into a bonus pool. That little extra in the paycheck plus individual incentives can amount to 20% of a worker's compensation. MasterCare auto service centers, the $1-billion-a-year chain owned by Bridgestone/Firestone, started linking pay to customer retention six months ago in Columbus, Ohio, and Memphis. Surveys of 4,000 car owners there showed that they despised MasterCare's hard sell. Says senior vice president John Rooney: ''We purported to be the premium provider of auto services in the U.S., but we failed. We found we were rude, that mechanics left grease on car seats -- all sorts of things.'' CUSTOMERS TOLD the company that honest, courteous service is twice as important to them as the price of a repair job. So now each month Rooney has an outside firm poll 50 customers from each store, asking them whether they received good service and plan to return to MasterCare. Employees who keep customers loyal get bonuses of about 10% of their salaries. Even the mechanics' pay depends on the survey scores. Says Rooney: ''It's not just the smoothness of the salesman that's important. It's also the quality of the work.'' MasterCare centers using the new pay system have raised customer retention 25% and lowered employee turnover some 40%, which is vital given the nationwide shortage of mechanics. For a brief time it looked as if user-friendly computers had licked the labor problem in personal service. But, alas, the limits of a machine are now clear. Customers want empathy, and not even the world's most sophisticated computer can provide that. Experimenting with nonhuman ''Touch N' Go'' order-takers -- you pressed buttons on something that looked like a mainframe computer and picked up your order minutes later -- Burger King has learned that customers want a machine that speaks in a human voice, not a series of R2-D2 belches. And American Express wouldn't dare force a computerized phone system on a complaining card member. Says Edwin Cooperman of Travel Related Services: ''We don't think computers can replace people.'' The real role for technology is to turbocharge workers -- make them smarter and faster service-givers. For example, a $4 million investment in a new computer system has helped once troubled American Savings Bank become No. 1 in consumer banking, according to California Business magazine. Formerly part of Financial Corp. of America, American Savings was rescued from near insolvency by the government and sold to Texas billionaire Robert Bass in late 1988. Despite a recent ill-timed adventure in junk bonds, it has been reviving under a new chairman, Mario Antoci, the former president of H.F. Ahmanson. WHEN HE MOVED to American Savings in late 1988, Antoci was dismayed by what he found: ''No one in the loan servicing department knew how to solve a problem. Customers would be switched from agent to agent, and each time they would become more furious, until everyone was screaming at each other.'' He raised service representatives' pay from $20,000 to $35,000 , elevated their positions to the highest nonmanagement level, added training in telephone etiquette, and brought in a computer system that gives every agent immediate access to a borrower's complete account history. Now, 93% of the time, a customer can take care of any problems in his account with one phone call -- and he stays on hold an average of 28 seconds, instead of two to three minutes. The computer has helped the bank cut costs by $3 million annually, which means it will pay for itself in a little over a year. Technology can also make service more personal, a contradiction until you see what PepsiCo has done at its $4.2 billion Frito-Lay snack operation and its $2 billion Taco Bell restaurant chain. Though PepsiCo is considered an industrial company, Chairman Wayne Calloway insists he runs the ultimate service enterprise: ''Nobody has more customer contact than we do,'' he says. Frito-Lay's 10,000 salespeople make 400,000 store visits a week, and Taco Bell's 70,000 restaurant workers serve three million customers daily. He figures that by arming the sales and service staffs of his operations with computers, he can liberate them from the grunt work to spend more time with their customers. When a Frito-Lay route salesman visits a store, he plugs sales information on Doritos, Fritos, and Ruffles into his hand-held computer; that night he zaps the data to Frito-Lay's computer center in Plano, Texas, where it's analyzed for sales trends. When the analysis is relayed back to the local office and into the hands of the route salesman, he uses it to advise retailers about what to put on their shelves. Says John Hooley, senior vice president at Super Valu's Cub chain: ''The system has made Frito-Lay's service second to none. The salespeople know the trends so well that they never let us run out of stock.'' Only two of Frito-Lay's salesmen quit the company during the switch to the machines two years ago. President Robert Beeby believes the salespeople went along even though the customer reaps most of the advantages because ''we always emphasized, 'Here's how this is going to be a good thing for you.' '' And it has been. Says Dale Theriault, who's been driving the same Frito-Lay truck around Worcester, Massachusetts, for 16 years: ''It saves me 90 minutes a day, eliminates my errors, absolutely does all the paperwork for me.'' Last year Taco Bell's profits increased 38%. A new marketing strategy -- cheap food and free drink refills -- was only half the story. Says President John Martin: ''We are shifting the focus of our employees from operations to interacting with the customer.'' WITH THE HELP of an in-store computer system called Total Automation of Company Operations -- yes, TACO -- the company is eliminating about 15 hours a week of such management tasks as making out the payroll and scheduling workers. Taco Bell is also eliminating kitchen space by having its vendors deliver more prepared ingredients and by installing machinery that reduces the number of cooks required to fix the meals. The newest kitchens take up only 40% of a Taco Bell Spanish-style restaurant, vs. 70% a decade ago. Today a 1,800-square-foot store seats 80 people, vs. 45 in 1983. At the Taco Bell that Jody South manages in Tustin, California, none of her crew works full time in the kitchen anymore, so everybody meets customers. She says she used to be lucky to spend an hour a day with customers, but today she spends about four. ''I know my customers now,'' she beams. ''I've been in fast food for 18 years and I've never been able to say that.'' South reports that she has more than doubled her compensation in two years, and after hopping from McDonald's to Taco Tico to Pizza Inns, she's at Taco Bell to stay. ''It's not hard work anymore,'' she says. Evidently the other Taco Bell managers think so too, because the company has reduced systemwide store-management turnover from 50% to 20% annually. Most of its fast-food competitors lose 35% to 40% of their managers every year. Although every service operation is different, there are several lessons about giving the customer what he wants that apply to all. Pay attention to retention because your current customers are the most profitable bunch. Expand ; your hiring horizons, then make sure you train your workers to think about customer retention too. And reward them for it. Use technology to give your workers the information they need to serve the customer and the time to attend to him. When you make the customer ''first, second, third,'' as author and consultant Tom Peters once said, you are also doing the same for your employees. It's a cycle of success: Good customer service leads to loyal customers, who produce higher profits that make employees want to stay with the company, which in turn produces better customer service. Which came first, the chicken or the egg? In a workplace where hanging on to your customers and your employees is everything, does it matter?

CHART: NOT AVAILABLE CREDIT: SOURCE: ADAPTED FROM '' BREAKING THE CYCLE OF FAILURE IN SERVICES,'' BY LEONARD A. SCHLESINGER AND JAMES L. HESKETT CAPTION: THE CYCLE OF GOOD SERVICE THE CYCLE OF POOR SERVICE Customer retention and employee retention feed each other. That means satisfying your customers pays two big bonuses: higher profits and the ability to keep good workers at a time when new ones are increasingly difficult to find.