(FORTUNE Magazine) – THE CRASH scene at the intersection of 40th Street and 26th Avenue in Tampa is chaotic and tense. The two cars are bent and battered. Their drivers and passengers are not bleeding, but they are shaken up and scared. Just minutes after the collision, a young man dressed in a polo shirt, khakis, and wingtips arrives on the scene to assume command. Bearing a clipboard, a camera, a cassette recorder, and an air of competence, Lance Edgy, 26, calms the victims and advises them on medical care, repair shops, police reports, and legal procedures. Edgy is not a cop or a lawyer or a good samaritan. He is a senior claims representative for Progressive Corp., an insurance company that specializes in high-risk drivers, high-octane profits -- and exceptional service. Edgy invites William McAllister, Progressive's policyholder, into an air- conditioned van equipped with comfortable chairs, a desk, and two cellular phones. Even before the tow trucks have cleared away the wreckage, Edgy is offering his client a settlement for the market value of his totaled 1988 Mercury Topaz. McAllister, who does not appear to have been at fault in this accident, is amazed by Progressive's alacrity: ''This is great -- someone coming right out here and taking charge. I didn't expect it at all.'' Welcome to the front line of the new American economy, where service -- bold, fast, unexpected, innovative, and customized -- is the ultimate strategic imperative, a business challenge that has profound implications for the way we manage companies, hire employees, develop careers, and craft policies. It matters not whether a company creates something you can touch, such as a computer, a toaster, or a machine tool, or something you can only experience, such as insurance coverage, an airplane ride, or a telephone call. What counts most is the service built into that something -- the way the product is designed and delivered, billed and bundled, explained and installed, repaired and renewed. Product quality, once a competitive advantage, is now just the ante into the game. Says Eric Mittelstadt, 58, president and CEO of Fanuc Robotics North America: ''Everyone has become better at developing products. In robotics, the robot itself has become sort of a commodity. The one place you can differentiate yourself is in the service you provide.'' Companies that achieve distinctive service often have to redefine their very reason for doing business. Fanuc has transmuted itself from an assembler of robots into a designer and installer of customized manufacturing systems. Progressive no longer simply sells insurance policies; it sees itself as a mediator of human trauma. Toyota's Lexus division has invented not just a new luxury car but a whole new standard of luxury service. Johnson Controls, a seemingly mature manufacturer of thermostats and energy systems, has discovered startup-style growth in the business of managing other companies' buildings. ServiceMaster, a company that fertilizes lawns, kills bugs, and scrubs floors, has prospered by, in effect, selling people back their own leisure time. Taco Bell has been ringing up juicy profits because it knows that its main business is not preparing food but delivering it -- and not just in restaurants but in schools, hospitals, kiosks, and pushcarts. As a result of epiphanies like these, entire companies are -- literally -- moving closer to their customers. At Progressive, claims adjusters who used to spend much of their time working phones and pushing papers are ambulatory. At Johnson Controls, design engineers who were once ensconced in cubicles and harnessed to their computers are out in their customers' buildings, managing the systems they helped create. Says Patrick Harker, director of the Wharton School's Fishman-Davidson Center, which studies the service sector: ''Once you start thinking of service as a process instead of as a series of functions, the old distinction between the front office (the people who did the selling) and the back office (the people who pushed the paper but never saw the customer) disappears.'' The changing nature of customer relationships demands a new breed of service worker, folks who are empathetic, flexible, informed, articulate, inventive, and able to work with minimal levels of supervision. ''Rather than the service world being derided as having the dead-end jobs of our time, it will increasingly become an outlet for creativity, theatricality, and expressiveness,'' says Larry Keeley, president of Doblin Group, a Chicago management and design consulting firm. It's no coincidence that companies everywhere now profess an ardent desire to ''delight'' their customers. For far longer than most of us realize -- for most of this century, in fact -- services have dominated the American economy. They now generate 74% of gross domestic product, account for 79% of all jobs, and produce a balance-of- trade surplus that hit $55.7 billion last year, vs. a deficit of $132.4 billion for goods. The demand for services will remain strong. The Bureau of Labor Statistics expects service occupations to be responsible for all net job growth through the year 2005, spawning whole new legions of nurses, physical therapists, home health aides, and social workers to minister to the needs of an aging population, along with phalanxes of food servers, child-care providers, and cleaning ladies to cater to the wants of harried two-earner families. Also rising to the fore will be a swelling class of technical workers, including computer engineers, systems analysts, and paralegals. THE SERVICE ECONOMY, despite its size and growth, remains extraordinarily misunderstood, mismeasured, and mismanaged. ''We still have this perception that making a product is better than providing a service,'' says James Brian Quinn, professor of management at Dartmouth's Tuck School and author of the book Intelligent Enterprise. That notion, which Quinn traces back to prophets as diverse as Adam Smith and Karl Marx, is reinforced by present-day politicians, economists, trade union officials, and journalists -- service workers all -- who decry the demise of high-paying manufacturing jobs and rue the propagation of low-paying service positions like burger flippers, floor sweepers, and bedpan changers. Well, it's not that simple. The service sector, whose cohorts include richly remunerated cardiac surgeons, tort lawyers, and movie stars, is as varied as the economy itself. The gap between manufacturing and service wages is narrowing. (So, too, is the difference between productivity rates in goods and services industries. See story, page 79.) In 1992 the median goods-producing job paid only $19 per week more than the median service-producing job, according to a recently published study by the Federal Reserve Bank of Cleveland. More telling: The distribution of low-paying and high-paying jobs in each sector is virtually identical. The real problem isn't the wage gap between workers who produce goods and those who provide services. It's the wage chasm between employees with higher education and those without. Despite the steady expansion of the service economy, American management practices, accounting conventions, business school courses, and public policies continue to suffer from an acute Industrial Age hangover. ''Most people still view the world through manufacturing goggles,'' complains Fred Reichheld, leader of the customer-loyalty practice at Bain & Co. ''We use an accounting system that was designed to serve 19th-century textile and steel mills.'' That system tallies returns on equipment, inventories, and other physical assets, but what really matters in a service business is the return a company reaps from its human assets -- the brainpower of its employees and the loyalty of its customers. Try reporting something like ''return on intellect employed'' on your next P&L statement, and see how the analysts and auditors react to that. Service executives often behave much like belly dancers trying to march to a John Philip Sousa song, subjecting their companies to management theories -- both traditional and trendy -- that were invented in the factory. Says Leonard Schlesinger, a Harvard business school professor who has studied service companies for two decades: ''Old legends die hard. Many service firms have aped the worst aspects of manufacturing management. They oversupervise; they overcontrol.'' Even new managerial precepts like total quality management, statistical process control, reengineering, and benchmarking are rooted in manufacturing. ''Senior management continues to focus on incremental improvements in quality, on redesigning internal processes, on restructuring, on taking people out of the equation,'' says a frustrated Craig Terrill, an innovation consultant at Kuczmarski & Associates in Chicago. ''That's such a defeatist approach. They should be coming up with whole new ways to serve their customers.'' The good news is that an increasing number of companies are inventing new ways to reach those customers. Forcing them to change is that fabled taskmaster -- the marketplace. Progressive Corp. used to have a winning formula for coining money in auto insurance, a business with notoriously low margins. The company, headquartered in Cleveland, wrote policies for high-risk drivers that its competitors wouldn't touch, and charged high prices to match. The ride ended in 1988, when two things happened. Allstate outflanked Progressive in the high-risk niche, and voters in California, where Progressive made 25% of its profits, passed Proposition 103, a law that sharply curtailed insurance rates. Peter Lewis, 60, Progressive's plain-speaking chairman, CEO, and president, saw the double wake-up call as an opportunity both to revise his company's practices and to tame the public's hostility. Says he: ''People get screwed seven ways from Sunday in auto insurance. They get dealt with adversarially, and they get dealt with slowly. I said, 'Why don't we just stop that? Why don't we start dealing with them nicely? It would be a revolution in the business.' '' With its round-the-clock Immediate Response program, introduced four years ago, Progressive representatives now make contact with 80% of accident victims less than nine hours after learning of the crash. Adjusters inspect 70% of damaged vehicles within one day and wrap up most collision damage claims within a week. By scurrying to the scene, adjusters obtain accurate information fast, which they feed into PACMan (Progressive automated claims management system). The streamlined process reduces costs, builds customers' good will, and keeps the liability lawyers at bay. At the crash scene in Tampa, even the driver of the other car, Xavia Culver, was impressed: ''I think all insurance companies should come out and see what's going on, to help out with all the hassle and confusion.'' Lance Edgy, Progressive's man on the scene in Tampa, is the very model of a modern service worker. The lead member of a six-person team of adjusters, Edgy joined Progressive in 1990 after graduating from the University of Florida with a degree in finance. The company has invested heavily in his training, offering him courses not just in the arcana of insurance regulation but also in the art of negotiation and in grief counseling (part of his job involves dealing with the relatives of dead crash victims). Progressive's gain-sharing program, keyed to a formula based on revenues, profits, and costs, gives Edgy an opportunity to increase his base salary of $38,480 a year by as much as $5,400. Says CEO Lewis: ''To the extent that auto insurance is a commodity, our biggest differentiator is our people. We want the best people at every level of the company, and we pay at the top of the market.'' When a competitor recently tried to hire away three of Progressive's highly paid division claims managers by offering them large pay hikes, Lewis increased the pay scales not just for the three would-be defectors but for all 15 of their colleagues as well. Investing in people pays dividends. Progressive's net income, $267 million last year, has increased at an average annual compound rate of 20% since 1989. For service companies, retaining good employees is essential to winning and keeping good customers. ''It's impossible to build a loyal book of customers without a loyal employee base,'' says Fred Reichheld of Bain. ''It's like trying to build a brick wall without mortar.'' As obvious as this connection seems, managers of service companies routinely disregard it. The annual rate of employee turnover in department stores and restaurants routinely tops 100%. Says Harvard's Schlesinger: ''Most service companies operate with a cycle-of- failure mentality. They assume labor is an expendable, renewable resource, and they create a cadre of poor, unmotivated employees who couldn't care less if the customer is satisfied.'' WHEN IT COMES to the link between employee turnover, customer loyalty, and profits, Lexus understands the nexus. Two-thirds of the people who buy a Lexus have bought one before, the highest repeat purchase rate in the luxury car market. That's an extraordinary statistic, considering that the first Lexus went on sale less than five years ago, and considering that the appreciation of the yen has sent the price of a top-of-the-line LS 400 sedan soaring above $54,000. For three years running, customers surveyed by J.D. Power & Associates, the industry's leading pollster, have ranked Lexus No. 1 in product quality and dealer service among all cars sold in the U.S. ''We try to make it very hard for you to leave us,'' says Lexus general manager George Borst. ''When you buy a Lexus, you don't buy a product. You buy a luxury package.'' Wrapped in the package is a style of service crafted with the same precision Toyota put into the design of the car itself. Says Borst: ''Our challenge was to get people to buy a Japanese luxury car. The quality of the product wasn't the issue. Everybody knew that Toyota could make a top-quality product. The issue was creating a sense of prestige. And where we saw the hole in the market was in the way dealers treated their customers.'' When you walk into the showroom at South Bay Lexus, not far from Toyota's Torrance, California, headquarters, the most striking thing is what doesn't happen. No salesmen -- sales consultants, to use the proper title -- approach. They don't hover, they don't pry, they don't solicit. Even though they're paid on commission, these guys stay totally out of sight until you tell the receptionist you're ready for a consultation. Says South Bay service manager John Lane: ''Customers won't stand for the hustle effect.'' Like all employees at Lexus dealerships (including receptionists), Lane regularly attends national and regional training courses to learn about cars, even those made by competitors, and customers. Lane figures he received more training in his first month at Lexus than he did in his entire 18-year career at Cadillac. But back to the showroom. If you want to buy a car -- and most customers make two or three visits before they're ready -- your sales consultant will usher you into a product presentation room, an alcove with no doors, no clutter, a semicircular marble-topped table, and three leather chairs that are precisely the same height. The implicit message: There are no traps and no surprises. The first two regularly scheduled maintenances of your car are free. While you're waiting for the work to be done, you can use an office with a desk and a phone. Or you can stand in the customer viewing room and watch the mechanic -- sorry, the service technician -- attend to your car in a brightly lit garage that seems devoid of grease. If you need to be someplace, the dealer will lend you a car or give you a ride. When you pick up your vehicle, you'll find that it has been washed and vacuumed by a ''valet detail specialist,'' whose compensation, like everyone else's at South Bay, is pegged to customer satisfaction. The annual employee turnover rate since South Bay opened its doors in 1989 is a lowly 7%. Okay, it's one thing to provide silky service when you're selling a silk- purse-type product. But how much innovation can you possibly bring to the preparation and delivery of a $1.39 chicken taco or a 99-cent bean burrito? Plenty. Over the past decade Taco Bell, a subsidiary of PepsiCo, has evolved from a regional quick-service restaurant chain with $700 million in system-wide sales and 1,500 outlets into a multinational food delivery company with $3.9 billion in revenues and more than 15,000 ''points of access'' (POAs). What, you ask, is a POA? It is any place where people can meet to munch -- an airport, a supermarket, a school cafeteria, a college campus, or a street corner. Says Charlie Rogers, Taco Bell's senior vice president for human resources: ''We've changed the way we think about ourselves, moving from a company that prepares food to one that feeds hungry people.'' Like many business insights, this one sounds insanely simple, almost like a Peter Sellers pronouncement in the movie Being There. But don't be fooled. Getting from Point A to Point B necessitated a revolution in the way Taco Bell manages people, information, and machines. The first step, unveiled by President and CEO John Martin in 1989, was called K-minus. (The ''K'' stands for kitchen.) Martin took the heavy-duty food preparation -- crushing beans, dicing cheese, and preparing beef -- out of the restaurants and centralized it in commissaries run by outside contractors. The cost savings allowed Taco Bell to slash its prices. More significantly, the company was able to shrink the average size of a restaurant kitchen by 40%, freeing up more space -- and more employees -- to serve customers. Says Rogers: ''Most of the people in our restaurants really worked in manufacturing, not service.'' Once Taco Bell got the manufacturing out of its restaurants, it began to get the manufacturing out of its management. Like most fast-food chains, Taco Bell used a command-and-control system of supervision that came straight out of Detroit, circa 1960. There was one manager for each restaurant, one area ^ manager for every six restaurants, and one repetitious, mind-numbing job for each employee. Today many Taco Bell outlets operate with no manager on the premises. Self-directed teams, known as ''crews,'' manage inventory, schedule work, order supplies, and train new employees -- make that ''crew members.'' Team-managed restaurants have lower employee turnover and higher customer satisfaction scores than conventionally run outlets.

Regional managers, formerly factory-style supervisors who earned about $25,000 a year, are now business school graduates who oversee as many as 30 POAs. Their pay, closely linked to sales results and customer-satisfaction scores, can top $100,000. ''I see myself not just as a fast-food manager but as an entrepreneur who manages a multi-million-dollar corporation with 250 employees,'' says Sueyoung Georgas, a fortysomething native of South Korea, whose territory in the southern suburbs of Detroit includes five restaurants, five schools, three community colleges, and a catering service that provisions banquets and festivals. With people like Georgas on board, CEO Martin is aiming to increase Taco Bell's points of access to 200,000 -- a more than tenfold increase -- by the year 2000. SOME OF THE MOST exciting action in services is occurring behind the scenes, deep in the bowels of the economy -- down in the boiler room, to be precise. Okay, a boiler room isn't an intrinsically thrilling place. But it is for Johnson Controls, an old-line Milwaukee manufacturing company, whose founder, Warren Johnson, invented the thermostat in 1883. Sales of Johnson's traditional products -- heating controls, batteries, plastic bottles, and automobile seats -- continue to expand at a steady pace. But ''facilities management services,'' which Johnson entered in 1989, is running like a racehorse, with revenues growing at a triple-digit clip. Controls Group vice president Terry Weaver waxes euphoric when he describes the opportunity in managing the heating, lighting, security, and cleaning operations of office buildings. ''It's explosive. It's almost impossible to quantify, a market worth tens of billions of dollars in the U.S. alone. It's a wave. It's a megatrend.'' Yep, it's exciting. And here's why: As companies restructure, they are paring costs and focusing on what they do best (their core competencies, in B- school jargon). At the same time, they are ditching the things that they do worst, like managing their computer networks, phone systems, and boiler rooms. Through the magic of outsourcing, one company's cost center becomes Johnson Controls' (or some other firm's) profit center. Johnson Controls Chairman and Chief Executive James Keyes, 53, says service now drives his entire corporation. ''Most of our growth has come from the fact that we do more for our customers.'' Strictly speaking, Tina Brueckner, 27, an engineer in the Controls Group's Milwaukee branch office, had always been a service worker. But she almost never met the people she was serving. Hunched in front of a computer, she designed heating, ventilation, and air- conditioning control systems to specifications drawn up by the customer or the customer's consultant. Now, instead of basically filling orders, Brueckner finds solutions to her customers' problems. She spends at least half her time in the field as part of a four-person team that helps schools improve their energy efficiency. Says she: ''Before I sat at a desk and engineered. Now I go out and talk to my customers. This makes the job a lot more satisfying.'' THE OUTSOURCING phenomenon fueling growth at companies like Johnson Controls is also spreading to the consumer world. There the powerhouse is ServiceMaster, a company in Downers Grove, Illinois, that has made a mint by doing things for people that they don't want to do themselves: Dust their bookshelves, care for their lawns, and exterminate their roaches. The company, which also cleans and maintains hospitals, schools, and other buildings, reported net income of $145.9 million on revenues of $2.8 billion in 1993, its 23rd consecutive year of record top- and bottom-line results. Chairman William Pollard, 56, admits to being miffed that his colleagues in the business community don't always treat his enterprise with the greatest respect: ''They say, 'Oh, you're just the mop-and-bucket guys.' But then they look at our financial results and wonder, 'How did they do that?' '' How indeed? By carefully selecting employees (''service partners'' is what the company calls them), training them thoroughly, and giving them the right tools to do the job. ServiceMaster's R&D center, which is focusing this year on floor care, recently invented the Walk-Behind Scrubber, a self-propelled contraption that helped cut by 20% the amount of time it takes to clean a vinyl surface. Next year, incidentally, will be the Year of the Carpet. ServiceMaster's real genius lies in the way it manages to instill a sense of ; dignity and importance in low-paid people doing menial jobs. The company's Merry Maids subsidiary rejects nine out of ten applicants for the entry-level position of ''teammate.'' Every prospective teammate goes through a 45- question interview known as the Perceiver. Managers review the results, looking for WOO words -- for Winning Others Over -- such as ''win,'' ''commitment,'' ''we,'' ''yes,'' and ''us.'' Merry Maids' pickiness in hiring teammates stems from a new perception of why it's in business. Says President Mike Isakson: ''We used to focus on the process of cleaning, making sure the home was free from dust. Now we understand that the ultimate benefits to the customer are peace of mind, security, and stress reduction.'' In other words, the customer wants to know not only that her home will be cleaned but that nothing will be stolen, broken, or rearranged. Says Cindy Luellen, 33, a Merry Maids office manager in Indianapolis who started out as a teammate: ''This job is very rewarding emotionally, especially for a divorced, single mother with just a high school education. It's nice to have the respect of your fellow employees and your customers too.'' Respect, loyalty, security, dignity -- old-fashioned qualities for a new- fashioned economy. Earlier this century machines helped liberate our ancestors from the toil of the fields. In this generation, wondrous technology has freed us from the drudgery of the assembly line and enabled us to speed new products to far-off markets. As we approach a new millennium, it is people who will carry us forward. In an economy built on service, the extent to which we prosper will depend on our ability to educate, entertain, empower, and ennoble ourselves -- and each other.

BOX: INSIGHTS

All net job creation through 2005 will come from services.

Think of service as a process, not as a series of functions, then realign the organization.

The changing nature of customer service demands a new breed of worker -- one who is empathetic, flexible, inventive, and able to work with minimal levels of supervision.

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