Business Value of IT

Professor Matt Thatcher, MIS 748

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Last Class Course website

– http://faculty.unlv.edu/thatcher/mis748 Class structure

– lectures and class discussion Assignments

– short essays (20%)– team topic presentation (15%)– mid-term exam (20%)– term paper (20%)– term paper presentations (5%)– attendance/participation (20%)

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Last Class Course Topics

– Business value of IT– Information-based strategies– Privacy and information access– Liability, safety, and reliability– IT roles and responsibilities– Intellectual property rights– IT and work– Computer crimes and computer security– Social impacts of computers

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Business Value of IT Value What is the impact of IT investments on:

– firm strategies (product quality and prices)– firm performance (profits and productivity)– consumer value (consumer surplus)– society (social welfare)

How do we (or can we) measure these impacts empirically?

Are traditional assumptions of the relationship between IT and productivity valid?

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Measure of Firm Performance Profits (Revenues – Costs) Consumer Welfare (Willingness-to-Pay – Price) Productivity (output value / input value) Measuring output value

– traditional measures = counts» # of widgets produced, lines of code, tons of steel, # checks processed

– are these appropriate measures for today’s information economy? What else determines output value?

Measuring input value– traditional measures = labor hours or number of workers

» But what about quantity and quality of capital equipment used, materials used, worker training and education, investment in complementary processes?

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IT Productivity Paradox (A Review of Two Decades of Quantitative Analysis)

Economy-wide studies– Baily(1986), Jorgenson and Stiroh(1995)

» sharp downturn in economy-wide labor productivity for information workers began in early 1970s and coincided with rapid increases in IT investment and use

– Roach (1987)» output/production worker = 16.9%» output/information worker = -6.6%

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IT Productivity Paradox (A Review of Two Decades of Quantitative Analysis)

Industry-wide studies– Loveman (1991) - manufacturing sector (60 business

units, 5 yrs)» contribution of IT to output = zero

– Strassman (1990), Hackett(1990), Roach(1991) - services sector

» no correlation between IT and productivity

– Panko (1991)» negative relationship between IT and office worker

productivity “We see computers everywhere except in the

productivity statistics”, Robert Solow, Nobel Laureate

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5 Explanations of the Paradox Computers were not a major share of the economy until

recently– “needle in a haystack” problem– need to look at more recent data– need to perform studies with much bigger sample sizes to get

tighter confidence intervals Mismeasurement of outputs and inputs

– aggregated measures are problematic (usually govt. stats)» especially a problem in the services sector

– output value should include improvements in:» product quality, variety, customer service, timeliness, responsiveness» can’t only consider output value to firm but to consumer

– input value can’t focus only on labor hours or # of workers– must consider multi-factor productivity

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Explanations of the Paradox Lags due to learning and adjustment

– learning curve of the users– leveraging the technology

Redistribution and dissipation of profits Mismanagement of IT

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Firm-Level Studies Much larger sample size

– not just dozens of observations but hundreds or thousands– better, more precise estimates of parameters

Better measurements– output value can be measured by firm revenues (which to

some extent accounts for consumer valuation of such things as product quality)

Brynjolfsson and Hitt (1996)– these guys really changed the way we think– won “Most Significant Paper in IT field in the Past Decade” at

WISE 2000

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Brynjolfsson and Hitt (1996)

Data– 367 large firms, 1987-1991, over 1100

observations Productivity measures

– output value --> firm revenues– input value --> total IT hardware spending

(measured in dollars, not labor hours)

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Brynjolfsson and Hitt (1996)

Hypotheses– output contributions of IS capital and staff are

(+)– contribution of IT is greater than its cost

Conclusions– IS spending has made a substantial and

statistically significant contribution to firm output and productivity

– On average, the contribution of IT to output outweighs the costs

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Application-Level Studies Rai(1997)

– hardware (+), software (-), telecommunications (+), and IT staff (+) Banker and Kauffman(1991)

– ATM networks, market share (+), labor productivity (-) Weill(1990)

– (+) rel. between data processing systems and productivity – (-) rel. between strategic systems (esp. CASE tools) and

productivity Mukhopadhyay et al.(1997)

– optical character recognition and bar coding technologies used to sort mail by the U.S. Postal Service (mail sorting output (+), and quality (+))

Devaraj and Kohli(2000)– 8 hospitals, DSS to help evaluate contracts --> revenues (+), better

quality services and products David et al.(1996)

– in hotels, many IT applications adversely affect productivity but improve service quality

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Enter Thatcher and Oliver(2001)(Let’s Take a Step Back and Look at This Problem)

Production efficiency– cost reduction and lower prices

Quality Improvement– better products and higher prices (often times)

Profit– difference in output value and input value

Productivity– ratio of output value to its related input value

Consumer Surplus– better pricing or quality increases demand

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Initial Contribution to IT Value We consider profit-maximizing firms

– offer a product or service characterized by price and quality

The firms may invest in technologies that expand production capabilities (i.e., improves the cost function)– product design: CAD / CASE tools, data

warehousing/mining tools, prototyping tools – Product manufacturing/distribution: sales support

systems, CRM, e-distribution systems, DSS We develop economic (closed-form) models

– technology investments may not improve profits– technology investments may not improve productivity– these relationships are moderated by:

» type of IT investment» market structure» cost structure

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Model (1/3)

Two (2) firms compete in a single-product market Product attributes

– quality (s)– price (p)

Demand (Q)

21211 cssbppaQ

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Model (2/3)

Total costs (C)– direct costs of production

» research, design and development (e.g., marketing surveys)» manufacturing the product / providing the service

IT investments are represented by changes in cost parameters – f, v

1211 vQfsC

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Model (3/3)

Firm performance measures

cost - revenueprofit

Cost

Revenuetyproductivi

Price -pay tosWillingnesSurplusConsumer

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Impact of IT Investments on Production Capabilities

2 types of investments– design, startup, and development of a product

or service ( f )» CAD / CASE tools, prototyping tools, usability labs, data

mining tools, etc.

– improvement in the manufacturing or service provision capability ( v )

» DSS, reservation systems, sales support systems, e-commerce tools, etc.

Model assumption– IT improves production efficiency– IT investments are costless (provides best case

scenario to see productivity improvements)

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Market Structure and Cost Structure

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Results IT investments in design tools (f) or production

tools (v) should– improve product quality and consumer value

IT investments in production tools (v) should– increase firm profits and productivity

Monopoly: IT investments in design tools (f) should– increase firm profits but decrease productivity

Competition: IT investments in design tools (f) may– increase or decrease firm profits (depends of the level of

firm design efficiency and substitutability of products)

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Status Quo Quality Strategy Model adjustment to provide insights

– firm keeps product quality fixed but may adjust price

Impact on firm performance– IT investments increase profit and productivity

» note that this is sub-optimal if the firm can adjust quality but does not

– lower v price / demand and revenues / total costs ?

– lower f price same / demand and revenue same / total costs

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π*(vhigh)

Product Quality (s)

0

Profits (π)

π*(vlow)

s*(vlow)s*(vhigh)0

Before investment

(high v)

After investment

(low v)

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Summary Two universal theorems

– investments in IT (f or v) should improve product quality– investments in IT that lower v will increase firm profits, firm

productivity, and consumer value After that, the impacts depend critically on

– product category – market structure

Specific IT investments in certain environments may lower productivity, increase total costs, or lower profits (but you may have no choice!!!)

Status quo quality strategy– technology investments that expand production capabilities

lead to an increase in both profit and productivity» sub-optimal

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Implications “Companies continue to make IT investments in the

dark, without a clear conceptual understanding of the ultimate strategic and financial impact” Carr(2004)– formalization of impact of various technology

investments on:» production capabilities» product quality and pricing decisions» production costs, profits, productivity, and consumer value

– helps explain some seemingly counter-intuitive empirical findings in the IT literature

Managerial– be wary of inappropriate focus on “productivity”

measures for employee incentives– may lead to under-investment in product quality

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What Determines IT Investment Priorities?

Professor Matt Thatcher, MIS 748

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Empirical StudyCha, Pingry, and Thatcher (2005)

The Data and Survey Respondents– Business Leadership Confidence Index

(Compass Bank)– 1,495 firms– 4 states (AL, AZ, CO, TX)– wide range of industries– each firm assessed the impact of past IT

investments and ranked their future IT spending priorities

» See the survey on the next slide

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Other Critical Results Firms that have leveraged past IT expenditures to

increase quality – more likely to rank CRM as their highest IT priority

Firms that have leveraged past IT expenditures to increase revenues– more likely to rank managerial decision-making as their

highest IT priority. Small firms

– more likely to rank IT investments in support of security as their lowest priority

Service firms – more likely to rank IT investments in support of R&D and

security as their highest priority

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Marginal Effect of Ind. Var. on Choice of First and Last IT Priority

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Summary IT value paradox or rational firm decisions What drives IT investment priorities?

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Questions?