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OCR for page 97
3
Impacts of Information Technology at
the Enterprise Level
The differing structure, environment, and competitive situation in each
service industry explain only some of the differences in performance rela-
tive to investments in IT. Other differences reflect the experiences of indi-
vidual companies within each industry. Both performance and the use of IT
can vary greatly among companies in the same field (see Appendix A for
references to relevant studies). Most of the variation reflects the fact that
decisions concerning IT investment programs are made at different points in
time by managers with different abilities and perspectives. Since most
major decisions about IT investment are made by individual executives at
the enterprise level, understanding how these decisions are made and evalu-
ated is critical if national policy initiatives are to be effective.
This chapter examines why firms invest in IT, how firms invest in IT
and the categories of applications that are typical, and how firms assess the
impacts of their use of IT. It also discusses cross-cutting observations on
IT and examines the widespread belief among executives that IT has en-
hanced performance overall, regardless of what macroeconomic measure-
ments may indicate. The chapter is based on committee discussions in-
formed by a set of semistructured interviews (Appendix D) held with about
80 senior managers in 46 major firms drawn from each of the major service
industries transportation, communications, retailing, wholesale distribution,
health care, financial services, and professional services.
The interviews sought (1) to discover what types of enterprise-level
data and experience might be available, (2) to validate further or raise
97
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INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY
informed questions about the basis for industry- and macroeconomic-level
data and analysis, (3) to understand what factors managers consider impor-
tant in making decisions about investing in IT, (4) to obtain some useful
insights into how companies manage their IT investments for greater effec-
tiveness, and (5) to explore further the causes for and implications of the IT
paradox.
This exploratory investigation was designed to yield insights, not to
substitute new statistical data for data obtained in other studies. The par-
ticular firms whose managers were interviewed were chosen because they
had verifiably strong reputations as leaders in the use of IT. As such they
were more likely to have both positive and negative experiences to draw on,
to have thought carefully about critical issues, and to be willing to discuss
them. However, their response cannot be generalized beyond this sample,
because these firms were clearly more likely than the average company to
provide evidence of a positive relationship between use of IT and perfor-
mance. Some conclusions follow.
WHY FIRMS INVEST IN IT
Executives generally invest in IT to increase expected profits, margins,
or returns on capital. Some investments those made to reduce costs, to
generate new products, to make measurable improvements in quality may
be discernible as gains in productivity in standard published reports. How-
ever, executives may also invest in IT for reasons that do not show up
readily in such reports but may still be vital to the success of enterprises.
For example, in some endeavors (e.g., research, engineering design, or medicine),
the capacity to work at the intellectual frontier or to solve advanced prob-
lems may depend on having the most current technologies. In others (e.g.,
accounting, consulting, legal work, credit clearance, or trust management),
flexible access to the most powerful current databases and efficient data-
manipulating capabilities may be essential to deliver a competitive level of
quality.
Managers generally regard IT as only one of many possible investments
that may benefit their firms. When they choose to invest in IT, they do so
in the belief that such an investment will provide better returns as compared
to other alternatives, for example, not investing or investing in other pro-
grams. But many of the factors they consider and many of the effects of
their successful investments may not show up in aggregated economic mea-
sures such as productivity, return on investment (ROI), sales, or margins.
For example, since companies can neither calculate nor report their "alter-
native cost" gains or losses where their companies would have been posi-
tioned without an investment versus where they are with it it is impossible
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IMPACTS OF INFORMATION TECHNOLOGYAT THE ENTERPRISE LEVEL 99
for more aggregated databases to reflect such gains or losses.2 Managers,
especially in professional firms, may consider the cost of overinvestment in
IT as insignificant against (the potentially much larger) losses the firm
might incur if it fails to attract top talent, sustain its competitive edge, or
hold market share because its IT systems are inadequate.
Amona the more important rational reasons for investing in IT that are
.
not picked up in aggregate databases are the following:
Expanding market share or avoiding catastrophic losses. While
aggregate industry output is a key economic indicator for policymakers,
managers focus more on the performance of their individual companies. A
company may gain or lose share even though statistics on an industry's
performance in the aggregate may indicate relative stability. For execu-
tives, market share is a key parameter of successful performance as well as
a basis for marketing, purchasing, and personal power for those in the com-
pany. Investments in IT that only shift market share may indicate little or
no measurable benefit at the industry or macroeconomic level. The same is
.
true of investments that successfully prevent very large losses-like air-
plane crashes or environmental catastrophes. Yet both types of investment
are economically rational.
Creating greater flexibility and adaptability for future business en-
vironments. Changes in the business environment (e.g., greater regulation,
increased market or operational complexity) often demand significant changes
in the way a company operates. In some cases, investments in IT may
represent essential elements of the infrastructures that allow companies to
survive despite rapid and unforeseeable changes in the external environ-
ment. In other cases, companies may invest in IT to gain future flexibility
for creating products that may not yet be planned or even conceived. In
still other cases, IT may enable a company to maintain or reduce its costs
while providing greater variety and flexibility in its services.
· Improving the quality and stability of internal environments. Some
firms invest in IT to obtain and analyze information that can provide a
greater degree of predictability or stability in their operations and that can
help them to avoid undue fluctuations in sales, profitability, or employment.
Other firms may invest in IT to improve employee satisfaction or to en-
hance worker safety. IT can help to eliminate burdensome tasks, make jobs
more attractive, shorten training cycles before an employee becomes pro-
ductive, and improve morale. IT is an especially powerful tool that compa-
nies with life-critical operations can use to manage large amounts of data in
real time to improve the safety of employees, customers, and the general
public.
· Improving the quality of products and of a firm's interactions with
customers. For many service firms, IT is an important element in creating
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INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY
services that are better customized and tailored to meet the needs of indi-
vidual customers. Companies increasingly compete in other aspects of cus-
tomer service quality, often using IT to serve customers more rapidly, pleasantly,
responsively, accurately, and completely. Such improvements help gener-
ate long-term loyalty among customers. Similarly, IT can play an important
role in improving reliability by ensuring more consistent levels of perfor
mance and minimizing errors and can thus enhance customers' perceptions
of a company and its products.
As indicated above, individual firms have invested in IT to achieve a
variety of results that are not generally captured in aggregate databases. A
recent study by Brynjolfsson and Hitt3 provides quantitative support for
these ideas. Specifically, Brynjolfsson and Hill analyzed output data and
data on IT spending from 380 large firms that generate about $2 trillion in
output annually, and found that increases in output at the firm level corre-
late strongly with IT expenditures, even if the macroeconomic data do not
demonstrate increases in productivity across the national economy or in
individual service industries. These data were taken from the 1987 to 1991
time frame.
HOW COMPANIES USE AND INVEST IN IT
Types of Applications
Senior managers interviewed by the committee tended to cluster their
selected uses of IT into several broad categories that they evaluated using
various techniques. The uses of IT included systems to support (1) basic
infrastructure for communications and data handling, (2) mandated require-
ments, (3) cost reduction, (4) specific new products, (5) desired improve-
ments in quality, and (6) major strategic repositionings (perhaps including a
complete reorientation of a company's business). ~ ' '
evaluate investments in IT on a program-by-program basis, rather than be-
ing concerned with measures of overall productivity. In the committee's
(companies tended to
sample, the techniques used to estimate or evaluate the impacts of IT were
comparable to those used for other major investments.
Basic Infrastructure for Communications and Data Handling
Information technology infrastructures consist of those basic informa-
tion storage, retrieval, communications, processing, and distribution sys-
tems that provide the backbone or framework interconnecting the multiple
information-generating and information-using nodes in an organization. Although
definitions may differ in detail from company to company, the IT part of a
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IMPACTS OF INFORMATION TECHNOLOGY AT THE ENTERPRISE LEVEL 101
firm's basic infrastructure generally includes the core voice-transmission,
data-communication, record-keeping, and transaction-processing systems
necessary to conduct business. What a firm regards as infrastructure may
change over time as new technologies become available and customers come
to expect certain basic facilities from their service providers. Interactive
data communications, for example, may be essential today, although this
was rarely the case a decade ago.
Basic IT infrastructure systems are often approached as a "cost of being
in the business." The majority (67 percent) of companies interviewed by
the committee had done preproject analyses of IT investments in this area.
But they often found that it was not worthwhile to separate out and justify
individually the IT component of infrastructure any more than it would be
to use ROI techniques to justify the purchase of hammers for a carpenter,
the acquisition of a telephone for a lawyer, or the installation of a roof on a
new building for a real-estate developer. Some items are integral to being
in a certain business. Firms tend not to give serious thought to doing
without such elements of infrastructure in toto, and they often do not make
a formal evaluation of their overall payback. But they frequently do evalu-
ate incremental investments in infrastructure on a cost-benefit basis relative
to other means of accomplishing a particular goal. On this basis, a majority
(73 percent) of interviewed companies said that they had attained accept-
able to high measured returns on such investments. But 27 percent reported
negative or indeterminate returns. Measurement complexities represented
serious problems.
For example, a study by the Aetna Insurance Company once analyzed
the impact of IT on expense-revenue ratios over a 15-year period. Although
the study concluded that IT had had little impact on these ratios, it also
noted that the company could never have increased its handling of health
care claims from 250,000 per week to 1.3 million per week without using IT
and acknowledged the fact that this business was very profitable. Back-
office automation in financial services, electronic point-of-sale systems in
retail and wholesale trade, computer reservation systems in travel services,
communications systems in all companies, and automatic flight control sys-
tems in aircraft for air transport are examples of large IT infrastructure
systems without which individual companies could not compete today but
for which specific financial impacts are difficult to calculate.
Observed Richard Liebhaber, chief strategy and technology officer at MCI,
There is an extensive infrastructure of holes in the ground, structures on
the ground, and apparatus in the sky. That is our fundamental infrastruc-
ture. We regard it as a commodity asset: the transportation mechanism of
our company. We view it from the standpoint of a cost factor, and we
either build it, buy it, or lease each component depending on comparative
cost and performance characteristics. The real problems in evaluating
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INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY
productivity for these IT applications lie in those situations where the
outputs are difficult to quantify in financial terms: "If I do this I will save
2 minutes here; if I do that I will save 8 minutes there," versus another
alternative, "If I do this, I will save $9 million."
As noted above, managers are not indifferent to infrastructure costs and
impacts. When IT is regarded as basic infrastructure, the managerial deci-
sion is not whether to invest in IT, but rather how to obtain needed IT
capabilities at the lowest cost. If a firm's IT infrastructure requires some
new capability, managers may consider alternative sources of that capabil-
ity (e.g., performed in-house vs. purchased from an outside source) and
seek to obtain it at the lowest long-term cost. When providing new levels
of service to existing customers requires that incremental power or features
be added to the base structure, companies may compare the net incremental
costs and benefits of each of these features, in financial terms if possible. If
features cannot be evaluated directly in financial terms, many companies
use other metrics such as improvements in response times, levels of cus-
tomer satisfaction, market penetration, or company image.
Several of the firms interviewed by the committee suggested that the
only truly rigorous way of evaluating the payoff from investments in IT
infrastructure would be to calculate the opportunity costs of not being in the
business, that is, the losses that would have been incurred if the investment
had not been made. However, such a calculation could be highly tenuous
because of difficulties in estimating what would have happened if the in-
vestment had not been made. As Roger Ballou, president of the Travel
Services Group (USA), American Express, noted:
A good example of an infrastructure investment would be our automated
authorization system. To determine the benefit of that system even today,
I'd have to recreate mathematically what would exist if we didn't have it
and only had our old personal telephone authorization system. For that
you'd have to guess how a 20-year-old system would operate in today's
world. That would be a highly theoretical exercise.
The complications of evaluating the impacts of infrastructure and the
possibilities of basing some decisions about investing in IT on cost and
others on factors besides cost-were illustrated by J. Raymond Caron, president
of CIGNA Systems, who observed that
there are two types of infrastructure investments. For some, specific pay-
back and evaluation mechanisms are used; for others, they are not. For
example, for our data or voice communications we have put together a
program based on AT&T's Tariff 12 and network costs. We know what
our costs are, and we have goals to reduce those costs per minute, per
connect, to the point where there are clear measures of benefits. In this
case we can show dramatic evidence of our communications facilities cost
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IMPACTS OF INFORMATION TECHNOLOGYAT THE ENTERPRISE LEVEL 103
ing far less today than they did 5 years ago.... When it comes to PC
platforms (our CIGNA-Link platforms, which include PCs, LANs, the soft-
ware to go along with them, plus e-mail), we find it very difficult to
develop a useful cost-benefit measure. We've taken a position that we
shouldn't waste time trying to do it.
Caron's comments about personal computers (PCs) illustrate a special
problem in measuring enterprise-level impacts of infrastructure. The falling
costs of computer hardware and applications software, the greater user friendliness
of many computer systems, and the increased capability to interconnect
local and remote systems have started to change the very nature of business
infrastructure. IT systems are used to increase the level of information and
flexibility within an entire enterprise. Such generalized impacts are exceed-
ingly difficult to measure in the short run.
However, similar PC-based hardware and software can be specifically
targeted to improve the performance of a particular operation. When used
in this way, PC applications (e.g., to improve order handling, purchasing,
customer inquiries or complaints, truck dispatching, field repair, editor-to-
printed-page cycles, and broker-to-customer interfaces) have had consider-
able payoff. When specific goals are set, processes are properly reengineered,
organizational interfaces are redesigned, and new incentives are provided,
performance gains from specific applications can be impressive. Cycle
times can be cut from days or weeks to a few hours or minutes. Layers of
management or entire departments can be eliminated. For example:
· At the New York Times Company and Time Inc., PCs enable edit-
ing to continue right up to the moment when a story is electronically typeset
for printing. Entire intermediate hierarchies and the attendant complexity
of coordinating different functional centers have been eliminated.
· At McKesson Corporation, retail customers can use PCs to interact
directly with the company's computers to eliminate many delays in order
processing and much of the bureaucracy that used to exist to handle this
function. The number of order takers at McKesson has been reduced from
more than 700 to almost zero. The size of the sales force has been cut in
half, even while sales have risen by a factor of 8. The number of buyers has
been reduced from 150 to 200 located at over 100 distribution centers to
just 12 sitting in front of desktop computers at a central site. Levels of
management have been reduced in keeping with these changes.
In other settings (e.g., universities, research laboratories, or publishing
houses), professionals often prefer to write and edit directly at their own
computers, thus decreasing the number of secretaries needed for these tasks
and flattening and downsizing the organization. It is not clear at this point
whether measured productivity improves when (often) higher-priced em-
ployees like professors or researchers undertake such tasks.4 In other situa
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INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY
lions, built-in desktop computer controls have eliminated much of the need
for personal oversight in insurance, brokerage, and accounting applications-
eliminating layers of bureaucracy.
Despite the undeniable utility of PC applications in certain settings,
many executives interviewed by the committee were ambivalent about the
impact of across-the-board access to desktop computing in their firms. Measures
of performance are unclear, and personal intuitions about the potential and
real payoffs from this type of IT vary widely. For instance, a majority of
managers interviewed believed that the printed appearance and visual clar-
ity of correspondence, graphics, reports, and desktop printed matter are
better because of PC use. Communication between knowledge workers
(i.e., the professionals responsible for interpreting and analyzing informa-
tion made available to a company), as well as the information available to
such workers, may also have been improved. But the measurable value of
these improvements remains unclear when compared to the significant costs
of having desktop computing available throughout an organization.
· At CIGNA Corporation, James Stewart, executive vice president
and chief financial officer, said, "I'm not yet convinced that dispersal and
utilization of PC-based technology have proven to be efficient. The busi-
ness people in our organization drive me crazy on the subject of cost and
benefit. I see increasing expenditures for what I perceive occasionally as
'toys in the business world,' which don't add up to measurable output or
improve our results. I think better discipline in the effectiveness of PC
technology is one of our great challenges."
· At BankAmerica, Martin Stein, vice chairman, noted: "The area
where I would be the first to agree is that the banking industry has not done
a good job in utilizing the PC as an office automation tool. We are faced
with the typical problem. Everybody's secretary must have a 486 chip in
his or her PC because it's much faster. And the question becomes, So
what? The metrics for measuring this kind of productivity are not very
good."
Interviewees reported that, to better manage the costs of their basic IT
infrastructures, some companies regarded them as a "utility" and charged
divisions for their use, just as divisions would be charged for externally
purchased services. To further control costs, a few companies (10 to 20
percent) had begun to benchmark the utility's costs and performance against
the prices and performance available for similar services bought externally.
(Benchmarking is discussed in greater detail in Chapter 5.)
Skepticism concerning the degree of payoff from general office use of
desktop computers seemed widespread among interviewed executives. This
may reflect the fact that PC software in its first decade was not well suited to
the needs of nontechnical users and that many senior executives used comput
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IMPACTS OF INFORMATION TECHNOLOGY AT THE ENTERPRISE LEVEL 105
BOX 3.' thong Lotus Notes at (:hase Manhattan Bank
Chase Manhattan is beginning ~ project to deliver financial informa-
t~on to its customers using Lotus Nlotes, a '~groupware" application de-
signed to facilitate transfers of information contained in large databases.
Senior Vice President Craig Goldman argues that Flutes creates a new
attitude for the information services department, allowing managers to
focus on the Font office where employees interact with customers rather
than on the back offices Goldman believes that Notes provides an envi-
ranment that will let employees react quickly to new business ooDortuni
ties.
. .
SOURCE: Vizard, Michael. 1993. "Chase Banking on Notes to Reach
Customer Desktops," Computerwor~d, April 12, p. 47.
ers sparingly because of unfamiliarity or discomfort with them. However, this
is clearly changing; software is improving rapidly, and upper-level managers
increasingly are individuals who grew up with personal computing.
Recently, a number of companies have reported observing enhanced
performance when new, specialized "groupware" communication tools (like
TeamFocus, Lotus Notes, or VisionQuest) are used to capture system knowledge,
make meetings more efficient, and realize some of the communications
benefits sought for PCs (Box 3.1~. The emergence of simpler network
software, multimedia capabilities made possible by autosynchronous trans-
fer technologies, and greater capacities for electronically connecting fixed
and mobile workstations may increase the benefits derived from desktop
computing.
Mandated Systems
Regulators such as the Internal Revenue Service, the Food and Drug
Administration, the Securities and Exchange Commission, state and local
regulatory agencies, and other constituents like the investment community
now require companies to provide specific reports or to have in-line moni-
toring systems for operations. Most respondents to the committee's ques-
tions considered the necessary investments as costs of being in their par-
ticular business and used IT as an element in reducing the cost of complying
with increasing demands from regulators and other constituents. These
investments in IT are made with no possibility of showing a specific profit
or gain to the company except as compared to performing the task by
more manual means. On that basis, most interviewed executives believed
that the returns on investments in mandated systems were satisfactory. For
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INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY
many companies, mandated requirements for reporting and monitoring have
escalated in recent years, perhaps because computers have made more com-
plex reporting easier or even possible. Almost by definition, mandated
investments in IT do not contribute to a company's measurable overall
productivity or gains in performance.
But interviewed company executives did not manage mandated invest-
ments in IT casually. Many estimated the relative cost of achieving the
desired result using system A versus system B. While no evaluations were
made of direct payoffs or returns for such investments, they were carefully
monitored and evaluated using benchmarks, performance metrics established
on installation, and operations costs versus other alternatives.
Cost Reduction
Cost reduction is often a major goal of investing in IT. This was
especially true in first-generation applications, in which IT often substituted
directly for manual or clerical labor in repetitive transactions such as mate-
rials-handling activities or in large record-keeping departments such as ac-
counting, purchasing, or personnel. Other first-generation uses allowed
firms to achieve substantial gains by avoiding costs associated with exces-
sive capital float, inventories, and billing or payment errors and by saving
on the costs of paper processing, check handling, production set-up, engi-
neering drawings, or shipping. While the benefits of these systems were
said to be substantial, independent studies and the committee's interviews
suggest that large companies have begun to reach limits in automating re-
petitive functions and achieving what might be called the industrialization
of services.5 They are now focusing on using IT for other, more complex-
and often strategic purposes.
Second-generation cost-reducing systems are often focused on consoli-
dating or eliminating facilities such as data centers, production-planning
departments, or order-processing bureaucracies. An interesting application
in this area was illustrated by Craig Goldman, senior vice president and
chief information officer of Chase Manhattan Bank:
There is a significant cost-reducing phenomenon that is not well docu-
mented in the industry. That is picking a single site [from which] to
deliver an information-intensive product on a global basis. It means you
have common software in one location that delivers outputs to multiple
sales locations or distribution centers. Anytime you have software in mul-
tiple locations, it is never common and this lack of commonality is usually
very expensive. That is where we see large potential efficiencies.
A large majority (85 percent) of the companies interviewed made for-
mal evaluations of their cost-reducing IT projects. These firms generally
found that direct financial savings and returns on investment could be cal
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IMPACTS OF INFORMATION TECHNOLOGY AT THE ENTERPRISE LEVEL 107
culated with relative ease. Standard formal capital planning and payback
analysis techniques widely accepted in industry are applicable in this con-
text. Although often not implemented consistently or well in the early days
of IT, ROI calculations for these projects were said to be fairly straightfor-
ward now. In most cases, interviewed companies now claimed to achieve
targeted results or to exceed them through secondary uses of the same IT
technology. At the same time, the payoffs from cost-reducing systems
often were not as high as they could have been because of inadequate
reengineering of processes and inadequate reorganization of personnel. (This
point is addressed further in Chapter 4.)
Specific New Products or Opportunities
IT can enable the creation and delivery of specific new information-
based service products that are extensions of a company's basic repertoire.
Sometimes, such extensions are relatively modest, for example, a new "shopping
channel" offered by a cable TV company. In other cases, such extensions
have a major impact; for example, a telecommunications company may
install new software that allows differential billing rates for calls placed to
special parties or at a given time of day (MCI's Friends and Family pro-
gram or AT&T's Reach Out America program).
If a new product is distinctive enough, a company can measure its impact
on profit and sales quite explicitly. However, many new products merely
apply new applications software to flexible IT infrastructures already devel-
oped, as when a new insurance product is offered using existing systems. In
such cases, it is difficult to assess the total costs of the new product, although
its incremental costs may be easy to evaluate. Such joint cost situations may
introduce other complexities. By further utilizing existing IT infrastructure,
some particularly innovative new products may simultaneously lower average
costs in the system, thus allowing greater pricing and servicing flexibility on
existing products. A prime example is MCI's Friends and Family program,
which lowers costs for residential customers yet uses the network's otherwise
excess capacity in nonbusiness hours. In the words of Richard Liebhaber at
MCI:
The decision to do Friends and Family was a combination of retention and
market share: 62.8 percent of MCI's traffic was during the day; 33
percent of the traffic (in 1990) was off shift. The percentages in residen-
tial traffic were approximately reversed. Even today much of our infra-
structure is idle during the night. So when we introduce a new product for
nighttime residential traffic, such as Friends and Family, it may not require
much capital. Many of the key investments will be for marketing rather
than technological infrastructure. Returns are going to be largely the dif-
ference between increased market volume (share) and marketing costs.
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IMPACTS OF INFORMATION TECHNOLOGY AT THE ENTERPRISE LEVEL 125
variety of applications. Standards have been crucial to growth and progress in
a number of industries, including travel agencies and airlines (standards for
CRSs), retail-manufacturing (universal product code and EDI standards), fi-
nancial services and banking (magnetic ink recognition and message security
standards), and standards for asynchronous multimedia (data, voice, and video)
communications. Despite such progress, meaningful standards for inter-appli-
cations data transfer have yet to be developed for important specific applica-
tions, such as standards for recording medical information, for monitoring
outcomes of various procedures, or even for billings
There are, of course, important possible drawbacks to standards notably
a premature "freezing" of technology. For standards to be accepted, members
of the relevant community must be willing to forego some unforeseen future
opportunities and potential technological advances in favor of those created by
enhanced current interoperability and electronic data interchange. When the
former outweigh the latter, interested partners will resist standards, causing
higher current costs but perhaps enhancing future capabilities as did the
opponents of analog standards for high-definition television.
Problems in Assessing Enterprise Performance
For companies in certain industries such as air transport and telecom-
munications, there are some readily quantifiable and widely accepted mea-
sures of output. Ton-miles or passenger-miles handled in transportation,
packages or documents processed in overnight delivery, kilowatt-hours or
cubic feet of gas delivered by utilities, and the number of calls connected,
minutes connected, or access lines provided by the telecommunications in-
dustry are widely accepted examples.
In industries for which measures of physical output are available (e.g.,
telecommunications, transportation, electric utilities, large fast-food and
merchandise chains), levels of productivity (as measured, e.g., by revenues
or value added per unit of labor input) have traditionally compared favor-
ably to those in manufacturing. However, the correlation between growth
in these measures and higher profits is not always good. Fare wars in the
airline industry have destroyed profits even when revenue passenger-miles
have risen, and the profits of individual companies within the industry have
shown even greater variations. Even a uniformly positive correlation be-
tween measures of physical output and profitability or revenues may be the
result of other business practices or investments, or the result of a regula-
tory environment that assures operating companies a "reasonable" rate of
return.
For many firms (e.g., those in financial services, health care, medicine,
law, accounting, design, software, or government services), it is almost
impossible to define a consistent measure of physical output that will reflect
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INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY
variety, complexity, quality, or value produced (see Chapter 1). In some
cases, gross statistics such as the number of clients or customers served or
the number of audits or medical procedures performed may be available.iS
But the qualitative nature of the output of many service companies makes
its precise numerical measurement much more difficult than in goods-pro-
ducing enterprises. Yet it is often along these qualitative dimensions that
individual service firms compete with one another.
In such cases, financial metrics such as gross revenues or profitability
may be the only alternative, although even financial metrics have their
limitations. A company may be a nonprofit enterprise (e.g., a nonprofit
hospital). Revenues or profits may not be valid measures of output in
enterprises where prices have been regulated (as in property and casualty
insurance or telecommunications), where price increases are due to increased
risks (as in insurance or obstetrics), or where revenues are determined by
budget allocations (as in museums, foundations, or educational institutions).~7
Assessing the performance of individual firms involves several critical
difficulties, a number of which affect the usability of measures at the
macroeconomic or industry levels and have been discussed from that stand-
point in previous chapters.
Pass-Through of Benefits
A variety of respondents reported that the rapid advances in IT and the
high levels of competition in both the IT-supplying and IT-using industries
made it difficult for even innovative companies to capture benefits from
their investments in IT. With rare exceptions, IT hardware and software-
and supporting communication services are available from many compet-
ing vendors. Hence it is hard to create technological barriers to entry in the
service sector other than those attributable to software developed internally.
Even then, since a wide variety of software approaches can (with almost
equal efficiency) solve almost any given problem, there are few protectable
intellectual property rights that prevent replication of results.
Fast followers can move with relative assuredness toward known re-
sults and often at costs lower than those of the innovators because of
ongoing technological advances. Technologies diffuse so rapidly that even
the most innovative respondents said that, with few exceptions, IT gave
them only a temporary competitive edge. When asked how long this edge
might last, the usual answer was "a few months," which on further inquiry
resolved into 3 to 9 months' time. Once new products or improvements in
quality are copied, companies are forced to compete largely in terms of
price. The same is true for each competitor, with the result that overall
industry revenues may not fully reflect the benefits of an innovation-
which are largely passed through to the customer instead. The innovation
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IMPACTS OF INFORMATION TECHNOLOGYAT THE ENTERPRISE LEVEL 127
may proliferate so quickly that it soon becomes a routine and "commoditized"
expectation of all customers. Unless the total market is growing substan-
tially, overall industry revenues will not increase significantly despite mul-
tiple investments dedicated to innovation.
The tendency for profits from IT-based innovations to be short-lived is
exacerbated by IT hardware trends. The computing power of IT has been
growing so rapidly relative to unit cost (recently 35 percent per year for
processors and 45 to 50 percent per year for memory) that the same dollar
investment at a later time purchases substantially more power or capability.
Competitors who invest later are able to buy more capacity per dollar than
the original innovator, and competitors end up with either an equal capacity
at less cost (reducing their fixed costs relative to those of the innovator) or
a greater capacity for the same cost (resulting in a greater potential for
business expansion relative to the innovator). The net result is that the ease
of access to productivity-enhancing hardware (usually available to all com
petitors) forces many service producers to pass benefits through to others
and often lowers rather than raises their prices while increasing their break-
even volume.
Given that the benefits of IT-enabled innovations in services are not
fully realized by the innovator, who does capture them? Three beneficiaries
stand out: (1) the company's direct customers, (2) its suppliers, and (3) the
general public.
For example, wholesalers such as McKesson or SuperValu are linked to
retail drugstores and grocery stores. As these wholesalers improved their
service capabilities for customers, they actually lost percentage in margins.
In the case of McKesson, currently a $7.8 billion firm, the percentage of
wholesaling margins has dropped from about 7 percent to 3 percent over the
last 15 years, making another 4 percentage points available for the margins
of its retailers and producers. McKesson passed savings on to others by
lowering prices and by providing higher levels of service to its suppliers
and customers (e.g., McKesson's central maintenance of virtually all price
stickers and price files for its drug retailers). As David Malmberg, vice
president of McKesson's inventory management and systems services, said,
"These used to be extremely time-consuming and expensive things for the
retailer. They are done by our technology now. But this doesn't show up in
our margins, and our competitors have to match the service. In effect,
we've upped the investment ante for everyone."
The experience of SuperValu, a $9.4 billion distributor to independent
grocers, is comparable. SuperValu has developed extensive inventory and
product-handling technologies that allow it to manage thousands of product
lines and assist suppliers and retail customers with their distribution func-
tions, including architectural design, construction, and space management.
IT systems provide services upstream, downstream, and geographically. In
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128
INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY
addition to controlling inventories in transit, SuperValu also offers exten-
sive host-support services for the electronic point-of-sale systems of its
supermarket customers, permitting them to manage their operations better
through instant access to price files, shelf tag printing, and detailed reports
about their products' turnover, gross profits, category profits, and so on. So
effective is SuperValu at providing these services that several major super-
market chains now buy from SuperValu in order to obtain the economies of
its system. No single food product manufacturer could compete with these
services. This is even truer for food producers for whom SuperValu handles
the complex functions of coordinating field-produce contracting and trans-
portation, fresh-meat delivery and marking, and in-store shelf-price verifi-
cation. Yet because of competitive forces, SuperValu's total aggregate
margins have not changed significantly.
Firms outside the service sector that purchase services from an innova-
tor e.g., manufacturers buying communication services from AT&T or MCI-
are often major beneficiaries. Strategic alliances or major "outsourcing"
arrangements- can present even greater potentials for pass-throughs. A
large downstream partner may radically reduce its internal costs by cooper-
ating with an efficient service provider whose own costs may not be re-
duced by the partnership. In these cases, the service producer may show no
gain in productivity, while service users reap substantial benefits. An ex-
ample is the alliance between State Street Bank and Trust Company and
Ford Motor Company. State Street has had a program with Ford for several
years to connect Ford's U.S. treasury and trading operations with State
Street's. In the words of State Street's Marshall Carter, "Ford feels pretty
strongly that they've managed to increase quality yet reduce their staff
substantially as a result of this alliance and its electronic connections. You
wouldn't necessarily see a productivity gain here at State Street, but you
would see a dramatic productivity gain at Ford."
A third major category of beneficiary may be end users or the general
public. When a transaction's marginal benefit to a customer is high and its
cost drops precipitously, transaction volumes are likely to increase; this has
been especially true in financial services, banking, and communications.
For interstate toll calls, volume has increased since deregulation at a rate of
10.6 percent a year, while prices have decreased at a rate of 7.1 percent a
year.~9 New York Stock Exchange transactions have risen from a daily
average of 10 million to 12 million shares in the early 1970s to an average
of 183 million shares in the third quarter of 1992.2° Both of these service
industries were deregulated during the 1980s, eliminating the monopoly
profits of existing producers. Customers benefited from lower costs and
subsequently a greater selection of services. Often the volume of transac-
tions increased so rapidly that companies could not reduce the number of
total employees or costs despite much more efficient transaction-level auto
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IMPACTS OF INFORMATION TECHNOLOGYAT THE ENTERPRISE LEVEL 129
mation. In other nonregulated situations, many professional companies in-
terviewed by the committee reported that they could not increase prices to
reflect the greater value added and the lower costs enabled by their IT
systems because of overcapacity, competition, industry practice, or legal
constraints on pricing.
This phenomenon appears paramount in evaluating the impact of word
processing and spreadsheets on report writing. The cost of making a change
in a document is quite small; the result is that authors or analysts revise
their manuscripts with much higher frequency (compared to pre-PC days).
The customer or user of the report receives the benefit of a thoroughly
massaged final product, but the total effort that went into the production of
that draft may not have declined. A similar situation obtains in the use of
automated teller machines (ATMs). The cost to customers of using ATMs
is low; hence they engage in many more transactions than would be the case
in the absence of ATMs. The ATM user thus benefits from the machine,
but the expense incurred in deploying the ATM was at first generally borne
by the bank. Later, banks sought to recoup some of these costs through
usage fees.
On the other hand, the use of IT sometimes allows companies to pass
costs through to customers as well especially in the form of personal labor
or waiting times. For example, IT enables telephone customers to dial
long-distance telephone calls themselves and enter their own accounting
information (credit card numbers) at pay telephones; bank customers per-
form for themselves many of the functions of bank tellers at ATMs (e.g.,
checking account balances or processing deposit and withdrawal transac-
tions). While customers may prefer to perform these activities for them-
selves because doing so is more convenient or faster the actual labor
required to provide a service has not been altered much by the introduction
of IT. However, it is customers who are now doing much of the work. In a
similar manner, IT has enabled airlines to manage more efficient "hub-and-
spoke" routing systems, and retailers to provide "retail warehouse" sales of
goods in bulk. But customers also bear some of the costs from these inno-
vations, in the for of additional waiting times or a less friendly shopping
atmosphere. Very few firms if any track costs borne by the customer in
any systematic manner, and the overall effects on society are impossible to
estimate.
Time Lags and the Need for Higher Skills
Timing and implementation factors also complicate measures of IT's
impact on performance at the enterprise level.22 Various studies indicate
that, as in other technology areas, there are long average time lags before
highly innovative new IT systems may achieve expected payoffs.23 Work
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INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY
ers' productivity constantly lags behind the systems' potentials as workers
learn new tasks, and there are costs associated with confusion that arises as
the systems are debugged. Sometimes, workers may barely reach full capa-
bilities before the next generation of equipment requires changes to keep up
with customer demands for quality and responsiveness. One implication is
that if the benefits of a system are evaluated too early in its life cycle, they
are likely to be underestimated. The other is that learning effects, training
requirements, backup systems, extra supervision, and delays must be pro-
vided for in any complete plan for introducing new IT systems.
The time needed for workers to learn how to interact with a new system
may be compounded by concurrent changes in ways outputs are produced.
Some systems may facilitate or may require the use of more expensive or
more highly trained knowledge workers in the place of less skilled workers.
A now familiar example is the movement away from centralized typing
pools, first to distributed word processing by secretaries and then to direct
preparation of texts by their professional or managerial authors. An analy-
sis of word processing's payoffs in the early 1980s would differ consider-
ably from today's reality. If the complexity of a business problem also
increases sufficiently, both the number of workers and their skill require-
ments may go up24 (Box 3.4~.
In other cases, the use of IT may simplify tasks, so that the required
skill levels may drop, with the effect of deterring increases in wages.25
This pattern has been particularly evident in repetitive tasks such as product
sorting, or in retail sales. A combination of lower skill requirements and
wanes in some cases may encourage higher staffing levels than in the past,
,, ~e, _ ~ ~ .. _ _
and hence reduce measured productivity.26 On the other hand, the capacity
BOX 3~4 Better Cancer Treatments Nay Cost Fore
New cancer treatment procedures (e.~., bone marrow transplants)
omen require inure ,~rec~se and expensive equipment, greater training,
higher wages, more laboratory facilities, and more people to operate (per
procedure) than the older chemotherapy treatn~ents dads At the same
time, the new procedures nosy be significantly more eRective in terms
clinically measured patient outcomes' including morbidity, modality, and
fong-term care costs.
However, while the costs of new procedures may well be incurred
by treatment providers, none of these benefits may show up in their
balance sheets or income statements. Actual outcomes may be uncertain
for years, and prices established through d~agnostic-related-group com-
pensation caps may prevent prices far medical services from rejecting
the higher value added
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IMPACTS OF INFORMATION TECHNOLOGYAT THE ENTERPRISE LEVEL 131
to use less skilled people may have the benefit of increasing employment
opportunities. This appears to have been the pattern in low-wage services
such as retailing or fast foods. Such complexities obviate the use of any
simple measures of productivity at the enterprise level.
Shifts in the Basic Nature of the Business
As noted earlier in this chapter, the use of IT may change the very
nature of a firm's business. In this case, comparisons of a firm's productiv-
ity or performance in two different time periods may not be a true "apples-
to-apples" comparison. It may even be the case that performance metrics
designed for the old business lag in reflecting changes at the enterprise
evel.27
For example, in many large professional service organizations, tasks
that used to be the very core of professional practices (e.g., doing audit
checks in public accounting or preparing bubble charts for portfolio analy-
ses in financial services or consulting firms) have become so routine and
automated that they are almost loss leaders, much of whose value is passed
through in order to sell clients other services that are now the professionals'
core competencies. In many cases, the basic business of professional firms
has become the capture, analysis, communication, and leveraging of higher-
value current information for clients. Such information-intensive tasks re-
quire a high level of specialized intellectual expertise from sophisticated
knowledge workers. Professional firms often obtain a competitive edge by
leveraging their high-priced talent through automation of most routine tasks
(e.g., literature searches, table look-ups, and routine or standardized design
calculations) and development of very powerful analytical algorithms, ex-
pert systems, and extensive networking capabilities.
Investment companies provide a high-profile example. High-perfor-
mance computing and electronic data systems have enabled development of
complex, customized financial instruments that are difficult to create and
support but that are generating totally new kinds of business. State Street
Bank-managing assets of over $1 trillion and enjoying a 20 percent growth
rate is typical of those working on this complex business frontier (specifi-
cally portfolio and trust management). State Street's Carter noted:
There are people out there all the time trying to create financial instruments
that give a better yield on a portfolio. We are working on the edges of a
system creating complex instruments that right at the beginning will be
inefficient operations because of their new characteristics. Yet these are
expanding the capital markets. The old instruments have become very sta-
ble, efficient, and easy to serve. The average statistics may say you're not
getting "productivity" increases. If you disaggregate it you'd see more
productivity on the older (lower-margin) instruments than on the newer,
higher-margin ones. But as a businessman, where do you want to be?
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32
INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY
SUMMARY AND CONCLUSIONS
Executives invest in IT programs with the intent of increasing expected
returns as compared to other alternatives, for example, not investing or
investing in other programs. The returns they derive from these decisions
may be vital to the success of the enterprise but may not show up readily in
standard measures of industry revenues or sector productivity. Information
technology has enabled service firms not just to do things better in the old
way (efficiency) but also to do entirely new things that provide greater
benefits to outside parties (effectiveness). Many of these improvements in
performance may not be reflected in increased ROI, sales, or margins, or in
macroeconomic statistics. Thus, many of the difficulties in measuring the
productivity and effectiveness of IT in services at the macroeconomic level
have their origin at the enterprise level.
Impacts of IT that may not show up in standard financial or data reports
include maintaining market share in a relatively mature marketplace, avoid-
ing catastrophic losses due to process failures, avoiding losses of market
position or profits if a competitor adopts a new technology and the firm
does not, increasing flexibility to respond to unknown future market or
process changes, improving employee relations or the work environment,
improving the quality of customer service, handling increasing complexity,
and improving the scope and responsiveness of the firm's service outputs.
These are key elements of service performance, although they may not
affect productivity.
In the committee's sample of companies, techniques used for decisions
about investments in IT are comparable to those used for corporate deci-
sions about investments in R&D or other complex technologies. As in
R&D investments, none of the sampled companies could separate the ef-
fects of a single input (R&D or IT) from other factors that might affect the
ultimate success of a given project. Nor could they always estimate or
calculate financial returns accurately. For this reason many firms use engi-
neering metrics rather than financial measures to evaluate the potential and
actual impacts of an investment in IT. But these metrics also do not permit
aggregation at the industry or macroeconomic levels.
Within enterprises, investments tend to fit into a few basic categories:
those supporting basic infrastructure, mandated requirements, cost reduc-
tion, new products, improvements in quality, new strategic potentials, and
new desktop or workstation information exchange networks. In some of
these cases (e.g., cost-reducing systems, systems to support new products),
financial returns are relatively easy to evaluate through the use of well-
understood formal investment analyses. In others (e.g., systems like those
for basic infrastructure, improvements in quality, and new strategic uses),
other metrics like engineering metrics or results of customer surveys
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IMPACTS OF INFORMATION TECHNOLOGY AT THE ENTERPRISE LEVEL 133
may be used to estimate impacts. Even though managers may use the best
techniques available, some investments in IT still are based to a large extent
on the intuition or judgment of management.
Some of the more important problems in measuring impacts of IT at the
firm level are (1) defining meaningful units of output that are consistent
over time, (2) defining the contributions of IT as a component in the total
investment package needed to create a result, (3) capturing or measuring
benefits passed through to customers or suppliers, (4) establishing financial
measures of the impact of intangible benefits (such as faster cycle times,
greater reliability, or a broader selection of service products), (5) estimating
the "opportunity costs" of what would have happened without use of a
technology, (6) dealing with payoffs that are delayed due to learning factors
and with (sometimes extensive) lags until actual outcomes are known, and
(7) measuring changes in productivity when IT has changed the basic nature
of a business and the competitive environment.
Granted all of these complications, a large majority (80 percent) of re-
spondent companies felt that their investments in IT overall had paid off well.
A majority said that they had made special studies of IT's payoff, although
none had made routine measurements of overall IT returns. A large majority
indicated that their special studies confirmed a positive overall payoff from IT
(see Appendix D). Most expressed concern that their earlier management
techniques had not been as efficient or effective as they should have been.
Most were trying to improve these currently (see Chapter 5~.
NOTES AND REFERENCES
1See, for example, Keen, P. 1988, Competing in Time: Using Telecommunications for
Competitive Advantage, Ballinger Publishing Company, Cambridge, Mass.; U.S. Congress,
Office of Technology Assessment, 1985, Automation of America's Offices 1985-2000, Govern-
ment Printing Office, Washington, D.C.; and Watts, L., 1986, "What Price Automation?,"
Northeastern University Magazine, December.
2Denison, E. 1989. Estimates of Productivity Change by Industry: An Evaluation and
an Alternative, Brookings Institution, Washington, D.C. Denison makes a strong case for the
last explanation, though there is disagreement in the community on this point.
3Brynjolfsson, Erik, and Lorin Hilt. 1993. "Is Information Systems Spending Produc-
tive? New Evidence and New Results," MIT Sloan School of Management, Working Paper
3571-93, September 24. (To appear in Proceedings of the 14th International Conference on
Information Systems.)
4The work of Sassone suggests that downsizing secretarial pools may have the unin-
tended result that professionals end up doing many more non-IT-based support tasks that were
previously done by secretaries. Thus, on balance, the result may be lower measured productiv-
ity. See Sassone, Peter. 1992. "Survey Finds Low Office Productivity Linked to Staffing
Imbalances," National Productivity Review, Spring, pp. 147-158.
SLevitt, Theodore. 1976. "Industrialization of Service," Harvard Business Review, Sep-
tember-October, pp. 63-74.
6Brynjolfsson, Erik, and Bruce Bimber. 1991. "Information Technology and the Produc-
tivity Paradox," Working Paper, Brookings Institution, Washington, D.C., February 7.
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INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY
7Porter, Michael E., and Victor E. Millar, 1985, "How Information Gives You Competi-
tive Advantage," Harvard Business Review, July-August, pp. 149-160; Quinn, J.B., 1992,
Intelligent Enterprise, Free Press, New York; and Wriston, Walter B., 1992, The Twilight of
Sovereignty, Scribners, New York.
8Loveman, Gary, 1988, "An Assessment of the Productivity Impact of Information Tech-
nologies," MIT Management in the 1990's Program, 88-054, July.; and Kendrick, John W.,
1988, "Productivity in Services," in Technology in Services: Policies for Growth, Trade, and
Employment, Bruce R. Guile and James Brian Quinn (eds.), National Academy Press, Wash-
ington, D.C.
9The inadequacy of financial metrics alone for assessing the performance of a firm is
discussed in Eccles, Robert, 1991, "The Performance Measurement Manifesto," Harvard Busi-
ness Review, January-February, pp. 131 - 137.
10A Bellcore study showed that the number of employees per 1000 access lines one of
the operating company's key performance metrics had dropped from 110 to 40 (or about a 10
percent per year compounded improvement) between 1970 and 1990.
Roach, Stephen, Morgan Stanley & Co., unpublished data, April 1993.
12Fudenberg, Drew, and Jean Tirole. 1985. "Preemption and Rent Equalization in the
Adoption of New Technology," Review of Economic Studies 52:383-401.
13Bresnahan, Timothy F. 1986. "Measuring the Spillovers from Technical Advance: Main-
frame Computers in Financial Services," American Economic Review 76(4, September):742-755.
14Institute of Medicine. 1991. The Computer-based Patient Record, National Academy
Press, Washington D.C., pp. 85-87.
15The meaning of aggregated statistics is also clouded by the fact that parameters such as
relative unit volumes, revenues, costs, timing factors, number of clients, and so on may have
little real meaning as indicators of productivity when ultimate outcomes are unknown. For a
bank, the face value of loans or the number of loans handled is meaningless without knowing
the quality of those loans or the creativity they represent. The number of procedures per-
formed at a hospital compared to their cost is useless information, unless one knows their
success rate and the relative health of patients at the time they were served. Even the success
rate must be qualified by the subsequent quality of life or care costs patients encounter.
16Mark, Jerome, 1986, "Problems Encountered in Measuring Single and Multifactor Pro-
ductivity," Monthly Labor Review, December, pp. 3-11; Baily, Martin Neill, and Robert J.
Gordon, 1988, "The Productivity Slowdown: Measurement Issues and the Explosion of Com-
puter Power," in Brookings Papers on Economic Activity, Vol. 2, William C. Brainard and
George L. Perry (eds.), Brookings Institution, Washington, D.C., pp. 347-431; and Brynjolfsson
and Bimber, 1991, "Information Technology and the Productivity Paradox."
17Kutscher, R., and J. Mark. 1983. "The Service Sector: Some Common Perceptions
Reviewed," Monthly Labor Review, April, pp. 21 -24.
18Bresnahan, 1986, "Measuring the Spillovers from Technical Advance: Mainframe Computers
in Financial Services."
19Federal Communications Commission. 1991. Trends in Telephone Service, FCC, Washington,
D.C., February, p. 25.
20Standard & Poor's Corp. 1992. Current Statistics, October.
21Both the committee's interviews and independent studies testify to the ubiquity of this
phenomenon. See, for example, Brynjolfsson and Bimber, 1991, "Information Technology and
the Productivity Paradox."
22Curley, Kathleen Foley, and Philip J. Pyburn. 1982 "'Intellectual' Technologies: The
Key to Improving White-Collar Productivity," Sloan Management Review, Fall, pp. 31-39.
23Guile, Bruce R., and James Brian Quinn (eds.). 1988. Managing Innovation: Cases
from the Service Industries, National Academy Press, Washington D.C. Also Brynjolfsson,
Erik, Thomas W. Malone, and Vijay Gurbaxani. 1988. "The Impact of Information Technol
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IMPACTS OF INFORMATION TECHNOLOGY AT THE ENTERPRISE LEVEL 135
ogy on Markets and Hierarchies," Sloan School of Management, Working Paper 2113-88,
Massachusetts Institute of Technology, Cambridge, Mass.
240sterman, Paul. 1986. "The Impact of Computers on the Employment of Clerks and
Managers," Industrial and Labor Relations Review 39:175-186. Also, Krueger, A. 1993.
"How Computers Have Changed the Wage Structure: Evidence from Microdata, 1984-1989,"
The Quarterly Journal of Economics 39(February):175-186.
25Bright, J. 1958. Technology in Automation, Harvard Business School Press, Boston,
Mass. This is the classic statement of this argument.
26Baily and Gordon, 1988, "The Productivity Slowdown: Measurement Issues and the
Explosion of Computer Power." Also, Hunt, H., and T. Hunt. 1986. Clerical Employment
and Technological Change, Upjohn Institute for Labor Studies, Kalamazoo, Mich.
27Stalk, G., and T. Hout. 1990. Competing Against Time: How Time-based Competition
Is Reshaping Global Markets, Free Press, New York.
)
Representative terms from entire chapter:
service society
