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Summary and Overview The use of information technology (IT) has revolutionized the structure of management and the nature of competition in a variety of indus- tries.i IT is especially important in the service sector, which now ac- counts for about 74 percent of the value added in the U.S. gross domes- tic product (GDP) and about 76 percent of national employment (Table S.1) and enjoys a healthy $52 billion trade surplus. Estimates indicate that about 85 percent of all measured investments in IT hardware are in services. Contrary to the widespread misconception of services as predominantly simple, labor-intensive activities, the service industries include many large, technology-intensive and technically sophisticated firms in transportation, financial services, banking, insurance, retail and wholesale trade, telecommunications, health care, and professional and personal services. As IT becomes less expensive, more portable, better integrated and interconnected, and embedded in a wider variety of devices, new applications in these fields and whole new industries- such as interactive multimedia systems for business, home entertain- ment, and communications purposes are likely to evolve and to have profound effects on industry structures, employment, and economic growth. Moreover, the U.S. economy revolves increasingly around various important white-collar service activities (e.g., research, design, financ- ing, education, accounting, marketing, logistics planning, communica- tions, and information management) rather than blue-collar shop floor production. These activities are central to the individual service indus
2 INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY TABLE S.1 The Scale of Services and Investments in IT in 1991 Value AddedEmploymentInvestment in IT (billions of(millions of(billions of Industry1991 dollars)FTE jobs)1991 dollars) Nation4,587.5103.3 Agriculture, Forestry, Fisheries90.91.6 Mining188.8.131.52 Construction184.108.40.206 Manufacturing841.018.025.3 Total goods sector1,178.724.8 Transportation220.127.116.11 Communicationsa18.104.22.168 Utilitiesb99.00.98.0 Wholesale Trade266.05.917.0 Retail Trade403.316.217.9 FIREC685.06.538.7 Other servicesd1,002.426.120.3 Government699.418.6 Total service sector3,391.278.7 NOTE: All figures presented are for calendar year 1991. aIncludes telephone, telegraph, and broadcasting. bIncludes electric, gas, and sanitary services. CIncludes financial services, insurance, and real estate. dIncludes health care and delivery, business services, legal services, hotels, and recreation. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis. 1992. Survey of Current Business, July. Data on value added are from Table 6.1C (National Income Without Capital Consumption Adjustment), p. 82. The relationship between national income without capital consumption adjustment and gross domestic product (or gross product originating by industry) is specified in Table 1.9, p. 52, and is essentially gross domestic product without capital consumption or property and sales tax. Data on employment are from Table 6.5C, p. 84. Data on investment in IT include hardware costs only and are from Stephen Roach, Morgan Stanley & Co. tries and are critical in producing value within manufacturing and other goods-producing companies. The effectiveness with which IT is de- ployed in services thus strongly influences U.S. standards of living and competitiveness in world trade. THE INFORMATION TECHNOLOGY PARADOX The magnitude of the investment in IT in the past decade (as measured roughly by investment in hardware; Figure S.1) has prompted questions about payoff for both the nation and individual enterprises. Because IT is
SUMMARY AND OVERVIEW often used to automate processes (that is, to perform tasks that might other- wise require substantial human intervention), and because automation is popularly associated with efficiency and cost reduction, questions about payoff have usually centered on productivity. Productivity is a concept that relates the level of outputs to the level of inputs used in their production. In particular, some economic studies have suggested that the large investment in IT by the service sector has not been associated with substantial gains in productivity as measured by national macroeconomic statistics-the so-called IT paradox. While some studies indicate that U.S. productivitys levels them- selves compare quite favorably with those of international competitors in several important service industries, others suggest little correlation be- tween investments in IT and productivity, profitability, or return on invest- ment at the industry or enterprise level. 120 110 100 90 = o o o . _ ._ m 80 70 60 50 - 40 - 30 20 10 / / / - - / / / - O 1981 1982 1983 1984 1985 Year 1986 1987 1988 1989 FIGURE S.1 Growing investment in information technology (IT) by the service sector. The only systematic data available on IT expenditures account for hardware components but exclude software and services. Thus this figure shows expenditures only for office, computing, and accounting equipment, communications equipment, instruments, and photocopy and related equipment; it does not include expenditures for software, electronic information services, data processing and network services, computer professional services, custom programming, systems integration, consult- ing, or training services. SOURCE: Stephen Roach, Morgan Stanley & Co.
4 INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY The committee concluded, however, that these studies by themselves provide an overly narrow picture of what is happening in services. Macroeconomic data and traditional measures of productivity do not capture many of the crucial performance elements that are important to customers and are critical to service industry executives when they invest in IT. For most service companies, the use of IT now appears more essen- tial than optional, because IT is often an integral part of the infrastructures on which such organizations depend. Obvious elements of such informa- tion infrastructures are the telephone and transaction-processing systems without which most businesses could not function, the electronic navigation and control systems without which airlines could not operate, and the inter- connected networks of computers that are increasingly necessary to com- pete at all in financial services, wholesale and retail distribution, transporta- tion, entertainment, and health care. In addition, highly sophisticated systems can provide some innovators with important strategic leadership positions. The committee believes that understanding the impact of IT on the overall performance of service activities, not simply determining how the use of IT affects productivity in services, is the real challenge. And in contrast to what one would conclude based on the results of studies mentioned earlier, many observers of the service industries (including sev- eral members of the committee) and many service industry executives (in- cluding the majority of those interviewed in the course of this study) be- lieve that IT has had and will continue to have a real and significantly positive impact on overall service-sector performance. ANALYZING THE IMPACTS OF INFORMATION TECHNOLOGY To understand more fully how IT has changed the service sector and what the societal impacts of that transformation have been, the committee examined these issues at four different levels of analysis and considered both quantitative and qualitative observations (primarily collected during an extensive series of interviews with industry executives). Macroeconomic Analysis From the standpoint of readily available government statistics on the U.S. economy, during the 1980s the service sector showed limited gains in productivity despite an extraordinary burst of spending on IT. The service sector spent over $750 billion on IT hardware alone in that decade (Figure S.1) enough to result in the virtual doubling of the IT endowment of the average white-collar worker. At the same time, government economic sta- tistics point to only a 0.7 percent average growth in productivity in the
SUMMARYAND OVERVIEW service sector during this period- a distinct slowdown compared to that of previous years and far short of the average gains in the manufacturing sector during the same period. However, as mentioned earlier, there are various reasons why the readily available government statistics may not accurately reflect the full impact of IT on performance in the service sector. It is well known, for example, that the existing data on productivity do not capture im- portant elements of service quality, e.g., how well a hospital, airline, restaurant, hotel, or bank has satisfied its customers. In addition, sta- tistics on industry productivity are available for only a limited set of service industries that accounts for only 42 percent of all service work- ers. For some major service industries notably banking and other financial services, education, health care, and government- output is imputed solely on the basis of input; thus, by definition, output divided by input is a constant for these industries. This imputation affects measurement of output in about 25 to 30 percent of the service sector. Data collected at the industry level also tend to understate or ignore the influence of whole new service markets, even though a primary use of IT is to enable new services. Another factor that may distort the macroeconomic picture of IT's impact on performance in service industries (particularly telecommuni- cations, transportation, and finance) is the fact that such impacts may be reflected more in measurements of the productivity of customers of these service industries (often manufacturing) than in those of the ser- vice industries themselves. Competitive pressures often constrain ser- vice pricing, with the result that benefits enjoyed by customers may not appear in the revenue measures of the service-providing industry, while the costs of providing such benefits (e.g., the costs of IT) always will appear. For example, margins and prices in the wholesale trade, fi- nance, and transportation industries have dropped in real terms, al- though companies now provide a much more complex array of services to customers. Two other factors should be recognized when interpreting macroeconomic data on productivity and the use of IT. First, the effects on productivity of investing in and using IT cannot be isolated from other things that significantly influence productivity, such as the quality of the work force and management, training efforts, and most importantly, investment in other (non-IT) technologies necessary to achieve a desired result. Second, al- though the same is true for any other type of investment, macroeconomic data cannot account for the alternative costs and potential risks that compa- nies and industries might have encountered if they had not invested in IT. However, the central limitation of macroeconomic analysis is the fact that the usual measure of productivity industry or sector output (usually as
6 INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY assessed by some dollar measure such as deflated revenue or price) divided by input (often as assessed by hours of work or number of employees)- ignores important dimensions of performance in service industries (and goods- producing ones as well) that are critical to customers and to the managers of individual businesses making decisions about investments in IT. High among these dimensions of performance is the availability of new service functions that would be impossible without IT-such as the rapid deployment of hospital emergency services or 24-hour-per-day securities trading. Of per- haps greater importance are the handling of increased complexity and the provision of the greater quality, convenience, reliability, timeliness, safety, flexibility, and variety that use of IT makes possible in services. As firms begin to compete along these dimensions, the very nature of a service often changes in ways that make comparisons of service output and hence pro- ductivity measures increasingly problematic. Because of the above limitations, generalizing from macroeconomic data about the impact of IT on overall service-sector performance is likely to be misleading. Significant improvements have been made in macroeconomic data and analysis techniques relative to measuring IT's impacts on perfor- mance in the service sector. However, major challenges remain. Chapter 1 is devoted to exploring these issues. Industry-level Analysis Nearly all service industries make substantial use of IT. However, patterns of IT's use and impact vary widely across industries, in part because of differences in and limitations posed by industry structures, degrees of regulation, the timing of IT's introduction, and the adapt- ability of processes and products to change. In some service industries like transportation, communications, utilities, and wholesale trade, growth in productivity (in GDP per labor-hour) from 1948 to 1973 led that of the construction, durable goods, and nonelectrical machinery manufac- turing industries; in other service industries, it did not (Table S.2~. Nevertheless, since 1973, measured growth in productivity in most ser- vices appeared to drop despite large investments in IT, although there were still great variations among industries. Within the major service industries, increases in productivity (as measured by GDP per labor-hour) ranged from a very respectable 4.6 per- cent per year in communications to an anemic 0.17 percent in the finance, insurance, and real estate segment from 1973 to 1989 (Table Sib. The committee examined the impact of IT on service performance in six more disaggregated service industries: air transport, telecommunications, retail and wholesale trade, health care, banking, and insurance. Within these industries, some showed strong growth in GDP per labor-hour. Others,
SUMMARY AND OVERVIEW TABLE S.2 Average Annual Growth in Gross Domestic Product Per Labor-Hour for Major Sectors of the U.S. Economy, 1948 to 1989 Industry 1948-73 1973-89 Business Goods producing Farming 4.64 2.04 Mining 4.02 -0.82 Construction 0.58 -1.20 Manufacturing 2.87 2.75 Durable goods excluding nonelectrical machinery 2.56 2.05 Nonelectrical machinerya 2.03 6.01 Nondurable goods 3.40 2.37 Service producing Transportation 2.31 0.65 Communication 5.22 4.63 Utilities 5.87 2.46 Trade 2.74 1.18 Wholesale 3.14 1.18 Retail 2.40 1.13 FIREb 1.44 0.17 Other services 2.17 0.32 Government enterprise -0.15 0.26 General government 0.21 0.34 aNonelectrical machinery hours from Bureau of Labor Statistics. bFinance, insurance, and real estate. SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis. 1991. Survey of Current Business, April, Tables 6.2 and 6.11. notably insurance and health care, showed negative growth in GDP per labor-hour from 1981 to 1989 (Table S.3~. Many service industries are currently undergoing significant restructuring at least partially enabled by their IT systems. However, available data on industry-level productivity do not convey important aspects of the ways IT has affected these industries and their overall performance: . In airlines, innovations using IT have been associated with com- petitive leadership and with survival as complexity has increased. Air- lines depend on IT within aircraft and airports, in air traffic control systems, and for sales, marketing, maintenance, and safety systems, as well as for capacity, load management, and logistics planning. Computerized 7
8 INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY TABLE S.3 A Comparison of Various U.S. Service Industries in 1991 Average Compound Annual Annual Rate of Rate of IT Capital Change in Growth in Revenues Employment Stock GPO per Investment (billions of (millions of (billions of Labor-Hour, in IT, current FTE current 1981 to 1989 1981 to 1989 dollars) employees) dollars) (% per year)a (% per year) Industry Air transport 87.5 0.7 11.1 3.1 14.1 Telecommunications 129.7b 0.9 114.0 5.7 -5.1 Wholesale trade 469.5 5.9 60.2 2.8 11.0 Retail trade 884.5C 16.2 58.8 2.3 9.6 Health care 475.0b 7.4 19.6 -1.3 9.3 Bankingd 209.5b 2.1 28.5 0.1 27.9 Insurance (carriers plus agents) 226.7b 2.2 17.1 -1.4 30.8 aLabor productivity is often measured in terms of gross product originating (GPO) per hour of labor input. The GPO of an industry is a value-added measure of that industry's contribution to the gross domestic product. bl990 figure. CIncludes restaurant trade. dIncludes depository institutions only; excludes federal credit agencies, security commodity brokers, and mortgage bankers. SOURCES: Unpublished data on revenues are from the Bureau of Labor Statistics. Employ- ment data are from U.S. Department of Commerce, Bureau of Economic Analysis, 1992, Survey of Current Business, July, Table 6.5C (Full-Time-Equivalent Employees by Industry), p. 84. IT capital stock data are from Stephen Roach, Morgan Stanley & Co. reservation systems have changed the entire pattern of competition and profit making in the airlines industry, although in the 1980s, airline profits were highly erratic in the shakeout that resulted from the deregulation of the industry. Competition has forced airlines to pass on to customers the sav- ings gained through increased efficiency, but new route structures enabled by the use of IT have also allowed airlines to pass certain costs (notably inconveniences caused by the "hub-and-spoke" system) on to customers. · Telecommunications companies depend on IT for operations man- agement, billing and customer service, product differentiation, and new- product development. These companies further provide the infrastruc- tures of telephone, cable television, satellite, microwave, and fiber-optic-cable connections that enable other industries to operate effectively. They pro- vide the pathways over which a variety of new concepts and products have
SUMMARYAND OVERVIEW 9 been (and can be) introduced by the financial services, entertainment, data services, software, direct distribution, education, travel, and health care in- dustries, among others. Deregulation in the 1980s increased the variety of services available and decreased their costs for most customers. Improved communications have allowed companies to manage materials and services purchased anywhere in the world, control inventories on a just-in-time ba- sis, gather information, and manage diversified producing locations in ways that have changed basic premises about industry boundaries, the organiza- tion of enterprises, and many traditional management techniques. At the same time, the use of IT has enabled telecommunications companies to shift to the consumer much of the labor of placing calls, although consumers themselves often find self-service dialing a convenience. · Retailers and wholesalers have used IT to collect and analyze sales data more quickly and effectively, to plan purchasing and marketing activi- ties better, to communicate more rapidly with their suppliers, and to offer more differentiated services to customers. To improve the cost, quality, and timeliness of their offerings, many maintain worldwide sourcing and logis- tics systems that use IT. The variety of items carried and the hours retail stores remained open increased substantially during the 1980s. However, the industry found it difficult to convert its investments in IT into finan- cially measurable gains in productivity because of heavy and rapidly chang- ing competition. The basic structure of retail competition, sourcing of products, inventory management, and retailers' power relative to that of manufactur- ers shifted during the 1980s. In some cases, wholesaling and retailing merged. In addition to powerful general-merchandise and supermarket chains, highly specialized "category-killer" chains (e.g., Toys "R" Us or Foot Locker), warehouse clubs, superstores, and chain boutiques emerged as new forms of competition. All were highly dependent on IT and broad geographical sourcing. · In health care, the use of IT has become increasingly important in diagnosis and therapy (e.g., medical imaging, radiation therapy, and patient monitoring). For business operations, IT has generally been less well used in health care than in other industries, and there may be great untapped potentials for its use in such operations as well as in new clinical applica- tions, outpatient care, and monitoring of outcomes. Measures of economic output in health care are extremely tenuous because of the presence of many nonmarket forces and problems in defining quality. Although numerous new and improved cures, therapies, and diagnostics have been introduced since 1970, there is wide consensus that measured productivity in health care has been dropping. Yet few would like to do without the potentially better diagnosis and treatment that electronic devices permit in health care today. And the costs of dealing with today's complex reporting require- ments would soar further without electronic systems.
10 INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY . The banking industry has used IT to enable increases in the volume of transactions as well as the development of new products; applications have ranged from back-office (check and accounts) processing, mortgage and loan application processing, and electronic funds transfer to more stra- tegic innovations such as automated teller machines and new kinds of secu- rities. IT has been used to interlink financial services, banking, and invest- ment systems worldwide thus decreasing a nation's capacity to control its currency value or its economy by conventional policy interventions. IT has also been used to manage trillions of dollars in daily transactions by the securities markets of the world, functions that physically could not be handled without IT. Yet despite the fact that customers have benefited from the greater variety, convenience, and accuracy of services as the result of ex- panded use of IT in the 1980s, measured productivity in banking has grown only slightly, although this is at least partly because the output of banking is difficult to measure. Banks now compete with many other (nonbank) enterprises to provide credit card, investment, and other services. Systems for personal savings, credit extension, and management of financial transac- tions have been substantially improved. · Insurance companies have relied on IT for back-office claims pro- cess~ng and account updating and now use IT to enhance links to agents, to customize policies, to manage risks globally, and to develop new services (e.g., managed health care systems) nationally. Although industry-level data indicate that the insurance industry did not capture measurable produc- tivity benefits during the 1980s from its use of IT (Table S.3), the industry did introduce a variety of complex new services much more specifically tailored to individual customers' needs. The use of IT also radically im- proved in the cycles of new-product introduction in the insurance industry, and increased the scale and accuracy of the services provided. IT has been associated with growing complexity and customization in each of these different industries. At the same time, growth in the volume of transactions, in the number, variety, and linkages among enterprises, and in the kinds of equipment available has led to demands for greater technical standardization. Across all industries studied, lags in the development of standards, software, and management systems rather than hardware limita- tions have been the main constraints to progress. Cycle times for the introduction of products in all major service industries have dropped, and greater control over the mix and size of inventories (whether of airline seats, financial holdings, or distributed products) has become essential to success. The economies of scale offered by back-office automation have led to waves of mergers and acquisitions and increased concentration in financial services, health care, and air transport. IT has been used effectively to central
SUMMARY AND OVERVIEW 1l ize these new larger enterprises and also to facilitate later geographical decen- tralization into networks of local affiliates and branch offices. Chapter 2 discusses the impact of IT at the industry level in greater detail. Enterprise-level Analysis The enterprise level is where most of the decisions are made about the use of IT. Executives who actually make such decisions find that measures related to revenue, profitability, alternative costs, growth potentials, market share, and return on investment (ROI) are more relevant than the more abstract measures of "productivity" used at the industry and macroeconomic levels. When meaningful financial measures are not available, executives use engineering or quality metrics such as response time, reliability, and customer satisfaction to estimate IT's impact. For most investments in IT, executives interviewed by the committee tended to use decision-making processes (such as capital budgeting) similar to those used for investments in any other type of advanced technology. But, as for investments in ll&D and other new technologies, their decision making relied on intuitive and nonfinancial measures as well as formal ROI analyses and financial justifi- cations. The committee found that the companies it interviewed were not consistent in their use of postproject audits to determine benefits received from IT investments and projects. For some uses of IT, results are readily measurable. For others they are not. Companies interviewed by the committee often reported great difficulties in predicting strategic effects precisely, measuring certain types of output (such as increased flexibility), assessing benefits that might be diffuse or delayed (such as those made possible by desktop communica- tions, spreadsheets, and word processing), and separating the contributions of IT from those of other factors. IT has often been used (especially in early applications) to reduce per- sonnel costs in large paper-intensive departments such as accounting or purchasing, and in some cases even to eliminate or consolidate certain back- office operations. Better information-handling capabilities have also helped decrease other costs such as excessive capital float or inventories, billing or payment errors, logistics costs, and customer complaints. In addition, IT has been used to create new or improved services that a firm can offer to the public, such as the call-waiting service made available to residential telephone customers or the new "synthetic securities" offered by the invest- ment banking community. Providing more customized insurance policies to customers with special needs or reducing the time needed for a retail-store cashier to tally a customer's total purchase are examples of improved ser- vices.
2 INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY Although such benefits are often captured by available data, the com- mittee found that managers invest in IT to achieve a variety of impacts that are not reflected in industry-level or macroeconomic measures of productiv- ity. These include: . Preserving or expanding market share. While aggregate industry output is a key issue for national policymakers, individual companies care more about their individual firm's performance than about that of the indus- try as a whole. Market share is a key measure of competitive success and a basis for gaining relative marketing or purchasing power as well as im- proved economies of scale or scope. To maintain their market share, all companies in an industry may be forced to install an IT system even though it does not increase their own or the industry's output. Thus investments increase, but company or industry volume and profits may not. . Avoiding risks or alternative costs. Executives often invest to avoid risks, for example, malpractice suits in health care or accidents in the air- line industry. The benefits of avoiding losses by using better processes or controls are very real to a company, but only the costs of achieving them show up in company or national accounts. It is difficult to imagine how most companies in industries such as financial services, large-scale retailing and wholesaling, airlines, lodging and restaurant chain operations, health care, or communications could operate without the benefit of IT. Yet the losses they would incur if they did not use IT appear nowhere in company or national accounts. · Creating flexibility for changing business environments. Changes in the business environment (e.g., increased regulation, marketing, or operational complexity) may require unforeseeable changes in the way a company oper- ates. As many financial services and banking firms have learned, a flexible IT system may be essential to the very survival of the company as it attempts to cope with rapidly changing environments. In other cases, companies invest in IT to provide a flexible future platform for creating new products that may not yet have been planned or even conceived. · Improving the internal environment. Firms often invest in IT to ob- tain and analyze information that will provide a greater degree of predictabil- ity or stability for their operations. Such investments help companies to avoid undue fluctuations in sales or profitability as well as catastrophic failures caused by inadequate information. Other firms invest in IT to improve em- ployee relations. Properly installed, IT can be used to eliminate burdensome tasks, make jobs more attractive, shorten the training cycles needed before an employee becomes productive, and improve worker morale. · Improving the quality of products and interactions with customers. Companies increasingly compete on the quality of their customer service and have used IT to serve customers more rapidly, accurately, efficiently,
SUMMARYAND OVERVIEW 13 and with more customized service products. Such improvements help to generate long-term loyalty among customers. IT has been especially impor- tant in helping to improve reliability, ensuring more consistent levels of performance, minimizing errors, and improving customers' and employees' perceptions about companies and their products. IT is also a powerful tool for companies with life-critical operations in which real-time systems help to improve the safety of employees, customers, and the public. An important common finding was that, in the companies surveyed, decision-making processes for IT projects were comparable to those used for other complex advanced-technology projects. In many instances, decisions about investments in IT are like decisions about R&D. Pay- offs from both R&D and IT are likely to be uncertain in both scale and timing. Companies readily admitted that they had made investment errors. Expected value is often not quantifiable or even estimable, let alone predictable. It is not surprising that the experience of firms investing in IT varies considerably within an industry and by type of investment. When IT is used to reduce costs or to provide a specific new service, managers are often able to calculate rates of return and payback times with relative accuracy. However, for many other investments in IT like the strategic and infrastructure expenditures noted above it is nearly impos- sible to estimate such figures. Strategic uses of IT can change a firm's entire competitive or risk posture within an industry, affecting many differ- ent elements of customer, cost, and competitive relationships simultaneously- not just revenues or costs. Programs or systems such as MCI's Friends and Family program, American Airlines' SABRE computerized reservations system, Morgan Stanley's TAPS system for integrated trading, and McKesson's ECONOMOST system for ordering and inventory control affect those firms' quality of customer service, flexibility, reliability, breakeven points, re- sponse times, and market positioning in ways that cannot be measured in precise financial terms. When IT is used in this fashion, a firm's most valuable assets may become the professional know-how, flexible response and capabilities for innovation, information and management systems, and knowledge about customers and markets embodied in its IT and supporting sys- tems. These assets also are not reflected in the firm's accounting state- ments or in the nation's accounting system. When successful, such companies can redefine the standard to which other firms in the indus- try (and all cross-competing industries) are held by consumers of their services. A firm's use of IT may affect the entire structure of the firm's industry, its competitiveness with other industries, and even the nation's international competitiveness. Competitors may be forced to choose be
4 INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY tween making similar investments or being forced out of the business. En- tirely new subindustries can result from particularly fortuitous strategic changes, as cellular telephone, overnight package delivery, "swaps" and synthetic securities, and facsimile services demonstrate. But, as the failed experi- ments of Zap-mail, videotext, and AMRIS's CONFIRM system also show, favorable outcomes are far from assured. Chapter 3 deals in depth with these issues. Finally, IT has become a significant element in the cost structure of many companies. Even the service sector's $750 billion expenditure on IT in the last decade understates by a substantial amount the total cost of IT, since it includes only hardware and excludes essential elements such as software, training and support, and maintenance and upgrad- ing; the costs of these excluded elements may well be substantially greater than the costs of the hardware. The costs of a significant IT infrastruc- ture become more fixed than variable in nature and are especially bur- densome when revenues and margins are squeezed by recessions or competitive pressures and overcapacity results. In some cases, this problem leads to sizable financial losses even though the services being provided using the IT infrastructure may be of higher absolute value to the customer. The problem of overcapacity applies to entire industries and not just indi- vidual enterprises, since IT systems, especially large, complex ones, must be purchased in predetermined sizes that are not in direct proportion to demand and therefore usually provide more capacity than warranted by average levels of demand. Activity-level Analysis Although it is perhaps easiest to evaluate IT's impact on performance in services at the enterprise level by considering a firm's profitability, growth in market share, or survival, many of the impacts of IT can be understood only by an examination of IT's application in specific activities within enterprises, such as customer service, product design, image creation, qual- ity and cost control, and R&D. These activities may be performed within one functional organization or cut across several functional areas within one enterprise. Moreover, these activities may not all be performed within a single enterprise, but may be spread between the enterprise, its suppliers, and its customers. Because measures of performance at the enterprise level aggregate the effects of all activities within an enterprise, they may fre- quently miss critical shifts in structure or performance occurring at the activity level. Those shifts, however, may affect the structure and perfor- mance of many enterprises and industries. Examining the use of IT at the activity level allows more penetrating insight into why and how IT has been associated with major changes in job
SUMMARYAND OVERVIEW 15 content, forms of internal organization, industry structures, and cross-indus- try competition. For example, most overhead functions are merely services an enterprise has chosen to produce internally. If desired, many could easily be purchased externally. In fact, this is the way many service indus- tries started. Important tasks in services and manufacturing often resemble each other so much that the lines separating the two sectors are becoming ~ , arbitrary if not misleading for policy purposes. Within companies, an obvious impact of using IT in service activities is in providing specialized tools that enable more effective performance of particular activities (e.g., substituting on-line databases for paper records). Firms may also invest in IT-based systems that lower internal costs and prices but require more effort by the customer, a concept fundamental to many of the do-it-yourself "services" Provided by businesses (e.g., credit card gas pumps, long-distance dialing, machine-operated parking facilities, automated teller machines). Since these firms gain at the expense of the customer, the net performance gains (taking the customer into account) are clearly less than the gains to the firms themselves. In other instances, firms have used IT to rework how they perform service activities such as logistics activities that cut across individual functional organizations such as pur- chasing, inventory control, manufacturing, and distribution. IT is also used to facilitate the separation, reorganization, and recombi- nation of activities without regard to their location in space or time. This had led to the widespread development of "network" organizations. Flexibilities enabled by IT may also result in the flattening of organizations or the decentralizing of decision-making authority, thereby allowing more autonomy at lower levels and broadening the mix of tasks for which individuals are responsible. At the same time, managers have used IT to enhance dimen- sions of performance that depend on greater centralization (e.g., the consis- tency of fast foods or the accuracy of bank reports). IT-based linkages now allow managers to separate out many traditional activities (like payroll or accounting) from their core operations, procure them from outside suppliers, and still integrate them with important activi- ties that continue to be performed internally. Decisions to use "outsourcing" often rest on the fact that outside providers of highly specialized service activities who may have invested in or developed specialized IT technol- ogy and applications can often perform them more effectively or at less cost than firms that do not specialize in that activity. IT-based linkages often provide an opportunity to expand such choices by facilitating the monitoring and integration of service activities provided off-site with those kept in-house. Not only are large enterprises reorganizing or shedding entire departments and divisions, but they are also in some instances selling some of their skills in internal activities to outsiders, becoming the external service providers for other firms (as Federal Express has done with its
16 INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY telephone answering service). Electronic data interchanges now bind many firms in a web of worldwide purchasing, shipping, billing, and receiving connections. IT-based linkages have also been used to establish broader and more complex patterns of interconnections or alliances among different firms (which themselves may or may not be in the same industry). Entire industries such as telecommunications and investment banking compete largely as networks of independent enterprises temporarily linked to accomplish a specific task, for example, building a new telecommunica- tions system for a country. Such interconnections are frequently estab- lished to improve the performance of tasks by taking advantage of each enterprise's expertise in performing particular activity-level tasks. As the use of IT alters the nature and location of activities, it also alters the nature and location of work. Use of IT is one important force facilitating realignment of work flows, job redesign, organizational restruc- turing, and work relocation. As a result, the nature of jobs, skill require- ments, and requirements for training are changing rapidly. Radically revised organizational structures entailing different lines of managerial authority and different flows of information have emerged. Restructurings affect the tasks of personnel at all organizational levels, but middle-level technical and administrative managers may face the greatest challenges in retraining and adjusting to faster, less bureau- cratic decision-making structures. These trends have been the focus of much commentary in business publications. The committee's analysis underscores how using IT has amplified these trends. Chapter 4 ex- pands on these vital issues. KEY FINDINGS In the course of its deliberations, the committee examined the impact of IT on performance in the service sector not only from the standpoint of understanding the IT paradox, but also in terms of broader implications for decision making by business executives and government policymakers. De- tailed below are the committee's overall findings. The broader implications of these key findings as well as more specific findings as they relate to management and policy decision making are described in the remainder of this summary. · Traditional macroeconomic data collected to date do not cap- ture many important benefits or costs that accrue to firms from deploy- ing IT. Accordingly, it is not appropriate to use these data as a basis for judging the impact of service-sector investments in IT on the sector's per- formance. Even if growth in service-sector productivity were uniformly
SUMMARY AND OVERVIEW 17 poor, which it is not, traditional measures rarely take into account improve- ments in quality, convenience, and reliability for customers, or losses that using IT has helped avoid all important issues to individual firms. More- over, as with other important technological advances (such as electrification and telephones), it may take decades before aggregated measures fully re- flect the results achieved by the use of IT. · The use of IT has had a direct and positive operational impact on the performance of services by many individual firms, but the finan- cial impact of the use of IT has not always been as positive. Although it is often difficult to isolate the effects of IT use from other factors that may influence operational performance in service activities (e.g., qual- ity of the work force), individual firms have used IT to improve effi- ciency by reducing costs (e.g., through better logistics scheduling in airlines or more efficient routing in deliveries from suppliers to retail stores). In nearly all of the service industries, including those examined by the committee, firms have used IT to handle tremendous volumes of trans- actions. IT has been used to provide timely information that can substan- tially influence profits (e.g., investment bankers capture and analyze stock and bond price movements instantaneously; retail executives track sales from hour to hour; airlines perform real-time yield management). There are a variety of reasons why the use of IT has not always had a positive finan- cial impact on service firms. One reason is that many applications have used new technologies and other applications of IT have been experimental, and a basic characteristic of innovation is that experiments and new tech- nologies sometimes fail. A second reason is that the range of problems to which IT can be applied continues to expand so quickly that some compa- nies are forced to invest in new technologies to obtain new capabilities even before they have captured the full anticipated benefits of their installed IT infrastructures. · The use of IT has had important customer-supplier effects. For the customers of service providers, IT has been used to help improve the quality and variety of services in many industries, especially through its ability to amass, analyze, and control large quantities of specialized data. Such improvements include error reduction or increased preci- sion (e.g., more reliable medical diagnostics and procedures, more ac- curate billing on checkout activities); faster or more convenient service (e.g., computer-aided repair services, credit-card purchases, automated teller machines); improved security, safety, and reliability (e.g., auto- mated maintenance protocols, monitoring systems, or on-line audits). On the other hand, some important costs have been passed on to cus- tomers (e.g., while the hub-and-spoke routing systems and complex yield management strategies now used by airlines lower airline operating costs and sometimes the cost of tickets, they also may vastly increase
/ 18 INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY the inconveniences associated with air travel; while certain users find auto- mated communications systems and direct dialing procedures more conve- nient and private and they lower the price per call for everyone, many users are greatly frustrated by them) and on to suppliers (e.g., IT systems such as electronic data interchange have led to closer relationships and working partnerships between companies and their suppliers but also to greater costs for suppliers in terms of inventory carrying and coordination). The net effect of these changes is not always calculable. · IT has been an important element in promoting many broad restructuring and strategic changes in service industries. IT has been used to create new industries (e.g., the cellular telephone business) and has contributed to changes in traditional relationships between indus- tries (e.g., retailers dictating designs, packaging, and specifications to manufacturers). Entirely new lines of business have appeared, such as interest swaps, securitized mortgages, and indexed mutual funds. The economies of scale offered by back-office automation have supported some mergers and acquisitions, leading to reductions in the work force and increased concentration in some industries such as financial services or airlines. In other cases, the falling cost of IT has often facilitated the entry of relatively small businesses into new markets and the development of efficient local branches, franchises, or affiliates through which larger companies can ser- vice broader geographical areas or remote locations more effectively. IT has been used to increase cross-competition among various industries and among individual activities within companies in different industries. IT has been an enabling force in creating entirely new forms for economic activity (e.g., worldwide research networks, global sourcing arrangements, large- scale development and sharing of new databases, new training and educa- tional capabilities, faster-response innovation systems, and competition through disaggregated alliances or networks of companies). · The widespread use of IT in services has a profound effect on employment patterns. The committee's analysis of IT's roles at the activity and enterprise levels revealed changes in production processes, products, and lines of business that will produce substantial changes in employment patterns. When an industry's productivity increases and its output remains constant, jobs in that industry are of course lost. If that industry is committed to enhancing productivity through downsizing alone, those jobs will be lost permanently. However, if past patterns continue, total output is likely to grow, though jobs may well shift to different firms and industries or between geographical regions. Fore- casts indicate that the new jobs created and old jobs restructured will demand a new mix of skills. Emerging new forms of organization often require a wider range of skills than traditional forms. Future jobs are predicted to be more knowledge-based than in the past. Forecasting
SUMMARY AND OVERVIEW 19 specific skill needs is complicated by the fact that the job displacements and skill changes that typically accompany any major technological change will unfold at the same time that international competitive pressures, de- regulation, and other factors are causing major changes in the overall economy. Compounding analyses of these changes is the fact that many service activi- ties can easily be physically separated from their producing clients. As it has in software, the creation of domestic demand for other services might well result in substantial export of certain jobs overseas. MANAGEMENT IMPLICATIONS The use of IT can have a significant impact on the performance of service firms, both strategically and operationally. However, success- fully applying IT and reaping maximum payoffs from IT investments require good management. The question is not, Is IT useful? but rather, How can IT be successfully applied to enhance service performance? The committee's interviews with senior executives revealed several spe- cific areas that affect the likelihood of successfully managing applica- tions of IT. While not completely new, each provides an important focal point for concern and attention by managers investing in and using IT. The committee concludes that for maximum effectiveness: . ._ ~- - 1 ~ ~_ ~ A ~ There needs to be a comprehensive IT-based strategy designed not only to support the basic business but to create competitive advantage. Top management must understand this strategy, be deeply involved in its gen- eration. and be committed to its implementation if the strategy is to have . . · · . company-wide significance and transcend divisional boundaries. · Business processes should be examined and when appropriate rede- signed before IT is installed, paying special attention to functions that cross existing organizational boundaries. New management techniques and per- formance-reward structures are generally needed to support cross-functional systems. And internal activities and formal organizations should be explic- itly restructured to make the best use of these systems. · Customer and user needs (especially those of external customers) should normally drive the design, installation, and evaluation of IT systems. Users and customers should be involved whenever possible in system de- signs, and customer-driven metrics of quality should be used whenever pos- sible to assess the impacts of using IT. Customer-driven performance mea- surement systems (as opposed to hierarchically driven systems) should be important elements in evaluating cross-functional team performance. Most IT projects should focus on relatively short-term payoffs and should have well-defined goals within a long-term strategic framework. While "bet-the-company" IT projects have at times resulted in revolution .
20 INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY ary changes that have benefited their initiators, mega-projects are likely to be overly complex, over budget, delayed, and mismatched to customer needs by the time they are implemented. . The goals and desired outcomes of IT projects should be estab- lished using benchmarks for service performance established by exten- sive examination of possible "best-practice" processes as implemented in other firms, including specialized external service providers. Re- stricting searches for best-practice processes to peer firms may limit man- agement perspectives severely. As reported by executives interviewed by the committee, most of the problems in achieving payoffs from investment in IT came not from the investment decisions themselves but from inadequate planning and implementation of IT applications by management. Inadequate retraining and failure to continuously upgrade worker skills were a major prob- lem. Another was a failure to follow up installations of IT with appro- priate organizational structures, performance measurement systems, and reward and incentive plans. Details of the management implications of the committee's findings are found in Chapter 5. POLICY CONCERNS While the committee believed that it was beyond its scope and expertise to develop major policy or action recommendations, four primary areas of concern to policymakers were identified: enhancing the diffusion of IT throughout the service sector, dealing with the impacts of IT on employ- ment patterns, obtaining better data as well as a better understanding of organizational and structural changes occurring in the economy as a result of IT, and reassessing the impact of these changes on the effectiveness of traditional policy measures. Detailed recommendations on how to address these areas of concern are explored in Chapter 6. Diffusing the Benefits of IT in Services In general, market mechanisms have worked well in developing IT for services. Many individual companies have reaped substantial economic benefits from using IT, notwithstanding the fact that these benefits are fre- quently not reflected in traditional economic data and that certain attempts to use IT have been undeniable failures. There are two key areas where policy stimuli might affect future economic benefits from investments in IT. The first is IT's potential inclusion in or exclusion from investment incentives. To the extent that public policies are used to stimulate further investment (whether in new capital spending or in R&D), such policies
SUMMARY AND OVERVIEW 21 should treat investment in IT in services as they would any other capital or R&D investment. Preference should not be accorded to other types of capital investment or process experimentation- such as those for manufac- turing or fixed equipment over IT applications. Since service activities are integral to both service and manufacturing industries, IT applications that lower service costs or improve service performance are likely to have a significant positive impact on competitiveness in both sectors despite the low measured productivity increases seen to date. Moreover, given their importance, the nonhardware aspects of IT such as software and training should be included along with hardware in any definition of IT for invest- ment and/or tax purposes. The second relates to continued support for the development of infor- mation infrastructures, whether through public investment in certain critical areas (such as advanced R&D) or through changes in laws and regulations. The experiences of many large service enterprises illustrate the value of broad access to interactive computing systems connected by telecommuni- cations and data communications systems or integrated voice and data com- munications between different facilities, localities, and countries. Large U.S. firms have often been world leaders in the development and use of information infrastructures, especially for their own multinational networks. Increasingly, however, the emergence of relatively inexpensive desktop IT can bring sophisticated information-processing capabilities into the reach of the private home, as well as small and medium-size enterprises. Such enterprises (and home users) will require affordable access to public infor- mation infrastructures if they are to develop to their fullest extent. In some geographical areas, selectively stimulating the growth of information infra- structures, particularly for small businesses and for homes, could enhance interactions among all enterprises, promote expansion in both the number and types of jobs in the service sector, and lead to the creation of entirely new service industries. Enabling homes to have broad access to IT may also stimulate markets for many affordable products (e.g., multimedia de vices or services). Coping with the Impact of IT on Employment Patterns Large-scale changes in employment patterns have already occurred, and further changes seem inevitable. The real issue is how best to facilitate the continuing shift in job mix. Extensive retraining, education, and job cre- ation are essential tools for such facilitation. In a humane society, steps should also be taken to minimize the disruption and hardship of displaced individuals. As in the past, the volume of training and education needed is likely to exceed the capabilities of private industry. In addition, the rapid evolution of IT and other new technologies suggests that the need for re
22 INFORMATION TECHNOLOGY IN THE SERVICE SOCIETY training during a person's lifetime will be periodic. All this supports the broad-based call for strengthening the literacy and numerary provided by public K-12 education. Past studies indicate that education in general skills is likely to prove more beneficial in times of uncertainty and rapid change than education in specifically targeted and narrowly focused skills. Obtaining Improved Data and Conducting Research on Structural Changes The rapid growth of services and changes in the nature of service ac- tivities in the last two decades underscore the need for a better un- derstanding of changing conditions. The analyses on which such under- standing has traditionally rested have relied on statistical data collected by the Bureau of Labor Statistics and the Bureau of Economic Analysis. However, these data suffer from significant deficiencies. Efforts such as the Boskin Initiative to increase the disaggregation of federal data and statistics and to improve the scope of coverage (in terms of both price and quality measurements and the industries measured) were begun, and these efforts should continue. Better statistical data is not the only need. Specific research and con- tinuous monitoring are also needed to better understand (1) the nature of structural changes occurring within enterprises and industries, (2) those is- sues that are peculiar to small businesses, and (3) the large-scale impacts of IT on employment patterns at the activity and enterprise levels. Ironically, the United States funds research that addresses organizational and institu- tional changes overseas (e.g., change as the result of political or economic shifts in other nations), but funding for this kind of research tends to be difficult to find domestically. Reassessing the Effectiveness of Traditional Policy Measures Further research is also needed on the way information technologies affect the impact of traditional policy instruments. Some unintended results are possible, and their likelihood should be assessed. For example, because of integrated financial markets, interest rates lowered for policy reasons in the United States may merely (1) enable domestic or foreign companies to invest at lower costs overseas or (2) change the exchange rates for U.S. currency. Because of outsourcing abroad, increases in government pur- chases or government stimulation of consumer demand may simply increase imports and create jobs overseas. Enhanced data and communications net- works generally have international connections that increase access by for- eign competitors to U.S. markets as well as U.S. access to foreign resources, potentially increasing the pressure on and lowering returns for U.S. innova
SUMMARYAND OVERVIEW 23 tors and suppliers. The internationalization of financial markets spurred by worldwide IT networks makes it increasingly difficult to control a domestic economy using the standard macroeconomic levers and brings into question the entire concept of national sovereignty. Such subjects are worthy candi- dates for investigation. Additional conclusions and suggestions of the committee may be found in the body of the report. NOTE Throughout this report, unless otherwise specified, the term information technology in- cludes computer and communications hardware, as well as the software and associated services required to effectively use that hardware.