Organizations continue to increase their investments in information technology (IT) as a means of achieving higher levels of performance because their executives see these investments as a way to counter the impact of global competition. IT is seen as a means to create business value: substitute capital for high cost labor thereby improving productivity and reducing cost structures; facilitate new product development through concurrent processing; and improve business processes in general through redesign using IT capabilities. The high levels of IT investment have resulted in questions by researchers and senior executives about the actual payoff from IT. Some recent studies have demonstrated a positive return on IT investments, while others have not, and so significant questions remain:

1. Can the production function approach to measuring return on IT investments be improved by refining the microeconomic models, or using other models such as operations management models?
   
   
2. Can studies at the level of business processes rather than the whole organization improve previous results? Previous studies measure the average return on IT investments at the firm level in a sample of firms. However, much research has documented the vastly different levels of efficiency with which firms manage the IT resource. Thus, the measurement of average performance ignores the large variance in the sample. We believe that more research needs to be done to analyze how the best managed firms derive high performance benefits from their IT investments.
   
   
3. What are the organization-IT linkages by which successful firms manage their nvestments in IT to create business value? There are a large number of organizational variables that mediate the payoff from IT, which are omitted in microeconomic analyses, and that are important to understand for better IT management. Behavioral analyses indicate that organizational performance depends on the choice of a firm's strategy as well as its execution, and that IT contributes primarily to the latter though a set of organization-IT linkages. We propose to test an explanatory model of these linkages.

There are four key differentiators of this approach. First, we encompass the entire IT resource in organizations, whereas past research has often focused on the IS unit. Given the dramatic trend toward distributed computing, it is important to conduct such a comprehensive analysis. Second, we focus on business outcomes rather than IS service outcomes. Third, we analyze the linkages between business value outcomes and IT resources, IT management practices, and the fit of IT with the business strategy for different business processes. Fourth, we use both disaggregated analysis at the level of individual business processes and aggregated analysis at the level of the corporation as a whole. The purpose is to develop greater understanding of the processes by which IT contributes to business value.

Data collection involves multiple methods. We use secondary data on target corporations to determine their values on key variables in order to identify sites to be used for a mail survey. We use several mail questionnaires to collect complete data from corporations about the full set of variables of interest in the study. Respondents are the "process owners"--business executives who head product supply, manufacturing, distribution, marketing, sales and service; "service providers" of IS services; and "senior executives" who shape business strategy.

"The Business Value of Information Technology", Kenneth L. Kraemer and Vijay Gurbaxani ©1997


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Supported by a grant from the National Science Foundation, researchers at the University of California, Irvine have been measuring the value created by business investments in technology. They have focused on the technology's impact on intermediate business processes, rather than productivity or profitability at the firm level, because the impacts of technology use occur primarily at the process level. Moreover, it is the successful execution of the key processes - sometimes involving their transformation and reengineering - that is the critical component in the creation of business value from technology use.

Rather than measuring business value objectively, the researchers have used subjective measures of business value attributed to IT by senior executives in U.S. corporations. The rationale for focusing on senior executives is that these are the individuals responsible for making investments in IT. Besides, they must have some internal assessments of the value of those investments, or they would not continue to make them. The researchers therefore asked over 100 executives to assess the contribution of I/S to business value on a ten-point scale along 40 process dimensions. The executives responses were then grouped into ten major categories of business value as shown below:

The results of the study are very illuminating and run counter to much of the conventional wisdom. The dimensions on which IT was rated as delivering the most value were organizational effectiveness, organizational efficiency and new business innovation. Executives have clearly recognized the contribution of IT to improving internal communication and coordination, improving decision making, reducing labor costs, facilitating the implementation of new processes, and making new areas of business economically feasible. The use of E-mail and groupware have clearly improved communication and coordination, the provision of better information has improved the quality of decision making, and the widespread emergence of reengineering and downsizing has had a dramatic impact on labor costs and process performance.

On the other hand, the areas where IT was considered to have the least impact were competitive dynamics and market support. Competitive dynamics reflects the attributes typically associated with the strategic use of information systems. Our results suggest that managers in many organizations still do not consider IT to create strategic value. The results for market support were surprising to us. It appears that the use of information technology in identifying market trends and improving forecasts may not be as widespread as one might expect.

Looking next at firm performance, the researchers observed a few firms that were rated as providing excellent value on most dimensions. A slightly larger number of firms were consistently rated as poor across all measures. Another small set of firms provided good, solid value throughout. This seems to suggest that there are leaders "among the pack" who out perform all other firms across all dimensions of business value. Other firms appear to be playing catch-up by focusing on delivering value in a manner consistent with their core activities. Other firms, possibly laggards, are simply not in the running.

These findings suggest clearly that while some information systems departments in corporations clearly have a significant amount of work to do to increase the value that they deliver to their firms, many have in fact, identified some key processes in their firms and have achieved reasonable success at supporting these processes. Notably, some organizations are providing stellar value to their businesses. Not surprising, in an environment with rapid technological change and complexity, the quality of management practices in information systems departments varies significantly.

On the other hand, the successful I/S organizations provide some insight into how to achieve these results. By closely aligning their IT strategies with their business strategies and the resulting operating models, I/S managers at these firms have managed to beat the odds and deliver consistent value.

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Given that hardware costs decrease at an annual rate of 20%, while personnel costs increase slowly, the ability to substitute between the two inputs is critical to improving the efficiency of the production process for information systems. Firms that are better able to substitute hardware for labor will be able to exploit the cost trends in hardware to offset the growing costs of labor. The degree of substitutability between hardware and personnel is determined by the nature of the available tradeoffs between the two inputs. Available tradeoffs are of course a result of the choice of production techniques.

Supported by a grant from the National Science Foundation, researchers at the Center for Research on Information Technology and Organizations at the University of California, Irvine have been examining the relative efficiency of capital and labor inputs to the production of information services using a production theory approach. Specifically, the nature of the production process was modeled by a production function. Several specifications of standard production functions exist. These include the Cobb-Douglas production function, the CES production function and the fixed-coefficient production function. A key difference between these functional forms is the degree of substitution between the inputs. If one could successfully estimate both the form of the production function and its associated parameters, then one could provide managers with useful benchmarks for the optimal allocation of an IS budget into its principal components.

In order to do so, the researchers collected data on spending on information technology at the firm level. Based on econometric analysis conducted on this data, they estimated the form of the production function to be consistent with Cobb-Douglas production. The implications of this form of production function are that the budget shares of hardware and labor are constant over time. This implies that an organization's IT environment is getting increasingly hardware intensive over time.

This occurs because cost and competitive pressures force companies to invest in production technologies - like the use of software tools, advanced languages, graphical user interfaces - as a way of substituting hardware for labor. These technologies facilitate the substitution of hardware for labor by reducing the labor component of a task while requiring increased investments in hardware. Furthermore, Cobb-Douglas production also implies that the optimal ratio of hardware to labor is independent of scale. This implies that large and small IS organizations should have the same labor-hardware ratio. This research represents the first time that the nature of production of information services has been estimated at the firm level.

From a managerial perspective, these results have several salient implications. First, as firms grow in size, the optimal labor-capital budget ratio remains fixed for given set of prices. Second, prevailing levels of hardware to personnel price changes of approximately 20% are accompanied by a 20% increase in the quantity of hardware relative to personnel. Third, the optimal labor-capital ratio is estimated around 1.87. That is, firms which are more efficient have IS departments which invest nearly twice as much in hardware as in personnel.

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In an attempt to address these issues, researchers at the Center for Research on Information Technology and Organizations at the University of California, Irvine have been examining how IT creates value for the business. They are examining the impacts of IT at the process-level, since many of the qualitative benefits of IT investment are accessible at this level. Their research looked at the measurement and creation of IT business value using perceptual measures. In effect, their objective was to design and test a thermometer of IT business value.

The basis for the model of IT business value creation is the Value Chain. The researchers dissected the value chain into distinct processes to identify areas where executives would likely concentrate IT resources in pursuit of organizational goals. These processes were then linked to signify how value accumulates as products and services pass along the value chain. The processes we identified were:

Since executives are responsible for initiating IT investments, they represent the most knowledgeable body of informants for how those investments have performed. If executives perceived that previous IT investments had failed to make an adequate contribution to firm performance, they would most likely curtail their spending, or desist from making further IT investments. To gather data for the study, the researchers designed a 36 item survey which was administered to over 180 business executives. Each item asked the executive to assess the contribution of a specific aspect of IT to firm performance. Responses were based on a ten-point scale.

The results of this study reveal how IT business value is created within the value chain. Specifically, the researchers found that the effects of IT investments cascade along the value chain with the result that value can be concentrated at specific points along the value chain. In particular, the analysis found that the most significant locus of IT business value was customer relations. These findings reveal that the benefits to the firm at this point come directly from IT investments focused within the customer relations process, and indirectly from investments made elsewhere in the value chain. The analysis also serves to highlight bottlenecks within the value chain where value creation is hampered by ineffective linkages between successive processes.

These findings have implications for business managers who use IT to support and enhance various aspects of the value chain. Although managers might invest in IT for a specific purpose, the impacts of these investments can be felt beyond their intended domain. For example, IT investment directed towards improving supply chain management could also yield efficiencies in production. Therefore, the value of IT investments is best understood in terms of their direct and indirect effects. Investments, that at first glance appear to yield significant direct benefits to the organization, might yield even greater benefits when indirect effects are included. Similarly, investments that appear to yield marginal direct benefits might yield significant total benefits when indirect effects are considered. Thus indirect effects and their subsequent contribution to IT business value must be considered within the IT evaluation process.


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