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Research by Sunil Mithas
By the late 1980s there was computer on every desk. But that wasn’t
necessarily a good thing, according to some researchers, who observed that there
was hardly any visible workplace productivity improvement in services despite
this initial influx of information technology. But IT has come a long way since
then. While the productivity effects of IT have been obvious for some time, new
research indicates that investing in IT may have more of an effect on a firm’s
profitability than advertising or even R&D.
Most previous research into the profitability of IT used data collected prior
to the mid-1990s. Many of those studies failed to detect the effect of IT on
profitability. But in a new study Sunil Mithas, assistant professor of decision,
operations and information technology; Ali Tafti, University of
Illinois-Urbana-Champaign; Indranil Bardhan, University of Texas-Dallas; and Jie
Mein Goh, a doctoral student at the Smith School, found that “new” information
technologies, those deployed since 1995, have a significant positive impact on
firm profitability.
The study uses proprietary, archival data from more than 400 global firms
collected over a six year time period. The worldwide benchmarking survey was
administered annually over this period to CIOs and other senior IT executives
from large global firms, and collected firm-level IT investment data and other
IT investment-related information. IT investments include all hardware,
software, personnel, training, disaster recovery, facilities, and costs
associated with supporting the IT environment, from servers and desktop machines
to help desk staff.
Research conducted before the advent and widespread use of the Internet found
no effect of IT expenditures on firm profitability. But this study found a
strong connection. Unlike their older counterparts, newer IT systems seem to
help firms improve their bottom line—which should dispel any doubts of the
strategic value of IT investments, says Mithas.
But some kinds of IT projects will prove more advantageous than others. IT
can be used to reduce costs by creating more efficient operations, or it can be
used to support sales growth through customer satisfaction and customer
retention strategies. Cost reduction had a negligible effect on the
profitability of IT investments, the authors found.
But IT investments did have a marked positive effect on revenue growth.
Companies that are able to take advantage of the power of IT to serve customers
in increasingly more personalized ways are benefiting from the new value
propositions IT has made possible: by allowing firms to create more customized,
personalized offerings to their customers; by creating new marketing channels to
promote awareness of the company’s product or service; and by improving the
company’s ability to manage its customer lifecycle, leading to greater customer
loyalty.
Mithas also found something that managers may find surprising: investment in
IT has more of an impact on firm profitability than either advertising or
research and development efforts.
“Most firms already know how to manage R&D and advertising to their best
advantage,” says Mithas. “There is much more variability in firms’ abilities to
manage IT. It is possible that a manager has implemented an ineffective IT
program and has gotten his fingers burned. So next year he says ‘we’re not going
to give resources to IT because that doesn’t work for us,’” says Mithas. “So
there is variation in how firms are handling IT, and the benefits they are able
to reap from it.”
IT investment seems to have a greater effect on the profitability of firms in
the service sector than on firms in the manufacturing sector, though Mithas says
that more firm-level evidence is needed to document the sources of profitability
provided by IT.
The pathways leading to profitability aren’t always compatible, so knowing
the impact of an IT investment can help managers make savvy choices among
discretionary expenditures. “This is a question of interest to many in the
business world—what really affects firm profitability?” says Mithas. “We can now
be sure that IT does impact firm profitability, and our findings suggest that
its effect is greater than that of R&D or advertising.”
“Information Technology and Firm Profitability: Mechanisms and Empirical
Evidence” is a working paper and has been presented at several research
conferences. For more information about this research, contact
smithas@rhsmith.umd.edu.
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