Chapter 4: Beyond Computation - Information Technology, Organizational Transformation, and Business Performance

Erik Brynjolfsson, Lorin M. Hitt

Overview

How do computers contribute to business performance and economic growth?

Even today, most people who are asked to identify the strengths of computers tend to think of computational tasks like rapidly multiplying large numbers. Computers have excelled at computation since the Mark I (1939), the first modern computer, and the ENIAC (1943), the first electronic computer without moving parts. During World War II, the U.S. government generously funded research into tools for calculating the trajectories of artillery shells. The result was the development of some of the first digital computers with remarkable capabilities for calculation—the dawn of the computer age.

However, computers are not fundamentally number crunchers. They are symbol processors. The same basic technologies can be used to store, retrieve, organize, transmit, and algorithmically transform any type of information that can be digitized—numbers, text, video, music, speech, programs, and engineering drawings, to name a few. This is fortunate because most problems are not numerical problems. Ballistics, code breaking, parts of accounting, and bits and pieces of other tasks involve lots of calculation. But the everyday activities of most managers, professionals, and information workers involve other types of thinking. As computers become cheaper and more powerful, the business value of computers is limited less by computational capability, and more by the ability of managers to invent new processes, procedures, and organizational structures that leverage this capability. As this form of innovation continues to develop, the applications of computers are expected to expand well beyond computation for the foreseeable future.

The fundamental economic role of computers becomes clearer if one thinks about organizations and markets as information processors (Galbraith 1977, Simon 1976, Hayek 1945). Most of our economic institutions and intuitions emerged in an era of relatively high communications costs, limited computational capability, and related constraints. Information technology (IT), defined as computers as well as related digital communication technology, has the broad power to reduce the costs of coordination, communications, and information processing. Thus, it is not surprising that the massive reduction in computing and communications costs has engendered a substantial restructuring of the economy. Most modern industries are being significantly affected by computerization.

Information technology is best described not as a traditional capital investment, but as a "general purpose technology" (Bresnahan and Trajtenberg 1995). In most cases, the economic contributions of general purpose technologies are substantially larger than would be predicted by simply multiplying the quantity of capital investment devoted to them by a normal rate of return. Instead, such technologies are economically beneficial mostly because they facilitate complementary innovations.

Earlier general purpose technologies, such as the telegraph, the steam engine, and the electric motor, illustrate a pattern of complementary innovations that eventually leads to dramatic productivity improvements. Some of the complementary innovations were purely technological, such as Marconi's "wireless" version of telegraphy. However, some of the most interesting and productive developments were organizational innovations. For example, the telegraph facilitated the formation of geographically dispersed enterprises (Milgrom and Roberts 1990); while the electric motor provided industrial engineers more flexibility in the placement of machinery in factories, dramatically improving manufacturing productivity by enabling workflow redesign (David 1990). The steam engine was at the root of a broad cluster of technological and organizational changes that helped ignite the first industrial revolution.

In this paper, we review the evidence on how investments in IT are linked to higher productivity and organizational transformation, with emphasis on studies conducted at the firm level. Our central argument is twofold: first, that a significant component of the value of IT is its ability to enable complementary organizational investments such as business processes and work practices; second, that these investments, in turn, lead to productivity increases by reducing costs and, more importantly, by enabling firms to increase output quality in the form of new products or in improvements in intangible aspects of existing products like convenience, timeliness, quality, and variety.^[1]

There is substantial evidence from both the case literature on individual firms and multi-firm econometric analyses supporting both these points, which we review and discuss in the first half of this paper. This emphasis on firm-level evidence stems in part from our own research focus but also because firm-level analysis has significant measurement advantages for examining intangible organizational investments and product and service innovation associated with computers.

Moreover, as we argue in the latter half of the paper, these factors are not well captured by traditional macroeconomic measurement approaches. As a result, the economic contributions of computers are likely to be understated in aggregatelevel analyses. Placing a precise number on this bias is difficult, primarily because of issues about how private, firm-level returns aggregate to the social, economy-wide benefits and assumptions required to incorporate complementary organizational factors into a growth accounting framework. However, our analysis suggests that the returns to computer investment may be substantially higher than what is assumed in traditional growth accounting exercises, and the total capital stock (including intangible assets) associated with the computerization of the economy may be understated by a factor of ten. Taken together, these considerations suggest the bias is on the same order of magnitude as the currently measured benefits of computers.

Thus, while the recent macroeconomic evidence about computers contributions is encouraging, our views are more strongly influenced by the microeconomic data. The micro data suggest that the surge in productivity that we now see in the macro statistics has its roots in over a decade of computer-enabled organizational investments. The recent productivity boom can in part be explained as a return on this large, intangible, and largely ignored form of capital.

^[1]For a more general treatment of the literature on IT value see reviews by Attewell and Rule (1984), Brynjolfsson (1993), Wilson (1995), and Brynjolfsson and Yang (1996). For a discussion of the problems in economic measurement of computers contributions at the macroeconomic level see Baily and Gordon (1988), Siegel (1997), and Gullickson and Harper (1999).