Companies using IT to change the way they conduct business often say that their investment in IT complements changes in other aspects of the organization. These complementarities have a number of implications for understanding the value of computer investment. To be successful, firms typically need to adopt computers as part of a "system" or "cluster" of mutually reinforcing organizational changes (Milgrom and Roberts 1990). Changing incrementally, either by making computer investments without organizational change, or only partially implementing some organizational changes, can create significant productivity losses as any benefits of computerization are more than outweighed by negative interactions with existing organizational practices (Brynjolfsson, Renshaw, and Van Alstyne 1997). The need for "all or nothing" changes between complementary systems was part of the logic behind the organizational re-engineering wave of the 1990s and the slogan "Don't Automate, Obliterate" (Hammer 1990). It may also explain why many large-scale IT projects fail (Kemerer and Sosa 1991), while successful firms earn significant rents.
Many of the past century's most successful and popular organizational practices reflect the historically high cost of information processing. For example, hierarchical organizational structures can reduce communications costs because they minimize the number of communications links required to connect multiple economic actors, as compared with more decentralized structures (Malone 1987, Radner 1993). Similarly, producing simple, standardized products is an efficient way to utilize inflexible, scale-intensive manufacturing technology. However, as the cost of automated information processing has fallen by more than 99.9 percent since the 1960s, it is unlikely that the work practices of the previous era will also be the same ones that best leverage the value of cheap information and flexible production. In this spirit, Milgrom and Roberts (1990) construct a model in which firms' transition from "mass production" to flexible, computer-enabled, "modern manufacturing" is driven by exogenous changes in the price of IT. Similarly, Bresnahan (1999) and Bresnahan, Brynjolfsson, and Hitt (2000) show how changes in IT costs and capabilities lead to a cluster of changes in work organization and firm strategy that increases the demand for skilled labor.
In this section we will discuss case evidence on three aspects of how firms have transformed themselves by combining IT with changes in work practices, strategy, and products and services; they have transformed the firm, supplier relations, and the customer relationship. These examples provide qualitative insights into the nature of the changes, making it easier to interpret the more quantitative econometric evidence that follows.
The need to match organizational structure to technology capabilities and the challenges of making the transition to an IT-intensive production process is concisely illustrated by a case study of "MacroMed" (a pseudonym), a large medical products manufacturer (Brynjolfsson, Renshaw, and Van Alstyne 1997). In a desire to provide greater product customization and variety, MacroMed made a large investment in computer integrated manufacturing. These investments also coincided with an enumerated list of other major changes including: the elimination of piece rates, giving workers authority for scheduling machines, decision rights, process and workflow innovation, more frequent and richer interactions with customers and suppliers, increased lateral communication and teamwork, and other changes in skills, processes, culture, and structure (see table 4.1).
Principles of "old" factory
Principles of the "new" factory
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However, the new system initially fell well short of management expectations for greater flexibility and responsiveness. Investigation revealed that line workers still retained many elements of the now-obsolete old work practices, not from any conscious effort to undermine the change effort, but simply as an inherited pattern. For example, one earnest and well-intentioned worker explained that "the key to productivity is to avoid stopping the machine for product changeovers". While this heuristic was valuable with the old equipment, it negated the flexibility of the new machines and created large work-in-process inventories. Ironically, the new equipment was sufficiently flexible that the workers were able to get it to work much like the old machines! The strong complementarities within the old cluster of work practices and within the new cluster greatly hindered the transition from one to the other.
Eventually, management concluded that the best approach was to introduce the new equipment in a "greenfield" site with a handpicked set of young employees who were relatively unencumbered by knowledge of the old practices. The resulting productivity improvements were significant enough that management ordered all the factory windows painted black to prevent potential competitors from seeing the new system in action. While other firms could readily buy similar computer-controlled equipment, they would still have to make the much larger investments in organizational learning before fully benefiting from them and the exact recipe for achieving these benefits was not trivial to invent (see Brynjolfsson, Renshaw, and Van Alstyne 1997 for details). Similarly, large changes in work practices have been documented in case studies of IT adoption in a variety of settings (e.g., Hunter, Bernhardt, Hughes, and Skuratowitz 2000; Levy, Beamish, Murnane, and Autor 2000; Malone and Rockart 1992; Murnane, Levy, and Autor 1999; Orlikowski 1992).
Due to problems coordinating with external suppliers, large firms often produce many of their required inputs in-house. General Motors is the classic example of a company whose success was facilitated by high levels of vertical integration. However, technologies such as electronic data interchange (EDI), Internet-based procurement systems, and other interorganizational information systems have significantly reduced the cost, time, and other difficulties of interacting with suppliers. For example, firms can place orders with suppliers and receive confirmations electronically, eliminating paperwork and the delays and errors associated with manual processing of purchase orders (Johnston and Vitale 1988). However, even greater benefits can be realized when interorganizational systems are combined with new methods of working with suppliers.
An early successful interorganizational system is the Baxter ASAP system, which lets hospitals electronically order supplies directly from wholesalers (Vitale and Konsynski 1988, Short and Venkatraman 1992). The system was originally designed to reduce the costs of data entry—a large hospital could generate 50,000 purchase orders annually which had to be written out by hand by Baxter's field sales representatives at an estimated cost of $25–35 each. However, once Baxter computerized its ordering and had data available on levels of hospital stock, it took increasing responsibility for the entire supply operation: designing stock room space, setting up computer-based inventory systems, and providing automated inventory replenishment. The combination of the technology and the new supply chain organization substantially improved efficiency for both Baxter (no paper invoices, predictable order flow) and the hospitals (elimination of stockroom management tasks, lower inventories, and less chance of running out of items). Later versions of the ASAP system let users order from other suppliers, creating an electronic marketplace in hospital supplies.
ASAP was directly associated with cost savings on the order of $10 million to $15 million per year, which allowed them to rapidly recover the $30 million up-front investment and ~$3 million annual operating costs. However, management at Baxter believed that even greater benefits were being realized through incremental product sales at the 5,500 hospitals that had installed the ASAP system, not to mention the possibility of a reduction of logistics costs borne by the hospitals themselves, an expense which consumes as much as 30 percent of a hospital's budget.
Computer-based supply chain integration has been especially sophisticated in consumer packaged goods. Traditionally, manufacturers promoted products such as soap and laundry detergent by offering discounts, rebates, or even cash payments to retailers to stock and sell their products. Because many consumer products have long shelf lives, retailers tended to buy massive amounts during promotional periods, which increased volatility in manufacturing schedules and distorted manufacturers' view of their market. In response, manufacturers sped up their packaging changes to discourage stockpiling of products and developed internal audit departments to monitor retailers' purchasing behavior for contractual violations (Clemons 1993).
To eliminate these inefficiencies, Procter and Gamble (P&G) pioneered a program called "efficient consumer response" (McKenney and Clark 1995). In this approach, each retailer's checkout scanner data goes directly to the manufacturer; ordering, payments, and invoicing are fully automated through electronic data interchange; products are continuously replenished on a daily basis; and promotional efforts are replaced by an emphasis on "everyday low pricing". Manufacturers also involved themselves more in inventory decisions and moved toward "category management", where a lead manufacturer would take responsibility for an entire retail category (say, laundry products), determining stocking levels for its own and other manufacturers' products, as well as complementary items.
These changes, in combination, greatly improved efficiency. Consumers benefited from lower prices, and increased product variety, convenience, and innovation. Without the direct computer-computer links to scanner data and the electronic transfer of payments and invoices, they could not have attained the levels of speed and accuracy needed to implement such a system.
Technological innovations related to the commercialization of the Internet have dramatically decreased the cost of building electronic supply chain links. Computerenabled procurement and on-line markets make possible a reduction in input costs through a combination of reduced procurement time and more predictable deliveries, which reduce the need for buffer inventories and reduce spoilage for perishable products; reduced price due to increasing price transparency and the ease of price shopping; and reduced direct costs of purchase order and invoice processing. These innovations are estimated to lower the costs of purchased inputs by 10 percent to 40 percent depending on the industry (Goldman Sachs 1999).
Some of these savings clearly represent a redistribution of rents from suppliers to buyers, with little effect on overall economic output. However, many of the other changes represent direct improvements in productivity through greater production efficiency and indirectly by enabling an increase in output quality or variety without excessive cost. To respond to these opportunities, firms are restructuring their supply arrangements and placing greater reliance on outside contractors. Even General Motors, once the exemplar of vertical integration, has reversed course and divested its large internal suppliers. As one industry analyst recently stated, "What was once the greatest source of strength at General Motors—its strategy of making parts in-house—has become its greatest weakness" (Schnapp 1998). To get some sense of the magnitude of this change, the spinoff in 1999 of Delphi Automotive Systems, only one of GM's many internal supply divisions, created a separate company that by itself has $28 billion in sales.
The Internet has opened up a new range of possibilities for enriching interactions with customers. Dell Computer has succeeded in attracting customer orders and improving service by placing configuration, ordering, and technical support capabilities on the Web (Rangan and Bell 1998). It coupled this change with systems and work practice changes that emphasize just-in-time inventory management, buildto-order production systems, and tight integration between sales and production planning. Dell has implemented a consumer-driven build-to-order business model, rather than using the traditional build-to-stock model of selling computers through retail stores, which gives Dell as much as a 10 percent advantage over its rivals in production cost. Some of these savings represent the elimination of wholesale distribution and retailing costs. Others reflect substantially lower levels of inventory throughout the distribution channel. However, a subtle but important by-product of these changes in production and distribution is that Dell can be more responsive to customers. When Intel releases a new microprocessor, as it does several times each year, Dell can sell it to customers within seven days compared to eight weeks or more for some less Internet-enabled competitors. This is a non-trivial difference in an industry where adoption of new technology and obsolescence of old technology is rapid, margins are thin, and many component prices drop by 3–4 percent each month.
Other firms have also built closer relations with their customer via the Web and related technologies. For instance, Web retailers like Amazon.com provide personalized recommendations to visitors and allow them to customize numerous aspects of their shopping experience. As described by Denise Caruso, "Amazon's on-line account maintenance system provides its customers with secure access to everything about their account at any time. [S]uch information flow to and from customers would paralyze most old-line companies". Merely providing Internet access to a traditional bookstore would have had a relatively minimal impact without the cluster of other changes implemented by firms like Amazon.
An increasingly ubiquitous example is using the Web for handling basic customer inquiries. For instance, UPS now handles a total of 700,000 package tracking requests via the Internet every day. It costs UPS 10 per piece to serve that information via the Web vs. $2 to provide it over the phone (Seybold and Marshak 1998). Consumers benefit too. Because customers find it easier to track packages over the Web than via a phone call, UPS estimates that two-thirds of the Web users would not have bothered to check on their packages if they did not have Web access.