Economics of Information Technology: Productivity and Profitability

Economics of Information Technology:Productivity and Profitability Hal R. Varian UC Berkeley http://www.sims.berkeley.edu/~hal SIMS

Economic Productivity • Productivity means… • Labor productivity: Output produced/labor input • Total factor productivity: Output/index of inputs • Problems in measuring outputs and inputs • Measurement of outputs and inputs • Output of services • Utilization of inputs • Etc., etc. • Nevertheless, productivity is a critical index for predicting future economic growth SIMS

Why? • Long run: primary determinant of per capita consumption • Short run: if output per labor hour increases, then Fed doesn’t have to reduce aggregate demand to prevent inflation SIMS

Post-War Productivity Growth ? SIMS

Recent experience • Normally productivity is pro-cyclical: grows when GDP grows, shrinks when GDP shrinks • But Q1 2002, productivity grew at a 8.6% annual rate! • Q4 2001: 5.2% • Why? • Firms laid off workers more quickly than usual… • Output didn’t drop as much as usual… • Because of IT? SIMS

Productivity and profitability • Growth in productivity does not imply growth in profitability • Example: telecommunications • 8% productivity growth, $2 trillion decline in stock value • Growth in profitability does not imply growth in productivity • Example: marketing • Sell more at expense of other firms in industry • As a general rule… • Increase in revenue doesn’t contribute to productivity, since it cancels out at industry level • Decrease in cost does contribute to productivity SIMS

Approaches to IT Productivity • Aggregate economy • 3 IT investment booms 1995-2000: telecom dereg, Y2K, dot coms. Drove growth, created stock of IT capability. How much cyclical? • Industry level • Stiroh and Jorgenson (uses govn’t data) • McKinsey study (industry case studies) • Litan and Rivlin (best practices + diffusion) • Firm level • Erik Brynjolfsson (statistical, data stops in 1995) • Net Impact Study (survey in Fall 2001) SIMS

Net Impact Study • Survey of 2065 US and 634 UK, French, German organizations • http://www.netimpactstudy.com • Sponsored by Cisco, conducted by Momentum Research advised by Litan and Varian • Where are payoffs from Internet? • Found widespread adoption of Internet Business Solutions • Biggest impact on revenue side • Some cost savings now, more expected in future SIMS

Figure 1: IBS Adoption Widespread Adoption SIMS

Figure 2: IBS Adoption by Industry Penetration by industry SIMS

Figure 3: Financial impact in US SIMS

Figure 4: Financial Impact in Europe SIMS

Figure 15: What Has Been Adopted SIMS

Impact on customers SIMS

Revenue Increases SIMS

Figure 23: Impact on COGS SIMS

Figure 25: Impact on SG&A SIMS

Figure 26: Use of metrics to track(by industry) SIMS

Figure 51: Adoption of Internet Business Solution Tracking-Metrics (U.S., and U.K., France and Germany) Common metrics SIMS

Figure 40: Adoption of applications SIMS

Figure 44: Impact on Costs SIMS

Figure 45: Impact on revenue SIMS

Figure 29: Barriers to use SIMS

Figure 52: Impact on customers SIMS

Figure 53: Impact on P&L SIMS

What correlates with success? • Revenue increase • Adoption of IBS in several business applications • Use of metrics • Data standardization • Mobile access • Cost savings • Supply chain management • Focus on reducing costs SIMS

Figure 55: SIMS

Figure 54: SIMS

Takeaway points • Widespread deployment of Internet applications • Most impact on revenue side so far • Cost side growing • Europe is behind US • Who is right? • Maybe both… • IT productivity effect appears to be real. • Good news for economy! SIMS

Economics of Information Technology: Productivity and Profitability