1

Information Technology Information Technology and the Economy:and the Economy:

Where Are We and Where Do We Where Are We and Where Do We Go From Here? Go From Here?

Erik BrynjolfssonErik BrynjolfssonCenter for Digital BusinessCenter for Digital Business

MIT Sloan School of ManagementMIT Sloan School of Management

OverviewOverview(Mostly) Good News: IT & Productivity(Mostly) Good News: IT & Productivity

Past and PresentPast and PresentFutureFuture

ConcernsConcernsInequality Inequality TurbulenceTurbulenceInnovation IncentivesInnovation IncentivesMismeasurementMismeasurement: Beyond Productivity: Beyond Productivity

Policy ImplicationsPolicy Implications

U.S. Labor ProductivityU.S. Labor Productivity

Source: Bureau of Labor Statistics

0%

1%

2%

3%

1973-1995 1996-2005

1.4%

2.8%

Labor Productivity (Output Per Hour), Nonfarm Business

4.3

Dec

-72

Sep-

73Ju

n-74

Mar

-75

Dec

-75

Sep-

76Ju

n-77

Mar

-78

Dec

-78

Sep-

79Ju

n-80

Mar

-81

Dec

-81

Sep-

82Ju

n-83

Mar

-84

Dec

-84

Sep-

85Ju

n-86

Mar

-87

Dec

-87

Sep-

88Ju

n-89

Mar

-90

Dec

-90

Sep-

91Ju

n-92

Mar

-93

Dec

-93

Sep-

94Ju

n-95

Mar

-96

Dec

-96

Sep-

97Ju

n-98

Mar

-99

Dec

-99

Sep-

00Ju

n-01

Mar

-02

Dec

-02

Sep-

03Ju

n-04

75

80

90

100

110

120

135

Q1 1973- Q4 1995Trend = 1.47% per year

Q1 1996-Q3 2004Trend = 3.06% per year

Index 1992 = 100

Source: BLS and Institute for International Economics

2

IT and Productivity: The Data SpeakIT and Productivity: The Data Speak

IT Stock (relative to industry average)

Productivity(relative to industry average)

Computers are associated with greater productivity...

...But what explains the substantial variation across firms?

Complementarities: Complementarities: More than computers aloneMore than computers alone

•• Flexible ManufacturingFlexible Manufacturing•• All employees make All employees make decisionsdecisions•• Team incentives/ownershipTeam incentives/ownership•• Flat designFlat design•• Product diversity, short runsProduct diversity, short runs

•• Mass productionMass production•• Managers make decisions, Managers make decisions, workers are laborersworkers are laborers•• Piece ratesPiece rates•• HierarchyHierarchy•• Few Standard products, long Few Standard products, long runsruns

NewNewOldOld

The The ““oldold’’ vs. vs. ““newnew”” Johnson & JohnsonJohnson & Johnson

Cost Structure of a Large IT ProjectCost Structure of a Large IT Project

Source: Gormely et al.

HardwareHardware Application, Web, and database serversApplication, Web, and database servers $0.8$0.8including storageincluding storage

SoftwareSoftware ERP application Suite LicenseERP application Suite License $3.2$3.2(HR, Financials, Distribution)(HR, Financials, Distribution)1,000 regular trained users, 2,000 casual users1,000 regular trained users, 2,000 casual users

ImplementationImplementation 9 months to complete pilot site including9 months to complete pilot site including $9.3$9.3process engineering, apps configuration, and testingprocess engineering, apps configuration, and testing30 external consultants as $1,200 a day30 external consultants as $1,200 a day30 internal staffers at an average salary of $100,00030 internal staffers at an average salary of $100,000

DeploymentDeployment 3 external consultants at 9 sites for 3 months3 external consultants at 9 sites for 3 months $7.5$7.59 internal staffers at each site for 6 month9 internal staffers at each site for 6 month5 days of user training 5 days of user training 3 full3 full--time training staff at an average burdenedtime training staff at an average burdened

StartStart--up Costs Totalup Costs Total $20.5$20.5

$millions$millions Computerization > ComputersComputerization > Computers

Image by Ralph Clevenger

IT Capital (10%)IT Capital (10%)

Technological Technological Complements (15%)Complements (15%)

Organizational Organizational Complements (75%)Complements (75%)

Intangible AssetsIntangible Assetsare more important in are more important in

the Information Economythe Information Economy

3

Interactions Between IT and Digital OrganizationInteractions Between IT and Digital Organization

Mar

ketin

g va

lue

IT Capital

Digital org.

Puzzle: Why Did Productivity Accelerate Puzzle: Why Did Productivity Accelerate Even MoreEven More After 2000?After 2000?

PostPost--2000 Surge caught most people by surprise2000 Surge caught most people by surpriseSimple growth accounting explanations of faster growth in the 90Simple growth accounting explanations of faster growth in the 90s s do not work welldo not work well

The StoryThe Story1.1. IT investment associated with very large intangible organizationIT investment associated with very large intangible organizational al

capital investments: up to 10x size of computer investment capital investments: up to 10x size of computer investment (Brynjolfsson & Yang, 2002)(Brynjolfsson & Yang, 2002)

Business process redesign, training. Implementation, market and Business process redesign, training. Implementation, market and product strategy innovationproduct strategy innovation

2.2. Organizational investments are mostly Organizational investments are mostly ““expensedexpensed”” (Brynjolfsson & (Brynjolfsson & Fitoussi. 2005)Fitoussi. 2005)

This shifts productivity from present to the futureThis shifts productivity from present to the future3.3. Businesses moved from Businesses moved from ““sowingsowing”” to to ““harvestingharvesting”” after 2001after 2001

IT and BPR investment way down; big focus on costIT and BPR investment way down; big focus on cost--cutting and cutting and realizing potential gains realizing potential gains vsvs gold rush of exploring opportunities in late gold rush of exploring opportunities in late 1990s1990s

=> Consistent with data that show 5 year lags before peak produc=> Consistent with data that show 5 year lags before peak productivity tivity gains from IT (Brynjolfsson & Hitt, 2001)gains from IT (Brynjolfsson & Hitt, 2001)

Implications of StoryImplications of Story1.1. Standard growth accounting is wrongStandard growth accounting is wrong

1.1. Major Major investmentsinvestments have been treated as have been treated as expensesexpenses

2.2. Productivity surge in 2001Productivity surge in 2001--2004 was 2004 was unsustainable because it reflects unsustainable because it reflects harvesting of past investments, and lack of harvesting of past investments, and lack of future investmentsfuture investments

3.3. Productivity is dipping back Productivity is dipping back belowbelow trend trend now as a resultnow as a result

The Future of Productivity GrowthThe Future of Productivity Growth

BaumolBaumol’’ss Disease and CarrDisease and Carr’’s Complaints ComplaintIT: The ElixirIT: The Elixir

From Asymptotic Stagnation to Increasingly Accelerating GrowthFrom Asymptotic Stagnation to Increasingly Accelerating Growth

If high productivity sectors have price elasticity > If high productivity sectors have price elasticity > --1, 1, then they will shrink as a share of the economythen they will shrink as a share of the economyBut, if high productivity sectors have price elasticity < But, if high productivity sectors have price elasticity < --1, then they will grow as a share of economy1, then they will grow as a share of economyPrice elasticity of IT has been estimated to bePrice elasticity of IT has been estimated to be

……. . --1.21.2 (Brynjolfsson, 1996)(Brynjolfsson, 1996)““I want to convert labor costs to IT costs to ride the technologyI want to convert labor costs to IT costs to ride the technologycurvecurve”” –– Todd Thompson, Todd Thompson, CitiCiti CFOCFOFrom From String QuartetsString Quartets to to U2 U2 replicated x 1million on replicated x 1million on iTunesiTunes

4

Information Technology Share Information Technology Share of private nonresidential fixed investmentsof private nonresidential fixed investments

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

1947

1950

1953

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

Information processing equipment and software

Computers and peripheral equipment

Software\2\

Computers and Software

Looking ForwardLooking ForwardA) A) Easy Prediction: MooreEasy Prediction: Moore’’s Law and related trends s Law and related trends

for storage, communications, etc will continuefor storage, communications, etc will continueThe power of exponentialsThe power of exponentials

B) B) IT share of GDP is likely to grow furtherIT share of GDP is likely to grow furtherCommon to assume constant shareCommon to assume constant shareCFOs want to shift costs onto technology curveCFOs want to shift costs onto technology curve

C) C) Points A) and B) imply Points A) and B) imply growinggrowing impact of IT on impact of IT on productivityproductivity

D) D) Can IT Reverse the Curse of Can IT Reverse the Curse of ““BaumolBaumol’’ssDiseaseDisease””??

Depends on the substitutability of IT (and other rapidly Depends on the substitutability of IT (and other rapidly improving inputs)improving inputs)IT economyIT economy--wide price elasticity has been ~1.2wide price elasticity has been ~1.2LongLong--term elasticity may be higher (a la Le term elasticity may be higher (a la Le ChatelierChatelier))

ConcernsConcerns

Inequality Inequality TurbulenceTurbulenceInnovation IncentivesInnovation IncentivesMismeasurementMismeasurement: Beyond Productivity: Beyond Productivity

IT, Labor and WealthIT, Labor and Wealth

The changing demand for laborThe changing demand for laborWhat types of work will be replaced by machines and What types of work will be replaced by machines and which will be in greater demand?which will be in greater demand?

How will the distribution of wealth be affected How will the distribution of wealth be affected by continuing advances in IT?by continuing advances in IT?

ComputerComputer--skill complementarityskill complementarityGrowing InequalityGrowing Inequality

The Superstar effectThe Superstar effectThe top 1%; the top 0.1%The top 1%; the top 0.1%

5

Turbulence is GrowingTurbulence is Growing

Turbulence in sales, 1987-1996 vs. 1997-2004

0

5

10

15

20

25

30

35

40

0 5 10 15 20 25 30 35 40

Average rank change in sales, 1987-1996

Ave

rage

rank

cha

nge

in s

ales

, 199

7-20

04

Below Median IT IntensityAbove Median IT Intensity

Chemical mfg.

Publishing

Credit intermediation

Comptuer and electronic product mfg. IT as a Strategic DifferentiatorIT as a Strategic DifferentiatorAverage profit margin IQR by industry category, 1960-2004

0

10

20

30

40

50

60

70

80

90

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Ave

rage

pro

fit m

argi

n IQ

R

Business Process Replication: Business Process Replication: Achieving Scale Without MassAchieving Scale Without Mass

Case Study: CVSCase Study: CVSBasic Basic ‘‘script fulfillment process:script fulfillment process:

27% of scripts 27% of scripts encountered a encountered a problemproblem16% of customers 16% of customers disappointed at disappointed at pickpick--upup

Quality

Assurance

INVENTORY

INVENTORY

Drop-off DataEntry Production Quality

Assurance Pick-up

Standardscript path

Data entry

RPh

RPh

Shelves

Dr. call or

Production

ConsultareaDrop-off

Pick-up

Quality

Assurance

INVENTORY

INVENTORY

Drop-off DataEntry Production Quality

Assurance Pick-up

Standardscript path

Data entry

RPh

RPh

Shelves

Dr. call or

Production

ConsultareaDrop-off

Pick-up

1 hour before pick-up1st step = drug utilization review (DUR)

2nd step = insurance check

Case Study: CVSCase Study: CVS

ShortShort--term results: customer satisfaction scoresterm results: customer satisfaction scoresWait times: 76 Wait times: 76 8686Overall pharmacy satisfaction: 86 Overall pharmacy satisfaction: 86 9191

New process embedded in EITNew process embedded in EIT100% compliance100% compliance

< 1 year rollout to o< 1 year rollout to over 4000 retail pharmaciesver 4000 retail pharmacies

Drop-off DataEntry

Insurancecheck Production DUR QA Pick-up

While customer is present

Drop-off DataEntry

Insurancecheck Production DUR QA Pick-up

While customer is present

New fulfillment process:

6

Zero Marginal Costs and EfficiencyZero Marginal Costs and Efficiency

q

p

Cost = 0

CS

Profit DWL

P*

The The MismeasureMismeasure of Valueof Value

Value of New Goods, Product Variety and Value of New Goods, Product Variety and QualityQualityValue of Value of ““free goodsfree goods””

WikipediaWikipedia vs. Britannicavs. BritannicaThe growing gift economyThe growing gift economy

Product Variety ComparisonProduct Variety Comparison

Product Category Amazon.com Typical Large Brick-and-Mortar Store

Books 2,100,000 40,000 – 100,000 CDs 250,000 5,000 – 15,000 DVDs 18,000 500 – 1,500 Digital Cameras 213 36 Portable MP3 players 128 16 Flatbed Scanners 171 13

Wal-Mart stocks six times as many SKUs online versus in superstore

Policy ImplicationsPolicy ImplicationsBeyond (Tangible) TechnologyBeyond (Tangible) Technology

Two cheers for Management Consultants and BTwo cheers for Management Consultants and B--Schools!Schools!

Education: A winEducation: A win--winwinManaging TurbulenceManaging Turbulence

Protect people, not firms or industriesProtect people, not firms or industries

Incentives for InnovationIncentives for InnovationPick prices, not winnersPick prices, not winnersNew institutionsNew institutions

Opportunities for Better Measurement Opportunities for Better Measurement Measuring Organizational CapitalMeasuring Organizational CapitalProduct Variety & Consumer SurplusProduct Variety & Consumer SurplusMicroMicro--Micro DataMicro Data

7

Beyond Productivity: Consumer Beyond Productivity: Consumer SurplusSurplus

Productivity is output/inputProductivity is output/inputConsumer surplus is difference between Consumer surplus is difference between what consumer what consumer wouldwould pay vs. what pay vs. what consumer does payconsumer does pay

Consumer Surplus Consumer Surplus from Price Drop from Price Drop

or from New Goodor from New Good

P

Q

P

Q

p0p1

q0q1

p0

q0

IT Investment Slowed after 2000

0

1

2

3

4

1959 1964 1969 1974 1979 1984 1989 1994 1999 2004

Note: Investment in computer hardware, software, and telecommunications equipment as a share of GDP. Data are from the National Incomeand Product Accounts.

Share of GDPPercent

Real U.S. Computer Stock Real U.S. Computer Stock

Source: Bureau of Economic Analysis. Nonresidential assets. Quantity index, Year 2000=100

0

50

100

150

200

1990 1995 2000 2005

8

SummarySummary

Computerization Computerization Creation of intangible assets.Creation of intangible assets.

The value of these intangibles can be as much as 20 The value of these intangibles can be as much as 20 times as the value of computer assets alonetimes as the value of computer assets aloneTechnologyTechnology--enabled business process reengineering enabled business process reengineering can lead to significantly higher market value than can lead to significantly higher market value than computers or reengineering alone.computers or reengineering alone.Finally, the Finally, the interactioninteraction of business process of business process reengineering, computer capital, reengineering, computer capital, and and a cluster of new a cluster of new work practices and culture is even work practices and culture is even more more valuable.valuable.

Organizational Capital and Organizational Capital and IntangiblesIntangibles

Increasing share of all investment is in Increasing share of all investment is in business processes, human capital, and business processes, human capital, and other intangiblesother intangibles

Computerization > ComputersComputerization > Computers

Image by Ralph Clevenger

IT Capital (10%)IT Capital (10%)

Technological Technological Complements (15%)Complements (15%)

Organizational Organizational Complements (75%)Complements (75%)

Intangible AssetsIntangible Assetsare more important in are more important in

the Information Economythe Information Economy

TobinTobin’’s q in 2006s q in 2006

4.54.5$15.0$15.0$67.8$67.8DellDell

2.12.1$66.1$66.1$140.1$140.1HewlettHewlett--PackardPackard

24.724.7$5.3$5.3$130.9$130.9GoogleGoogle

4.14.1$8.5$8.5$35.0$35.0YahooYahoo

1.51.5

8.78.7

1.51.5

1.91.9

TobinTobin’’s s qq

Book Book Value of Value of AssetsAssets

Total Total Market Market ValueValue

$4.7$4.7

$18.3$18.3

$42.3$42.3

$278.7$278.7

$3.1$3.1

$2.1$2.1

$28.4$28.4

$145.2$145.2

Barnes and NobleBarnes and Noble

Amazon.comAmazon.com

SearsSears

WalmartWalmart

Source: Google Finance. Cash is subtracted from market value and assets.

9

Seven Practices of Seven Practices of Digital OrganizationsDigital Organizations

1.1. Move from analog to digital business Move from analog to digital business processes processes

2.2. Distribute decisionDistribute decision--rightsrights3.3. Foster open information accessFoster open information access4.4. Link incentives to performanceLink incentives to performance5.5. Maintain focus and communicate goalsMaintain focus and communicate goals6.6. Hire the best peopleHire the best people7.7. Invest in human capitalInvest in human capital

ScatterplotScatterplot: Sales Concentration : Sales Concentration GrowthGrowth

Average growth rate in HI of sales, 1987-1996 vs. 1997-2004

-15

-10

-5

0

5

10

15

20

25

30

-15 -10 -5 0 5 10 15 20 25 30

Average of yearly HI sales growth rate (%) , 1987-1996

Ave

rage

of y

early

HI s

ales

gro

wth

rate

(%) ,

19

97-2

004

Below Median IT IntensityAbove Median IT Intensity

Real estatePerforming Arts

Textiles

Wholesale

Construction

Competition in Product MarketsCompetition in Product Markets

How does IT affect product marketsHow does IT affect product marketsProduct variety and the Long TailProduct variety and the Long TailWinnerWinner--taketake--all marketsall markets

Information OverloadInformation Overload

10

Digital information is Digital information is doubling every 1.1 yearsdoubling every 1.1 years Information Consumes AttentionInformation Consumes Attention

“The scarce resource is not information,

it is the processing capacity to attend

to information”- Herbert Simon

Responses to Information Responses to Information OverloadOverload

1.1. AutomateAutomateOffOff--load work from humans to machinesload work from humans to machines

2.2. Train and hireTrain and hire skilled, educated workersskilled, educated workersIncrease the capacity of human processorsIncrease the capacity of human processors

3.3. ReorganizeReorganize to distribute decision makingto distribute decision makingDelegate to involve more brainsDelegate to involve more brains

4.4. Focus and FilterFocus and FilterLearn to ignore; Learn to prioritize; Learn to say noLearn to ignore; Learn to prioritize; Learn to say no

5.5. CombinationsCombinations of the aboveof the aboveCreativity needed to boost information metabolismCreativity needed to boost information metabolism

Emerging topicsEmerging topics

Funding models for digital infoFunding models for digital infoBundling and aggregation, targeted ads, open source, Bundling and aggregation, targeted ads, open source, information complements, etc.information complements, etc.

Innovation incentives for digital goodsInnovation incentives for digital goodsOnline CommunitiesOnline Communities

CyberbalkanizationCyberbalkanization or Global Villageor Global Village

Platforms for products and innovationPlatforms for products and innovationReputation and RecommendersReputation and RecommendersStickinessStickiness

11

Innovation Incentives for Digital Innovation Incentives for Digital GoodsGoods Couponing MechanismCouponing Mechanism

Sell the bundle of Sell the bundle of i i goods to each of goods to each of jj consumersconsumersChoose Choose mm××nn random consumers and issue each random consumers and issue each of them a digital rebate coupon tied to DRMof them a digital rebate coupon tied to DRM

nn : : price levelsprice levelsm m :: coupons coupons offered for each offered for each price levelprice levelmm××nn << << ii××jj soso

relatively few consumers facerelatively few consumers faceprices for a given goodprices for a given good

ExampleExample

$.17$.17

$.36$.36

$.73$.73

$.99$.99

mm=3=33 coupons3 couponsper priceper pricelevellevel

nn=4=44 price4 pricelevelslevels

pp

qq

.99.99

.73.73

.36.36

.17.17

11 22 33

SimulationSimulation

10107.57.555

2.52.5

11 22 33

12

Which Innovation Will Be Pursued?Which Innovation Will Be Pursued?p

P*P*

QQq*

Targeted Innovation Targeted Innovation –– High High TypeType

*p

q*QQ

P*P*

Targeted Innovation Targeted Innovation –– Low Low TypeType

*p

q* q’QQ

P*P*

Targeted Innovation Targeted Innovation –– For Marginal For Marginal ConsumersConsumers

*p

q*QQ

P*P*

13

Targeted Innovation Targeted Innovation –– For Marginal For Marginal ConsumersConsumers

q*

p*+δ

Social ContributionSocial Contribution

SellerSeller’’s gainss gains++

δδ

δ *

*2

**

2)(

21

)(onContributi Social

Gains sSeller' p

pf

pfp==

QQ

P*P*

Frontier Research OpportunitiesFrontier Research Opportunities1.1. Using TaskUsing Task--level Datalevel Data

Social Network AnalysisSocial Network AnalysisControlled ExperimentsControlled Experiments

2.2. Consumer SurplusConsumer SurplusBeyond ProductivityBeyond Productivity

3.3. Organizational Capital and IntangiblesOrganizational Capital and Intangibles4.4. IT, Labor and WealthIT, Labor and Wealth

Education, skills and income inequalityEducation, skills and income inequalityThe economics of superstarsThe economics of superstars

5.5. Competition in Product MarketsCompetition in Product MarketsThe long tail vs. winner take all markets?The long tail vs. winner take all markets?

6.6. Business Process ReplicationBusiness Process ReplicationAchieving scale without massAchieving scale without mass

7.7. Information OverloadInformation OverloadHow much information is produced each year?How much information is produced each year?Technological and organizational responsesTechnological and organizational responses

8.8. Innovation Incentives in Information GoodsInnovation Incentives in Information GoodsMechanism designMechanism designOpen source and the gift economyOpen source and the gift economy

TaskTask--level datalevel data

Finer grained dataFiner grained dataLike using a microscopeLike using a microscope

Look at communication flows to create Look at communication flows to create social networkssocial networksDesigned experimentsDesigned experiments

14

IT variables Intermediate Output Final Output

A Model of A Model of Information Work:Information Work:

RevenueCompletion

Rate

Multitasking

Duration perTask

ESSSkill & Use

CommunicationNetwork

Size & Structure

IT variables Intermediate Output Final Output

53,050.

-.692.17

1.9

.126

.009

.751

Revenue From Obscure TitlesRevenue From Obscure Titles

0

1

2

3

4

5

6

7

8

9

10

0 200,000 400,000 600,000 800,000 1,000,000 1,200,000 1,400,000 1,600,000 1,800,000

Rank

Sale

s

What proportion of sales at Amazon.com are from obscure What proportion of sales at Amazon.com are from obscure books?books?Use rank, assume Pareto relationship between rank and sales: Use rank, assume Pareto relationship between rank and sales: Q= a* Q= a* RankRankbb

Mapping Communication NetworksMapping Communication Networks

Sector 1

COO & Pres.

Sector 2Sector 3

ResearchStaff

Design of the ExperimentDesign of the Experiment

“Best” Customers

10,000

“Other” Customers

10,000

Initial Sample

20,000

Random assignment Random assignment

Control Group

5,000

Test Group

5,000

12 catalogs 12+5 catalogs

Control Group

5,000

Test Group

5,000

12 catalogs 12+5 catalogs

15

Fixed Investment and Information Fixed Investment and Information Technology Investment Share Technology Investment Share

of GDPof GDP

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

1947

1950

1953

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

Private fixed investment

Nonresidential Fixed Investment

Information processing equipment andsoftwareComputers and peripheral equipment

Software\2\

Computers and Software