Information Technology and Firm Boundaries: Evidence from Panel Data

Previous literature has suggested that information technology (IT) can affect firm bound- aries by changing the costs of coordinating economic activity within and between firms (internal and external coordination). This paper examines the empirical relationship between IT and firm structure and evaluates whether this structure is consistent with prior arguments about IT and coordination. We formulate an empirical model to relate the use of information technology capital to vertical integration and diversification. This model is tested using an 8- year panel data set of information technology capital stock, firm structure, and relevant control variables for 549 large firms. Overall, increased use of IT is found to be associated with substantial decreases in vertical integration and weak increases in diversification. In addition, firms that are less vertically integrated and more diversified have a higher demand for IT capital. While we cannot rule out all alternative explanations for these results, they are consistent with previous theoretical arguments that both internal and external coordination costs are reduced by IT

The Internet and the Future of Financial Services: Transparency, Differential Pricing and Disintermediation

The Internet has had a profound effect on the financial service sector, dramatically changing the cost and capabilities for marketing, distributing and servicing financial products and enabling new types of products and services to be developed. This is especially true for retail financial services where widespread adoption of the Internet, the standardization provided by the world-wide web, and the low cost of Internet communications and transactions have made it possible to reach customers electronically in ways that were prohibitively costly even 5 years ago; indeed, pre-Internet attempts at the online distribution of retail financial services were outright failures in the mid-1980s. The concurrent growth and de-facto standardization of Internet-enabled personal financial management software (e.g., Quicken and Microsoft Money) have also contributed to an increasing array of low cost and potentially richer ways to provide information and transaction services to customers. The growth in Internet-enabled products and service has been rapid in some sectors and slower in others. Retail brokerage has seen a dramatic change with more than 15% (Salomon Smith Barney, 2000) of brokerage assets now managed in on-line trading counts, and substantially more if "traditional" brokerage accounts and mutual funds with on-line access are included. Similarly, approximately 10 million US customers currently use on-line banking (O'Brien, 2000) and 39 of the top 100 banks offer fully functional internet banking (ePayNews, 2000). Many banks and brokerages are on their second or third release of their on-line delivery platform. Credit cards, while not radically transformed in operational aspects of the business, have begun to have some volume of new origination on-line. In addition, leading credit card companies such as Capital One Financial have been some of the largest "traditional" companies in the use of Internet advertising (see www.adrelevance.com, 1999). More regulated and complex financial products such as mortgages and insurance have had some origination volume on the Internet (an estimated $17Bn of mortgages will be originated and ~$400mm in insurance premiums will be sold online in 2000). For these sectors, the adoption of on-line origination has been much slower and concentrated in entrants, rather than incumbent firms. However, despite the small level of originations, the Internet has become a significant and growing source of product information - it is estimated that about 10% of insurance customers and 15% of mortgage customers have used the internet to shop for these products (Forrester, 1998; McVey, 2000). This may ultimately affect product purchase and pricing structure, irrespective of the delivery channel. Internet companies have also played a role in many other segments of the industry such as financial information and news, rating and comparison services, and even some areas where one might think the Internet would have a less significant role, such as financial planning and investment banking. While the continued growth rates are uncertain and the penetration for the more complex products has not yet been shown to be widespread, it is safe to conclude that the Internet will play a significant role in consumer financial services for a large subset of customers, and that this role will be significantly different across different sub-sectors of the financial industry. In discussions of the Internet impact on the financial services sector, the emphasis has often been placed on the direct cost-saving effects of using the Internet to provide transaction services. These potential cost savings are indeed significant and in the long term may lead to significant creation of value. However, there also substantial barriers to realizing much of this value. In some industries, such as the credit card industry, many of the potential gains from automation have already been realized, and in others, the gains may be concentrated in only a few areas of the value chain. For products which are sold through branches or agents (banking, mortgage and insurance), realization of cost savings will require a difficult and time consuming redesign of the retail delivery system. Finally, many of these efficiencies are accompanied by improved customer convenience. To the extent that consumers respond by consuming more services, particularly those that generate costs but not revenue, overall costs may not be substantially reduced. This has been the experience of previous innovations in retail financial service delivery such as automated teller machines (ATMs). Computers, and more recently the Internet, are best described as "general purpose technologies" (Brynjolfsson and Hitt, 2000), like the electric motor or the telegraph (Bresnehan and Trajtenberg, 1995). For general purpose technologies, most of the economic value they create is associated with their ability to enable complementary innovations in organization, market structure, and products and services. However, at the same time, these complementary changes are often disruptive to the existing structure of an industry (Tushman and Anderson, 1986; Bower and Christensen, 1995), leading to significant redistribution of value among industry participants and between producers and consumers. To understand the true impact of the Internet on the financial service industry, it is therefore necessary to identify how the Internet affects the critical drivers of industry structure, and how it enables or necessitates changes in products and services. This will necessarily be difficult, as it is hard to isolate the contribution of the Internet separately from the effects of other complementary innovations, and to distinguish Internet effects from other of long-term industry trends and exogenous factors. While obtaining precise numerical estimates of the productivity effects will be hard, in many cases the direction and general magnitude of the impact on productivity, profitability and consumer surplus (consumer value) will be clear. We see three principal issues that will determine the transformation of retail financial services: Transparency, or the ability of all market participants to determine the available range of prices for financial instruments and financial services; Differential pricing, in which finer and finer distinctions must be made among groups of customers, setting their prices based upon the revenue streams they generate, the costs to serve them, and their resulting profitability; Disintermediation or bypass, in which net-based direct interaction eliminates the role previously enjoyed by financial advisors, retail stock brokers, and insurance agents. Each of these will affect the roles to be played by financial service providers, the sources of profits available to them, and the strategies they may choose to pursue in order to earn those profits. However, different financial products will be affected differently by each of these issues in both the nature and the magnitude of the effect. In addition, these factors are often interdependent - for example, differential pricing is often a necessary response to increasing price transparency to prevent erosion of margins, and the ability to deliver sophisticated (although typically not complex) pricing strategies to customers may be affected by the incentives and structure of the distribution system. For these reasons, we will organize the remainder of the paper around the discussion of these effects as they apply within different sectors in financial services. The emphasis of our analysis will be on the primary sectors in retail financial services: credit cards, deposit banking, mortgages, brokerage, and insurance. Our focus is the retail segment because it has been the most radically transformed by the Internet to date, primarily because the retail business has the most to benefit from the reduction in customer interaction costs, the ability to reach mass markets, and the reduction in the role of geography in determining the strategies of financial services providers. Much of the computing- and communications-enabled transformation in the relationships among financial institutions or between financial institutions and consumers of wholesale financial services (for example, brokerage houses and exchanges, or large firms and their commercial lenders) have already occurred or were well underway before the Internet was commercialized. For these markets, the economics of computing and networking were still favorable under previous generations of technology. Many of the commercial financial services that are likely to be transformed by the Internet, at least in the medium term (3-5 years), are those that closely resemble retail services (such as commercial mortgage, short term lending, leasing, cash management, and the like). That is not to say that business to business (B2B) e-commerce opportunities do not exist in the financial sector - only that many of the medium term opportunities that are directly a result of the Internet are closely analogous to changes in the retail sector, and the others are probably more closely related to organizational and market innovation rather than a result of ubiquitous and low-cost communications technology.

Do Better Customers Utilize Electronic Distribution Channels: The Case of PC Banking

Firms are increasingly implementing electronic distribution strategies to augment existing physical infrastructure for product and service delivery. However, to date there has been little systematic study on how these distribution channels affect customer profitability. In this study, we explore the revenue enhancement potential for electronic delivery in retail banking by comparing customers who utilize personal-computer based home banking ("PC Banking) to other bank customers. Our results, based on case studies and detailed customer data from four institutions, suggest that while PC banking customers appear to be more profitable, most of the differences are due to unobservable characteristics of these customers that were present before PC banking was adopted. Demographic characteristics and changes in customer behavior following the adoption of the product account for only a small fraction of the overall differences. We conclude that, at least to date, the primary potential value of the product is in the retention of high value customers rather than cost savings or incremental sales. Our results also suggest that it is important to distinguish behavioral changes from pre-existing customer characteristics when evaluating the impact of added electronic delivery channels.

Vertical Scope Revisited: Transaction Costs vs Capabilities & Profit Opportunities in Mortgage Banking

What determines vertical scope? Transactions cost economics (TCE) has been the dominant paradigm for understanding "make" vs. "buy" choices. However, the traditional focus on empirically validating or refuting TCE has taken attention away from other possible drivers of scope, and it has rarely allowed us to understand the explanatory power of TCE versus other competing theories. This paper, using a particularly rich panel dataset from the Mortgage Banking industry, explores both the extent to which TCE predictions hold, and their ability to explain the variance in scope, when compared to all other possible drivers of integration. Using some direct measures of transaction costs, we observe that integration does mitigate risks; yet such risks and transaction costs do not seem to drive firm-level decisions of integration in retail production of loans. Rather, capability-driven and capacity- (or limit to growth-) driven considerations explain a significant amount of variance in our sample, under a variety of specifications and tests. We thus conclude that while TCE explanations of vertical scope are important, their impact is dwarfed by capability differences and by the desire of firms to leverage their capabilities and productive capacity by using the market.Mortgage Banking; Transaction Costs; Integration; Capabilities; Capacity Constraints; Limits to Growth

How Do Data Skills Affect Firm Productivity: Evidence from Process-driven vs. Innovation-driven Practices

As digitization of human behaviors become more prevalent, we examine whether data-analysis capabilities can help with process- and innovation-oriented firm practices. Using firm level data on employee data analysis capabilities combined with a survey of organizational practices for 330 large firms, we find that while neither data skills nor process-related practices affect productivity directly, they have a substantial positive interaction. Specifically, firms with process-related practices receive a greater marginal benefit for the presence of or acquisition of data-related skills in their workforce. However, we do not find the same complementarities between data-related skills and innovation-oriented practices and at times the interaction can even be negative. These results are also unique to data-related skills and not IT skills generally. Overall these results highlight the potential tradeoffs of using data analytics at firm, similar to the tradeoffs between exploitation and exploration

Transaction Costs and Market Efficiency

Previous research suggests that a decline in transactions costs leads to improved economic efficiency. In this paper, we show that such a decline will introduce increasingly uninformed consumers into established markets. Using a model of financial market inefficiency, we show that this increase in uninformed individuals can increase market risk (volatility), can decrease efficiency, and may reduce social welfare even when market participantsareperfectlyrational. Wethentestthepredictionsofourmodelusingdataontheretailequities market. Our results suggest that securities that have a large proportion of small trades (presumably dispro- portionately from small, online retail investors) tend to be less efficient by conventional measures, consistent with our model predictions

The Economics of Telecommuting: Theory and Evidence

While there has been considerable research on the effect of telecommuting on worker’s productivity and quality of work life, there is considerably less work on the managerial problems associated with selecting, monitoring, and compensating workers involved in telecommuting. We propose a model based on contract theory to analyze the managerial decisions on telecommuting, focusing on (1) how managers should decide which workers will have the opportunity to telecommute and (2) how managers should monitor and provide incentives to workers who participate in telecommuting programs. Based on the model, we find that managers’ willingness to allow telecommuting is related to the amount of information they have about their employees and that employees who telecommute should have incentives based both on subjective evaluations and objective measures. Using data from the 1998 Workplace Employment Relationship Survey (WERS98), we test these predictions and find that they are supported by the data

Information Technology as a Factor of Production : The Role of Differences Among Firms

Despite evidence that information technology (IT) has recently become a productive investment for a large cross-section of firms, a number of questions remain. Some of these issues can be addressed by extending the basic production function approach that was applied in earlier work. Specifically, in this short paper we 1) control for individual firm differences in productivity by employing a firm effects specification, 2) consider the more flexible translog specification instead of only the Cobb-Douglas specification, and 3) allow all parameters to vary between various subsectors of the economy. We find that while firm effects may account for as much as half of the productivity benefits imputed to IT in earlier studies, the elasticity of IT remains positive and statistically significant. We also find that the estimates of IT elasticity and marginal product are little-changed when the less restrictive translog production function is employed. Finally, we find only limited evidence of differences in IT\u27s marginal product between manufacturing and services and between the measurable and unmeasurable sectors of the economy. Surprisingly, we find that the marginal product of IT is at least as high in firms that did not grow during 1988-1992 sample period as it is in firms that grew

Information Technology and Product Variety: Evidence from Panel Data

This paper examines the relationship between information technology and product variety. Consistent with prior theoretical work, we argue that IT and product variety are complements. IT innovations such as computer-aided design and flexible manufacturing technology have enabled firms to offer greater product variety at a reasonable cost. Similarly, firms seeking to offer greater variety can facilitate this strategy through IT investment. Using a novel approach to measuring product variety at the firm level through trademark counts we examine the relationship between IT and variety in four ways: direct correlations, IT and variety demand estimation, productivity analyses, and market value analyses. We utilize an 11-year panel data set of information technology capital stock, trademark holdings, and other measures for 512 Fortune 1000 firms to test our hypotheses. Overall, we find that IT is found to be associated with increased product variety, and that increased product variety increases demand for IT investment. Complementarities between IT and product variety are not significant in the productivity analysis but appear strongly when we consider their influence on firm valuation

IS INFORMATION SYSTEMS SPENDING PRODUCTIVE? NEW EVIDENCE AND NEW RESULTS

The productivity paradox of information systems (IS) is that despite enormous improvements in the underlying technology, the benefits of IS spending have not been found in aggregate output statistics. One explanation is that IS spending may lead to increases in product quality or variety which tend to be overlooked in aggregate output statistics, even if they increase sales at the firm level. Furthermore, Lhe restructuring and cost-cutting that are often necessary to realize these potential benefits have only recently been undertaken in many firms. Our study uses new firm-level data on several components of IS spending for the period 1987 to 1991. The dataset includes 380 large firms which generated approximately two trillion dollars in output annually. We supplemented the IS data with data on other inputs, output, and price deflators from several other sources. As a result, we could assess several econometric models of the contribution of IS to firm-level productivity. Our results indicate that IS have made a substantial and statistically significant contribution to firm output. We find that between 1987 and 1991, return on investment (ROD for computer capital averaged 54% in manufacturing and 68% for manufacturing and services combined in our sample. We am able to reject the null hypothesis that the ROI for computer capital is no greater than the return to other types of capital investment and also find that IS labor spending generates several times as much output as spending on non-IS labor and expenses. Because the models we applied were essentially the same as those that have been previously used to assess the contribution of IT and other factors of production, we attribute the different results to the recency and larger size of our dataset. We conclude that the productivity paradox disappeared by 1991, at least in our sample of firms