Digital Intelligence
What Every Smart Manager Must Have for Success in an Information Age
Sunil Mithas
Digital
Intelligence
©
2011Sunil K. Mithas
All Rights Reserved. No part of this book may be reproduced in any form by any electronic or mechanical means (including photocopying, recording, or information storage and retrieval) without permission from the author.
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To Priti
Chapter 1: Crafting Digital Business Strategies
Chapter 2: Navigating Digital Innovations and Industry Transformations
Chapter 3: Governance of Digital Resources
Chapter 4: Allocating Digital Resources and Prioritizing IT Projects
Chapter 5: Delivery of IT Services: In-house, Outsource, or Offshore?
Chapter 6: Managing Digital Infrastructure
Chapter 7: Managing Digital Enterprise Systems
Acknowledgments
I am indebted to the countless people who have shaped the contents of this book, directly or indirectly, and have allowed me to undertake this effort. There is no way I can name everyone here, so I seek apologies from those whose name does not appear.
I am grateful to my colleagues who have taught information systems and related courses at University of Maryland and other business schools; it is through conversations with them that I realized the need for a book like this. I thank Hank Lucas, Ritu Agarwal, Anand Gopal, Joe Bailey, and Chris Dellarocas for stimulating interactions that shaped some of my thinking articulated in this book. I am also thankful to my other colleagues at the University of Maryland for providing a supportive and encouraging environment for research and teaching, which led to this book. Among them are Dean Anand Anandalingam, Howard Frank (former Dean), Zhi-Long Chen, Roland Rust, Hugh Courtney, Susan Taylor, and many others. I was inspired by conversations with Dennis Severance, Scott Moore, Tom Schriber, and M.S. Krishnan along with numerous other colleagues in the information systems field with whom I have interacted about teaching- and research-related issues at conferences, teaching workshops or in other settings.
I thank colleagues and research collaborators with whom I have worked over the years, and I draw on some of that work in writing this book. I would like to acknowledge some of them here, in no particular order: M.S. Krishnan, Claes Fornell, Hank Lucas, Ritu Agarwal, Will Mitchell, V. Sambamurthy, Roland Rust, Jie Mein Goh, Indranil Bardhan, Kunsoo Han, Joni Jones, Forrest Morgeson, Narayan Ramasubbu, Jonathan Whitaker, Ali Tafti, and Daniel Almirall.
I want to thank friends and executives who have facilitated my research and teaching activities, which form the basis for some of the ideas in this book. I could not have conducted my research without significant help from Bob Evans, Brian Gillooly, Rusty Weston, Stephanie Stahl, and Lisa Smith at InformationWeek. I thank Claes Fornell, Forrest Morgeson, David VanAmburg, and Jaesung Cha of the National Quality Research Center (NQRC) at the Ross School of Business at the University of Michigan for making the American Customer Satisfaction Index (ACSI) data available for my dissertation research.
I am grateful to J.J. Irani, B. Muthuraman, Bimlendra Jha, Sunil Sinha, Firdose Vandrevala, Jehangir Ardeshir, Shreekant Mokashi, Chetan Tolia, and Ravi Arora for their help in my past and ongoing work with the Tata Group. I thank Prasanto K. Roy for his friendship and support of my research related to Indian IT and the BPO industry.
Among more direct shapers of this work, I thank the hundreds of students with whom I have shared many of the ideas articulated in this book. You have helped to refine my thinking over the years through your questions and curiosity. You also taught me, while I was trying to teach you.
I thank Andy Seagram for careful editing and numerous suggestions to improve the presentation of ideas in this book.
Finally, I want to acknowledge perhaps the most important people who allowed me to deny them the time that it took to write this book—Priti and Aditya. Thank you for your support and understanding and letting me get away with this venture.
Preface
“No thought has a real meaning unless it is written or spoken.”
—Andy Rooney (his last interview with Morley Safer on 60 Minutes on 2 Oct 2011)
“How can I know what I think or feel until I see what I say and do?”
—Karl Weick (Weick 2001, p 463)
Why This
Book?
The motivation for writing this book comes out
of a conviction that managing information technology (IT) in an
organization requires a competence or skill set, what I call "digital
intelligence" or “ITracy.” Digital intelligence is a
fundamental and prerequisite skill for all managers in today’s
information economy. It is not something that applies only to IT
professionals. It is a competence as essential as numeracy, literacy,
or basic familiarity with accounting, finance (Berman and Knight
2009), supply chain (Dischinger et al. 2006), global business
(Javidan, Teagarden and Bowen 2010), or marketing (Rust, Moorman and
Bhalla 2010).
It is perhaps not an overstatement to say that digital intelligence is becoming a critical skill for anyone aspiring to become a senior leader or CEO (Earl and Feeny 2000; Mithas and Lucas 2010b). While basic numeracy and literacy will still be necessary for economic success, they alone will not be sufficient and adequate for success in jobs in the information economy. Increasingly, contemporary firms such as Barnes & Noble and Sears are hiring their CEOs and top executives on the basis of their ITracy, or their ability to navigate the digital future their industries face (Bustillo and Lubin 2011; Mithas, Agarwal and Courtney 2011a; Trachtenberg 2010). Barnes & Noble chose to appoint a relatively young 39-year-old executive named William Lynch, who joined Barnes &Noble in 2009 as president of the Barnes&Noble.com online unit, to the position of CEO because of his ITracy (Trachtenberg 2010). The CEO of ICICI, a private bank in India, claims to be its CIO as well (Puri 2007).
In another example of how a lack of digital intelligence can sink a company, Carl Icahn partly blamed the lack of digital savvy of Blockbuster’s CEO for its bankruptcy (Icahn 2011). Procter & Gamble (P&G) has reportedly created a “digital skills inventory” of its employees, which includes a baseline assessment of skills such as how to connect to the Internet and use basic collaboration and knowledge-exchange tools for online meetings and mail as well as how to participate in firm’s internal social network, P&G Pulse, for news and training (Hardy 2011).
By focusing on digital intelligence, I also confront two misconceptions that I came across in my teaching, research, and consulting experience with hundreds of business students and executives. The first misconception is that managing IT is something that should be delegated to IT employees and that business managers can succeed simply by focusing on conventional skills, such as accounting, finance, or marketing. However, this is often not true; in today’s job market, all managers need some fundamental IT competencies to be successful in their jobs.
A second misconception is that some people believe that they already know how to manage IT because they can shop online, check e-mails, or engage with social media. This misconception is also not true; being able to work with computers and digital devices alone is not going to ensure personal or professional success in today’s information age. Digital intelligence is not the same as computer literacy—it encompasses these basic skills but goes beyond them. It is also different from IT fluency, in that ITracy focuses more sharply on competencies for success in organizations from a managerial perspective.
The Need
Why focus on digital intelligence and IT? IT is fundamentally changing our society and the world of business. Some believe that IT is “flattening” the world (Friedman 2005) and may have negative consequences for jobs and salaries in developed economies (Blinder 2006). Others have a somewhat different perspective, arguing that current geographical patterns in occupations and business activity will likely continue and that those with better skills will do well regardless of their location (Bhagwati, Panagariya and Srinivasan 2004; Florida 2005; Florida 2007; Mithas and Whitaker 2007). Despite these differing perspectives, there is general agreement that the changes unleashed by IT are similar in magnitude to those evident in first and second industrial revolutions.
It is difficult to think of any business process or functional area that is unaffected by IT in contemporary firms. From our personal experience and what we witness taking place around us, it is easy to see how IT is changing our lives in many ways, including how we learn, work (Zuboff 1988), play, communicate, fight, and do business. Chandler (2000) refers to these collective changes as “the information revolution,” while Blinder (2006) suggests that these changes are “early stages of a third industrial revolution.” This revolution affects everyone across the globe regardless of where a person lives and works.
Why should all this matter to a business manager? From a strategic perspective, IT can create and sustain competitive advantage, if managed well. While there are some examples of leaders and managers having been able to use IT as a lever to transform their organizations for competitive success, many more have failed to successfully manage IT. Those who have used IT effectively have done well for themselves and for their firms, and those who have ignored or mismanaged IT have destroyed societal value and have led their firms toward failure or bankruptcy.
All conscientious managers, particularly those who are or aspire to be leaders, have a duty to manage resources, including IT resources, in their organizations in a responsible and thoughtful manner (Khurana and Nohria 2008). Regardless of their current functional affiliation or career goals, their future success will critically depend on how they lead and manage IT-enabled strategic changes. To that end, this book can be of help.
Intended Audience
This book is intended for general managers and students who want to improve their digital intelligence or digital IQ. The book espouses the belief that ITracy is an important competence that global leaders need to have in today’s economy to become more productive and informed members of the society and to enhance the performance of their organizations. The book lays out the most basic competencies and skill sets for thinking about IT and IT-enabled changes that all managers should have (Goldsmith et al. 2003).
It draws on related work that articulates some of the dimensions of digital intelligence (Dhar and Sundararajan 2007; Earl and Feeny 2000; National Research Council 1999); yet because of the focus on general managers, it avoids details of technologies and implementation that should ideally be handled by trained IT professionals who may have computer science or engineering backgrounds and related education. It is not necessary for managers and entrepreneurs to have a programming or computer science background to acquire ITracy. It may surprise some that even Steve Jobs, one of the most successful technology entrepreneurs and executives, did not have a degree or background in computer science or programming. Steve is not alone; this is also true of many other “digital immigrants” who have made significant contributions to IT. If people without a technology background can be technology pioneers, such success should encourage everyone to embrace ITracy and use technology intelligently in business.
How This Book Differs from Others
Although there are already several good books that deal with IT-related topics, this book differentiates itself in several key respects. First, unlike many good textbooks (Applegate, Austin and Soule 2009; Gallaugher 2010; Lucas 2005; Pearlson and Saunders 2006; Piccoli 2007), this book is primarily written from the perspective of an informed and curious manager or executive.
There are also some good trade books that cover IT management, IT-enabled transformation, and IT-enabled innovations. They cover important topics that complement or amplify some of the themes of this book (Brynjolfsson and Saunders 2010; Levy and Murnane 2004; Lucas 2008; McKenney, Copeland and Mason 1995; Prahalad and Krishnan 2008; Severance and Passino 2002). However, they do not focus as sharply on fundamental competencies that underlie what I call ITracy. Likewise, other books focus on how to lead change efforts (Kotter 2007; Kotter and Cohen 2002; Kotter and Whitehead 2010), but they are silent on how to identify what type of change is needed and the role of IT in catalyzing industry transformations.
Second, although I try to be brief and direct whenever possible, I provide citations to relevant scholarly research and other sources for readers who may want to explore a given topic in greater detail.
In summary, this book introduces some of the key issues in managing IT. It provides an overview of IT systems in contemporary firms and how they enable and support a firm’s strategic and operational goals. By understanding how IT is shaping industry structure and the competitive environment and how to manage IT-related decision making, managers can craft superior strategies and use IT as a lever to innovate and transform to satisfy their internal and external customers.
Sunil Mithas
sunil.mithas@gmail.com
www.sunilmithas.com
College Park, Maryland
January 2012
Introduction
Digital Intelligence: A New Competence for Success in the Information Age
“Using the technology to its full
potential means using the man to his full potential.”
—An anonymous worker, quoted in Zuboff (1988, p. 414)
Digital
intelligence, the ability to understand and make use of the power of
information technology to one’s advantage, is becoming a critical
skill for survival and success in today’s economy. Every manager,
organization, and even nation needs to be asked and be able to answer
the question, What is your digital business strategy? How should you
strategically manage your digital resources?
Digital resources may present an opportunity for a firm, as they did for eBay, Google, Amazon.com, and Netflix, or these resources might threaten a firm, as they have for Kodak, Borders, Blockbuster, and the New York Stock Exchange. Global spending on IT resources exceeds US$3 trillion a year, and many organizations spend more than a billion dollars every year on IT (Scheck, Worthen and Tam 2008). While senior managers sometimes ask what the return is from their investments in technology, a better counterfactual question might be, How can we use technology as a strategic asset to enable new competencies or maintain a competitive advantage?
The Digital Advantage
Consider Netflix: IT is a vital component of Netflix’s business model and strategy. The firm’s business model was to provide video entertainment over the Internet. However, achieving this objective required extensive negotiations with those entities that held the rights to these videos—namely, movie studios and television networks. Netflix also had to solve the problem of how to move video to the television set using the Internet.
To establish itself in the marketplace, Netflix’s interim strategy was to use IT to create a highly efficient system for the distribution of physical DVDs through the mail. Its longer-term strategy, however, was to use technology to allow consumers to download videos to their personal computers over the Internet and to partner with services like Roku and other consumer electronics manufacturers to allow consumers’ to download directly to a their television set over the Internet.
Thanks to its digital business strategy, Neflix was ready for changes in technology and consumer behavior in 2010; it reports that approximately 60% of its customers have already experimented with streamed videos over the Internet (Grover 2010). In contrast to Netflix, Blockbuster’s digital strategy was too little, too late.
Making IT as a Strategic Asset
Given the significance of IT, senior managers need to develop a digital business strategy and communicate it throughout the organization. Developing such a strategy requires synchronizing digital assets and IT infrastructure with business strategy (Prahalad and Krishnan 2002). As managers develop a strategy to achieve their goal—for example, to be the low-cost producer or to be number 1 or 2 in each market in which the firm competes—that goal should also be informed by a discussion of how investments in IT can help achieve the objective.
Top managers have an important role to play in defining digital business strategy. They need to view IT as a lever that they can manipulate to influence the success of their organizations; then, they must communicate that belief to the entire organization.
Fortunately, there is now significant research evidence (and more accumulating) that IT resources are critical determinants of an organization’s success. Firms can use IT investments, IT infrastructure, and IT-enabled information flows to enter new markets, create new products and services, and improve their productivity, profitability, customer satisfaction, and organizational capabilities (Barua and Mukhopadhyay 2000; El Sawy and Pavlou 2008; Melville, Kraemer and Gurbaxani 2004; Mithas, Ramasubbu and Sambamurthy 2011b; Pavlou and El Sawy 2010; Piccoli and Ives 2005; Sambamurthy, Bharadwaj and Grover 2003; Tafti, Mithas and Krishnan 2011; Tallon, Kraemer and Gurbaxani 2000; Wade and Hulland 2004).
Although IT resources can improve performance, there remains significant variance in achieving that potential, and realized performance varies significantly across organizations. Worse-than-expected performance arises from the dysfunctional management of IT in organizations. The senior management team, the CEO, and the CIO must all work together to ensure that the firm executes its digital business strategy. CIOs, in particular, must engage their business counterparts to shape IT decisions and create buy-in for IT efforts.
In my experience, many organizations are still in a nascent stage of developing a coherent understanding of IT’s potential. Very few firms have made the needed investments to imbue a shared understanding of IT’s role in an organization and how that role is influenced by—and influences—the firm’s business strategy. The success of IT efforts depends on communicating the firm’s strategy and enlisting managers at all levels in making decisions about technology. This area is where many organizations flounder. However, it is possible to overcome this hurdle by investing in what I refer to herein as ITracy.
ITracy: A New Competence for the Information Age
There is a compelling need for CEOs and CIOs to make necessary investments in ITracy for key executives and future leaders of their companies. ITracy is a new word and skill set that should be a part of boardroom discussions regarding strategy or selecting business leaders; it is a skill, similar to literacy or numeracy, that all successful managers must have in today’s information economy. ITracy is more than being able to work with computers or IT (Cramm 2011; National Research Council 1999); it involves some expert thinking and complex communication skills (Levy and Murnane 2004).
More specifically, ITracy rests on three pillars: It implies a basic understanding of (1) how a firm should synchronize its business strategy with its IT strategy, (2) how the firm should govern IT, and (3) how the firm should manage IT infrastructure and implement IT projects. Next, I consider these in turn.
Synchronize IT and Business
Synchronizing IT and business strategies requires developing an understanding of how a firm can manage IT to improve its competitive position and how it should manage or shape industry transformations. As Michael Porter, a Harvard Business School professor has argued (Porter and Millar 1985), there are three principal ways to gain competitive advantage using IT.
The first is by changing industry structure, which involves using IT to tilt the balance of supplier power, customer power, competitive rivalry and the threat of entry and of new and substitute products in your favor. A second way is to outperform rivals using IT in terms of costs, differentiation, or the ability to serve a niche segment exceptionally well by providing differentiated, cost-effective products and services. A third way is to create new businesses using IT.
In addition, the firm needs to decide its strategic posture with respect to industry transformation and new technologies. New technologies, particularly those that create a trade-off between serving current customers and attending to new or underserved customers, are particularly challenging.
Govern IT Effectively
Even if managers are able to synchronize their IT and business strategy, that is not enough. There remains a need to ensure that the digital strategy is made part and parcel of an organization’s governance processes. In other words, managers also need to govern IT effectively. Governance involves dealing with four issues. First, the manager must decide what the key IT decisions are, who should make them, and how they should be decided upon. The second consideration is how the IT function should be organized—as a cost center or a profit center?
Third, the manager must determine how much to spend on IT, what types of projects to fund (i.e., for revenue-growth or cost-reduction projects), and how to justify and prioritize different types of IT projects to arrive at a portfolio that will achieve the firm’s key strategic objectives. The final consideration is deciding what to keep in-house, what to outsource or rent, and the extent to which the firm will use globally dispersed resources. All these governance decisions have options, only some of which might be practical given the organization’s resources and competitive environment.
Manage IT with Discipline
There are still additional efforts required before an organization has a coherent digital business strategy. Even with effective governance, there is still the issue of having to manage IT projects toward successful completion. Success requires managers to develop a vision of how they will deal with the evolution of computing, manage legacy upgrade decisions, manage risks in IT projects, determine what systems development life-cycle approach to use, and select which enterprise systems to deploy.
Although I have discussed synchronization–governance–management decisions separately, they are interconnected. Governance cannot be viewed in isolation from strategy. Governance processes in firms that emphasize revenue growth differ from governance processes in firms that emphasize cost reduction in their digital business strategy. In turn, governance ultimately influences management in terms of what types of projects an organization will implement and how certain trade-offs (standardization versus customization, single vendor versus best of breed) will be made.
Toward Digital Intelligence
Like other competencies, such as leadership, digital intelligence is not something that a person is born with. Thankfully, however, it can be acquired through education and appropriate experiences.
In conclusion, senior executives and IT professionals have a responsibility to ensure that all IT and strategic decisions in their firms are approached by individuals who have the requisite digital intelligence and who are exposed to the three pillars of a digital business strategy. Doing so will require investing in the education of key professionals, followed by continuous dialogue between business and IT personnel. Only then will digital business strategies successfully lead to business value and contribute to organizations’ success in the marketplace.
Part
1
Synchronize IT and Strategy
Chapter
1: Crafting Digital Business Strategies
“All men can see the tactics
whereby I conquer, but what none can see is the strategy out of which
victory is evolved.”
—Anonymous
“Would you tell me, please, which way I ought to walk from here? That depends a good deal on where you want to get to, said the Cat. I don’t much care where, said Alice. Then it doesn’t matter which way you walk, said the Cat—so long as I get somewhere, Alice added. Oh, you’re sure to do that, said the Cat, if you only walk long enough!”
—Carroll (2004)
What do the words “strategic and
transformational IT” mean to you? Why has IT become so important
that everyone must know about it? To understand IT and its role, it
is first necessary to articulate what “strategy” and
“transformation” mean? Only then can the role and contribution of
IT in strategy and transformation be more fully understood.
1.1 Why Top Managers Need to Bother with IT
Top managers have a responsibility to help their organizations navigate IT-enabled transformations because it is their acts of commission or omission, not those of lower-level employees, that will ultimately shape the destiny, success, or failure of their organizations. IT has played an important role in the success of corporations such as Bank of America, American Airlines, USAA, American Hospital Supply, and Frito-Lay since at least the 1950s (McKenney et al. 1995). However, the dramatic changes in IT in last 20 years, certainly since mid-1990s when the Internet and the World Wide Web became more pervasive, have made IT even more important from a strategic perspective.
Why has IT become an imperative for any manager who aspires to be a leader or a CEO (Earl and Feeny 2000)? There are at least three reasons: the importance and ubiquity of IT, the duality of IT, and the performance implications of managing IT resources. I consider each in turn.
1.1.1 IT
Resources are becoming more important and more pervasive
The world of business is experiencing a sea change due to the pervasive digitization of activities and business processes and the concomitant and commensurate investments in IT. It may surprise some to know that the worldwide spending on IT now exceeds $3 trillion every year (Scheck et al. 2008). To put it in context, this spending represents the approximate GDP of the United States in the early 1980s, in 2009 dollars (Wilson 2009), and is almost equal to the 2010 U.S. federal budget of $3.6 trillion.
For further perspective on the extent of IT spending, consider this: The United States spent about $3.6 trillion on World War II, which stretched several years (Montgomery 2007; Wilson 2009)—we spend nearly the same amount on IT each year. Worldwide IT spending in 2009 exceeded the GDP of the fourth largest economy in the world. Compared with about $3.6 trillion of global spending on IT, global spending on research and development (R&D) was approximately $1.1 trillion, and global advertising spending was closer to $.44 trillion in 2009. This is a remarkable feat for a relatively young and emerging industry that first emerged around the 1950s.
IT also appears to have a disproportionately large influence on the overall economic activity if one were to consider some other indicators, such as percentage of venture capital funding devoted to IT production and information industries, the value of nonmarket transactions, and the fraction of time spent on income-generating activities versus that spent on leisure activities (Brynjolfsson and Saunders 2010). Although less than 2% of the U.S. economy is dedicated to producing hardware or software, this percentage rises to approximately 7% of the total value added if a wider definition of “information industries” is adopted (including, for example, publishing, IT services, broadcasting, telecommunication, and so forth).
Brynjolfsson and Saunders (2010) report that 50%–75% of venture capital funding went to IT production and information industries in the 1995–2007 period. In addition, IT drives many nonmarket transactions that are not fully captured in GDP numbers and tangible products and services. Consider free Google search or the ability to read a free newspaper article on the web, or consider the improvements in automobile quality or health care that are not captured in prices that you pay.
1.1.2 The duality of IT
Being a general-purpose technology like the steam engine, a dynamo, or a laser (David 1990; Gordon 2000), IT is extremely powerful in its consequences. It is multifaceted and can have paradoxical effects that reveal its Janus-faced character. For some, IT is flattening the world (Friedman 2005), but for others, some spikes created by history and geography are too stubborn (Florida 2005). Not everything that IT does is favorable: While some of the changes unleashed by IT are good, others are not so good.
Let us begin with some social and societal impacts of IT. Among the dual aspects of IT-induced changes, GPS has made life easier when it comes to driving cars or navigating ships. However, it has also taken some drivers to a cliff and would lead to certain death if they did not know when to disobey the technology (Saranow 2008).
Smartphones have saved lives by locating people and providing them with help. However, they have also raised stress levels and turned some users into phone “addicts”—so much so, some reports suggest, that some people check their smartphones as soon as any new message pops up; they check their phone before they go to sleep, they check it first thing upon waking up, and they keep checking it even while eating breakfast; some people even check it while engaging in more “intimate” human activities. If that is not enough, some people prefer to enjoy Second Life, often at the expense of ignoring their partners or spouses in this (presumably first) life (Alter 2007).
IT can make people less productive or more productive, depending on how it is used. Some people worry that the increasing use of computers and IT has affected our ability to think critically and makes us “stupid” (Carr 2008; Greengard 2009). Certainly, it has created many new distractions and, if not handled well, can ultimately make us unproductive.
However, evidence suggests that IT has contributed significantly to productivity at the economy level. The average labor productivity growth in the U.S. economy averaged only about 1.4% from 1973 to 1995. It rose to 2.6% from 1996 to 2000 and to 3.6% from 2001 to 2003. Then it dipped to 1.3% from 2004 to 2006, only to rise again to 2.4% in the 2007–2008 period (very close to 1996–2000 levels) (Brynjolfsson and Saunders 2010).
There appears to be widespread agreement that IT has played a major role in the increased productivity evident in the 1996–2000 period. Some researchers argue that at least a part of the continued productivity growth in the 2001–2003 period can be attributed to lag effects of investments in complementary assets and business processes.
IT contributed to approximately 80% of the productivity increase from the 1973–1995 period to the 1996–2000 period through an increase in capital deepening and multifactor productivity. Although the share of productivity growth attributable to IT has fallen in the 2000–2006 period, at least some of the multifactor productivity growth among industries that use IT can be attributed to investments in complementary assets and business process redesigns undertaken between 1995 and 2000 (Brynjolfsson and Saunders 2010).
The relationship between IT and productivity also has implications for jobs, a relevant factor for both individuals and policy makers. Although IT can destroy jobs (Brynjolfsson and McAfee 2011; Rifkin 2011), it can also create new jobs, change the mix of jobs in the economy, and alter the nature of tasks within jobs (Levy and Murnane 2004; Simon 1960).
In particular, computers can become a substitute for humans by simplifying the whole job (computerized robots replacing workers on an assembly line), by substituting some tasks within a job that are amenable to rule-based logic (ATMs taking over some of the functions of a human teller), and by supporting outsourcing or offshoring to other countries (Levy and Murnane 2004). At the same time, computers can complement humans in jobs that require pattern recognition or case-based reasoning (e.g., GPS devices helping drivers navigate roads, computer imaging assisting radiological diagnosis).
Assuming that computers are 100 times faster than bookkeepers in doing arithmetic but only 10 times faster than stenographers in taking dictation, employing humans in tasks in which they have a comparative or relative advantage (e.g. stenography) creates more output (Simon 1960). This is true even though computers may have an absolute advantage in performing both bookkeeping and stenography and follows from the theory of comparative advantage, which goes back to Ricardo.
Autor et al. (2003) classify occupations according to their skill requirements: nonroutine manual, routine cognitive, routine manual, complex communication, and expert thinking. Their work suggests that jobs requiring expert thinking and complex communication have grown in the United States from 1969 to 1999. However, whether this pattern has held subsequently in United States and whether a similar pattern will hold in India or China are questions that require investigation.
Although the social, societal, and macroeconomic effects of IT are important, the focus here is on the strategic issues related to IT: How can managers use IT strategically to create or sustain a competitive advantage? How can they successfully navigate IT-enabled transformations?
1.1.3 IT matters for performance
IT has become an extremely critical resource for the competitive success of organizations. Just as IT consumes a lot of money on a worldwide basis every year, it also consumes significant resources at the firm level. In today’s business environment, firms spend more than 50% of their capital expenditures on IT; this figure was closer to 15% in the 1960s (The Economist 2009b). The U.S. government spends more than $60 billion on IT every year. Some large firms such as Wal-Mart, FedEx, Hewlett-Packard (HP), and Citibank spend more than a billion dollars on IT alone every year. Recent research implies that firms are beginning to allocate their discretionary dollars from R&D and advertising toward IT (Mithas et al. 2012).
Figure 1.1 shows the trends in IT, R&D, and advertising expenditures for a sample of 452 global firms from 1998 to 2003. The figure shows that average IT expenditures gained a higher share of discretionary expenditures over average R&D and average advertising expenditures, while the relative share of average advertising expenditures declined after 2000. Part of the reason for the reallocation of expenditures may be that using IT can lead to more effective R&D and marketing.
Figure 1.1: Trends in Discretionary Expenditures and Profitability (Source: Mithas et al. (2012))
There is good reason for firms to invest more in IT. Research on the business value of IT has documented the effect of IT resources on a variety of outcome measures:
Productivity (Brynjolfsson and Hitt 1996; Dewan and Kraemer 2000; Melville, Gurbaxani and Kraemer 2007; Menon, Lee and Eldenburg 2000; Tambe and Hitt 2011),
Profitability (Mithas et al. 2012),
Foreign revenues and foreign profits (Mithas, Whitaker and Tafti 2011c),
Shareholder value (Bharadwaj, Bharadwaj and Konsynski 1999),
Firm Risk (Dewan and Ren 2007; Dewan, Shi and Gurbaxani 2007),
Consumer surplus, customer relationships and customer satisfaction (Bapna, Jank and Shmueli 2008; Mithas, Krishnan and Fornell 2005; Ray, Muhanna and Barney 2005),
Innovation output (Kleis et al. 2011; Kohli 2007; Ravichandran, Han and Mithas 2011),
Supply chain and inventory costs (Bardhan, Mithas and Lin 2007; Bardhan, Whitaker and Mithas 2006; Choudhury, Hartzel and Konsynski 1998; Mithas and Jones 2007; Mukhopadhyay, Kekre and Kalathur 1995; Rai, Patnayakuni and Seth 2006),
Product variety (Gao and Hitt 2005) and product quality improvement (Bardhan et al. 2006),
Cost of debt (Kim and Mithas 2011), and
Organizational capabilities (Aral and Weill 2007; Mithas et al. 2011b; Tafti et al. 2011).
Studies also suggest that IT has a greater effect on profitability than R&D or advertising (Mithas et al. 2012). Many academic colleagues (too numerous to mention, though see the various references cited in my academic papers) have also reported related findings. Increasingly, progressive CEOs and senior executives are beginning to embrace the strategic importance of IT, across both IT-producing industries (e.g., HP) and IT-using industries (e.g., cement, steel) (Marchand 2002).
Although IT shows a positive association with firm performance on average, not all firms are equally good at making use of IT. Just as the successful management of IT can enhance chances of success, poor implementation of IT can be disastrous. It is certainly possible to overspend on IT and mismanage it (Porter 2001; Prahalad, Krishnan and Mithas 2002).
IT-related failures come in various forms: waste of scarce organizational resources, poor management of customer trust and loyalty, and failures leading to bankruptcies and even loss of lives. Organizations that have experienced IT-related failures include some of the most reputed and well-known companies. Even organizations that are expected to have particularly smart employees are not immune to IT failures.
Some firms have even gone bankrupt while implementing IT projects that were a fraction of the overall revenue of the firm, with adverse consequences for managers, employees, and other stakeholders of these firms (Nash 2000). FoxMeyer Drug (Charette 2005) and Rich-Con Steel are two examples. Even more serious, many lives have been lost because of the lack of use of proper IT systems or governance (e.g., “9/11 Commission Report,” 98,000 preventable deaths in the United States due to wrong medications) or the abuse of IT.
Refer to Figure 1.2 for IT failures across a wide variety of industries over years.
Figure
1.2: IT Hall of Shame
In summary, all managers need to care about IT and must know about IT for at least three reasons. First, it is the single largest expenditure in firms. Smart visionaries and managers can use IT as a lever to enhance their personal and professional competitive advantage.
Second, sooner or later, most managers will be involved in an IT project. Given how risky and important these projects are, one must invest the necessary effort to understand how to manage these projects to ensure success.
Finally, IT-induced technological advances affect all industries and functional areas, and managers can navigate these impending changes more successfully by understanding what drives these changes. Together, these should be good reasons for managers to invest in their own ITracy and that of the people they supervise.
1.2
What is Strategy?
1.2.1 Defining strategy and competitive advantage
Strategy is an amorphous concept and has been defined differently by various authors (Bradach 1996; Brandenburger and Nalebuff 1995; Collis and Montgomery 1995; Collis and Rukstad 2008; Eisenhardt and Sull 2001; Ghemawat 2010; Grimm, Lee and Smith 2006; Hambrick and Fredrickson 2001; Porter 1996; Rivkin 2002).
Broadly, strategy can be viewed at multiple levels, and it seeks to answer questions such as where to compete (this is related to corporate strategy), how to compete (this is related to competitive strategy), and when to compete. Sometimes, functional areas, such as operations or marketing, frame strategies at functional levels to support competitive strategy and answer narrower questions, such as whether to compete by attracting new customers or by retaining current customers.
Strategy matters because research suggests that business unit effects account for approximately 37% of variance in return on assets, corporate effects account for approximately 18%, and macroeconomic and industry effects account for approximately 45%. In general, business units and corporate effects are under the control of managers, while this is less often the case for macroeconomic and industry effects.
Fundamentally, strategy is about gaining and sustaining competitive advantage, which is, broadly speaking, the creation of unique added value and the ability to capture some of that value for a firm’s stockholders.
A practical and tangible way of defining strategy or competitive advantage (CA) is to create and capture economic value (EV). Economic value is the difference between customers’ willingness to pay (WTP) and a supplier’s opportunity cost (SOC) (Ghemawat 2010). In mathematical terms, EV or CA = WTP – SOC.
Although willingness to pay and supplier opportunity costs are useful concepts, they are not easily measurable quantities. This is because customers rarely honestly reveal what they are willing to pay. Even if they did, customers vary significantly in their willingness to pay, and it would be very difficult for firms to charge a unique price to each of its customers. A soft drink firm tried to do this, but it did not succeed. Amazon.com was also reported to have been unsuccessful at such a strategy of first-degree price discrimination. Similarly, suppliers also do not truthfully reveal the lowest amounts they would accept for services and resources to supply specified products and services.
Consider Apple’s iPhone 4S as an example. It costs Apple about $188 to buy parts for the 16 GB version of its iPhone 4S, and it sells that phone in the United States for $649 (Hesseldahl 2011). It is difficult to know how much consumers would have been willing to pay for the iPhone and how much less suppliers may have charged just to be part of the growing iPhone ecosystem had Apple negotiated even harder. Even within the United States, consumers pay only about $200 for their iPhone, and telecommunications carriers cover the remaining $450 in exchange for a two-year service plan.
Thus, a practical way to view competitive advantage is simply price of products and services that a firm offers minus their cost. In the case of iPhone 4S, $649 and $188 are much more convenient to work with than more abstract economic concepts and quantities such as willingness to pay and supplier’s opportunity cost.
In terms of publicly reported financial numbers, competitive advantage or economic value is approximately profit, and it is influenced by a firm’s revenues and total costs. Porter (2001) argues that economic value is reliably measured through sustained profitability.
In turn, profitability depends on two fundamental factors: industry structure and sustainable competitive advantage. Industry structure determines the profitability of the average competitor. For example, industry structure of the airline industry can help determine profitability of an average player in that industry. In contrast, sustainable competitive advantage enables a company to outperform the average competitor, and it determines excess profitability relative to an average competitor. For example, Southwest has significantly higher profitability than Delta within the airline industry.
Sustainable competitive advantage depends on operational effectiveness and strategic positioning. Operational effectiveness is doing the same thing your competitors do, but better (e.g., Ford using Internet-based procurement system to reduce costs). Operational effectiveness is necessary but does not provide sustainable advantage in the long run because of two reasons: rapid diffusion of best practices and competitive convergence.
In contrast to operational effectiveness, strategic positioning—doing things differently from competitors in a way that delivers a unique value to customers—is a more sustainable source of competitive advantage. Strategic positions can be based on choice of product or service variety, choice of needs of a specific segment of customers (IKEA serving all needs of its target customers), and access to a particular group of customers (e.g., customers in small rural towns).