Introduction
Today world deal with ascend and descend of the “new economy.” As the bubble inflated, many felt that information technology, and the Internet in particular, would “change everything.” Today, with the technology sector in shreds, more than a few believe that IT changed scarcely anything at all. McKinsey Global Institute has been studying labor productivity in the United States, France, and Germany and its connection to corporate IT spending and use. This institute found that a new economy did indeed come into being in the 1990S, but that it is very different from the one that was widely promoted and discussed at the time.
Information technology’s role in the new business world is more complicated than has been assumed. IT is of great, but not primary, importance to the fate of industries and individual companies. By uncovering the true drivers of corporate success today, McKinsey’s research provides a clearer understanding of the recent upheavals in business and points the way to a more effective deployment of corporate IT investments and assets.
New Concept of Productivity
Something did change in the economy in the late 1990S, and it is visible in the productivity statistics. The late 1990S productivity surge coincided with a big increase in the money and attention U.S. companies devoted to information technology. In many industries, technology spending doubled as businesses wove computer and communications systems more deeply into the fabric of their operations. Overall, the percentage of the gross domestic product accounted for by technology goods raised six fold, from 2% to 12%, during the decade.
When McKinsey Global Institute examined the performance of different industries, it saw little correlation between productivity and IT investment. In fact, in the United States, productivity gains were concentrated in just six sectors: retailing, securities brokerage, wholesaling, semiconductors, computer assembly, and telecommunications. These sectors account for only 32% of the U.S. GDP, but they contributed 76% of the country’s net productivity gain. Many other sectors, such as hotels and television broadcasting, invested heavy in IT but saw little or no productivity growth.
Intensifying competition led to productivity boosting innovations in the six key sectors. McKinsey’s research shows that managers in those industries were forced to innovate aggressively to protect their revenues and profits in the face of strong competition. It was those innovations – in products, business practices, and technology-that led to the gains in productivity. In fact, an important dynamic of the new economy-the real new economy-is the virtuous cycle of competition, innovation, and productivity growth.
Fierce competition spurs innovation, in both technology and business processes. These innovations spread quickly, improving productivity across the sector. The crucial role played by competition can be seen clearly in the performance variations that were evident across countries and industries. Look at the mobile-telecommunications industry. In the United States, the government’s auction of additional spectrum in 1995 led to increased competition, with the average number of competitors in a local market jumping from two to almost five. Prices fell, usage increased, and the entire sector’s productivity grew at an average annual rate of 15% during the decade. That’s a very healthy rate, yet it pales in comparison with the 25% gains posted by the mobile-telecom sectors in France and Germany. The difference is that U.S. regulations created a fragmented and protected market with dozens of subscale regional providers and little national competition.
Competition was not the only force driving productivity in the 1990S. Strong consumer confidence, for example, led customers to purchase more expensive goods; which also helped boost productivity. And buoyant capital markets contributed to gains in the securities sector. But McKinsey’s research clearly shows that wherever competitive intensity was greatest, innovative products and practices proliferated and productivity grew robustly. And wherever competition was constrained, innovation waned and productivity suffered.
The Role of Information Technology
When competition intensifies and companies face the possibility of lost customers and profits, managers have overwhelming incentives to pursue creative ways to cut the costs of their operations and increase the value they provide to buyers. The choice really is to innovate or die.
During the 1990S information technology proved to be a particularly powerful tool. First, IT enabled the development of both attractive new products and efficient new business processes. Second, it facilitated the rapid industry wide diffusion of innovations. And third, it exhibited strong scale economies- its benefits multiplied rapidly as its use expanded. IT’s power to promote innovation was not felt equally in all industries, however. The sectors most dependent on intensive information processing-those with highly complex operating processes, heavy transaction loads, or technically sophisticated products.
Some of the IT-based innovations of the last decade came in the form of new products and services. Others were enhancements to existing business processes. In many cases, the new products and processes were tightly intertwined (i.e. semiconductor industry). The six industries we identified as showing the greatest productivity gains during the 1990S all leveraged new IT capabilities to create products or refine processes. Sophisticated new IT systems were, for example, a godsend for retailing. Big retailers execute millions of relatively small transactions each day, creating extraordinary operating complexity. IT helps them manage that complexity much more effectively. It not only automates routine functions such as inventory receiving and control, price scans, and checkout, it also optimizes many complicated processes, including supply chain management, merchandising, and customer relationship management.
Interestingly, on-line trading was the only instance in which the Internet contributed significantly to the economy’s overall productivity jump during the so-called do.com boom. In U.S. wholesaling, the use of IT in distribution centers significantly boosted productivity. By combining relatively simple hardware (like bar codes, scanners, and picking machines) with sophisticated software (warehouse management systems for inventory control and tracking, for example), wholesalers were able to partially automate the flow of goods and thereby reduce labor costs significantly.
As new technologies spread across a sector, they often had a striking impact on productivity. In the retail sector, for instance, many companies were quick to adopt warehouse management and automation systems, bar code scanners and readers, and ERP modules for human resources, payroll, and reporting. Those systems helped automate processes that traditionally required large staffs, leading to significant reductions in labor costs throughout the industry. Technological innovations not only increased productivity in some sectors; IT itself also directly facilitated the diffusion of many business and technological innovations.
Companies used more sophisticated corporate planning tools, improved communications systems, and continuous on-line monitoring to increase the speed with which they replicated the breakthroughs of their competitors. New technological capabilities played a particularly strong role in spreading innovations across distribution centers and stores in the retail sector and across banking and brokerage branches in the financial sector.
Fast diffusion is a double-edged sword, however. While it improves overall industry productivity, it can erode the competitive advantages of individual companies. Once rivals in a sector adopt an IT innovation, after all, it becomes just another cost of doing business. As a result, many companies that spent heavily on state-of-the-art technology in the 1990S failed to recoup their investments.The secret to retaining an edge from rapidly diffusing technologies is to couple them with other distinctive capabilities or processes in ways that are hard to replicate.
The benefits of most IT innovations grow dramatically as scale increases. Once you install new software for transaction processing, for example, the marginal cost of processing additional transactions falls rapidly toward zero. Indeed, given the often high up-front costs of adopting a new technology, achieving scale is often crucial to reaping a return on an IT investment. IT innovations had their greatest impact in industries with a high degree of concentration or with a high volume output per customer (i.e. Retail).
Summery
The success of IT investments ranges on the particular characteristics of different industries and the particular practices of different companies. That fact goes a long way toward explaining the lack of correlation between IT spending and productivity that we’ve seen in recent years. For IT to fulfill its promise, users and vendors must deploy it thoughtfully, tailoring it to individual sectors and businesses and merging it with other product and process innovations. The challenge will be to use existing systems effectively while at the same time making targeted new investments that maintain competitive parity and, when possible, strengthen differentiation and buttress advantage. IT is not a silver bullet. But if it is aimed correctly, it can be an important competitive weapon.
