There is no denying the pain inflicted by the global financial crisis, but a decade from now this period in our history might be cast in a more favorable light than we imagine. In fact, according to MIT Sloan School of Management economist Professor Erik Brynjolfsson, future generations will see the Great Recession as the Great Restructuring that marked a turning point in the way the U.S. economy works.
Brynjolfsson is director of the MIT Center for Digital Business, and is an expert on how advances in information technology contribute to business performance and organizational change. In collaboration with academics from Harvard, Wharton and Stamford universities, he studied more than one thousand companies and identified a restructuring revolution that started in the mid- to late 1990s.
The trigger was the realization that information technology allied to changes in business practices can unleash big productivity gains. Leading companies embarked upon investments in a broad swath of IT solutions ranging from enterprise resource planning systems to more specific packages such as logistics software.
But not every company harnessed the full benefits of these investments. Brynjolfsson describes the leaders as “high IT” organizations. These are not necessarily enterprises that produce technology such as Intel and Microsoft, but industries and companies that are heavy consumers of IT and use these solutions to transform their businesses.
The result is a remarkable divergence in performance between the leaders and the laggards (described as “Low IT” companies). The economists charted the gap in terms of a number of metrics including gross profit margin. The gap between the bottom 25% of firms and the top 25% remained steady at 15% to 20% through the 1960s and 1970s. But in recent years the difference has grown much larger to 40% to 50% according to the analysis. In other words, high-IT firms enjoy a profit margin that is almost 50 points higher than laggard companies.
Brynjolfsson and his colleagues attribute this stellar performance to the IT-related changes that started some 15 years ago. The economists correlated firms’ productivity with their IT investments, and studied how the technology was deployed. They found that even within clusters of firms that invested roughly the same in IT, there were leaders that achieved significantly higher levels of productivity.
The secret sauce is that the enlightened companies used IT to develop smarter ways to do business, and not as off-the-shelf solutions to their business problems. Simply importing software that other companies have used successfully is analogous to attaching electronic circuits from a digital watch to the mechanical flywheels of an analog device and expecting it to perform more efficiently, Brynjolfsson suggests.
In effect, high IT organizations – which hail from a wide cross section of industries – are able to build extra capacity without building physical plant by making business processes and practices more efficient. But these “invisible factories” do not show up in government statistics. It is not a trivial omission. The economists estimate that these hidden assets are worth about $2 trillion to the U.S. economy.
The study also uncovered a number of specific factors that distinguish the IT leaders. Here are three examples. First, they organize their work differently, much as Henry Ford did when he introduced his revolutionary production lines. Second, these practices are not only novel they also yield much higher pay offs. Thirdly, the IT solutions the leaders adopt complement their organization to a point where the combination is much more valuable than the component parts.
But Brynjolfsson’s work goes beyond the follies of buying IT by the pound. As he points out, if productivity grows at about 1% per year it takes about 70 years for a country’s living standards to double. If it grows at around 4% per annum as was the case over the last decade living standards can double in 17 years and quadruple in 35 years. That kind of spending power can buy a lot of health care reform.