Does Technology Deliver Productivity?

by Bruce Silver

From time immemorial, individual businesses have looked for return on investment in information technology primarily in terms of enhanced productivity. In the world of content management and process automation, that means less wasted time searching for files, routing work through a manual business process and having to call back customers with requested information.

Thus we took heart in the late 1990s when it looked like that productivity enhancement was finally paying dividends at the macroeconomic level. Until 1995, economists had been telling us that the prior fifteen years of investment in PCs, servers, networks, ERP and the Internet hadn't raised national productivity growth a single bit. But suddenly, from 1995 to 2000, the U.S. productivity growth rate nearly doubled to 2.5 percent, up from the anemic 1.4 percent level we'd been stuck at for the previous two decades. This doubling coincided with a doubling in the growth of IT investment.

Productivity growth means growth in gross domestic product per capita (our standard of living), and we were feeling great. Economists were starting to call high IT investment linked to high productivity growth the "new economy." For the good times there seemed to be no end in sight — until the bubble burst. Now, confused and under attack, we wonder if the new economy was ever real.

A recent study by McKinsey Global Institute sheds sobering new light on the subject of productivity. According to the study, nearly the entire post-1995 jump in productivity growth came from just six sectors of the U.S. economy — retail, wholesale, securities, telecom, semiconductors and computer manufacturing. The other 53 economic sectors, representing 70 percent of the economy and 62 percent of the acceleration in IT intensity, basically contributed no increase in productivity growth over that same period.

The McKinsey study also tries to explain the role IT investment played in the six "jumping" sectors and in several "paradox" sectors, meaning those with high growth in IT investment but no overall productivity growth to show for it. It turns out that IT does play a role in productivity growth, but it's only one of several factors and not always decisive. However, business process innovation, often driven by competition as much as by technology, consistently appears to be at the heart of productivity acceleration — even when McKinsey does not count it as "IT-driven."

For example, McKinsey attributes productivity growth in the retail sector to the successful innovations of Wal-Mart, including economies of scale in warehouse logistics, purchasing, EDI and wireless bar code scanning. Wal-Mart's huge advantage in productivity has not only directly raised the overall U.S. numbers, but has transformed the entire retail sector. Similar innovations in distribution and warehousing are credited with productivity acceleration in the wholesale sector as well.

The securities industry is the only sector where significant productivity gain is laid at the feet of e-business transformation. By the end of 1999, around 40 percent of retail trades were handled online, up from 0 percent in 1995. As a result, the number of trades per broker industrywide increased by a factor of 10. That's macroeconomic productivity gain. Moreover, the rise of low-cost online brokerages forced the entire industry to become more efficient.

Outside of the six jumping sectors, however, IT investment is found to have had no impact on productivity growth beyond that of any other form of capital investment. The report singles out retail banking as a sector in which large increases in IT investment have not paid off in accelerated productivity.

But McKinsey's analysis of this "IT paradox" in banking suggests a significant difference between how macroeconomists measure benefit and how an individual business looks at return on IT investment. Macroeconomics ignores the benefit of increased revenue or market share accruing to any one company through competitive advantage, since it does not benefit the sector as a whole. If that competitive advantage is one of productivity, and that company's methods are imitated by others (as in the case of Wal-Mart), there is a macroeconomic benefit. But if the competitive advantage is one of greater convenience that leads to superior customer retention, for example, there is no macroeconomic benefit. Thus, the large investments banks have made in customer relationship management get a bad rap from McKinsey, in part because any investment in "customer acquisition," from a macroeconomic viewpoint, is not "productive."

While McKinsey does not specifically hail the rise of e-business as a factor that will keep productivity growth high in the years to come, many of its promised features — especially those that eliminate human intervention in newly automated supply chain and demand chain processes — should deliver real macroeconomic benefits. The recent large investments in e-business infrastructure and bandwidth so far go on McKinsey's books as a minus. If we can make e-business transformation work, however, it will be a rising tide that lifts us all.

Bruce Silver (brsilver@earthlink.net) is president of Bruce Silver Associates, Aptos, CA, 831-685-8803. Reports are available at www.brsilver.com.