Lecture Note: Digital Innovation Value Maximization

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1 Lecture Note: Digital Innovation Value Maximization by Robert G. Fichman, for MI720 IT for Managers, Boston College, 2012 Introduction In the late 1990 s, Harrah s Entertainment invested $100 million to implement database marketing and radically change their customer relationship management strategy. In the wake of this implementation, Harrah s, whose aging properties were thought to be poorly positioned to compete in the age of glitzy casinos, doubled its market value to over $5 billion, and exhibited growth in sales and profits that outpaced the rest of the casino industry. Around the same time, Cisco Systems undertook a profound transformation of its IT infrastructure, first to implement a new ERP system, and then to pioneer an architectural strategy called web-enablement, which sought to make all IT systems available to any computer connected to the Internet through a web browser interface. Cisco attributed over $1 billion in documented costs savings to this digital transformation. These two firms operated in different industries, had different corporate strategies, and used different technologies. However, unlike many of their compatriots, both Harrah s and Cisco were able to fashion highly remarkable positive impacts from digital innovation. What differentiated Cisco s and Harrah s efforts from numerous other less successful would-be innovators? More specifically, how can digital innovations be deployed in a way that generates outsized business value? And, what is the nature of the fit between the elements of a digital innovation and other organizational resources that Cisco and Harrah s were able to achieve that led to such success? We can identify three key similarities in the two cases that allow us to start addressing the above questions: first they were early to invest in emerging digital innovations systems; second they were able to assimilate those systems; and third, they possessed strong positions on certain organizational elements that have major complementarities with information technology. (Two elements possess complementarities when doing more of one increases the return to doing more of the other.) For example, Cisco s innovative use of the Internet to support business processes allowed them to serve a leading example of how businesses can exploit the power of the Internet. That had the effect of creating a unique marketing asset. Cisco was, after all, the leading Internet infrastructure vendor! If a lot more companies tried to follow Cisco s example then Cisco would sell a lot more routers. In a similar way, Harrah s had a large geographic scope, larger than any competitor. The use of business analytics to drive loyalty across properties creates a more valuable asset when you have a lot of properties! IT Investment and Organizational Performance In the late 1980 s, economists began to observe a peculiar phenomenon. US businesses had been making massive capital investments in IT, but at the very same time macro-level 1

2 productivity growth was stagnant or even declining. In classical economics there is supposed to be a very straightforward, positive connection between capital investment and productivity growth, so in the minds of economists a failure to observe this connection was an apparent contradiction, or a paradox. The IT Productivity Paradox 1 encouraged a generation of IT researchers and economists to examine the relationship between IT investment, productivity, and business value in detail. A great variety of studies were performed Erik Brynjolfsson (MIT), Lorin Hitt (Wharton) and a number of other researchers, but the common finding was that positive relationship predicted by classical economics does in fact exist, but was previously obscured by measurement issues, and by long lags in the time it takes for productivity from IT investments to be fully achieved. The generally positive link between IT investment and organizational performance was an important finding, but what is true in general is by no means true in every specific case. In reality, there are wildly varying payoffs to IT investments from firm to firm, and even from investment to investment within firms. A large set of subsequent studies have given some insights into what some of these conditions are. Specifically, organizations are more likely to get high payoffs when: (1) they apply IT to strategic ends, (2) they reside in industries where IT is more strategic, (3) they have organizational characteristics that complement 2 greater IT use, (4) they have greater IT capabilities, and (5) they thoroughly deploy the systems created through IT investment. A General Model of Digital Innovation Value Maximization Based on the above research related to IT investment in general I have synthesized a model that explain why some firm get more value from their digital innovation initiatives that others (Figure 1.) Figure 1. 2

3 The central logic of this model is as follows: the benefits from investments in digital innovation ( A ) will be greatest when these investments are reinforced by complementary positions on four other organizational elements, including: Business and IT strategy ( B1 ), the Technical and Competitive Context ( B2 ), general Organizational Characteristics consistent with the digital organization ( B3 ), and IT Capabilities ( B4 ). These four elements work together to enhance Technology Deployment ( C ). Then, the level of fit across the entire system of all six elements ( A, B1-B4, and C ) determines the level of Digital Business Value ( D ). The most important message of this model is that simply spending more on digital initiatives is not a reliable route to business value. Rather, investments have to be tied to existing complementary organizational elements, or must be implemented together with new organizational elements that are complementary with IT. IT & Business Strategy (B1) Strategy is largely a process of creating fit between different organizational elements. IT Strategy, a subset of Business Strategy, is the mechanism by which managers decide how they will maximize the business value flowing from digital innovation initiatives. This means creating an optimal fit between the other elements of the Digital Innovation Value framework and the overall Business Strategy. Because IT managers have the most influence over IT Capabilities (B4) and IT Deployment and Use (C) ensuring organizational effectiveness on these elements will naturally be the primary focus of IT strategic thinking. The Technological and Competitive Context (B2) Some industries are more strongly driven by innovation and technological change than others. Examples include pharmaceuticals, financial services, and the technology industry itself (i.e. providers of hardware, software, and services). Not surprising, investments in digital innovation tends to have especially high pay offs within industries that are most driven by innovation and change. Also, since it helps to be able to spread the costs of digital innovation over an expanding set of business activities, investments in digital innovation will achieve higher payoffs in business sectors that are growing most rapidly. Complementary Organization Practices ( Digital Organization ) (B3) In a concise and readable article, Erik Brynjolfsson has summarized the findings of several studies that draw a linkage between IT investment payoffs and cluster of related practices that he calls the digital organization. 3 This cluster includes the following: Automation of routine tasks Highly skilled labor More decentralized decision making Improved vertical & lateral information flow Strong performance-based incentives Increased emphasis on training and recruitment 3

4 With a little reflection, you can see the logic for why investments in digital technologies should have synergistic relationship with each of these practices. To take the most obvious one, routine tasks are particularly suitable for complete automation because they are most easily standardized and programmed. So, organizations that are more willing and able to automate routine tasks can expect a particularly high payoff to investments that facilitate such automation. On the other hand, organizations that can t automate routine tasks (e.g., due a lack of vision, cultural barriers, or work-rule restrictions) will lose out on a key route to digital business value creation. IT Capabilities (B4) Organizations vary dramatically in terms of their IT capabilities. On one end of the spectrum we have firms like Rich-Con, on the other we have firms like Harrah s or BP. Many frameworks have been developed to identify just what counts as an IT capability; however I like the following three dimensions: 4 IT Human Assets (senior management strategic IT vision and support; highly skilled IT staff) IT Technical Assets (robust IT architecture and infrastructure) IT Relationship Assets (effective management of internal and external linkages) Most of these assets are highly inter-related. Without senior management vision and support is it unlikely that a firm will invest in a robust and state-of-the-art architecture, or a highly skilled IT unit. Without a highly skilled IT unit, it is unlikely that a firm will be able to implement effective IT processes, or establish strong relationship assets (internal or external). IT Capabilities Three Dimensions Asset IT Human Assets IT Technical Assets 4 Explanation Senior management team must have a clear vision for how IT fits into the firm s strategy IT staff must be knowledgeable and skilled (i.e., technical skills, strong analytical capabilities, extensive knowledge of the business, and effective communication skills) IT Infrastructure includes components like hardware, networks, operating system platforms, data management platforms, application platforms The IT Architecture is the blueprint for how IT infrastructure components actually fit together. Just as house is more than the sum of its building materials, a firm s IT architecture is more than the sum of its infrastructure technologies. A strong IT architecture is flexible, robust, reliable, cost effective to operate, and easy to change. Developing and maintaining a strong architecture is one of the most difficult challenges in IT management

5 IT Relationship Assets Strong internal relationships are built on a foundation of shared knowledge and trust between IT and business people. In the ideal case, IT and line managers view themselves as having a genuine partnership when it comes to IT initiatives. The need for strong external relationships comes from the rise in the use prepackaged software, complex systems integration problems, and increased use of IT outsourcing. While shared knowledge and trust are important here too, there are several additional concerns, including the ability to develop effective contracts and governance structures. The Link Between IT Capabilities and Digital Innovation Value. The general link between IT capabilities and enhanced value from digital innovation is almost self-evident. Strong IT capabilities allow organizations to recognize good digital innovation opportunities; to evaluate those opportunities properly; to develop a plan to implement the IT supporting these innovations; then to actually effectively manage the implementation. Deployment (C) In the end, digital innovations only provide value from how and how much they are actually deployed and used. In particular, there is more value creation potential when: (a) digital innovations are more thoroughly assimilated, and (b) they are accompanied by co-innovations related to organizational processes, policies, skills and incentives. Assimilation. It may seem obvious that innovative technologies that are used more extensively and actually infused into work processes have more value creation potential than IT that is used only superficially or left on the shelf, but that does not make assimilating IT any easier! Organizational Co-Innovations. Although it is often possible to implement digital technology simply to automate discrete tasks and leave everything else unchanged, this is rarely a route to a high payoff. The true power of technology is unleashed when it is used to enable fundamental organizational changes. The implication is that any given IT initiative is likely to have a higher pay off when an organization is willing to challenge fundamental assumptions about current operations, and to make organizational changes that best complement the new technology. For example, consider an initiative to implement a Customer Relationship Management (CRM) platform. The core digital innovation is the CRM software itself along with possible infrastructure upgrades. The organizational co-innovations would be changes to strategy, processes, employee roles, incentives, etc. that are implemented with the CRM platform. These could include an increase in emphasis on one-to-one marketing; an increased emphasis on data driven decision making; and hiring (or retraining) of employees with specialized analytical abilities or technical knowledge. The extent of improvement in business processes (e.g., customer acquisition) depends not just on how much is invested in CRM technology per se, but rather, on the extent to which the technology has been joined into a complementary system of organizational elements. 5

6 Summary The guiding logic of the Digital Innovation Value Framework is that certain organizational elements complement higher levels of technology investment in general, and this apply equally if not more so to investments in digital innovation. These elements include certain features of IT and Business Strategy, certain kinds of Technological and Competitive Contexts, certain General Organizational Practices and Assets (i.e. the digital organization ), and strong IT Capabilities. The implication is that organizations that have strong positions in these complementary organizational elements should be among the more aggressive investors in digital innovation. The corollary implication is that organizations that wish to more aggressive digital innovators have to work towards in improving their positions on these elements. Endnotes 1. Brynjolfsson, E. "The Productivity Paradox of Information Technology, "Communications of the ACM (36:12) 1993, pp For a rigorous explanation of the theory of complements as it relates to investments in new technology, see Milgrom, P.R., and Roberts, J. "Complementarities and fit: Strategy, structure and organizational change in manufacturing," Journal of Accounting and Economics (19:2/3) 1995, pp Brynjolfsson, E. The IT productivity gap, Optimize (21), Ross, J.W., and Beath, C.M. "Develop Long-Term Competitiveness through IT Assets, "Sloan Management Review (38:1) 1996, pp

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