Information Technology Investment and Adoption: A Rational Expectations Perspective

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1 Informion Technology Invesmen nd Adopion: A Rionl Expecions Perspecive Yoris A. Au Rober J. Kuffmn Docorl Progrm, Informion nd Decision Co-Direcor, MIS Reserch Cener nd Sciences, Crlson School of Mngemen, Professor nd Chir, Informion nd Decision Univ. of Minneso, Minnepolis, MN Sciences, Crlson School of Mngemen, Phone: (612) , Fx: (612) Univ. of Minneso, Minnepolis, MN Emil: [email protected] Phone: (612) , Fx: (612) Emil: [email protected] Absrc This sudy exmines he poenil pplicions of he Rionl Expecions Hypohesis (REH) in informion echnology (IT) invesmen nd dopion decisionmking. Alhough REH hs been widely used in oher res of microeconomics nd mcroeconomics, we hve no ye seen common use of he reled heory in he Informion Sysems (IS) field. In his pper, we inroduce REH heory ogeher wih some of is pplicions in non-is/it res. Despie he fc h rionliy is commonly ssumed in economic nlyses, he REH s rher srong ssumpions mke i unique heory nd llow us o offer new perspecives on IS/IT dopion nd invesmen decisionmking. We discuss how he heory cn poenilly be pplied in IS/IT cses by presening severl illusrive exmples. We hen exmine issues in he evluion of dopion nd invesmens of new nd emerging ITs. Bsed on he heory, we rgue h mngers h re risk-verse re mos likely o wi nd dop or inves in new nd emerging echnologies ler hn mngers h re riskkers. We sugges h for he erlier dopion or invesmens, he convenionl mehod for esiming invesmen vlue my no be pproprie. We lso sugges reserch direcions wih regrd o he pplicion of REH in he IS field. Inroducion The ssumpion h economic gens know or cn predic he vlues of cerin economic vribles is frequenly mde in he Economics lierure. In nlyzing iming of new echnology dopion by firms, for exmple, economic gens re ssumed o know bou pos-dopion benefis [e.g., Jensen, 1982], echnology coss [e.g., Sonemn nd Irelnd, 1983], nd nework exernliies [e.g., Frrell nd Sloner, 1985; Kz nd Shpiro, 1985, 1986; Choi nd Thum, 1998]. In mos cses, however, here is lile discussion bou how hese economic gens (i.e., mngers) obin heir knowledge or form heir expecions bou he fuure vlue of n economic vrible h will help hem mke decision on wheher o dop priculr echnology. In he Informion Sysems (IS) re, reserchers hve exmined, mong oher issues, he role of nework exernliies in he dopion of informion echnology (IT). Brynjolfsson nd Kemerer [1996], for exmple, exmined he mrke for microcompuer spredshee sofwre. They found h nework exernliies significnly incresed he price of spredshee producs, indicing h he dopers nd users were willing o py more becuse hey expeced n increse in he vlue of he produc s he number of users incresed. In n empiricl sudy on shred elecronic bnking neworks, Kuffmn e l. [2000] found h due o he nework exernliies, firm dopion decisionmking ws influenced by he expeced size of he shred nework. In ddiion, due o heir individul sregic posiions, bounded rionliy regrding he poenil of he echnology in he chnging mrkeplce nd differen levels of cpciy o process informion, firms ypiclly hve heerogeneous percepions of he business vlue of given echnology h hey re considering doping. More recenly, Au nd Kuffmn [2001] exmined he dopion of elecronic bill presenmen nd pymen (EBPP) echnologies in finncil services. The uhors show h depending upon he expeced level of nework exernliies, billers my decide o dop he exising echnology sooner rher hn wi for he nex echnology o come o mrke, even hough mos dopers expec h he nex echnology will be superior. Tken ogeher, his reserch shows he impornce of expecions in ddiion o nework exernliies in he developmen of heories of echnology dopion. This is in line wih Shpiro nd Vrin [1999, p.181], who minin h success nd filure [of Proceedings of he 36h Hwii Inernionl Conference on Sysem Sciences (HICSS 03)

2 echnology produc] re driven s much by consumer expecions nd luck s by he underlying vlue of he produc. However, how poenil echnology dopers (including firms nd consumers) rech cerin level of expecions nd which fcors ffec he expecion formion hve no been fully undersood. In his pper, we discuss he Rionl Expecions Hypohesis (REH) s poenil heory o be pplied in IT invesmen nd dopion decisionmking seings h require mngers (s economic gens) o hve he biliy o form cerin levels of expecions bou he vlues of cerin economic vribles. Alhough REH hs been widely used in oher res of microeconomics nd mcroeconomics, nd nowihsnding he fc h rionliy is commonly ssumed in IS/IT economic nlyses, we hve no ye seen his priculr heory used in echnology priculrly IT invesmen nd dopion reserch. In his pper, we inroduce rionl expecions heory nd how i cn poenilly be pplied in IS/IT cses. Through number of exmples, we chrcerize he issues in he evluion of dopion nd invesmens of new nd emerging IT from he perspecive of his new heory. We lso will rgue h mngers eiher mke erly or le echnology dopion nd invesmen decisions depending on he level of risks hey re willing o ke. This is especilly rue for unproven new nd emerging echnologies. As depiced in Figure 1, new nd emerging echnologies ypiclly go hrough severl phses, which Grner Reserch [Linden e l., 2001] erms he Hype Cycle. The mos ineresing of he phses is he pek of infled expecions, when over-enhusism for nd unrelisic projecions of new echnology occur due o well-publicized civiies by dvoces of he echnology, poenilly sending he wrong signls o decisionmkers. However, in he subsequen phses, he hype rpidly diminishes due o he inbiliy of he echnology o live up o is infled expecions, nd decisionmkers will be in beer posiion o ssess he echnology s pplicbiliy, risks, nd benefis. The recen exubernce, followed by he bursing of he DoCom echnology socks bubble mkes he Hype Cycle look ll oo fmilir. I should remind us of he impornce of looking echnology dopion nd invesmens from boh shor- nd long-erm perspecives. Our dpion of he REH o he IT dopion conex will llow us o re he invesmen nd dopion issues using perspecive h is bsed on longer ime horizon. This is in line wih he fc h mos ITs hve muli-yer lifecycle, mking i essenil o consider invesmen nd dopion decisionmking relive o hem s n ongoing process h involves long observion in he mrkeplce rher quick profimximizing decision. We believe his represens he cul chllenge h mngers fce in heir IT inves- Figure 1. Emerging Technologies Hype Cycle 2001 Visibiliy Web Services PDA Phones Synheic Chrcers Trough of Disillusionmen Semnic Web Hed- Mouned Displys Personl Fuel Cells Technology Trigger Pek of Infled Expecions Source: Grner Reserch [Linden e l., 2001] men nd dopion decision process. Consequenly, we offer new heoreicl pproch o improve our undersnding of IT invesmen nd dopion issues. The REH s rher srong ssumpions mke i unique heory nd llow us o offer new perspecives on IS/IT dopion nd invesmen decisionmking. The heory is pplicble o he fs-chnging environmen of IT where forwrd-looking decisions re of he essence. I helps o beer undersnd he complex nure of echnology dopion in dynmic wy beyond wh cn be offered by he rdiionl views. Bckground lierure Enerprise Insn Messging M-Commerce Digil Signures P2P Wireless Web/WAP B2B E-Mrkes ASPs Enerprise Porls Wireless LANs/ Blueooh Voice Over IP B2C E-Business E-Pymens Slope of Enlighenmen Pleu of Produciviy Muriy The Rionl Expecions Hypohesis (REH) hs rced s mny supporers s criics since i ws firs formuled by Muh in his 1961 seminl ricle [Muh, 1961]. Is mos well-known pplicions re found in he works of Lucs, Srgen, nd ohers in he erly 1970s (e.g., Lucs [1972, 1975], nd Srgen nd Wllce [1976])) on he new clssicl explnions of oupu nd inflion. The REH mkes some rher srong ssumpions nd, s resul, is very differen from noher populr heoreicl perspecive clled dpive expecions. In his secion, we presen he conrs beween hese wo ides o highligh he key ssumpions ssocied wih rionl expecions. We inroduce dpive lerning, which is bsed on he REH bu considers economic gens bounded rionliy. Adpive vs. rionl expecions: Bsic conceps Expecions re ypiclly reled o ps informion vilble o economic gens or firms. A clssic exmple is problem h involves lg of Proceedings of he 36h Hwii Inernionl Conference on Sysem Sciences (HICSS 03)

3 producion, where frmer mus esime he price of corn omorrow which ime he corn will be hrvesed in order o decide how much o pln ody. Nerlove (1958) uses n dpive expecions model o show h frmers plning decisions depend upon nd re dped o he prices hey expec o receive when he crop is mrkeed. In urn, he cul price for he crop depends on he moun finlly hrvesed nd he curren level of demnd. A bsic model is formuled wih respec o period, in which he corn price niciped by frmer p is given by: p = p 1 + η ( p 1 p 1) (1) where p 1 is he niciped price in period 1 (s of period 2 ), p is he cul spo price in period 1 1, nd 0 < η < 1. Grossmn [1981] reminds us h his is disribued lg model wih he form: p j= 0 j = η (1 η) p (2) j 1 He furher minins h i is essenil o pu some priori resricions on he form of he lg srucure. One resricion, s suggesed by Muh [1961], is h he disribued lg should be rionl. This mens h if priculr sochsic process generes sequence of cul prices{ p } = +, hen he niciped price in = period (i.e., p ), s of period 1, should be given by p = E [ p p 1, p 2, K]. Therefore, if he frmer knows he sochsic process, he should be ble o deermine he expeced price for period bsed on he condiionl expecion of p given ll ps prices. The frmer is considered rionl becuse he uilizes ll he price informion o correcly compue he rue condiionl expecion. Grossmn [1981] provides his exmple o show how Muh s rionl expecions noion differs from Nerlove s dpive expecions model. Suppose h he sochsic process genering {p } is given by: 1 for 1 p = (3) 2 for 2 Then, following he disribued lg model in (2), under dpive expecions: p2 = 1, p3 = 1(1 η ) + 2η, p = (1 + η )(1 η) + 2η, KK, lim p 2; 4 = However, under rionl expecions srucure, p = E p p, p, K] 2 since p 2. 2 [ = 2 The bove exmple illusres h under dpive expecions, gens will need some ime before hey lern h he price hs chnged from 1 o 2 since ll hey do is look ps prices. On he oher hnd, he rionl expecions noion ssumes h people know he sochsic price process in (3) so hey know h fer = 1, price will hve chnged permnenly from 1 o 2. The rionl expecions hypohesis (REH) The essence of Muh s [1961] rionl expecions is h economic gens form heir expecions on he bsis of he rue srucurl model of he economy in which heir decisions re mde. So, expecions re essenilly he sme s predicions of he relevn economic heory: heir expecions re informed predicions of fuure evens. The REH eques gens subjecive, psychologicl expecions of economic vribles o he mhemicl condiionl expecion of hose vribles. Subjecive expecions on verge, re equl o he vribles rue vlues. Muh suggess we should expec economic cors o chnge he wy hey form heir expecions if he underlying economic sysem chnges nd, hus, should no be sisfied wih dopion evluion funcions nd models wih fixed expecions h do no llow chnge. Lucs [1975] inerpres he REH s hypohesis h ssumes h every economic gen opimlly uilizes vilble informion in forming expecions. He proposes he minimum men squre error (MSE) crierion for ssessing he opimliy of individul expecions. Using his opimliy crierion, individul gens re ssumed o form heir forecss by minimizing he expecion (bsed on he equilibrium probbiliy disribuion) of he forecs error condiionl on he informion vilble o hem. In his cse, he rionl expecions soluion is bsed on he ssumpion h individuls behve opimlly. This is consisen on he whole wih rdiionl economic heory [Frymn, 1982]. Informion requiremens nd ssumpions in REH Alhough he informion requiremens he REH mkes on economic gens re no more hn in models wih disribued lgs, he ssumpion h economic gens need o know he sochsic process genering he equilibrium condiion mens hey know gre del bou he economy. The pplicion of hese ides cme wih he developmen of forml heory for gen recions o djusmens in mcroeconomic nd monery policy vribles h hve been chrcerized by noed economic heoriss, Lucs [1972, 1975], Srgen nd Wllce [1976], nd Sims [1980] in he rionl expecions economics lierure [Lucs nd Srgen, 1981; Pesrn, 1987; Sheffrin, 1996]. However, his ssumpion ofen is considered s oo srong. Why? Becuse i requires h economic gens Proceedings of he 36h Hwii Inernionl Conference on Sysem Sciences (HICSS 03)

4 hve full knowledge of he srucure of he relevn models nd heir prmeer vlues. I lso requires h rndom shocks h ffec gens expecions re independen nd ideniclly disribued. Empiricl economiss ypiclly dmi hey do no know he prmeer vlues nd mus esime hem economericlly. A somewh weker ssumpion is more pproprie: h gens c like economericins when hey mke forecss bou he fuure. By his, we men h hey re willing nd ble o upde heir expecions bou relevn prmeer vlues on he bsis of newlyreceived informion. This perspecive inroduces specific form of bounded rionliy which is clled dpive lerning [Srgen, 1993; Evns nd Honkpohj, 2001]. 1 When bounded rionliy is considered, economic cors re ssumed o lern o use resonble model specificions (nd choose meningful model prmeers), which re ofen pproprie in he resuling observed oucomes bu misspecified when here is lerning. We emphsize h lhough dpive lerning llows gens o lern he prmeers cul vlues in he equilibrium relions, i sill ssumes h gens know he correc specificion of he equilibrium relionships in he economy. For he pplicions of REH in IT invesmen nd dopion decisionmking h we discuss in his pper, we doped he ssumpions of dpive lerning. We did his becuse we believe hey re prgmic nd reflec cul siuions h we observe in he rel world. Non-IS/IT pplicions of REH We nex presen severl pplicions of he REH in non-is/it res o build he reder s inuiion bou he new heoreicl perspecive we offer. Wge-seing in he lbor mrke The REH hs been used o criicize rdiionl Keynesin views of wge-seing decisions in he lbor mrke. The rgumen here is h he Keynesin perspecive does no dequely ke ino ccoun he fc h lbor cn rionlly form expecions bou fuure condiions when hey se heir wge conrcs. Consider n economy h is in slump. A governmen h bses is policy on he rdiionl perspecive will ry o fuel hiring nd producion in he prive secor by incresing is own spending while minining he moun of money i drws from xes. 1 Simon [1957] rgues h bounded rionliy exiss becuse gens hve limied cogniive resources nd cpbiliies, nd i is ofen impossible for hem o obin he soluion lgorihms required o del wih ll vilble informion in mnner h would llow opimizion by he ime decision is o be mde. As resul of he incresed spending by he governmen, produc prices increse, creing new profi opporuniies for prive corporions, which in urn will enble hem o expnd heir businesses nd hire more workers. A big ssumpion in his scenrio of governmencreed profi opporuniies creed is h lbor will coninue o work bou he sme wge, llowing businesses o increse heir revenues while keeping heir coss under conrol. Workers re ssumed o be willing o ccep he sme wge res while fcing prospecively higher prices nd incresing living coss. In he rionl expecions view, however, his kind of policy will hrdly work becuse workers hve he biliy o hink rionlly nd forecs he fuure se of he economy bsed on wh hey observe. Also, hey my hve he mens (e.g., workers unions, flexible conrcs) o enble hem o demnd nd cully obin higher wges when hey see poenil increses in produc prices. Finncil mrkes The REH is he foundion of he efficien mrke view. In he finncil mrkes, decision o buy or sell compny s sock is bsed on expecions bou he compny s fuure finncil performnce. The price of he shres of compny, herefore, will reflec he expeced boom line of he compny. The equilibrium price is deermined by some mrke clering mechnism. Under rionl expecions, he mrke is considered o be efficien since he sock price ny poin in ime is bsed on some expecions formed by king ino ccoun ll possible informion bou he compny. If mrkes were no efficien, hen here would be rbirge opporuniies h rionl rders could exploi. In n efficien mrke, ll rders re rionl nd chnges in sse prices re compleely rndom, solely driven by unexpeced "news" bou chnges in economic fundmenls, such s ineres res, inflion, exchnge res, unemploymen figures, nd growh res. Ineres res Consider gin siuion wih n economy h is experiencing inflion. To ese he siuion, he Fed will increse he money supply growh re by series of purchses in he sock mrkes. This cion ends up wih he economy hving n inflow of new csh, subsequenly resuling in bnks obining new reserves h llow hem o increse lending o businesses. We cn hen expec o see ineres res go down, no only becuse he buying cions of he Fed hve boosed securiies prices lowering ineres res on hose securiies bu lso becuse bnks now hve o compee wih ech oher in ggressively disbursing lons, resuling in relive decrese in cos of cpil for oher firms. Proceedings of he 36h Hwii Inernionl Conference on Sysem Sciences (HICSS 03)

5 As businesses see chnces o use cheper funding o mke new invesmens, hey will sr building new plns nd hiring new workers, cusing oupus o increse. Some invesmen ides h were no considered profible previously suddenly seem lucrive due no o he fc h expeced revenues hve no chnged, bu insed becuse expeced coss hve declined. This is due o he reduced cos of cpil. The nex hing we expec o see is h he newly-hired workers will drive ddiionl new spending hemselves, resuling in more producion by businesses. As resul, we will see some rel effecs on he economy hrough he inducemen for iniil invesmens h reflec smll chnges in monery policy. From he rionl expecions poin of view, however, he bove scenrio is no very relisic. Why? The scenrio does no dequely ccommode people s biliy o form heir expecions. The decrese in ineres res s resul of he Fed s securiy buying cions will be emporry nd shor-lived bes. Rionl lenders nd invesors who hve he biliy o look fr enough ino he fuure will see h ny effor on he pr of he Fed o increse growh res for money will evenully increse he generl price level. Consequenly, lenders will no commi heir funds in long-erm lons he lower ineres res of ineres becuse of expeced fuure inflion. Micro-level decisionmking The REH is pproprie in siuions where economic gens hve o mke predicions of fuure vribles when mking curren decisions [Sheffrin, 1996]. For exmple, Rus [1987] exmined he monhly observions on bus milege, repirs, nd engine replcemens from he minennce records of he Mdison Meropolin Bus Compny. The bus engine is reed s porfolio of prs, ech hving sochsic filure re s funcion of use. An engine componen h fils relively low milege migh ge repired or replced, s i is considered he opiml opion. However, if he pr fils high milege, i migh be bes o simply replce he enire engine since i is resonble o ssume he oher prs will lso fil soon. This engine-replcemen sregy is n opiml-sopping model. The minennce superinenden decides when i is opiml o replce he engine, weighing rde-off beween minimizing minennce coss nd minimizing unexpeced engine filures. The purpose of he sudy is o consruc model o predic he ime nd milege which engine replcemen occurs. Fcors considered re ccumuled milege since he ls replcemen, expeced coss of bus minennce, nd n esime of los ridership nd goodwill of cusomers due o brekdown. The superinenden s decision is ssumed o be bsed on he curren vlue nd ll ps vlues of he se vribles, s well s he ps hisory of engine replcemen. So, he superinenden mkes decision bsed on vilble informion nd ll ps decisions, suggesing h REH holds. Poenil pplicions of REH o IS/IT There re numerous IS/IT invesmen nd dopion cses where REH heory cn offer insighs. IT wih nework exernliies: The EBPP cse A key elemen of mny ITs is nework exernliies, which indice h he vlue of echnology will increse wih he number of users. An exmple of his kind of echnology is elecronic bill presenmen nd pymen (EBPP) sysems, echnology h llows consumers o view nd py heir bills elecroniclly. EBPP exhibis nework exernliies since he more billers offer he service, he more consumers re willing o sign up. Thus, he vlue of ech biller s EBPP sysem will increse wih he number of billers offering he sme service. There re wo mjor groups h will compee o enice boh billers nd consumers ino using ech service. The firs group consiss of bill consolidors, hird-pry ggregor of d from muliple billers. They prepre bills for presenmen hrough rrngemens wih bnks or populr Inerne porls, such s Yhoo nd Americ Online. The second group, clled Specrum EBP, ws founded by consorium of mjor bnks, including J.P. Morgn Chse, Wchovi Corp., nd Wells Frgo nd Co. Specrum, now owned by Mevne Inc., hs spen lo of money developing online billing services nd devising sndrd bu hs no ye experienced widespred dopion. Bill consolidors (e.g., CheckFree) seem o be more redy wih heir service offerings of EBPP hn he consorium of bnks does. However, he Mevne Inc. cquisiion now posiions Specrum s more of neurl non-bnk hird-pry echnology provider. (See Au nd Kuffmn [2001] nd Specrum EBP [2002] for ddiionl deils.) Wihou doub, billers will benefi from he echnology since i will help hem sve money from he reduced coss of genering bills. In ddiion, hey cn lso use he echnology o enhnce relionships wih consumers. For exmple, hey cn offer new services bsed on dynmic nd rel-ime informion exchnge, s well s personlized mrkeing cmpigns h rge specific groups of consumers. Therefore, he dopion of he echnology is jus mer of ime for every biller. However, ech biller mus decide wheher i should dop he echnology now (i.e., go wih CheckFree s) or wi unil Specrum/Mevne s echnology is redy nd see which one is beer. Billers will decide o dop he Proceedings of he 36h Hwii Inernionl Conference on Sysem Sciences (HICSS 03)

6 curren echnology sooner, insed of wiing unil he nex echnology is redy, if hey nicipe lrge enough nework exernliies benefis from he curren echnology. The REH cn explin how billers form expecions bou he nework exernliies benefis by showing h ech biller will observe oher billers behviors h perin o he poenil dopion of he echnology nd will djus is own behvior ccordingly. If convergence of behviors occurs (i.e., billers hve similr iudes owrd doping he curren echnology), hen dopion will ke plce. We should emphsize h i is no necessry h he whole universe of billers converges in heir expecions before he dopion kes plce. I my be jus subse of billers h serves he sme groups of cusomers. Wireless echnology: GPRS sregy Moorol Tody s digil cellulr neworks re bsed on he second generion (2G) of wireless echnology, which hs limied cpbiliies in delivering high-speed digil pplicions (e.g., inercive gming, video conferencing). The hird generion (3G) of wireless echnology, while widely niciped, is no fully developed ye. The more recenly developed 2.5G echnology primrily embodied in he Generl Pcke Rdio Service (GPRS) is expeced o bridge he gp beween 2G nd 3G, providing soluion for consumers who demnd for beer echnology now. GPRS is n upgrde o curren Globl Sysem for Mobile (GSM) Communicions sysems. GSM implemened in he mjoriy of 2G wireless neworks worldwide is bsed on rdiionl circui-swiched echnology, which is opiml for voice bu no for d pplicions. Moorol mjor mnufcurer of semiconducors nd mobile communicions devices is he leder of GPRS. In July 2001, he compny nnounced h i plnned o offer is 2.5G semiconducor nd sofwre echnology o oher mobile phone mkers. This is n imporn move by Moorol nd i hs come s surprise o mny observers. The complexiy of he 2.5G echnology hs been significn brrier o oher mobile phone mkers eger o ener he mrke. By offering is experise, Moorol bsiclly opens up he 2.5G mrke. The quesions now re: Firs, why would Moorol be willing o offer is echnology o oher mobile phone mkers, who re essenilly is compeiors? Second, will he compeiors ccep Moorol s echnology? The rionl expecions hypohesis (REH) offers nswers o hese quesions. From Moorol s poin of view, supplying oher phone mkers is n obvious opporuniy o increse is business in he embedded wireless mrke. Furhermore, indusry pricipion is essenil in rolling ou mjor new echnology. More impornly, Moorol sees h he oher phone mkers do no hve ny compeing echnology on hnd mids he growing ineres in such echnology mong consumers. Rel nd de fco sndrds for XML web services The Exensible Mrkup Lnguge (XML) hs rced enion from he Inerne communiy. I involves sndrds developed by he Inerne Engineering Tsk Force (IETF) nd World Wide Web Consorium (W3C). They specify forms for srucured documens nd d, llowing esy d shring nd ccess. XML-bsed proocols UDDI, SOAP nd WSDL hve been promoed by IBM nd Microsof s foundion for Web services. 2 However, none hs received officil pprovl. Web services re new ype of Web pplicion. They re self-conined, self-describing, modulr pplicions h cn be published, loced, nd invoked cross he Web. They perform funcions h rnge from simple requess o compliced business processes. Once Web service is deployed nd mde vilble, oher pplicions, s well s oher Web services cn discover nd invoke he deployed service. Their poenil is huge since hey will llow he shring of muliple pplicions mong muliple developers round he world o be run on muliple differen plforms. The UDDI, SOAP, nd WSDL llow he Web services o perform hose sks. Considering he big poenil h Web services offer, mny compnies hve begun looking ino he possibiliies of uilizing he echnology. However, should he fc h he proocols hve no been officilly pproved by he sndrds-seing bodies dely compny in doping he echnology? From he rionl expecions perspecive, given he join srengh of IBM nd Microsof, hey should be ble o rnsform he echnology nd is proocols ino de fco sndrds. If every compny hinks his wy, he sks for IBM nd Microsof will become even esier. If h is he cse, he nex quesion is: Should IBM nd Microsof mke he echnology vilble for free or should hey chrge he Web developers nd users for using he proocols? Assessing REH for IT dopion nd vlue In mny cses, firms mus mke ineremporl decisions in spie of unceriny bou he fuure. Mos ineremporl decisionmking processes require mngers o form expecions bou he fuure vlues of economic vribles such s income nd prices. Formion of Expecions There hs been much debe over how mngers cully form heir expecions. Some rgue h 2 UDDI snds for Universl Descripion, Discovery, nd Inegrion; SOAP snds for Simple Objec Access Proocol; WSDL snds for Web Services Descripion Lnguge. Proceedings of he 36h Hwii Inernionl Conference on Sysem Sciences (HICSS 03)

7 mngers rely on simple "rules of humb"; ohers minin h hey use complex decisionmking processes. The mos srighforwrd rule of humb is o ssume h nex yer will be like his yer, rule clled sic expecions. However, mngers my lso employ dpive expecions o upde heir expecions bou he fuure bsed on heir previous errors in forecsing. The more sophisiced mechnism s we hve seen is rionl expecions, which specifies h gens mke efficien use of ll vilble informion nd heir undersnding of he economic model governing he economy in order o formule heir expecions [Schwrz, 1998]. Informion Processing nd Bounded Rionliy The biliy of ech gen o ccess nd process informion plys n exremely imporn role in he gen s decision bou when o dop or inves in echnology. This is becuse from he REH perspecive, expecions re rionl only if people fully uilize ll relevn vilble ps informion in forming heir expecions. However, in mny siuions, informion ccess nd/or processing biliies my be limied, phenomenon clled bounded rionliy. Though Simon [1957] ribues bounded rionliy more o he limied informion processing nd compuionl cpbiliies, Willimson [1975] in his inroducion of rnscion cos economics clims h bounded rionliy is more bou limied ccess o informion. Bounded rionliy for Simon implies he vilbiliy of more informion hn cn be processed by economic gens s decisionmkers, wheres for Willimson bounded rionliy mens he lck of informion, creing consrin in opimizion procedures. Informion processing nd mrke inelligence cpbiliies of firms re likely o ffec dopion iming nd invesmen willingness. For exmple, firm h hs srong cpbiliies in his re should be ble o nrrow he perceived vrince nd undersnd he reled risks fser, wihin n ccepble rnge of error, hus poenilly ccelering is decisionmking process. Vlue Vrince, Pyoff Horizon nd Firm Resources Rpid echnologicl chnge pus significn pressure on decisionmkers, who mus eiher opimize using n indeque moun of informion or process only subse of vilble informion due o he consrins of ime. The vrince in poenil pyoffs or coss of he new echnology under considerion, he ime i kes o merilize he expeced benefis from he echnology, nd he vilbiliy of resources of ech firm re ll likely o impc decisionmking. High iniil coss will mos likely slow down he dopion or invesmen decisionmking process, nd vice vers. Soon-o-merilize versus longer-o-merilize benefis will cerinly ffec he dopion or invesmen iming. Csh-rich dopers or invesors h hve greer ccess o resources will be ble o dop or inves erlier, simply becuse hey hve he funds vilble, while csh-poor firms will end o dop ler. Undersnding he Underlying Economy This discussion rises quesion bou wheher REH is cully relisic in he IS/IT dopion nd invesmen decisionmking conexs. The biliy of decisionmking dopers nd invesors o idenify he rue equilibrium relions of he economy is essenil in ny REH-bsed model. However, s we hve seen in he Hype Cycle, he rend for mos new nd emerging echnologies is o go hrough he phse of pek of infled expecions, when over-enhusism nd unrelisic projecions occur. Esimes of cos nd vlue will be ffeced by ggrege unceriny in he mrke. This mkes i hrd for decisionmkers o predic how he new nd emerging echnology will fre nd ffec he economy in he fuure. Any esimes involve high levels of vrince, boh in erms of coss nd benefis. This is becuse mos new nd emerging echnologies do no hve long-enough rck record, nd over-enhusism nd unrelisic projecions will mos likely cree noise in ny forecs. The Role of Risk Aversion Wihou well-defined picure of he fuure economy, i will be hrd o expec h he decisionmkers will figure ou he so-clled rue equilibrium relions of he economy s required by he REH. We cn rgue h in such seings, erly dopion or invesmen decisionmking re bsed more on riskking behvior hn rionl expecions. Decisionmkers more verse o risk re more likely o mke decision ler when enough informion hs been vilble nd processed properly. In he cse of e-commerce-reled echnologies, for exmple, we hve winessed how new enrepreneuril firms, such s Amzon.com nd E-Trde, doped nd leverged on he echnologies erlier hn he more esblished brick-nd-morr compnies, such s Brnes nd Noble nd Merrill Lynch. Mny of hese enrepreneuril firms rgubly more risk-king quickly developed ino compeiive hre, drmiclly rnsforming he mrkeplce. The ssumpions of REH h people cnno sysemiclly be fooled nd will ry o mke unbised forecss bsed on he vilble informion should led us o believe h risk-verse decisionmkers will be ble o lern he rue equilibrium relions of he economy, nd even if hey re uncerin bou some of he prmeers of hose relionships iniilly, under he Proceedings of he 36h Hwii Inernionl Conference on Sysem Sciences (HICSS 03)

8 dpive lerning frmework ssumpion hey will be ble o lern he cul vlues of he prmeers evenully, fciliing he dopion nd invesmen of echnology. Muul Consisency nd Consensus Formion In ddiion o individul rionliy, REH imposes muul consisency of percepions mong decisionmkers s economic gens. This implies h dopion my occur even ler becuse i my ke some ime before he economic gens rech consensus mong hemselves bou he economic benefis new nd emerging IT my bring. This is especilly rue for ITs whose poenil benefis minly come from nework exernliies (e.g., EBPP, HD-TV, CORBA, ec.) The need for poenil dopers o rech consensus crees ineresing dynmics in he dopion nd invesmen decisionmking process. Firms mus now observe ech oher s cions nd perhps ke heir cue from ech oher before mking echnology dopion or invesmen decision. There re mny dimensions h ech firm needs o exmine o chieve he bes decision. Risk profile is one dimension we hve discussed. We hve rgued h risk-verse firms ough o be more relucn o dop or inves hn risk-neurl firms, ll else equl. In mrke dopion erms, hen, i will be imporn for firms o hve rionl expecions relive o he differen risk olernces oher firms h influence decisionmking. Rionl expecions men knowing bou he posiion of ech poenil doping or invesing firm wih regrd o he vrious dimensions, nd hen cing ccordingly. In dynmic dopion nd invesmen decisionmking process, subse of firms h hve beer posiions in one or more dimensions re likely o dop erlier nd become clyss in he whole sysem, fciliing he decisionmking process of he remining firms. Reserch direcions The rionl expecions hypohesis (REH) cn inspire decisionmkers o crefully consider heir policies nd decisions by insising h expecions of economic cors be consisen wih he economic models used o explin heir behvior. In he recen er of irrionl exubernce sprked by unrelisic expecions of mny e-commerce business models, REH-bsed hinking migh hve been svior for he presen down mrke. As we hve seen, during he Pek of Infled Expecions in he Hype Cycle, i is possible h selffulfilling expecions will develop when possibly flse model is considered by mos mrke pricipns s he rue economy relionship [Pesrn, 1987], creing rp for mngers o mke he wrong IT decisions. In ddiion o requiring gens o hve n biliy o figure ou he rue economic model, he REH lso ssumes h every economic gen mkes efficien use of he vilble informion. In mny cses, we cn invesige if here is evidence o suppor he ssumpion. In he cse of dopion of ITs h exhibi nework exernliies, for exmple, i my be possible o find ou wh economic fcors compny will look ino before i will decide o dop he echnology. This will involve he use of dpive lerning o ke ino considerion h mos compnies need some ime o observe he echnology s well s heir business environmen before mking ny decision. We need o mke sure h he IT under considerion hs reched he muriy phse in is lifecycle. By h ime, he poenil dopers lredy will hve good ide bou how he IT is likely o benefi hem. When his hppens, we cn imgine h here will be group of poenil dopers h will be willing o dop he echnology cerin price due o he nework exernliies benefis he IT cn poenilly deliver. We ssume h his group will mke he dopion decision bou he sme ime o mke sure h ech of hem will cully relize he nework benefis. The dopion decisions hemselves re bsed on observions over some period of ime. Wh economic fcors hese compnies hve observed becomes n imporn quesion o sudy. Anoher poenil reserch direcion involves surveying group of firms involved in emerging echnology dopion in longiudinl sudy spnning severl ime periods (e.g., qurers). In ech period, compny mngers will fill ou quesionnire h sks hem bou heir expecions bou he vlues (expressed in erms of specific mesures nd unis) of he IT hey hve doped or re bou o dop. These responses cn ler be compred wih he cul vlues. The min reserch quesion will be: Are mngers rionl in mking heir forecs bou he vlues of he IT hey doped? The REH implies h forecs is rionl if is forecs error is unpredicble, given wh he forecser knew when mking he forecs. The findings will be imporn in h hey will provide some indicions of he consisency h mngers hve in heir forecss nd decisionmking processes before deciding o dop priculr IT. A one level of nlysis, we cn imgine h here re some firms h re risk-kers nd some h re risk-verse. Furhermore, some orgnizions, boh public nd prive, my be less ble o innove due o heir orgnizionl culures. As resul, hey my no be ble o chnge he wy hey do business esily. These compnies cn be considered lggrds mong he riskverse firms in he conex of echnology dopion nd Proceedings of he 36h Hwii Inernionl Conference on Sysem Sciences (HICSS 03)

9 invesmens. For exmple, some orgnizions seemed o wi oo long before hey go on he e-commerce bndwgon, despie he fc h he echnology hd become minsrem nd mny oher compnies hd some success using hem. These lggrds did no use he vilble informion efficienly, resuling in very slow cions. From he perspecive of REH, hey migh be viewed s less hn rionl. The fmilir S-shped curve (which chrcerizes he re of dopion or he diffusion of innovions) groups dopers ino five cegories: innovors, erly dopers, erly mjoriy, le mjoriy, nd lggrds. The grouping is bsed on norml disribuion h is priioned ino he five doper cegories by lying off sndrd deviions from he verge ime of dopion [Rogers, 1995]. This resuls in innovors being 2.5% of he populion, erly dopers 13.5%, erly mjoriy 34%, le mjoriy 34%, nd lggrds 16%. We cn furher group he erly nd le mjoriies s he minsrem dopers. Anoher reserch issue presens iself in his conex: Wh re he orgnizionl economic fcors h differenie beween he minsrem dopers nd he lggrds, which signify he rionl nd non-rionl orgnizions, respecively, in priculr IT dopion conex? These fcors my include firm size, mrke shre nd mrke size, firm s revenue nd ernings, nd indusry secor, mong ohers, for exmple. The developmen of de fco sndrds is noher issue for which he REH my offer useful perspecive. Exmples include opering sysems sndrds such s Windows nd Unix (nd now Linux) h replced propriery sysems (e.g., DEC s VMS nd IBM OS/400 in mny compnies). Also Adobe s Porble Documen Form (PDF) is de fco sndrd for finl form delivery nd disply of elecronic documens. Clerly, some rionl expecions should hve developed mong mrke pricipns bou he benefis of ech of he echnologies h mde hem decide o dop he echnologies. Wh s ineresing is h here seems o be no single dominn fcor h cn explin why hese echnologies become he de fco sndrds. The reserch quesion is herefore: Wh (economic) fcors did he mrke pricipns consider when ech of hem decided o dop priculr echnology h helped o mke he echnology ner sndrd? Conclusion The rionl expecions hypohesis cn be quie powerful if pplied properly in IT invesmen nd dopion decisionmking siuions. I helps decisionmkers o pu hings ino perspecive by chllenging bsic ssumpions h ofen seem o be ken for grned. As resul we cn expec mngers o be ble o engge in decision mking processes h re endowed wih sounder nd more useful informion. Alhough he key ssumpion of he REH h economic gens know he rue srucurl relions of he economy is probbly oo srong, he dpive lerning noion h llows some djusmens of prmeer vlues over period of ime mkes he heory looks more relisic. Noneheless, he originl ssumpion hs enbled us o develop rgumens h led o he proposiions esblished in his pper. Expecions of profis nd of relevn economic evens re lwys essenil o he nlysis of finncil nd economic processes, nd IT dopion nd invesmen decision mking re imporn for senior IS mngers. Indeed, mngers should no bse heir invesmen or producion decisions on he resuls of he ps beyond he poin where he ps informion serves s n inpu for forming expecions bou he fuure. This is why we believe h he REH heory is pproprie o he IT invesmen nd dopion nlyses. Economiss ody rouinely use rionl expecions nd reled ides s he bsis for heir heory-building work. In fc, Sheffrin [1996] minins h no using rionl expecions requires specific jusificion nd nlysis in vriey of decision mking seings. Mny ineresing heoreicl consrucs in fvor of he rionl expecions pproch hve been presened in he Economics lierure in order o provide explnions for leding issues in mcroeconomics, finncil mrkes, nd microeconomics. Some of he mos ineresing reserch such s noise rding in finnce combines rionl nd non-rionl cors. In reled empiricl work, despie n overll mixed bg of resuls, here re some findings h srongly suppor he heory [e.g., see Kene nd Runkle, 1998]. Our discussion lso suggess h when nlyzing n erly dopion or invesmen of new nd emerging echnology, we should reconsider he use of he convenionl mehod for esiming he vlue of invesmens (including IT invesmens) vi he discouned csh flow (DCF) nlysis pproch. DCF essenilly involves discouning he expeced ne csh flows (he risk-djused discoun re) bsed on he ime vlue of money. In his pproch, forecs mus be mde bou he expeced fuure csh flows. Needless o sy, he forecs mus be prey ccure in order for his pproch o provide resuls h re useful in IT dopion nd invesmen decisionmking. And o mke relible forecs, economic gens mus be rionl in he REH sense. Consequenly, he convenionl mehod for esiming he vlue of invesmens he discouned csh flow (DCF) nlysis cnno provide he correc esimes when used o vlue n invesmen or dopion decision h is mde erly bou new IT. In closing, we believe h i is now ime o explore, Proceedings of he 36h Hwii Inernionl Conference on Sysem Sciences (HICSS 03)

10 uilize nd es he heory in IS reserch. Alhough he presen effor is only preliminry emp, we hope h furher explorion of he heory in his new conex in our field will help solve some puzzles nd shed ligh on some reserch quesions h will remin difficul o undersnd wihou giving serious considerion o he ssumpion h economic gens mke efficien use of ll informion h is vilble o hem. References [1] Au, Y. A. nd Kuffmn. R. J Should we wi? Nework exernliies, compibiliy, nd elecronic billing dopion. J. Mgm. Info. Sys. 18(2) [2] Brynjolfsson, E., nd Kemerer, C. F Nework exernliies in microcompuer sofwre: An economeric nlysis of he spredshee mrke. Mngemen Science. 42(12) [3] Choi, J. P., nd Thum, M Mrke srucure nd he iming of echnology dopion wih nework exernliies. Europen Economic Rev. 42(2) [4] Chrisensen, C. M The Innovor s Dilemm: When New Technologies Cuse Gre Firms o Fil. Hrvrd Business School Press, Boson, MA. [5] Evns, G. W., nd Honkpohj, S Lerning nd Expecions in Mcroeconomics. Princeon Universiy Press, Princeon, NJ. [6] Frymn, R Towrds n undersnding of mrke processes: individul expecions, lerning, nd convergence o rionl expecions equilibrium. The Americn Economic Review. 72(4) [7] Grossmn, S. J An inroducion o he heory of rionl expecions under symmeric informion. The Review of Economic Sudies. 48(4) [8] Jensen, R Adopion nd diffusion of n innovion of uncerin probbiliy. Journl of Economic Theory. 27(1) [9] Kz, M. L., nd Shpiro, C Nework exernliies, compeiion, nd compibiliy. The Americn Economic Review. 75(3) [10] Kz, M. L., nd Shpiro, C Technology dopion in he presence of nework exernliies. Journl of Poliicl Economy. 94(4) [11] Kuffmn, R. J., McAndrews, J., nd Wng, Y Opening he `blck box' of nework exernliies in nework dopion. Info. Sys. Res. 11(1) [12] Kene, M. P., nd Runkle, D. E Are finncil nlyss forecss of corpore profis rionl? Journl of Poliicl Economy. 106(4) [13] Linden, A., Fenn, J., nd Hley, K hype cycle of emerging rends nd echnologies. Grner Reserch Noe. T (July 2, 2001) 1-4. [14] Lucs, R. E., Jr Expecions nd he neurliy of money. J. Economic Theory. 4(2) [15] Lucs, R. E., Jr An equilibrium model of he business cycle. J. Poliicl Economy. 83(6) [16] Lucs, R. E., Jr., nd Srgen, T. J. (Eds.) Rionl Expecions nd Economeric Prcice. Universiy of Minneso Press, Minnepolis, MN. [17] Muh, J. F Rionl expecions nd he heory of price movemens. Economeric. 29(3) [18] Nerlove, M Adpive expecions nd cobweb phenomen. Qurerly Journl of Economics [19] Pesrn, M. H The Limis o Rionl Expecions. Bsil Blckwell, Oxford, UK. [20] Rogers, E. M Diffusion of Innovions. 4 h ed. The Free Press, New York, NY. [21] Rus, J Opiml replcemen of GMC bus engines: An empiricl model of Hrold Zurcher. Economeric. 55(5) [22] Srgen, T. J., nd Wllce, N Rionl expecions nd he heory of economic policy. Journl of Monery Economics. 2(2) [23] Srgen, T. J Bounded Rionliy in Mcroeconomics. Oxford Univ. Press, Oxford, UK. [24] Schwrz, H Rionliy Gone Awry? Decision Mking Inconsisen wih Economic nd Finncil Theory. Preger Publishers, Wespor, CT. [25] Shpiro, C. nd H. R. Vrin Informion Rules: A Sregic Guide o he Nework Economy. Hrvrd Business School Press, Boson, MA. [26] Sheffrin, S. M Rionl Expecions. 2nd ed. Cmbridge Universiy Press, Cmbridge, U.K. [27] Simon, H. A Models of Mn. John Wiley nd Sons, New York, NY. [28] Sonemn, P., nd Irelnd, N The role of supply fcors in he diffusion of new process echnology. Economic Journl. 93(conf. supp.) [29] Sims, C. A Mcroeconomics nd reliy. Economeric. 48(1) [30] Specrum EBP Mevne o cquire Specrum, n open ineroperble swich for exchnging bills nd pymens online. Specrum EBP LLC Press Relese. (July 29, 2002). [31] Willimson, O. E Mrkes nd Hierrchies. Mcmilln, New York, NY. Proceedings of he 36h Hwii Inernionl Conference on Sysem Sciences (HICSS 03)