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The IT Productivity Paradox

Ethan Dreyfuss, Andrew Gadson, Tyler Riding, Arthur Wang

IT Redistributes Wealth

In the realm of capital investments, Information Technology is of particular interest because it has the potential to redistribute market share rather than increase overall productivity. When looking at the economy as a whole, this can create the illusion of the Productivity Paradox - IT investments don't appear to increase overall productivity. In truth, IT is benefiting the firms that invest in it, but it is taking away from those firm's competitors yielding no net gain. As Erik Brynjolfsson puts it, "IT rearranges the shares of the pie without making it any bigger."

Conceptual Model

Consider two firms -- Firm A and Firm B. They are members of the same economic industry, and within that industry Firm A holds 50% of the market and Firm B holds the other 50%. If Firm A chooses to invest in IT to improve their research and marketing they may gain a competitive edge over Firm B and therefore have the ability to take a percentage of Firm B's market share, say 25%. Thus, because of succesfully investing in IT Firm A has improved their market share to 75%, but the overall market and overall productivity remains the same. Therefore, from an outside perspective one could say that Investments were made in IT within that industry (by A), but there was no overall gain (because B lost as much as A gained). Viewed in this light, the Productivity Paradox is merely the result of looking at the economy from the wrong perspective. Instead of considering the economy or industries as a whole, one must look at IT investments and their yields at the firm level.

It is interesting to note that if this were an absolute rule for IT investments (which we believe it is not, as covered in our other sections), then investing in IT would be a waste of resources for the economy as a whole despite benefitting individual firms.

Case Study - American Airlines and the Sabre System

IT has given rise to Strategic Information Systems - systems aimed at taking business away from competitors rather than more traditional strategies like lowering business costs.

In the 1950s, American Airlines was reaching the limits of their manual system for booking fligths. In a joint venture with IBM they developed the Sabre compter system. This gave American Airlines an automated system for checking flight and seat availability and making reservations for clients. Eventually it was expanded beyond just AA employees to include travel agents as well.

An AA study found that travel agents were more likely to select flights appearing earlier on their screens. The first flight would be selected more than half of the time, and the chosen flight was almost always on the first screen (92% of the time). As a result AA used the Sabre System to manipulate their flight information to take advantage of the ranking algorithms and ensure their high placement on agent's screens.

Evidence suggests that this was an extremely effective move on AA's part. For example, New York Air, an upcoming competitor, was forced to withdraw all eight of their flights to Detroit when all of their flights kept being pushed to the bottom of booking screens.

In 1984, Congress ruled against intentionally giving AA flights preferential screen placement, but agents that had used the system remained statistically more likely to choose AA flights. The 1984 fairness rules expired in 2004.

Takeaway Points

From a firm's perspective, this means that investing in IT is of critical importance. Not only will a lack of IT investment allow competitors to improve their businesses, but it may also let them take away your firm's market share.

When viewed with this concept of Market Redistribution in mind, the Productivity Paradox also begins to make more sense. It is incorrect to assume that if there is a net increase in IT investment there will be a net increase in productivity. Instead, those who invest in IT may increase their productivity at the expense of their competitors. Thus, investing in IT does in fact increase productivity, but in order to see the increase you must first no where to look.