The Impact of Information Technology on Quality Improvement, Productivity, and Profits: An Analytical Model of a Monopolist

Matt E. Thatcher University of Arizona

mthatcher@cmi.arizona.edu

Jim R. Oliver VP of Business Development, CrossCommerce

jim.oliver.wp96@wharton.upenn.edu

Abstract Empirical and analytic research in the IT and economics literatures have paid little attention to the distinction between the goals of cost reduction and quality improvement when examining the impact of IT investments on firm performance (i.e., firm profits and productivity). In this paper we present a simple analytical model that examines the impact of various types of IT investments on the quality and pricing decisions made by firms and on the economic performance of these firms. The model demonstrates that while investments in the technology types examined in this model are all expected to increase firm profits the impact of these investments on firm productivity vary and depend on the type of technology implemented. More specifically, the model demonstrates that a profit-maximizing firm may make a conscious decision to invest in certain technologies that lead to product quality improvements to capture higher profits, but sometimes at the expense of firm productivity. 1. Introduction

Firms typically make investments in information

technology (IT) to accomplish two goals [16]:

Cost Reduction occurs when an IT investment enables a firm to produce more of a given product (or service) with fewer resources. IT investments in the production of food, chemicals, transportation equipment, and other traditional production are primarily devoted to cost reduction; for example, a technology investment that leads to increased production of wheat (of the same quality) per acre of land is clearly devoted to cost reduction. IT investments in data processing functions are also primarily devoted to cost reduction. As a result, investments in these types of technologies are often associated with a fall in the equilibrium price for a product or service.

Quality Improvement occurs when an IT investment leads to the creation of new products, or new features on existing products, that directly increase human desire to consume those products. IT investments in medical/health services are often devoted to improving the quality of medical care (e.g., diagnosis accuracy and treatment strategies) provided to patients. In addition, many investments in the telecommunications industry are devoted to developing new and improved services (e.g., interactive TV and Internet services) for consumers. Since these types of investments increase consumer demand for products and services, they are often associated with a rise in the equilibrium price for a product.

Different IT investments help firms accomplish different goals (or some combination of these goals). However, empirical and analytic research in the IT and economics literatures have paid little attention to the distinction between the goals of cost reduction and quality improvement when examining the impact of IT investments on firm performance (i.e., firm profitability and productivity) [16]. Therefore, little research has focused on formalizing the relationships discussed above. In this paper we develop an analytic model that explicitly acknowledges this distinction and examines the impact of various types of IT investments on the quality and pricing decisions made by firms and on the economic performance (i.e., profits and productivity) of these firms.

In this model we consider a single-product monopolist, and we distinguish among three different types of IT investments that the monopolist may undertake. We demonstrate that while investments in each technology type should improve firm profits, the impact of each investment on product quality and firm productivity vary and depend on the technology type implemented. The model results suggest that a profit-maximizing firm may make a conscious decision to invest in technologies that lead to product quality improvements to capture higher profits, but sometimes at the expense of firm productivity.

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