TBI Study Case Assignment

RESEARCH NOTE

HOW INFORMATION TECHNOLOGY STRATEGY AND INVESTMENTS INFLUENCE FIRM PERFORMANCE:

CONJECTURE AND EMPIRICAL EVIDENCE1

Sunil Mithas and Roland T. Rust Robert H. Smith School of Business, University of Maryland,

College Park, MD 20742 U.S.A. {smithas@rhsmith.umd.edu} {rrust@rhsmith.umd.edu}

In this paper, we develop conjectures for understanding how information technology (IT) strategy and IT investments jointly influence profitability and the market value of the firm. We view IT strategy as an expres- sion of the dominant strategic objective that the firm chooses to emphasize, which can be revenue expansion, cost reduction, or a dual emphasis in which both goals are pursued. Using data from more than 300 firms in the United States, we find that at the mean value of IT investments, firms with a dual IT strategic emphasis have a higher market value as measured by Tobin’s Q than firms with a revenue or a cost emphasis, but they have similar levels of profitability. Of greater importance, IT strategic emphasis plays a significant role in moder- ating the relationship between IT investments and firm performance. Dual-emphasis firms have a stronger IT–Tobin’s Q relationship than revenue-emphasis firms. Dual-emphasis firms also have a stronger IT– profitability relationship than either revenue- or cost-emphasis firms. Overall, these findings imply that, at low levels of IT investment, the firm may need to choose between revenue expansion and cost reduction, but at higher levels of IT investment, dual-emphasis in IT strategy or IT strategic ambidexterity increasingly pays off. TBI Study Case Assignment

Keywords: Information technology strategic emphasis, IT ambidexterity, IT strategic ambidexterity, firm performance, profitability, IT investments, revenue growth, cost reduction, dual emphasis

Introduction1

Firms spend significant sums of money on information tech- nology (IT) resources, yet they are often challenged in developing appropriate strategies to direct these resources to realize business value (for a discussion, see Kohli and Devaraj 2004). Previous research has studied either the im- pact of IT investments on firm performance (e.g., Barua and Mukhopadhyay 2000; Dedrick et al. 2003; Hoadley and Kohli 2014; Kohli and Devaraj 2003; Kohli et al. 2012) or the effect of IT strategic emphasis on firm performance (e.g., Leidner et al. 2011; Oh and Pinsonneault 2007; Tallon 2007; Tallon et

al. 2000). However, few studies focus on the effect of IT investments and IT strategic emphasis simultaneously. Given that profit is equal to revenue minus cost, it is clear that there are three strategic paths from IT to firm performance: IT can be used to (1) reduce costs by improving productivity and efficiency; (2) increase revenues by fully exploiting oppor- tunities through existing customers, channels, and products/ services and by finding or creating new customers, channels, and products/services; or (3) reduce costs and increase revenues simultaneously. What is not clear is the relative degree to which these strategies and IT investments jointly influence firm performance. In other words, despite signifi- cant progress in the literature with regard to understanding the business value of IT, little is known about how IT strategy moderates the relationship between IT investments and firm performance.

1Rajiv Kohli was the accepting senior editor for this paper. Andrew Burton- Jones served as the associate editor.

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This study seeks to answer the following research question: How do IT strategic emphasis and investments in IT resources affect firm performance? To answer this question, we pro- pose conjectures that link IT strategy and IT investments with firm performance. Although firm performance is a multi- dimensional concept (Richard et al. 2009), following recent work (Kohli et al. Ow 2012), we use two complementary measures of firm performance in this study (profitability and market value) which relate to both fundamentals and stock market assessment (for a discussion, see Blanchard et al. 1993; Henwood 1997). We empirically test the conjectures using archival data from more than 300 U.S. firms.

Our work is related to but distinct from prior research linking IT investments with profitability and Tobin’s Q (Bharadwaj et al. 1999; Kohli et al. 2012; Mithas et al. 2012; Tafti et al. 2013) because we also consider the effect of IT strategy, per- haps for the first time using a data set that has information on both IT investments and IT strategy. Our contribution is to show that the firm’s IT strategic emphasis moderates the relationship between IT investments and firm performance; firms with a dual emphasis have higher profitability and market value at higher levels of IT investments. In other words, successful dual IT emphasis appears to require higher levels of IT investments. A key insight from our results is that IT investments and IT strategy should not be viewed separately from each other and that firms need to synchronize their IT investment levels and their IT strategies for improved performance. The study has implications for firms as they consider adopting dual strategies in increasingly turbulent markets. Thus, this study not only answers an interesting and managerially relevant empirical research question but also provides directions for motivating a program of research to clarify and elaborate the findings through further theoretical or empirical work. TBI Study Case Assignment

Background and Theory

Background

Our review of prior literature suggests that despite much pro- gress in the business value of IT literature, two opportunities for contributions remain. First, although prior studies have discussed the relationship between IT strategy and perfor- mance, and IT investments and performance, few studies focus on how IT strategic emphasis and investment level jointly affect performance. We define IT strategic emphasis as the dominant strategic objective that the firm chooses to emphasize in its IT strategy, which can be revenue expansion, cost reduction, or a dual-emphasis in which both goals are pursued. Other studies have used other terms such as IT

strategic orientation and IT strategic focus to refer to similar ideas. Among prior information systems (IS) research on the direct effects of strategic emphasis on firm performance, Tallon et al. (2000) find that executives in firms with more focused IT goals (e.g., operations focus, market focus, dual focus) perceive greater payoffs from IT across the value chain. Subsequently, Tallon (2007) uses Treacy and Wiersema’s (1993) typology (operational excellence, customer intimacy, and product leadership) and finds that IT business value is the highest in firms with a multifocused business strategy and lowest in those with a single focus. Oh and Pinsoneault (2007) study the strategic value of IT in terms of the deployment of IT applications (cost reduction, quality improvement, and revenue growth) and find that contingency approaches better explain the impact of cost-related applications while a resource-centered perspective better predicts the impact of IT on revenue and perceived profitability; however, they do not study the effect of dual or mixed emphases. Leidner et al.’s (2011) exploratory results suggest that IS ambidextrous firms (firms pursuing an IS innovator and an IS conservative strategy at the same time) had higher perceived organizational performance. None of these studies investigates how IT strategic focus moderates the relationship between IT investments and firm performance, which is the focus of the current study.

Second, although prior research in marketing provides useful insights for the effect of strategic emphases in terms of quality strategy or customer focus on firm performance, the extent to which their findings apply to IT strategy is an open empirical question. For example, Rust et al. (2002) show that firms with a revenue growth emphasis in their quality strategy outperform firms with a cost reduction emphasis, and firms with a primary emphasis on either revenue growth or cost reduction outperform firms that attempt a dual emphasis. Further research (Rust et al. 2016) shows that a revenue emphasis and cost emphasis are cultivated in different ways, with a revenue emphasis propagating “bottom up” and a cost emphasis propagating “top down.” These results illustrate the complexities of quality management, and are generally con- sistent with the notion of trade-offs among different strategic emphases in the strategy literature (Porter 1980). Mittal et al. (2005) study the moderating effect of dual emphasis on the association between customer satisfaction and long-term performance and report that association between customer satisfaction and Tobin’s Q is positive and relatively stronger for firms that successfully achieve a dual emphasis. TBI Study Case Assignment

With this backdrop, our work seeks to advance our under- standing of how IT strategic emphasis and investments in IT resources affect firm performance. We conceptualize IT strategy in terms of revenue focus and cost focus. Our approach is consistent with recent studies that have articulated

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strategic focus in terms of objective metrics, such as revenues or costs in a firm’s income statement, to more directly assess the impact of such cost- or revenue-focused strategies on firm performance (Kohli 2007; Oh and Pinsonneault 2007; Rust et al. 2002). Chief information officers (CIOs) also find this revenue and cost typology more useful, as reflected in comments by AstraZeneca’s CIO (Hickins 2012):

The key to winning approval from executive man- agement and boards…is to talk about IT projects in terms of the business opportunities they afford. “Are you going to generate additional revenue or are you going to reduce the cost structure” of the organization.

Recent IS research has acknowledged this need to use business-oriented metrics as IT increasingly takes on a more strategic role in corporations, and research suggests that use of business terms “helps IT personnel focus even more clearly on business value” (Mitra et al. 2011, p. 57). Besides, such objective metrics lend themselves for better target-setting and monitoring of progress to enable timely corrective actions that are directly tied to firm performance. TBI Study Case Assignment

Although IT, being a general-purpose technology, can be viewed as being capable of both increasing revenues and reducing costs, does this mean that firms no longer have to choose a strategic emphasis? Choosing a particular strategy implies making some trade-offs (Hindo 2007; Skinner 1986)—that is, choosing some goals and functionalities while forsaking others in the hope that the overall combination of choices will ensure a better fit for organizational activities in the value chain and will make that fit less replicable for com- petitors (Porter 1996). Accordingly, firms often choose between revenue expansion or cost reduction in their strategic IT emphasis. For example, the CIO of FedEx, Robert Carter, contrasts FedEx’s approach to IT with that of UPS in the following way:

We tend to focus slightly less on operational tech- nology. We focus a little more on revenue-gener- ating, customer-satisfaction-generating, strategic- advantage technology. The key focus of my job is driving technology that increases the top line (Colvin 2006).

In other words, in Carter’s view, FedEx has a revenue emphasis while UPS has a cost emphasis. Kohli’s (2007) work with UPS suggests that the company may be using IT for revenue growth as well. However, at the 2014 Frontiers in Service Conference, Romaine Seguin, President of UPS Americas Region, indicated in a question-and-answer session following her keynote presentation that the FedEx (revenue

emphasis) versus UPS (cost emphasis) distinction was essentially correct, lending credence to Carter’s view. There are other firms, such as Johnson & Johnson (Mithas and Agarwal 2010) and Coca-Cola (see Levin 2013), in which CIOs have tried to emphasize revenue growth in their IT strategy. As we have noted, FedEx and UPS do not have to restrict themselves to either revenue growth or cost reduction; alternatively, they can adopt a dual emphasis.

Consider some examples. While customer relationship man- agement (CRM) systems can enable some cost savings if they help reduce the costs of maintaining customer relationships, the primary reason for deploying these systems is often to increase revenues by either attracting new customers or enabling cross-selling, upselling, or repeat sales from existing customers (Mithas et al. 2005, 2016; Saldanha et al. 2016). If firms use CRM systems to help with revenue growth and cost reduction in equal measure, then such an approach could be characterized as a dual-focus investment. Likewise, in an academic setting, systems used to maintain alumni develop- ment and relationships may be characterized primarily as revenue enhancing, while systems related to the automation of class scheduling or course bidding systems (as opposed to manual processes) can be viewed as cost reducing (Kohli and Melville 2009). TBI Study Case Assignment

Among cost-focused applications, firms often use reverse auctions and many other supply chain management appli- cations primarily to reduce their procurement costs (Mithas and Jones 2007). As another example of a cost-focused project, UPS linked bar-code data on its packages (called Package Level Detail) but retained the capability to provide seamless tracking information to its customers while out- sourcing some rural deliveries to the U.S. Postal Service (USPS) to lower its overall costs (Kohli 2007). A similar opportunity for cost reduction was provided by UPS’s Geo- graphical Information Systems, which enabled the firm to get its customers to do some data entry themselves, further reducing UPS’s costs. UPS also used its integrated supply chain assets to do customers’ work for them, which helped realize revenue opportunities; in this case, we could charac- terize the investment as being revenue-focused (Kohli 2007). It is also likely that some systems can initially be deployed for their cost-saving potential or to streamline internal processes, but later they may provide revenue benefits. For example, UPS’s Delivery Intercept Service, which has the capability to locate and intercept any package within 15 minutes, was ini- tially deployed to improve UPS’s internal processes through the use of XML, but it also enabled revenue growth over time through additional fee-based services (Kohli 2007).

We argue that it is not so much which applications firms use but rather what their strategic objectives are for deploying

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those applications, in that managerial beliefs and strategic posture shape an organization’s IT governance and manage- ment of IT projects to create business value. This logic applies to IT assets, which are mostly general in nature and, with some customization and appropriate changes in business processes, training, and incentive structures, can be targeted to achieve strategic objectives defined by managers. These changes in business processes and reengineering efforts are often shaped by the firm’s overarching IT strategic objectives (Barua et al. 1996; Cederlund et al. 2007; Kohli and Grover 2008; Kohli and Hoadley 2006; Kohli and Johnson 2011). In other words, while any individual IT system presents potential opportunities to reduce costs or to enhance revenue, or both, we argue that it is perhaps more useful to think of the portfolio of IT applications that firms want to create to operationalize their strategic emphasis by instantiating necessary configurations of individual IT applications. TBI Study Case Assignment

Why IT Strategic Emphasis Moderates the Relationship Between IT Investments and Firm Performance

To understand how IT strategic emphasis and IT investments jointly influence profitability and market value, we first articulate why we expect a firm’s IT strategic emphasis to affect firm performance at typical levels of IT investments. A firm’s strategic emphasis affects the firm’s choices with respect to the types of technologies and applications it acquires and the types of governance processes and firm performance metrics it uses. The comment of the CIO of FedEx, referred to previously, provides support for this idea (see Colvin 2006). We recognize that, ultimately, any strategy needs to be instantiated through appropriate combina- tions of IT systems to result in firm performance. In other words, strategy execution can be viewed as the actualization of a specific configuration of systems.

We argue that a dual emphasis in IT strategy may lead to better firm performance than a single emphasis in IT strategy, despite some risks in executing a dual-emphasis strategy. We draw on prior theories in the IS literature such as the resource- based view, the accounting literature (Dehning et al. 2006), and the emerging literature on ambidexterity which empha- sizes the power of stretch targets (Bartlett and Ghoshal 1995; Birkinshaw and Gibson 2004; Gibson and Birkinshaw 2004; Im and Rai 2008; Markides 2013; Raisch and Birkinshaw 2008) to frame our arguments (see Table 1). We use a broader conceptualization of ambidexterity here, similar to such usage by Markides (2013) and Kude et al. (2015), as a way to frame the simultaneous pursuit of two seemingly opposing ideas.

First, following RBV (Barua et al. 1996; Barua and Mukho- padhyay 2000; Piccoli and Ives 2005), a dual-emphasis IT strategy (compared with either a revenue- or a cost-emphasis IT strategy) is likely to lead to potentially superior firm per- formance due to (1) greater social complexity, (2) greater causal ambiguity, (2) greater path dependence, and (4) organi- zational learning. Let us consider these four mechanisms (social complexity, causal ambiguity, path dependence, and organizational learning) based on RBV in turn.

• Social Complexity: The social complexity of a dual- emphasis strategy comes from its relatively ambitious scope of trying to achieve two goals at the same time. Because of the complexity and breadth of applications that a dual-emphasis strategy requires, it is much more difficult for competitors to replicate the successful execu- tion of such a strategy than it is to replicate a revenue- or a cost-emphasis strategy. Prior research in the quality management literature provides support for this idea. As Flynn et al. (1995, p. 666) note, “simultaneous pursuit” of several competitive advantages can lead to a stronger performance because competing on “several fronts simultaneously” makes it more difficult for competitors to replicate such configurations. In addition to the breadth and variety of IT applications needed in a dual- emphasis IT strategy, it also requires much more recon- figuration or restructuring of business processes, thus contributing to the greater social complexity inherent in such an emphasis. TBI Study Case Assignment

• Causal Ambiguity: It may be more difficult to disen- tangle and attribute the advantages resulting from a dual- emphasis IT strategy from publicly available information because firms following a dual-emphasis strategy defy conventional logic and their initiatives and resulting competitive advantages are harder to classify or are more ambiguous to decipher for competitors.

• Path Dependence: A dual strategic emphasis may have an inherent path dependence that is relatively more diffi- cult to replicate compared with that in either a revenue or a cost emphasis. For example, for a firm employing a dual strategic emphasis, cost-reduction efforts may pro- vide opportunities to target new market segments, such as the bottom of the pyramid, which in turn could enable the firm to realize higher revenue growth than if it were to focus only on cost reduction without a link to its revenue growth strategy or only on revenue growth by focusing on premium market segments. Tighter coupling between strategic options, such as revenue growth and cost reduction, is much less replicable by competitors than only one such option. Likewise, firms with a dual

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Table 1. Risks and Rewards of a Dual IT Strategic Emphasis

Key Mechanisms Rewards of a Dual IT Strategic Emphasis Risks of a Dual IT

Strategic Emphasis Relevant literature

1. Resource-based view (RBV)

• Social Complexity Much higher social complexity of IT because of its role in enhancing the breadth and depth of relationships. For example, firms will need to work on both the front end with customers to create one-to-one customer relationships through CRM and on the back end with suppliers to create highly responsive yet low- cost delivery mechanisms.

Firms may not be able to realize complex interrela- tionships among IT systems.

Resource-based view (RBV) (Barney 1991)

• Barriers to the Ero- sion of Competitive Advantage

The scope of activities spanning business processes that touch customers and suppliers create higher barriers to erosion along several dimensions simultaneously due to the cross-functional nature of IT initiatives

Cross-functional IT projects are more prone to coordination problems.

RBV (Cederlund et al. 2007; Grover et al. 2009; Piccoli and Ives 2005)

• Path Dependence and/or Asset Stock Accumulation

Much greater path dependence and/or asset stock accumulation because IT capabilities that evolve gradually through integration with many business processes are likely to be more tacit and sustainable over a longer time. TBI Study Case Assignment

Firms may get locked into poor and incompatible systems due to inertia.

RBV (Eisenhardt and Martin 2000; Teece et al. 1997)

• Organizational Learning

Higher levels of organizational learning because learning spans many more inter- related business processes, routines, and IT systems that are more tacit, complex, and novel than that for a single-emphasis strategy.

The organization may suffer from information overload, leading to reduced learning.

RBV (Bharadwaj 2000; Cederlund et al. 2007; Dierickx and Cool 1989)

2. Reduced Diminishing Returns in Opportunity Space

Plentiful “low-hanging fruit” to increase revenues and reduce costs.

Firms may lose the ability to spot fundamental trans- formations or avoid reaching for “higher- hanging fruit” that may be rewarding in the long run.

Accounting literature (Dehning et al. 2006)

3. Stretch Targets Stretch targets can motivate managers toward high performance.

Too much stretch can be debilitating.

Ambidexterity literature (e.g., Bartlett and Ghoshal 1995; Gibson and Birkinshaw 2004)

strategic emphasis can use outsourcing and offshoring for both cost reduction (through arbitrage) and revenue expansion (through sales in foreign markets by adapting offerings in those markets) (Ghemawat 2007).

• Organizational Learning: Dual emphasis firms may have higher levels of organizational learning because learning spans many more interrelated business pro- cesses, routines, and IT systems that are more tacit,

complex, and novel than that for a single-emphasis stra- tegy (Cederlund et al. 2007). Together, the greater social complexity, causal ambiguity, path dependence, and organizational learning of a dual-emphasis IT strategy can provide effective ex post limits to competition and can protect a firm against resource imitation, transfer, and substitution (Barney 1991; Wade and Hulland 2004), thereby making firms with a dual strategic emphasis more profitable and more valuable. TBI Study Case Assignment