Information Technology and Competitive Advantage in Small Firms

Brian Webb, Frank Schlemmer

• Publisher: Taylor & Francis
• Year: 2008
• eBook ISBN: 9781134113996
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Does Information Technology matter? This book argues that even as Information Technology hardware, software, data and associated processes are becoming more of a commodity, it has never been more important to manage Information Technology as a strategic asset. However, managing Information Technology as a strategic asset is notoriously difficult, a

1 Introduction

Setting the scene

Does IT matter? The question was raised most prominently by Carr (2003a; 2004; 2005) who argued that, as information technology’s power and ubiquity has grown its strategic importance has diminished. Brown and Hagel (2003) described Carr’s (2003a) initial contribution as an ‘important, perhaps even seminal, piece’. There is little doubt that Carr’s intervention is timely (because there is increasing evidence that IT is becoming a commodity) and provocative (because IT spend continues to take a significant slice of the corporate budget¹). But is he right?

In his later prediction of ‘The end of corporate computing’ Carr (2005) cites the development of advanced information technologies such as web services, grid computing and service-oriented architectures as evidence that IT is becoming (or has already become) commoditised. It follows that, because bundles of hardware, software and processes are available to everyone, no one firm can gain a competitive advantage by acquiring and using them. As processes are increasingly bundled with software (for example, a credit checking function has become an automated routine of computer instructions) then opportunities for firms to differentiate on the basis of processes are reduced, and IT (as a bundle of hardware, software and processes) becomes more of a utility.

Carr’s questioning of the strategic value of IT has energised academic and practitioner discourse on the relationship between IT and competitive advantage. Unsurprisingly, his thesis has not gone unchallenged. Sward (2006: 7) appears readily dismissive when he writes: ‘the response from gurus in the IT field was immediate. Individuals like Paul Strassman, John Seely Brown, and Chris Langdon, along with numerous business school professors, responded, as did several leading CIOs. These individuals outlined counter arguments that were powerful, articulate and persuasive’. However, citing House (2004), he then acknowledges a downside. The responses were targeted at IT professionals, whereas Carr wrote his original article for CEOs. In fact, as we shall discover, there are several good, direct responses to Carr addressed at CEO level and a great deal of intellectual ‘heavy lifting’ in the strategic management literature that can be used for this purpose.

Brown and Hagel (2003), in one of the rebuttals to which Sward presumably refers, pointed out that ‘even though Carr is not [in fact] claiming that IT doesn’t matter (rather his main assertion is that IT is diminishing as a source of strategic differentiation)’, his message ‘is potentially dangerous for it appears to endorse the notion that businesses should manage IT as a commodity input because the opportunities for strategic differentiation with IT have become so scarce’. This, they believe, is a misguided view. On the contrary, ‘IT is inherently strategic because of its indirect effects – it creates possibilities and options that did not exist before’ and that while ‘IT may become ubiquitous [the] insight required to harness its potential will not be so evenly distributed’ 2003: 109). Similarly, McAfee (2005) distinguishes between the ‘raw materials’ of IT (hardware, networks and commercially available software) and the ‘finished goods’ of IT (technology that can be used productively and that adds value). Although the former are now more available, this does not mean that they can be readily converted into the latter. Smith and Fingar (2003) make a related point when they conclude ‘IT doesn’t matter – business processes do’.

Brown and Hagel’s (2003) response was published two months after Carr’s article, and in the same journal (Harvard Business Review), under a Letters to the Editor feature. Also included is a much shorter piece by a business school dean that specifically addresses CIOs. More interestingly, the feature includes a reply by Carr (2003b). He thanks both contributors ‘for making the valuable point that a company’s skill in using its resources, even those that are commodities, is essential to strategic distinctiveness. A superior ability to interpret and act on information has, in particular, always been a hallmark of outstanding companies. That doesn’t mean, however, that the systems that provide the information have any intrinsic strategic value. It is not the hammer that makes the carpenter’ (2003b: 112). But surely this is the crux of the matter? Here Carr’s metaphorical hammer hits the proverbial nail firmly on the head! Can a variable which itself has no intrinsic value (such as IT hardware and software) add value to other variables such that there is a net increase in firm performance and competitive advantage? Carr clearly believes not; others disagree. This book investigates the evidence on both sides of this debate.²

Our analysis is based upon an assumption explicit in Schumpeterian economic theory and implicit in much strategic management theory that IT is an endogenous factor of production. Where IT is seen merely as a technology, then it is seen also as an exogenous factor of production, one that has a direct but external impact on firm performance. It also follows that where IT is viewed as an exogenous factor, its introduction will tend to be radical (rather than incremental), its management loosely coupled with other firm resources and capabilities (rather than tightly coupled), and its evaluation in isolation as an independent variable (rather than in conjunction with other co-dependent variables). It is also much more likely to be ineffective. As we shall argue at length in the next chapter, it is through endogenous technological change that firms create real profits, experience real economic growth, and enjoy sustainable competitive advantage. The implications of this argument are profound, shaping not only how we manage IT but how we study it.

The ‘productivity paradox’ is a case in point. Simply put, the productivity paradox refers to the observation that, although IT expenditure increases, firm productivity stays the same, or actually declines.³ Carr (2003a: 49) cites two studies which report negative correlation between IT spend and performance. Even Brown and Hagel (2003) accept that there is little evidence of a positive correlation between IT and firm performance.⁴ Against this, Brynjolfsson and Hitt (2000) found a positive return on IT investments and Dedrick et al., (2003) concluded that greater investment in IT is associated with greater productivity growth at company and country level. Meanwhile, Rosenberg (2000) argues that it is simply too early to say what the productivity benefits of IT will be because IT itself has changed fundamentally over recent years. To illustrate his point, he makes a comparison with earlier general purpose technologies.

Steam, the railways and electricity burst forth in one relatively concentrated innovation and the opportunity to improve business practices around these technologies was relatively short lived. Further, these technologies achieved standardisation within a relatively short period of time (e.g. railway gauges). IT, on the other hand, is quite different. IT is still expanding and changing at a rapid pace and opportunities to re-design business practices around new technologies remain plentiful. Recent innovations such as web services offer firms the opportunity to crash through several technologies and architectures as they seek to re-engineer their operations, but generally speaking, ‘IT’s economic impact has come from incremental innovations rather than big bang initiatives’ and what has been important has been the ‘cumulative effect of sustained changes’ (Rosenberg, 2000: 110).

Although IT components are readily and cheaply available, when they are new they are untested in organisational settings and the skills needed to use and manage the technology are in short supply. These are exactly the points made by Brown and Hagel (2003) in their response to Carr. The problem is that these new technologies create so many opportunities, so many tactical and short-term possibilities to improve business practices that organisations frequently fail to see the strategic wood for the operational trees, and opportunities for long-term sustainable advantage are lost. The situation is exacerbated by technology companies whose actions often reinforce the common but misguided belief that IT is an external phenomenon, one best absorbed in manageable chunks of ‘big bang’ innovations. The recent development and popularisation of web services is one example. More significantly, in the context of a broader discussion of IT and competitive advantage, web services illustrate the evolving relationships between IT (and specifically the internet) and organisational processes, resources and capabilities.

Web services – commodity or capability?

Web services are variously described in the literature as technology (Gottschalk et al., 2002; Lim and Wen, 2003: Joshi et al., 2004), standards (McAfee, 2005), services (Jobber, 1998; Elfatatry and Layzell, 2004) or some combination of these (Hagel and Brown, 2001). The polymorphous nature of web services is reflected in the following definition

Web services [are] modular internet based business functions that perform specific business tasks to facilitate business interactions within and beyond the organization. By this definition Web services reflect and refer to loosely coupled reusable software components that are able to semantically encapsulate discrete functionality and are programmatically accessible over standard internet protocols.

(Ratnasingam, 2004: 382)

Although sometimes viewed as an extension of electronic data interchange and the internet (Ratnasingam, 2004), web services differ from previous technologies because of the absence of human intervention in key processes (McAfee, 2005). Whereas both EDI and internet technologies rely on human – application and human – human interaction to work (for example, when placing and fulfilling an order on the web) web services require, indeed are predicated upon, no human involvement. That is, a process running on machine A will communicate with a process running on machine B in order to complete a certain task. This task itself will also be a process (for example, performing a customer credit check) and may itself be called by another process. Machine A and machine B, the process which calls them, and the process which in turns calls that process, may be located within the same firm or across two or more different firms.

Whilst it is true that web services are uniquely defined by their ability to enact ‘programmatic interaction’ (Murtaza and Shah, 2004), nevertheless, ‘because web services are essentially described using semi-structured natural language mechanisms, considerable human intervention is needed to find and combine web services into an end application’ (Davies et al., 2004). This suggests that individual and organisational capabilities in the development and management of web services will remain important, even as the utility value of the technology declines.

Similar to the internet, because web services are built using open and freely available standards they are relatively inexpensive, simple and quick to develop, certainly in comparison with proprietary based solutions. Rooney (2002) claims that it requires two-thirds less time to build a web service than to develop a typical client/server application. Gillmor (2002) claims a two-thirds cost reduction in a major implementation project when web services were used in preference to a traditional proprietary based approach. Stal (2002) has noted reduced complexity, time and cost and Fletcher and Waterhouse (2002) have noted that users of web services face fewer maintenance costs than those who use competing integration technologies.

Anderson et al., (2005) expanded upon the findings of Dembla et al., (2004) and examined ‘the significance of technological, methodological and business factors in contributing to the success of initial web services projects (2005: 66). They used four case studies from the financial services sector. Each case study was evaluated against 36 success factors, derived from the ‘industry experiences of several of the authors and a synopsis of practitioner studies’ (ibid: 67). Their factors included business client contribution, customer demand and financial rate of return. They ranked business factors ahead of technological factors (which broadly equate to IT knowledge, operations and objects) and methodological factors (which include aspects of dynamic capabilities such as learning, integration and re-configuration). Anderson et al., also found that their (case) ‘studies indicate importance in the collateral and incremental benefits of the existing or introduced technological factors in the success of the (web services) projects’ (ibid: 73).

The Dembla et al. (2004) and the Anderson et al. (2005) studies highlight the importance of business factors over technological factors in web services adoption and success. Although their studies were of large firms, we may infer some correspondence in the small firm environment. For example, the first case study in the Anderson et al. study was of a smaller and less sophisticated firm than the other three case studies but still ranked business factors ahead of technological and methodological factors (although not so strongly). Better evidence for successful small firm adoption of web services is found when small firms are invited or mandated as suppliers to large firms to join supply chain management systems (Ulfelder, 2003). Murtaza and Shah (2004) suggest that such developments have become a strategic necessity for small firms because ‘real time collaboration is a key element of agile manufacturing strategies as it can lead to significant strategic and operational benefits for all business partners’ (2004: 50). In high-tech, high-velocity markets, examples of successful implementations are rarer. The way in which small firms collaborated and co-evolved in the creation and development of the ASP⁵ industry is one example but even here the industry soon came to be dominated by fewer larger firms, with the result that routines became more established, outcomes more predictable and capabilities less dynamic (Austin, 2002).

A key development in web services (as suggested in Ratnasingam’s (2004: 382) definition) is the move to semantic web technology.

the semantic web will enable the accessing of web resources by semantic content rather than just by keywords. Resources (in this case web services) are defined in such a way that they can be automatically ‘understood’ and processed by machine. This will enable the realization of semantic web services, involving the automation of service discovery, acquisition, composition and monitoring. Software agents will be able to automatically create new services from already published services, with potentially huge implications for models of eBusiness.

(Davies et al., 2004: 118)

This step change in capability has required a development away from the XML⁶ based standards that currently underpin the semantic web (and which underpin web services and internet technologies) to a new language, capable of expressing semantic metadata.⁷

The semantic web promises the emergence of a viable, large-scale utility model based on high-capacity, fibre optic communication networks. If information technology is increasingly seen as a ‘general purpose technology’ then the semantic web and web services (along with virtualisation and grid computing) represent its transformation into a ‘centralized utility’ (Carr, 2005).⁸ With this model we may suppose that, as the utility value of technology declines, the capability value in building and maintaining web services will increase. With increased ‘commoditisation’ of IT in the form of web services, superior firm performance will be determined by the ability of the firm to manage IT through a unique set of capabilities (McAfee, 2005).

As more and more service or functional capabilities become embedded in web services software (for example, the capability to perform credit checks or to process payments will be codified in web services software and available across the internet) then firms must compete on other distinct competencies. It is clear that management capabilities will be important to the success of web services implementations; but what sort of capabilities? How will these combine with other strategic assets? And what is the likely impact upon firm performance?

Unfortunately we cannot readily go out and measure such capabilities, particularly in small firms. web services technology is too new, and implementations too few, to make cross-sectional or longitudinal studies feasible. Case studies of web services success stories offer important initial direction, but these cannot substitute for a body of empirical data, and are anyway mostly confined to large firms. In the absence of significant implementations of web services technology, we are left to study ‘intermediate’ web services adoption, predicated on the internet where ‘the web services initiative effectively adds computational objects to the static information of yesterday’s web and as such offers distributed services capability over a network’ (Davies et al., 2004).

Commonalities between internet adoption and web services adoption may yield important insights into the role of business resources and management capabilities in web services performance. The commonalities go beyond merely technical considerations (where the internet is the ‘carrier technology’ for web services) to include managerial and organisational considerations (where that same carrier technology facilitates enhanced knowledge management and organisational learning). Whereas the impact of the internet on competency development and organisational learning has already been studied in the small firm environment (for example, Chaston et al., 2001; Pollard, 2003; Martin and Matlay, 2003; Ellis and Wagner, 2005) there is a need to extend this line of inquiry to web services (Webb and Schlemmer, 2008).

Similar to the internet, web services are key enablers of other firm resources and capabilities and are themselves subject to the management of these resources and capabilities. As with the internet, effective knowledge management may depend upon understanding web services as bundles of firm-specific assets that both reflect and contribute towards the management of firm performance in other areas. Indeed (as with the internet), much may be gained from studying the interaction effects or complementarity of web services on other firm resources and capabilities. This suggests that effective knowledge management is best achieved when web services are managed as strategic assets.

Another interpretation of such studies is that they anticipate the commoditisation of technology and capabilities under web services. With the internet/world wide web human–human interactions have been replaced by human–application interactions in the majority of B2B transactions. Web services in turn replace many human–application interactions with program–program or application–application interactions. When a web service is essentially a process that runs on the web, technology and capability are bundled and made freely available. In this scenario competitive advantage will not come from low-level, operational or functional capabilities that are embedded in web services but from higher-level, strategic capabilities that are developed and retained by the firm.⁹ This suggests that business and IT resources will be important to building such capabilities and that the mere possession of resources will be insufficient to create competitive advantage from web services (although it may yield some short-term benefits).

We may expect with web services that IT becomes more like a commodity. In fact, the opposite is true. When considered as an asset beyond mere hardware, software and processes, IT has become more strategic because the skills, capabilities and competencies required to build and manage web services successfully are at a premium. Few companies have yet developed these but when they do (and do it well) they are firm-specific, critically path dependent, heterogeneous and inimitable. The related development of service-oriented architecture (SOA) computing is illustrative of this point. A service-oriented architecture, as the name suggests, is the organisational blueprint or framework for web services.¹⁰ It defines and declares all web...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• List of illustrations
• Preface
• Acknowledgements
• 1 Introduction
• 2 IT and economic theory
• 3 IT and management theory
• 4 IT and the creation of Ricardian rents
• 5 IT and the creation of Schumpeterian rents
• 6 Conclusions
• Appendix 1
• Appendix 2
• Notes
• References