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Article Excerpt
Abstract
The resource-based view has been proposed to investigate the impact of information technology (IT) investments on firm performance. Researchers have shown that a firm's ability to effectively leverage its IT investments by developing a strong IT capability can result in improved firm performance. We test the robustness of this approach and examine several related issues. Our results indicate that firms with superior IT capability indeed exhibit superior current and sustained firm performance when compared to average industry performance, even after adjusting for effects of prior firm performance. However, the differences in the results from various analyses suggest that the impact of "halo effects" and prior financial performance of firms must be taken into consideration in future tests of IT capability. Further, it is critical to develop theoretically derived multidimensional measures of IT capability in order to continue to apply the RBV approach to assess the impact of IT investments on firm performance.
Keywords: Resource-based view, IT capability, firm performance
ISRL Categories: A10104, AF01.02, E10102
Introduction
Corporations allocate resources to acquire IT-related products because it is assumed that these investments provide economic returns to a firm. Research studies to prove this premise have, however, generated mixed results, creating a productivity paradox (Brynjolfsson and Hitt 1998; Lucas 1999). This prompted an editorial comment in MIS Quarterly:
It is the obligation of every IS professional to understand the issues that surround the paradox.. .and each of us must then be prepared and willing to participate knowledgeably in the debate. (Ives 1994, pp. 21-24)
To address this productivity paradox, a theory-based framework commonly referred to as the resource-based view (RBV) has been adopted. Based on this, Bharadwaj (2000) proposed that if firms can combine IT related resources to create a unique IT capability, it can result in superior firm performance. She demonstrated that the average performance of firms identified as possessing superior IT capability was significantly superior to the average performance of a matched set of firms.
A true test of a theory's usefulness depends on proper replications, extensions, and generalizations (Rosenthal 1991; Tsang and Kwan 1999). Such replications play a central role in the construction of IS knowledge (Berthon et al. 2002) and can help build a much needed cumulative tradition in IS (Benbasat and Zmud 1999; Sambamurthy 2001). Because the RBV is increasingly being used to address a critical IS research issue, namely the productivity paradox, further investigation of this framework is necessary. Hence, the objective of this study is to test the robustness of the concept of IT capability and its relationship to firm performance, and to identify critical issues in the application of RBV to examine the productivity paradox.
Research Framework
Empirical evidence to unambiguously support the view that investments in IT-related resources enhance firm performance has been elusive (for a review, see Chan 2000). The inconsistencies observed among various studies have been attributed to variation in methods and measures used in the analyses (Hitt and Brynjolfsson 1996). Because the assessment of the economic impact of IT is of critical importance to IS researchers, more research using unifying theory-based frameworks is necessary (Chan 2000; Ives 1994).
Barney (1991) proposed that firms could obtain competitive advantages on the basis of corporate resources that are firm specific, valuable, rare, imperfectly imitable, and not strategically substitutable by other resources. This is often referred to as the resource-based view (RBV) of a firm. Grant (1991) and Makadok (1991) emphasize that while resources by themselves can serve as the basic units of analyses, firms create competitive advantage by assembling these resources to create organizational capabilities. Makadok states that these firm-specific capabilities, embedded in organizational processes, provide economic returns because the firm is more effective than its rivals in deploying resources. IS researchers have adopted this capability notion of resources by arguing that competitors may easily duplicate investments in IT resources by purchasing the same hardware and software, and hence resources per se do not provide sustained competitive advantages. Rather, it is the manner in which firms leverage the ir IT investments to create unique capabilities that impact a firm's overall effectiveness (Clemons and Row 1991; Mata et al. 1995). Using this RBV framework, firms can devise strategies to create and sustain advantages from investments in IT (Duliba et al. 2001). Ross and Beath (1996) provide illustrative case examples to underscore the idea that a firm's IT capability can indeed provide competitive advantages and enhance a firms' performance.
Recently, Bharadwaj (2000) empirically tested the relationship between the IT capability of a firm and its performance by comparing the financial performance of firms rated as IT leaders to those of comparable firms. The list of IT leaders was obtained from In formation Week and represented a set of firms chosen by a panel of industry experts as the most efficient and effective users of IT in the industry. Each of these IT leader firms was matched with another firm of similar size. The financial performance of the IT leaders and the matching firms were compared. The results indicated that the average financial performance measures of IT leader firms (hereafter referred to as leaders) were significantly better than those of the matched firms on several measures of financial performance. This provided support for the argument that those firms that develop an effective IT capability are able to obtain superior financial performance compared to those who do not develop an effective IT capability.
While this study is an important first step in investigating the productivity paradox using RBV, there are several issues that need to be addressed. Resolution of these issues is important in order to generalize the results and establish the robustness of the RBV framework. In the following sections, we identify and discuss issues relating to (1) the benchmark firms used for comparison with leader firms, (2) adjustments for prior financial performance of firms, and (3) evaluation of sustained performance effects.
Benchmarks for Comparison
In Bharadwaj, a single benchmark (or control) firm was chosen for each leader firm based on the criteria that it was of comparable size and in the same industry as the IT leader. Such a matching procedure allows for a strong statistical test, but has important implications regarding the robustness of the results. When multiple organizations fit the criteria, one was chosen at random. The differences between the financial performance of the leader firms and these benchmark firms were analyzed. The choice of a single benchmark from a potential set of firms may make the observed results sensitive to the selection of individual benchmark firms. Poor management practices of a benchmark firm may impact the observed differences in the financial performance between leader and benchmark firms. In fact, some of the firms used as a benchmark (such as Montgomery Ward) have gone out of business. While the impact of a single benchmark firm may not be substantive in analysis involving a large number of firms, the study cons isted of only 56 leader-control pairs. Hence, the choice of benchmark firms in this relatively small sample goes directly to address the issue as to whether the results are robust to changes in the choice of benchmark firms.
An alternative approach to selecting a single benchmark firm for each IT leader firm would be to consider all the firms in that industry as the benchmark for comparison. This procedure provides a more robust test of the IT capability framework for several reasons. First and foremost, this approach is consistent with the selection procedure for leaders. The leaders were selected because, "within each industry group, the firms receiving the highest number of votes are selected as IT leaders" (Bharadwaj 2000, pg. 177). Since the criterion for choosing the IT leaders was the firm's IT capability in relation to all other firms in the industry, it stands to reason that a consistent benchmark for comparing financial performance should also be all other firms in the industry. Second, average industry performance is often suggested as the standard of comparison in research as well as in practice (Robbins and Pearce 1992; Wisner and Eakins 1994). Third, from a statistical perspective, using all of the firms in the indu stry reduces the potential variability that could arise from choosing a single firm as the benchmark for comparison. Fourth, using the industry as a basis for benchmarking allows us to define the "industry" in different ways. If data can be analyzed for different definitions of industry, it can provide a better measure of the robustness of the results. Finally, and perhaps most importantly, Tsang and Kwan (1999) suggest that such types of replication are important in determining the extent to which the results of the prior study can be generalized. Therefore, we propose the following hypotheses:
Hypothesis 1: The average profit ratios of firms that have superior IT capability are higher than the average profit ratios of all other firms in the industry
Hypothesis 2: The average cost ratios affirms that have superior IT capability are lower than the average cost ratios of all other firms in the industry.
Adjusting for Prior Financial Performance
The selection of IT leaders was determined by a panel of experts who identified these firms as the most "effective and efficient users of information technology" (Dreyfus 1094, p. 30). Prior research has suggested that reputation ratings by industry experts are often influenced by a firm's prior financial performance and subject to a "halo effect" (Brown and Perry 1994). Hence, the selection of a firm as an IT leader could be influenced by their superior financial performance rather than their IT capability. Bharadwaj calculated a halo index for each leader firm based on their prior financial performance. She did not find sufficient statistical evidence to indicate a relationship between the halo index for the firm and its rating as an IT leader and hence conducted her analysis assuming there was no halo effect.
This particular halo index was created from performance measures that were different from the actual dependent measures used to test the performance effects of IT capability. Secondly, the halo index utilized the average financial performance of the prior five years while rankings might have been more influenced by a firm's immediate past performance. Given that several prior research findings have indicated the presence of a financial performance halo effect and...
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