The old ways of measuring productivity don't work; an Information Age replacement is desperately needed. In this excerpt from his new book, Information Productivity, Computerworld columnist Paul A. Strassmann suggests an approach every executive should add to his tool kit: Measure the economic value produced by information.Today, we can observe a change that in every respect is as dramatic as anything that took place when the Industrial Era was born. During the transition from an order based on land ownership to economies based on capital ownership, many old institutions remained in place that masked the transformation. The measures of productivity are similar relics.
U.S. companies only rarely report about productivity, even though it's frequently touted as one of the firms' objectives. Conventional accounting is more concerned with the interests of the holders of debt than with the concerns of those who would like to understand how the company could grow and prosper.
Rare attempts to report on productivity, such as Forbes magazine's annual ranking of U.S. corporations, measure it in terms of sales per employee. Revenue- and profit-per-employee ratios are not only inconclusive but also usually invalid and misleading for making productivity comparisons. For instance, in one mature industry food processing the sales per employee for 25 firms range from a high of $745,000 to a low of $56,300. Does this suggest that the highest-ranking firm is more than 13 times more productive than the lowest-ranking firm? That's not the case, since the company with the high sales per employee deploys 10 times more assets per employee, pays its employees higher salaries and purchases most of its packaging and transportation services from others.
The most frequently quoted indicators for assessing corporate productivity rely primarily on capital asset ratios such as return on assets, return on investment or return on equity. The capital-based approach to evaluating the productivity of firms is fundamentally flawed for the following reasons:
Capital is no longer the most important economic input for a modern industrial corporation to function. The typical U.S. industrial corporation ceased to be a capital-intensive enterprise more than 50 years ago. Only 130 of the 1,605 "major" U.S. industrial corporations, or 8.1% of all corporations, had costs of capital ownership greater than their costs of information management. These were mostly primary metal producers.
Capital has become a commodity instead of a scarce resource. It is readily available for a price that is commensurate with risk.
The most important assets of a corporation are the people who sustain it and the relationships they develop both internally and externally. To compare the effectiveness of firms requires productivity metrics that consider all of the variables which influence the ability to create shareholder wealth. True increases in productivity are the result of an effective combination of many factors of production, including land, labor, capital and information. Taking any one input factor in isolation, such as revenue per employee or IT per revenue, to explain productivity will always be misleading.
We must change the way productivity is defined and calculated. It is my intention to overcome the defects of the measures based on simple ratios. We will therefore concentrate on a composite measure of productivity that reflects the decisive influence of information management along with all of the other input factors. With capital constituting a significantly smaller influence than information, what matters now is the productivity of information management.
The stakes are enormous. The performance of the stock market and the prospects of achieving a balanced federal budget all depend on the expectation of steadily rising productivity gains. Meanwhile, the presumption that information technologies improve productivity gives legitimacy to proposals to invest more money on computers. Much of the current thrust to transfer business communications to Internet-based commerce is based on the presumption that IT will offer corporations sustainable new opportunities to boost their productivity and profitability. Without productivity assessment and productivity monitoring, it is unlikely that enormous investments in Internet-based commerce will deliver the expected results.
It is only a matter of time before corporate leadership will be forced to shift attention to information management as evidenced by increased emphasis on overhead cost reduction, value-chain streamlining and savings through mergers and consolidations. In each such case IT plays the key, if not the leading, role in making a change feasible. To guide such improvements one needs to answer the following questions:
Measuring Information ProductivityThe computation of information productivity depends on getting the costs of information approximately right. My definition of information costs is very broad. It includes all costs of managing, coordinating, training, communicating, planning, accounting, marketing and research. Unless an activity is clearly a direct expense associated with delivering a product or service to a paying customer, it will be classified as an information expense.
Activity-based costing methods are particularly useful in separating cost elements that are directly related to the production of customer value from those that are engaged in coordination and support. My approach to determining information inputs is to first account for all the costs of delivering goods and services to customers. All remaining costs are "overhead" costs that I define as the costs of information management. Such information management costs would include all costs of internal coordination such as personnel, financial and marketing expenses. Information management also includes the costs of training, employee meetings and all IT costs that are not included in the cost of goods sold.
By this definition, the costs of information management also include the costs of maintaining external relationships such as marketing, advertising, purchasing, government relations, regulatory compliance and all costs incurred in creating better relationships with suppliers and customers.
To come up with an estimate of the costs of information management, the data compiled by stock market analyst research services is of great value. The data is obtained from corporate filings with the Securities and Exchange Commission as well as from published annual reports. Such data has the advantage in that it is audited, available quarterly and always subject to public scrutiny by investors, analysts and shareholders. In this respect, such data is far superior to productivity estimates available from government sources, which depend on data aggregations and surveys.
With more than 12,000 firms in my database, it is then possible to calculate the information productivity of individual firms as follows:
"Information productivity" yields a conservative estimate for the purpose of relative ranking and benchmarking comparisons. Published financial reports are likely to understate the total cost of information. This happens whenever overhead is absorbed in the cost of goods sold or in the cost of purchases.
The purpose of information productivity analysis is to shift attention from IT itself to the effectiveness of the executives who manage it. The key to obtaining business value from computers lies in linking the uses of the technology to business plans. This connection must be explicit by showing how it overcomes existing business problems and how it contributes to future gains.
We have to evaluate the contributions of information technologies in terms of their effects on increasing the ratio of management value-added to management costs, which is how we define information productivity. If information productivity increases as a result of effective deployment of information technologies, that would be one of the indicators whether one's computers are producing a business payoff. Focusing on information productivity rather than on IT will lead to the following improved practices:
CIO ImplicationsIf chief information officers are to acquire the influence implied by their title, they must shift attention from information technology to information management. In fact, they may have no choice in this matter since the payoffs from IT can be assessed only in terms of how it affects economic value-added (which is not the same as corporate profits!) as well as information management. These two variables just happen to define information productivity. A firm's information technologies must first be judged in terms of their demonstrable impact on long-term gains in information productivity, as well as in delivering higher levels of information productivity than their principal competitors.
Strassmann's Information Productivity Assessing the Information Management Costs of U.S. Industrial Corporations (The Information Economics Press, New Canaan, Conn.; 168 pages; $49, paperback) is available at http://www.infoeconomics.com. The book includes information productivity rankings and ratios for 1,560 firms, including a list of 400 firms with superior information productivity performance.
Strassmann (email@example.com) can be reached at his Web site, www.strassmann.com.
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