The Role of Information Technology in Modern Production: Complement

Previous work has shown that the economic impact of IT in general varies systematically with the way a firm is organized. This study investigates the effect of organizational factors on a particular aspect of the economics of IT: the substitution of IT capital for other inputs such as ordinary capital and labor. Much of the previous discussion of IT impact has focused on the substitution of IT for labor, yet much of the managerial literature has recently stressed the importance of finding complementarities between IT and other organizational practices. The ability to identify and leverage potential complements between IT and other factors may become increasingly important as IT investments are used less for simple cost reduction and more for creating customer value. Using firm level data for over 400 large firms, we find that a firm’s ability to complement existing capital with IT investments is dependent on organizational factors. For “modern” organizations, exemplified by a decentralized organizational form, greater use of skilled staff, newer capital investments, and less inventory, IT and capital are complements, while for their “traditional” counterparts they are substitutes. Also, we find that all forms of organizations use IT as a net substitute for labor. As the price of information technology continues to decrease, we expect firms that have the ability to capitalize on complements with other inputs to become more profitable. Our results suggest that the ability to complement other investments with IT is not limited to certain sectors, but does depend on appropriate organizational design that includes adoption of modern practices. IT and Modern Production 1