Tuesday, October 27, 2009

Book Review: Wired for Innovation

“Wired for Innovation: How Information technology is Reshaping the Economy” by Erik Brynjolfsson & Adam Saunders, MIT Press, 2010.

Main argument of the book is that the so-called “productivity paradox” of the period 1970-1995, whereby the adoption of IT failed to boost per capita productivity growth in the US, is now seen to be due to a lack of concomitant investment in organizational capital. In other words, people tended to “computerize” existing tasks in a brain-dead way, without investing in new business processes, employee training, and the like. The literature shows that the period 1995-2008 saw far greater gains, but only for those companies that combined new technology with a range of complementary practices around job redesign, openness of information, and empowerment of workers.

These “complementarities” are not just the “best practices” beloved of management consultants of every stripe, but aspects of a company’s culture, including things like profit sharing, flexible work hours and reorganization of workflows to really capitalize on new technology, so that even where there are fewer jobs, these jobs are more interesting than before. These practices are only effective if they work together to reinforce each other, both incenting workers and helping them innovate. Studies show that productivity programs such as TQMS don’t produce results otherwise.

Secondary related topic is that GDP tends to underestimate the value generated by IT innovations. The argument is that traditional measures of inputs and outputs used by the government do not capture “consumer surplus”, i.e., the net benefit that consumers derive from a product or service after you subtract the amount paid. E.g., various studies claim that eBay alone generates several billion a year in consumer surplus, and Amazon’s used book sales generate tens of millions in surplus, given aggressively low pricing. Another study found that the government’s 10 year regulatory delay in allowing cell phone usage cost consumers about $100 billion in lost surpluses!

Chapter 6, on ‘Incentives to Innovate in the Information Economy’ is especially worth reading, for an economist’s view of our world. The authors characterize information as a ‘non-rival good’, i.e., if I consume a piece of information that doesn’t prevent anyone else from consuming it (unlike a piece of cake, say). They also argue that people are reluctant to pay full-price for information goods, since they don’t know how useful they will be until they consume them (by which time they have already paid). Bundling is advocated, because it gets you away from the problem of pricing individual pieces of information in a situation where the marginal cost is close to zero (so that formulas like marginal cost plus a markup don’t work).

Another consequence of information being a non-rival good is ‘knowledge spillovers’, which typically mean that the private return for innovation will be less than the return for society as a whole. (Think about cell phones, and the value they create for society compared to the returns for cell phone companies.) The authors argue that this kind of disparity leads to a ‘chronic underinvestment in R&D’ by the private sector. Even within a single corporation, like Thomson Reuters, you can see this play out. Individual business units that invest in R&D often feel that other businesses that benefit from the ‘spillover’ are freeloaders who have not taken the risk or borne the cost of R&D, but nonetheless derived its benefits. This is why companies like 3M try to take a broader view of R&D cost-benefits across the organization as a whole.

Finally, the authors address the issues of price dispersion and low-cost copies of information goods, and how disruptive they really are. With respect to pricing, studies show that Amazon retains market share, even though it doesn’t actually have the lowest online books prices, thanks to their customer experience and reputation. (This doesn’t bode very well for Walmart in their current price war with Amazon over holiday sales.) With respect to low-cost copies, the authors argue that high availability can create demand for publishers’ wares under some circumstances. For example, lending libraries created readership and stimulated book sales rather than depressing them; more recently, VCRs created demand an insatiable demand for video.

At 150 pages, this is a slim, dense book that contains many insights into the forces behind innovation. Unlike many of the volumes that one finds in airport bookstores, the facts and claims are backed by citations to recent research. Although the main theme is really the relationship between innovation, IT and productivity, there are many interesting reflections upon leadership, change, knowledge, value and the distribution of wealth. It’s not a light read, because it doesn’t shrink from complexity, but it’s not turgid either. The authors are from MIT’s Sloan School and U Penn’s Wharton School, so you are getting an up-to-date view of the very latest thinking at these august institutions.