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Competitive Advantage

Creating CompetitiveAdvantage WithInterorganizationalInformation Systems

By: H. Russell JohnstonAssociate ProfessorBoston UniversityBoston, Massachusetts 02215

Michael R. VitaleAssociate ProfessorHarvard Business SchoolAnderson 25Boston, Massachusetts 02163

Abstract

Many well-known examples of the use of infor-mation technology for competitive advantage in-volve systems that link an organization to sup-pliers, distribution channels, or customers. Ingeneral, these systems use information or proc-essing capabilities in one organization to im-prove the performance of another or to improverelationships among organizations.

Decfin~ng costs of capturing and using informa-tion have joined with increasing competitive pres-sures to spur numerous innovations in use ofinformation to create value. This article drawson concepts of competitive advantage and onexperience gained from successful innovationsto generate classifications and a framework toguide the search for opportunities. The ideasdo not constitute a procedure leading inexora-bly to competitive advantage. However, theyhave been of value when combined with an ap-preciation of the competitive dynamics of spe-cific industries and a grasp of the power ofinformation.

Keywords: Competitive advantage, interorgani-zational systems, performance im-pacts of information, opportunitysearch, shared information, sharedsystems

ACM Categories: H.4, J.1, K.6

IntroductionThe notion that informa’tion systems can be usedto achieve competitive advantage has passedfrom concept to cliche. The dramatic successesof United Airlines’ Apollo reservations system,American Hospital Supply’s ASAP, and otherlarge computer and communications systemshave been publicized in the business press andanalyzed in academic journals (Business Week,1985; Fortune, 1985; Porter and Millar, 1985).Managers in many companies look to these ex-amples as indications of what might be accom-plished in their own organizations.

Many of the best known and most successfulexamples of competitively advantageous infor-mation systems are those that link a companyto its suppliers, distributors, or customers. Suchsystems, called interorganizational systems(lOS), enable the movement of informationacross organizational boundaries. Apollo andASAP are interorganizational systems, as are net-works of automated teller machines, the Econo-most electronic order entry system sponsoredby McKesson Drug Company, and GeneralMotors’ computer-to-computer links with its pri-mary suppliers.

It is not entirely clear whether lOS provides thebest opportunities for the strategic use of infor-mation systems, or whether the public natureof these systems has simply made them betterknown. What is clear is that lOS can bring sig-nificant competitive advantages, including lowercosts, tighter links to customers, and increasedproduct differentiation. These benefits are some-times shared among industry participants at sev-eral levels. In many cases, however, the first com-pany to build an lOS in a given industry achievesa long-term, sustainable advantage.

This article first defines and describes lOS, cate-gorizing them both technologically and organi-zationally. An explanatory framework for the com-petitive advantages achieved through lOSs ispresented next, followed by some process stepsfor finding new lOSs. The article concludes witha list of important questions for top managementto consider before embarking on lOSdevelopment.

What is anInterorganizational System?The essential characteristics of an lOS are both

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technological and organizational. Cash andKonsynski (1985).give a simple, useful defini-tion of an lOS as "an automated informationsystem shared by two or more companies" (p.134). An lOS is built around information tech-nology, i.e., around computer and communica-tions technology that facilitates the creation, stor-age, transformation, and transmission ofinformation. An lOS differs from an internal, dis-tributed information system by allowing informa-tion to be sent across organizational bounda-ries. Access to stored data and applicationsprograms is shared, sometimes to varying de-grees, by the participants in an lOS.

This spread across organizational boundarieshas several implications. First, lOS must provideincentives for use to all intended participants.Unlike some in-house systems, an lOS will rarelybe implemented by fiat. Thus, the search for com-petitive opportunity must consider the payoffs formultiple organizations, not just one organization.Second, since the participants typically have dif-ferent goals and interests, an lOS must includeprovisions for reliability, data security, user pri-vacy, and system integrity that exceed whatmight be built into an internal system. Third, itis not sufficient for an lOS to improve the overallefficiency of an industry; it must provide somepositive return to its sponsor. On the other hand,because lOS can improve the situation of sev-eral companies simultaneously, they may pro-vide more strategic leverage than traditionalsystems.

lOSs are not new. Apollo and ASAP becameavailable more than ten years ago and havebeen replicated by competitors in the industry.In other industries order entry systems that havesimilar types of transactions between organiza-tions have appeared with less fanfare. However,recent changes in technology and economics,as well as increased competitiveness in manyindustries, are leading to further growth in thenumber, variety, and scope of lOSs. Both infor-mation systems professionals and line manag-ers are becoming more aware of the opportuni-ties for using lOS and of the barriers, bothinternal and external, to increased use. As man-agement teams begin to understand and carryout the adaptations necessary for effective useof lOS, as the potential of lOS continues to pushfirms toward agreement on standards and pro-tocols for data transmission, and as informationtechnology becomes even less expensive, the

rapid pace of lOS development is certain tocontinue.

Categorizing lOSIn order to understand strategic opportunities forthe use of lOS, it is helpful to categorize lOSin a number of ways. This article proposes clas-sifications based on the business purpose of thesystem, on the relationship between the spon-soring organization and the other participants,and on the information function in the system.

Why utilize an lOS?First, let us look at business purpose. Althoughan lOS by definition crosses organizationalboundaries, in some cases the lOS is designedas a means to gain advantage over competitorsin a basic business of the sponsor. In othercases, the lOS itself is the basic business. Inboth scenarios, the sponsoring company is re-sponsible for making decisions about who canparticipate in the system, which participants canhave access to what data, how much each par-ticipant must pay, and so on.

American Hospital Supply’s ASAP system is aparadigm for the lOS as a means of doing busi-ness competitively. The terminals and other de-vices used to access ASAP are owned by thehospitals themselves, and the communicationslines are largely leased. But American HospitalSupply has ultimate control ovei" participation,data protocols, access to information, and otherconditions of ASAP use. American also has com-plete responsibility for planning, developing, main-taining, and managing ASAP. Another type oflOS is controlled by an organization that pro-vides nothing to lOS participants that is not veryclosely related to the interorganizational system.The sponsoring organization is essentially in thelOS business. For example, NewsNet offersalmost 300 online services, including access tonewsletters provided by independent publishers,airline reservations, stock quotations, sportsscores, and seminar registrations. NewsNet es-sentially acts as a facilitator, allowing organiza-tions to communicate through a network estab-lished and maintained by NewsNet. Similarly,Cirrus System Inc., a network of more than10,000 automated teller machines (ATMs) fromfinancial institutions in the U.S. and Canada, isowned by five large commercial banks. Custom-

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ers of any bank that participates in Cirrus canuse an ATM owned by another participant;Cirrus System, Inc. is responsible for the net-work that moves information among the banksbut provides no other services.

There is little doubt that the lOS arena offersplentiful opportunities for building systems of thissecond type. Moreover, such systems raise im-portant questions, of cost and access that mustbe considered before customers agree to par-ticipate. In order to focus this article on moretraditional organizations, however, only lOSs thatare controlled by organizations having othergoods or services to sell and are seeking to usean lOS as part of a more inclusive strategy areconsidered here.

Who will participate in the lOS?lOS can be further categorized on the basis ofthe relationship between the controlling organi-zation and other participants. Customers, deal-ers, suppliers, and even competitors are all po-tential participants, as are customers’ customers,suppliers’ suppliers, and other members of thedistribution chain. It is possible that participantswill be of several types: TWA’s PARS reserva-tion system, for example, is used by the airline’sown clerks, by travel .agents, by employees ofother airlines, and by travelers themselves. De-veloping a clear understanding of how the lOSwill produce improved performance for each typeof participant is an important step toward gain-ing competitive advantage. The first key ques-tion is, "How will the lOS help this potential par-ticipant succeed in accomplishing valued goals?"

For the lOS to provide competitive advantageto its sponsor, it must provide valued and sig-nificant benefits to each participating organiza-tion in proportion to its use of the system. Therequirement that the system provide benefits toparticipants applies both to participating organi-zations and to individuals within those organiza-tions who will be directly involved in using thelOS.

The best known examples involve an electronicconnection between a company and its custom-ers. McKesson, Singer, General Electric, InlandSteel, and Eastman Kodak, among others, haveimplemented systems of this type. Connectionswith suppliers have been built by General Motorsand American Hospital Supply. lOSs linking acompany to its dealers or agents were built first

by the airlines, and more recently by insurerssuch as CIGNA and State Farm, by financial serv-ice companies including Security Pacific, and byFord and Chevrolet (Business Week, 1984). FirstBoston’s Shelternet is an lOS available to cus-tomers’ customers -- in this case home buyerswho are customers of real estate brokeragefirms. Shelternet provides information on loanproducts available to the home buyer and initi-ates a mortgage application (PC Week, 1984).First Boston provides qualified real estate firmswith a line of credit, enabling them to close ap-proved loan applications locally. First Bostonthen buys the loans and resells them to secon-dary-market investors.

As information technology becomes less expen-sive and better able to communicate, it is ex-pected that lOSs will grow to include an everwider variety of participants. The ultimate usermay not, in fact, always know or care who actu-ally controls a given lOS. The sponsoring or-ganization, however, must clearly understand itsrelationship with potential participants, since thisrelationship is an important determinant of thelevels of availability, security, and privacy re-quired in the lOS.

What functions will the lOSperform ?A description of the participants and their rela-tionship to the sponsoring organization ad-dresses one major aspect of an lOS. The otherimportant aspect is revealed by a categorizationaccording to the information function of thesystem. The simplest lOSs handle only bound-ary transactions -- for example, order-entry sys-tems. These may provide a limited "shopping"capability, but basically such systems acceptorders from participants and confirm them. Moreadvanced systems have some sales character-istics as well: they may suggest one product overanother, offer delivery options, or promote spe-cial items. The sponsors of such systems haveestablished the start of a two-way electronic dia-logue with the other participants.

Other lOSs allow participants to retrieve and ana-lyze data as well as execute boundary transac-tions. Both the Inland Steel system and freight-tracking systems such as those installed byEmery Air Freight and American President Lines,allow customers to check on the progress of theirorders, thereby reducing the customer’s uncer-

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tainty and allowing customers to measure thesponsor’s performance. CIGNA allows its casu-alty insurance customers to examine their owndata stored on the insurer’s computers in orderto find ways of reducing their insurance bills. Asystem developed by Eastman Kodak for smallfilm developing laboratories allows the labs toobtain advice on pricing and work schedules aswell as order Kodak paper, chemicals, and othersupplies.

Finally, some lOSs allow participants to enter,store, and manipulate information that is not trans-mitted to the sponsor. These systems provideinformation power within the boundaries of theuser organization. Examples include systemsthat perform "back office" chores for travel agen-cies, insurance offices, pharmacies, and othersmall businesses as part of their overall role.This additional capability can be important in in-creasing acceptance of the system.

Using the categorization schemeThe three functions discussed form a continuumin the extent to which they are integral to theoperations of participants. This continuum is im-portant for several reasons.

1. The continuum parallels to a significantdegree the complexity of securing participa-tion in the lOS and implementing a systemthat successfully meets the needs of partici-pants. It is relatively simple to devise asystem to improve handling of administrativetransactions that already take place betweentwo organizations. It is more complex to pro-vide information to a wide range of users thatallows them to more effectively manage theirrelationships with the sponsor. It is even moreambitious to provide capabilities through anlOS that enable users to manage broader as-pects of their business more effectively.

Some successful lOSs have evolved alongthis continuum from boundary transactionstow~.rd integration into core aspects of theparticipants’ business. McKesson’s Econo-most system provides a well known exampleof this development pattern. Economostbegan as a simple order-entry system, wasexpanded to include related functions like in-ventory management and pricing, and even-tually had features such as store design and

layout, and preparation of income statementsand balance sheets for retail customers.

2. Moving along the continuum in developingand implementing an lOS is a logical way forthe sponsor to develop a depth of understand-ing of the other participants’ business. Suchmovement also generates confidence in theability and integrity of the sponsor as a part-ner in the participant’s business.

3. As the relationship with the sponsor movesfrom periphery to core of the participant’s busi-ness, the relationship becomes more signifi-cant to the participant. As a consequence,it becomes more difficult for a competitor todisplace the sponsor.

The suggested categorization along the dimen-sions of business purpose, participation, and in-formation function is certainly not the only onepossible, nor are the individual categories mutu-ally exclusive. The value of the categorizationscheme arises from its utility in structuring themany combinations of possibilities for gaining ad-vantage through use of an lOS. The schemediscussed above suggests three dimensions thatcan be labeled simplistically as "why, who, andwhat." The material discussed in the next sec-tion presents a conceptual framework to guidethe search for competitive advantage and canbe thought of as "how."

Competitive Advantages toSponsoring an lOSThe proliferation of interorganizational systemscertainly suggests that many companies are find-ing lOSs to be important sources of competitiveadvantage. What can be said about the originalof this competitive advantage? Bakos andTrea.cy (1986) argue that competitive advantagestems fundamentally from two factors: compara-tive efficiency, which allows an organization toproduce its goods or services more cheaply thanits competitors; and bargaining power, whichallows a firm to resolve bargaining situations withits customers and suppliers to its own ad-vantage. The strength of these factors is deter-mined by even more fundamental issues -- com-parative efficiency by both internal efficiency andinterorganizational efficiency, and bargainingpower by unique product features, switchingcosts, and search-related costs (see F.igure 1).

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Search-RelatedCosts

UniqueProductFeatures

SwitchingCosts

InternalEfficiency

Interog. _1~Efficiency

Bargaining Power

ComparativeEfficiency

CompetitiveAdvantage

Source: Bakos and Treacy, 1986.

Figure 1. A Casual Model of Competitive Advantage

The lOS examples given above fit neatly intothe Bakos and Treacy framework; it is easy tosee why some of them have been of such re-markable strategic importance. More genericsources of competitive advantage from lOSs aredescribed in the next section.

Comparative efficiencyInternal Efficiency

--Lower inventory costs by allowing "just-in-time" delivery

-- Encourage standardization of data represen-tation, making data easier to manipulate andanalyze internally

-- Capture data more quickly, leading to fasteranalysis and shorter response time

Interorganizational Efficiency

--"Export work" by getting customers or sup-pliers to do data entry and editing

-- Allow customers to "shop" and check orderstatus electronically, without tying up cus-tomer service representatives

-- Provide benefits of vertical integration (morecontrol, coordination, lower costs) without re-quiring actual ownership of otherorganizations

-- Facilitate cross-selling of additional or highermargin products

-- Permit inexpensive, rapid electronic transmis-sion of sales and service messages

-- Increase sales of company products, due toease and efficiency of ordering and to favor-able display on order-entry screens

-- Remove a level of the distribution chain bygoing direct to customer or user rather thanthrough an intermediary

-- Capture more precise, timely usage data, al-lowing production scheduling according touse rather than according to sale or shipment

-- Evaluate quickly and economically the effectsof advertising, rebates, and other marketingprograms

-- Extend market reach to customers who couldnot be economically served by conventionalfield sales calls

--Relate sales message, including price andother terms, to buyer’s previous experiencewith seller and with product

--Ship in more economical lots and be pre-pared tO receive incoming goods by commu-nicating with transportation companies

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-- De~iver products or services (e.g., softwareor financial advice) electronically, monitor com-pliance with policies related to customers,dealers, etc.

--Observe ordering pattern for, and usage of,competitors’ products

Bargaining powerRaising Switching Costs

--Raise users’ need to retrain personnel, tomodify operating procedures, or to invest innew or additional hardware or software if theychange to a different system

-- Threaten change in status of personnel if auto-mated system is replaced by nonautomatedsystem

Unique Product Features

--Make product easier or less expensive toselect, order, handle, use, or account for

-- Enhance product image as state-of-the-art

-- Improve customer service by identifying andreporting problems more quickly, allowingmore accurate diagnosis and faster response

-- Provide immediate feedback on product avail-ability and price

-- Lower required inventory levels

Search-Related Costs

-- Lower cost of "shopping" via links to suppli-ers; control, observe, or profit from shoppingvia links to customers

-- Improve customers’ ability to shop for a third-party product that generates fee income oradditional sales of primary product

-- Suggest alternative product specifications thatreduce customers’ costs or improve custom-ers’ performance

--Get the best available prices on purchasedcommodity materials

--Alert customers to opportunities to obtainvolume discounts by altering order patternsslight}y

These generic uses of interorganizational sys-tems address each of the theoretical sourcesof competitive advantage identified by Bakos and

Treacy (1986). Beyond recognizing the explana-tory power of their framework, it is useful in lo-cating attractive opportunities for new lOSs.

Looking for lOSOpportunitiesThe search for lOS opportunities can utilize thecategorization scheme and the framework forcompetitive advantage together as guides for thesearch process. Figure 2 is a schematic exam-ple of this approach, depicting the search as abranching process. As mentioned earlier, thesearch is complex because of the large numberof combinations that can be evaluated -- par-ticularly when the search is extended to includeinvestigation of secondqevel relationships suchas those between dealers and their customers.In practice, the search is bounded by exerciseof judgment about

-- the fit of search directions with the sponsor’sstrategic interests and capabilities, and

--insights from information technology profes-sionals about relationships between industrystructure and practices and potential lOSpayoffs.

Some of the background analysis is best car-ried out through interviews and data gatheringby company employees or outside consultants.It is important to involve a sample of potentialparticipants -- customers, suppliers, distributors,etc. -- in the process. In fact, once the principleobjectives and broad design parameters havebeen established by the sponsoring organiza-tion, it is critical to involve people from other or-ganizations in the resolution of functionality andhuman engineering issues for those subsystemsthat impact their organizations. As happens withintraorganizational systems, involving usersslows the design but pays off during implemen-tation. It is also important to involve a cross-section of company employees, including repre-sentatives from the information systems groupas well as the group(s) that might be affectedby a new lOS. Such participation both helps de-velop new ideas and builds support for thesystem that is ultimately developed.

Comparative efficiencyThe attempt to improve comparative efficiency

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through an lOS should begin by examining ex-isting flows of information across organizationalboundaries: orders, invoices, specifications, bids,inquiries, confirmations, notices, claims, and soon. The goal is not so much to automate whatexists as to uncover the source, content, anddestination of each flow. Could the flow be cap-tured closer to its origin or delivered closer toits destination, perhaps by cutting out anintermediary?

For example, if a food manufacturer could eco-nomically capture orders directly from custom-

ers, would the food broker be necessary? If alarge farm could save money by placing its orderfor pesticides directly with a distributor, wouldit continue to buy from a dealer?

In some situations, direct computer-to-computerlinks can eliminate the embarrassing inefficiencyof situations in which the buyer’s computer pro-duces a printed list of items to be ordered thatis mailed to the supplier and then re-entered intoanother computer. As data formats and trans-mission protocols become more standardized,the ability to accept and transmit orders elec-

Why?

(BusinessPurpose)

Leverage of PresentBusiness

Either¯ Customers¯ Dealers¯ Suppliers¯ Competitors

Who?

(Relationships/Participants)

OrSpecificFunctionsPerformed& SpecificPerformerswithinEach

Seek New j

Information~e~ ~Driven Business c.~s~o.~" _ ~

What?

(InformationFunction)

¯ BoundaryTransactions

¯ Retrieve andAnalyzeShared In-formation

¯ Internal Use-System Func-tions byParticipant

Shared

Why? Who? What?

How?

(ImprovementFocus)

¯ Search-RelatedCosts

¯ Unique ProductFeatures

¯ SwitchingCosts

¯ InternalEfficiency

¯ interorganiza-tional Efficiency

Switching

~"....Jnt~L Costs~rt?e-

HOW?

Figure 2. A Schematic Diagram of the Opportunity Search

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tronically may move from a competitive advan-tage to a business necessity.

A complete analysis of information flows shoulduncover not just what does flow, but what couldflow. What other information -- instructions, as-sistance, parts and supplies ordering, etc. --could be supplied to customers via an lOS?What informal links might be strengthened, im-proving the long-term relationship with custom-ers or suppliers? For example, a medical sup-plier equipped its sales force with portablecomputers that could access an electronic mailsystem. The sales representatives soon beganacting as an informal job referral network for thespecialty they served, thereby tightening the con-nection’ between the representatives and theircustomers.

There is an instructive analogy with the earlydevelol~ment of information processing systemswithin an organization. Systems developers mustmove beyond the question, "How do I automatewhat isbeing done?" to the more creative ques-tion, "Given existing information technologies,how could our firm’s objectives best beaccomplished?"

Bargaining powerConsider ways to improve the product purchas-ing and usage processes, both for the organiza-tion and for its customers and suppliers (Ivesand Learmonth, 1984). What is the search proc-ess? What unique product features are impor-tant? What are the switching costs, and how im-portant- are they?

An lOS may be particularly useful if a productis complicated to specify or order. An intelligentorder-entry system, for example, could assurethat the buyer has considered all the options andhas supplied all the necessary information. Com-panies in industries where competitors offerbroad product lines with many similar products,where the same products are ordered routinely,or where products are sometimes needed ur-gently, may also find significant advantage bysponsoring an lOS.

Providing unique product features with an lOScan be done most easily for products that arecomplicated or expensive to use. The Kodak andCIGNA systems described above are in this cate-gory. In other cases, an lOS becomes the deliv-ery mechanism (home banking, corporate cash

management). Products that are otherwise rela-tively undifferentiated can be distinguished bythe ability to order or use them electronically.

Switching costs are more significant when theordering task is complex, when the user’s start-up costs are high (e.g., home banking), andwhen the system can be built into the product(e.g., travel agents make the boarding passesprovided by an airline,reservation system partof their overall "product").

Management IssuesThe preceding sections have described the typesof advantages that can be gained through theuse of lOS and have suggested ways to lookfor lOS opportunities. Once a potentially signifi-cant system has been identified, a series of ques-tion should be posed before embarking onsystem development. These questions shouldevaluate the impacts arid opportunities from sev-eral management pergpectives. For example:

Questions for general managers:

-- What would the system do for my business?What are the costs, the benefits, and the or-ganizational impacts?

-- What would the system do for the other par-ticipants? Why should they use it? What bar-riers will there be t0’ their usage and how canwe overcome them?

--What effects would the system have on in-dustry structure? Are there threats or furtheropportunities associated with these changes?Do we have the resources and the strategicposition to respond quickly and effectively toemerging threats or opportunities?

Questions for functional managers:

-- What impacts would the system have on tac-tics and operations of this function? Whatnew opportunities and challenges will it pre-sent? What skills, knowledge, and other ca-pabilities will be needed to respond? Do wehave sufficient time, authority, and resourcesto develop or acquire the capabilities?

Questions for information systemsmanagers:

--Will our present b~ckbone systems supportthe information and processing requirementsfor the proposed lOS without major revisions?

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Do we have or can we develop or acquirethe resources necessary to make later revi-sions and additions?

-- What new capabilities will be needed in theIS function to ensure sufficient grasp of notonly our own business situation but that ofother participants as well, so that we will beable to design and execute a system that willadd value for all anticipated participants?

--How can the IS function be linked to otherfunctions and to general management proc-esses so that it can be a full and valuablepartner in both the initial development proc-ess and the evolution of the lOS over time?

-- What adaptations will be required of systemusers in our organization and in other partici-pating organizations, and can we provide thatsuppoi’t?

Managers in each participating organization willface a similar but somewhat "mirror image" setof questions which they should ask about theirown organization and the capabilities of the pro-posed sponsor.

Costs, Benefits, andOrganizational ImpactsEstimating the cost of developing an lOS is notsignificantly more difficult than performing thesame task for other information systems. Makingsuch an estimate is often as much an art as ascience, and the result should include a marginfor uncertainty. Development costs will gener-ally be higher than for an internal system of thesame size due to increased requirements for

. data privacy, security, and integrity, lOS operat-ing costs are also subject to uncertainty, dueto changes in transaction volume, .usage char-acteristics, and telecommunications rates.

Quantifying the benefits of an lOS can also bedifficult, since the system is primarily intendedto increase revenue rather than to decreasecosts. Even so, a benefit analysis should be un-dertaken. Attempts at quantification can be valu-able in gaining support for an lOS developmentproject and in monitoring its progress, in addi-tion to improving understanding of the potentialbenefits.

The most obvious, and most easily quantified,benefits come from cost reductions, at both in-

ternal and interorganizational levels. For in-stance, McKesson Drug was able to eliminate250 clerks who took orders and typed up pur-chase forms; American Hospital Supply was ableto triple its sales volume with virtually no increasein its customer support staff. Such savings ariselargely from exporting the work-order entry andediting to customers:

A second easily quantified benefit is fee reve-nue from other lOS participants. Such revenuecan be significant; in 1985 American Airlines’Sabre system generated nearly $340 million infees, mostly from other airlines, and $116 mil-lion in after-tax profits (Johnston and Carrico,1988). Of course, questions may arise about par-ticipants’ willingness to pay for the use of thesystem. Controversy over aggressive and/or un-equal pricing may increase the risk of govern-ment intervention, as has occurred in the airlinereservation systems area.

An even larger source of revenue may be in-creased sales of the sponsoring company’s prod-ucts. Such an increase can result from:

--Enlarged scope, e.g., national sales via anlOS

-- New kinds of customers, reachable economi-cally through an lOS

--Larger product line made possible by im-proved ability to process sales and inventorydata

-- Increased customer awareness, due to favor-able display position, substitution for competi-tors’ products, or cross-selling

-- "Halo effect": customers may be more willingto deal with lOS sponsor due to image, fa-vorable impact of system on customer’s busi-ness, etc.

Increased sales due to an lOS are difficult toquantify in advance and nearly impossible to iden-tify precisely in retrospect, since typically the spon-soring organization will have made otherchanges simultaneously. Moreover, most organi-zations are accustomed to justifying new appli-cations of information technology only throughcost reductions, never on the basis of increasedrevenues. The same skills used in making newproduct decisions must be used in making lOSdecisions if an organization is ever to reap thecompetitive advantages of this type of system.

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Another set of benefits is even more difficult toquantify, yet must be considered. These bene-fits include reducing overhead, raising switchingcosts and other barriers to entry, and increasingproduct differentiation. As yet, few theoreticaltools are available for measuring the strengthor importance of such benefits. Perhaps the bestway to consider these factors in an lOS cost/benefit analysis is to perform the analysis firstwithout them. If the new system can be justifiedusing only the other, more quantifiable costs andbenefits, then management can feel comfortablein proceeding to an analysis of industry impact(described f.urther below). If, however, dis-counted cash flow analysis using a reasonablehurdle rate and time horizon does not show apositive return from the quantifiable costs andbenefits, then management should ask what ad-ditional cash flow is needed in order to achievea positive result. Management can then use theirjudgment to determine whether the "nonquanti-fiable" competitive benefits are worth the amountrequired. (For example, will the new lOS raiseswitching costs enough to bring the companyan additional $500,000 in after-tax profits in eachof the next three years?) Most organizations arenot accustomed to making decisions about in-formation systems in this way, but the skills arenot unique. Management is constantly expectedto make similar judgments regarding advertisingand promotion, product quality, customer serv-ice, and other activities. Generally only the costside of these activities can be known in advance,and yet companies routinely undertake them, re-lying largely on management judgment to deter-mine the appropriate level of spending.

Management judgment is also needed to under-stand the potential internal impacts of a new lOSon its sponsoring organization. Often the systemwill require a change in employee skills and so-phistication in order for it to be used effectively.The customer service representative must beable to help the technophobic customer, as wellas explain the product line. The sales agent mustbe skilled at the keyboard, and the purchasingagent must be as adept at shopping by com-puter as by telephone. Training personnel whosejobs will be affected by an lOS is an obvious,but often neglected, step towards assuring thesystem’s success. Internal procedures will alsobe affected, and should be redesigned to fit ef-fectively with the lOS. A large impact will be feltin the information systems department, which typi-cally now has a more immediate and more obvi-ous impact on the company’s bottom line than

in the past. This group may be faced with newtechnological challenges as well. They mustdesign and implement a system for use bypeople outside the organization who may havedifferent objectives and intentions than companyemployees. Education on both business and tech-nical topics should be provided before any newlOS is undertaken.

On a more global level, sponsorship of an lOSmay expose a company to completely new op-portunities for close relationships with its cus-tomers or suppliers and to new business possi-bilities based on lOS technology. It is importantfor management to establish channels for sys-tematically tracking these opportunities, commu-nicating the ones that look promising for the or-ganization, and taking appropriate action. Again,since many companies typically do not perceiveinformation systems of any kind as likely to in-fluence structure or strategy, procedures shouldbe initiated during system development to raiseconsciousness about the potential impacts of thelOS on strategy and on tactics at the functionallevel. Cross functional meetings can pose evoca-tive questions as to how the new system andthe information it provides can be used to pro-duce added value or benefits within internal op-erations and in relationships with other plannedor potential participants. A question such as, "Willthis system provide an opportunity to improveour physical distribution system or to redirect andretrain our field sales resources to increase theireffectiveness?" may trigger changes that bothlever the immediate benefits of the lOS and pro-vide a stream of secondary impacts that keepcompetitors off balance while initial gains are con-solidated and system enhancements areintroduced.

Another benefit observed in some organizationsthat have operated lOSs for several years is aheightened awareness by managers and pro-fessionals throughout the sponsoring organiza-tion of market and competitive conditions. Theincreased flow of data between the sponsor andusers of the lOS provides a basis for earlier de-tection of shifts in market requirements, moreaccurate assessment of competitor capabilitiesand intentions, and improved ability to predictreactions of customers, channels, and competi-tors to competitive initiatives by an player in theindustry. Information gleaned from lOS data canraise the competitive savvy of the managementteam in ways that enhance both operation effi-ciency and market responsiveness.

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The other participantsThe previous material addressed the lOS deci-sion from the sponsoring organization’s point ofview, at which this article is aimed. Neverthe-less, it is helpful to consider the point of viewof the other participants, who will be asked touse the lOS and perhaps pay for such use. Un-derstanding the costs and benefits to these otherparticipants will be helpful to the sponsoring or-ganization in designing the lOS, in promotingits use, and in modifying it for the future. Ifsystem capacity is limited, this awareness willalso be useful in selecting users.

The p~tential lOS participant faces the same setof issues -- costs, benefits, and organizationalimpacts -- as the lOS sponsor, but may viewthem quite differently. Some participants will beable to reduce direct costs of order entry or re-ceipt, for example. Others will be able to reduceindirect costs such as holding and managing in-ventory. By sharing information with the lOSsponsor, participants may be able to highly tuneproducts and services for their individual busi-ness situations; the pharmacy customers ofMcKesson Drug Company, for example, receiverestocking orders that are not only of the exactquantity they desire, but are also arranged in theshipping cartons in the same order as the stores’shelves. Price labels for the shelves and for theindividual items are also included.

Other lOSs allow participants to increase theirsales by better serving customers. The airlinereservations systems used by travel agents, forexample, make it much easier for the agent toprovide a combination of convenience and pricethat will satisfy an individual traveler or a corpo-rate travel department. Hotel and rental car re-servations can be made through the same sys-tem, increasing customer satisfaction and com-missions for the agent (and for the sponsor).Such systems also reduce costs by speeding upcustomer service and by performing bookkeep-ing, billing, and similar back-office tasks. Somereservations systems even allow travel agents toarrange theater reservations for their clients, andto order their own office stationery and other sup-plies directly from the terminal.

By simplifying order entry and giving immediatefeedback on order acceptance and delivery data,some lOSs allow participants to reduce inven-tory levels, thereby bringing them closer to the"just in time" systems used in some manufac-turing plants. Some lOSs may also suggest less

expensive or more readily available alternativeproducts with the same characteristics. More ad-vanced systems can even analyze usage pat-terns and customer trends to provide advice onwhat, how much, and when to order. The sup-plier linked to a customer via an lOS may havelonger advance notice on orders as well as re-ceiving the order in a standardized format.

Beyond reduced costs and improved perform-ance, lOS participants may benefit from the "high-tech" image conferred through the use of asystem they could never afford to develop ontheir own. It is common, for example, for travelagents to advertise that they use a computer-ized reservations system, or perhaps severalsuch systems. The employees of an lOS partici-pant may be enthusiastic about both the imageand the content of a job done via a computerterminal rather than with paper, pencil, andphone.

The other side of the benefits question is, ofcourse, the costs imposed on lOS participants.Like the benefits, the costs are both direct andindirect. Participants may pay the sponsor forequipment, communications, and system usage.For example, other airlines pay American $1.75per seat booked through Sabre. Direct lOS costsmay not seem onerous at first, particularly whenmeasured against potential savings in staff time.Once an lOS is established, however, the usagefees may be subject to increase because: useof the system has become a virtual necessity;the system has been developed to the point thatduplicating it is economically impossible; and thesystem has raised significant switching costs.

lOS participants want to achieve most cost andperformance benefits possible without becom-ing completely tied to the system. Equally obvi-ous, smart lOS sponsors will do their best toprovide significant benefits that can be obtainedonly by investing in equipment or training thatis specific to a single system. Sponsors will makeit as attractive as possible for participants to buildthe lOS into their own internal system for inven-tory tracking, pricing, customer service,etc. Ear-lier this article acknowledged that the benefitsto be achieved through raising switching costsare difficult to measure. The costs of beingclosely tied to a single supplier or customer iseven more difficult to determine. The same sortof analysis proposed for the potential sponsoris appropriate for the potential participant, whomust determine whether a probable increase inswitching costs is worth the benefits that can

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be achieved. Participants, in fact, probably needto work harder than sponsors to ensure that lOSdecisions are made appropriately. A potential

¯ sponsor typically considers making a fairly largeinitial investment, automatically raising the levelof consideration given to the decision. A poten-tial participant, however, may be asked to investonly a small amount up front; indeed, some air-lines are reputed to have paid travel agents toaccept their reservations systems. Because littleexpense is involved, the danger is that the deci-sion to participate may be made by lower levelstaff who may not adequately consider the cur-rent and future organizational and competitiveimpacts. There is a clear need for managementpolicies regarding lOS decisions whether theyconcern sponsorship or participation.

Structural impactsA third important lOS question relates to thesystem’s potential impact on industry structure.We have discussed the ability of an lOS to raiseswitching costs and other entry barriers, presum-ably both positive developments from the spon-soring organization’s point of view. Requiring sup-pliers or customers to use an lOS link may forcesmaller players out of the market if they cannotor will not adapt to the standards imposed bythe system.

A large investment in an lOS may deter poten-tial new entrants who are unwilling or unableto match an incumbent’s investment. Similarly,a successful lOS may force some, traditionalrivals to leave the industry or at least to retreatto a market segment that can be served withoutan lOS. The exit of numerous small operatorsfrom drug distribution after aggressive introduc-tion of lOSs by both Bergen Brunswig and McK-esson illustrates this effect. The lOS investmentmay look particularly unattractive to a secondor third player if the first mover is able to installa system in the best locations. The first movermay also have an opportunity to establish defacto standards for data representation and trans-mission, further solidifying its position in the in-dustry. I~f an lOS can be made practically obliga-tory, would-be providers of substitute productswill be forced to develop a system of their ownor to find a new way to compete.

The industry impacts described thus far arelargely positive for the sponsoring organization.

Potential rivals may be’ deterred, current rivalsmay leave the industry or begin using the spon-sor as a distributor, buyers and/or suppliers mayhave inqreased switching costs, and substituteproducts may be harder to develop and intro-duce. Some of these advantages will accruelargely to the sponsors of the first lOSs in agiven industry. Even these initial sponsorsshould be aware that an lOS commitment mustbe long-term if it is to be effective. A systemthat is not maintained and upgraded risks beingreplaced by a new system, perhaps based ona different technology. Moreover, establishing anlOS as an important basis for competition opensthe industry to entry by’ completely new playerswho will lever their information systems skills.Would it be hard to imagine, for example, a suc-cessful videotex company buying an airline, orat least becoming a travel agent so large thatit had significant bargaining power with thecarriers?

In some situations technological and industry fac-tors seem to point to the inevitable developmentand use of lOSs, and in these cases it may verywell be better to be first than wait to see whatthe competition does. In other circumstances,however, companies have a larger measure ofcontrol of the pace of~ lOS development, andthese companies need to consider carefully thelong-term impact on their industry before theyrush into lOS development.

These questions for management are intende~to lead to serious consideration of the costs andbenefits of lOS usage, both for the sponsor andfor the other participants. These questionsshould also focus lOS design on those areasthat are most likely to bring the sponsor long-term competitive advantage. The necessarilypublic nature of lOSs makes their developmenta more serious matter than the development ofan internal information system: if an initial spon-sor goes public with an ineffective system, theoutcome may not be just wasted time, but theformation of another lOS sponsored by acompetitor.

SummaryThe steady increase in the potential use of lOSto improve the joint performance of company net-works makes the search for opportunities bothimportant and complex. A set of categories orframeworks can guide exploration of choosing

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appropriate organizations, deciding what func-tions the system will perform, and determininghow these functions will provide sustainableadvantage.

An effective structure for the search processhelps to achieve clarity about the fundamentalobjectives of the lOS and the prospective costsand benefits to all participants. Experience withlOS development has shown that clarity onthese issues is an important prerequisite tosystem success. The proposed structure canalso assist in evaluating the potential impactsto all participants of proposed systems opera-tions, of tactics and strategies of participatingcompanies and their competitors, and in antici-pating key implementation issues.

Perhaps the most significant outcome of an ef-fective search and planning process should bethe recognition that the electronic link betweenseparate organizations is a part of a majorchange in the relationship between the parties.The most successful users of lOS have recog-nized that the increased familiarity with their cus-tomers, dealers, or suppliers afforded by theirjoint systems was an avenue to collaboration ona widening range of initiatives that improved theeconomic performance of each partner. Aggres-sive pursuit of new possibilities for joint perform-ance improvement has proven to be a sourceof sustainable advantage that far exceeds theimpact of initial processing of boundarytransactions.

ReferencesBakos, J.Y. and Treacy, ME. "Information Tech-

nology and Corporate Strategy: A ResearchPerspective," MIS Quarterly (10:2), June1986, pp. 107-119.

Business Week. "Information Power," October14, 1985, pp. 108-116.

Business Week. "Would You Buy a Car From ThisComputer?" December 17, 1984, pp. 93-97.

Cash, J.l., Jr. and Konsynski, B.R. "IS RedrawsCompetitive Boundaries," Harvard BusinessReview, March-April 1985, pp. 134-142.

Fortune. "How to Keep Customers Happy Cap-tives," September 2, 1985, pp. 42-46.

Ives, B. and Learmonth, G.P. "The InformationSystem as a Competitive Weapon," Commu-nications of the ACM (27:12), December1984, pp. 1193-1201.

Johnston, H.R. and Carrico, S.R. "DevelopingCapabilities to Use Information Strategically,"MIS Quarterly (12:1), March 1988, pp. 37-48.

PC Week. "Shelternet," May 29, 1984, pp. 45-47.

Porter, M.E. and Millar, V.E. "How InformationGives You Competitive Advantage," HarvardBusiness Review, July-August 1985, pp. 149-160.

About the AuthorsH. Russell Johnston is associate professor ofmanagement at Boston University. He returnedto academia in the fall of 1986 to conduct re-search into emerging impacts of information andinformation technologies on the structure andprocesses of diversified and vertically integratedorganizations. Much of his research stems fromexperience with consulting clients.

I~lichael R. Vitale received a B.A. in mathemat-ics from Oakland University and attended gradu-ate school at. Dartmouth College, earning aPh.D. in mathematics. He taught mathematicsat Skidmore College, was an assistant directorof the computation center at Dartmouth, and wasdirector of marketing for DTSS Incorporated, thecomputer software and services subsidiary of Met-ropolitan Life. He then attended Harvard Busi-ness School, receiving an MBA in 1982. Sincethen Professor Vitale has been a member of thefaculty there, where he has taught both controland information systems. He has developedcases, software, and teaching notes, and hasparticipated in executive education programs atHarvard and off campus. His research and con-sulting work focuses on the strategic use of in-formation systems. Together with three of hiscolleagues Professor Vitale is the author of therecently published, Corporate Information Sys-tems Management: Text and Cases, secondedition.

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