The impact of information systems on organizations and markets

Reviewer: Jonathan Oseas

Information technology (IT) is being adopted throughout the business world. This paper claims that a rational economic model exists that explains the relationships between key measures of organizational structure and the use of information systems. The authors analyze the role of evolving information systems and their effects on the organizations using them as well as their effects on the markets served in this context. This analysis focuses on two important organizational attributes—firm size and the allocation or placement of the decision-making authority among the management players, called actors. In support of this analysis, two non-original and disparate economic theories are presented: agency theory and transaction cost economics. As described by the paper, agency theory holds that a business organization is built on a set of implicit employee contracts, which connect the self-interests of these somewhat independent employee agents. As a result, when business decisions are made, they may not be in the best interest of the firm in that stockholder profits may not be optimized. This situation is clearly costly for the investors, and additional problems may proliferate. Notwithstanding these problems, an economically viable organization may exist, although it is less than optimum as measured by traditional means. Transaction cost economics is essentially an orthogonal theory. It views a business firm as a solution to an existing market. It recognizes that market operations are not free and that transaction costs are an important part of economic activity analysis. Accordingly, the firm exists as a substitute for the market mechanism and subsists by reducing transaction costs. Profits are thus an arbitrage operation. The authors use both agency theory and transaction cost economics to develop relationships between information costs and the attributes of organizations. That is, firm size and placement of the organization decision process among the `actors' are a direct result of the costs associated with acquiring, storing, processing, and disseminating information. In short, IT can and does have a direct impact on optimal firm size by affecting the organization's underlying cost structure. Additional detail, definitions, and analysis are provided in the same vein. Descriptive examples further promote the authors' prem ise, but the detailed analysis given while explaining and enlarging the concepts is totally devoid of any calibration, metric, or statistics. The result is an uncalibrated model of a business firm, which has no useful application. In fact, since no formal evidence of cause and effect is presented, the entire premise is suspect. Clearly, the application of computers and information technology is necessary to the efficient operation of any but the smallest mom-and-pop enterprise. It is equally obvious that in an organization of any size, local job specialization dominates employee performance and its recognition. That is, sales sells, manufacturing produces product, and purchasing buys. Employee views of a company are dependent upon the internal structural interrelationships and may not be judged solely on the basis of an information-driven fixed model. By applying the concept of varying cost minimization, one can claim adherence to an economic model and define the ideal organization as one that minimizes the sum of these costs, but the practical application of this approach remains elusive. Beyond the superficial level, the authors have demonstrated little. Conclusions are drawn without supporting evidence from the examples chosen. For example, in discussing the somewhat complex relationship between H. Ross Perot and General Motors, the authors assert that GM bought out Perot to save computational transaction costs. They further claim that these gains were achieved by applying Perot's holdings to vertical integration within the GM structure. My view of the same events is that Perot sold out, thereby optimizing his return on investment in the classic economic sense. Clearly, Perot was a thorn in the side of the GM board and they were willing to take a financial bath in order to be rid of him. The case was clearly a conflict-of-interest situation, optimized for Perot and not GM. The product was computers and information technology, an area in which GM was hardly inadequate. The theory the authors promote is not applicable. The authors cite insider trading as an example of superior business information. To imply that technology of any kind is relevant to this case is more than misleading. That economically advantageous, though illegal, information can yield outrageous returns is true, but it has nothing to do with information technology, computers, economic models, economy of scale, or justification of expense other than bribery. The beginning and final sections are awkward and forced, while the middle flows smoothly and reads well. Unfortunately, the key premises and theory are embodied in the hard-to-read sections, while the best-written parts are fraught with poor scholarship. I found the use of the pronoun “her” (as in “her store”) forced, not because “his” would have flowed better but because the sentences could easily have been arranged to be sexually neutral. Perhaps the academic approach should have considered another economic theory, that of the cart before the horse. Consider that farmers who arrange their wagons and draft animals in this sequence will clearly have their goods arrive first to market, all other things being equal. Clearly, one whose goods arrive at the market first has an economic advantage over those who have their wagons pulled. If this kind of logic and view of economic models is to your liking, you should love this paper.