An Economic Analysis of Strategic Information Technology Investments

The information systems literature is replete with conceptual frameworks for analyzing strategic applications of information technology (IT). In this article, the strategic impacts of IT investment are studied through the development of a formal economic model. In particular, it focuses on IT-related quality competition in a duopoly, where the services may not be priced initially (e.g., in the financial services sector), and where the benefits may come indirectly (e.g., in the form of interest earned on consumer deposits or float on checking accounts). A firm may have to invest in IT, regardless of its underlying cost structure, as a response to its competitor’s investment level. (We analyze the division of technology benefits between the firms and the consumers and study welfare implications for simultaneous and sequential investments.) Both firms prefer sequential over simultaneous investments, even when both have the required technology. While the IT-inefficient firm (one with higher IT cost for a given service quality) has followership incentives, the leadership incentives for the IT-efficient firm depend on the difference in IT cost structures and the degree of substitutability between the services of the two firms. A preliminary treatment of pricing issues is provided in conjunction with consumer switching cost, which not only has a negative impact on consumer welfare but may also reduce total industry profits. For dynamic markets with new consumers, the negative effect of switching cost on th welfare of existing consumers is reduced when the IT-efficient firm moves first.