Effect of Information Systems Resources and Capabilities on Firm Performance: A Resource-Based Perspective

Abstract:

We draw on the resource-based theory to examine how information systems (IS) resources and capabilities affect firm performance. A basic premise is that a firm's performance can be explained by how effective the firm is in using information technology (IT) to support and enhance its core competencies. In contrast to past studies that have implicitly assumed that IS assets could have direct effects on firm performance, this study draws from the resource complementarity arguments and posits that it is the targeted use of IS assets that is likely to be rent-yielding. We develop the theoretical underpinnings of this premise and propose a model that inter- relates IS resources, IS capabilities, IT support for core competencies, and firm performance. The model is empirically tested using data collected from 129 firms in the United States. The results provide strong support for the research model and suggest that variation in firm performance is explained by the extent to which IT is used to support and enhance a firm's core competencies. The results also support our propo- sition that an organization's ability to use IT to support its core competencies is dependent on IS functional capabilities, which, in turn, are dependent on the nature of human, technology, and relationship resources of the IS department. These results are interpreted and the implications of this study for IS research and practice are discussed.

Introduction:

The potential of information technology (IT) to provide firms competitive advantage has been a topic of interest to practitioners and academicians. This interest is reflected in the large number of studies that have examined the strategic value of IT and its effect on firm performance. In part, this attention to IT value stems from the significant investments organizations have made in information systems (IS) and the increasing role IT plays in the strategic thinking of most organizations. Despite significant work in this area, the need to examine the IT-firm performance relationship exists for two reasons. First, although studies have found that IT affects firm performance, the underlying mechanisms by which IT relates to firm performance remain under examined in both the IS and the management literatures [17,99]. Past studies have investigated the IT-firm performance relationship at an aggregate level and have attempted to quantify the marginal effects of IT investments on firm productivity, profitability, and consumer surplus (e.g., [22, 48, 61, 82]). Although, recent studies have provided evidence that IT contributes to firm performance (e.g., [61, 89, 96, 124), the cumulative results of the IT-firm performance research have been mixed.

Second, the underlying theories to explain why and how IT innovations contribute to firm performance have undergone a paradigm change, creating a need for more current examination [109]. Previously, the structure-conduct-performance model of industrial organizations economics [90, 91] was the most dominant theory infiuenc- ing the thinking of IS researchers. The positioning arguments that underlie this paradigm have been questioned in the strategy literature [13, 33, 52, 128], where it has been suggested that there is a need to focus on factors internal to the firm in addition to the industry structure in understanding the sources of competitive advantage. Re- searchers have argued that the resource-based theory [13, 52, 128] and its extensions [122], with their focus on firm resources and capabilities, provide the appropriate theoretical lens to examine how factors internal to the firm can be a source of competitive advantage.

In this paper, we draw from the resource-based theory to examine how IS resources and capabilities affect firm performance. A basic premise of this paper is that a firm's performance is infiuenced by how effective the firm is in using IT to support and enhance its core competencies. In contrast to past studies that have implicitly as- sumed that IS assets could have direct effects on firm performance, this study draws from the resource complementarity arguments [29, 30] and posits that it is the tar- geted use of IS assets that is likely to be rent-yielding. We develop the theoretical underpinnings of this premise and propose a model that interrelates IS resources, IS capabilities, IT support for core competencies, and firm performance.

IT and Firm Performance Research: A Critical Review

Past research linking IT and firm performance has largely focused on the competitive advantage derived from IT applications and the relationship between IT investments and firm performance. Early research drew from the industrial organization perspective and proposed conceptual frameworks to examine the competitive advantage offered by key IT applications (e.g., [9, 16, 63, 77, 90, 91, 110]). This research stream argued that IT innovations have the potential to alter a range of strategic and industry factors such as cost positions, scale economies, and power relations with buyers and suppliers, and thereby provide competitive advantage. However, the focus on strategic applications as a source of competitive advantage has been critiqued. IT applications might provide only limited advantages to innovators before being copied by competitors, which essentially extends current competitive positions, but at increased costs [126]. Strategic applications create switching costs, which in turn, were expected to be a source of competitive advantage. The conceptual limitations of attributing the source of competitive advantage from IT- based switching costs have been pointed out [73]. These include the inability of firms to profit from switching costs because of potential customer backlash in competitive markets and the emergence of open systems that considerably reduce, if not eliminate, switching costs.

Adopting a more macro perspective, another research stream has examined the relationship between IT investments and firm performance and found mixed results. Some studies [11, 14, 23, 40, 49, 115] have reported a positive relationship between IT investments and firm financial performance, whereas others have found no significant relationships [10, 48, 65, 72].

In resolving these inconsistent findings, researchers have stressed the need to shift the analytical focus to a more granular level and to refine the operationalization of firm performance variables. Since the immediate effects of IT manifest in process improvements, more conclusive results are expected when IT investments are related to process performance [83, 113]. Empirical studies using intermediary performance measures such as process efficiency and quality have reported more consistent results [86, 98], though only very few studies have been undertaken so far. The scope of the performance measures has also been expanded to include consumer surplus, based on the argument that the value created by IT need not be appropriated by firms in a manner that manifests in improved financial performance [61]. Instead, it could enhance the value customers get through improved product and service offerings. The effect of IT investments on firm productivity has also been examined [23], with mixed results.

The contingencies under which IT investments become valuable to a firm have also been examined. The performance effects of IT investments has been found to differ under monopolistic and duopolistic conditions, and market sensitivities to price and product quality have also been found to affect the relationship between IT investments and firm performance [96,124]. Moreover, these relationships have been found to vary across industries. Although a few industry-specific studies have been reported so far [40, 69, 75, 78, 96], further research is needed to develop deeper knowledge about the contingencies under which IT investments enhances firm performance.

Investing in IT is not a necessary and sufficient condition for improving firm performance, since IT investments might be wasted [38, 81, 116, 119]. Adopting a process view, Soh and Markus [116] proposed that IT investments should be converted into IT assets such as IT infrastructure and applications. Furthermore, the IT assets would have to be put to appropriate use for them to be of value to the firm. Appropriate use is expected to create intermediary effects, such as IT being embedded in prod- ucts and services, streamlined business processes, improved decisions, and dynamic organizational structures, which in turn can be expected to affect firm performance.

Whereas conceptual models have emphasized the importance of IS capabilities in converting investments into IT assets, and that of targeted IT use, for firms to benefit from IT investments [81, 104, 110], limited research has been undertaken to elaborate both of these concepts. In this paper, we seek to address this gap by theorizing about targeted IT use, IS resources, and IS capabilities. Adopting an approach similar to the process perspective proposed by Soh and Markus [116], we examine how IS resources, IS capabilities, and targeted IT use interrelate to affect firm performance. We draw from the resource-based theory to develop the theoretical explanations un- derlying these causal links.

Theoretical Background:

The resource-based theory prescribes that firm resources are the main driver of firm performance [13,41,52,54,55, 128]. The resources needed to conceive, choose, and implement strategies are likely to be heterogeneously distributed across firms, which in turn are posited to account for the differences in firm performance [13, 52]. This theory posits that firm resources are rent-yielding when they are valuable, rare, imperfectly imitable, and nonsubstitutable [13]. Moreover, resources tend to survive competitive imitation because of isolating mechanisms such as causal ambiguity, time- compression diseconomies, embeddedness, and path dependencies [13]. Resources are stocks of available factors of production owned or controlled by a firm [4]. Capabilities, in contrast, refer to a firm's capacity to deploy resources using organizational processes [4]. Capabilities can be viewed as the capacity of a team of resources to perform some task or activity [52], and are often developed in functional and subfunctional areas by combining physical, human, and technological resources [4].

From a resource-based perspective, IS resources that are inimitable and valuable can be rent-yielding. Technology assets such as networks and databases are unlikely to be rent-yielding, since they could be easily procured in factor markets [76]. However, combining hardware and software assets to create a flexible and sophisticated IT infrastructure can be inimitable, because creating such an infrastructure requires carefully melding technology components to fit firm needs and priorities [43, 106]. In addition to a sophisticated IT infrastructure, skilled human resources, relationships between the IS department and user departments, and IS managerial knowledge are valuable resources that are posited to be rent-yielding [76, 106].

A related research stream has focused on the functional capabilities of the IS de- partment as a source of competitive advantage. Feeny and Willcocks [45] identified nine critical IS capabilities—leadership, business systems thinking, relationship build- ing, architecture planning, making technology work, informed buying, contract facilitation, contract monitoring, and vendor development—and used anecdotal evidence to argue that these capabilities can have a direct effect on firm performance. More- over, the competencies of the IS department in acquiring, deploying, and leveraging IT in pursuit of business strategies are likely to have a positive effect on firm performance [17, 104]. Ravichandran and Lertwongsatien [99] identified two dimensions of IS competence—transformational competence, which represents the ability to transform the organization using IT; and operational competence, which represents the ability to provide reliable and consistent IT support to the business. They argued that these IS competencies are likely to have a direct effect on firm performance.

Whereas these studies posit a direct relationship between IS resources/capabilities and firm performance, others have questioned the direct-effect argument and emphasized that IS resources/capabilities are likely to affect firm performance only when they are deployed to create unique complementarities with other firm resources [30, 93]. In the resource-based view (RBV) literature, resource complementarities have been conceptualized in two broad ways. Firm resources are considered complementary when the presence of one resource enhances the value or effect of another re- source. This interaction perspective of complementarity is typically operationalized using multiplicative terms in statistical analyses. For example, Powell and Dent- Micallef [93] used interaction terms to test the effects of complementarities between human resource practices and IT use on retail store performance.

Another perspective conceptualizes resource complementarity based on how resources are channeled and utilized. It is not the copresence of resources or capabilities that results in complementarities. Rather, firms have choices about how resources/capabilities are deployed. Complementarities arise when resources/capabilities are used in a mutually reinforcing manner, demons and Row [30], for example, argued that IT can provide sustainable competitive advantage when it is used to leverage structural differences between firms, such as the degree of vertical integration and diversification. The IS alignment literature [60, 89, 112] also refiects this perspective of resource complementarities, even though this literature stream does not make any explicit reference to the resource-based theory. The central premise of this research stream is that mutual coherence between IS priorities and initiatives and firm strategies is necessary to effectively prioritize IT activities and channel IS resources toward areas of strategic importance to the firm. Empirical studies have found that firms with a higher IS align- ment are more likely to utilize IT for strategic purposes [108], arrange IT resources and capabilities to support market positions [60], and focus IT efforts on areas most critical to the firm [35].

In summary, although previous IS research has examined the contributions of IS resources and capabilities to firm performance, the research is fragmented, and key gaps exist in the literature. First, although several IS resources/capabilities have been identified and their direct effects on firm performance posited, the relationships be- tween IS resources and capabilities have not been systematically examined. Resources are the raw materials in the development of capabilities, and examination of the rela- tionships between IS resources and IS capabilities can provide a better understanding of how resources could be deployed to develop capabilities. Two distinct mechanisms—resource picking and capability-building—underlie the resource-based arguments about how economic rents can be created by firms. The former mechanism asserts that firms create economic rents by being more effective than their rivals in selecting resources [72]. This Ricardian perspective stresses that heterogeneity in performance is due to ownership of resources that have differential productivity [12, 13, 80, 121]. In contrast, the capability-building mechanism asserts that firms create economic rents by being more effective than their rivals at deploying resources. While past IS studies have examined these two mechanisms independently, Makadok [72] argued that resource picking and resource deployment are not necessarily indepen- dent and may complement each other. One dependency stressed in the literature is that resources are the raw materials to build capabilities [128] and that resource availability determines a firm's ability to develop capabilities.

Second, while the complementarities between IS assets and other firm resources have been emphasized, limited work has been undertaken to examine the effects of complementarities on firm performance. In this study, we adopt the channeling view of complementarity discussed earlier, and posit that one way to achieve mutual coherence between IT activities and firm priorities is to use IT to support and enhance a firm's core competencies. We argue that it is primarily through such targeting that firms create inimitable competencies likely to be rent-yielding.

Research Model and Hypotheses:

Contributions and Implications:

While significant research has focused on the IS-firm performance relationship, the mechanisms through which IS assets affect firm performance remain underexamined. This study is one attempt to bridge this gap, where we drew from the resource-based theory and argued that IS assets, per se, may not be rent-yielding. Rather, it is their targeted use that is likely to be rent-yielding. Our fmdings provide general support to the resource complementarity arguments put forth in the IS literature. Among the past studies that have addressed the issue of complementarities between IS and firm resources, Clemons and Row [30] focused on how IT could be used to exploit the unique structural characteristics of a firm, and Powell and Dent-Micallef [93] focused on how the value of IS resources could be enhanced in the presence of other business resources such as an innovative culture. This study extends this line of research by examining the complementarities that could be achieved by focusing IT initiatives on firm competencies.

The model developed can serve as a basis for IS performance evaluation. While a number of performance evaluation models have been proposed, these models assess IS performance in one or a few of the functional areas such as systems development, planning, or systems acceptance and use. Moreover, the IS success models [39, 111] have focused on the individual effect of IS and implicitly assumed that individual effect will lead to organizational effects. This position has been critiqued, where researchers have pointed out that the link between individual level system use and organizational performance improvement is not automatic [50, 110], and that IS success models have to more directly link IS activities with firm performance. Moreover, since successful IS units do more than develop easy-to-use and usable IS, success models have to incorporate other core IS activities in addition to systems develop- ment. The model developed here addresses some of the shortcomings of the current IS success models by providing a more direct assessment of the organizational effect of IS activities and by including core IS functional activities such as planning, systems development, IS operations, and IS support. Thus, this study complements and adds to the IS performance research and provides a basis for the development of IS performance assessment tools for managerial use.

From a practical standpoint, this study makes several contributions. Before we discuss these contributions, we should highlight that the findings reported here should be viewed as preliminary evidence, and further research aimed at both refining the constructs and their measures and testing the model with other data are needed before definitive guidelines for practice could be derived. Nevertheless, this study does offer some useful insights for practice.

By providing empirical evidence that IT support for core competencies has a positive effect on firm performance, this study highlights that IS managers have to do more than invest in the latest technologies or develop a strong IS department. Theresults indicate that IS managers have to clearly understand the strategic thrust of the organization and institute mechanisms to ensure that IS capabilities are channeled toward areas of importance to the organization. Among other things, this requires close interactions with business managers and coopting business leaders to play an active role in IT deployment decisions.

By providing empirical evidence of the strategic value of core IS functions, this study stresses the importance of investing in the development of a strong IS department. While senior executives acknowledge the strategic value of IT, they tend to view IS activities as commodity services, and target these activities for cost cutting. Our findings that strong IS functional capabilities enable organizations to effectively leverage IT in pursuit of firm strategies suggest that such a cost-focused approach to managing IS might be dysfunctional. IS managers who understand the strategic value of IS capabilities must proacti vely educate the senior management on the value of IS activities and seek the necessary funding to renew and improve these capabilities.

Our findings that resource endowments affect capability development suggest that IS managers have to develop effective resource acquisition strategies in order to maintain a valuable asset base comprising of personnel, technology, and relationships to support IS initiatives. Given the difficulties in hiring and retaining skilled IS personnel, IS units have to think creatively to design attractive careers paths for IS recruits, invest in training and development, and adopt novel recruitment strategies such as countercyclical hiring to hire and retain skilled personnel. Similarly, careful planning in the acquisition of technology platforms is required to ensure that the IT infrastructure remains state-of-the-art. Coopting key vendors as partners and adopting sound vendor management practices are critical for developing close vendor partnerships. While IS units might have adopted some of these practices, it is possible that they might be more successful in acquiring some IS resources and not others. For example, it is not uncommon to find organizations that are quick in investing in the latest technologies, but lag in the human resources practices needed to retain technical personnel. IS managers have to recognize that all three types of resources are equally important and ensure a balanced approach to the acquisition and renewal of IS resources.

Conclusion:

In the past decade,organizations have increased their investments in IS significantly with the expectation that these investments will improve firm performance. How- ever, some organizations continue to be able to gamer better value from IS than others. This has created a need to better understand the sources of such differences and, consequently, the mechanisms by which IS contributes to firm performance. This study is one attempt to answer this question. We drew from the resource-based theory to posit that intangible IS resources and IS functional capabilities are critical determinants of how IT is deployed in the organization, which in turn can affect firm performance. This study departs from past IS-firm performance research by using resource-based theory as the theoretical lens to define and interrelate resources, capabilities, competencies. and firm performance. Moreover, this study extends IS performance research by providing a conceptual foundation to link IS activities to firm performance. It is hoped that the theoretical model and the empirical results presented here provide a useful starting point for future empirical studies that examine the IS-firm performance relationship from a resource-based perspective.