McKinsey: Why IT does not improve productivity

The recent McKinsey report, IT and Productivity, pours cold water on the widespread belief that IT has improved productivity.

The recent McKinsey report, IT and Productivity, pours cold water on the widespread belief that IT has improved productivity.

Here are a few parts of the report that executives might use during the next budget review to knock down your spending requests.
  • "IT investments did not have an impact on productivity in 53 out of 59 economic sectors."

  • "The relationship between IT and productivity improvement is murky."

  • "Except in rare cases, IT did not produce dramatic increases in labour productivity."

The report legitimises a shift from an era of generous IT funding to one of doubts about anything you promise. If you're watching IT budget requests for 2002 get shredded, what can you do? Here are some flaws in the McKinsey findings that you can exploit:

Productivity is firm-specific, not sector-specific
McKinsey associates 99% of IT productivity growth with six "jumping" economic sectors - retail, wholesale, securities, telecoms, semiconductors and computer manufacturing - then dismisses productivity gains in 53 other sectors. However, productivity gains from IT are company-specific and should not be generalised to an economic sector. There are abysmal failures in the application of IT among retailers, for example, yet there are also spectacular gains in the steel industry.

Even the favourable gains are smaller than claimed. McKinsey attributes 30% of the value of the economy to the jumping sectors, leaving the remaining 70% with only small productivity gains, offset by comparable losses.

I found detailed sector data for 7,719 US companies with total 1999 profits of $417.3bn (£293bn). According to my data, the six jumping sectors accounted for only 16.4% of the economy, and the inclusion of three sectors is based on questionable measures. For example, the securities sector's measure of output reflects rising stock prices based on investor psychology, not IT investments.

If the questionable sectors are removed from the calculations, the jumping sectors account for only a very small share of the economy.

Reliance on US government statistics is questionable
The McKinsey conclusions are based entirely on contradictory US government statistics regarding productivity gains, as evidenced by frequent after-the-fact revisions of published productivity data. Therefore, McKinsey uses data similar to what Alan Greenspan and other economists have used to assert that IT was the engine that would assure remarkable further productivity gains.

Only corporate-level financial reports are sufficiently reliable and consistent for judging actual productivity gains. US Government-issued statistics represent averages, whereas the effective uses of IT are highly concentrated in a small number of leading-edge companies. The report does not usefully discriminate among individual patterns of success or failure.

Labour productivity is not a measure of IT productivity
The McKinsey analysis uses an obsolete view of labour productivity, measured in labour hours per capita or in terms of people employed in production.

Companies measure IT's contributions based on how they affect profit. Management makes investment decisions based on cash flow that includes employee compensation, as well as the cost of capital.

Since salaries in sectors such as banking rose much faster than revenue during the past decade, headcount-based ratios are meaningless. Also, a rising outsourcing of services renders the employee-hour ratios unreliable.

The implications
Despite the flaws in the McKinsey report, I agree with its broader conclusion that IT spending and productivity are related.

If someone hits you with the McKinsey findings during budget deliberations, take the position that McKinsey's conclusions are irrelevant and cannot be applied to your company's conditions. Your budget proposals should be judged solely on how they contribute to your shareholder value.

You will also have to produce credible numbers that show how your IT spending contributes to profit. You do not need McKinsey to do that, but from now on, getting more money for IT will be hard. Accept the McKinsey study as a warning to prepare for coming budget battles.

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