Ebook Determinants and Consequences of Firm Information Technology Budgets
Over the last three decades, firms increased spending on information technology (IT) hardware and software from 5% of non-residential fixed investment in 1978 to 23% in 2005, totaling $305 billion — nearly equaling investments in land and structures (Bureau of Economic Analysis 2006). Despite this substantial growth in IT spending, the contributions of IT to business value remain uncertain(Brynjolfsson and Hitt 1998; Chan 2000; Santhanam 2003; Kearns 2004; Bhatt and Grover 2005). As a result, senior managers continue to question whether their firms are spending too much or too little on IT (Ross and Weill 2002; Lee and Bose 2002).
In this paper we use IT budget data (hereafter the ‘IT budget’) for a group of large IT spending firms, known as the InformationWeek 500, to investigate three related questions: 1) What contextual factors influence managers’ allocations of resources to IT, 2) is there a relationship between IT budgets and firm performance, and 3) does spending more or less on IT than other similarly positioned firms affect performance? Building on accounting and information systems research, we model IT budget levels as contingent upon the environmental, organizational, and technological factors that constrain the firm’s opportunity space. We use this model to separate the actual IT budget into two components: the amount expected given the firm’s context (predicted IT), and any excess or shortfall (residual IT). The relation between predicted IT and performance reflects mean performance given the context. The relation between residual IT and performance reflects the marginal returns to IT budget allocations.
For most firms, the IT budget represents a sizeable component of the overall firm budget. IT budgets include expenditures directly associated with a firm’s IT function, i.e., for IT staff salaries, payments to vendors and services firms, hardware/software upgrades and replacements, training of IT staff and system users, and new development associated with systems software and application software portfolios. As such, it is through the IT budget that many, if not most, of a firm’s requests for IT services are met and supported. IT budgets that are too constrained inhibit firms’ abilities both to meet new service requests and fully leverage installed technology. IT budgets that are too slack encourage the inefficient use of firms’ assets.
Despite the importance of the IT budget to most firms, little (if any) prior research is available that investigates the factors affecting managers’ IT budget allocations. In the information systems (IS) field, only Dewan et al.’s (1998) study, which investigates how contextual factors (specifically market diversification, growth and vertical integration) predict the level of IT capital (or assets, such as hardware and software) investment, provides insights regarding factors likely to influence IT budget levels. A firm’s IT capital investment, however, differs from its IT budget in numerous ways (e.g., annualized versus cumulative expenses, scope of IT-related activities involved, source of funding, etc.).
There is considerable research that attempts to link IT spending with firm performance, though the manner by which IT spending has been operationalized varies considerably across this body of research. Over fifty studies examine facets of the relationship between IT spending and productivity (i.e., real output for a given total cost) since the early 1990s. A majority of these firm-level studies conclude that gross returns to IT exceed returns to other investments (Dedrick et al. 2003). Notwithstanding the relation between IT investment and productivity, evidence of IT’s impact on financial measures of performance has until recently remained elusive. For example, Hitt and Brynjolfsson (1996) found no relationship between IT capital investment and next-year total shareholder return, return on assets (ROA), or return on equity (ROE). They suggested that IT’s productivity benefits are competed away, creating consumer surplus rather than firm profits. Others argue that firm- and industry-specific factors help explain the wide variance in IT’s impact on performance across firms (Bharadwaj 2000; Stratopoulos and Dehning 2000; Ross and Weill 2002; Bhatt and Grover 2005). The current study is the first to investigate systematically how these contextual factors influence IT budget levels as well as the relationship between IT budgets and financial performance.
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