Productivity Jumps With Help From Net

Although technology has been winning increasing credit for its role in the current economic boom, experts are only now beginning to understand how that’s happening.

The growing consensus, in brief: It’s the Internet.

By tying hundreds of millions of computers together into a common network, the Internet has turbocharged the nation’s economy and is helping to generate long-elusive improvements in productivity, a critical factor in the country’s ability to improve living standards.

A close look at how companies are using the Internet to save billions of dollars in distribution and transaction costs reveals a global productivity revolution in the making. From online self-service systems for employees and customers to direct sales to remote management of far-flung facilities, corporations are changing the way business gets done.

Computers themselves have been omnipresent for decades, without much measurable impact on the efficiency of the overall economy. But only in the last few years has the Internet been put to widespread commercial use, and the nation’s long-stagnant productivity began to surge at about the same time, particularly in the service economy.

Government statistics aren’t precise enough to show a direct relationship, but a growing number of economists note that the economy’s 99-month expansion and the improved output per worker have closely paralleled the rise of the World Wide Web. They suggest that improved efficiency in the nation’s manufacturing and service sectors is largely the result of Internet-related activities such as e-mail and online commerce.

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Economists used to puzzle over why output per worker in this country had remained almost flat since the early 1970s despite hundreds of billions of dollars spent by businesses on computers. The mystery, often referred to as the “productivity paradox,” has provided ammunition to critics who say computers have merely wasted the nation’s time and money.

But now it seems clear that the Internet, by leveraging the power of computers, is playing a big role in the recent rebound in productivity growth to a respectable 2% to 3%.

“Every once in a while, a technology comes along that profoundly changes the way work is done,” says Erik Brynjolfson, a respected expert on productivity at the Massachusetts Institute of Technology’s Sloan School of Management. “The Internet is just a better mousetrap.”

“Computers weren’t able to realize their true potential until they were all connected together,” says Ira Magaziner, who recently retired as President Clinton’s special advisor on the information economy.

Productivity matters. Only by improving productivity can the nation boost wages without igniting inflation or hurting profitability.

Federal Reserve Chairman Alan Greenspan has cited technology as a key reason that the economy has been running at full steam for several years without much evidence of inflation.

“Important technological changes have been emerging in recent years that are altering, in ways with few precedents, the manner in which we organize production, trade across countries and deliver value to consumers,” Greenspan said in a recent speech.

The Internet may prove to be to computers what the electric motor was to electricity. Stanford University economist Paul David points out that though electricity became available for lighting in 1881, it wasn’t until the 1920s, after the widespread adoption of the electric motor, that electricity really boosted productivity in factories.

New technology doesn’t show clear productivity gains, David argues, until you can measure improved labor productivity in specific tasks.

That’s already happening. Cisco Systems, for example, has used the Web to convert its expense reporting system to a self-service process that requires only two people to handle 15,000 reports filed each month. The system costs $5 a report, compared with $50 a report for the industry. That’s a saving of $675,000 a month. Pete Solvik, Cisco’s chief information officer, says the system paid for itself in three months.

New electronic billing schemes are slashing the cost to such users as utilities to send bills and the cost to customers of mailing back payments. IBM figures that these systems, which allow customers to pay bills with a few mouse clicks, will save banks, billers and customers as much as $46 billion a year.

Consider the commissions airlines pay to travel agents. These payments cost airlines almost 15% of total revenues, third in expenses after labor and fuel. America West, for example, figures it costs the company $6 to sell the average ticket over the Internet, versus $26 through a travel agent. By using the Net to bypass travel agents, airlines are able to slash expenses.

Or consider IBM. The computer giant saved $300 million in telephone support costs by directing 14 million customer questions to self-service Web sites. The company expects to save an additional $240 million this year by using the Net to sell $15 billion in products and to buy $12 billion in parts and services. Moreover, the company figures it will save $100 million by training employees online.

“IBM has reaped huge returns,” says Lee Caldwell, the company’s director of Internet technology strategy. “A lot of bits and pieces of technology are coming together.”

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Ethan Harris, a senior economist at investment bank Lehman Bros., compares the rise of the Net to the creation of railroads, which boosted economic growth first by the investments required to build the railroads and later as the various lines were linked to transport people and goods more efficiently.

In the last four years, investments in information technology have accounted for 60% of the capital investments of corporations and one-third of the growth in the economy, according to a Commerce Department report released last week.

Investing in computers has often been a mixed blessing. A recent study of 63 companies by research firm Meta Group found that the average enterprise system took two years to develop, cost $10.6 million and lost the company $1.5 million in the first five years in use.

Federal Express systems that allow tracking of packages and software used at Wal-Mart that instantaneously shows what consumers are buying are among the rare success stories, and those systems required huge investments.

Internet technology, by contrast, allows companies to use the computer systems already in place to give employees, suppliers and customers access to critical information stored in corporate databases.

There are still plenty of skeptics. Paul A. Strassman, who headed information systems first at Xerox and later at the Pentagon, believes cheap imports and lower interest rates, not computers, are the key reasons corporations have been able to cut costs in recent years. He warns that an economic downturn or a rise in interest rates could result in a decline in technology purchases and a drop in economic growth and productivity.

The Internet has also generated a great deal of wasteful activity.

When Jeff LePage, director of information systems at Seattle-based American Fast Freight, became concerned by the poor performance of the company’s internal computer networks, he installed filtering software that let him take a peek at what employees were doing on the Web. He discovered many employees were downloading pornography, sometimes for hours at a time. LePage has since blocked employee access to such sites.

The company is hardly unusual. Media Metrix, which meters the Internet usage of 40,000 people randomly chosen, found that 30% of those people viewed pornographic sites from work, spending an average of 46 minutes a month at such sites. Other studies have shown heavy use of the Net for games, shopping and stock trading during work hours.

But some of that wasted time at work may be recouped in the evening hours, when many employees spend hours at home reading work-related e-mail.

And the Internet offers the potential for dramatic gains in efficiency by using stock-exchange-type automated markets to connect suppliers of everything from steel to medical products with their customers.

Or consider the productivity gains that come from telecommuting, which has become common in recent years in large part because of e-mail and the Web.

Roy Dohner, vice president in charge of real estate at telecommunications giant Nortel Networks, used to have 20 people flying all over North America handling real estate matters. Today he oversees all the company’s office space for North America and Latin America from his home office in Virginia, saving Nortel $2.4 million a year. “I can get online at any time to see where the transactions stand,” Dohner says.

The Internet also allows companies to slash inventories.

Bellevue, Wash.-based HomeGrocer.com, which delivers groceries ordered over the Web directly to kitchen counters, carries no inventory of fish, for example. Close to midnight each day, after it has received online orders from its customers, it orders the fish from the company that owns the fishing fleet, effectively eliminating spoilage.

Computers and other equipment don’t spoil, but with prices falling fast, they quickly lose value. By using the Net, corporations can get a more accurate sense of what customer demand is for any given product. The Internet could, over time, help corporations reduce inventories by as much as $350 billion, according to a report on electronic commerce by the Organization for Economic Cooperation and Development, a Paris-based research and policy group consisting of the world’s richest nations.

When Cisco receives an order from a customer electronically, its manufacturers around the world are immediately relayed the order, all but eliminating the need for inventory. The product is often delivered to the customer without a Cisco employee getting involved.

For example, when a customer recently placed an order for more than $100 million worth of equipment, the only involvement by a Cisco employee was a call to the company to make sure there was no mistake.

Now that’s productivity.