IT Innovations and the Productivity of the Japanese Information Services Industry : What is Preventing the Growth of Total Factor Productivity?

ABSTRACT

In the wake of the IT recession, there are now many companies in the electronics industry that have shifted their business domain from hardware to the field of software and IT services. Though the information services industry is currently in the same productivity slump as the other service industries in Japan, the industry is expected to break away into high productivity given the impetus of today's information and telecommunication innovations.

A key characteristic of the information services industry is that, rather than containing their operations within the walls of one firm, companies generally make inter-company alliances in which outsourcing and collaborations occur. Cost reductions in labor, and the transfer of the technology and know-how of other companies are often pointed to as the purpose for this strategy. It is well known that in America's Silicon Valley, for instance, the heartland of the world information, telecommunication, and technology industry, the companies have formed a community and collaborations occur regularly amongst its members.

According to the Silicon Valley model, the most efficient method in an environment of frequent technological innovation is to outsource parts production. One of the things that the following report will show, however, is that amidst active technological innovations, it is not always desirable to outsource. In fact, outsourcing can become adverse if an adjustment in the integrated assembly of parts is required each time a new innovation occurs. In order for outsourcing to be advantageous, it is necessary that the outsourced product have a sufficient modularity of process.

When an increase in product modularity causes a dramatic rise in total factor productivity, a growing rate of outsourcing - an indicator for the level of outsourcing, which is the ratio of outsourcing expenditure to net sales - must naturally have a positive effect on productivity. However, as a result of empirical analysis, it was found that a growing rate of outsourcing is actually having a detrimental effect upon the total factor productivity of the information services industry as a whole. The reason for this is that companies are outsourcing despite the fact that their development and production processes have a low level of modularity.

Through empirical studies, it was found for instance that because of the way companies are typically organized, increasing the number of system engineers on a particular project generally has a negative effect upon total factor productivity. Using the case of software architecture, adding engineers to a software-design project team led to the unexpected costs required in updating and then communicating with the new members, costs which led to the overall inefficiency of the project. The case may be different with open-source software development (e.g. Linux), where engineers around the world voluntarily vie their technical skills, but this was not a common practice in the 90s, the target of this analysis.

Efficient outsourcing is indispensable to increasing the competitiveness of the Japanese information services industry. For this reason, a prime task for companies is the establishment of project managers who would oversee the entire operation process. Also important is an institutional infrastructure that would enable an efficient distribution of operations, and smooth communication amongst the developers within the company. If inter-company collaborations are to be successful, it is necessary for the parts of the company itself to be in correct and efficient alignment.