The Strategic Value of Information Technology in Setting Productive Capacity

Abstract

Capacity is the maximum short-run output with capital in place under normal operations, and capital investment increases capacity. Excess capacity can be used as entry deterrence by lowering average costs over a greater range of output, and as an operations strategy by providing value through flexibility to manage demand fluctuations and production disturbances. We study the way that information technology (IT) can contribute to a strategy of holding excess capacity by comparing the relationship between IT capital and capacity with that of non-IT capital and capacity. We find that increases in IT capital yield almost fourfold greater expansion in capacity than do increases in non-IT capital. Thus, as both types of capital are constraints on capacity, for a strategy of holding excess capacity, IT capital is a more valuable constraint to relax than non-IT capital. In addition, since the late 1990s, IT capital and, to a lesser extent, non-IT capital have reduced capacity utilization (output divided by capacity), meaning increasing levels of excess capacity are being held across manufacturing industries and utilities across the economy.