The Impact of Information Technology on Quality Improvement, Productivity, and

Profits: An Analytical Model of a Monopolist

Matt E. Thatcher
University of Arizona
mthatcher@cmi.arizona.edu

Jim R. Oliver
VP of Business Development, CrossCommerce
jim.oliver.wp96@wharton.upenn.edu

Abstract
Empirical and analytic research in the IT and economics
literatures have paid little attention to the distinction
between the goals of cost reduction and quality
improvement when examining the impact of IT
investments on firm performance (i.e., firm profits and
productivity).
In this paper we present a simple
analytical model that examines the impact of various
types of IT investments on the quality and pricing
decisions made by firms and on the economic
performance of these firms. The model demonstrates that
while investments in the technology types examined in this
model are all expected to increase firm profits the impact
of these investments on firm productivity vary and depend
on the type of technology implemented. More specifically,
the model demonstrates that a profit-maximizing firm may
make a conscious decision to invest in certain
technologies that lead to product quality improvements to
capture higher profits, but sometimes at the expense of
firm productivity.

1. Introduction
Firms typically make investments in information
technology (IT) to accomplish two goals [16]:

Cost Reduction occurs when an IT investment enables

a firm to produce more of a given product (or service)
with fewer resources. IT investments in the production
of food, chemicals, transportation equipment, and other
traditional production are primarily devoted to cost
reduction; for example, a technology investment that
leads to increased production of wheat (of the same
quality) per acre of land is clearly devoted to cost
reduction. IT investments in data processing functions
are also primarily devoted to cost reduction. As a
result, investments in these types of technologies are
often associated with a fall in the equilibrium price for
a product or service.

Quality Improvement occurs when an IT investment

leads to the creation of new products, or new features
on existing products, that directly increase human
desire to consume those products. IT investments in
medical/health services are often devoted to improving
the quality of medical care (e.g., diagnosis accuracy and
treatment strategies) provided to patients. In addition,
many investments in the telecommunications industry
are devoted to developing new and improved services
(e.g., interactive TV and Internet services) for
consumers. Since these types of investments increase
consumer demand for products and services, they are
often associated with a rise in the equilibrium price for
a product.
Different IT investments help firms accomplish
different goals (or some combination of these goals).
However, empirical and analytic research in the IT and
economics literatures have paid little attention to the
distinction between the goals of cost reduction and quality
improvement when examining the impact of IT
investments on firm performance (i.e., firm profitability
and productivity) [16]. Therefore, little research has
focused on formalizing the relationships discussed above.
In this paper we develop an analytic model that explicitly
acknowledges this distinction and examines the impact of
various types of IT investments on the quality and pricing
decisions made by firms and on the economic
performance (i.e., profits and productivity) of these firms.
In this model we consider a single-product monopolist,
and we distinguish among three different types of IT
investments that the monopolist may undertake. We
demonstrate that while investments in each technology
type should improve firm profits, the impact of each
investment on product quality and firm productivity vary
and depend on the technology type implemented. The
model results suggest that a profit-maximizing firm may
make a conscious decision to invest in technologies that
lead to product quality improvements to capture higher
profits, but sometimes at the expense of firm productivity.

0-7695-0981-9/01 $10.00 (c) 2001 IEEE