THE TECHNOLOGY PAYOFF
Behind its faux-Georgian facade, the Federal National Mortgage Assn. seemed the very essence of a modern, high-tech organization. The market prowess of Fannie Mae, the nation's largest buyer of home mortgages, was built on an imposing foundation: banks of mainframe computers. The blinking behemoths processed huge quantities of loan information and permitted the company to pool millions of mortgages into easily sold securities.
But by the early 1990s, those mainframes and a highly centralized management system had become barriers to Fannie Mae's further expansion. Despite their enormous power, the Washington-based company's computers simply couldn't keep up with the growing volume of work. So Fannie Mae began remaking itself, breaking down the old centralized departments that slowed things down and replacing them with work teams that linked financial, marketing, and computer experts at the start of each deal. Tying it all together is a network of more than 2,000 personal computers and new software that makes the machines accessible to workers with a minimum of training.
The $10 million investment in the new computers paid for itself in less than a year. When interest rates plunged in 1992, refinancings surged. Volume soared. But so did productivity: Even as Fannie Mae handled $257 billion in new loans, nearly double its 1991 volume, it had to add only 100 more employees to a work force of nearly 3,000. "If we had not used this technolo-
gy," says Vice-Chairman Franklin D. Raines, "our business would have collapsed." Instead, Fannie Mae's profits jumped 13%, to $1.6 billion.
The Fannie Mae story is a small part of a revolution that is sweeping America's offices and factories. At last, after years of costly struggle, U.S. business is finally making the information revolution pay off. One reason: Historically, it has taken companies a generation or more to truly master major new waves of technology. For instance, U.S. manufacturers first used electric motors in the 1890s, but productivity didn't take off until the technology finally dominated factories--nearly 30 years later. Now, 40 years after IBM sold its first commercial mainframe, information technology has penetrated every corner of the U.S. economy. What's more, today's computers are cheap and, thanks to new software and networks, far more accessible and useful.
PARADOX LOST? But the real breakthrough isn't just in technology. It's the sweeping changes in management and organizational structure that are redefining how work gets done. Largely prodded by rising global competition, these overhauls are known loosely as "reengineering," a process that questions traditional assumptions and procedures--and then starts over. Often, this means breaking down the old functional fiefdoms--in marketing, engineering, manufacturing, and finance, for instance--and redeploying workers in multidisciplinary teams, such as the ones at Fannie Mae, that concentrate on getting the right products and services to the customer.
Once the work has been redefined, the new information technology plays a key role. "User-friendly" software, PC networks, handheld wireless terminals, and other gadgets are used to move information to the front lines--to give the folks on the factory floor or in the customer-service department the knowledge they need to act quickly.
For instance, when Aluminum Co. of America began feeding production data back to the factory floor, workers at its Addy (Wash.) magnesium plant quickly saw ways to boost productivity by 72%. Says Harvard business school professor Gary W. Loveman: "Gains come not because the technology is whiz-bang, but because it supports breakthrough ideas in business process." For Fannie Mae, changing the process meant doing lots more work with just a few more people. For dozens of other corporations, reengineering has meant being able to take on more work--even while downsizing.
That's the formula for a productivity explosion. If this new industrial revolution continues to spread from big outfits, such as Fannie Mae, to hundreds of thousands of smaller companies, the U.S. economy could be in for a new era of economic growth. Increased productivity, driven by a sea change in technology and management, may set off a powerful cycle of fatter profits, new investment, higher wages, and a rising standard of living.
It's a stunning reversal of the picture just a few years ago. Throughout the 1980s, U.S. businesses invested a staggering $1 trillion in information technology. For a long time, it looked as though most of that money was going down a rat hole. Economists spoke of a productivity paradox: Despite the huge investment, businesses saw little payoff. Profits were flat, and productivity growth was stagnant. And, most troubling of all, in the service sector, where businesses sank more than $800 billion into technology, the results were the worst. Overall, national productivity rose at a puny 1% annual rate, compared with nearly 5% in Japan, and the U.S. standard of living stagnated.
Now, there are tantalizing hints that the big payoff may finally be at hand. The first sign: Since the bottom of the recession in 1991, productivity gains have been outpacing overall economic growth. While productivity always picks up in a recovery cycle, this is the first postwar recovery in which productivity raced ahead of growth. And even though productivity growth sagged in the weather-ravaged first quarter of 1993, in the eight quarters since the trough, output per hour has increased at an average annual rate of 2.3%. In 1992, productivity rose nearly 3%, its best showing in 20 years (charts). Most encouraging: Service-sector productivity finally sprang to life, matching the gains that began in manufacturing in the 1980s.
The second sign: In the face of a sluggish recovery, corporate profits are up sharply. Much of the profit surge comes from lower interest rates, but higher productivity is playing a role, too. "The productivity level emerging in this age is opening up profit margins. It is creating a significant amount of new investment, and what history tells us is that this is an early stage of a major expansion of employment," says Federal Reserve Board Chairman Alan Greenspan.
Increasingly, business leaders and economists are pointing to the melding of new corporate structures and advanced information technology to explain the productivity surge. A new look at investment by 400 large companies from 1987 to 1991 shows, for the first time, evidence of a real technology payoff. According to the soon-to-be-published analysis by Erik Brynjolfsson and Lorin Hitt of Massachusetts Institute of Technology's Sloan School of Management, the return on investment in information systems averaged a stunning 54% for manufacturing and 68% for all businesses surveyed. And perhaps most significant, productivity gains aren't just coming from cost-cutting or cost avoidance: The reengineered corporations are boosting their top lines, too.
Such results are making all sorts of economists take notice. Morgan Stanley & Co. economist Stephen S. Roach, who sounded the alarm about the productivity paradox in the mid-1980s, is now convinced that information technology is driving what he's calling a productivity-led recovery. "We're just beginning the journey," he says, "but we've moved to a higher productivity growth path."
SKIMPY EVIDENCE. Not every economist is convinced that the U.S. is on the verge of such a productivity explosion. Skeptics point out, for example, that the usual evidence is nowhere to be found: If we were really seeing productivity gains, incomes would rise, which would spur increased demand for goods and services, and, eventually, new hiring. So far, real wages continue to stagnate and in this recovery, job growth is lagging (page 72).
One explanation is that it's simply too early in the process to see such concrete evidence. And unemployment still hovers at 7%, partly because the changes in corporate structure are causing short-term dislocations--known euphemistically as downsizing.
Corporations have been laying off huge numbers of middle managers because the reengineering and technology make it possible to do without them. In the old corporate hierarchies, middle management's function was to transmit information from the field or factory to the executive suite and relay commands from the corner office back to the troops. Data bases and computer networks now do the job--faster, better, and for less. "People who don't add value are going to be in trouble," says Melvyn E. Bergstein, president of Technology Solutions Co., a systems integrator. "If your job is just passing orders along," you could get lost in the shuffle.
Skeptics insist that only a handful of large, high-profile companies have reaped benefits from a combination of technology investment and structural change. They say that outfits such as Apple Computer, Chrysler, and General Electric may be racking up impressive gains (page 79), but they are the exception. Recently, however, evidence has begun to accumulate that these success stories are being repeated throughout the economy. Richard L. Florida, professor of management at Carnegie Mellon University, recently surveyed 2,000 small and midsize businesses in the Great Lakes states. He found that as many as 60% realized some improved return by restructuring work.
Small companies are also being infected by the big companies they deal with. As the large outfits extend their electronic tentacles, the new information technologies are moving down the corporate food chain, from big buyers to their suppliers, through the service sector, and even into small businesses. DuPont Co., for example, no longer expects invoices from some of its vendors. Instead, it just processes bills electronically. And with about 5% of its suppliers, the chemical giant doesn't even bother with purchase orders. Outside vendors are linked electronically with DuPont's internal inventory system. When the suppliers see that DuPont is running short on an item, they simply deliver replacement goods. "When you do it electronically," says Thomas F. Holmes, director of materials and logistics, "you simplify the process."
Just ask Phoenix Designs Inc. in Zeeland, Mich. A year ago, the Herman Miller Inc. subsidiary sold office furniture the old-fashioned way. Independent dealers sent a salesperson to a customer's office, where the rep would gather ideas for a designer, who would work up a draft. After six back-and-forth weeks, the sales rep would finally show the customer a proposal. The arrangement drove buyers nuts--and cost Phoenix sales.
DESKTOP DESK. Now, thanks to some PCs and a custom software program called Z-Axis, salespeople have become their own designers--and are generating proposals in four or five days. One dealer, Continental Office Furniture & Supply Corp. in Columbus, Ohio, has made a sale each of the 70 times it has used the system. And some small dealers have reported an average increase in sales of 1,000%. The next step begins next month: a portable system that will allow sales reps to work on designs in the customer's office. So far, Phoenix has spent about $1 million and has been rewarded with a 27% jump in aftertax income. "We're convinced this is the way to go," says Gary W. VanSpronsen, Phoenix vice-president of market development. "The whole idea is to streamline a cumbersome process."
Could such reengineering cure the health-care industry? Hospitals are virtually temples of technology, full of diagnostic equipment and back-office computers that tally up bills. But doctors, the hospitals' production workers, have resisted changes in their work routines. When physicians at the University of Virginia Hospital were asked to use computers to order drugs and other treatments, they were so angry they staged a job action. Now, a new crop of computer-literate residents has embraced the system. "Almost five years into the process, we are finally where we want to be," says pediatrics professor Thomas A. Massaro, "using technology to improve productivity."
Doctors and other professional-class Luddites won't be able to escape the web of information technology for long, however. Electronic mail, videoconferencing, laptops, car faxes, and cellular phones have changed the very definition of the office. Robert F. Mitro, senior vice-president at PictureTel Corp., a Danvers (Mass.) maker of videoconferencing equipment, says some buyers still justify the cost of a system by savings on travel, but the real payoff lies elsewhere: "Customers tell us that the benefit is in their ability to bring together more expertise, faster." The impact, he says, is really on the revenue line, not on costs.
WORKER INPUT. Extending the networks and the information throughout the organization also helps improve quality, responsiveness, and, inevitably, sales and profits. "In factories, people on the line are thinking like industrial engineers," says Carnegie Mellon's Florida.
That's certainly true at General Electric Co. After spending a bundle on technology in the 1980s, some GE managers now believe that redesigning work is the real long-term solution to productivity problems. "We've taken automation out of factories," says Gary Reiner, GE's vice-president for business development. "We have found that in many cases technology impedes productivity."
Instead, GE's big breakthrough has been giving workers flexibility and unprecedented authority to decide how to do their work. "All of the good ideas--all of them--come from the hourly workers," says Reiner. At GE Power Systems, a $6.8 billion unit that makes generating equipment, changes in production methods cut inventory carrying charges by $90 million to $100 million a year.
Perhaps the biggest opportunity for reengineering is where the old approach to information technology has been most disappointing--in financial-services companies. The big banks and insurers were notorious in the 1980s for plugging in more and more number-crunching power every year and trading up to every new gizmo out of Silicon Valley. But, pressed by losses in real estate and other problems, insurers are giving up their hidebound ways.
Aetna Life & Casualty Co., for example, has completely overhauled the process of issuing a policy. A year ago, Aetna had 22 business centers, with a staff of 3,000. It took about 15 days to get a basic policy out of the office, in part because 60 different employees had to handle the application. Now, the operation has been pared down to 700 employees in four centers--and customers get their policies within five days. How? Because a single rep sitting at a PC tied to a network can perform all the steps necessary--calling into an actuarial data base, for example--to process an application immediately. When all the relevant information is gathered, the policy is passed along the network to headquarters in Hartford, where it's printed and mailed within a day.
MORE WITH LESS. The technology has also given Aetna's sales force more autonomy. The old hierarchy of supervisors and agents has been replaced by work teams of about 17 people. At Aetna's Tampa office, the new system for issuing policies will save $40 million and improve productivity by 25% this year, according to Bob Roberts, who heads the office. Adds Aetna Chairman Ronald E. Compton: "Reengineering helps us solve that modern business dilemma--how to do more with less, and do it better."
That's what banks must do, as well. The first step toward automation was, of course, the now-ubiquitous automated teller machine. More recently, banks have boosted their bottom lines by simply farming out costly information-processing jobs, such as check processing. Today, about half of the nation's check processing--once the mainstay of the bank back office--has been farmed out to more efficient specialty firms, such as Electronic Data Systems Corp. and Perot Systems.
Now, banks are using technology to make their front-office workers far more efficient. At Cleveland's Society National Bank, for example, routine customer-service work has been automated so that 70% of phone calls are handled through a voice-mail system. That frees customer-service reps to help depositors who really need a human's assistance. And laptops have liberated loan officers from their desks. "If you call us and say you want to refinance," says Executive Vice-President Allen Gula Jr., "we'll meet you in your parking lot at lunch."
But the real challenge for financial institutions will be to get rid of the millions of tons of paper--from checks to loan applications--that soak up millions of employee hours and add billions of dollars to costs. One possible solution is image processing. Some big insurers already use these setups to move digital pictures of documents through their offices at the speed of electrons, rather than at the speed of the guy from the mail room. In addition, many workers can look at a document simultaneously.
INERTIA. Fannie Mae hopes to sharply cut costs of mortgage applications by banishing paper. It's linking 3,000 lenders by computer and developing software that will cut processing time by putting the whole operation on computer networks. Today the average cost of processing a new loan is $5,337, or 4.5% of the loan amount. But the most efficient lenders can do the job for half that. Their secret: slashing paperwork. "The technology exists," says Raines. "It's a matter of overcoming the inertia."
Perhaps nowhere in the service sector has information technology had more of an impact than in retailing. In the 1980s, Wal-Mart Stores Inc. leaped to No.1 in the U.S. retail business by keeping its prices low, its stores better stocked, and its inventories tight. Its not-so-secret weapon was technology--including satellite networks linking each point-of-sale terminal to distribution centers and headquarters in Bentonville, Ark. By tracking every sale to see what's selling and what's sitting, Wal-Mart avoids costly markdowns to inventory.
Now, scores of retailers are following in Wal-Mart's footsteps--because they must. At Detroit-based Frank's Nursery & Crafts, managers can use wireless handheld scanners to check inventory on the store shelves. It can even add stock in stores where the weekend weather forecast is good. Pressure is coming from manufacturers as well. To make its retailers more efficient, Levi Strauss & Co. created its own inventory tracking system. According to Paul Benchener, Director of Global Quick Response, the results have been handsome. About half of Levi's 100 biggest accounts use the system and, for them, sales shot up 24% last year. At the other big stores, sales rose a paltry 3.6%.
The future? Ask John W. Fitzgerald, vice-president of information services at McKesson Corp., the nation's largest distributor of pharmacy and health and beauty-aid products. McKesson has been using computerized inventory systems for more than a decade. And Fitzgerald thinks he already sees the next wave of productivity-enhancing change: systems that tightly link customers, retailers, distributors, and manufacturers. Instant response means less money spent on interest charges, idle plants, and inventory buildups. The paper invoice will go the way of the quill pen. "We're going to have a seamless network. It will be transparent to everybody, and all without paper."
These information systems are now snowballing as more and more suppliers and vendors get on the networks. Strawbridge & Clothier, a Philadelphia retailer, has been getting rid of ven-dors that are not hooked into its point-of-sale systems. "They couldn't compete," says Corporate Vice-President Thomas S. Rittenhouse.
The new links even hold out the promise of revival for U.S. clothing manufacturers. Apparel makers took a terrible beating in the 1980s from low-cost Asian producers. Jobs dried up, factories closed. But reorganizing around the new networks has brought the industry fresh hope. Levi's, for example, is replacing its 19th-century piecework system with new, team-based production. The objective is to start building the clothing that has actually been ordered instead of piling up sleeves and pants legs for garments that might never be needed.
At the same time, Levi's is planning to upgrade its national distribution system. Retailers, says Levi's Benchener, "started demanding more efficiency. They said: 'We can get orders to you more efficiently and accurately. So where's the product?'"
For such improvements to really permeate the all-important service sector, hundreds more companies will have to get on board. Many will first have to undo what they did in the 1980s, says Steven Walleck, a director at McKinsey & Co. "The people who were throwing capital at the issue of labor productivity got the cart before the horse," he says. And now, "a lot of wreck-and-rebuild is required."
Before it's over, we may not recognize the workplace. Technology is turning sales reps into designers and production workers into engineers. It is wiping out whole layers of managers and emptying warehouses. Says Ford Motor Co. engineer Peter R. Sferro: "We won't need draftsmen, designers, purchasing agents, or even mold makers."
That will mean big changes for workers. Those who survive the downsizing, says Bergstein of Technology Solutions, "will have more tasks, more responsibility, and more information to work with." They should earn more money as well. According to Princeton University economist Alan B. Krueger, workers who use computers earn an average of 10% to 15% more than those who don't, even for the same job. Secretaries who use computers, for instance, enjoy a premium of up to 30%. And, says Krueger, the differential has held up despite a big increase in the number of workers with computer skills.
And those who don't get those upgraded new jobs? One possibility is that they'll decline into an expanding underclass. But that, too, may be a short-term phenomenon. Technology may actually close the gap between the techno-workers and the less skilled. New graphical programs, such as software written for Microsoft Corp.'s Windows, are making computers more accessible to millions of workers.
Where will the work come from? "Farmers asked the same question in the 1800s, and sweatshop workers asked it in the early part of this century," says Morgan Stanley's Roach. "In each of those times, the system was flexible enough to come up with new job-creating solutions." After all, a decade ago, Microsoft employed 300 people. Today, the number is 15,000.
THE KEY. Major technological changes have always meant enormous upheaval for both economies and societies. But the U.S. will surely be far better off with technology-driven productivity gains than without them. Improved productivity is still the only way we know to boost a nation's standard of living. And U.S. productivity gains, in turn, can come only from technology and the workplace changes it spawns. "It's absolutely unambiguous," says Columbia University economist Frank R. Lichtenberg. "Productivity gains are crucial for our long-term economic well-being."
That's especially true in an era of intense international competition. If U.S. companies don't take advantage mf technological and management innovation, their foreign competitors will. The same reengineering wave that is transforming American business is building in Europe (page 61) and could someday spread to Japan.
More than macroeconomic policy, international trade agreements, and even access to natural resources, the ability to harness extraordinary technological change will define economic winners and losers in the foreseeable future. And it appears that, after a decade of trying, American business may finally have the key to the new industrial revolution.Howard Gleckman in Washington, with John Carey in Washington, Russelll Mitchell in San Francisco, Tim Smart in New Haven, Chris Roush in Tampa, and bureau reports