Since 1995, productivity growth in the U.S. has doubled from its sluggish pace over the previous two decades, in part because of heavy investments in Internet gear and other information-technology equipment. It has been especially strong in industries that embraced the Internet with gusto, such as manufacturing, retailing, and financial services. But can information technology keep contributing to productivity growth? After all, the Net bubble has long since splattered, and corporate technology investment has tumbled from its peak.
The tech productivity boom may have stronger legs than most people think. A BusinessWeek analysis suggests that cost savings from IT investments in six industries alone could hit more than $140 billion a year by 2007 -- on top of the savings achieved from the rapid productivity gains between 1995 and 2002.
Four big reasons for tech's resilience stand out. First, industries that have lagged in productivity growth, such as government and health care, are slowly starting to get serious about tech investments. Second, retailers are slowly rolling out an industrywide project to standardize and maintain e-catalogs of the products they sell, setting the stage for a decade-long surge that ultimately could save store chains and consumer-goods manufacturers $50 billion a year.
More important, there is far more productivity stimulus still coming from the boom than most realize. When companies buy technology, productivity doesn't jump right away. It takes time to remake strategies and business processes to take advantage of the new hardware and software. A recent study by Massachusetts Institute of Technology economist Erik Brynjolfsson and University of Pennsylvania's Lorin M. Hitt says the biggest gains come five to seven years later. If true, last year's 4.8% productivity surge traces to investments made in 1997 or before. And that would mean big gains from the late-'90s technology spendathon are still coming. "There's a big learning curve," says James Q. Crowe, CEO of Level 3 Communications (LVLT ) Inc., a telecom upstart. "We're still working with investments we made years ago."
The other big reason productivity will stay strong is, paradoxically, the weak economy. Because the recovery has been so sluggish, retailers, manufacturers, travel companies, and finance firms still face overcapacity. To survive, companies have to keep wringing productivity gains out of tech gear they own now and resume at least modest spending by next year. "They have to do it, or they're dead," says Standard & Poor's economist David A. Wyss.
For consumers, the best place to look for tech-related productivity this decade will be the supermarket. More efficient food stores will drive costs savings in the retail industry that could hit $25 billion by 2007. The largest single slice of that, as much as $10 billion, will come from an industrywide effort to coordinate data sharing among stores and suppliers of consumer packaged goods. The project, dubbed UCCnet because it's being coordinated by the Uniform Code Council trade group, will maintain manufacturers' product catalogs and distribute them to retailers.
Bad data in supermarkets have been a huge problem for consumers and companies alike. Stores order products they don't really need, manufacturers ship the wrong sizes, and both sides need to hire staffers to sort everything out. Simon Bell, an A.T. Kearney Inc. consultant who studied the issue for the Grocery Manufacturers of America, thinks stores and manufacturers each lose up to $2 million in profits on every $1 billion of sales because of bad data. "We have billions of dollars in waste," says Bill Grize, CEO of Ahold USA (AHO ) which owns such supermarket chains as Giant and Stop & Shop.
While much depends on how fast UCCnet is implemented, Bell says the project could mean $10 billion in annual cost savings by 2007. The other $10 billion to $15 billion in savings should come from smaller projects driven by retailers' tech spending. Home Depot (HD ) Inc., for example, plans to spend $360 million this year on cost-saving initiatives, including more self-service checkouts. It also plans to implement online learning, which will let experts train staff around the country on, say, a new power drill, using Web-linked kiosks instead of visiting each store.
Like retailing, high-tech manufacturing had a late-'90s productivity surge that should keep going. Most of the tech giants who led manufacturing to 4.3% annual productivity growth between 1995 and 2002 say they can increase productivity just as fast this decade. Intel Corp. is one example. New forecasting software will let the company react more quickly to changes in demand, reducing the time it takes to shift chip production lines from a month to as little as two days. Just one such nimble maneuver can save Intel $1 billion, says Chief Financial Officer Andy D. Bryant. With that and several other projects, Bryant thinks the chipmaker can boost productivity by 10% a year.
The productivity outlook gets much brighter if health care and government perk up -- and the chances are pretty good. Economy.com Inc. says federal government productivity will rise 1.7% a year through 2007, compared with only 0.9% from 1992 to 2002, because of increased spending on IT and more aggressive outsourcing. If tech drives half of that acceleration, government would save an extra $1 billion the first year, topping $5 billion a year by 2007. That's a big gain compared with the $260 billion economic output of federal workers.
One reason that estimate is reasonable: a new strategy released in April by the Office of Management & Budget. Its centerpiece is 24 big tech projects, nearly all to be completed by late next year. Among the largest: a consolidation of 22 payroll-processing centers into just two, which will save an estimated $1.2 billion over 10 years, and online tax filing, which saves the Internal Revenue Service about $1 per return. By 2007, the IRS is set to accept more than 100 million e-returns, up from 40 million in 2002. That's $60 million in fresh cost savings annually.
Although health care will continue to lag behind in IT-related productivity growth because hospitals and doctors spend relatively little on technology, there are positive signs. Web technologies are making it easier to knit disparate computer systems. And high-tech hospital systems such as the University of Pittsburgh Medical Center are leading by example: By switching to electronic health records, the emergency room of one of its hospitals is handling 40% more volume over the past 18 months with no staff increase. Add it up, and Economy.com says health-services productivity will grow nearly 1% a year after shrinking 1% a year for the past decade.
To be sure, not every industry will get a big boost. Productivity in education will barely rise in the next five years. Most schooling demands personal interaction, and the most rigorous studies show no gains from computer-aided teaching. Harvard Business School Professor Clayton M. Christensen says the Web will find a niche letting small districts offer low-enrollment courses such as Russian or advanced-placement physics. But its biggest education impact will be in corporate training and university-level distance learning.
Despite the hand-wringing over the bursting of the Net bubble, information technology continues to contribute to productivity growth. And the efforts under way in several U.S. industries suggest that how far technology takes the economy may be limited only by the imagination.
By Timothy J. Mullaney and Peter Coy