Determining firm-level IT investments to facilitate value chain activities: Should spillovers accruing to value chain members be incorporated?

• Published in: European journal of operational research 2004-08, Vol.156 (3), p.665-682
• Main Authors: Mahajan, Jayashree, Vakharia, Asoo J
• Format: Article
• Language: English
• Subjects: Information technology; Operations research; Spillovers; Studies; Supply chains; Value chain; Value-chain/supply-chain management
• ISSN: 0377-2217; 1872-6860
• DOI: 10.1016/S0377-2217(03)00143-7

In recent years the relationship between intermediaries in a value chain has undergone significant changes in which information technology (IT) has played a critical role. Of importance is the formation of alliances between channel members and the effect of IT investments on these evolving relationships. A critical aspect of a firm's IT investment is that it not only provides gains for the investing firm, but also creates positive spillovers for value chain members. These spillovers are attributable to the fact that firm level IT investments result in the automation and/or reengineering of internal processes downstream. In this paper, we address the issue as to how a firm should determine its investment in an IT system which is primarily designed to facilitate value chain activities. Under the assumptions of perfect information in terms of potential gains for value chain members from this IT investment, and the fact that each member may need to be guaranteed some minimum gain (i.e., a reservation utility) to adopt the IT, we model the IT investment decision under two alternative strategies. The first strategy (referred to as the myopic strategy) is where the firm simply makes the IT investment decision by maximizing its own gains and ignoring those of the value chain. Under an alternative strategy (referred to as the global strategy), the firm decides to make the IT investment decision by simultaneously maximizing not only its own gains but also the gains accruing to the entire value chain. In this case, the firm could make a sub-optimum decision regarding the IT investment from its own perspective. However, under the latter strategy, the firm could also structure a simultaneous one-time charge for each value chain member which could compensate for this sub-optimum decision. After modeling both these strategies, we then proceed to characterize conditions under which each strategy is the preferred choice for the firm. Through an illustration of our framework, we show that the global strategy dominates the myopic strategy in a number of situations.