Executive Thought Leadership

Net Impact Study

The Net Impact study , sponsored by Cisco Systems and a product of researchers Hal Varian of the University of California-Berkeley, Robert E. Litan of The Brookings Institution and Momentum Research Group, was designed to be the first to measure the current and anticipated cost savings and revenue increases that organizations believe have been created by their investment in Internet business solutions.

iQ: What are the findings of the Net Impact study and what are the implications for the U.S. economy?

Litan: Productivity growth is the best measure of the long-term performance of the economy. For the five years between 1995 and 2000, productivity growth increased at an annual rate of roughly two-and-a-half percent, which was a full percentage point higher than the rate of increase for the preceding 20 years.

There is a growing body of evidence that information technology was a major factor in helping to generate this productivity acceleration. The Net Impact study attempts to gauge the impact that can be attributed specifically to the Internet. The study looks back over the five years between 1996 and 2000, and forecasts the projected impact the Internet is likely to have on productivity growth over the next 10 years. The short answer is that the impact is significant.

Even though use of the Internet in business-to-consumer transactions was relatively limited in the late 1990s, our study found that substantial Internet usage occurred at the business-to-business level, and within firms themselves, with applications that we call “Internet business solutions.” These Internet business applications hold the greatest promise for increasing productivity. We estimate that from 1996 to 2000, the Internet contributed as much as .17 percent annually to productivity growth—a rather substantial figure, considering that the overall acceleration of productivity growth during that period was roughly 1 percent.

Looking ahead, the Net Impact study findings project that over the next several years the Internet could contribute as much as .43 percent to annual productivity growth.

iQ: How does this study differ from others that have looked at the impact of the Internet on the economy?

Litan: It's very difficult to estimate the impact of the Internet because it's so new. As a result, you don't see a lot of conventional economic analysis, which relies heavily on the analysis of data collected over a period of years.

We don't have those years of data in the case of the Internet, so there aren't many studies of the Internet. In my prior work with Alice Rivlin, also of Brookings, and several other academic scholars from universities around the country, we made an educated guess that the Internet would contribute from one-quarter to one-half percent annually to future productivity growth. But we made this estimate using expert analysis from the 1999-2000 period, which already seems dated, and it was based on judgments about entire sectors rather than on the experience of individual firms.

The Net Impact study differs from the previous study in which I participated in its breadth and scope. Working with the assistance of Momentum Research, we surveyed some 2,000 US firms about their current and projected future use of the Internet. The survey evidence is based on responses during the September-November 2001 time frame and thus provides the most up-to-date results about the impact of the Internet. We also were able to gather data from about 600 European firms, and thus could make projections about the likely impact of the Internet in Europe, something that we were not able to do in the prior Brookings study.

To our knowledge, the Net Impact study is by far the most extensive and comprehensive survey ever undertaken of the Internet's past and likely its future impact. At least for the foreseeable future, it should be the gold standard, the benchmark against which other studies will be compared.

A recent study by McKinsey is the one other significant study of the Internet. McKinsey’s research examines the reasons for productivity acceleration in different sectors of the U.S. economy. The McKinsey researchers found that while information technology was an important contributing factor, many other changes in managerial techniques led to productivity improvements as well.

The McKinsey study marks an important contribution to the research about the Internet. But we do not believe it sends a significantly different message than the one that emerges from the Net Impact study. McKinsey also found IT generally, and the Internet specifically, to be important factors behind recent productivity growth. In the Net Impact study, we were able to go further, however, in projecting the likely impact of the Net in the future. The Net Impact study also takes advantage of extensive survey evidence that is the most up-to-date that is available.

iQ: The U.S. Congressional Budget office projects a productivity growth rate of 2.1 percent for the next 10 years, an increase of 1.1 percentage points over the productivity growth rate from 1974 to 1995. The Net Impact study findings indicate that Internet business solutions will contribute nearly half of this .9-point increase in the productivity growth rate. What other innovations have had a similarly significant impact on the economy?

Litan: First, I want to clarify that the acceleration as projected by the CBO is .9 percent relative to the previous period. Our study projects that of this acceleration in the productivity growth rate, IBS [Internet business solutions] could contribute .43 percentage points, or nearly half.

What other innovations have had this kind of impact? There have been a number of previous studies of the impact of electricity, telephone and telegraph, automobile, and so forth. But they tend to be qualitative in nature and I'm not aware of the kind of quantitative precision that we attempt to provide in our study that was actually applied in these previous studies. We really can't know whether the Internet will have a larger or smaller impact on overall productivity growth than electricity, the telegraph, the telephone, and these other major innovations. My hunch, however, is that, in the pantheon of great inventions, certainly the Internet will belong up there, and I think that five years from now (if not before) this will be widely recognized.

iQ: In your previous work with Alice Rivlin, The Economy and the Internet, What Lies Ahead?, you addressed the question of how the Internet will affect the performance of the economy and the standard of living of average Americans. What did you find?

Litan: In the long term, the rate of productivity growth in the economy is the most important determinant of the improvement of living standards. The more productive the economy is, the more output we can achieve with any given workforce. And with more productivity wages rise and people are better off.

In our previous study, we estimated that the Internet would contribute somewhere between a quarter and a half percent improvement in productivity per year. If this rate of improvement were carried out over a full decade, by 2010, on average Americans’ incomes would rise by approximately two-and-a-half to five percent per year, after adjusting for inflation.

To give a concrete illustration of the importance of that projection, 2.5 to 5 percent higher per capital incomes in 2010 translates into roughly $1250 and $2500 per year, which is a lot of money, by any standard.

The Net Impact study comes up with similar estimates. Assuming an increase due to IBS in annual productivity of .43%, by 2010 average incomes will be roughly 4.3% higher than they otherwise would be, which translates into about $2150 per person. That is an annual gain that should be realized that year and every year after, because incomes will be that much higher.

In fact, to me, one of the surprising results of the Net Impact Study is that its projections are essentially in line with the projections made earlier by the Brookings team of experts. However, because the Net Impact study is based on the results of extensive interviews of individual firms during a more recent period, there is reason to have somewhat more confidence in its results.

In short, the evidence is growing that the Internet will make the substantial improvements in productivity and that this will lead to a significant increase in average incomes for Americans in the years ahead.

iQ: What other results from the Net Impact Study surprised you?

Litan: Two results in particular. One is that a surprisingly large fraction of American businesses—over 60%—report that they are already using IBS to reduce costs or increase revenues. Going into the study, I would have thought that the percentage would have been far below that.

Second, the survey suggests that the projected rate of productivity improvement due to IBS in three major European economies—the U.K., Germany and France—is considerably lower, on the order of .1% over the next 10 years, than the .43% projected for the United States. This result appears to be because European companies have been slower to adopt IBS, and those that plan to use it project fewer benefits than their American counterparts.

iQ: Did you see any consistency in the types, or waves, of Internet business applications that corporations are rolling out?

Litan: Businesses are using IBS in many ways to reduce costs and generate more revenues. They are using the Internet to streamline inventories. They're using it for customer support. They're using it to generate more sales. They're using it to get rid of paper and invoices and reduce transactions costs.

Not all businesses are convinced of the power of IBS, however. According to our survey, roughly 40% of companies in the United States and 54% in the U.K., France, and Germany still haven’t used the Internet to improve their performance.

iQ: What is the greatest challenge facing organizations in terms of deploying Internet business solutions and realizing the projected productivity gains for the economy?

Litan: One of the most important things people should realize is that the benefits from the Internet to the economy that are measurable flow overwhelmingly from business use of the Internet, whether it's streamlining B2B commerce or transforming the internal processes within a company.

That is somewhat different than the popular perception of the Internet, which is that the average person at home uses eBay, Amazon, or some other Web site to buy retail goods. It turns out that B2C usage, which still is in its relative infancy, is not the major driving force behind productivity improvement in the economy. The major driving force continues to be business use.

Therefore, the most important challenge that faces the American economy in realizing benefits of the Internet is to how to induce more businesses to use the Internet to change the way they function. The pressure of competition certainly provides a powerful impetus for change. But so can improved education on the part of vendors of IBS services.

It should not be a hard sell. We find that, on average, firms that have adopted Internet solutions will have lower costs and generate higher revenues than firms that have not adopted the Internet. That means, over time, that the Internet-enabled firms will gain market share over firms that are still stuck in the late 20th century. The greatest challenge is for those that are behind in the race to improve their business performance through the Internet to catch up to the front runners and adopt Internet solutions as quickly as possible.

iQ: Do you see the recession inhibiting the deployment of Internet business solutions or will it be even more critical for companies to become more competitive in this type of environment?

Litan: Until the recession is over we will not be able to gauge its full impact on Internet adoption. But my suspicion is that the recession is probably encouraging faster adoption of Internet solutions than would occur otherwise. I know that's contrary to conventional wisdom, which says that firms don't spend more on IT in a downturn. They tend to spend less and, therefore, productivity enhancements associated with IT should slow down.

But with the Internet you don't need a lot of extra hardware. To Web-enable your firm, you need a change in culture. You need software and you need to change your business operations. A downturn in the overall business climate should make you even more intent on doing these things than in good times, because the only way to keep profits up in a recession is to cut costs, and what better way to cut costs than to get rid of paper, streamline inventories, and do all the things that Internet business solutions enable you to do?

So I suspect that the Internet has actually been encouraged by the recession, although we won't know for sure until after it's over.

iQ: What is your advice to managers?

Litan: Our survey suggests some very simple advice for managers. We found that roughly 60% of them already understand the power of the Internet right now and have made major investments in their net business solutions. They have changed their firms or are in the process of doing so.

The other 40% of the American economy doesn't seem to have gotten it yet, although our survey shows that some significant portion plan to change their firms in the near future.

My advice to managers is that if you don't get with Internet business solutions very quickly, you'll risk falling irrevocably behind in the competitive race.