An Economic Model of Product Quality and IT Value

We use an economic model to formalize the complex relationships among IT investments, intermediate performance measures (e.g., product quality and output levels), and economic performance (e.g., productivity, profits, and consumer surplus). We demonstrate that a profit-maximizing monopolist invests in IT (modeled as changes in parametric characteristics of the firm) to design a better-quality product and charge a higher price. While this profit-maximizing adjustment generates more consumer surplus, it also increases production costs in a way that adversely affects productivity. In contrast, a simple model extension shows that when a firm is unwilling or unable to improve product quality, then IT investments result in suboptimal improvements in profits, an increase in consumer surplus, and an increase in productivity. Together, these models highlight the way in which product quality moderates the relationship between IT investments and economic performance. We also demonstrate that these relationships are robust to the socially optimal case in which a social planner chooses price and quality to maximize social welfare. In addition, we demonstrate that the results of the monopoly model hold when considering the design and development of products offered free of charge (e.g., free online content), but that provide indirect benefits to the firm (e.g., more advertising revenues).