The Strategic Value of Information Technology in Setting Productive Capacity

Capacity is the maximum short-run output with capital in place under normal operations, and capital investment increases capacity. Excess capacity can be used as an economic strategy for entry deterrence by lowering average costs over a greater range of output, and as an operations strategy by providing value through flexibility to manage demand fluctuations and production disturbances. Our primary focus is to study the way that information technology (IT) can contribute to a strategy of holding excess capacity by comparing the relationship between IT capital and capacity with that of non-IT capital and capacity. Using production theory–based empirical analyses, we find that increases in IT capital yield almost fourfold greater expansion in capacity than do increases in non-IT capital. Thus, as both types of capital are constraints on capacity, for a strategy of holding excess capacity IT capital is a more valuable constraint to relax than non-IT capital. In addition, since the late 1990s, IT capital, and to a lesser extent, non-IT capital, has reduced capacity utilization (output/capacity), meaning increasing levels of excess capacity are being held across manufacturing industries and utilities across the economy.