Effect of Information Technology Investments on Customer Satisfaction: Theory and Evidence

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Product Number 200500971
Released 6/15/2005
From the Department of
Business Information Technology
WORKING PAPER SERIES
> Effect of Information Technology
Investments on Customer Satisfaction:
Theory and Evidence
by
Sunil Mithas
PhD - Business Information Technology
M.S. Krishnan
Michael R. and Mary Kay Hallman Fellow & Professor of Business
Information Technology
Claes Fornell
This research addresses the following questions:
Donald C. Cook Professor of Business Administration, Professor of
Do information technology (IT) investments have
Marketing, & Director of National Quality Research Center
an effect on customer satisfaction? What are the
causal mechanisms that mediate the effect of IT
systems on customer satisfaction? Does the effect
of IT on customer satisfaction differ across
industry sectors? Based on an analysis of
longitudinal data on 50 U.S. firms for the period
1994-2000, we document the association between
IT investments and customer satisfaction. We find
support for the hypotheses that the effect of IT
investments on customer satisfaction is mediated
through the effect of IT on perceived quality and
perceived value. Our results also indicate that the
effect of IT investments on customer satisfaction
differs between the manufacturing and service
sectors. While prior work on the business value of
IT at the firm level focused on financial and
accounting measures, our research establishes
the effect of IT investments on overall customer
satisfaction of a firm. We propose and validate a
theory of mediation effects of perceived quality
and perceived value. This proposal has the
potential to synthesize information systems
effectiveness and marketing literature towards an
integrative understanding of the relationship
between IT investments and customer satisfaction.
L E A D I N G I N T H O U G H T A N D A C T I O N

15 June 2005
Effect of Information Technology Investments on Customer Satisfaction: Theory and
Evidence

Sunil Mithas ([email protected])
Ross School of Business
University of Michigan
701 Tappan Street
Ann Arbor, MI 48109-1234
Phone: 734-763-8290
Fax: 734-936-0279

M. S. Krishnan ([email protected])
Professor and Area Chair
Michael R. and Mary Kay Hallman e-Business Fellow
Ross School of Business
University of Michigan
701 Tappan Street
Ann Arbor, MI 48109-1234
Phone: 734-763-6749
Fax: 734-936-0279

Claes Fornell ([email protected])
Donald C. Cook Professor of Business Administration
Director of the National Quality Research Center
Ross School of Business
University of Michigan
701 Tappan Street
Ann Arbor, MI 48109
Phone: 734-763-5937
Fax: 734-647-2343

Please do not cite, quote, or distribute without permission of the authors.


Acknowledgements: We thank the Department Editor, Associate Editor, and two anonymous referees of
Management Science for their help in improving this manuscript. We also thank seminar participants at the
Workshop on Information Systems Economics (WISE) 2002, WISE 2003, International Conference on
Information Systems (ICIS) 2004 Doctoral Consortium, University of Maryland at College Park,
University of Southern California, Purdue University, Penn State University, Rensselaer Polytechnic
Institute, University of Tulsa, California State University at San Marcos, Indian School of Business,
Michigan State University Eli Broad College of Business, and the University of Michigan Ross School of
Business for their comments. We acknowledge helpful suggestions and comments from Chris Achen, Ritu
Agarwal, Rajiv Dewan, Omar El-Sawy, Alok Gupta, Il-Horn Hahn, Hank Lucas, Tridas Mukhopadhyay, V.
Sambamurthy, Amit Seru, Ramanath Subramanyam, Arun Sundarrajan, Phil Yetton, Bin Wang, and
Jonathan Whitaker to improve this manuscript. We are grateful to InformationWeek and the National
Quality Research Center at the University of Michigan for providing the data for this research. We also
thank Stefan Dragolov and Eli Dragolov for their excellent research assistance. Financial support for this
study was provided in part by the Michael R. and Mary Kay Hallman fellowship at the University of
Michigan Ross School of Business.

Effect of IT Investments on Customer Satisfaction
Effect of Information Technology Investments on Customer Satisfaction: Theory
and Evidence


Abstract
This research addresses the following questions: Do information technology (IT)
investments have an effect on customer satisfaction? What are the causal mechanisms
that mediate the effect of IT systems on customer satisfaction? Does the effect of IT on
customer satisfaction differ across industry sectors? Based on an analysis of longitudinal
data on 50 U.S. firms for the period 1994-2000, we document the association between IT
investments and customer satisfaction. We find support for the hypotheses that the effect
of IT investments on customer satisfaction is mediated through the effect of IT on
perceived quality and perceived value. Our results also indicate that the effect of IT
investments on customer satisfaction differs between the manufacturing and service
sectors. While prior work on the business value of IT at the firm level focused on
financial and accounting measures, our research establishes the effect of IT investments
on overall customer satisfaction of a firm. We propose and validate a theory of mediation
effects of perceived quality and perceived value. This proposal has the potential to
synthesize information systems effectiveness and marketing literature towards an
integrative understanding of the relationship between IT investments and customer
satisfaction.

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Effect of IT Investments on Customer Satisfaction
1.0 INTRODUCTION
Customer relationships have emerged as a critical asset for firms, because the
locus of power across industries and businesses is increasingly shifting towards
customers. Firms are moving from a product-centric model to a customer-centric model
to sense and meet customer demands for changes in the features of products and services,
distribution channels, and pricing structure (Financial Times 2002; Nambisan 2002;
Prahalad and Ramaswamy 2004; Seybold, Marshak and Lewis 2001). Customer
satisfaction and customer retention have emerged as key metrics for measuring the
effectiveness of IT systems and the competitive success of firms (Agarwal and Venkatesh
2002; Anderson, Fornell and Mazvancheryl 2004; Chen and Hitt 2002; Fornell and
Wernerfelt 1988; Kambil et al. 2000). Research shows that higher levels of customer
satisfaction have the potential to double or triple firm profits (Reichheld and Sasser 1990;
Rose 1990).
To improve their customer satisfaction, firms are making greater use of IT tools in
their internal and customer facing business processes (El Sawy and Bowles 1997;
Srinivasan, Lilien and Rangaswamy 2002). Managers consistently rank “improvement in
customer satisfaction” as one of the prime motivations for making IT investments.
Significant investments in IT applications in recent years indicate the industry belief that
IT applications can streamline both internal and customer-interfacing business processes
(Chopra and Meindl 2003; Karimi, Somers and Gupta 2001; Romano and Fjermestad
2001). Since customer satisfaction is a leading indicator of firm performance (Ittner and
Larcker 1998), it is important to understand the role of IT investments in enhancing
customer satisfaction.

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Effect of IT Investments on Customer Satisfaction
Much of the empirical research in business value of information systems focuses
on the effect of IT expenditures on tangible measures of firm performance such as
productivity or market value (Bharadwaj, Bharadwaj and Konsynski 1999; Brynjolfsson
1993; Brynjolfsson and Hitt 1996). Researchers are increasingly calling for the discovery
of the effect of IT investments on intangible measures of firm performance, such as
greater responsiveness to customers, more variety, and overall customer experience,
which are reflected in customer satisfaction (Bharadwaj, Bharadwaj and Konsynski 1999;
Brynjolfsson 1993; Brynjolfsson and Hitt 1996). Our study seeks to understand the effect
of investments in IT systems on customer satisfaction by answering two primary research
questions: (1) What is the effect of IT investments on customer satisfaction?, and (2)
What are the causal mechanisms that mediate the effect of IT systems on customer
satisfaction? We develop and validate our theoretical models using archival data on IT
investments and customer satisfaction collected by reputable third-party organizations.
The remainder of the paper is structured as follows. Section 2 describes the
theoretical framework and research hypotheses, and section 3 describes the research
design and empirical models. We present the results in section 4, and discuss our results
and provide concluding remarks in section 5.
2.0 THEORY AND HYPOTHESES
Our goal in this study is to understand the effect of IT investments on customer
satisfaction. In this section, we briefly review relevant prior literature on the business
value of IT investments. This is followed by the theory underlying our hypotheses
linking IT investments to customer satisfaction.

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Effect of IT Investments on Customer Satisfaction
2.1 Prior Literature
The subject of business value from IT investments continues to attract significant
interest in the business press and academic literature (Kohli and Devaraj 2003; The
Economist 2002). Beginning with in-depth studies of specific IT applications at the firm
level (Banker, Kauffman and Morey 1990; Banker and Kauffman 1991; Lucas 1975), this
stream of literature now encompasses large sample empirical studies linking IT
investments with outcome measures at the economy, firm, and process levels (for recent
reviews of this literature, see Barua and Mukhopadhyay 2000; Dedrick, Gurbaxani and
Kraemer 2003).
While previous research has provided valuable insights into the relationship
between IT investments and business value, with the notable exception of Devaraj and
Kohli’s (2000) work in the health sector, very few studies have accounted for the
customer perspective of the value gained from IT investments. Focusing on customer
satisfaction is particularly relevant because customer relationships have emerged as a
critical asset for firms, and customer satisfaction is positively associated with the market
value of firms (Anderson, Fornell and Mazvancheryl 2004; Ittner and Larcker 1998).
The quantification of intangible improvements in product quality, variety or consumption
experience through a customer satisfaction index at the firm level complements the
productivity-based measurement of economic growth (Waters 2004). Although
information systems researchers have studied the effect of IT investments on consumer
surplus and consumer welfare at the economy level (Brynjolfsson 1996; Hitt and
Brynjolfsson 1996), to our knowledge there is no empirical study that links IT
investments to customer satisfaction at the firm level across sectors.

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Effect of IT Investments on Customer Satisfaction
2.2 Relating IT Investments to Customer Satisfaction
Customer satisfaction is an important measure of firm performance because of its
positive influence on customer loyalty (Anderson, Fornell and Rust 1997; Fornell 1992;
Fornell 2001). Previous research has documented that increased customer loyalty
secures future revenues, reduces the cost of future transactions, decreases price elasticity,
and minimizes the likelihood of customer defection in the event of poor quality
(Anderson 1996; Anderson and Sullivan 1993; Reichheld and Sasser 1990; Rust and
Keiningham 1994). Customer satisfaction may also reduce costs related to warranties,
complaints, defective goods, and field service costs (Anderson, Fornell and Lehmann
1994; Fornell 1992; Garvin 1988). Empirical evidence also suggests that customer
perceptions of superior quality are associated with higher economic returns (Aaker and
Jacobson 1994; Capon, Farley and Hoenig 1990; Fornell 2001; Nelson 1995). Naumann
and Hoisington (2001) report positive associations between employee satisfaction,
customer satisfaction, market share, and productivity measures at IBM Rochester.
Several case-based research studies also find that customer satisfaction is positively
associated with employee loyalty, cost competitiveness, profitable performance and long-
term growth (Heskett, Sasser and Schlesinger 1997; Reichheld and Teal 1996). In a
recent study of the relationship between customer satisfaction and shareholder return,
Anderson, Fornell and Mazvancheryl (2004) find a strong relationship between customer
satisfaction and Tobin’s Q (as a measure of shareholder value) after controlling for fixed,
random and unobservable factors. Finally, Fornell et al. (2005) show that firms with
higher customer satisfaction provide higher stock returns with less risk.

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Effect of IT Investments on Customer Satisfaction
IT systems play an important role in enabling a firm’s customer management
capability. Ives and Learmonth (1984) were among the first researchers to recognize the
role of information systems, and proposed a customer resource lifecycle (CRLC) model
depicting how firms can deploy information technology tools to support different stages
of their customers’ purchasing process. They were soon followed by Porter and Millar
(1985) who articulated the various roles that IT can play in the value chain of a firm to
serve its customers better. More recently, in a conceptual paper, Sambamurthy,
Bharadwaj and Grover (2003) provided a theoretical framework to understand the effect
of IT infrastructure capabilities on the ability of firms to better manage customer
knowledge. Their theory is based on the argument that deployment of the right IT
systems may enable agile processes in the customer interface with firms, and thereby help
in proactively managing customer information. Nambisan (2002b) presents a theoretical
argument for the positive effect of an IT-enabled virtual customer environment on the
effectiveness of new product development.
Among empirical studies, Rathnam, Whinston and Mahajan (1995) show how IT
improves coordination among customer support teams. Similarly, Karimi, Somers and
Gupta (2001) report that firms with better IT planning and integration are more effective
at managing IT to improve customer service and thus at managing customer
relationships. The role of IT in affecting customer satisfaction has attracted the attention
of marketing researchers. In several studies, these researchers have acknowledged the
potential impact of IT on the customer satisfaction performance of firms and have
pointed to the need to study the relationship between IT investments and customer

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Effect of IT Investments on Customer Satisfaction
satisfaction (Anderson, Fornell and Rust 1997; Bitner, Brown and Meuter 2000;
Parasuraman 1996; Parasuraman and Grewal 2000). Thus,
H1a: IT investments are positively associated with higher levels of customer satisfaction.
2.3 Mediating Mechanisms of Perceived Quality and Perceived Value
Linking IT investments with customer satisfaction requires an understanding of
the antecedents of customer satisfaction at the firm level. Previous research points to
several theoretical constructs as determinants of customer satisfaction at the firm level:
perceived quality, perceived value and customer expectations (Anderson, Fornell and
Rust 1997; Fornell 2001; Fornell et al. 1996). Perceived quality, which captures recent
consumption experience, has two components: (a) customization, i.e. the degree to which
the firm’s offering is customized to meet heterogeneous customer needs, and (b)
reliability, i.e. the degree to which a product or service is standardized and free from
deficiencies. Perceived value refers to the perceived level of product quality vis-à-vis the
price paid. Finally, customer expectations refer to customer perspectives on prior
consumption experiences as well as customer beliefs in the firm’s ability to deliver
quality in the future. Empirical studies on the relative importance of these three
determinants of customer satisfaction show that perceived quality has a significantly
greater effect on customer satisfaction than does perceived value (Anderson and Sullivan
1993; Fornell et al. 1996), and that customer expectations do not play a major role in
affecting customer satisfaction. Hence, this study focuses on understanding how IT
influences the perceived quality and perceived value of a firm’s offerings.
To establish that perceived quality and perceived value are two mediating
mechanisms that explain the association between IT investments and customer

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Effect of IT Investments on Customer Satisfaction
satisfaction, we first understand how IT investments affect perceived quality and
perceived value. Then we relate perceived quality and perceived value with customer
satisfaction.
2.3.1 Effect of IT Investments on Perceived Quality and Perceived Value
We posit that IT applications have the potential to enable firms to influence the
perceived quality and perceived value of goods and services leading to an increase in
customer satisfaction. For example, IT can enable both the determinants of perceived
quality (customization and consistency of consumption experience) by capturing
customer information and using such customer information to customize a firm’s
offerings and by providing a seamless service experience to customers. Bharadwaj,
Bharadwaj and Konsynski (1999) have noted the importance of IT-enabled customization
and improved customer service in creating intangible value for firms. In addition, by
facilitating the seamless flow of information in an organization, IT enables business
process transparency and efficient allocation of resources, shorter response times and
improved quality. This in turn leads to improvement not only in the quality of the core
products or services offered by a firm, but also in the quality of after sales support
provided to customers. Further, IT also facilitates business process innovation by
redefining and redirecting business relationships and core processes through new
channels leading to significant improvements in total customer experience (Armstrong
and Sambamurthy 1999). These outcomes may enhance the perceived quality of a firm’s
customer service, with a favorable impact on customer satisfaction. Thus,
H1b: IT investments are positively associated with higher levels of perceived quality.

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Document Outline

  • 2.1 Prior Literature