Information technology: the third wave. (November is Computer Month) (Cover Story)by Elliot, Robert K.
Information technology--child of the digital computer--is the latest force behind wealth creation. It has created a wave of changes in business practice and management.
Information technology (IT) is changing everything. It represents a new, post-industrial model of wealth creation that is replacing the industrial model and is profoundly changing the way business is done. Because of these changes in business, the decisions that management must make are very different from former decisions.
IT IS THE DRIVER
Alvin Toffler's image of the "third wave" is a good model for considering economic changes. He notes, in his book The Third Wave, that until about 8000 B.C., the dominant mode of life was foraging, fishing, hunting, and herding. You caught what you ate and you ate what you caught. But, about 10,000 years ago, agriculture was developed, and became the first major new wealth-creating technology. Agriculture had momentous implications for civilization, as formerly nomadic people became bound to the land they were cultivating. This led to requirements for defense, government, and laws. It is our first example of enormous social and economic changes flowing from the introduction of a new technology.
The agricultural model of wealth creation was dominant for about 10 millennia, until the second great wave of new technology occurred -- industry -- exploiting the discovery that energy could be harnessed to amplify human labor in the factory. Far more raw material could be converted to finished goods than with manual labor alone. Industrialization also had huge implications for civilization, as the cities, where the factories were located, became more densely populated, and marketplaces developed for the exchange of increasingly specialized products. This is our second example of profound social and economic changes flowing from the introduction of a new technology.
The industrial model was dominant for a much shorter time, until it began to be replaced by the third great wave of change -- the information revolution. This can be dated to the 1950's, with the invention of the transistor and the installation of the first commercial computer (although the first computers used vacuum tubes, the happy marriage of computing and semi-conductors was prompt). In the third wave, the engine that drives the system is not physical labor, as it is in agriculture; not machines, as it is in industry; but information. As with prior waves of technological change, we can expect important social and economic changes, and we can already see the dim outlines. These include the increase in economic power of those countries that can make the most effective use of knowledge-workers. They also include accelerating the demise of the socialist economies, which could only hang on during the relatively slower rates of change in the industrial era. The information age demands the rapid adaptation that a free market thrives on, and the socialist systems were too phlegmatic -- governmentally and managerially -- to adapt.
These three great waves of change have characteristic technologies in several dimensions.
There are characteristic information technologies for each wave. The IT for the first wave was writing, which was developed to keep accounting records. (If you sent a camel-load of spices to Damascus, you had to have some way of knowing that the camel driver was not misappropriating the cargo, so you needed a bill of lading, etc.)
The IT underlying the second wave was movable-type printing, which was developed by Gutenberg around 1450, although the onset of the industrial age did not occur for several centuries thereafter. The development of movable type was a necessary (although not sufficient) condition for the industrial revolution. For the first time, knowledge could come out of the monastic libraries, where it had been locked up in unique, handwritten books. With the invention of moveable type, books could be mass produced. Thus, information could be widely diffused, permitting the development of modern science and technology.
The IT for the third wave is the digital computer, making possible fast, inexpensive information storage and processing. When harnessed to its full potential (that is, in conjunction with the associated software, data bases, and telecommunications), the digital computer permits vast leveraging of knowledge-work.
Just because we are in a post-industrial economy doesn't mean that we can forget the first two waves. People still like to eat (the agricultural wave), and they still like to drive around in automobiles (the industrial wave). But the current distribution of the U.S. workforce leaves only two percent of the people growing food and ten percent actually making things in factories. Already over sixty percent of the workforce is on the third curve, made up of primary and secondary information sectors. The primary information sector comprises entities that are principally concerned with the production or use of information -- for example, computer manufacturers, universities, law firms, accounting firms, publishers, and entertainment. The secondary information sector comprises those parts of non-information businesses that produce or use information, such as the engineering and marketing departments in an industrial firm. Already, modern IT is pervading every aspect of our economy and changing the way we do business.
IT CHANGES BUSINESS
Leadership businesses -- those that can grasp the business potential of IT -- use the technology to get closer to their customers. As IT condenses time and space, it literally closes the time and space gaps between customers' demands and enterprises' fulfillment. They use IT to improve quality, in fact, to achieve ever-improving quality. And they use technology to "demassify" their products, that is, provide more differentiated products or services for market segments or even individual customers.
The industrial era relied upon mass production to reduce prices. Henry Ford would sell you a Model T in the color of your choice, as long as it was black. Restricted choice is acceptable to customers only as long as there are no alternatives in the marketplace. But today, companies use IT to create a much broader array of products. In fact, computer integrated manufacturing (CIM) permits them to produce "one-off" products.
An example of demassification through IT can be seen in home entertainment. Not too long ago, you had a choice among three networks: NBC, CBS, and ABC. Today, your cable company provides 40 to 80 channels. Moreover, your VCR expands that to a virtually infinite array of programming that can be very tightly tailored to your specific interests.
Yet another feature of IT's influence is the capacity it has provided to manage an enterprise on a global scale -- to operate everywhere in a coordinated fashion.
Leadership companies use IT to create these kinds of strategic advantage. Then companies not in the leadership class wake up to find that their customers are abandoning them, leaving them with only two choices: harness IT themselves to try to catch up to the leaders or go broke. The followers embark upon a frantic quest to exploit IT -- to improve quality, decrease product and production cycle times, focus on the creation of value for the customers, go global themselves, and fill in the gap in their human and technological resources through such new business forms as partnering and alliances. They're forced to discover how to make strategic use of IT.
IT CHANGES MANAGEMENT
In this period of technological discontinuity, business managers face a set of issues different from those faced by the managers of industrial enterprises. We can contrast the management issues facing second-wave vs. third-wave enterprises.
The second-wave manager operates an enterprise with a hierarchical organizational structure. Within that structure, managers try to achieve some target rate of economic activity.
The hierarchical structure appears like an inverted tree, modeled on the structure of the Church and the military. The advantage of this structure is that a very large number of employees can be managed and controlled. For example, if each boss in a company managed six subordinates, a nine-layer organization could contain two million employees. But with the size advantage comes a disadvantage: lack of agility.
This can be seen by altering the hierarchical figure to enclose each of the main functional branches in stovepipes. These stovepipes impede the horizontal flow of information and facilitate vertical flows. A typical organization has such stovepipes as marketing, engineering, manufacturing, sales, accounting, and finance.
The stovepiped company may discern that its competitors have a better product and realize that it must adapt rapidly. So the marketing function figures out what basket of capabilities would appeal to customers. They deliver the requirements to the engineering function, which replies that the product can't be designed. So the marketers and engineers trade ideas for a while until they reach agreement on a product that would appeal to customers and can be designed. They then take it to the manufacturing function, which replies that it can't make the product. After considerable additional exchange of messages, these three agree. Next the sales force views the prospective product and asks how it can be expected to sell such a product at the price necessary to cover costs. Many more exchanges later, the finance department blows the whistle, because there's no funding available to buy the necessary manufacturing equipment. An all-too-typical result of this type of halting behavior in the stovepiped company is that American automakers require an average of six years to bring a new product idea to the showroom floor.
Managers of these hierarchical, second-wave companies at least have a relatively simple job. They receive an endowment of resources when they become managers, and they employ those resources to convert raw materials into finished goods, assuming it's a manufacturing company. Managers determined the best way to do things, using such tools as time- and-motion studies. The "best way" was then locked into the organization to make sure it would continue to do things the best way. Control systems were developed to achieve that lock-in. A scientifically managed company had an optimal rate of return and an optimal rate of activity. Such a system even has an optimal, non-zero rate of scrap.
But the management of a third-wave company is different. There is both a different organizational structure and a different set of managerial tasks.
The organization changes from the tree structure to the networked form of organization. The network is enabled by IT -- the technology of wide- area networks -- which permits the firm to have any two or more people cooperate on any specific task as required. Messages can flow unimpeded in any direction. The networked organization rapidly forms and reforms itself around a rapidly changing set of tasks.
To visualize how a networked organization operates differently, consider Digital Equipment Corporation (DEC). This company has one of the largest wide-area networks in the world, with over 80,000 employees on the network. Every second year, DEC holds the largest single-vendor trade show in the world, called DEC World. DEC budgets over $60 million and invites more than fifty thousand people to attend the show, which takes place over a two-week period. DEC designs and produces this show over the wide-area network, obviating the need for persons to be assigned to the task full-time and even the need for meetings. DEC people throughout the world participate in the design and execution of this enormous project using the medium of an "electronic conference."
When companies are able to break through the functional stovepipes, results similar to those in Figure 6 can be achieved. If Detroit takes six years to get a new car to market and market conditions change -- say, as a result of changes in oil prices or consumer preference for safety -- and Honda can get a new car to market in three years, it is easy to predict which will end up with increased market share.
Organization forms can be arrayed in a two-dimensional space: size and adaptability. In one corner are the hierarchical organizations; they can be as large as necessary, but move like sloths. The entrepreneurial form in another corner is much prized for its flexibility and nimbleness in the marketplace; the entrepreneur can turn the organization on a dime. Unfortunately, such an organization is condemned to remain small. In another corner is the networked organization; IT permits it to possess both large scale and agility. Of course, the hierarchical organization form has not vanished; most organizations can still produce a hierarchical organization chart. However, if you look at the way the organization actually operates, it typically has many networks -- formal and informal -- superimposed on the hierarchy. The fully networked firm has not yet emerged, but the direction of evolution is clear.
THE RESOURCES ARE OBSOLETE
In addition to working in a newly emerging organizational structure, third-wave managers face a new -- and more difficult -- set of managerial demands. Unlike the typical second-wave managers, who received an endowment of assets to operate and turn over to their successors unimpaired, third-wave managers haplessly inherit an obsolescent basket of resources. They get the keys to a local firm that must go global, an oversized firm that must be downsized, an electro- mechanical firm that must go solid-state. One of the hardest tasks is the conversion of the human resource base from the old model (white collar-blue collar) to the new model (knowledge-workers). The white- collar workers were the brains who told the blue-collar workers (the brawn) what to do. The accounting systems measured whether the brawn did what they were told so that they could be disciplined.
But the third-wave organization seeks and thrives on change -- innovation and improving quality -- and to achieve that, everyone in the organization, right down to the shop floor, must participate. Those we often still think of as blue-collar workers become knowledge-workers in the third-wave firm. A gasoline truck driver now drives up to the tanks and opens the valves. This is not a second-wave truck -- it has an on- board computer that tells the driver where to go next and how to optimize the route. Every job is becoming a knowledge-work job. Consider that shop-floor workers in a Japanese automobile factory spend 20 percent of their time in educational activities; management envisages them not as the brawn that is just supposed to do what it is told, but as a part of the aggregate brainpower of the organization; they are supposed to help figure out how to improve quality, speed production, and contribute to customer satisfaction.
Moreover, it is not sufficient for management merely to change all the resources of the organization; it must also change all the production processes. It must, for example, shrink product-design and production cycles. This can't be done simply by doing everything faster ("turning up the RPMs"). Management must re-design both products and production processes. They must reorient the entire organization from facing inward to the product to facing outward to the customer.
Most important, management must strive for quality products and services -- not just good or excellent quality, but ever-improving quality. There is never a time when you can't figure out some way to improve. So quality targets are adjusted upwards over time. For example, the automobile you would have considered high quality in the 1930's would not rate your second glance today. Nostalgically, we like to say that cars were better in the old days, but it is not true. In the old days, after you drove an automobile 50,000 miles, you junked it. Today you drive it 50,000 miles and change the oil. There has been a huge improvement in quality, but the job is never finished.
Once a company masters fits, finishes, and durability, it proceeds to more abstract qualities, such as the intuitive feel of the product. At length, you begin to realize that there is never any product or service that is so good that it can't be made better.
Management must create the organization that is inexorably biased toward process and product improvement.
CHANGES IN BUSINESS AND ACCOUNTING REQUIRE CHANGES IN ACCOUNTING FIRMS
Public accounting firms have not adjusted to the third wave. The biggest challenge they face is that a very large part of their practices is tied -- loosely or tightly -- to historical cost-basis financial statements that are losing their utility. Most accounting, auditing, and tax work and perhaps half of consulting work is related to historical cost-basis financial statements or accounting systems that are neither as relevant as they were nor as responsive to the opportunities advanced information technology makes possible. They favor cost-basis information despite the fact that assets and liabilities are subject to increasingly rapid shifts in value; they favor historical information despite investors' interest in the amount, timing, and uncertainty of future cash flows; they ignore the intangible assets that have become ever more important, and in some cases vital, in the information era (such as human assets, information assets, and R & D); they are periodic, when continuous reporting would be more desirable and is increasingly becoming possible with on-line, real-time IT; and they focus on information about exchange transactions when all sorts of other indicators of economic success could be measured and reported (such as customer satisfaction, cycle times, and evidence of reliability and rate of innovation).
This presents a challenge to the profession. Yet unlike other enterprises whose product is declining in utility, public accounting firms cannot unilaterally redesign the product, because GAAP and tax laws are determined externally.
CPA firms are also organized the way second-wave entities are organized. They are "stovepiped," as depicted in Figure 8, instead of networked, divided instead of teamed. They must break through these stovepipes in order to better serve their clients.
CPA firms have two separate, though related, product lines: attest services and consulting services (which, broadly defined, subsume tax services). Each of these will be dealt with in turn.
The third wave creates two separate opportunities for attest service: it produces vast new streams of information that demand attestation, and it provides the means to automate much of the attest process.
Historically, CPAs have attested to financial statements, but these statements contain a declining share of the information used by investors. In a survey I did about ten years ago, I already found more than 400 examples of attestation to information other than the financial statements. These included attestation to forecasts, projections, feasibility studies, EDP software, internal controls, utility rate applications, contract costs (cost-plus-fixed-fee contracts), regulatory filings, lease contingencies, royalties (coal, oil, motion pictures, etc.), compliance with regulations, occupancy statistics, enrollment statistics, attendance statistics, political contributions, labor negotiations data, third-party reimbursement claims, and many others. The more new data streams, the more attestation opportunities arise.
The development of new data streams must be seen in terms of the conditions for economic demand for attestation services. Whenever users need the information, there is a conflict of interest between the preparer and the user of the information, the information is "auditable," and there is a favorable cost-benefit ratio for attestation, the conditions for economic demand of attest services are in place. Taken together with the new streams of information being generated, the opportunities are promising.
At the same time these opportunities are developing, IT is changing the production technology of auditing, providing more efficient and different means of attestation. These include more and cheaper computing power, wide-area networks, and the emergence of "intelligent" software. In combination, these resources permit redesigning the audit to piggy- back the client's systems in real time, producing attestation on demand.
INFORMATION AS A SPECIALTY
Now we turn to the nonattest services of CPA firms. If accounting firms are to prosper, they must make their clients better off. They cannot make their clients better off through selling them raw materials at lower prices or lending them money at lower rates. So how can CPA firms make their clients better off? What is their special value to clients? What can they do for clients swimming in pools of new information? One formulation is that CPAs can attempt to make their clients better off through the use of information and information systems. This is because clients are all interested in the strategic use of the growing sources of information available to them, and CPAs are information specialists.
The CPA firm's goal is to make its clients better off -- to maximize total value. The way to do that is to help the client make its customers better off.
If we look at the traditional products of CPA firms -- audits and tax compliance, we see that they are directed to the support activities of client firms. These services provide value by lowering the cost of capital and by minimizing tax expense. Nevertheless, these services are not directed at the clients' primary value-adding activities. In order for the CPA firm to flourish, it must focus on services directed to the strategic use of information to facilitate the primary value-adding functions in its clients' organizations.
First steps necessary to achieve this include the following:
* Develop a fundamental understanding of the strategic value of information systems.
* Understand how the client's primary value-adding activities create value.
* Figure out how the client can create more value through the use of information and information systems.
* Identify, coordinate, and develop the resources in the firm to make it happen.
Only then are CPA firms likely to flourish in the long term.
Robert K. Elliott, CPA, is a partner in the executive office of KPMG Peat Marwick. He serves on the AICPA Board of Directors, the AICPA Special Committee on Financial Reporting, and the Accounting Change Commission of the American Accounting Association. He is a frequent contributor to professional journals, including The CPA Journal.
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