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The fi nancial performance effects of IT-based supply chain management systems in manufacturing fi rms Bruce Dehning a,1, Vernon J. Richardsonb,*, Robert W. Zmudc,2 aArgyros School of Business and Economics, Chapman University, Orange, CA 92866, United States bSam M. Walton College of Business, University of Arkansas, Fayetteville, AR 72701, United States cMichael F. Price College of Business, University of Oklahoma, Norman, OK 73019, United States Received 19 August 2004; received in revised form 18 May 2006; accepted 14 June 2006 Available online 2 November 2006 Abstract This paper examines the fi nancial benefi ts of information technology investments around newly adopted IT-based supply chain management (SCM) systems by 123 manufacturing fi rms over the period 19942000. We form hypotheses using the value chain to specify the expected fi nancial impact of SCM systems. By examining the change in fi nancial performance pre- and post-adoption controlling for industry median changes in performance, we fi nd that SCM systems increase gross margin, inventory turnover, market share, return on sales, and reduce selling, general, and administrative expenses. We also provide a model showing how process improvements around supply chain initiatives combine to improve overall performance. Finally, we show that contextual effects such as fi rms in the high-tech industry and the scope of the supply chain implementation have dramatic effects on the overall fi nancial performance resulting from supply chain implementations. # 2006 Elsevier B.V. All rights reserved. Keywords: Information technology; Supply chain management; Firm performance; Value chain; Manufacturing 1. Introduction RecentevidencesuggeststhatITinvestments,suchas IT-based SCM systems, are most likely to provide tangible business value when well targeted, well timed, well managed and accompanied with complementary investments and actions (Barua and Mukhopadhyay, 2000).ThatITinvestmentsarewelltargeted,i.e.,theyare undertaken to attain specifi c business objectives, is perhaps most important. Thus, assessments of the business value of IT investments should likewise refl ect a direct path from the nature of the IT investment being undertaken to specifi c metrics refl ective of the business objectives being sought. Most of the research examining the business value of IT, however, has focused on broad, overarching fi rm performance metrics, such as Tobins q (Bharadwaj et al., 1999), equity market capitalization (Brynjolfsson and Yang, 1999) or stock price changes aroundtheannouncementofITinvestments (DosSantos etal.,1993;Dehningetal.,2003).Whilethesestudiesdo provide insights into the overall business value of IT investment, associated analyses are accompanied by considerable measurement noise attributed to (1) the indirect path between the IT investment and these Journal of Operations Management 25 (2007) 806824 * Corresponding author. Tel.: +1 479 575 6803; fax: +1 479 575 2863. E-mail addresses: (B. Dehning), (V.J. Richardson), (R.W. Zmud). 1 Tel.: +1 714 628 2702; fax: +1 714 532 6081. 2 Tel.: +1 405 325 0791; fax: +1 405 325 7482. 0272-6963/$ see front matter # 2006 Elsevier B.V. All rights reserved. doi:10.1016/j.jom.2006.09.001 overarching performance metrics and (2) a recognition that these overarching performance metrics are affected by numerous factors other than the focal IT investment (Dehning and Richardson, 2002). In a similar vein, the fi rm performance effects associated with SCM systems have tended to be measured with high-level measures of fi nancial perfor- mance or with self-reported, survey-based process performance measures. Extant research suggests that large-scale empirical studies of the fi nancial benefi ts from SCM are as elusive as a consensus defi nition of SCM (Scannell et al., 2000). The best recent evidence of the value of SCM is Hendricks and Singhal (2003), who demonstrate that production or shipment delays attrib- uted to SCM systems decrease fi rm value by an average of 10.28%. However, Hendricks and Singhal note that large sample empirical evidence directly linking SCM systems to fi nancial fi rm performance metrics is quite limitedgivencurrentlyavailableevidence(e.g.,Frohlich and Westbrook, 2001; Krause et al., 2000; Narasimhan and Das, 1999; Narasimhan and Jayaram, 1998; Shin et al., 2000; Tan et al., 1999). Theintentofthisstudyistoexplicitlyhypothesizethe direct impacts of supply chain investments on (supply chain specifi c) process metrics along with overall fi nancial performance metrics using audited, externally reportedfi nancialperformancemeasures.Usingaudited, externallyreportedfi nancialperformancemeasuresadds an important degree of verifi ability, an essential characteristic of a performance metric (Melnyk et al., 2004). It is certainly possible to assess the impact of focused IT investments by considering the impacts of these investments vis-a -vis correspondingly focused fi nancial accounts. Mukhopadhyay et al. (1995), for example, offer a rare glimpse at the specifi c changes in detailed fi nancial performance measures by considering the effects of EDI on total inventory, obsolete inventory, and premium freight charges; and Barua et al. (1995) identify relations between various IT and non-IT inputs and business processes, and relations between these business processes and overall fi rm performance fi nding (a) a positive impact of ITon business processes and (b) thatcertainbusinessprocessesrelatepositivelytooverall fi rm performance. We follow a similar approach, guided by Porters value chain (Porter, 1985). Motivation for using the value chain to guide the selection of targeted performance measures can be found in Vickery et al. (2003, p. 523). The theoretical foundation for supply chain integra- tion can be traced to the Value Chain Model (Porter, 1980, 1985), and specifi cally, its notion of linkages. A linkage is the relationship between the way in which one value activity is performed and the cost or performanceofanother.Porteradvocatedthe identifi cation and strategic exploitation of linkages within a fi rms value chain (i.e., horizontal linkages) and between the fi rms value chain and the value chains of its suppliers and customers (i.e., vertical linkages).1 Specifi cally, we develop a conceptual model that considers the impact of IT-based SCM systems on discrete components of the value chain and predict changes in specifi c fi nancial performance measures associated with these components. IT-based SCM systems are of particular interest due to the heightened cross-organizational event visibility enabled through active process monitoring and automatic information routing, thus attaining levels of supply chain integration not previously possible (Benjamin and Wigand, 1995; Gunasekaran et al., 2004). Then, using an industry- adjusted sample, we assess the impact of IT-based SCM systems on fi nancial performance measures such as raw materials, work-in-process, fi nished goods inven- tory, gross margin, and selling, general, and adminis- trative (SG Tan et al., 1999). Perhaps the most often cited defi nition comes from the Global Supply Chain Forum: B. Dehning et al./Journal of Operations Management 25 (2007) 806824807 1 Emphasis in original. Supply chain management is the integration of key business processes from end user through original supplierthatprovidesproducts,services,and information that add value for customers and other stakeholders(GlobalSupplyChainForumas reported in Lambert et al., 1998, p. 1). IT-based SCM systems coordinate and integrate the fl ow of materials, information, and fi nances from supplier to manufacturer to wholesaler to retailer to the end consumer. Here, IT serves as a key enabler of value chain integration through the capture, organization, and sharing of vital information regarding key business processes, both within and outside a fi rms boundaries and contributes to fi rm profi ts by improving quality and cycle times and by reducing coordination costs and transaction risks (Nooteboom, 1992; Stroeken, 2000; Clemons and Row, 1992; Clemons et al., 1993; Mabert and Venkataramanan, 1998; Tan and Kannan, 1998; Frohlich and Westbrook, 2001; Sanders and Premus, 2002; Vickery et al., 2003). Thus, it is expected that IT- based SCM systems would contribute signifi cantly to both front-end and back-end improvements in fi nancial performance. The underlying causal relationships linking invest- ments in IT-based SCM systems to improvements in specifi c fi nancial performance metrics are based on the conceptual framework developed by Dehning and Richardson(2002)inwhichITinvestments are proposed to have both direct and indirect effects on fi rm performance. Here, intermediate process measures (e.g., metrics regarding improvement in inventory turnover, gross margin, and customer service) capture thedirecteffectsofITinvestmentswhilerecognizingthat such investments also indirectly infl uence overall fi rm performance measures. For example, SCM systems can directly improve inventory management (by reduced inventorylevels,holdingcosts,andspoilage)resultingin increased profi tability (i.e., gross profi tmargin) andmay also have indirect effects on fi rm performance through the lowering of coordination and SG and, the computational capacity of IT-based SCM systems allow sophisticated what-ifmodelingandscenarioanalysis of the entire supply chain. Although increased computational capacity and access to large data stores are valuable, the primary advantage of IT-based SCM systems comes from the ability to share information across all supply chain functions and, increasingly, across a fi rms supply chain partners. IT has transformed the supply chain, increasing information sharing within organizations and between organizations with inter-organizational systems (Chen and Paulraj, 2004). IT-based SCM systems deliver information to decision makers when they need it and in the format they need it. Decision makerscancreate,customize,anddeployreportseasily and effi ciently as required. IT-based SCM systems allow monitoring of the extended supply chain, providing entire supply chain visibility and both inter- and intra-fi rm collaboration. Stated more simply, todays IT-based SCM systems are much faster, more far reaching and provide more visibility into supply chain events than traditional supply chain initiatives. As such, they serve to create a multiplicity of digital options (Sambamurthy et al., 2003) to be applied for operational, tactical and strategic purposes. 3. Hypotheses development As depicted in Fig. 1, our simplifi ed value chain model has fi ve keycomponents. The studys hypotheses are developed following Fig. 1: inbound processes, operations processes, outbound processes, support processes, and overall fi rm performance. We conclude this section with the development of a hypothesis that accountsforagreatersalienceofSCMsystemsforfi rms in high-technology industries and a brief justifi cation for the selection of fi nancial performance measures. In selecting the performance measures to use in this study, we relied extensively on previous theory of SCM performance measurement (Spekman et al., 1994; B. Dehning et al./Journal of Operations Management 25 (2007) 806824808 Fisher, 1997; Mainardi et al., 1999; Elmuti, 2002; Hult et al., 2000; Wisner and Tan, 2000; Chan et al., 2003; Hendricks and Singhal, 2003). 3.1. Inbound processes The traditional value chain model (Porter, 1985) classifi es procurement as a support activity rather than a value-adding process. Recent developments in SCM, however, include purchasing as a strategic function (Chen and Paulraj, 2004). Thus we include procure- ment, as an integral SCM functionality, as a value- adding process and therefore procurement is included with inbound logistics as the inbound processes sector of the value chain. As an illustration of procurement as a value-adding process within the SCM context, consider the role of procurement at Dell Computers (Harrington, 2002). Dell generates and makes available to its suppliers a new manufacturing schedule and expected demand for the next 52 weeks every 2 h. This schedule refl ects the latest customer orders, backlog numbers, stock status, and supplier commitments. Dells SCM system directs suppliers to deliver the needed materials to a specifi c building and dock door for assembly on a particular manufacturing line at an appointed time. Due to these supply chain improvements, Dell has the highest inventory turnover ratio in the computer industry and ships more than 90% of its product all confi gured-to- order, not built-to-stock within 5 days of receiving the order. Such procurement-related effects then possess indirect fi nancial implications that ripple across the value chain. Enhancedintegrationwithsupplierscanimpactmany dimensions of fi rm performance, including cost, quality, technology, delivery, fl exibility, and profi ts (Gupta and Zhender, 1994; Blaxill and Hout, 1991; Krause et al., 2000). With inbound logistics, SCM system implemen- tationsaddvaluethroughtheavailabilityofmorecurrent and more accurate information regarding orders that is then shared with suppliers enabling tight coordinationof inbound logistics processes (which then increases capacity utilizations across the value chain). As a consequence, inventory levels and associated costs are reduced.ThisisconsistentwithElmuti(2002),whofi nds that the number one reason fi rms implement SCM is to reduce cost, inventory, and cycle time. Decreases in the cost of raw materials, the carrying cost of raw materials inventory due to lower inventory levels, and increased capacity utilization will directly affect cost of goods sold, and therefore gross margin (or more specifi cally gross profi tmarginpercentage, calculated as sales ? cost of goods sold/sales) (Mon- den,1998).Consideringthecomponentsofcostofgoods sold (raw materials, direct labor, and overhead), SCM systems are expected to decrease overhead and raw materials cost, and therefore should increase gross marginsandrawmaterialsinventoryturnover(Ginterand LaLonde, 2004). Gross margin is considered here as a measure of inbound processes due to the anticipated impact of SCM systems on cost of goods sold. IT-basedSCMsystemsimprove inbound processes in avariety ofwaysover traditionalsupplychainfunctions. First, IT-based SCM systems can automate the replen- ishment function. Using IT to monitor inventory levels and perform the consumption planning replenishment task reduces excess inventory while at the same time reducing stock outs. IT-based SCM systems with embedded radio frequency identifi cation (RFID) and voice technology allow workers to see and direct B. Dehning et al./Journal of Operations Management 25 (2007) 806824809 Fig. 1. Simplifi ed value chain model with performance measures where gross margin = gross profi t/sales; raw materials inventory (RMI) turnover = cost of goods sold/RMI; asset turnover = sales/total assets; work-in-process inventory (WIPI) turnover = cost of goods sold/WIPI; relative market share = sales/median industry sales; fi nished goods inventory (FGI) turnover = cost of goods sold/FGI; selling, general, and administrative expenses (SG total inventory turnover = cost of goods sold/total inventory; ROA = return on assets = income before extraordinary items/total assets; ROS = return on sales = income before extraordinary items/net sales. inventory faster and more accurately. IT-based SCM systems with RFID allow receiving departments to process incoming items with a single radio frequency scan. IT-based SCM systems automate the planning process; inventory replenishment and production are based on actual demand. IT-based SCM systems can automate re-confi guring and re-pricing requests for bidding and contract negotiation. Multi-round bidding can become easier through optimization of cost reduction and multiple performance or customer service levels. Thus, analysis of the changes in gross profi t margin percentage and raw materials inventory turnover after implementing IT-based SCM systems can be attributed to their impact on inbound processes. We therefore expect to observe increases in both raw materials inventory turnover and gross margin for fi rms adopting SCM systems: H1. Firms that adopt IT-based SCM systems will have improvedperformanceininboundprocessesas refl ected in increased raw materials inventory turnover and increased gross margin. 3.2. Operation processes The operations sector incorporates activities such as manufacturing, assembly, and packaging. Once raw materials are received and inspected, they are entered into the manufacturing process and become work-in- process. Manufacturing fl ow management has been identifi ed by The Global Supply Chain Forum as one of the seven key business processes affected by SCM (Lambert et al., 1998). As such, the manufacturing process affects numerous aspects of the product, including cost, quality, and performance; consequently, it must be constantly monitored and evaluated from a continuous improvement perspective (Mapes et al., 1997; Gunasekaran et al., 2004). SCM systems can improve fi nancial performance in operationsbycoordinatingmarketingforecasts, production schedules, and inbound logistics through the availability of enhanced informational support for operations planning and control resulting in reduced levels of work-in-process and higher capacity utiliza- tion (Kleijnen and Smits, 2003; Gunasekaran et al., 2004). Kleijnen and Smits (2003) emphasize the importance of WIP measures to the fi rm stating the factory manager, however, does want to minimize WIP. Ginter and LaLonde (2004), for example, found companies generally have had the most success in improving the turnover of their raw materials and work-in-process inventories following supply chain imp