January 8, 2005

Effect of Information Technology on Customer Satisfaction










Sunil Mithas (smithas@bus.umich.edu)
PhD Candidate
Ross School of Business
University of Michigan
D0263, 701 Tappan Street
Ann Arbor, MI 48109-1234
Phone: 734 763-8290
Fax: 734 936-0279



COMMENTS WELCOME
Please do not cite, quote, or distribute without permission of the author











Acknowledgements: I thank my dissertation committee and M S Krishnan and Claes Fornell in
particular for their help in improving this paper. I also thank Department Editor, Associate Editor,
anonymous referees of Management Science for their guidance and suggestions in enriching this
paper. I acknowledge helpful comments of seminar participants of WISE 2002, WISE 2003 ICIS
2004 Doctoral Consortium, Ross School of Business at University of Michigan and Eli Broad
College of Business at Michigan State University. I am grateful to InformationWeek for
providing the necessary IT-investments data for this research. In particular, I would like to thank
Rusty Weston, Lisa Smith, Stephanie Stahl and Brian Gillooly for their encouragement and
support. I thank the National Quality Research Center at the University of Michigan Business
School for providing the customer-satisfaction data. I 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 Ross School of Business at
University of Michigan.

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Effect of IT Investments on Customer Satisfaction
Effect of Information Technology on Customer Satisfaction


Abstract
This research addresses the following questions: Do information technology (IT) investments
have an effect on customer satisfaction? Does the effect of IT on customer satisfaction differ
across industry sectors? What are the causal mechanisms at work? How valid are the assertions in
practitioner press that customer relationship management (CRM) systems have not paid off for
firms?
Based on an analysis of longitudinal data on fifty U.S. firms for the period 1994-2000, I first
document the association between aggregate IT investments and customer satisfaction. The
results also indicate that the effect of IT investments on customer satisfaction differs across
manufacturing and service sector. I find support for the hypotheses that effect of IT investments
on customer satisfaction is mediated through effect of IT on perceived quality and perceived
value.
While linking aggregate IT investments with customer satisfaction is a useful beginning for
guiding appropriate levels of IT investments, in order to better understand the functional level
effects, I also study the effect of more proximal customer interfacing IT applications such as
customer relationship management (CRM) systems on customer satisfaction. Contrary to popular
belief, my analysis of archival data collected for a broad cross section of firms in the US shows a
positive effect of customer interfacing CRM systems on customer knowledge and customer
satisfaction. The results suggest that CRM systems help firms in improving their customer
knowledge that in turn leads to more targeted customer experiences thus improving customer
satisfaction.
This research makes three important contributions. Although much of the prior work on the
business value of IT at the firm level focused on financial and accounting measures, this research
explores the effect of IT investments on overall customer satisfaction of a firm for the first time.
Second, I propose and validate a theory of mediation effects of perceived quality and perceived
value. This proposal has the potential for synthesizing information systems effectiveness and
marketing literature towards an integrative understanding of the relationship between IT and
customer satisfaction. Finally, I pinpoint role of customer knowledge as a key causal mechanism
in deriving value from CRM systems. These contributions provide a new lens for assessing
returns from IT investments and provide guidance for managerial action in using IT for
improving customer satisfaction.

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Effect of IT Investments on Customer Satisfaction
1.0 INTRODUCTION
Customer franchise has emerged as one of the critical assets for firms because locus of power
across industries and businesses is increasingly shifting towards customers. It has been argued
that companies need to move from a product centric culture to a customer centric model to sense
and meet customer demands for changes in specific 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 not only for measuring success of IT systems and websites
(Agarwal and Venkatesh 2002) but also for measuring competitive success and long-term
economic performance of firms (Anderson, Fornell and Mazvancheryl 2004; Chen and Hitt 2002;
Fornell and Wernerfelt 1988). Research shows that higher levels of customer satisfaction have the
potential to double or triple firm profits (Reichheld and Sasser 1990; Rose 1990). These research
findings are consistent with perception among senior managers about critical importance of
customer satisfaction for sustainable firm performance. Industry surveys also report that senior
executives and CEOs rank customer satisfaction and retention as their topmost challenge
(Rosenbleeth et al. 2002).
In order 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 and CRM (Customer
Relationship Management) implementation is one of the top priorities of IT managers
(Brynjolfsson and Hitt 1998; Rosenbleeth et al. 2002). Significant investments in IT applications
in general and CRM systems in particular in recent years indicate the industry belief that IT
applications can streamline both internal and customer-interfacing business processes (Chopra
and Mieghem 2000; Karimi, Somers and Gupta 2001; Romano and Fjermestad 2001; Wells and

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Effect of IT Investments on Customer Satisfaction
Hess 2002). Forrester (2002) predicts that investments in CRM (including applications, services
and infrastructure) will grow from $ 42.8 billion in 2002 to 73.8 billion in 2007.
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.
Much of the empirical research in information systems focuses on the effect of generic IT
investments and IT capabilities on financial or market value related measures of firm
performance (Barua and Mukhopadhyay 2000; Bharadwaj 2000; Dewan and Kraemer 1998;
Dewan and Min 1997; Santhanam and Hartono 2003; Subramani and Walden 2001). However,
increasingly, researchers are calling for uncovering the effect of IT investments on intangible
customer-oriented measures of firm performance, such as greater responsiveness to customers,
more variety, and overall customer experience, which are reflected in customer satisfaction
(Brynjolfsson 1993). For example, Brynjolfsson and Hitt (1996), in their influential paper
documenting productivity gains due to IT, call for future research utilizing “more direct
approaches…such as directly accounting for intangible outputs such as product quality or variety
(p. 557).” Bharadwaj, Bharadwaj and Konsynski (1999) endorse this view by noting that “useful
direction for future research would be to model IT’s impact on intangible dimensions of [firm]
performance such as …customer service, and customer relationships (p. 1020).” Against this
backdrop, this study seeks to understand the effect of investments in IT and customer relationship
management systems on customer satisfaction. Following Devaraj and Kohli (2000) who
recently documented the effect of IT systems on customer satisfaction in the health sector, this
study extends their work to a much broader cross section of firms across diverse industry sectors.
In this study, we use archival IT investments and customer-satisfaction data collected by
reputable third-party organizations that follow a well-defined, standardized approach for
collecting such data. We combine these standardized IT investments and customer-satisfaction
measures for a broad range of manufacturing and service firms to examine the relationship
between IT investments and customer satisfaction. In addition to looking at the effect of

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Effect of IT Investments on Customer Satisfaction
aggregate IT investments (such as IT hardware and software expenditures), we also explore the
effect of investments in specific customer related IT applications such as CRM systems on
customer-satisfaction performance of firms.
The remainder of the paper is structured as follows. Section 2 provides a description of the
theoretical framework and research hypotheses. Section 3 describes the research design and
empirical models while section 4 describes the results. Section 5 contains concluding remarks.
2.0 THEORY AND HYPOTHESES
Our goal in this study is to understand the effect of aggregate IT investments and customer
related IT applications on customer satisfaction. In the next section, we briefly review prior
literature on the business value of IT investments pertinent to this research. In section 2.2, we
present the theory underlying our hypotheses linking aggregate IT investments to customer
satisfaction by positing two causal mechanisms: perceived quality and perceived value. In section
2.3, we present the theoretical linkages between customer related CRM investments and customer
satisfaction and argue that the effect of CRM systems on customer satisfaction is mediated
through customer knowledge.
2.1 Prior Literature on the Business Value of IT Investments
The subject of business value from IT investments has a long history but continues to
attract significant interest both in the business press and academic literature (Kohli and Devaraj
2003; The Economist 2002; Waters 2004). Beginning with in-depth, case-based 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).
In studying the effect of IT on firm performance, researchers have looked at the effect of
aggregate IT expenditures as well as specific IT applications. Both sets of studies have their

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Effect of IT Investments on Customer Satisfaction
advantages. While studies examining the effect of aggregate IT expenditures answer managerial
concerns about appropriate level of IT expenditures and their effects on firm level outcome
measures such as productivity and shareholder value (Bharadwaj, Bharadwaj and Konsynski
1999; Brynjolfsson and Hitt 1996; Dewan and Kraemer 1998; Dewan and Min 1997; Menon, Lee
and Eldenburg 2000); studies at the IT application level provide a better understanding of the
causal mechanisms that underlie value creation from IT (Banker et al. 2003; Barua, Kriebel and
Mukhopadhyay 1995; Kauffman and Kriebel 1988; Mukhopadhyay, Kekre and Kalathur 1995;
Mukhopadhyay, Rajiv and Srinivasan 1997).
While previous research has provided valuable insights into the relationship between IT
investments and business value, other than the work done by Devaraj and Kohli in the health
sector as noted earlier, very few studies have directly accounted for the customers’ perspective of
the value gained from IT investments. Most of the prior studies have addressed managers’ and
investors’ perspectives of business-value measures such as productivity or market value.
Focusing on customer satisfaction is particularly relevant because, as noted earlier, customer
franchise has emerged as a critical asset for firms, and customer satisfaction has been reported as
a leading indicator of the market value of firms (Ittner and Larcker 1998).
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). In addition to these advantages,
customer satisfaction also helps in accounting for intangible outputs such as product quality or
variety that are not captured in firm productivity measures (Quinn and Bailey 1994). The
quantification of such intangible improvements in product quality, variety or consumption
experience through a customer-satisfaction index at the firm level has the potential to

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Effect of IT Investments on Customer Satisfaction
complement 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),
with some exceptions (Devaraj and Kohli 2000), very few studies have related IT investments to
customer satisfaction at the firm level.
2.2 Relating Aggregate IT Investments to Customer Satisfaction
Previous research in marketing literature 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 customers’ belief 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 customer expectations do not play a major role in affecting customer
satisfaction and perceived quality has a significantly greater effect on customer satisfaction than
perceived value (Anderson and Sullivan 1993; Fornell et al. 1996). We, therefore, concentrate on
elaborating how IT influences perceived quality and perceived value of a firm’s offerings.
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 firms’ offerings and by providing a seamless service
experience to customers. Bharadwaj, Bharadwaj and Konsynski (1999) have noted the

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Effect of IT Investments on Customer Satisfaction
importance of IT enabled customization and improved customer service in creating intangible
value for firms. In addition, by facilitating seamless flow of information in an organization, IT
facilitates efficient allocation of resources, shorter response times and improved quality.
Furthermore, 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.
Besides its impact on perceived quality, IT may also affect perceived value of a firm’s
offering. For example, IT investments in supply chain and ERP systems with end-to-end
integration have the potential to improve perceived value of a firm’s offering from a customer
viewpoint through quicker responses to customer enquiries and consistent order fulfillment
processes. IT may also help in the automation of business processes leading to efficiency gains
and cost reductions. Such efficiency gains and cost reductions, if passed on to the consumers,
may enhance the perceived value of a firm’s offerings.
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 for studying the
relationship between IT investments and customer satisfaction (Anderson, Fornell and Rust 1997;
Bitner, Brown and Meuter 2000; Parasuraman 1996; Parasuraman and Grewal 2000). The above
discussion leads to our first set of hypotheses:
H1a: IT investments are positively associated with higher levels of perceived quality.
H1b: IT investments are positively associated with higher levels of perceived value.
H1c: IT investments are positively associated with higher levels of customer satisfaction.
In addition to considering the effect of IT investments on perceived quality, perceived
value and customer satisfaction, there is a need to consider the moderating influence of industry

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sector in these relationships. Prior research on business value of IT has shown that the effect of IT
investments may differ across manufacturing and service industries, underscoring the need to
understand these differences (Brynjolfsson and Hitt 1996; Kudyba and Diwan 2002). For
example, in their study of the contribution of IT to firm output, Brynjolfsson and Hitt (1996)
excluded all firms in the financial-services and telecommunications industries from their sample
because their model “poorly predicted (p.549)” the output for such industries, reflecting the
differences in the effect of IT across manufacturing and service firms. Several other studies also
have failed to find any significant IT impact in the service sector (Quinn and Bailey 1994; Roach
1991).
In order to understand the effect of IT across industry sectors, it is important to examine
the nature of customer interactions and experiences across the manufacturing and service sectors.
Prahalad and Krishnan (1999) argue that the customer view of quality may differ across products
and services. For example, customers who purchase a manufactured product may regard the
conformance of the product features to specifications as important. However, in the service
business, such as hospitality or airlines, customers may consider the “adaptive view of quality”
(i.e., the flexibility to respond to the specific needs of individual customers) as equally or more
important. Based on similar reasoning, marketing researchers have also argued that the drivers of
customer equity may be different across industry sectors (Rust, Zeithaml and Lemon 2000).
Additionally, compared to manufactured goods, it is also much more difficult to evaluate services
using objective criteria because the consumption experience is very personal and subjective
(Anderson, Fornell and Rust 1997). Following a similar line of reasoning, Johnson and Fornell
(1991) have argued that average customer satisfaction should be higher for goods than for
services.
Even though services may have lower levels of customer satisfaction, IT can play a
greater role in enabling service-sector companies to improve their customer satisfaction because
the service business is more information intensive. Barua and Mukhopadhyay (2000) also note

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that the services sector possibly stands to gain more than the manufacturing sector from IT
applications despite the positive effect of IT enabled supply chain management and production
management processes for manufacturing firms. However, since supply chain and production
management processes are largely at the back end in the manufacturing sector, IT enabled
innovations in these processes may have a marginal impact on customer satisfaction. In contrast,
services require adaptation to individual customer requirements and this can be accomplished by
leveraging IT capability to customize product delivery and consumption experience in real time.
For example, the innovative use of IT has enabled firms such as Amazon.com (retailing services)
and Charles Schwab (financial services) to record high levels of customer satisfaction. Marketing
researchers also have argued that IT may have greater leverage for achieving customer
satisfaction in service businesses that are more information intensive (Anderson, Fornell and Rust
1997). Therefore, we expect IT investments to have a greater effect on perceived quality,
perceived value and customer satisfaction for firms in the service sector compared to those in the
manufacturing sector.
H2a: IT investments will have greater effect on perceived quality for firms in the service sector
than for firms in the manufacturing sector.
H2a: IT investments will have greater effect on perceived value for firms in the service sector
than for firms in the manufacturing sector.
H2a: IT investments will have greater effect on customer satisfaction for firms in the service
sector than for firms in the manufacturing sector.
2.3 Relating Specific Customer Related IT Systems with Customer Satisfaction
While the previous section links aggregate IT investments with customer satisfaction
following the conventional approach used in the business value of IT literature (Hitt and
Brynjolfsson 1996), we also study the effect of more proximate IT investments (such as CRM
applications) that encompass business processes involved in affecting customer experience
(Bitner, Brown and Meuter 2000; Meuter et al. 2000). Studying the business value of IT at the

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Document Outline

• January 8, 2005
• 2.1 Prior Literature on the Business Value of IT Investments
• 2.3 Relating Specific Customer Related IT Systems with Customer Satisfaction
• 2.3.2 Relating CRM Systems with Customer Satisfaction
• Panel Data for Studying Effect of Aggregate IT Investments on Customer Satisfaction
• Cross-sectional Data for Studying Effect of CRM Investments on Customer Satisfaction
• Table 8. Estimating the Effect of CRM on Firm Performance Using Matching Estimator
• Estimating the Effect of CRM on Firm Performance Using Matching Estimator

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