An Empirical Analysis of the RFID Effect on Suppliers' Financial Performance

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1 Assocaton for Informaton Systems AIS Electronc Lbrary (AISeL) ICIS 2008 Proceedngs Internatonal Conference on Informaton Systems (ICIS) 2008 An Emprcal Analyss of the RFID Effect on Supplers' Fnancal Performance Young Bong Chang Unversty of Brtsh Columba, Okanagan, Follow ths and addtonal works at: Recommended Ctaton Chang, Young Bong, "An Emprcal Analyss of the RFID Effect on Supplers' Fnancal Performance" (2008). ICIS 2008 Proceedngs Ths materal s brought to you by the Internatonal Conference on Informaton Systems (ICIS) at AIS Electronc Lbrary (AISeL). It has been accepted for ncluson n ICIS 2008 Proceedngs by an authorzed admnstrator of AIS Electronc Lbrary (AISeL). For more nformaton, please contact elbrary@asnet.org.

2 AN EMPIRICAL ANALYSIS OF THE RFID EFFECT ON SUPPLIERS FINANCIAL PERFORMANCE Analyse emprque de l effet de la RFID sur la performance fnancère des fournsseurs Completed Research Paper Young Bong Chang Unversty of Brtsh Columba, Okanagan 3333 Unversty Way Kelowna, BC, VVV7 young.bong.chang@ubc.ca Abstract The objectve of ths study s to rgorously examne the effects of RFID on supplers proftablty whle adjustng for endogenety bas arsng from the decson process for RFID adopton. To ths end, we use a Heckman two-stage estmaton method, whch allows us to control for endogenety between a frm s organzatonal characterstcs and ts decson for RFID adopton. We fnd that supplers faced wth both a low level of nventory effcency and wth hghly uncertan demand are more lkely to adopt RFID. Further, supplers that have adopted RFID acheve greater fnancal gans than ther counterparts that have not. More mportantly, we show that these fnancal gans result from mproved nventory and sales effcences after RFID s deployed. In sum, our study sheds new lght on what drves supplyng frms to adopt RFID and on ts role n shapng relatvely hgher fnancal performance n a post-adopton perod. Keywords: RFID; SCM; supply chan management; fnancal performance Résumé Cette étude examne les effets de la RFID sur le rendement des fournsseurs. Nous constatons que les fournsseurs confrontés smultanément à un nventare peu effcace et à une demande fortement ncertane sont plus susceptbles d adopter la RFID. En outre, les fournsseurs qu ont adopté la RFID réalsent des gans fnancers plus mportants, comparés à leurs homologues qu ne l'ont pas adopté. Ces gans fnancers résultent de l améloraton de l nventare et des ventes sute au déploement de la RFID. Introducton Rado frequency dentfcaton (RFID) has ganed great attenton n academc lterature and n practce ever snce Wal-Mart mandated that ts top supplers place RFID tags on the cases or pallets (RFID Journal, 2003). Smlarly, several prvate and publc organzatons, ncludng Target, Tesco, and the U.S. Department of Defense (DoD), have taken sgnfcant steps toward the use of RFID n managng supply chans. As a consequence, RFID-related spendng s estmated to contnuously, grow and reach $3 bllon n 200 (RFID Update, 2005). In the context of busness, RFID s recognzed as a technology that mproves supply chan effcency through Twenty Nnth Internatonal Conference on Informaton Systems, Pars 2008

3 Economcs of Informaton Systems helpng to acheve a better flow of nformaton and materals, and mproved nventory effcency along the value chan (Delen et al., 2007; Whtaker et al., 2007). For nstance, RFID may mprove nventory accuracy of auto manufacturers by trackng the movement of assembled parts at dfferent statons (Curtn et al., 2007). Frms may beneft from the deployment of RFID technology snce RFID allows them to capture and analyze nformaton and materal flows n real tme (Psello, 2006). Accordngly, RFID enables frms to realze benefts whch nclude mproved nventory controls, warehouse labor cost savngs, and ncreased sales (Abell, 2003; Curtn et al., 2007; Heese, 2007; Whtaker et al., 2007). From a practcal pont of vew, an ndustry analyss also suggests that U.S. DoD expect to save $.7b through RFID use (Collns, 2006). Gven that RFID has huge potental to save costs and mprove performance, busness press has pad great attenton to RFID projects. Prevous studes have emphaszed the potental benefts of RFID. However, most of them prmarly take ether an analytcal or a case-based approach (Barratt and Cho, 2007; Heese, 2007; Gaukler et al., 2007; Lee and Ozer, 2007). Furthermore, most studes focus on the benefts to large retalers or buyers, such as Wal-Mart and the U.S. DoD and address how RFID wll brng great benefts to large retalers or buyers (Walgum, 2004). Whle these studes contrbute to a sgnfcant understandng of the value RFID can create, to the best of our knowledge, only a few studes emprcally examne the mpact of RFID on fnancal performance from the perspectve of supplers. Gven that some supplers stll hold back on RFID adopton due to hgh adopton costs, technologcal uncertanty and a lack of busness cases (RFID Gazette, 2006; Walgum, 2004), t s of mportance to emprcally examne whether RFID wll beneft supplers as t dd for large retalers.. The man objectve of our study s to examne whether or not RFID mproves a suppler s fnancal performance. For ths purpose, we collected two sets of data whch consst of supplers that adopt RFID and ther matched frms that do not. Then, we consder the dfferences n fnancal performance between two sets of frms by comparng proftablty changes over a pre-to-post adopton perod. We also account for potental endogenety between the decson for RFID adopton and fnancal performance by employng a Heckman s two-stage regresson analyss (Heckman, 979; Maddala, 983; Greene, 2000). In our context, t s mportant to reflect the noton of endogenety snce frms do not randomly make decsons as to whether they wll adopt RFID or not. That s, a frm s decson for RFID adopton s made based on ts own needs, opportuntes, and comparatve advantages. For nstance, frms faced wth demand uncertanty may have a greater ncentve to adopt RFID. RFID may allow for them to acheve greater benefts by dramatcally reducng demand fluctuatons. Importantly, ths type of dependency rases the ssue of endogenety whch should be dealt wth explctly to obtan unbased estmates (Heckman, 979; Greene, 2000). Because organzatonal characterstcs are lkely to affect adopton choce, we cannot evaluate the true effects of RFID on frm performance f they are not controlled for. By explctly accountng for potental endogenety, we can obtan unbased estmates whle estmates from a tradtonal regresson approach such as ordnary least square (OLS) are based (Heckman, 979; Greene, 2000). Specfcally, our frst stage estmaton s devoted to uncoverng the condtons under whch supplers are lkely to adopt RFID. Then, we examne whether these supplyng frms that have adopted RFID acheve greater fnancal gans compared wth non-rfid adopters after ncorporatng the estmates obtaned from the frst stage. Our results from the frst stage analyss suggest that supplyng frms are more lkely to adopt RFID when ther nventory effcences are low and demand fluctuatons are not stable. Our estmates from the second stage analyss show that frms that adopt RFID have acheved greater gans n proft margns and return on asset (ROA) relatve to ther counterparts that dd not adopt RFID. Further, we fnd that these fnancal gans are attrbutable to RFID deployment, whch mproves nventory and sales effcences. To the best of our knowledge, ths s one of the frst studes that rgorously examnes the mpact of RFID on supplers fnancal performances. Our study shows evdence of the tangble value derved from the newly emergng technology RFID. Further, we are able to control for potental endogenety and dentfy the sources of fnancal gans for RFID adopters by ncorporatng a frm s decson process nto the estmaton. In sum, we beleve that our study sheds new lght on why supplers adopt RFID and whether and how RFID can mprove supplers fnancal performance. The paper proceeds as follows: The next secton dscuss the relevant theoretcal backgrounds and develop hypotheses. We then develop an emprcal model. We descrbe the data we use for analyses. Emprcal results are dscussed. The fnal secton contans concludng remarks. Theory and Hypotheses Why do frms adopt RFID? RFID s an emergng technology that mproves supply chan effcency by provdng greater vsblty of nventory 2 Twenty Nnth Internatonal Conference on Informaton Systems, Pars 2008

4 Chang / An emprcal analyss of the RFID effect and mprovng nformaton flows along the supply chans. RFID prmarly conssts of two components, a tag and a reader. An RFID tag s a small devce that contans a mcrochp and an antenna. The tag stores extensve data on ndvdual tems. Wth the RFID tag, a reader transmts a magnetc feld that actvates the tag, whch enables t to transmt and store data (Curtn et al., 2007). Ths nnovaton allows frms to ntegrate and share nformaton wthn and between frms and enables substantal effcency gans of supply chans (Heese, 2007; Whtaker et al., 2007). Accordngly, n recent years, an ncreasng number of frms have ntated RFID projects to mprove ther supply chan effcency (Heese, 2007). We frst explore transacton cost economcs (TCE) to dentfy factors affectng a frm s decson for RFID adopton. TCE ntroduces the noton of bounded ratonalty and opportunsm as characterstcs of the behavor of economc agents whch ncurs transacton costs when these characterstcs are combned wth uncertanty, asset specfcty, and nformaton asymmetry (Wllamson, 985). Whle asset specfcty and nformaton asymmetry also play a crtcal role n TCE, we focus on uncertanty snce one of the prmary functons of RFID s to acheve operatonal effcences by reducng uncertanty n supply chans (Lee, 2002; Heese, 2007). Uncertanty can be nterpreted as a lack of nformaton that results from ambguty n future demand (Wllamson, 985, 99; Aubert et al., 996). TCE predcts that frms wll be more vertcally ntegrated under a hghly uncertan envronment to mnmze potental rsk assocated wth demand uncertanty (Shelansk and Klen, 995). In our context, supplers attempt to mtgate the effects of demand uncertanty by deployng RFID whch enables them to share nformaton wth tradng partners. In practce, supplyng frms have observed that demand fluctuatons ncrease as they move up a supply chan, wth the fluctuaton ncrease beng known as the bull-whp effect (Lee et al., 997). To mtgate the bull-whp effect, Wal- Mart and Procter & Gamble, for nstance, establshed a vendor-managed nventory (VMI) partnershp so that Procter & Gamble can reduce unnecessary demand fluctuatons. In a smlar ven, RFID acts as a condut to facltate nformaton sharng between tradng partners (Heese, 2007). Thus, shared nformaton by the ad of RFID allows supplers to have real-tme access to a retaler s sales data and to predct future demand more accurately so that they can reduce demand fluctuatons (uncertantes). Thus, we propose the followng hypothess: Hypothess : Supplers faced wth large demand fluctuatons are more lkely to adopt RFID. Second, deployng RFID technology may have an mpact on nventory controls by trackng materal movement and optmzng nformaton flow along the supply chan (Dehnng et al., 2007). For nstance, RFID can be used to keep track of expensve equpment and can locate tems n the rght place at the rght tme. In practce, many organzatons decde to adopt RFID to mprove nventory effcency snce the technology has the capablty of enhancng nventory vsblty and trackng the movements of materals (Curtn et al., 2007). Therefore, we expect that supplers that carry a large volume of nventory may have a greater ncentve to adopt RFID. Ths leads to the followng hypothess: Hypothess 2: Supplers wth a hgh nventory rato are more lkely to adopt RFID. Fnally, we dentfy frm sze as a factor that may nfluence a frm s decson for RFID adopton (Iacovou et al., 995; Zhu and Kraemer, 2002; Whtaker et al., 2007). In general, frm sze may reflect several mportant aspects of organzatonal features, such as resources avalablty and technologcal experence (Rogers, 995; Zhu and Kraemer, 2002; Zhu et al., 2006). Ths s because larger frms may have slack resources so that they can be better postoned n deployng new technologes (Tornatzky and Flescher, 990; Iacovou et al., 995). In our context, RFID deployment vewed as a complex IT project may requre a sgnfcant commtment of fnancal resources (Iacovou et al., 995; Whtaker et al., 2007). For nstance, mplementaton costs of RFID for a typcal large consumer goods manufacturer s estmated to be between $9 and $25 mllon (Shutzberg, 2004). Further, placng RFID tags on ther pallets and cases wll ncur addtonal costs (Gaukler et al., 2007). Thus, larger frms that can afford costly RFID projects may be better postoned n mplementng new technologes such as RFID. Ths yelds the followng hypothess: Hypothess 3: The larger the suppler sze, the more lkely t s to adopt RFID. Next, we move our dscusson to whether or not RFID adopton mproves a frm s fnancal performance. Benefts of RFID Consderng the nature of RFID, t can be vewed as a subset of Interorganzatonal Systems (IOS) and can be used as a tool to reduce stock-outs and mprove nventory turnovers by provdng detaled nformaton along the supply chan (Clarke et al., 2006; Curtn et al., 2007). Informaton Systems (IS) researchers have examned the mpact of IOS on busness value n the context of EDI, E-busness, and RFID. For nstance, Mukhopadhyay et al. (995) fnd Twenty Nnth Internatonal Conference on Informaton Systems, Pars

5 Economcs of Informaton Systems that EDI usage contrbutes to cost reductons and mproves qualty of transactons wth tradng partners. Zhu and Kraemer (2002) show that retal frms acheve greater benefts when they have developed approprate E-busness functonaltes. In a smlar context, a recent RFID study shows that techncal and organzatonal resources contrbute to returns on RFID nvestments (Whtaker et al., 2007). Our study s n lne wth prevous studes on the value of RFID but s dstnct from them because we examne the mpact of RFID on fnancal performance from the supplers perspectve. RFID can help acheve operatonal effcences by coordnatng the flow of materals and mprovng nventory transparency. Wth the use of RFID tags and readers, supplers that adopt RFID mnmze nventory costs n a post-adopton perod by lowerng order costs, reducng batch sze, and mprovng order fulfllment (Cachon and Fsher, 2000). These postve changes wll, n turn, mprove the fnancal performance of RFID adopters (Knney and Wempe, 2002; Dehnng et al., 2007). That s, frms that have adopted RFID acheve nventory effcency along the supply chan, resultng n hgher fnancal performance than ther counterparts. Hypothess 4a: Supplers that adopt RFID wll mprove nventory effcency, resultng n greater fnancal performance n a post-adopton perod relatve ther counterparts that do not. In addton to the drect effect of RFID on nventory effcency, the use of RFID may also mprove sales effcency measured as sales per unt of labor by reducng labor requred to montor goods and nventory flow and mprovng accuracy n operatons schedulng, data collecton, and qualty management (Psello, 2006; Curtn et al., 2007). That s, RFID enables workers to montor ncomng and outgong materals faster and more accurately. For nstance, the mplementaton of RFID allows Dell computers to check the confguratons of assembled PC n real tme, to automate the prntng of outgong address labels, and so on. Because of the automated busness processes, Dell Computers could realze substantal labor cost savngs (Hoffman, 2005). In ths context, we conjecture that RFID adopton s postvely assocated wth sales effcency n a post-adopton perod, leadng to hgher fnancal performance. Ths yelds the followng hypotheses. Hypothess 4b: Supplers that adopt RFID wll mprove sales effcency, resultng n greater fnancal performance n a post-adopton perod relatve to ther counterparts that do not. Emprcal strategy The proft functon In ths secton, we descrbe an emprcal model that examnes the fnancal mpact of RFID. Followng the IT busness value lterature, we construct two ndces for frm proftablty (Barua et al., 995; Htt and Brynjolfsson, 996; Bharadwaj, 2000; Stratopoulos and Dehnng, 2000). These two are ) proft margns whch measure how effectvely a frm generates ts operatng profts and ) return on asset (ROA) whch llustrates how effectvely a frm deploys ts assets to generate net ncome. As dscussed, we expect that frms that have adopted RFID acheve greater fnancal gans relatve to those that have not. These gans for RFID adopters result from two channels: ) mproved nventory effcency and ) mproved sales effcency. Ths yelds: (a) Δ Proft, = 0 + βδir, + β 2ΔSE, β + ε where Δ denotes the frst dfference from adopton year to one year after RFID s adopted. Subscrpt and t denote frm () and tme (t). IR s the rato of nventory to sales. SE s the sales effcency measured as the sales per unt of labor. Based on our earler dscusson (see H4a and H4b), we nclude nventory rato and sales effcency n the proft functon. In partcular, the dependent varable of equaton (a) s specfed as a proft change n a post-adopton perod by takng the frst dfference. Then, we use correspondng changes of nventory rato and sales effcency as ndependent varables. We do so snce frms may not realze benefts mmedately after deployng new technologes lke RFID (Brynjolfsson and Htt, 2000). In addton to two factors contrbutng to proftablty, we nclude several control varables to capture addtonal varatons n proftablty. Frst, we note that a suppler s fnancal performance depends on ts barganng power. For nstance, sales rato attrbutable to four major retalers n the U.S. has ncreased to 40.% n 2004 from 6.8% n 992, ndcatng that an ncrease n buyer (retaler) concentraton has occurred over recent years (Gosman and Kohlbeck, 2006). If a large buyer uses ts barganng power wth supplers, they may be forced to lower prces to mantan busness. As a result, supplers fnancal performances can be squeezed by the power of larger buyers (Bloom and Perry, 200; Banco and Zellner, 2003). When large buyers are lkely to weld ther barganng power, a suppler s market share may be able to work as a safeguard n mtgatng the potental nfluence of large buyers 4 Twenty Nnth Internatonal Conference on Informaton Systems, Pars 2008

6 Chang / An emprcal analyss of the RFID effect (Scherer and Ross, 990). Snce a substantal porton of our sample frms have relatonshps wth larger buyers (retalers) such as Wal-Mart, we nclude a suppler s market share to capture ts potental effects on profts. Second, we note that tme-nvarant ndustry-specfc factors may have a substantal nfluence on frm proftablty. For nstance, a frm that operates n a more concentrated ndustry may have an opportunty to capture hgher economc rents than do others n a less concentrated ndustry (Ban, 956; Melvlle et al., 2007). Some ndustres may be characterzed by a hgh entry barrer snce frms may be requred to acheve a certan level of scale economes and ncur hgh up-front costs to do busness. However, these ndustry-specfc factors are lkely to change relatvely slowly. Therefore, we can capture ndustry-specfc effects by ncludng ndustry dummes (Htt and Brynjolfsson, 996). We also nclude year dummes to capture any unobserved tme-varyng effect. Fnally, we nclude a zero-one dummy for RFID, whch allows us to evaluate the mpact of RFID on frm proftablty. If we fnd a postve and statstcally sgnfcant coeffcent of RFID, therefore, we can argue that a frm s profts are postvely assocated wth RFID adopton. Thus, we have a followng specfcaton extended from equaton (a): (b) Δ Proft, = 0 + βδir, + β 2ΔSE, + β3ms, + β 4RFID, t β + controls + ε where IR, SE, and MS n equaton (b) denote nventory rato, sales effcency and market share of frm at tme, * respectvely. RFID, t s a zero-one dummy for frm at tme t. It takes on f RFID s adopted or 0 otherwse at tme t. Controls nclude ndustry dummes at the 2-dgt SIC level and year dummes. By addng control varables and an RFID dummy n the proft functon, we beleve that our emprcal model captures a substantal porton of varatons n frm proftablty. However, t s worthwhle to recall that a suppler s decson to adopt RFID may not be exogenous and nfluenced by ts unque characterstcs. For nstance, t may be easer for a larger frm to nvest n a new technology such as RFID due to fnancal and organzatonal slack avalable (Whtaker et al., 2007), or a frm that operates n a more dynamc ndustry may have a greater ncentve to adopt RFID to reduce demand uncertanty (Melvlle et al., 2007). When endogenety s lkely to matter, we cannot obtan unbased estmates usng a tradtonal regresson technque such as by estmatng equaton (b) wth an RFID dummy varable (Greene, 2000). Accordngly, we need to look for an alternatve way that allows us to control for potental endogenety (Maddala, 983; Chang and Gurbaxan, 2008). In the next secton, we dscuss how we can obtan unbased estmates by accountng for potental endogenety. The proft functon after accountng for endogenety The RFID decson s made based on potental costs and benefts. Ths mples that a suppler s choce for RFID adopton s a functon of ex-ante expectaton of ts future proftablty dependng on ts organzatonal characterstcs. Partcularly, ths type of dependency rases the ssue of endogenety (Heckman, 979; Greene, 2000). Therefore, we take the endogenety nto consderaton by explctly ncorporatng a frm s organzatonal characterstcs nto the estmaton procedure. Based on our dscusson earler (see theory secton and hypotheses secton), we use demand fluctuatons and an nventory rato as factors that lead RFID adopton to be favorable. We construct a varable for demand fluctuatons by measurng the dffculty n predcton of future demand (Mlls and Schumann, 985; Melvlle et al., 2007). We also use a rato of nventory to sales one year pror to RFID adopton snce supplers wth a hgh nventory rato may expect to gan greater benefts from usng RFID (Knney and Wempe, 2002). Then, we ncorporate these factors by modelng the selecton functon wth a latent varable * ( RFID,t ) whch represents the preference of a suppler ether to adopt RFID ( RFID, t =) or not ( RFID, t =0) (Heckman, 979; Lee, 983; Maddala, 983). Ths yelds the followng systems equatons: (2) Δ Proft, = 0 + βδir, + β2δse, + β3ms, * f RFID, t = γ 0 DF, t 2IR, t RFID, t = β + controls + ε 3FS, t + controls + η > 0 (3) 0 otherwse where DF, IR and FS n equaton (3) denote demand fluctuatons, nventory rato and frm sze of frm at tme t-, respectvely. ε and η are error terms. The defnton of all other varables s dscussed n equaton (). As n equaton (b), the proft functon ncludes nventory rato, sales effcency, a suppler s market share and Our model also automatcally controls for a porton of ndustry-specfc effects snce a substantal part of ndustry heterogenety can be removed by frst-dfference specfcaton. Twenty Nnth Internatonal Conference on Informaton Systems, Pars

7 Economcs of Informaton Systems control varables. However, equaton (2) does not nclude a dummy varable for RFID adopton, whch s denoted as RFID, t n equaton (b). Rather than drectly estmatng the RFID varable by pluggng t nto the proft functon, we separate t and form systems equatons. That s, the systems equatons allow us to examne the effect of RFID on frm proftablty through the selecton functon (eq.3) whle accountng for potental endogenety (see Maddala, 983 for detals). To resolve the dependency, we also allow the correlaton between the proft functon (eq. 2) and the selecton functon (eq. 3). In other words, the decson process of RFID adopton s reflected on the proft functon through correlaton between two functons. 2 More specfcally, a two-stage regresson approach s employed to estmate the systems of equatons whle controllng for endogenety (Lee 983; Maddala 983). In the frst stage, we run the probt regresson to estmate the probablty of a suppler to adopt RFID based on ts organzatonal characterstcs (eq.3). Then, the proft functon (eq.2) s estmated by ncorporatng the nverse mll s rato (IMR), 3 whch s estmated at the frst stage analyss. As a result of a two-stage estmaton procedure, we can compute the expected proft for a suppler that adopts RFID as follows (see appendx for proof). * (4) E( Δ Proft, RFID, t > 0) = β 0 + βδir, + β2δse, + β3ms, + controls+ ρσimr φ( γ 0 DF, t 2IR, t 3FS, t + controls) where IMR = Φ( γ 0 DF, t 2IR, t 3FS, t + controls) Φ are the normal densty and normal dstrbuton functon, respectvely. φ and performance equaton and the selecton equaton. σ ε s the standard devaton of performance., IMR s the nverse mlls rato. ρ s the correlaton between the We note that the nverse mlls rato (IMR) measures the covarance between the decson for RFID adopton and profts. Accordngly, the statstcal sgnfcance of the IMR coeffcent provdes useful nformaton about the extent to whch the proft and selecton functons are nterrelated. As shown n equaton (4), expected proftablty s dependent on the nverse mlls rato (IMR) whle beng assocated wth uncondtonal expectaton of profts. In addton to the statstcal sgnfcance of the selecton term, the sgn of the coeffcent of IMR s worthwhle to note. The postve coeffcent of IMR mples that RFID adopters are more lkely to acheve greater benefts due to ther characterstcs that make the adopton of RFID more attractve. Accordngly, tradtonal regresson technques such as OLS provde estmates based upward. 4 Data The sample for ths study conssts of frms that have adopted RFID, whch are dentfed by searchng prmary press meda ncludng Busness Wre, PR Newswre, and many others. We use a varety of combnatons of keywords, such as RFID, mplement, adopt, select, announce, and SCM, n the Lexus/Nexus search engne to capture as many RFID-assocated events as possble. We do not consder RFID adopton before 2003 snce the use of RFID n the supply chan drew meda attenton prmarly after Wal-Mart mandated the use of RFID tags for ts supplers n 2003; pror to that, the meda dd not report a frm s plan for RFID adopton as frequently as they do now (RFID Journal, 2003). We also consult Compustat to obtan fnancal nformaton for an analyss we conduct. We drop any frms from our analyss f they are prvately-held or f Compustat does not provde fnancal nformaton such as sales, nventory, and proft-based measures. As a result, we collect 62 supplers that adopted RFID. Next, we create a matched sample of 62 frms that have not adopted RFID as a benchmark for performance mprovements of RFID adopters. Followng the Fnance and IS lterature, we begn wth a set of frms that are n the same 2-dgt SIC code but that dd not adopt RFID (Barber and Lyon, 997: Bharadwaj, 2000). From the screened 2 The estmaton methods that gnore the correlaton between the proft functon and the selecton functon lead to based estmates (Maddala, 983; Greene, 2000). 3 It s a monotonc decreasng functon of the probablty that an observaton s selected nto the sample (Heckman, 979). 4 We wll compare the results estmated from 2-stage regresson wth those from OLS to check the drecton of basness later. 6 Twenty Nnth Internatonal Conference on Informaton Systems, Pars 2008

8 Chang / An emprcal analyss of the RFID effect dataset ntally based on the 2-dgt SIC code, we select the matched frm for the RFID frm as the one closest n sze measured as market captalzaton (L and McNally, 2007). 5 Descrptve statstcs for the key varables are presented n table. We match the data of each RFID adopter wth ts correspondng non-adopter n an adopton year (year 0). Further, note agan that our study examnes the fnancal performance of frms after RFID adopton and dentfes the drvers for RFID adopton by examnng organzatonal factors pror to the decson for RFID adopton. Accordngly, our sample spans from year before RFID adopton to year after RFID adopton. 6 The average frm sze measured n sales s $.27 and $0.69 bllon for RFID and matched frms, respectvely. Ths ndcates that larger frms have been more aggressve n adoptng RFID. Proft margns measured as the rato of operatng profts to sales vary from to and from -0.5 to for RFID and matched frms, respectvely. Lkewse, another proftablty ndex, ROA measured as the rato of net ncome to total assets, shows a smlar pattern. We also consult Compustat to compute sales effcency, nventory rato, a suppler s barganng power and demand fluctuatons. Sales effcency s measured as sales per unt of labor. We use an nventory rato as an nverse measure for nventory effcency by dvdng total nventory nto sales. The market share of a suppler s constructed as a proxy for ts barganng power (Gottnger, 2003). To compute a frm s market share, we aggregate the sales of all frms that operate n the same 2-dgt SIC ndustry wth our sample frm. Accordngly, market share s expressed as a frm s sales dvded by the total sales made n the same 2-dgt SIC ndustry. We also obtan demand fluctuatons by regressng sales on a constant term and a tme trend over 0 years and dvde the resultng standard errors by the average sales of a frm (Mlls and Schumann, 985; Melvlle et al., 2007). Accordngly, the ndex captures the degree of dffculty for a frm to predct ts sales demand. Our sample also ndcates that all varables encompass a wde range, whch leads to hgher explanatory power n regresson analyses. Table : Summary statstcs for the key varables RFID frms Matched frms Average mn max Std Average Mn max std Sales (M$) 2, , , , , ,84.4 proft margns ROA Sales effcency , , Inventory rato Market share Demand fluctuaton Next, t s useful to see f there s any systematc dfference between two sets of frms n a way consstent wth RFID adopton before proceedng wth our formal analyss. It appears that the declne of nventory rato for RFID frms s small from the pre-adopton perod to the post-adopton perod (-0.%). However, non-rfid frms experenced a 5 Whle we follow the standard approach to choose approprate matched frms, our sample selecton crtera mght affect our test results. To check the robustness, we also select the frm that s closest n sze measured as total asset (Stratopoulos et al, 2000) and as net sales (Knney and Wempe, 2002). Results are qualtatvely smlar to those obtaned from orgnal estmates. 6 Whle we capture the effect of RFID by examnng the proftablty for a post-adopton perod ( year after RFID s adopted), t s worthwhle to expand the post-adopton perod to longer years for a longtudnal analyss. Snce most of RFID decsons were made recent years after 2003, however, we are not able to expand our dataset n longer perods. As the technology becomes mature over tme, we wll be able to do further analyses. Twenty Nnth Internatonal Conference on Informaton Systems, Pars

9 Economcs of Informaton Systems 2.03% ncrease n nventory rato. Ths mples that a barely sgnfcant mprovement of nventory effcency for RFID frms may be due to external envronments whch nfluence both RFID and non-rfid frms. To solate external effects, we use control-frm adjusted nventory rato for a year pror to RFID adopton and for a year after RFID adopton. We test control-frm adjusted pared changes from a year pror to RFID adopton to a year after adopton for nventory rato (column 3 n table 2). Ths type of pared-test allows us to examne the net changes n nventory rato and sales effcency, whch are not drven by ndustry heterogenety and economc condtons over sample perods (Bharadwaj, 2000). Our test shows that there s a sgnfcant dfference n an nventory rato between two sets of frms (p=0.0423). As n the case of nventory effcency, however, there s no sgnfcant dfference n sales effcency between two perods, year pror to RFID adopton and year after RFID adopton. However, our test shows that the pared-dfference n sales effcency between two sets of frms s margnally sgnfcant (p=0.094). In general, table 2 shows that RFID frms have acheved hgher nventory and sales effcency relatve to ther counterparts whch mples the heterogenety between two sets of frms. These prelmnary results motvate us to more formally examne the effect of RFID on the fnancal performance of RFID frms. Further, recall that ths motvates us to employ a two-stage Heckman procedure whch accounts for potental endogenety by ncorporatng frm heterogenety n the frst stage analyss. Table 2: Inventory rato and sales effcency changes for RFID and matched frms Inventory rato RFID frms M atched Pared frms dfferences p-value Pre RFID adopton N.S. Post RFID adopton N.S. Δ ( nventory rato) R Δ(nventory rato) M Sales effcency Pre RFID adopton N.S. Post RFID adopton N.S. Δ ( Saleseffcency) R Δ(Saleseffcency) M * Δ denotes the frst dfference; N.S. denotes non-sgnfcant; subscrpt R and M are RFID frms and ther matched sample frms, respectvely. Results As dscussed earler, supplers that adopt RFID wll acheve hgher proft margns than non-rfid adopters. However, a sngle equaton framework addresses lmted nformaton on what organzatonal factors force supplers to adopt RFID and what allows them to acheve hgher proft margns over the years. Our two-stage estmaton procedure provdes a deeper nsght nto condtons under whch supplers adopt RFID and nto whether ther decson leads to hgher performance. We frst begn by presentng the results of the selecton functon that captures organzatonal drvers for RFID adopton (see table 3). The varable of demand fluctuatons expressed as a devaton from prevous sales s postvely assocated wth RFID adopton. As expected, supplyng frms faced wth larger demand fluctuatons are more lkely to adopt RFID (H supported). Ths s consstent wth the noton that RFID provdes the potental for frms to facltate the sharng of demand nformaton along the supply chan whch can remove a sgnfcant porton of demand uncertanty (Cachon and Fsher, 2000; Lee et al., 2000). RFID s recognzed as a technology that mproves nventory effcences by enhancng the vsblty of materals and coordnatng the flow of materals (Mclntyle, 2006; Psello, 2006). Accordngly, frms wth a hgh level of nventory are more lkely to adopt RFID, whch results n hgher nventory effcences. Consstent wth our expectaton, we 8 Twenty Nnth Internatonal Conference on Informaton Systems, Pars 2008

10 Chang / An emprcal analyss of the RFID effect fnd that a pror nventory rato s postvely assocated wth the probablty of RFID adopton at the 0% sgnfcance level. To vsualze our dea, we compute the expected probablty that a frm adopts RFID based on the estmates obtaned from the 2-stage estmaton procedure. Then, we plot the probablty aganst nventory ratos. Fgure presents that the probablty that a frm adopts RFID ncreases as ts nventory rato ncreases. Taken together, our estmates and fgure confrm that frms are more lkely to adopt RFID when ther nventory effcency s low (H2 supported). Frm sze measured as a frm s sales volume s postve and statstcally sgnfcant at the % level (H3 supported). Ths may result from more slack resources avalable for larger frms to ntate costly RFID projects, whch s consstent wth prevous studes (Zhu and Kraemer 2002; Zhu et al. 2006; Whtaker et al. 2007). Taken together, all the varables n the selecton functon are statstcally sgnfcant mplyng that a frm s decson for RFID adopton s nfluenced by several organzatonal characterstcs. Table 3: Estmates from the selecton functon 7 Proft margns ROA Prevous nventory 3.76 (.67)* 3.76 (.67)* Demand fluctuatons (2.9)** (2.9)** Frm sze 0.23 (2.75)*** 0.23 (2.75)*** Constant (-2.7)*** (-2.7)*** *p<0. **p<0.05; t statstcs are ncluded n parentheses. Year and ndustry dummes are not reported for expostonal brevty. Next, we estmate the two proft functons specfed as ether a form of ) proft margns or ) ROA. Table 4 reports an overvew of the results for the two proft functons wth the nverse mlls rato whch s used to control for 7 The estmates from the probt regresson are the same for both proft margns and ROA snce the selecton functon n the frst stage s specfed wth the same varables. That s, we frst run the probt regresson whch use RFID adopton as a dependent varable and organzatonal characterstcs dscussed earler as ndependent varables. Therefore, the estmates from the frst stage probt analyss are dentcal wthout regard that we use proft margns or ROA as a dependent varable n the second stage. Recall that we use both proft margns and ROA to check the robustness of our results. Twenty Nnth Internatonal Conference on Informaton Systems, Pars

11 Economcs of Informaton Systems endogenety n the 2 nd stage estmaton procedure. Table 4: Estmates of the proft functon Proft margns ROA Post Inventory (-3.3)*** (-.94)* Post Sales effcency (.98)** (.7)* Suppler s Market share (-.58) (-0.50) Constant (0.22) (-0.59) Inverse Mll's rato 0.34 (2.06)** 0.5 (.8)* *p<0., **p<0.05, ***p<0.0; t statstcs are ncluded n parentheses. Year and ndustry dummes are not reported for expostonal brevty. We expect that RFID mproves nventory effcency, whch s vewed as a lowered nventory rato n a post-adopton perod. Our estmates suggest that the coeffcent of nventory rato n the proft functon s negatve and sgnfcant, as expected at the % and 0% sgnfcance level for both proft margns and ROA, respectvely. Of course, ths s not surprsng snce frms wth a hgh level of nventory effcences may automatcally be assocated wth n hgher profts (Knney and Wempe, 2002). We conjecture that RFID allows frms to dentfy hdden costs assocated wth large buffer stocks by tracng the flows of materals and nformaton. Thus, frms may be able to reduce nventory nvestments by the ad of RFID. From the prelmnary analyss (see fgure ), we also fnd that RFID adopters acheve greater gans n nventory effcency one year after RFID adopton than ther counterparts. When combned wth our prelmnary analyss, our results suggest that frms that adopted RFID have mproved nventory effcency over years, leadng to hgher proft margns (H4a supported). In a smlar ven, frms may mprove sales effcency, measured as sales per unt of labor over years, after deployng RFID snce t enables them to streamlne and optmze tradtonal packng and shppng actvtes (Curtn et al., 2007). As n the case of mproved nventory effcency n a post-adopton perod, RFID s expected to enhance proft margns through mproved sales effcency (H4b supported). We also nclude a suppler s market share to capture potental varatons n proftablty drven by the barganng power of a suppler n ts suppler-buyer relatonshp. Unlke our expectaton, however, the coeffcent of a suppler s market share s not postvely assocated wth two proftablty measures. Further, the sgns of coeffcents are negatve, although both of them are not sgnfcant. Gven that RFID projects are prmarly motvated by large retalers n a suppler-buyer relatonshp, we conjecture that proftablty of supplers may have been squeezed by retalers market power. (Galbrath and Stles, 983; Kelly and Gosman, 2000). For nstance, large retalers lke Wal-Mart ncreased market power over years and mandate that ther top supplers adopt RFID (Bloom and Perry, 200; Gosman and Kohlbeck, 2006). 8 In a stuaton lke ths, retalers barganng power may have a stronger effect on a suppler s proftablty than that of a suppler (Cool and Henderson, 998; Schamlensee, 985). In another word, a suppler s barganng power proxed as market share mght not play a crtcal role n shapng proftablty n our context. Further, supplers that are forced to adopt RFID are usually large and are more lkely to be represented n our sample. Ths may also mtgate the effect of supplers market share, leadng to nsgnfcant contrbuton of market share to proftablty. Next, t s worthwhle to note the sgn and sgnfcance of the selecton term, the nverse mlls rato (IMR). We fnd a postvely sgnfcant coeffcent of the selecton term (IMR), mplyng that supplers that adopt RFID acheve relatvely greater gans n proft margns and ROA than do randomly selected supplers. Ths ndcates that frms wth unobservable advantages from RFID technology are more lkely to adopt RFID and acheve greater benefts n 8 Due to a lack of data, we are not able to dentfy a set of supplers that are forced to adopt RFID and another set of supplers that are not. However, we have no pror reasons for proft-maxmzng supplers to comply wth large retalers requests wthout consderaton of ther own costs-benefts analyss. Accordngly, we do beleve that t s mportant to reflect supplers decson process for RFID adopton as we do here. 0 Twenty Nnth Internatonal Conference on Informaton Systems, Pars 2008

12 Chang / An emprcal analyss of the RFID effect a post-adopton perod. On the other hand, a tradtonal regresson analyss such as OLS does not account for unobservable benefts. Accordngly, OLS produces estmates that are based upward. Table 5 reports the dfference of OLS estmates from 2-stage estmates we use for analyses. Our test results suggest that OLS estmates are based upward at the 5% or 0% sgnfcance level. Ths allows us to make stronger statements regardng the roles of endogenety n estmatng the effects of RFID. Table 5: The dfferences of OLS and 2-stage estmaton Proft margns ROA 2 stage OLS Dfferences 2 stage OLS Dfference Post Inventory *** *** 0.06* * * 0.020** (-3.3) (-2.64) (-.87) (-.94) (-.65) (-.97) Post Sales effcency * * * * (.98) (.7) (-.65) * * * (.7) (.82) (-.76) Suppler s Market share (-.58) (-.8) (-.23) (-0.59) (-0.5) (-.59) *p<0., **p<0.05, ***p<0.0,+: the coeffcents are computed as the dfference between coeffcent obtaned from OLS and those obtaned from 2-stage estmaton Concluson In ths paper, we examne the mpact of RFID on frm proftablty usng a sample of supplyng frms that adopt RFID and ther matched frms. For ths purpose, we frst analyze the organzatonal drvers for supplers to adopt RFID and examne whether a suppler s decson for RFID adopton mproves profts. Consstent wth our expectaton, the RFID decson s made based on future benefts and costs that are dependent on a suppler s organzatonal characterstcs. We fnd that supplers encountered wth a low level of nventory effcency are more lkely to deploy RFID. Further, frms faced wth large fluctuatons n sales demand are more aggressve n RFID adopton. Ths s consstent wth our noton that supplers consder RFID as a way to mprove nventory effcences and to stablze future demand fluctuatons through mproved nformaton sharng and the flows of materals along sze, possbly due to the supply chans. Our results also show a postve assocaton between RFID adopton and frm avalable resources slack that a frm needs for nvestments n new technologes such as RFID. Our frst stage estmates are ncorporated nto the second stage estmaton, whch allows us to control for potental endogenety between a frm s RFID decson and proftablty. We show that RFID adopters have acheved greater benefts n a post-adopton perod, whch are attrbutable to mproved nventory and sales effcences. Ths s n lne wth our noton, n an analyss of the selecton functon, that frms adopt RFID to mprove nventory effcency. We also fnd a postvely sgnfcant coeffcent for the nverse mlls rato (IMR). Ths suggests that the organzatonal characterstcs analyzed n the frst stage have a sgnfcant mpact on a suppler s decson for RFID adopton. Thus, the use of a two-stage estmaton procedure s crtcal n estmatng the effects of RFID on fnancal performances. In sum, our results provde evdence that RFID adopters outperform non-adopters n the mprovement of proft margns and ROA over a post adopton perod. To the best of our knowledge, ths s one of the frst studes that examnes the fnancal effects of RFID. We extend the lterature by rgorously examnng the busness value of RFID n the context of fnancal performance. Further, we are able to provde an n-depth understandng of how RFID mproves the fnancal performance of RFID adopters by explctly ncorporatng the drvers for RFID adopton nto the estmaton procedure. Our study also provdes valuable nsghts for managers. Frst, we show that RFID can be used to leverage nventory as a compettve weapon by better managng supply chan. Managers should also note that RFID may delver greater benefts when frms are operated n a more dynamc busness envronment. Second, our study suggests that the benefts of RFID may not be lmted to effcency gans n nventory management. We show that RFID adopters fnancally outperform ther counterparts by mprovng sales effcency. Accordngly, managers should evaluate RFID projects perodcally to see f they can beneft from RFID. Fnally, our study gudes managers who are Twenty Nnth Internatonal Conference on Informaton Systems, Pars 2008

13 Economcs of Informaton Systems mandated to adopt RFID but delay ther decson by documentng tangble benefts from RFID. Fnally, t s worthwhle to address the lmtatons of our study. Frst, our search for data collecton from the meda may favor large frms. Accordngly, our data sample mght be drawn from a set of large frms. Snce large frms are more lkely to be better postoned n adoptng new technologes, we should be careful n applyng our results to smaller frms. Second, the mplementaton of RFID s stll n an mmature stage, and frms have started deployng RFID only n recent years. Therefore, we consder a short tme perod, whch does not allow us to gauge the longterm effects of RFID. Fnally, due to a lack of avalable data, we are not able to nclude IT capabltes as a complementary asset to RFID; dong so mght provde more nsghts to researchers and managers (Bharadwaj, 2000; Brynjolfsson and Htt, 2000). We are also not able to control for potental nfluence of busness partner s mandates on supplers RFID adopton. Further research wll beneft from a rcher dataset. Despte these lmtatons, we beleve that our research provdes valuable nsghts nto the value of RFID and an understandng of the nature of benefts derved from RFID adopton. Acknowledgement We thank the track chars, the assocate edtor and three anonymous referees for ther constructve feedback. Fnancal support has been supported by the Unversty of Brtsh Columba, Okanagan Internal Research Grant Program. Appendx In ths appendx, we prove how a suppler s proft s assocated wth ts organzatonal factors by dervng the expected proft. Followng the lterature (Heckman, 979; Maddala, 983; Greene, 2000), we assume that error terms for the proft functon ( ε ) and the selecton functon ( η ) follow normal dstrbuton. Then, the expected proft s specfed as follows: * (A) E( ΔProft, RFID, t > 0) = E( PΔroft, γw, t + u, t > 0) where γ and w are a set of parameters and varables that denote suppler s organzatonal characterstcs. When the proft and the selecton functons have a bvarate normal dstrbuton, we can decompose the expected proft nto two components, uncondtonal expectaton and condtonal expectaton of error term as follows: * E( ΔProft RFID > 0) = E( ΔProft ) + E( ε γw + u > 0) (A2),, t,, t, t Under the assumpton of bvarate normal dstrbuton forε and η the second term of the rght hand sde can be represented va normal densty and cumulatve functons and correlaton between the proft and the selecton functons (Greene 2000). Ths yelds: (A3) * E( Δ Proft, RFID, t > 0) β + β ΔIR + β ΔSE = 0, 2, + β 3MS, + controls + σ ε w ρ f ( φw ) / F( φ ) where f s a normal probablty densty functon and F s a cumulatve normal dstrbuton functon. ρ s the correlaton between the proft functon and the selecton functon. σ ε s the standard error n the proft functon. f ( φ w ) / F( φw) s the nverse mlls rato. Before we descrbe the meanng of equaton (A3), recall that pror nventory rato and demand fluctuatons nduce supplers t o adopt RFID (see table 3). Further, the expected proft of supplers that adopt RFID s determned by the last term, σ ε ρ f ( φw ) / F( w) φ. That s, the effects of a suppler s organzatonal characterstcs have two parts. One s due to ther nfluence on ncreasng the tendency to adopt RFID, and the other s due to ts nfluence on proft through the selecton functon as shown n equaton (A3). Our results show the postve correlaton ( ρ ) between the proft and the selecton functons. Ths ndcates that a hgher tendency to adopt RFID, whch s drven by pror nventory rato and demand fluctuatons n the selecton functon, s postvely assocated to hgher productvty. 2 Twenty Nnth Internatonal Conference on Informaton Systems, Pars 2008

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