Over 400,000 people visited Farnam Street last month to learn how to make better decisions, create new ideas, and avoid stupid errors. With more than 100,000 subscribers to our popular weekly digest, we've become an online intellectual hub. To learn more about we what do, start here.

How do firms make a better decision?

There is a growing movement to change the way organizations make decisions – from a reliance on a leader’s “gut instinct” to increasing data-based analytics. Interesting things happen in organizations when you argue more over data and less on subjective thoughts.

The authors below point out that organizations employing data driven decisions tend to perform better than their peers.

While there is a great deal of anecdotal evidence of firms’ using data to gain a competitive edge in the business press and popular books, there has been virtually no systematic data analysis of the productivity effects of data-driven decisionmaking (or DDD) using statistical methods. We seek to address this gap by examining in detail business practices and the information technology investments of 179 publicly traded large firms in the US. We find that DDD can explain a 5-6% increase in their output and productivity, beyond what can be explained by traditional inputs and IT usage. DDD is also associated with significantly higher profitability and market value. While these correlations are consistent with the case evidence, as well as economic theory, econometrics alone cannot rule out the possibilities of reverse causality or omitted variables bias. However, our basic findings remain robust when we use instrumental variables and explore a number of alternative variables that might explain our results. To the best of our knowledge, this is the first study to report a large scale econometric analysis of the relationship between DDD and firm performances.”

Abstract:

We examine whether performance is higher in firms that emphasize decisionmaking based on data and business analytics (which we term a data-driven decisionmaking approach or DDD). Using detailed survey data on the business practices and information technology investments of 179 large publicly traded firms, we find that firms that adopt DDD have output and productivity that is 5-6% higher than what would be expected given their other investments and information technology usage. Using instrumental variables methods, we find evidence that these effects do not appear to be due to reverse causality. Furthermore, the relationship between DDD and performance also appears in other performance measures such as asset utilization, return on equity and market value. Our results provide some of the first large scale data on the direct connection between data-driven decisionmaking and firm performance.

Source: Brynjolfsson, Erik, Hitt, Lorin M. and Kim, Heekyung Hellen, Strength in Numbers: How Does Data-Driven Decisionmaking Affect Firm Performance? (April 22, 2011).

Date:
Filed Under: