FRBSF Economic Letter
2004-24; September 3, 2004
City or Country: Where Do Businesses Use the Internet?
In just about ten years or so,
the commercial use of the internet has metamorphosed from a researcher's
tool to an everyday business necessity. Indeed, a large fraction
of the boom in business investment in information technology (IT)
was related to business applications and infrastructure using internet-related
technology.
As more and more firms adopted internet-related technology,
many forecasters predicted that the internet would change both
the way Americans do business and where they do business. Essentially,
the predictions presented two possible scenarios on the latter
point. In one scenario, the internet would bring firms together
into a single "global village," suggesting internet technology
would diffuse more quickly to rural areas than to urban areas.
The argument for this scenario is that the internet decreases coordination
costs within firms and between firms, which reduces the importance
of distance; and internet technology dramatically reduces the costs
of performing isolated economic activity, particularly in rural
settings. In the other scenario, the diffusion of the commercial
internet would follow the historical pattern of "urban leadership." The
argument for this scenario is that the internet, like many other
IT innovations, requires complementary infrastructure and support
services, which are more readily available in urban settings. This
scenario is often used to argue that there is a geographic "digital
divide" favoring larger urban areas in commercial internet
use.
This Economic Letter summarizes research (Forman, Goldfarb,
and Greenstein 2003a, 2003b) finding that the use of basic internet
technology is widely dispersed among both urban and rural locations.
Moreover, although advanced internet technology was adopted most
rapidly in large urban areas, the research finds that much (but
not all) of the apparent "digital divide" in internet
use can be explained by the heavy concentration of internet-intensive
industries in large urban areas.
Commercial uses of the internet:
participation and enhancement
The most common yardstick for measuring new technology use is
the rate of adopting the technology's applications. Forman, Goldfarb,
and Greenstein (2003a) conducted a census on firms' adoption of
internet technology using data on establishments. An establishment
is a single point of contact for a business, usually using a single
mailing address. Most large firms have multiple establishments,
in which case they appear in our study multiple times. We analyzed
the dispersion of use of the internet in two distinct layers, participation and enhancement.
Participation is associated with the adoption
of basic communications, like e-mail use, browsing, and passive
document sharing. It also
represents our measure of the basic internet investment required
to do business. This was easy to measure.
Next we measured the adoption of internet technology as a means
of enhancing sophisticated business computing processes. In
spirit, enhancement uses internet technologies to change existing
internal
operations or to introduce new services. Examples of our measure
of enhancement include electronic commerce transactions with
value chain partners and final purchasers as well as internet-enabled
internal business applications, like enterprise resource planning.
To measure both layers, we used data from the Harte Hanks Market
Intelligence CI Technology database, a private survey of technology
use that includes firms in the manufacturing and services sectors.
Our final sample included 86,879 commercial establishments with
100 or more employees at the end of 2000, and we used routine
statistical methods to project our results to all establishments
in the U.S.
with over 100 employees. This covers the workplaces for two-thirds
of the U.S. labor force.
Urban leadership in internet use?
The overall rates of adoption for participation and enhancement
differ widely. Participation use is widespread across the U.S.
economy, adopted by 88.6% of establishments when projected on to
the true distribution of establishments in the economy. In contrast,
levels of enhancement are much lower, adopted by 12.6% of establishments.
Figure 1 shows the rates at which establishments adopt participation
and enhancement across U.S. metropolitan statistical areas (MSAs)
of varying sizes. Although each type of location shows a high
rate of adoption for participation, the rate of adoption increases
with
location size.
The disparities in enhancement adoption rates are
even greater. The results displayed in Figure 2 show that large
MSAs have the
highest average adoption rates, almost one-third greater than
medium MSAs and nearly 40% higher than rural areas. These simple
differences
in averages suggest that the diffusion of internet technology
followed a traditional urban leadership pattern. However, looks
can be deceiving. The role of industry composition
It is well known that certain industries tend to be concentrated
in different parts of the country—automakers in the Detroit area,
film production and distribution in the Los Angeles area, and financial
services in New York, just to cite a few.
Our results suggest another
kind of concentration; specifically we find that the mix of industries
with the highest enhancement
adoption rates tends to be in the biggest cities. These industries
include management of companies and enterprises, media, telecommunications
and data processing, utilities, finance and insurance, professional,
scientific and technical services, and wholesale trade.
 Our method
of obtaining this result involved calculating the fraction of
the number of these leading establishments (in terms of enhancement
adoption) over the total number of establishments in an MSA;
to
calculate leading establishments, we used the top quartile of
adopters. The results are displayed in Figure 3, and they suggest
that industry
composition accounts for much of the difference in adoption rates
between smaller and larger MSAs.
The marginal effects
of location
To test whether patterns of adopting the internet are consistent
with the global village or urban leadership view, we need to separate
the effects of location from the effects of industry composition.
Therefore, we examined the marginal effects of location on establishment
adoption decisions. These marginal effects answer the question, "How
does location influence internet adoption, controlling for an establishment's
size and industry?" Roughly speaking, marginal effects enable
us to identify whether moving the same establishment from Chicago
to Peoria had an impact on its likelihood of adopting the internet.
In Forman, Goldfarb, and Greenstein (2003b), we controlled for
an establishment's industry and showed that urban leadership
does not describe establishment adoption of participation technology.
If anything, a mild form of the global village view seems more
evident. Medium-sized and large MSAs are 0.5% to 1.0% less likely
to have adopted participation than those in rural areas by the
end of 2000. However, these effects are relatively small compared
to average participation rates of 88.6%. Overall, for simple
technologies,
some of the internet's promise to reduce the costs of distance
seems to hold.
We reach the opposite conclusion for enhancement.
Even with industry controls, the pattern of adoption is more
consistent with the urban
leadership view than the global village view. Establishments
in medium-sized and large MSAs adopt enhancement at a rate 0.8%
to
1.1% higher than do rural areas. These differences are economically
significant in light of the overall enhancement rates of 12.6%.
The dichotomy in diffusion patterns between simple and complex
technologies is consistent with recent work that has emphasized
the importance of adaptation costs to the adoption of "general
purpose" technologies like the internet. To be specific, adoption
of the internet involves substantial costs to adapt a general technology
to idiosyncratic business needs. This adaptation often involves
third-party support and complementary services—often IT services
firms and systems integrators—who will be most commonly found
in urban areas. Moreover, these complementary services will be
most important for complex applications like enhancement. As a
result, we interpret the differences in adoption patterns between
participation and enhancement as evidence that applications more
dependent on third-party support are most costly to deploy in less
dense locations.
Conclusions
Has the use of internet technology by businesses been greater
in urban areas—following the geographic diffusion pattern of earlier
computing technologies—and has it thereby exacerbated local differences
in the potential for economic growth? Or, as a communications technology,
has the diffusion of the internet been more consistent with the
view that it reduces the importance of distance to economic activity?
Our research shows that there are elements of both the global
village and urban leadership views in the geographic pattern of
internet
adoption. By 2000, participation activities like e-mail and web
browsing had diffused almost everywhere, indicating that the
pattern for participation adoption is better explained by the global
village
view. In contrast, for complex enhancement technologies, adoption
behavior is better explained by urban leadership theory; this
pattern makes economic sense, because it could arise from thin
technical
labor markets in smaller MSAs and rural areas, which would drive
up the costs of operating facilities using internet technology.
The answers to these questions are important because of their
implications for regions' comparative advantage. Concentration
of internet use—as
implied by urban leadership—may increase short-run urban/rural
differences in productivity. In the longer run, inexpensive
communications may mean that establishments relocate from high-cost/high-density
areas to low-cost/low-density areas. These remain open questions,
however. Future work should compare the location decisions
in
industries where internet use is prevalent with those in other
industries.
This will help complete the picture of how the internet affects
geographic variance in productivity and employment.
Chris Forman
Assistant Professor, Tepper School of Business, Carnegie Mellon
University, and CSIP Visiting Scholar
Avi Goldfarb
Assistant Professor, Rotman School of Management, University of
Toronto
Shane Greenstein
Elinor and Wendell Hobbs Professor, Kellogg School of Management,
Northwestern University
References
[URLs accessed August 2004.] Forman,
Chris, Avi Goldfarb, and Shane Greenstein. 2003a. "The Geographic
Dispersion of Commercial Internet Use." In Rethinking
Rights and Regulations: Institutional Responses to New Communications
Technologies, eds. Lorrie Faith Cranor and Steven S. Wildman. Cambridge,
MA: MIT Press.
Forman, Chris, Avi Goldfarb, and Shane Greenstein.
2003b. "How Did Location Affect Adoption of the Commercial
Internet? Global Village, Urban Leadership, and Industry Composition." NBER
Working Paper #9979.
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