Copyright 2000 Paul Farris, Phil Pfeifer, and The Darden ... · Internet. What is the highest bandwidth that a cable modem can carry?” 28.83% wrong At present, 10Mbps is the highest

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Copyright 2000Paul Farris, Phil Pfeifer, and The Darden School

Copyright © 2000 by Paul Farris, Phil Pfeifer, and the Darden School of the University of Virginia, Charlottesville, VA. All rights reserved. No part of this document may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means –electronic, nechanical, photocopying, recording or otherwise – without the permission of the copyright holder. 1

Evolution of Internet Business Models

Content Advertising Commerce Relationships

B2C C2C B2B B2E

BXB B2A P2P

Evolution of Internet Business Models• Business Types/Models• ISP Online Access

– Prodigy, Compuserve• WWW Software (Mosaic)

– Netscape, Eudora,• Content

– USA Today• Navigators/infomediaries

– Yahoo, gopher• Advertising

– DoubleClick, Yahoo• E-tailing

– Amazon.com• Services

– E-trade, Travelocity• Exchanges

• Concepts

• Relationships • Networks, lock-in• Standards wars• Community• Affiliation• Disintermediation

• Reintermediation• Hypermediation• Syndication• Click & Mortars

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E-business I: The Transformational Impact of Electronic Commerce

• Business models• LTV/Traffic Metrics• Disintermediation• Virtual integration• Exchanges• Portals/ISPs• Convergence• Content models• Webonomics

• Progressive/Insweb(disinermediation, infomediaries)

• Online Grocery Models (brick & clicks, the last mile)

• Cisco Systems (global networked business models)

• Beer Game/Dell• Ford (E-hubs)• W.R. Hambrecht, Island, Catex• Onstar (syndication)• AOL + TWX = ?• Napster (peer-peer)

Business Development

BusinessFunction &Value Chain

Competition:Click & Bricks Profit &

EconomicModel

FinancingModel

UserActivity

Operating &Technology

Human Resources

KnowledgeManagement

Progressive

Cisco

Ford Online Groceries

Catex

Island

W.R.Hambrect

OnStar

AOL/TWX

Webonomics

Traffic Metrics

Lifetime Value

Technology

Beer Game

Napster

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Brooklyn Bridge

• The fact that the Internet is not ownable is an annoyance that few buyers are willing to accept. They know there must be something they can buy. In the age of the Internet, many Brooklyn Bridges will be sold.

Burn Rate by Michael Wolff

Intro to Ebiz I

• Atoms to Bits -- Moore’s Law• Networks -- Metcalfe’s Law• The New Economy

– Increasing returns– Deconstruction

• Business Models?• Course Details• Review

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Top 10 Toughest e-Quiz

Questions

#10. From the web metrics quiz:

'Dividing a Web site's total monthly sessions by its monthly unique visitors would yield a number analogous to what?'

23.81% wrong

Frequency is obtained by dividing a Web site's total monthly sessions by its monthly unique visitors.

A. Reach

B. Page views

C. Frequency [correct answer]

D. Hits

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#9. From the technology quiz:

“Cable modems are the cable industry's response to the demand for increased access to the Internet. What is the highest bandwidth that a cable modem can carry?”

28.83% wrong

At present, 10Mbps is the highest bandwidth a cable modem can carry.

I wouldn’t worry about this one for

the exam!

A. 400 Kbps

B. 10 Mbps [correct answer]

C. 100 Mbps

D. 500 Mbps

#8. From the web metrics quiz:29.76% wrong

On the internet, a site's reach is defined as:

A. The number of gross impressions during a given time period

B. Unique visitors as a % of the total Web visitors during a given time period [correct answer]

C. Gross impressions as a % of the total audience during a given time period

D. The number of hits divided by the number of files served in a given time period, expressed as a %

A site's reach is defined as the number of unique visitors as a % of the total Web visitors during a given time period.

Remember, reach is an unduplicatedpercentage based on a total target audience.

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Another View

• Impressions = Reach * Frequency• GRPs = Reach% * Frequency• Total Sessions = Unique Visitors * Sessions/UV• Web Reach = UV site/ UV all of web

#7. From the lifetime value quiz:

When Amazon.com announced it was going to sell toys, the LTV of eToys’ customers:

A. Went down [correct answer]

B. Stayed the same

C. Went up

D. I have no idea

The moment eToys finds out that Amazon will enter the toy business,eToys expectations for future profits from its customer relationships have to go down (assuming, of course, that Amazon is a competent competitor).

30.46% wrong

Hmmmmm……

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#6. From the web metrics quiz:30.95% wrong

What are the following? A user is on one Web content page and clicks on a link to go to another page. The ads below appear after the user clicks the link, but before going to the next page. What kinds of ads are these?

A. Intermercial

B. Interstitial

C. Transitional

D. All of the above [correct answer]

#5. From the lifetime value quiz:37.09% wrong

What horizon is assumed in the simple LTV model?A. 10 periods

B. 15 periods

C. An infinite number of periods [correct answer]

D. The simple LTV model makes no assumption about the length of the horizon

The simple LTV model discounts all future expected cash flows over an infinite horizon.

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#4. From the web metrics quiz:

Some measure web traffic by the number of "hits" a Web page receives. What is a hit?

A. A unique page request

B. The accessing of a file on a server by a user [correct answer]

C. The number of opportunities for a Web site to appear in a user’s browser

D. All of the above

Every element of a requested page, including its html file, counts as a hit. Therefore, if a user requests a web page from a server containing 9 pictures, then the act of accessing the page generates 10 hits. Therefore, this is not the most reliable measure of web traffic

38.69% wrong

#3. From the lifetime value quiz:In the complicated LTV model example, LTVs went from $186 to $395 to $494 to $509 with each purchase. What will the LTV be at the next purchase?

A. Something higher than $509

B. $509 [correct]

C. $499 [also correct]

D. I’ve got no idea –I’ve always hated these kind of questions

If you use the spreadsheet to calculate the LTV at the fifth purchase, you get $498. A customer at the fourth purchase is identical to a customer at the fifth purchase because both have a constant future renewal rate of 95%. The LTV calculated at the fifth purchase is lower only because the spreadsheet model uses a finite 15-year horizon.

If we extend the horizon, the calculated LTVswould not be appreciably different from each other. So in “theory” the LTV should remain constant after the fourth purchase, but in practice the finite-horizon calculation decreases.

41.06% wrong

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#2: From the lifetime value quiz:

True/False: If the top 20% of firm A’s customers represent 80% of A's profits and the top 20% of firm B’s customers represent only 60% of B's profits, then firm A probably has a more diverse set of customers.

A. True [correct answer]

B. False

Higher profits from the top 20% are a sign that your customers are more diverse. (There is more heterogeneity in individual customer profits…the best are better and the worst are worse.)

59.6% wrong

#1: From the lifetime value quiz:After careful analysis, a firm discovered that the top 20% of its customers accounted for about 20% of company profits. What can we say about the firm’s customers?

A. The customers’ profits are uniformly distributed.

B. The customers’ profits are normally distributed.

C. The firm profits equally from each customer. [correct answer]

D. The customers are not as profitable as they need to be for the firm to remain competitive.

The firm profits equally from each customer.

The only way 20% of company profits comes from the top 20% of the customers is if all customers have identical profitability. If even one customer is more profitable than the others, the top 20% will represent more than 20% of total company profits. If even one customer is less profitable than the others, again the top 20% will represent more than 20% of company profits.

62.25% wrong

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Honorable Mention: From the LTV quiz:Arttoday.com sells annual memberships for $59.95. Fulfillment and remarketing take place over the web at close to zero incremental cost. What is the LTV of a customer at an annual churn rate of 40%? (Use a 10% hurdle rate)

A. $94

B. $100

C. $132 [correct answer]

D. $150Using the simple LTV model with $M = $59.95, r = 0.6, d = 0.1, and $R = 0 gives $132.

23.18% wrong

LTV = $M + [$M – $R/r]? [r/(1+d-r)]

LTV = 59.95 +[59.95-0/0.6] x [0.6/(1+0.1-0.6]

LTV = 59.95 +[59.95] x [0.6/(0.5)]

LTV = 59.95 +71.94

LTV = 131.89

discount rate per periodd

retention rate (fraction of current customers retained each period)

r

Retention Spending per period per active customer.

$R

Contribution per period from active customers.

$M

Intro to Ebiz I




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Intro to Ebiz I




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Start with people who Believe

• “If you don’t believe deeply, wholly, and viscerally that the Net is going to change your business, you’re going to lose. And if you don’t understand the advantages of starting early and learning fast, you’re still going to lose.” – Hamel & Sampler, Fortune, 12/7/98

Intro to Ebiz I




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Moore’ Law(Gordon Moore, Co-founder, Intel)

Source: the killer app, Larry Downes and Chunka Mui, Harvard Business School Press, 1998

• Computing power doubles every 18 months while costs are constant.

Storage has followed the same law!

Bandwidth too!

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Avoiding a Data Crunch

100,000,000

10,000,000

1,000,000

100,000

10,000

1,000

100

10

119721962 19671957 1977 19971987 19921982 2002

DENSITY OF DATA STORED on a magnetic hard disk increased 1.3 –million-fold in the four decades after IBM’s introduction of the first commercial disk drive in 1957. Improvements in miniaturization have been the primary catalyst for the spectacular growth.

Year

SOURCE: Avoiding a Data Crunch (Scientific American 05/00) - Magnetic Recording: The First 100 Years by E. D. Daniel ET AL IEEE Press, 1999.

Are

a/D

ensi

ty (k

ilobi

ts p

er s

quar

e in

ch)

Hard-Disk Drives

SALES OF HARD-DISK DRIVES have soared as costs per megabyte have plummeted. Sales revenues are expected to grow to $50 billion in 20002

SOURCE: Avoiding a Data Crunch (Scientific American 05/00, p.59)

In the coming years the technology could reach a limit imposed by the superparamegnetic effect, or SPE. When the energy that holds the magnetic spin in the atoms making up a bit (either a 0 or 1) becomes comparable to the ambient thermal energy. When that happens, bits become subject to random “flipping” between 0’s and 1’s, corrupting the information they represent.

Prices

Sales

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Gilder’s Law

Source: Forbes ASAP, April 3, 2000, pg. 171-2 (http://www.forbes.com/asap/00/0403/171.htm)

Bandwidth rising 10 times as fast as Moore's Law and storage nearly twice as fast, computers no longer spearhead the economy.

The telecosmic vision of nearly infinite wave-borne bandwidth does for communications what Moore'sLaw did for computing: It defines the direction of technological advance. The capacity of a fiber-optic cable is measured in petabits --10 to the 15th bits--per second. In 1998, all Internet traffic in the world added up to a few petabits per month.

Storewidth?

With the wait for information on the World Wide Web governed by the latency of light, storewidth brings the data closer and makes them more accessible.

The keys to storewidth are directories, search engines, databases, and disk arrays. With the Internet best defined as a colossal computer database on a planet, the storewidth stars are becoming market luminaries. Leading today in directories is Novell; in search engines, Inktomi; in databases, Oracle; and in disk arrays, Quantum and IBM.

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Input Substitution

Land

Labor

Capital

Land

Labor

Capital

Land

Capital

LaborThe Enterprise

DigitalInputs

PhysicalInputs

Moore’s Law Predicts:

The Enterprise

DigitalInputs

PhysicalInputs

Digital Inputs will substitute for Physical Inputs

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Input Substitution at Dell

Capacity

Inventory

Information

Capacity

Inventory

Information

The Enterprise

Moore’s Law Predicts:

Atoms

0011100 0011100011001110001110

10011100 00111

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Intro to Ebiz I




Sarnoff’s LawBroadcast Networks

• The value of a broadcast network is proportional to the number of members – television network– magazine advertising

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Metcalfe’s Law(Robert Metcalfe, Inventor of Ethernet)

• The value of a communications network is proportional to the number of members SQUARED– Telephones, faxes, Email

Utility

Utility = Users2

UsersSource: the killer app, Larry Downes and Chunka Mui, Harvard Business School Press, 1998

The Value of a Communications Network Is Proportional to n2

• For each individual, the value of the network is proportional to the number of other individuals on the network.

Vi = k ? (n-1)• Since there are n members of the network, the

TOTAL value is: n ? k ? (n-1) = k ? n ?(n-1) ? k ? n2

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Reed/Kelly’s LawCommunity Networks

• The value of a group-forming network is proportional to the number of possible groups---2^n– AOL chat– eBay

Network Scaling Economies

• Networks can support multiple value propositions

• TOTAL VALUE = a*n + b*n^2 + c*2^n– typically a > b > c

• COST is proportional to n

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Standards War, Path Dependence4’ 8.5” versus 5’

Rutsin theRoad

Wireless Standards War?

• WML instead of HTML• “In truth, WAP probably isn’t the best solution, bu

that is almost immaterial. The rest of the world has siezed on it. The U.S. providers should too.

– E.Hold, Industry Standard , 5/29/00

• Geoworks owns key patents of certain components in the U.S., but not Europe.

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Intro to Ebiz I




Ronald Coase

One Big Firm Lots of Little Firms

TRANSACTION COSTS

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Transaction Costs

• Information costs• Bargaining Costs• Decision Costs• Policing Costs• Enforcement Costs

The Internet Reduces Transaction Costs.

Proof? Go to EBAY.

One Big Firm Lots of Little Firms

The IN Reduces Transaction Costs faster

than it reduces beurocracy

Law of Diminishing Firms

VERTICAL INTEGRATION

VIRTUAL INTEGRATION

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Reasons for Smaller Firms:Need for Speed

The bad news is small, agile firms are eating our lunch!

• The good news is that at the rate we are losing business, we’ll soon be a lot smaller!

• Business is more complicated, we need to focus on what we do well.

Deconstruction• The connection between information and things is

weakening:

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Deconstruction• The economics of information is fundamentally

different from the economics of things – Once something is sold, the seller no longer “owns” it.

– Things are costly to manufacture, duplicate, and ship.– Things wear out with use.– Things are costly to store and maintain.– Things exists in a location—to be taxed and regulated.– Perfect competition (helps) determines the price of things.

DeconstructionMost businesses are bundle of information and physical things.

TRADITIONAL BOOK STORE

Books as information about the book

Books as available inventory

Unbundling the information from the physical things allows each to operate according to its own distinctive economics.

AMAZON.COM

Website with information about the books

Warehouse delivery of physical books

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Deconstruction

• Deconstruction will strike where the incumbent can least afford it.– Newspapers’ classified ads– Groceries’ prescription drug sales

• The insurgent’s greatest advantage is the unwillingness of the incumbent to fight on a deconstructed definition of the business.

Intro to Ebiz I




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Everything we need to know about the New Economy, we learned …

Playing Monopoly

Most^

A Quick Review

Metcalfe’s Law--RRs

TOTAL VALUE

one RR $25

two RR $100

three RR $300

four RR $800

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Increasing Returns--Mediterranean

Increases in Rent

one house $6

two houses $20

three houses $60

four houses $70

hotel $90

Increasing Returns Up to Some PointThen Decreasing & Constant Returns

BoardwalkIncreases in Rent

one house $100

two houses $400

three houses $800

four houses $300

hotel $300

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Positive Feedback

Rental Income

Property

either $ or bankruptcies

Hallmarks of the New Economy

• Market instability (markets tip in favor of a product that gets ahead).

• Multiple potential outcomes• Unpredictability• The possible predominance of an inferior product• Fat profits for the winner-take-all

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• The makers of MONOPOLY needed a winner take all situation, so they created increasing returns.

• If new economy is characterized by increasing returns…it will create winner take all situations.

Playing in the Casinos of Technology

• Start with something that works• Then adapt, adapt, adapt. • Be prepared to abandon your old business model.• Manage innovation as a portfolio of options –

place many bets (use real option theory)• Invest heavily in your advantages• Move at internet speed

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Evolve or Die

• Start with something that works• Then adapt, adapt, adapt. • Be prepared to abandon your old business model.

Look for Partners, Form Alliances

• Have to focus on what you do best, but..• Selective acquisitions can change your relative

position

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The Deal

• By giving AOL part (19.9%) of our company, it would give us access to its audience. The monthly guarantee would force AOL to make good on this access; the more AOL opened its audience to us, the more money AOL made from commissions. By giving AOL control of our ad sales AOL would be motivated to open the spigot of its audience to us.


Acquisitions Pace Picking Up

• “Market sectors are converging, so those who don’t move swiftly risk being left behind. If a deal makes sense, it will close fast. The combination must put the company in the driver’s seat as the dominant market leader, rising above a splintered group of competitors.”

– Roger Siboni, CEO E.piphany– Bought three companies this year

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GOOD LUCK ON

THE EXAM!

The EndThe End

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Advertising

• What’s your business model? Oh, advertising. Suddenly, you would have been hard-pressed to find anybody but some old fools who didn’t think the future of marketing was in interactive media.

• Where’s the money? You’re gonna sell advertising? Advertising? I know about selling advertising? It’s hard to sell advertising. You can’t just sell advertising.”


Advertising Costs

• The cost was $.02 for every person who typed in “cigar.” ..the Web surfer would see, in addition to the forty thousand or so references to cigars on the Web, our horizontal ad…you have to click on our ads and be transported to our Web site, where we would tell you about our book..3% of the people clicked on our ad. Instead of $20 CPM our real cost was something like $666 CPM. Of those people, .005 bought a book – a $22 book…for $666 we generated $110 in sales.


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Relationships

• First capture large audiences of users or shoppers (selling products below cost, if necessary) and only later “monetize” those audiences.– profit from a customer = quality/cost advantage + total

switching costs– AOL email addresses, buddy lists, keywords– MyYahoo! Portfolio trackers– FedCenter Web Hosting for Sellers

– Amazon – One-click Shopping

A ROAD MAP THROUGH THE DECISION PROCESS

Source: Get the Right Mix of Bricks & Clicks, Ranjay Gulati and Jason Garino Harvard Business Review (May -June 2000, p. 114)

yes Will we target a different customer segment or offer a different product mix on-line than in stores?

Separation IntegrationBrand

yesDoes the brand extend naturally to the internet?

yes Will we need to price differently on-line than in stores to stay competitive?

ManagementyesDo current executives have the skills and experience needed to pursue the internet channel?

yesAre they willing to judge the Internet initiatives by a different set of performance criteria?

yes Will there be major channel conflict?

yes Does the Internet fundamentally threaten the current business model?

Operations

yesDo our distribution systems translate well to the Internet?

yesDo our information systems provide a solid foundation on which to build?

yesDoes either system constitute a significant competitive advantage?

yes Are we having trouble attracting or maintaining talented executives for the Internet division?

yes Do we need outside capital to fund the venture?

yes Is a certain supplier, distributor, or other partner key to the venture’s success?

Equity

Which clicks-and-mortar approach should you adopt? Although the integration-separation decision is not an either-or choice, the following questions will help you discover which aspects of your on-line channel you should integrate and which you should keep distinct.

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Business Development

Advertising (Online)Portal dealsAdvertising (Offline)Affiliate dealsReferralsViral marketingDirect salesBricks & mortars

The Deal

• By giving AOL part (19.9%) of our company, it would give us access to its audience. The monthly guarantee would force AOL to make good on this access; the more AOL opened its audience to us, the more money AOL made from commissions. By giving AOL control of our ad sales AOL would be motivated to open the spigot of its audience to us.


Documents

Copyright 2000 Paul Farris, Phil Pfeifer, and The Darden ... · Internet. What is the highest bandwidth that a cable modem can carry?” 28.83% wrong At present, 10Mbps is the highest