Economics and Justification of Electronic Commerce

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

Economics and Justification ofElectronic Commerce


1. Describe the need for justifying electronic commerce (EC) investments, how it is done, and how metrics are used to determine justification.

2. Understand the difficulties in measuring and justifying EC investments.

3. Recognize the difficulties in establishing intangible metrics and describe how to overcome them.

4. List and briefly describe traditional and advanced methods of justifying IT investments.

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5. Understand how e-CRM, e-learning, and other EC projects are justified.

6. Describe some economic principles of EC.7. Understand how product, industry, seller, and

buyer characteristics impact the economics of EC.8. Recognize key factors in the success of EC projects

and the major reasons for failures.

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• INCREASED PRESSURE FOR FINANCIAL JUSTIFICATION– IT executives feel the pressure for financial

justification and planning from top executives, but most face an uphill battle to address this accountability

– In order to achieve the optimal level of investment, CIOs will need to calculate and effectively communicate the value of proposed EC projects

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• OTHER REASONS WHY EC JUSTIFICATION IS NEEDED– Companies now realize that EC is not necessarily the

solution to all problems– Some large companies, and many public

organizations, mandate a formal evaluation of requests for funding

– Companies are required to assess the success of EC projects after completion

– The success of EC projects may be assessed in order to pay bonuses

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• EC INVESTMENT CATEGORIES AND BENEFITS– IT infrastructure provides the foundation for EC

applications in the enterprise– EC applications are specific systems and programs

for achieving certain objectives– Purpose of the investment

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• HOW IS AN EC INVESTMENT JUSTIFIED?– cost–benefit analysis

A comparison of the costs of a project against the benefits

– Business Justification and Business Case

• WHAT NEEDS TO BE JUSTIFIED? WHEN SHOULD JUSTIFICATION TAKE PLACE?

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• USING METRICS IN EC JUSTIFICATION– metric

A specific, measurable standard against which actual performance is compared

– Metrics, Measurements, and Key Performance Indicators• key performance indicators (KPIs)

The quantitative expression of critically important metrics

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• THE EC JUSTIFICATION PROCESS– Five areas must be considered in the justification

of IT projects:1. Strategic Considerations2. Tactical Considerations3. Operational Considerations4. Intangibles5. Tangibles

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• DIFFICULTIES IN MEASURING PRODUCTIVITY AND PERFORMANCE GAINS– Data and Analysis Issues– EC Productivity Gains May Be Offset by Losses in

Other Areas– Hidden Costs and Benefits– Incorrectly Defining What Is Measured– Other Difficulties

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• INTANGIBLE COSTS AND BENEFITS– Tangible Costs and Benefits• Tangible costs are those that are easy to measure and

quantify and that relate directly to a specific investment

– Intangible Costs and Benefits• When it comes to intangible costs and benefits,

organizations must develop innovative metrics to track them as accurately as possible

– Handling Intangible Benefits

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• THE PROCESS OF JUSTIFYING EC AND IT PROJECTS– Lay an appropriate foundation for analysis with your

vendor, and then conduct your ROI– Conduct a good research on metrics and validate them– Justify and document the cost and benefit assumptions– Document and verify all figures used in the calculation– Do not leave out strategic benefits, including long-term

ones– Be careful not to underestimate cost and overestimate

benefits – Make figures as realistic as possible and include risk

analysis– Commit all partners, including vendors and top

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• OPPORTUNITIES AND REVENUE GENERATED BY EC INVESTMENT

• METHODOLOGICAL ASPECTS OF JUSTIFYING EC INVESTMENTS– Types of Costs• Distinguish between initial (up-front) costs and

operating costs• Direct and indirect shared costs• In-kind costs

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• TRADITIONAL METHODS FOR EVALUATING EC INVESTMENTS– The ROI Method– Payback Period– NPV Analysis– Internal Rate of Return (IRR)– Break-Even Analyses

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– total cost of ownership (TCO)A formula for calculating the cost of owning, operating, and controlling an IT system

– total benefits of ownership (TBO)Benefits of ownership that include both tangible and intangible benefits

– Economic Value Added– Using Several Traditional Methods

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• IMPLEMENTING TRADITIONAL METHODS– Business ROI Versus Technology ROI

• ROI calculatorCalculator that uses metrics and formulas to compute ROI– Other Calculators

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• ADVANCED METHODS FOR EVALUATING IT AND EC INVESTMENTS– Most justification methods can be categorized

into the following four types:• Financial approaches• Multicriteria approaches• Ratio approaches• Portfolio approaches

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• JUSTIFYING E-PROCUREMENT• CUSTOMER SERVICE AND E-CRM– e-CRM Metrics

• JUSTIFYING A PORTAL• JUSTIFYING E-TRAINING PROJECTS

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• JUSTIFYING AN INVESTMENT IN MOBILE COMPUTING AND IN RFID

• JUSTIFYING SECURITY PROJECTS• JUSTIFYING SOCIAL NETWORKING AND THE

USE OF WEB 2.0 TOOLS

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• REDUCING PRODUCTION COSTS– Product Cost Curves

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– production functionAn equation indicating that for the same quantity of production, Q, companies either can use a certain amount of labor or invest in more automation

– agency costsCosts incurred in ensuring that the agent performs tasks as expected (also called administrative costs)

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– transaction costsCosts that are associated with the distribution (sale) or exchange of products and services including the cost of searching for buyers and sellers, gathering information, negotiating, decision making, monitoring the exchange of goods, and legal fee

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– Categories of transaction costs:1. Search costs2. Information costs3. Negotiation costs4. Decision costs5. Monitoring costs6. Legal-related costs

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• INCREASED REVENUES– Reach Versus Richness– Other Ways to Increase Revenues

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• REDUCING TRANSACTION FRICTION OR RISK• FACILITATING PRODUCT DIFFERENTIATION– product differentiation

Special features available in products that make them distinguishable from other products. This property attracts customers that appreciate what they consider an added value

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• EC INCREASES AGILITY– agility

An EC firm’s ability to capture, report, and quickly respond to changes happening in the marketplace and business environment

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• VALUATION OF EC COMPANIES– valuation

The fair market value of a business or the price at which a property would change hands between a willing buyer and a willing seller who are both informed and under no compulsion to act. For a publicly traded company, the value can be readily obtained by multiplying the selling price of the stock by the number of available shares

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– Three most common valuation methods:1. The comparable method2. The financial performance method3. The venture capital method

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• FACTORS THAT DETERMINE E-COMMERCE SUCCESS– Product Characteristics– Industry Characteristics– Seller Characteristics– Consumer Characteristics

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• E-COMMERCE FAILURES– Three economic phenomena related to EC failure:

1. At a macroeconomic level, technological revolutions, such as the railroad and the automobile industries, have had a boom–bust–consolidation cycle

2. At a mid-economic level, the bursting of the dot-com bubble from 2000 through 2003 is consistent with periodic economic downturns

3. At a microeconomic level, the “Web rush” reflected an over allocation of scarce resources

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• OPPORTUNITIES FOR SUCCESS: CREATING DIGITAL OPTIONS– digital options

A set of IT-enabled capabilities in the form of digitized enterprise work processes and knowledge systems

• CULTURAL DIFFERENCES IN EC SUCCESSES AND FAILURES

• CAN EC SUCCEED IN DEVELOPING ECONOMIES?

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1. How should the value of EC investment be justified?2. Which investment analysis method should we adopt

for EC justification?3. Shift from tangible to intangible benefits4. What complementary investments will be followed?5. Who should conduct the justification?6. How does one know if the valuation of EC companies

is justifiable?7. Is it possible to predict EC success?

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Documents

Economics and Justification of Electronic Commerce