Ch15 06 29 05

Chapter 15Economics and Justification of Electronic Commerce

Electronic Commerce Prentice Hall © 2006 2

Learning Objectives

1. Describe the need for justifying 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.


Learning Objectives

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 to the success of EC projects and the major reasons for failures.


Why Justify EC Investments? How Can They Be Justified?

• Increased Demand for Financial Justification– Addressing accountability is difficult:

• 65% of company executives lack the knowledge or tools to do ROI calculations

• 75% of company executives have no formal processes or budgets in place for measuring ROI

• 68% of company executives do not measure how projects coincide with promised benefits 6 months after completion



• Other Reasons Why EC Justification Is Needed– Companies now realize that EC is not necessarily

the solution to all problems. Therefore, EC projects compete for funding and resources with other internal and external projects. Analysis is needed to determine when funding of an EC project is appropriate

– In some large companies, and in many public organizations, a formal evaluation of requests for funding is mandated



• Other Reasons Why EC Justification Is Needed– Companies need to assess the success of EC

projects after they have been completed and then on a periodic basis (see Chapter 14)

– The success of EC projects may be assessed in order to pay bonuses to those involved with the project



• EC Investment Categories and Benefits– The IT infrastructure provides the foundation for EC

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

for achieving certain objectives



• Specific Benefits– cost reduction (85%)– productivity improvement (7%)– improved customer satisfaction (6%)– improved staffing levels (5%)– higher revenues (4%)– higher earnings (4%)– better customer retention (4%)– more return of equity (3%)– faster time-to-market (3%)



• How Is an EC Investment Justified?

cost-benefit analysis

A comparison of the costs of a project against the benefits



• Justification may not be necessary when:– The value of the investment is relatively small for the

organization– The relevant data are not available, inaccurate, or too

volatile– The EC project is mandated—it must be done

regardless of the costs and benefits involved



• Using Metrics in EC Justificationmetric

A specific, measurable standard against which actual performance is compared

key performance indicators (KPI)

The quantitative expression of critically important metrics


Difficulties in Measuring and Justifying EC Investments

• The EC Justification Process– The EC justification process varies depending on the

situation and the methods used– In its extreme, it can be very complex


Exhibit 15.1 A Model for EC Project Justification



• Difficulties in Measuring Productivity and Performance Gains

– Data and Analysis Issues– EC Productivity Gains May Be Offset By Losses in

Other Areas– Incorrectly Defining What Is Measured– Other Difficulties



• Relating IT Expenditures to Organizational Performance

• The relationship between investment and performance is indirect

• Factors such as shared IT assets and how they are used can impact organizational performance and make it difficult to assess the value of an IT (or EC) investment



• Difficulties in Measuring Costs and Benefits– Tangible Costs and Benefits—are those that are easy

to measure and quantify and that relate directly to a specific investment

– Intangible Costs and Benefits• Costs may involve having to change or adapt other

business processes or information systems

• Intangible benefits include faster time-to-market, increased employee and customer satisfaction, easier distribution, greater organizational agility, and improved control



– Handling Intangible Benefits• The most straightforward solution to the problem of

evaluating intangible benefits in cost-benefit analysis is to make rough estimates of the monetary values of all of the intangible benefits and then conduct a ROI or similar financial analysis


Exhibit 15.2 Process Approach to IT Organizational Investment and Impact


Methods and Tools for Evaluating and Justifying EC Investments

• Methodological Aspects of Justifying EC Investments

– Types of Costs• Distinguish between initial (up-front) costs and

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

– Break-Even Analyses




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 the intangible benefits




– Business ROI– Technology ROI

ROI calculator

Calculator that uses metrics and formulas to compute ROI

– Economic Value Added



• Traditional (Generic) Methods for Evaluating IT Investments

– Rate of ROI Method– Payback Period– Net Present Value



• Advanced Methods for Evaluating IT and EC Investments

value analysis

Method where a company evaluates intangible benefits using a low-cost, trial EC system before deciding whether to commit a larger investment to a complete system

dashboard

A single view that provides the status of multiple metrics


Examples of EC Project Justification

• E-Procurement– E-procurement is not limited to just buying and selling– It also encompasses the various processes involved in buying

and selling:• Selecting suppliers• Submitting formal requests for goods and services to suppliers• Getting approval from buyers• Processing purchase orders• Fulfilling orders• Delivering and receiving items• Processing payments



• Justifying a Portal– Internal payoff must result in productivity

improvements– External value is determined by revenue generation

• Justifying E-Training Projects– When comparing e-training and traditional training

methods, several factors, most of which are intangible, must be evaluated



• Justifying and Investment in RFIDAlthough such systems offer many tangible benefits that can be defined, many measures cannot be developed due to the fact that the technology is new and that legal requirements (for privacy protection) are still evolving



• Justifying Security Projects– More than 85% of viruses enter business networks via

e-mail. Cleaning up infections is labor intensive, but anti-virus scanning is not

– Employee security training is usually poorly done. Employees told what to do, with little or no time devoted to why specific security rules are in place


The Economics of EC

• Production Costs– Increasing Returns to Scale

network effects

Effects created when leading products in an industry attract a base of users, which leads to the development of complementary products, further strengthening the position of the dominant product


The Economics of EC

• Production Costs– Increasing Returns to Scale

lock-in effect

Effect created when users do not switch to another site because of barriers posed by having to learn new site navigation systems and transaction processes


Exhibit 15.8 Increasing Versus Decreasing Returns


The Economics of EC

• Production Costs– Product Cost Curves

average-cost curve (AVC)

Behavior of average costs as quantity changes; generally, as quantity increases, average costs decline


Exhibit 15.9 Cost Curve of (a) Regular and (b) Digital Products


The Economics of EC

• Production Functionproduction function

An 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 costs

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


Exhibit 15.10 The Economic Effects of EC


The Economics of EC

• Production Costs

transaction costs

Costs that are associated with the distribution (sale) and/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 fees


Exhibit 15.11 The Economic Effects of EC: Transaction Costs


Exhibit 15.12 Reach Versus Richness


The Economics of EC

• Reducing Transaction Friction or Risk

product differentiation

Exploiting EC to provide products with special features to add greater value to customers


The Economics of EC

agility

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


The Economics of EC

valuationThe 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 the price the stock is selling over the exchange

• Valuation Methods– The comparable method– The financial performance method– The venture capital method


Factors That Determine EC Success

• Product Characteristics

• Industry Characteristics

• Seller Characteristics

• Consumer Characteristics


Factors That Determine EC Success

• The Levels of EC ManagementUltimately, the level of measurement relates to what is of value to the various constituents at each level


Opportunities for Success in EC and Avoiding Failure

• E-Commerce Failures– At a macroeconomic level, technological revolutions

have had a boom–bust–consolidation cycle– At a mid-economic level, the bursting of the dot-com

bubble in 2000–2003 is consistent with periodic economic downturns

– At a microeconomic level, the “Web rush” reflected an over allocation of scarce resources—venture capital and technical personnel—and too many advertising-driven business models



• Top three factors for EC success– B2C EC

• effective marketing management• an attractive Web site• building strong connections with the customers

– B2B EC• readiness of trading partners• information integration inside the company and in the supply chain• completeness of the EC system

– Overall success • proper business model• readiness of the firm to become an e-business• internal enterprise integration



digital options

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

complementary investments

Additional investments, such as training, made to maximize the returns from EC investments



• Cultural DifferencesCritical elements that can affect the value of EC across cultures are perceived trust, consumer loyalty, regulation, political influences

• EC in Developing EconomiesDeveloping economies often face power blackouts, unreliable telecommunications infrastructure, undependable delivery mechanisms, and the fact that only a few customers own credit cards


Managerial Issues

1. How do we measure the value of EC investment?

2. What complementary investments will be needed?

3. How do we shift from tangible to intangible benefits?

4. Who should conduct a justification?

5. Should we use the ROI calculator provided by a vendor who wants to sell us an EC system?


Summary

1. The need for EC justification.

2. The difficulties in justifying EC investment.

3. Difficulties in established intangible metrics.

4. Traditional methods for evaluating EC investments.

5. Understand how specific EC projects are justified.

6. EC investment evaluation.

7. E-marketplace economics.

8. Reasons for EC success and failure.

Education

Ch15 06 29 05