Electric commerce chapter 15 economics and justification of EC

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Chapter 15

Economics and Justification

of Electronic Commerce

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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.

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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

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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

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• 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

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• 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

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• 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

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• 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%)

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• How Is an EC Investment Justified?

cost-benefit analysis

A comparison of the costs of a project against the benefits

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• 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

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• Using Metrics in EC Justification

metric

A specific, measurable standard against which actual performance is compared

key performance indicators (KPI)

The quantitative expression of critically

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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

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Exhibit 15.1 A Model for

EC Project Justification

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Difficulties in

• 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

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Difficulties in

• 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

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Difficulties in

• 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

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Difficulties in

– 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

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Exhibit 15.2 Process Approach to IT

Organizational Investment and Impact

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Methods and Tools for

Evaluating and Justifying EC Investments

• Methodological Aspects of Justifying EC

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Investments

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

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• Traditional (Generic) Methods for Evaluating IT

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• 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

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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

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• 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

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• Justifying and Investment in RFID

Although 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

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• 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

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processes

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Exhibit 15.8 Increasing Versus

Decreasing Returns

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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

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Exhibit 15.9 Cost Curve of (a) Regular

and (b) Digital Products

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The Economics of EC

• Production Function

production 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

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Exhibit 15.10 The Economic Effects of EC

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sellers, gathering information, negotiating, decision-making, monitoring the exchange of

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Exhibit 15.11 The Economic Effects of EC:

Transaction Costs

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Exhibit 15.12 Reach Versus Richness

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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

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The Economics of EC

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 the price the stock is

selling over the exchange

• Valuation Methods

– The comparable method

– The financial performance method

– The venture capital method

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Factors That Determine EC Success

• Product Characteristics

• Industry Characteristics

• Seller Characteristics

• Consumer Characteristics

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Factors That Determine EC Success

• The Levels of EC Management

Ultimately, the level of measurement relates to what is

of value to the various constituents at each level

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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

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• Top three factors for EC success

– B2C EC

– B2B EC

– Overall success

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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

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• Cultural Differences

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

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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

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