Chapter 2 Information Technology’s Strategic Importance

Introduction IT is changing the fabric of our society –Shifts power from governments to citizens –Flow of intellectual property is no longer constrained by national boundaries IT is changing business –Senior executives expect IT to play a central role in streamlining operations and to link customers, suppliers, and employees more closely

The Current Challenge Walter Wriston, former Chairman of Citicorp, “The essence of an information strategy is to turn the burden of burgeoning business data into a bounty of business opportunity. The business organization has to be rebuilt around the goal of managing information productively. The object of the game is to get information to the person or company that needs and can use it in a timely way.”

Strategic Systems in Action Over the past two decades, information systems have been used to create value in business. Two industries, airlines and financial services, created systems that have resulted in significant competitive advantage to their owners. These systems have not been static, and their evolution is impressive given the dramatic changes in technology and the business environment over time.

Airline Reservation Systems In the 1960s, American Airlines created SABRE (Semi-Automated Business Research Environment) Initially invested $350 million to create the system –Provides reservation services for airlines, hotels, and rental cars –Links travel agencies, private or corporate travel systems, and Internet customers

SABRE Evolution AA continued to expand the system and provide outsourcing reservation services to competitors –Integrated back office management for travel agencies –Added a yield-management system to optimize fare structure and load factors –An upgraded yield-management system in 1997 increased corporate profits by $200 million

Competitors United Airlines created “Apollo” in the 1970s to compete with SABRE –Initial cost of $250 million –1987 spun off to UAL subsidiary COVIA Corp –COVIA sold to partners in 1988, valuing the company at $1 billion (renamed Galileo) –Galileo’s IPO in 1997 valued the company at $2.5 billion –In 1999, Galileo earned $218 million on revenues of $1.53 billion

Internet-Based Systems Alaska Air Group created ITMs (Instant Travel Machines) –These machines use a kiosk type interface to create travel reservations in hotels, airports, and business locations –They bring the power of advanced reservations systems to busy travelers in a convenient location –Coupled with paperless ticketing (e-tickets), these technologies are reducing business cost and increasing customer access

Online Travel Services Arguably, the single most successful B2C e- commerce segment – attracts single largest audience, and largest slice of B2C revenues Internet becoming most common channel used to research travel and book reservations 2003: $38 billion in revenue, expected to grow to $70 billion by 2007 Popular because they offer consumers more convenience (one stop – offers content, commerce, community, customer service) than traditional travel agents For suppliers, offers a singular, focused customer pool that can be efficiently reached

10 Total U.S. Online Travel Booking Revenue Figure 11.9, Page 663

Travel as the Ideal Internet Product/Service An information-intensive product An electronic product in the sense that travel arrangements can be accomplished for the most part online Does not require inventory Suppliers are always looking for customers to fill excess capacity Do not require an expensive multi-channel presence

Online Travel Services Components Airline reservations the largest single component ($21 billion in 2002; $39 billion in 2006) Hotel reservations ($7 billion in 2002, $15 billion in 2006) Car reservations ($3 billion in 2002, $7 billion in 2006) Cruise/tour reservations: fairly slow growth since not as well suited for online environment Major segments: –Leisure –Business travel – expected to be a major growth area as corporations seek better control of corporate travel expenses

13 Projected Growth of Online Travel Market Components Figure 11.10, Page 665

14 Projected Growth of Managed and Leisure/Business Travel Figure 11.11, Page 666

Online Travel Industry Dynamics Competition among online providers is intense Industry is going through a period of consolidation as stronger, offline established firms purchase weaker and relatively inexpensive online firms Suppliers (the large national airlines, hotel chains, auto rental companies, etc) are attempting to eliminate the intermediaries such as the global distribution systems and travel agencies, using the Web as a means  Examples: Orbitz (airline consortium), auto rental company direct-to-customer Web sites.

16 Large Online Travel Sites Table 11.11, Page 667

17 The Travel Services Value Chain Figure 11.12, Page 668

Insight on Business: Orbitz Takes Off A joint venture formed by American, Continental, Delta, Northwest and United Opened for business June 2000; today in 3 rd place behind Expedia and Travelocity in terms of visitors Offers unique search technology and wide selection, low fares from its industry owners One of few examples on Web of “manufacturer-direct” Industry competitors have claimed unfair competition and antitrust issues

E-commerce in Action: Expedia.com Online travel services company that provides access to information about and sales of travel arrangements Originally started by Microsoft, subsequently purchased by USA Networks (now InterActiveCorp) One of top players in online travel services, generating revenues of $591 million in 2002

20 Expedia, Inc. Consolidated Statements of Operations and Summary Balance Sheet Data Table 11.12, Page 673

Stock Brokerage Systems In 1977, Merrill Lynch introduced the CMA (Cash Management Account) –Combined checking accounts, debit cards, and margin-based brokerage accounts into a single entity –Customers received a consolidated account statement at the end of the month –Cash was automatically swept into a money market account –By 1980, it served 186,000 accounts

CMA Evolution 1981 – CMA available nationwide –500,000 accounts 1982 – International CMA launched 1987 – $150 billion in assets under management –1.3 million accounts –Started ATM access via Visa Premier program

CMA Intellectual Property Merrill was granted US patent in August 1982 –This patent effectively allowed Merrill to stop competition in unified accounts for 7 years During active development of CMA, the Merrill Lynch technology budget was estimated to be approx. $1.5 billion

Internet-Based Competitors The brokerage industry underwent dramatic changes with widespread Internet use –Barriers to entry were removed as local office infrastructure became less important to investors –Charles Schwab, E-Trade, Fidelity, and others embraced Internet transactions to expand and increase market share

Schwab.com Features

Online Financial Services Online financial services sector an example of an e-commerce success story, but success is somewhat different from what had been predicted Pure online financial services firms in general are not yet consistently profitable Multi-channel established financial services firms are showing fastest growth and strongest prospects

Online Asset Growth 2003: About $3.5 - $3.7 trillion managed online By 2005, estimated to grow to $5.4 trillion 2003: About million households bank online; about million household trade online By 2007, estimated online banking households will grow to 57 million; online investing households will grow to 41 million Northern Europe (Norway, Finland, Sweden) lead all regions in movement to online banking

28 Growth of Online Investable Assets (in Trillions) Figure 11.4, Page 633

29 Online Investing and Banking Figure 11.5, Page 634

30 Online Banking Penetration in Various Countries (2002, As a Percentage of Total Banking) Table 11.1, Page 635

31 Online Consumers’ Financial Activities (2002, As a Percentage of Online Consumers) Table 11.2, Page 635

Financial Service Industry Trends Financial services industry provides four generic kinds of services:  Storage of and access to funds  Protection of assets  Means to grow assets  Movement of funds Two important global trends  Industry consolidation (Financial Reform Act of 1998 amended Glass-Steagall Act and allows banks, brokerages and insurance firms to merge)  Movement toward integrated financial services (financial supermarket model)

33 Traditional Providers of Financial Services Table 11.3, Page 636

34 Industry Consolidation and Integrated Financial Services Figure 11.6, Page 637

35 The Financial Supermarket Model: Integrated Online Financial Services Figure 11.7, Page 638

Online Banking and Brokerage Online banking pioneered by NetBank and WingSpan Established brand name national banks have taken a substantial lead in market share Early online brokerage leaders, such as E*Trade and Ameritrade have also been displaced at top by established firms (Fidelity and Charles Schwab) Online consumers have made it known that they prefer multi-channel firms with physical presence Multi-channel firms have lower customer acquisition, conversion and retention costs However, users of pure online firms utilize them more intensively

37 The Leading Financial Services Firms Table 11.4, Page 640

E-commerce in Action: E*Trade E*Trade: 4.1 million online customers; offers online brokerage, banking,lending, corporate financial services  Discounted commissions on stock trades, free online information, online order entry, more efficient order execution, and better customer service Online brokerage industry growth torrid ; has slowed somewhat since However, despite extraordinary growth and success, not consistently profitable; collapse of stock market and its impact on E*Trade demonstrated fragility of its reliance on pure online domestic brokerage Has since been seeking to expand physical presence and diversify revenue streams

39 E*Trade Group’s Consolidated Statements of Operations and Summary Balance Sheet Data Table 11.5, Page 644

40 E*Trade Key Performance Indicators Table 11.6, Page 646

41 E*Trade Cost per New Account and Average Commission per Transaction Table 11.7, Page 646

Financial Portals Provide comparison shopping services, independent financial advice and financial planning Financial portals generate revenue from advertising referral fees and subscription feels Examples: Yahoo! Finance, Quicken.com, MSNMoney, AOL’s Personal Finance channel A major source of visitors to major established financial services sites Add to online price competition in financial services industry

Strategic E-Business Systems Internet-based technologies can radically reshape markets resulting in massive realignment of customer and partner relationships –Airlines previously viewed travel agents as their customers. Due to Web portals, they increasingly view individual travelers as customers, now that they have been given direct access to booking and flight information

Importance of Technology Advanced technology shapes the products and services of the future IT offers opportunities for innovative organizations to increase their value Information is so fundamental to business today, that small advances in information management are magnified as these increases are amplified across business processes

The Time Dimension Time is an irreplaceable asset and source of competitive advantage Information Technology and modern telecommunications systems are well suited to leveraging time as a strategic thrust Just-in-time manufacturing (JIT) is a common example

McDonnell Douglas Corp Implemented a JIT system for coordination of work flow. The resulting system required: –111 new programs –Modifications to 97 other programs –1900 person hours of programming labor –Meetings for project planning and execution

JIT Benefits at McDonnell Douglas

Networking’s Strategic Value

The Strategist Looks Inward Strategic systems are conceived by first analyzing the firm’s internal functions –85% of all e-business infrastructures are patterned after non “online” legacies Firms commonly have a portfolio of hundreds to thousands of applications –Deciding which ones to automate requires a keen understanding of the firm’s strategy, competitors, and culture

Value Chains for E-Business Modern e-business models operate in nearly all the dimensions of the figure –Use internal (example ERP) and external (Web-based B2C and B2B) –Exploit the six strategic thrusts Firms adopting e-business models reconstruct their value chains around powerful new information technology

Financial Implications Strategic information systems require continued investments to sustain their advantages First movers capture time at expense of cost and potential failure Even established firms can be beaten when technology appears that is so disruptive, like the Internet, that no advantage exists for the incumbents

Legal Considerations Resort to the courts can be a tool for competitors to blunt the advantages gained by technology Protection of intellectual property by patents can also be a powerful tool to further the advantages of an innovator by denying the competition access to a newly created market

Cautions Most strategic information systems are evolutionary. They are based on pre- existing systems within the firm Successful firms focus on the details of success instead of a grand scheme. Lasting competitive advantage is not found in a few grand strokes The entire firm must be competitive across all areas. IS alone can not deliver a “killer app” that eliminates the competition

Summary Information technology is vital to the continued success of modern firms Senior leadership understands that IT is a potent source of competitive advantage They are prepared to invest in needed applications and hardware, but expect a substantial return on that investment