1. Economics and Justification of Electronic Commerce
Chapter 15
Economics and Justification
of Electronic Commerce

2. Learning Objectives
Describe the need for justifying EC investments, how it is done, and how metrics are used to determine justification.
Understand the difficulties in measuring and justifying EC investments.
Recognize the difficulties in establishing intangible metrics and describe how to overcome them.
List and briefly describe traditional and advanced methods of justifying IT investments.
Electronic Commerce
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3. Learning Objectives
Understand how e-CRM, e-learning, and other EC projects are justified.
Describe some economic principles of EC.
Understand how product, industry, seller, and buyer characteristics impact the economics of EC.
Recognize key factors to the success of EC projects and the major reasons for failures.
Electronic Commerce
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4. 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
Electronic Commerce
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5. Why Justify EC Investments? How Can They Be Justified?
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
Electronic Commerce
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6. Why Justify EC Investments? How Can They Be Justified?
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
Electronic Commerce
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7. Why Justify EC Investments? How Can They Be Justified?
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
Electronic Commerce
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8. Why Justify EC Investments? How Can They Be Justified?
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%)
Electronic Commerce
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9. Why Justify EC Investments? How Can They Be Justified?
How Is an EC Investment Justified?
cost-benefit analysis
A comparison of the costs of a project against the benefits
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10. Why Justify EC Investments? How Can They Be Justified?
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
Electronic Commerce
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11. Why Justify EC Investments? How Can They Be Justified?
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 important metrics
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12. 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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13. Exhibit 15.1 A Model for EC Project Justification
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14. Difficulties in Measuring and Justifying EC Investments
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
Electronic Commerce
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15. Difficulties in Measuring and Justifying EC Investments
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
Electronic Commerce
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16. Difficulties in Measuring and Justifying EC Investments
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
Electronic Commerce
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17. Difficulties in Measuring and Justifying EC Investments
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
Electronic Commerce
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18. Exhibit 15. 2 Process Approach to IT
Exhibit 15.2 Process Approach to IT Organizational Investment and Impact
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19. 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
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20. Methods and Tools for Evaluating and Justifying EC Investments
Methodological Aspects of Justifying EC 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
Electronic Commerce
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21. Methods and Tools for Evaluating and Justifying EC Investments
Methodological Aspects of Justifying EC Investments
Business ROI
Technology ROI
ROI calculator
Calculator that uses metrics and formulas to compute ROI
Economic Value Added
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22. Methods and Tools for Evaluating and Justifying EC Investments
Traditional (Generic) Methods for Evaluating IT Investments
Rate of ROI Method
Payback Period
Net Present Value
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23. Methods and Tools for Evaluating and Justifying EC Investments
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
Electronic Commerce
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24. 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
Electronic Commerce
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25. Examples of EC Project Justification
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
Electronic Commerce
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26. Examples of EC Project Justification
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
Electronic Commerce
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27. Examples of EC Project Justification
Justifying Security Projects
More than 85% of viruses enter business networks via . 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
Electronic Commerce
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28. 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
Electronic Commerce
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29. 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
Electronic Commerce
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30. Exhibit 15.8 Increasing Versus Decreasing Returns
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31. 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
Electronic Commerce
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32. Exhibit 15.9 Cost Curve of (a) Regular and (b) Digital Products
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33. 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 tasks as expected (also called administrative costs)
Electronic Commerce
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34. Exhibit 15.10 The Economic Effects of EC
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35. The Economics of EC transaction costs Production 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
Electronic Commerce
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36. Exhibit 15.11 The Economic Effects of EC: Transaction Costs
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37. Exhibit 15.12 Reach Versus Richness
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38. 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
Electronic Commerce
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39. The Economics of EC agility
An EC firm’s ability to capture, report and quickly respond to changes happening in the marketplace
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40. 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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41. Factors That Determine EC Success
Product Characteristics
Industry Characteristics
Seller Characteristics
Consumer Characteristics
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42. 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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43. 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
Electronic Commerce
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44. Opportunities for Success in EC and Avoiding Failure
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
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45. Opportunities for Success in EC and Avoiding Failure
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
Electronic Commerce
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46. Opportunities for Success in EC and Avoiding Failure
Cultural Differences
Critical elements that can affect the value of EC across cultures are perceived trust, consumer loyalty, regulation, political influences
EC in Developing Economies
Developing economies often face power blackouts, unreliable telecommunications infrastructure, undependable delivery mechanisms, and the fact that only a few customers own credit cards
Electronic Commerce
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47. Managerial Issues How do we measure the value of EC investment?
What complementary investments will be needed?
How do we shift from tangible to intangible benefits?
Who should conduct a justification?
Should we use the ROI calculator provided by a vendor who wants to sell us an EC system?
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48. Summary The need for EC justification.
The difficulties in justifying EC investment.
Difficulties in established intangible metrics.
Traditional methods for evaluating EC investments.
Understand how specific EC projects are justified.
EC investment evaluation.
E-marketplace economics.
Reasons for EC success and failure.
Electronic Commerce
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