Chapter 15
Economics and Justification
of Electronic Commerce
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
projects and the major reasons for failures.
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Why Justify EC Investments?
How Can They Be Justified?
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Increased Demand for Financial Justification
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Addressing accountability is difficult:
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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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Why Justify EC Investments?
How Can They Be Justified?
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Other Reasons Why EC Justification Is Needed
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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
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Why Justify EC Investments?
How Can They Be Justified?
•
Other Reasons Why EC Justification Is Needed
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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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Why Justify EC Investments?
How Can They Be Justified?
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EC Investment Categories and Benefits
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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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Why Justify EC Investments?
How Can They Be Justified?
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Specific Benefits
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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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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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Why Justify EC Investments?
How Can They Be Justified?
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Justification may not be necessary when:
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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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Why Justify EC Investments?
How Can They Be Justified?
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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
important metrics
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Difficulties in
Measuring and Justifying EC Investments
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The EC Justification Process
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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
Measuring and Justifying EC Investments
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Difficulties in Measuring Productivity and
Performance Gains
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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
Measuring and Justifying EC Investments
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Relating IT Expenditures to Organizational
Performance
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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
Measuring and Justifying EC Investments
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Difficulties in Measuring Costs and Benefits
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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
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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
Measuring and Justifying EC Investments
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Handling Intangible Benefits
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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
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Methodological Aspects of Justifying EC
Investments
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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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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
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Methods and Tools for
Evaluating and Justifying EC Investments
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Methodological Aspects of Justifying EC
Investments
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Business ROI
Technology ROI
ROI calculator
Calculator that uses metrics and formulas to compute
ROI
Economic Value Added
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Methods and Tools for
Evaluating and Justifying EC Investments
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Traditional (Generic) Methods for Evaluating IT
Investments
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Rate of ROI Method
Payback Period
Net Present Value
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Methods and Tools for
Evaluating and Justifying EC Investments
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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
A single view that provides the status of multiple
metrics
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Examples of EC Project Justification
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E-Procurement
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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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Examples of EC Project Justification
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Justifying a Portal
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Internal payoff must result in productivity
improvements
External value is determined by revenue generation
Justifying E-Training Projects
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When comparing e-training and traditional training
methods, several factors, most of which are
intangible, must be evaluated
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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
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Examples of EC Project Justification
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Justifying Security Projects
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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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The Economics of EC
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Production Costs
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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
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The Economics of EC
•
Production Costs
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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
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Exhibit 15.8 Increasing Versus
Decreasing Returns
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The Economics of EC
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Production Costs
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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
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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)
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Exhibit 15.10 The Economic Effects of EC
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The Economics of EC
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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
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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
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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
agility
An EC firm’s ability to capture, report and quickly
respond to changes happening in the
marketplace
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The Economics of EC
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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
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Product Characteristics
Industry Characteristics
Seller Characteristics
Consumer Characteristics
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Factors That Determine EC Success
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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
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E-Commerce Failures
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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
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Opportunities for Success in EC
and Avoiding Failure
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Top three factors for EC success
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B2C EC
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B2B EC
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effective marketing management
an attractive Web site
building strong connections with the customers
readiness of trading partners
information integration inside the company and in the supply chain
completeness of the EC system
Overall success
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proper business model
readiness of the firm to become an e-business
internal enterprise integration
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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
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Opportunities for Success in EC
and Avoiding Failure
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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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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
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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?
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Summary
1.
2.
3.
4.
5.
6.
7.
8.
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.
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