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© 2008 Pearson Prentice Hall, Electronic Commerce 2008, Efraim Turban, et al.
Chapter 15
Economics and Justification
of Electronic Commerce
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Learning Objectives
1. escribe the need for justif!ing ECinvestments" ho# it is done" and ho# metricsare used to determine justification.
2. $nderstand the difficulties in measuring and justif!ing EC investments.
%. &ecogni'e the difficulties in establishingintangible metrics and describe ho# toovercome them.
(. List and briefl! describe traditional andadvanced methods of justif!ing )*investments.
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Learning Objectives
5. $nderstand ho# e-C&+" e-learning" and
other EC projects are justified.
,. escribe some economic principles of EC.
. $nderstand ho# product" industr!" seller" and
bu!er characteristics impact the economics
of EC.
. &ecogni'e /e! factors in the success of ECprojects and the major reasons for failures.
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0h! Justif! E-Commerce )nvestments
o# Can *he! 3e Justified4
Increased Demand for FinancialJustification )* eecutives feel the demand for financial
justification and planning from eecutivesbut6,57 of companies lac/ the /no#ledge or tools to
do &O) calculations
57 have no formal processes or budgets inplace for measuring &O),7 do not measure ho# projects coincide #ith
promised benefits si months after completion
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0h! Justif! E-Commerce )nvestments
o# Can *he! 3e Justified4
Other Reasons Why EC Justification IsNeeded Companies reali'e that EC is not necessaril! the
solution to all problems 8 formal evaluation of re9uests for funding is
mandated Companies need to assess the success of EC
projects after completion" and later on a periodic
basis *he success of EC projects ma! be assessed in
order to pa! bonuses
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0h! Justif! E-Commerce )nvestments
o# Can *he! 3e Justified4
EC Investment Categories and
Benefits IT infrastructure provides the foundation for
EC applications in the enterprise
EC applications are specific s!stems and
programs for achieving certain objectives
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0h! Justif! E-Commerce )nvestments
o# Can *he! 3e Justified4
:pecific benefits Cost reduction
;roductivit! improvement
)mproved customer satisfaction
)mproved staffing levels
igher revenues
igher earnings
3etter customer
&etention+ore return of e9uit!
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0h! Justif! E-Commerce )nvestments
o# Can *he! 3e Justified4
Ho Is an EC Investment Justified!cost"#enefit analysis
8 comparison of the costs of a project
against the benefits
3usiness justification and business case
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0h! Justif! E-Commerce )nvestments
o# Can *he! 3e Justified4
What Needs to Be Justified! When
$hould Justification %a&e 'lace!0hen the value of the investment is
relativel! small for the organi'ation
0hen the relevant data are not available"
are inaccurate" or are too volatile
0hen the EC project is mandated
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0h! Justif! E-Commerce )nvestments
o# Can *he! 3e Justified4
(sing )etrics in EC Justificationmetric
8 specific" measurable standard against
#hich actual performance is compared
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0h! Justif! E-Commerce )nvestments
o# Can *he! 3e Justified4
(sing )etrics in EC Justification+etrics can6
efine the value proposition of business models
Communicate a business strateg! to the#or/force )ncrease accountabilit! 8lign the objectives of individuals" departments"
and divisions to the enterprise?s strategic
objectives*rac/ the performance of EC s!stems 8ssess the health of companies
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0h! Justif! E-Commerce )nvestments
o# Can *he! 3e Justified4
+etrics" measurements" and /e!
performance indicators&ey *erformance indicators +,'I-
*he 9uantitative epression of criticall!
important metrics
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ifficulties in +easuring and
Justif!ing E-Commerce )nvestments
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ifficulties in +easuring and
Justif!ing E-Commerce )nvestments
Difficulties in )easuring 'roductivity
and 'erformance .ainsata and anal!sis issues
EC productivit! gains ma! be offset b!
losses in other areas
)ncorrectl! defining #hat is measured
Other difficulties
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ifficulties in +easuring and
Justif!ing E-Commerce )nvestments
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ifficulties in +easuring and
Justif!ing E-Commerce )nvestments
Difficulties in )easuring Intangi#le
Costs and Benefits*angible costs and benefits
)ntangible costs and benefits
andling intangible benefits
andling uncertainties
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ifficulties in +easuring and
Justif!ing E-Commerce )nvestments
%he 'rocess of Justifying EC and I% 'ro/ects La! an appropriate foundation for anal!sis #ith !our vendor"
and then conduct !our &O) Conduct a good research on metrics and validate them
Justif! and document the cost and benefit assumptions ocument and verif! all figures used in the calculation o not leave out strategic benefits 3e careful not to underestimate cost and overestimate
benefits
+a/e figures as realistic as possible and include ris/ anal!sis Commit all partners" including vendors and top management
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+ethods and *ools for Evaluating
and Justif!ing E-Commerce )nvestments
O**ortunities and Revenue
.enerated #y EC Investment 8 major difficult! in assessing the EC value
is the measurement of possible benefits that
drive EC investment
:ome of these are opportunities that ma! or
ma! not materiali'e" so there is onl! acertain probabilit! for return on the EC
investment /no#n as the opportunity matrix
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+ethods and *ools for Evaluating
and Justif!ing E-Commerce )nvestments
)ethodological 0s*ects of Justifying
EC Investments*!pes of costs
istinguish bet#een initial @up-frontA costs and
operating costs
irect and indirect share costs
)n-/ind costs
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+ethods and *ools for Evaluating
and Justif!ing E-Commerce )nvestments
%raditional )ethods for Evaluating EC
Investments&O) method
;a!bac/ period
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+ethods and *ools for Evaluating
and Justif!ing E-Commerce )nvestments
Net 'resent 1alue +N'1-3usiness &O)
*echnolog! &O)
ROI calculator
Calculator that uses metrics and formulas to
compute &O)
)nternal rate of return @)&&A
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+ethods and *ools for Evaluating
and Justif!ing E-Commerce )nvestments
3rea/-even anal!ses
total cost of onershi* +%CO-
8 formula for calculating the cost of o#ning"
operating" and controlling an )* s!stem
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+ethods and *ools for Evaluating
and Justif!ing E-Commerce )nvestments
total #enefits of onershi* +%BO-
3enefits of o#nership that include both
tangible and intangible benefits
Economic value added$sing several traditional methods
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+ethods and *ools for Evaluating
and Justif!ing E-Commerce )nvestments
0dvanced )ethods for Evaluating I%
and EC Investments
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Eamples of
E-Commerce ;roject Justification
E"'ROC(RE)EN% E-procurement encompasses bu!ing and selling"
selecting suppliers" submitting formal re9uests for
goods and services to suppliers" getting approval
from bu!ers" processing purchase orders" fulfilling
orders" delivering and receiving items" and
processing pa!ments
*he diversit! of activities involved in
e-procurement" the metrics used to measure the
value of e-procurement must reflect ho# #ell each
process is accomplished
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Eamples of
E-Commerce ;roject Justification
Customer $ervice and eCR)Onl! a small percentage of companies have
demonstrated a significantl! positive &O) for
their eC&+ investmentsC&+-based EC applications are most
effective #hen the! are part of a compan!?s
overall business plan and not just an ECinvestment
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Eamples of
E-Commerce ;roject Justification
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Eamples of
E-Commerce ;roject Justification
Justifying a 'ortal*he fundamental business case should be
made from the internal and eternal
perspectives of the business*he internal pa!off must result in
productivit! improvements" #hereas
revenue generation determines the eternalvalue
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Eamples of
E-Commerce ;roject Justification
Justifying E"%raining 'ro/ectsEnd-user training that helps emplo!ees
ac9uire or improve their EC and )* s/ills
pla!s a /e! role in ensuring the smoothoperation of organi'ations in the information
econom!
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Eamples of
E-Commerce ;roject Justification
Justifying an Investment in )o#ileCom*uting and in RFIDJustif!ing the cost of mobile computing ma!
be difficult due to cost sharing andintangible benefits
*hese calculations are helpful6&eturn on the #ireless #or/force
&eturn on outsourcing mobile devicemanagement
Cost of the #ireless net#or/s
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Eamples of
E-Commerce ;roject Justification
Justifying $ecurity 'ro/ects+ore than 57 of viruses enter business
net#or/s via e-mail. Cleaning up infections
is labor intensive" but antivirus scanning isnot
Emplo!ee securit! training is usuall! poorl!
doneCalculating the Cost of the $ar#anes"
O2ley 0ct
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*he Economics of E-Commerce
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*he Economics of E-Commerce
Reducing 'roduction Costs ;roduct cost curves
average"cost curve +01C-
3ehavior of average costs as 9uantit! changes generall!"
as 9uantit! increases" average costs decline
*roduction function
8n e9uation indicating that for the same 9uantit! of
production" Q" companies either can use a certain
amount of labor or invest in more automation
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*he Economics of E-Commerce
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*he Economics of E-Commerce
agency costs
Costs incurred in ensuring that the agent performs
tas/s as epected @also called administrative costsA
transaction costs
Costs that are associated #ith the distribution @saleA
or echange of products and services including the
cost of searching for bu!ers and sellers" gathering
information" negotiating" decision ma/ing"
monitoring the echange of goods" and legal fees
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*he Economics of E-Commerce
Increased Revenues&each versus richness
Other #a!s to increase revenues
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*he Economics of E-Commerce
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*he Economics of E-Commerce
Reducing %ransaction Friction or Ris&Organi'ations can increase the value of
their products or services b! using the
uni9ue capabilities of EC to reduce ris/s toconsumers" such as those involving
ps!chological relationships" 9ualit!
concerns" dela!s" and financial transactions
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*he Economics of E-Commerce
Facilitating 'roduct Differentiation*roduct differentiation
:pecial features available in products that
ma/e them distinguishable from otherproducts. *his propert! attracts customers
that appreciate #hat the! consider an
added value
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*he Economics of E-Commerce
EC Increases 0gility agility
8n EC firm?s abilit! to capture" report and 9uic/l!
respond to changes happening in the mar/etplaceand business environment
)ar&ets versus E")ar&ets Even if the flo# of ph!sical goods does not
decrease" the information provided in e-mar/etsbetter informs participants and" therefore" allo#s
them to ma/e better decisions
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*he Economics of E-Commerce
*hree most common valuation methods6
1. *he comparable method
2. *he financial performance method
%. *he venture capital method
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Factors that Determine
E"Commerce $uccess
Categories of EC $uccess;roduct characteristics
)ndustr! characteristics
:eller characteristics
Consumer characteristics
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Factors that Determine
E"Commerce $uccess
%he 3evels of EC )easurement+etrics var! based on #hether the level of
measurement is6 8n individual EC customer 8n EC firm
8n EC-enabled process
*he EC value chain
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Opportunities for :uccess in
E-Commerce and 8voiding
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Opportunities for :uccess in
E-Commerce and 8voiding
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Opportunities for :uccess in
E-Commerce and 8voiding
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Opportunities for :uccess in
E-Commerce and 8voiding
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Opportunities for :uccess in
E-Commerce and 8voiding
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+anagerial )ssues
1. o# do #e measure the value of EC investment4
2. 0hat complementar! investments #ill be needed4
%. )s a shift from tangible to intangible benefitsnecessar!4
(. 0ho should conduct a justification4
5. :hould #e use the &O) calculator provided b! avendor #ho #ants to sell us an EC s!stem4
,. o# does one /no# if the valuation of EC companies
is justifiable4. )s it possible to predict EC success4
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