0. Economics and Justification of Electronic Commerce
Chapter 14
Economics and Justification of
Electronic Commerce

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Learning Objectives
Describe the need for justifying electronic commerce (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.
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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 in the success of EC projects and the major reasons for failures.
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3. Why Justify E-Commerce Investments? How Can They Be Justified?
INCREASED PRESSURE FOR FINANCIAL JUSTIFICATION
IT executives feel the pressure for financial justification and planning from top executives, but most face an uphill battle to address this accountability
In order to achieve the optimal level of investment, CIOs will need to calculate and effectively communicate the value of proposed EC projects
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4. Why Justify E-Commerce 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
Some large companies, and many public organizations, mandate a formal evaluation of requests for funding
Companies are required to assess the success of EC projects after completion
The success of EC projects may be assessed in order to pay bonuses
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5. Why Justify E-Commerce Investments? How Can They Be Justified?
EC INVESTMENT CATEGORIES AND BENEFITS
IT infrastructure provides the foundation for EC applications in the enterprise
EC applications are specific systems and programs for achieving certain objectives
Purpose of the investment
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6. Why Justify E-Commerce 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
Business Justification and Business Case
WHAT NEEDS TO BE JUSTIFIED? WHEN SHOULD JUSTIFICATION TAKE PLACE?
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7. Why Justify E-Commerce Investments? How Can They Be Justified?
USING METRICS IN EC JUSTIFICATION
metric
A specific, measurable standard against which actual performance is compared
Metrics, Measurements, and Key Performance Indicators
key performance indicators (KPIs)
The quantitative expression of critically important metrics
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8. Difficulties in Measuring and Justifying E-Commerce Investments
THE EC JUSTIFICATION PROCESS
Five areas must be considered in the justification of IT projects:
Strategic Considerations
Tactical Considerations
Operational Considerations
Intangibles
Tangibles
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10. Difficulties in Measuring and Justifying E-Commerce Investments
DIFFICULTIES IN MEASURING PRODUCTIVITY AND PERFORMANCE GAINS
Data and Analysis Issues
EC Productivity Gains May Be Offset by Losses in Other Areas
Hidden Costs and Benefits
Incorrectly Defining What Is Measured
Other Difficulties
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12. Difficulties in Measuring and Justifying E-Commerce Investments
INTANGIBLE COSTS AND BENEFITS
Tangible Costs and Benefits
Tangible costs are those that are easy to measure and quantify and that relate directly to a specific investment
Intangible Costs and Benefits
When it comes to intangible costs and benefits, organizations must develop innovative metrics to track them as accurately as possible
Handling Intangible Benefits
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13. Difficulties in Measuring and Justifying E-Commerce Investments
THE PROCESS OF JUSTIFYING EC AND IT PROJECTS
Lay an appropriate foundation for analysis with your vendor, and then conduct your ROI
Conduct a good research on metrics and validate them
Justify and document the cost and benefit assumptions
Document and verify all figures used in the calculation
Do not leave out strategic benefits, including long-term ones
Be careful not to underestimate cost and overestimate benefits
Make figures as realistic as possible and include risk analysis
Commit all partners, including vendors and top management
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14. Methods and Tools for Evaluating and Justifying E-Commerce Investments
OPPORTUNITIES AND REVENUE GENERATED BY EC INVESTMENT
METHODOLOGICAL ASPECTS OF JUSTIFYING EC INVESTMENTS
Types of Costs
Distinguish between initial (up-front) costs and operating costs
Direct and indirect shared costs
In-kind costs
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15. Methods and Tools for Evaluating and Justifying E-Commerce Investments
TRADITIONAL METHODS FOR EVALUATING EC INVESTMENTS
The ROI Method
Payback Period
NPV Analysis
Internal Rate of Return (IRR)
Break-Even Analyses
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16. Methods and Tools for Evaluating and Justifying E-Commerce 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 intangible benefits
Economic Value Added
Using Several Traditional Methods
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17. Methods and Tools for Evaluating and Justifying E-Commerce Investments
IMPLEMENTING TRADITIONAL METHODS
Business ROI Versus Technology ROI
ROI calculator
Calculator that uses metrics and formulas to compute ROI
Other Calculators
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18. Methods and Tools for Evaluating and Justifying E-Commerce Investments
ADVANCED METHODS FOR EVALUATING IT AND EC INVESTMENTS
Most justification methods can be categorized into the following four types:
Financial approaches
Multicriteria approaches
Ratio approaches
Portfolio approaches
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19. Examples of E-Commerce Project Justification
JUSTIFYING E-PROCUREMENT
CUSTOMER SERVICE AND E-CRM
e-CRM Metrics
JUSTIFYING A PORTAL
JUSTIFYING E-TRAINING PROJECTS
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20. Examples of E-Commerce Project Justification
JUSTIFYING AN INVESTMENT IN MOBILE COMPUTING AND IN RFID
JUSTIFYING SECURITY PROJECTS
JUSTIFYING SOCIAL NETWORKING AND THE USE OF WEB 2.0 TOOLS
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21. The Economics of E-Commerce
REDUCING PRODUCTION COSTS
Product Cost Curves
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22. The Economics of E-Commerce
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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24. The Economics of E-Commerce
transaction costs
Costs that are associated with the distribution (sale) 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 fee
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25. The Economics of E-Commerce
Categories of transaction costs:
Search costs
Information costs
Negotiation costs
Decision costs
Monitoring costs
Legal-related costs
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27. The Economics of E-Commerce
INCREASED REVENUES
Reach Versus Richness
Other Ways to Increase Revenues
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28. The Economics of E-Commerce
REDUCING TRANSACTION FRICTION OR RISK
FACILITATING PRODUCT DIFFERENTIATION
product differentiation
Special features available in products that make them distinguishable from other products. This property attracts customers that appreciate what they consider an added value
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29. The Economics of E-Commerce
EC INCREASES AGILITY
agility
An EC firm’s ability to capture, report, and quickly respond to changes happening in the marketplace and business environment
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30. The Economics of E-Commerce
VALUATION OF EC COMPANIES
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 multiplying the selling price of the stock by the number of available shares
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31. The Economics of E-Commerce
Three most common valuation methods:
The comparable method
The financial performance method
The venture capital method
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32. Opportunities for Success in E-Commerce and Avoiding Failure
FACTORS THAT DETERMINE E-COMMERCE SUCCESS
Product Characteristics
Industry Characteristics
Seller Characteristics
Consumer Characteristics
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33. Opportunities for Success in E-Commerce and Avoiding Failure
E-COMMERCE FAILURES
Three economic phenomena related to EC failure:
At a macroeconomic level, technological revolutions, such as the railroad and the automobile industries, have had a boom–bust–consolidation cycle
At a mid-economic level, the bursting of the dot-com bubble from 2000 through 2003 is consistent with periodic economic downturns
At a microeconomic level, the “Web rush” reflected an over allocation of scarce resources
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35. Opportunities for Success in E-Commerce and Avoiding Failure
OPPORTUNITIES FOR SUCCESS: CREATING DIGITAL OPTIONS
digital options
A set of IT-enabled capabilities in the form of digitized enterprise work processes and knowledge systems
CULTURAL DIFFERENCES IN EC SUCCESSES AND FAILURES
CAN EC SUCCEED IN DEVELOPING ECONOMIES?
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Managerial Issues
How should the value of EC investment be justified?
Which investment analysis method should we adopt for EC justification?
Shift from tangible to intangible benefits
What complementary investments will be followed?
Who should conduct the justification?
How does one know if the valuation of EC companies is justifiable?
Is it possible to predict EC success?
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