Update on Internet Business Models: Emerging lessons and open questions about the transformation of business through information technology Taylor Randall University of Utah

Lecture Outline Emerging lessons on new business models. Choosing a model for electronic retailing.

Manufacturer Distributor Consumer Retailers Value chains have always consisted of product flows and information flows. Information flows Product flows Potential for information technology to transform information flows to create new business or streamline old business.

Common Business Propositions #1 - Business built on information content Information flows alone have significant value. Examples: iVillage, web communities. #2 - Direct sales and distribution Eliminate intermediaries Examples: Web Van, eToys, Amazon #3 - Streamlined transactions Automated purchasing functions exchanges Examples: E-bay, Exostar, Ventro Group

Proposition #1: Easier Delivery of Information Content i-Village: Information Content for Women

Proposition #2: More Efficient Sales - Eliminate Retail Locations e Toys: Toy Retailing

Proposition #3: Streamlined Purchasing: Business Exchanges Ventro Group - B2B purchasing

4 lessons emerging from the dot.com crash...

They who fail to learn from history are doomed to repeat it. Lesson 1: History shows that innovative business success depends on a solid technological infrastructure.… this takes time.

History Quiz: Who said it and when? “You may go to an average store, spend valuable time and select from a limited stock at retail prices… or have our Big Store of World Wide Stocks come to you.” a) Jeff Bezos - business plan of Amazon.com b) Bill Gates - on retail plans for Microsoft c) Vice President of Wal-mart e-tailing d) none of the above.

History Quiz: Who said it and when? Answer: d) none of the above From Sears-Roebuck Catalog 1915 Catalog regarded by economists as a “radical transformation in the marketing and distribution of consumer goods.”

Richard Sears begins to sell watches to railroad station agents. First large general Sears catalog. Sales Growth History of Sears Roebuck What happened here? High Growth

Tough to deliver goods prior to 1900

The King Road Drag Invention leveled and packed muddy roads. Made auto transportation possible.

Richard Sears begins to sell watches to railroad station agents. First large general Sears catalog. Sales Growth History of Sears Roebuck High Growth D. Ward King invents the “King Road Drag” Sears installs pick and ship plant (10x productivity increase) Congress mandates “Parcel Post” as long as you have good roads So what was the greatest innovation the catalog? or the King Road Drag?

“A lot of people jumped the gun. They tried to skip the first two phases.” Roger McNamee, Integral Capital Partners 2000 Technological change happens in 3 phases: 1. Creation of infrastructure 2. Arrival of enabling technologies 3. Business built on the previous 2

Creation of InfrastructureRoads??? Arrival of enabling technologiesPick System??? Postal Service Construction of businessCatalog Sales home delivery Stage of DevelopmentSears Direct Grocery Delivery Can you identify the key technological infrastructure for your business?

Even when American voters are most angry, they re-elect 88% of their politicians. Vital Statistics of Congress. Lesson 2: Because infrastructure changes slowly old companies still hold power.

Examples of incumbent power: Politicians have political action committee dollars. 3 times as expensive to acquire a customer “on-line” as it is to acquire a customer with physical stores. Over 60% of all traditional retailers had data processing and customer service capabilities before going on-line. In 1925 Sears opened retail stores by 1930 retail store sales had outpaced catalog sales. Incumbent power comes from existing infrastructure.

Richard Sears begins to sell watches to railroad station agents. First large general Sears catalog. Sales Growth History of Sears Roebuck D. Ward King invents the “King Road Drag” Sears installs pick and ship plant (10x productivity increase) Congress mandates “Parcel Post” as long as you have good roads Sears opens first retail stores

Lesson 3: The parameter estimates in e-business plans are so far off, even worst case sensitivity analysis isn’t bad enough…. Incorrect estimates lead to adoption of the unprofitable business models.

Example: Revenue Model for a Campus Intranet Provider Advertising Model vs. Software Model 1 school Advertising Software # Schools 1 Install $250,000 # Users Per School 8000 Maintenance $50,000 Active Usage 65% Sessions/Day 2 Page views/Session 12 Images/Page 4 Days year 180 CPM/1000 views $25 Total Revenue $2.25 M

Example: Revenue Model for a Campus Intranet Provider 1 school Phase I # Schools # Users Per School Active Usage 65% 65% Sessions/Day 2 2 Page views/Session Images/Page 4 4 Days year CPM/1000 views $25 $25 Total Revenue $2.25 M $2.5 B Business Valuation $250 M

Example: Revenue Model for a Campus Intranet Provider 1 school Phase I Phase II # Schools # Users Per School Active Usage 65% 65% 80% Sessions/Day Page views/Session Images/Page Days year CPM/1000 views $25 $25 $45 Total Revenue $2.25 M $2.2 B $6.3 B Business Valuation $250 M $500 M

Example: Revenue Model for a Campus Intranet Provider 1 school Phase I Phase II Actual # Schools # Users Per School Active Usage 65% 65% 80% 50% Sessions/Day Page views/Session Images/Page Days year CPM/1000 views $25 $25 $45 $3 Total Revenue $2.25 M $2.2 B $6.3 B $8.5 M Business Valuation $250 M $500 M ? Under actual numbers software model makes more sense.

Lesson 4: In many cases it is hard to sell the value of improved information flow without the accompanying product flow.

Example: Business to Business Purchasing Fragmented Manufacturers DistributorsHospitals Problem: Fragmentation makes purchasing function too complex (multiple shipments and invoices to track, pricing problems. Opportunity: Use New IT to consolidate invoicing and purchasing function

Example: Business to Business Purchasing B2B Exchange Question: How much is the improved information flow worth? Benchmark: Traditional Distributor gets 17% to 30% margin

New Propositions Use technology to make old infrastructure more efficient. #1 Enhance existing products and services with internet technology. #2 Use technology to reduce costs of coordination within companies. #3 Use technology to reduce transaction costs between business partners.

Summary Lessons from the dot.com crash 1 - Successful businesses built on new technology take time. 2 - Incumbents may be more successful using technology. 3 - Carefully consider the estimates in your business models. 4 - Carefully evaluate the value attached to information flows.

Choosing a business model for internet retailing Taylor Randall University of Utah

Two basic choices Retailer Wholesaler Customer Wholesaler Customer Retailer What factors influence the choice of supply chain? Inventory OwnershipDrop-shipping

Supply Chain options on the Internet* Primary way company fulfills online orders% of Internet-only retailers From company facility that existed13.9% From company facility that was developed30.6% Drop-shipped30.6% Outsourced8.3% From facility operated by a partner8.3% Electronic fulfillment (software)5.6% Other2.7% *The state of eRetailing Supplement to “eRetailing World” March Drop-shipped 30.6%

“Cheap tricks” Start-up capital: $825, ,000 CD titles available for immediate shipment No inventory Motivating Example: Meet Spun.com

One supply chain type not dominant within or across industries Retail Category CDs General Retailing Hold InventoryDrop-ship CDNow.comSpun.com Amazon Value America

BANKRUPT Business results not consistent Retail Category CDs General Retailing Hold InventoryDrop-ship CDNow.comSpun.com Amazon Value America

Making Supply Chain Choice: Theory Considerations in favor of drop-shipping: Reduced investment into fulfillment capabilities Wider product selection Lower fulfillment cost No inventory obsolescence Benefits due to inventory pooling Considerations in favor of inventory ownership: Higher product margin More control over stocking decisions More control over product offering Avoid encroachment of customers Ease of order consolidation Lower technology investment Hybrid strategy?

Factors Influencing Inventory Choice OwnDrop-Ship Development of Industry Firm Size Product Variety Demand Uncertainty Product Transportation Costs Product Obsolescence Risk Immature Large Low variants Low uncertainty Lower Mature Small High variants High uncertainty Higher

Sample Description Survey of 64 publicly held e-tailers 56 responses, 54 usable responses (84.4%) Between 60% and 70% of e-tailing revenue. Financial data from COMPUSTAT data base Example Companies Amazon.comPets.com Barnes&Noble.comEgghead.com CDNow.comDelias.com Fogdog.comAutobytel.com Webvan.comBuy.com 36 companies choose to hold inventory (67%) 11 bankrupt companies (20%)

Measure of rational supply chain choice Actual Choice Model Recommendation Own Not own OwnNot own Irrational 4 firms Irrational 4 firms Rational 21 firms Rational 17 firms Elected to drop-shipElected to own 01 Likely to drop-shipLikely to own inventory

Irrational supply chain choice is associated with bankruptcy! Probability of Bankruptcy RationalIrrationalDifference Choice * *statistically significant difference Irrational Supply Chain Choice and Probability of Bankruptcy Poor supply chain choice one of factors associated with failure.

Summary  Research results: – theoretically obtained criteria for inventory choice, – confirmed hypothesis empirically, – linked inventory choice and firm performance.

Supply Chain Choice Parameters in Grocery Industry Existing StoreDepot Fixed Costs per Year $20,000 $10 million Picking Labor Per Order $20 $5 Market Trends: 2% of all sales will be over internet $100 per order 20 or 30 times per year. 5% margin on food. 60 items per order $25 delivery charge When do you use a existing store and when do you use a depot?