1. The Business Case for the Networked Business
Ken Peffers
UNLV
October 2003

2. Comparing Industrial Era and Networked Firms
Industrial Era Firms—from 1830s
Production economies
Development of large organizations
Interchangeable parts
Consumer packaging
Shipment technologies
Communication technologies
Creation of continental markets

3. Industrial Era Firms Economies of Scale Structural mode
Production technologies
Automation
Structural mode
Hierarchy
Vertical integration

4. Comparing Industrial Era and Networked Firms
Economies of Scale
Often extreme
Economies of Scope
Economies of product scope
Economies of geographic scope
Network externalities
Structural mode
Virtual integration

5. Network Holes Role of small firms Disconnected spaces in the economy
Opportunities for Internet entrepreneurs

6. Network Economies of Scale & Scope
Community of firms produces goods cheaper, faster, etc.
Community of firms can use network to sell a variety of goods, enter new markets

7. Performance Drivers (Revenue)
Business concept
The opportunities a firm will pursue
The strategy for capturing dominant position in the industry
Frames assumptions used to forecast revenues

8. Performance Drivers (Costs)
Capabilities to execute the strategy
Resource requirements and availability
Leadership, people, partners, expertise, time, money.
Frames the assumptions used to forecast costs

9. Linking Strategy to Execution to Results
Revenue
Concept
Costs
EBITDA
Cash Flow
Market Value
Capabilities
Financial Structure
Value
Intangible Assets
From Applegate et al 2003

10. Three Levels of Organizational Capabilities
Operating and innovating capabilities
Managing and learning capabilities
Leading and engaging capabilities

11. Three Levels of Organizational Capabilities
Operating and innovating capabilities
Core processes: procurement, product development service delivery, order fulfillment, brand management
Processes to improve operations and launch new products: new product development, continuous improvement
IT infrastructure to support processes: info processing and distributed systems

12. Three Levels of Organizational Capabilities
Managing and learning capabilities
Process to plan, budget, monitor performance
Organizational design: units, reporting structures, governance
Processes for information, knowledge management, decision support systems
IT infrastructure that supports these processes: management reporting, DSS, database/data warehouse management

13. Three Levels of Organizational Capabilities
Leading and engaging capabilities
HR management systems
Alliance and partnership management
Customer and supplier relationship management systems
The IT infrastructure that supports these processes, e.g., communications, CRM systems, HR systems, etc.

14. Value Benefits delivered to investors and other stakeholders
Create the assets that drive financial and market performance

15. Scenario Based Approach to Evaluation
Identify the horizon of the valuation, e.g. 5 years
Forecast
Size of the whole market
Your market share
Revenues
How this would be achieved
Identify the assumptions
Forecast the cost to achieve the forecasted state
Construct an estimate of the financial performance, e.g., income, balance sheets, cash flows, as appropriate
Develop scenarios, best, worst, most likely
Compute alternate models if possible, e.g., DCF
Set up real time performance measurement
Revisit the model

17. The IT Business Value Scorecard
Benefits
Goals
Sample Measures
Type I: Benefits from Investments in a Networked IT Infrastructure--Internal
Functionality and Flexibility
Improve infrastructure performance; increase the functionality and range of strategic options that can be pursued
Decrease the cost and/or improve the performance of internal IT operations; enable new IT applications to be created at lower cost, in less time, and with less risk; expand the range of internal IT initiatives
Source: Applegate, Lynda M., Robert D. Austin, and F. Warren McFarlan, Corporate Information and Strategy Management. Burr Ridge, IL: McGraw-Hill/Irwin, 2002.

18. The IT Business Value Scorecard
Benefits
Goals
Measures
Type I: Benefits from Investments in a Networked IT Infrastructure--External
Functionality and Flexibility
Create an efficient, flexible online/offline platform for doing business with customers, suppliers, and partners
Decrease the cost and/or improve the performance of doing business online; decrease the time, cost and risk of launching new online business initiatives; expand the reach of existing IT enabled businesses and the range of business opportunities that can be pursued.
Source: Applegate, Lynda M., Robert D. Austin, and F. Warren McFarlan, Corporate Information and Strategy Management. Burr Ridge, IL: McGraw-Hill/Irwin, 2002.

19. The IT Business Value Scorecard
Benefits
Goals
Measures
Type II: Benefits from Doing Business on a Networked IT Infrastructure
Commerce
Improve internal operating efficiency and quality
Sample Measures: Internal process performance and work flow improvements; cost savings or cost avoidance; increased quality; decreased cycle time

20. The IT Business Value Scorecard
Benefits
Goals
Measures
Type II: Benefits from Doing Business on a Networked IT Infrastructure
Commerce
Streamline and integrate channels to market, create new channels, and integrate multiple online/offline channels
Sample Measures: Supply chain or distribution channel performance improvements; cost savings or cost avoidance for the organization and its customers, suppliers, or partners; decrease time to market or just-in-time order replenishment; enable new channels to market and/or extend the reach and range of existing channels

21. The IT Business Value Scorecard
Benefits
Goals
Measures
Type II: Benefits from Doing Business on a Networked IT Infrastructure
Content / Knowledge
Improve the performance of knowledge workers and enhance organizational learning
Sample Measures: Enable individuals to achieve and exceed personal performance goals; increase the speed and effectiveness of decision making; increase the ability of the organization to respond quickly and effectively to threats and opportunities

22. The IT Business Value Scorecard
Benefits
Goals
Measures
Type II: Benefits from Doing Business on a Networked IT Infrastructure
Content / Knowledge
Improve the performance of knowledge workers in customer, supplier, and partner organizations; add “information value” to existing products and services; create new information-based products and services
Sample Measures: Provide information to customers, suppliers, and partners that enables better decision-making; charge a price premium for products and services based on information value-added; launch new information-based products and services; increase revenue per users and add new revenue streams

23. The IT Business Value Scorecard
Benefits
Goals
Measures
Type II: Benefits from Doing Business on a Networked IT Infrastructure
Community
Attract and retain top talent; increase satisfaction, engagement, and loyalty; create a culture of involvement, motivation, trust, and shared purpose
Sample Measures: Length of time to fill key positions; attrition rate, trends in hiring and retaining top talent (over time, by industry, by region)

24. The IT Business Value Scorecard
Benefits
Goals
Measures
Type II: Benefits from Doing Business on a Networked IT Infrastructure
Community
Attract and retain high quality customers, suppliers, partners, and investors; increase external stakeholders satisfaction, engagement, and loyalty
Sample Measures: Customer, supplier, partner satisfaction and lifetime value; average revenues per customer and trend over time; level of personalization available and % that use it; churn rate

25. A Scenario-Based Approach to Valuation
Step 1: Define the purpose for the value assessment (e.g., seeking funding, buying a company, investing in an established business).
Step 2: Pick a point in the future when you expect your business strategy to deliver value, e.g., 3-5 years.
Step 3: Analyze business concept and strategy to forecast market size, your share, and revenues.
Identify yearly changes that reflect how your firm and the market would reach this future state.
List key assumptions used in constructing revenue forecasts.
Source: Applegate, Lynda M., Robert D. Austin, and F. Warren McFarlan, Corporate Information and Strategy Management. Burr Ridge, IL: McGraw-Hill/Irwin, 2002.

26. A Scenario-Based Approach to Valuation
Step 4: Analyze the capabilities and resources required to reach the future state and forecast the cost of building those capabilities and acquiring resources.
Identify yearly costs and resources that will be required by you, your partners, suppliers and customers.
List key assumptions used in constructing cost forecasts.
Step 5: Estimate financial performance and market value that reflect the "most likely" assumptions. Identify assumptions
Step 6: Develop several scenarios that represent upper and lower bounds on key variables in your forecasts.
Test the sensitivity of your forecasts based on changes in key assumptions.
Source: Applegate, Lynda M., Robert D. Austin, and F. Warren McFarlan, Corporate Information and Strategy Management. Burr Ridge, IL: McGraw-Hill/Irwin, 2002.

27. A Scenario-Based Approach to Valuation
Step 7: Validate your model using alternative approaches, such as Discounted Cash Flow and Comparable Company Analysis.
Step 8: Critique the findings and assumptions on a regular basis.
Source: Applegate, Lynda M., Robert D. Austin, and F. Warren McFarlan, Corporate Information and Strategy Management. Burr Ridge, IL: McGraw-Hill/Irwin, 2002.

28. Internet Securities
(Step 1) Purpose of assessment: determine value of the firm for sale
80% of Internet Securities sold in 1999 for $43 million
IS guaranteed that it could file for IPO in future
(Step 2) Let’s assume IPO in 2004

29. Step 3 Analyze Business Concept and Strategy
To forecast market size, share, and revenues
Business concept
Purchase data in developing countries on a revenue sharing basis (average 15% of revenues).
Sell to firms on subscription basis~$250 per user per month.

30. Internet Securities Strategy
IS moving quickly to establish presence in developing markets to gather contracts for access to information.
Low priced subscription service
Selling to firms

31. Internet Securities: Market Size & Share
Market Size: $61 billion business information services in 2004
Market share: $464 million = 0.76%
Assumptions
Total market will continue to grow at rate of 8.8%
Revenue can be grown at 99% annual growth through this period

32. Internet Securities in 2004
Statement of Operations (in thousands $)
Actual
Estimated
Forecast
1996
1997
1998
1999
2000
2001
2002
2003
2004
Revenues
875
3757
7469
14862
29576
58856
117124
233077
463823
Costs and Expenses
Cost of revenue
260
912
1836
3716
7394
14714
29281
58269
115956
Technical Development
884
2350
3437
4287
5348
6672
8323
10383
12953
Selling, gen, and administrative
3625
6349
7884
9835
12270
15306
19095
23820
29716
Total costs and expenses
4769
9611
13157
17838
25012
36692
56698
92472
158624
Loss from operations
(3894)
(5854)
(5688)
(2976)
4564
22164
60425
140604
305198
Net Interest income (expense) 68
176
Let earnings (losses)
(3826)
(5678)

33. Economies of scale
Low cost of revenue suggest very high economies of scale, i.e., IS can make additional sales without incurring much additional cost
Nature of this business suggests that development costs and sales, gen, and adm expense will start to level off
Cost of revenue will stay at 25% of revenue
Technical development will grow at 25% annually
Sales, gen, and adm exp will grow at 25% annually

34. Economies of Scope
IS business can be extended to new geographical areas without duplicating all of the infrastructure
IS can add new products with incurring much additional costs

35. Capabilities Required
General management
Recruitment of skilled, experienced managers
Sales
More highly coordinated, well managed
Informal communication failing
Network administration
Continued heavy investments

36. Competitive Position First mover advantage
Resources of competitor firms
Short term contracts with suppliers
Low barriers to entry

37. Enterprise Valuation Based on 1999 figures
Enterprise valuation: $43 million/.8 = $53.75 million
TEV/LTM revenue = 4.44
TEV/LTM for other comparable firms 0.7 to 94
Based on 2004 estimates
TEV/2004 est revenue = ?
TEV/2004 est net earnings = ?

38. Valuation Internet Securities Estimated 2004 earnings = $53 million
P/E ratio = 10
2004 value = $530 million
1999 value for ROI of 25% = $172 million

39. DCF Year CF CF after tax Discount DCF 1999 -5.7 -3.41 1.00 2000 -3.0
-1.79
0.80
-1.43
2001
4.6
2.74
0.64
1.75
2002
22.2
13.30
0.51
6.81
2003
60.4
36.26
0.41
14.85
2004
140.6
84.36
0.33
27.64
2005
305.2
183.12
0.26
48.00
Total
94.22
Discount rate assumed to be 0.25
Tax rate assumed to be 0.40
Cash flow assumed to be equal to earnings