Transcript Chapter 7

Chapter 7
Chapter 7
Value Creation and Strategic
Information Systems
What is added value and how can it be created by way of ITdependent strategic initiatives
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Course Roadmap
• Part I: Foundations
• Part II: Competing in the Internet Age
• Part III: The Strategic use of Information Systems
– Chapter 6: Strategic Information Systems Planning
– Chapter 7: Value Creation and Strategic Information
Systems
– Chapter 8: Value Creation with Information Systems
– Chapter 9: Appropriating IT-Enabled Value over Time
• Part IV: Getting IT Done
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Learning Objectives
1.
2.
3.
4.
5.
To define key terminology, including the concepts of total value created,
customer willingness to pay, supplier opportunity cost, and added value.
To compute total value created and added value.
To estimate the portion of the total value created that will be
appropriated by each of the entities who contributed to its creation.
To differentiate between strategic information systems and tactical
information systems.
To define and utilize the concept of IT-dependent strategic initiatives.
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Introduction
Creation and
appropriation of
economic value
The primary role of
functional and
general managers
Analysis of Added Value
• A formal mechanism to evaluate how much of
the value created the firm can appropriate by
employing the initiative
• This analysis is an essential step in the decision of
whether or not you should go ahead with the
initiative
– If the proposed initiative creates no tangible value,
you should shelve it
– If the initiative does contribute to the creation of
value, but your firm will be unable to appropriate such
value created, then you should also not go on with it
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Challenges
• Deciding whether you should go ahead with
the initiative or not
• Evaluating how to respond to a competitor
who took the leadership position
• How to react when you will only have limited
information
• How to create precise estimations for value
created and added value
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Value
• When something novel is done
• When this “something novel” is deemed
worthwhile by someone else
• Economic value is created through a
transformation process
Resource: Value $x (Input)
Transformation
process
Customer Willing to Pay: $x + $v (Output)
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Transformation Process
• Economic value is created through a transformation process when
some input resources that have a value of $x in their next best
utilization are transformed into outputs for which customers are
willing to pay $x + $v
• When such a transformation process takes place, it can be said that
value, in the amount of $v, has been created
– this new value was not there before and would not come to be unless
the transformation process did occur
• Input Resources:
– Any factor of production, such as raw materials, labor, equity and debt
capital, managerial talent, support services
• Output Resources:
– The product and/or service that the firm engaging in the
transformation process is seeking to sell and that a customer is
interested in acquiring.
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Key Components of Value
• Supplier Opportunity Cost (SOC):
– The minimum amount of money the suppliers are willing to accept to
provide the firm with the needed resources.
• Firm Cost (FC):
– The actual amount of money the firm disbursed to acquire the
resources needed to create its product or service.
• Customer Willingness to Pay (CWP):
– The maximum amount of money the firm’s customers are willing to
spend in order to obtain the firm’s product.
• Total Value Created (TVC):
– The difference between customer willingness to pay and supplier
opportunity cost.
– TVC = CWP – SOC.
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Example
• Input Resources
–
–
–
–
–
Labor,
Stores & warehousing facilities
Trucks and equipment,
Fuel for trucks & utilities for stores
Equity and debt capital
• Transformation Processes
– Acquiring products in bulk
– Warehousing them
– Distributing them to stores
• Output
– Convenient access to a large selection of
mainstream products.
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Supplier Opportunity Cost
• A rational supplier will only provide the firm
with its services if it receives at least the same
sum of money they would have received from
any other buyer
– SOC is NOT the amount that suppliers will be paid
(the firm cost)
– It is the theoretical minimum they will accept
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Supplier Opportunity Cost Example
• Looking for a new job
– You (the supplier) applied for five jobs
– You are selected for interviews at each job
• During the interviews, you formulated some idea
regarding your willingness to work for the each
company and how much you want to get paid.
– You received offers from three firms
• You select the offer that
– Exceeds your willingness to work at the firm
– Exceeds your minimum amount of money you want
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Customer Willingness To Pay
• Value is in the eyes of the customer
• Value is generated when
– Customers is willing to pay to acquire whatever
the firm has created
– This amount is larger than the supplier
opportunity cost
• The most elegantly engineered and technically
beautiful product is valueless unless a
customer is willing to pay for it
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Total Value Created
• Value is created when resources that in their
next best used would be worth a given
amount are transformed into something that a
customer is willing to pay more for.
Supplier
opportunity
cost
Coffee Shop
willingness to pay
Value
continuum
$11
$20
Total value created in the cakemaking transformation process:
$9
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Appropriating the Value Created
• TVC only tells us if there is an opportunity to make a
profit.
• Value appropriation:
– The process by which the total value created in the
transaction is allocated amongst the entities who
contributed to creating it
Supplier
opportunity
cost
Your
Firm’s
cost
Price
$11
$12
$18
Coffee Shop
willingness to
pay
Value
continuum
Supplier
Share
Your Firm’s
Share
$20
Coffee Shop’s
Share
Total value created in the cakemaking transformation process:
$9
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Cake-Making Example
• Supplier opportunity cost = $11
– Ingredients =$4
– Time = $6.5 per hour
– Electricity and delivery = $0.5
Supplier
opportun
ity cost
Your
Firm’s
cost
Price
$11
$12
$18
Coffee Shop
willingness
to pay
Value
continuu
m
• Firm cost = $12
– Ingredients =$5
– Time = $6.5 per hour
– Electricity and delivery = $0.5
• Price = $18
• Customer willingness to pay = $20
• Value Appropriation
Suppli
er
Share
Your
Firm’s
Share
$20
Coffee Shop’s
Share
Total value created in
the cake-making
transformation process:
$9
– The suppliers appropriate $1.00 in excess profits
– You appropriate $6.00 in excess profits
– The customer, the gourmet coffee shop, appropriates $2.00 in savings
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Added Value
• The portion of the total value created that would be
lost if the firm did not take part in the exchange
– The unique portion of the total value created that is
contributed by the firm itself
– It depends on the effects of existing competition
• Added value = $0 when you face
competitors with
– Same cost structure
– Perfect substitutes of your products
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Pricing Considerations
• Price becomes important to gauge what
portion of the value created each entity
partaking to the transaction can appropriate.
• No matter how much value your firm
contributes to creating, unless you can be (at
least in part) unique in your value creation,
you will quickly compete this value away to
customers.
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Competitive Advantage
• The maximum amount of value that a firm can
appropriate equals its added value.
• Added value is a measure of its competitive
advantage
– It measures the extent to which the firm is able to
do something:
• Unique
• Valuable
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Creating Added Value
• Creating unique characteristics of your cake
– Increase in SOC = $2
– Increase in CWP = $3
– Added value created = $1
Supplier
Opportunity Cost
Coffee Shop
willingness to
pay
$13
$23
Your
Firm
Cousin
Bettie’s
Firm
$11
$20
Your Firm’s Added
Value: $1
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Two Ways to Create New Value
• Increasing Customer Willingness to Pay:
– Doing something of value for customers
– Investing incremental resources to increase CWP
by a larger amount
• Decreasing Supplier Opportunity Cost
– Creating incentives for suppliers to supply the with
needed resources for less money
Customer willingness to pay
Supplier opportunity cost
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Some Considerations
• Value is in the eye of the customer
• Customer willingness to pay is not the same as
price
• Value can be tangible or intangible
• Creation of value is not the same as
appropriation of value
• Competitive advantage and added value are
closely related
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Added Value Analysis
1. Clearly define the initiative and understand
what it entails
2. Identify the comparison
3. Estimate Customer Willingness to Pay
4. Estimate Supplier Opportunity Cost
5. Estimate Added Value
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Added Value Analysis
• Clearly Define the Initiative and Understand What
It Entails
– We are very clear about what the firm will do for
customers or suppliers and what resources are
necessary to create the product or perform the
service being sold by identifying the intended value
proposition.
• Identify the Comparison
– Critical to identify a baseline comparison between the
competitor’s initiative or the firm’s own offers
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Added Value Analysis
• Estimate Customer Willingness to Pay
– Listing all of the positive & negative customer willingness to pay
drivers
• Estimate Supplier Opportunity Cost
– When the initiative’s main contribution to value creation is on
the supplier opportunity cost side, supplier opportunity cost
must be used.
– When the main effect of the initiative is on customer willingness
to pay, then a simplifying assumption using firm cost as a proxy
for supplier opportunity cost is acceptable.
• Estimate Added Value
– At the end, you can measure added value and begin to draw
value appropriation considerations.
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Strategic Information Systems
• A firm achieves competitive advantage when:
– It is able to generate added value
– By creating a unique and positive difference
between CWP and SOC.
• Strategic information systems
– Information systems used to support or shape the
competitive strategy of the firm
– Designed and implemented to enable the creation
and appropriation of value
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Strategic Information Systems
• Defined by their purpose and the objective with
which they are created
• No need for proprietary IT:
– Technology alone does not determine added value.
– The initiative and its Information System underpin the
firm’s value-creating strategy.
• Tactical systems are:
– Critical to business operations
– But do not generate added value.
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No Need for Proprietary IT
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Tactical Systems
• HR/PR systems
– Used to process
employees pay
• Point-of-sale (POS)
systems
– Used to manage
reservations, seating,
order taking and
delivery, and billing
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IT-Dependent Strategic Initiatives
IT-dependent strategic initiatives consist of
identifiable competitive moves (or projects) –
designed to lead to sustained improvements in
the firm’s competitive position – that depend on
the use of IT to be enacted.
IT-dependent
Strategic
Initiative
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Initiatives-Based Systems
• Specific projects with clear
boundaries that define
what the initiative is
designed to achieve, as well
as what it is designed to do
and not do.
• Examples (Tracking Tools):
– Shipping
• Fed Ex
• USPS
– Pizza deliveries
• Papa Johns
• Dominos
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Strategic-Based Systems
• Objective of producing new
value that the firm can
appropriate
• Creating competitive
advantage through the
initiative
• Example (Shipping Tools):
– Initial goal was to improve
customer service
– The tools result is a reduction
of calls regarding orders &
shipments (and therefore
customer willingness to pay)
which translated to reduced
costs
IT-Dependent-Based Systems
• Cannot be feasibly
created and executed
without the use of
information technology
at their core
• Example:
– Customer relationship
management
– e-Commerce
– e-Business
Do not focus on IT Investments
IT-dependent strategic
initiative
IT investments
only pay off if they are
part of a larger and
cohesive information
system design

consist of the
configuration of an
activity system,
dependent on IT at its
core that fosters the
creation and
appropriation of
economic value.
The Recap
• Economic value is created when some input resources
that have a value of $x in their next best utilization are
transformed into outputs for which customers are
willing to pay $x + $v
• The value thus created is partitioned amongst those
entities involved in its creation: a firm, its suppliers,
and its customers—a process known as value
appropriation
• A firm is able to appropriate that portion of the total
value created that would be lost if the firm did not
partake in the exchange—a figure we termed added
value
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The Recap
• Strategic information systems are those that are designed
and developed to create and appropriate value.
– They differ from tactical information systems, which are those
systems that, while often critical for the firm’s operations, do
not enable the creation of distinctive value
• IT-dependent strategic initiatives consist of identifiable
competitive moves and projects that enable the creation of
added value, and that rely heavily on the use of information
technology to be successfully implemented.
• General and functional managers must take the center
stage in the identification and analysis of opportunities to
create value with information systems.
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What we Learned
1.
2.
3.
4.
5.
To define key terminology, including the concepts of total value created,
customer willingness to pay, supplier opportunity cost, and added value.
To compute total value created and added value.
To estimate the portion of the total value created that will be
appropriated by each of the entities who contributed to its creation.
To differentiate between strategic information systems and tactical
information systems.
To define and utilize the concept of IT-dependent strategic initiatives.
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