Transcript Housekeeping - Prof. Sung Ho Ha's Homepage

Chapter 7
Value Creation and Strategic
Information Systems
What is added value and how can it be created by way of ITdependent strategic initiatives?
© Gabriele Piccoli
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
© Gabriele Piccoli
Learning Objectives
1. To define key terminology, including the concepts of total value
created, customer willingness to pay, supplier opportunity cost, and
added value
2. To compute total value created and added value
3. To estimate the portion of the total value created that will be
appropriated by each of the entities who contributed to its creation
4. To differentiate between strategic information systems and tactical
information systems
5. To define and utilize the concept of IT-dependent strategic
initiatives
© Gabriele Piccoli
Introduction
The primary role of
functional and
general managers
© Gabriele Piccoli
Creation and
appropriation of
economic value
Analysis of Added Value
• A formal mechanism to evaluate how much of
the value created the firm can appropriate
• This analysis is an essential step in the
decision of whether or not to introduce an
initiative:
– If the proposed initiative creates no tangible
value, you should shelve it
– If the initiative does contribute to the creation of
value and your firm can appropriate such value,
then you should invest in it
© Gabriele Piccoli
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
© Gabriele Piccoli
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)
© Gabriele Piccoli
Transformation Process
• Input resources (value of $x in their next best utilization) are
transformed into outputs for which customers are willing to
pay $x + $v
• $v is the amount of new value that was created
– It was not there before
– It would not come to be unless the transformation process
occurred
• 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 can sell and a customer
is interested in acquiring.
© Gabriele Piccoli
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
© Gabriele Piccoli
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
© Gabriele Piccoli
Image created by Michael Lee at the English Wikipedia Project
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
to provide resources
© Gabriele Piccoli
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 the minimum amount of money you want
© Gabriele Piccoli
Customer Willingness To Pay
• Value is in the eyes of the customer
• Value is generated when
– Customers are 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
© Gabriele Piccoli
Total Value Created
Supplier
opportunity
cost
Coffee Shop
willingness to pay
Value
continuum
$11
$20
Total value created in the cakemaking transformation process:
$9
© Gabriele Piccoli
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
© Gabriele Piccoli
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
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
© Gabriele Piccoli
Coffee Shop
willingness
to pay
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
attributable to the firm
– It depends on the effects of existing competition
• Added value = $0 when you face competitors
with
– Same cost structure
– Perfect substitutes of your products
© Gabriele Piccoli
Pricing Considerations
• Price determines what portion of TVC
each player appropriates
• No matter how much value a firm
contributes to creating, unless it is (at least
in part) unique, it will quickly be competed
away to customers.
© Gabriele Piccoli
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
© Gabriele Piccoli
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
© Gabriele Piccoli
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
customers with needed resources for less
money
Customer willingness to pay
Supplier opportunity cost
© Gabriele Piccoli
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
© Gabriele Piccoli
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
© Gabriele Piccoli
Added Value Analysis
• Clearly Define the Initiative and Understand
What It Entails
– Be clear about what the firm will do for customers
or suppliers
– What resources are necessary to create the
product or perform the service you offer.
• Identify the Comparison
– It is critical to identify a baseline comparison
– It could be what the firm does today or a
competitor's offer
© Gabriele Piccoli
Added Value Analysis
• Estimate Customer Willingness to Pay
– List all 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.
© Gabriele Piccoli
Strategic Information Systems
• A firm achieves competitive advantage
when:
– It is able to generate added value
– 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
© Gabriele Piccoli
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
© Gabriele Piccoli
No Need for Proprietary IT
Source: Imagebroker/Glow Images
© Gabriele Piccoli
Tactical Systems
• HR/PR systems
– Used to process employees pay
• Restaurant Point-of-sale (POS) system
– Used to manage
•
•
•
•
•
© Gabriele Piccoli
Reservations
Seating
Order taking
Delivery
Billing
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
© Gabriele Piccoli
Initiative
• Specific projects
• Clear boundaries
• Examples:
– Tracking shipping
• Fed Ex
• USPS
– Tracking pizza
• Papa Johns
• Dominos
Used with permission from Dominos
© Gabriele Piccoli
Strategic
• 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 also in a reduction of calls
which translate into reduced costs
© Gabriele Piccoli
IT-Dependent
• Cannot be feasibly created and
executed without the use of information
technology at their core
• Example:
– Customer relationship management
– e-Commerce
– e-Business
© Gabriele Piccoli
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
© Gabriele Piccoli

Consists of the
configuration of an
activity system,
dependent on IT,
fostering 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
© Gabriele Piccoli
The Recap
• Strategic information systems are those that are
designed and developed to create and appropriate
value.
– They differ from tactical information systems
• IT-dependent strategic initiatives consist of identifiable
competitive moves and projects that enable the
creation of added value
• They 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.
© Gabriele Piccoli
What We Learned
1. To define key terminology, including the concepts of total value
created, customer willingness to pay, supplier opportunity cost, and
added value.
2. To compute total value created and added value.
3. To estimate the portion of the total value created that will be
appropriated by each of the entities who contributed to its creation.
4. To differentiate between strategic information systems and tactical
information systems.
5. To define and utilize the concept of IT-dependent strategic
initiatives.
© Gabriele Piccoli