© Gabriele Piccoli

Value Creation and StrategicInformation Systems

What is added value and how can it be created by way of IT-dependent 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. Define key terminology, including the concepts of total value created, customer willingness to pay, supplier opportunity cost, and added value.

2. Learn to compute total value created and added value.

3. Learn to estimate the portion of the total value created that will be appropriated by each of the entities who contributed to its creation.

4. Differentiate between strategic information systems and tactical information systems.

5. Define and utilize the concept of IT-dependent strategic initiatives.

© Gabriele Piccoli

Introduction

The primary role of functional and

general managers

Creation and appropriation of economic value

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Analysis of Added Value

• A formal mechanism to evaluate how much of the value created the firm can appropriate by employing the initiative

• Benefits:– Deciding whether you should go ahead with

the initiative or not – Evaluating how to respond to a competitor

who took the leadership position

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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)

Customer Willing to Pay: $x + $v (Output)

Transformation process

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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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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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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

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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.

Value continuum

Supplier opportunity

cost

Coffee Shop willingness to pay

Total value created in the cake-making transformation process:

$9

$20 $11

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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

Value continuum

Supplier opportunity

cost

Your Firm’s cost

Coffee Shop willingness to

payPrice

Supplier Share

Your Firm’s Share

Coffee Shop’s Share

Total value created in the cake-making transformation

process: $9

$18 $20$12$11

© Gabriele Piccoli

Cake-Making Example

• Supplier opportunity cost = $11– Ingredients =$4– Time = $6.5 per hour– Electricity and delivery = $0.5

• Firm cost = $12– Ingredients =$5– Time = $6.5 per hour– Electricity and delivery = $0.5

• Price = $18• Customer willingness to pay = $20• Value Appropriation

– 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

Value continuu

m

Supplier opportunity cost

Your Firm’s cost

Coffee Shop willingness

to payPrice

Supplier

Share

Your Firm’s Share

Coffee Shop’s Share

Total value created in the cake-making

transformation process: $9

$18 $20$12$11

© Gabriele Piccoli

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 facecompetitors 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

Your Firm

Supplier Opportunity

Cost

Coffee Shop willingness to

pay

Cousin Bettie’s

Firm

$20 $11

$23 $13

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

Supplier opportunity cost

Customer willingness to pay

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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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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 sytems 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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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.

Initiative

Strategic

IT-dependent

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Do not focus on IT Investments

IT investments

only pay off if they are part of a larger and

cohesive information system

design

IT-dependent strategic initiative

consist of the configuration of an

activity system, dependent on IT at its core that fosters the

creation and appropriation of economic value.

© Gabriele Piccoli

What we Learned

1. Define key terminology, including the concepts of total value created, customer willingness to pay, supplier opportunity cost, and added value.

2. Learn to compute total value created and added value.

3. Learn to estimate the portion of the total value created that will be appropriated by each of the entities who contributed to its creation.

4. Differentiate between strategic information systems and tactical information systems.

5. Define and utilize the concept of IT-dependent strategic initiatives.