Chapter 7Value Creation and Strategic

Information Systems

What is added value and how can it be created by way of IT-dependent strategic initiatives

Chapter 7

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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. 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.

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Introduction

The primary role of functional and

general managers

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 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)

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

Transformation process

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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.

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

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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

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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 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 comparison3. Estimate Customer Willingness to Pay4. Estimate Supplier Opportunity Cost5. 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.

InitiativeStrategicIT-dependent

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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 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.

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. 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.

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