online file w15.1 nucleus research’s roi...

Chapter Fifteen: Economics and Justification of Electronic Commerce 1

Online File W15.1 Nucleus Research’s ROI Methodology

ROI is used best to compare potential EC projects with other internal projects and success factors—not with those of othercompanies. It also is important that a company develop a standard methodology and make it part of every technology reviewand investment.

The ROI CalculationTo compute ROI for one year, divide the year’s net benefits by the initial cost of the project and multiply that by 100. For instance,if a project initially costs $50 and returned $100 in net benefits (benefits minus costs), then the ROI in the first year would be(100 ÷ 50) × 100, or 200 percent. However, technology rarely recovers its costs in the first year; more accurate calculations use athree- or five-year horizon. With a three-year horizon, the ROI calculation is the average net benefits per year divided by 3. This isthen divided by the initial cost and multiplied by 100:

ROI � (((Net year 1 � Net year 2 � Net year 3) / 3) / Initial cost) � 100

An average ROI calculation yields numbers that are directly comparable with those one would find with other corporateinvestments, the cost of capital, or a simple bank certificate of deposit.

Payback PeriodIn many cases, the payback period may be more important than the ROI. Payback period provides an indication of risk andoffers insight into the company’s flexibility. Payback period is the point in time at which total benefits equal total costs. Let’slook at an example. Say that the initial cost of a project is $600 and that the net benefits are as shown in the following table:

Year 1 Year 2 Year 3

Net benefit � $200 Net benefit � $300 Net benefit � $300

In the first year, the company spent $600 but got $200, so it is out $400 at the end of the year. In the second year, itmakes $300, but it is still short $100. It takes half of the third year to cover the $100, resulting in a payback period of two andone-half years.

Why is payback important? Consider the following scenario: You’ve just deployed the perfect Web site with e-commerce linksto all your legacy systems. It took you a year’s time and significant costs, but you have beaten everyone else to the market. Yourthree-year ROI will be 1,000 percent, but the payback period is two years, meaning that you will not cover your costs for sometime. What if someone develops a new development tool that allows you and the competitors to create a better application in amuch shorter time? You know you should use this tool to redesign your site, but you still have not covered your initial costs.

No matter how attractive the ROI and how good the NPV, long payback periods are not preferable because technology changesquickly. One should be flexible enough to discard a technology decision and absorb sunk costs when a superior solution comes along.

CostsGathering cost information usually is easier because most companies know what they have spent or are planning to spend.To ensure that the company gathers the right costs:

◗ Count everything that is directly associated with the project (e.g., purchase of a new server).◗ Do not count infrastructure items not associated with the project (e.g., leveraging the existing network servers).◗ Count infrastructure items that were driven by the project (e.g., the company purchased a server because of this project and

two other projects like it; therefore, prorate and include one-third of the costs).

Direct BenefitsBenefits are either direct or indirect. Direct benefits include items such as decreased paper costs, reduced accounts receivable,reduced use of express mail, reduced or reassigned staff, sales of old hardware, and so on. These are tangible savings. Savingsmay be one time (e.g., reduced personnel) or recurring. Recurring savings should be included in every year’s computation.

Indirect BenefitsIndirect benefits can also be somewhat intangible. For example, indirect savings may include reducing the time needed to testnew software by 25 percent. If you expect the company to increase sales by 10 percent because of a new sales support system,do not include both the profit on the increased sales and the value of your salespeople’s becoming 10 percent more efficient.You should reasonably expect that the increased salesperson efficiency causes the increase in profit. It is always better tocount the more direct result (profit) rather than the indirect result (increased productivity).

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2 Part 6: EC Strategy and Implementation

Online File W15.1 (continued)

The following are some guidelines in assessing the value of an indirect benefit:

◗ Measure or estimate the expected change in time or productivity. For example, if you estimate that 1,000 employees each willsave 10 minutes per year, the change in productivity is 166.6 hours.

◗ Correct this amount based on the inefficient transfer of time. For example, if you save an hour, the employee may work only anadditional one-half hour. Therefore, the correction factor is 0.5 hour.

◗ Multiply the gain by the fully loaded cost of an employee (including retirement benefits, vacation, insurance, etc.) to calculatethe value of the benefit. If you are using multiple loaded costs, do this calculation for each category of employee.

◗ Reducing costs often looks better on paper than in reality. After implementing the project, go back and look for a corroboratingmeasurement. For example, if you estimated the legal department would save 10 percent of their time, then you would try todetermine the following:◗ Did the legal department reduce its staff by 10 percent?◗ Did the legal department’s expenditures grow at a rate slower than the rate for the rest of the organization?◗ Are the lawyers 10 percent more productive?

If any one of these is correct, your initial estimate was correct.

Calculating ROI and Other MetricsCalculate the net values at the initial year and for each subsequent year. Calculate the ROI using the formula presented earlier:

ROI � (((Net year 1 � Net year 2 � Net year 3) / 3) / Initial cost) � 100

The payback period is a little more difficult to calculate, but as mentioned earlier, it is a very important indicator of risk.Follow the formula presented earlier. However, automated ROI calculators make it easier to change assumptions and rerun theanalysis.

Formulas for NPV Analysis

where n � number of years and i � interest rate for investment (cost of capital). It is also known as the discount rate. The PVfactor is then multiplied by the future amounts to figure its value today, and compared to the discounted cost over the sameperiods to compute the NPV.

where:t � specific year: 1, 2, etc.T� project life (e.g., 5 years, 10 years, etc.)i � interest rate (discount rate)A � income at period tC � initial investment, or PV of all investments over T.

Sources: Adapted from the ROI Knowledge Center at nucleusresearch.com/tutorial.html (accessed March 2006) and from baselinemag.com.

NPVA

C=+

−=∑ t

tt

T

i( )11

PV =−1

1( )i n


Online File W15.2 Handling Intangible Benefits

The following are suggestions about how to handle intangible benefits.

◗ Think broadly and softly. Supplement hard financial metrics with soft ones that may be more strategic in nature and that maybe important leading indicators of financial outcomes. Measures such as customer and partner satisfaction, customer loyalty,response time to competitive actions, and improved responsiveness are examples of soft measures. Subjective measures can beobjective if used consistently over time. For instance, customer satisfaction measured consistently on a five-point scale can bean objective basis for measuring the performance of customer-facing initiatives.

◗ Pay your freight first. Think carefully about short-term benefits that can “pay the freight” for the initial investment inthe project. For example, a telecom company found that it could justify its investment in data warehousing based on thecost savings from data mart consolidation, even though the real payoffs from the project would come later from increasedcross-selling opportunities.

◗ Follow the unanticipated. Keep an open mind about where the payoff from IT and e-business projects may come from andfollow opportunities that present themselves. Eli Lilly & Co. created a Web site called InnoCentive (innocentive.com) to attractscientists to solve problems in return for financial rewards (“bounties”). In the process, Lilly established contact with 8,000exceptional scientists, and Lilly’s HR department has used this list of contacts for recruiting.

◗ Prioritize the benefits. Some benefits are more significant than others. Try to rank them or set weights on them. Note thatthe priorities may change over time and across applications.

◗ Intangible costs. Make sure to investigate the intangible cost as well. These may be interfering with production, making someemployees unhappy, or creating conflicts with distributors.

Sources: Compiled from Sawhney (2002) and Devaraj and Kohli (2002).

REFERENCES FOR ONLINE FILE W15.2Devaraj, S., and R. Kohli. The IT Payoff: Measuring Business

Value of Information Technology Investment. UpperSaddle River, NJ: Financial Times Prentice-Hall, 2002.

Sawhney, M. “Damn the ROI, Full Speed Ahead.” CIOMagazine, July 15, 2002.

REFERENCES FOR ONLINE FILE W15.1Nucleus Research. ROI Knowledge Center at nucleus

research.com/tutorial.html (accessed March 2005).Baseline. “How to Calculate ROI.” September 6, 2006.

baselinemag.com/article2/0,1540,2012723,00.asp(accessed November 2006).

information economicsAn approach similar tothe concept of criticalsuccess factors in thatit focuses on keyorganizational objectives,including intangiblefinancial benefits, impactson the business domain,and impacts on IT itself.


ONLINE FILE W15.3

ADVANCED METHODS FOR EVALUATING EC AND ITINVESTMENTS VALUE ANALYSISKeen (1981) developed the value analysis method to assist organizations in evaluating invest-ments in decision support systems (DSSs). The major problem with justifying a DSS is thatmost of the benefits are intangible and not readily convertible into monetary values. Some—suchas better decisions, better understanding of business situations, and improved communication—are difficult to measure even in nonmonetary terms. These problems in evaluating DSSs aresimilar to the problems in evaluating intangible benefits for other types of systems. Therefore,value analysis can be applied to several types of IT and EC investments in which a large propor-tion of the added value is derived from intangible benefits. The value analysis approach includeseight steps, grouped into two phases. The steps of the value analysis approach are shown inExhibit W15.3.1.

In the first phase, the decision maker identifies the desired capabilities and the (generallyintangible) potential benefits. The developers estimate the cost of providing the capabilities;if the decision maker feels the benefits are worth this cost, a small-scale prototype of the DSS(or another IT application) is constructed. Then, the prototype is evaluated.

The results of the first phase provide information that helps with the decision about thesecond phase. After using the prototype, the user has a better understanding of the value ofthe benefit and of the additional features the full-scale system needs to include. In addition,the developers can make a better estimate of the cost of the final product. The question atthis point is: What benefits are necessary to justify this cost? If the decision maker feels thatthe system can provide these benefits, a full-scale system is developed.

Though it was designed for DSSs, the value analysis approach is applicable to anyinformation technology that can be tested on a low-cost basis before deciding whether tomake a full investment. The current trend of buying rather than developing software, alongwith the increasingly common practice of offering software on a free-trial basis for 30 to 90days, provides ample opportunities for the use of this approach. Organizations may also haveopportunities to pilot the use of new systems in specific operating units and then implementthem on a full-scale basis if the initial results are favorable. For further discussion, see Fineet al. (2002).

INFORMATION ECONOMICSThe information economics approach is similar to the concept of critical success factors inthat it focuses on key organizational objectives, including intangible financial benefits, impactson the business domain, and impacts on IT itself. Each of the key organizational objectiveshas several components. In addition, more metrics can be added (see McKay and Marshall2004). Information economics incorporates the technique of scoring methodologies, which areused in many evaluation situations.

Identify value(intangible benefits)

Establish maximumcost willing to pay

Build prototype ifcost is acceptable

Evaluateprototype

2 3 41Phase 1

Phase 2

Enhance functionalityof full-scale system

Build full-scalesystem if benefits

justify it

Identify benefitsrequired tojustify cost

Establish cost of full-scale system

7 6 58

EXHIBIT W15.3.1 Steps in Value Analysis

metric benchmarksA method that providesnumeric measures ofperformance.

benchmarksAn approach to evaluatinginfrastructure that focuseson objective measures ofperformance.


SCORING METHODOLOGYA scoring methodology evaluates alternatives by assigning weights and scores to various factorsand then calculating the weighted totals. The analyst first identifies all the key performanceindicators (KPIs) and assigns a weight to each one. Each alternative in the evaluation receives ascore on each factor, usually between 0 and 100 points or 0 and 10 points. These scores aremultiplied by the weighting factors and then totaled. The alternative with the highest score isjudged the best (or projects can be ranked, as in the ROI Iowa case at the end of the chapter).Then, one can perform sensitivity analysis to see the impact of changing the weights.

The information economics approach uses organizational objectives to determine whichfactors to include and what weights to assign in the scoring methodology. The approach isflexible enough to include factors in the analysis such as impacts on customers and suppliers(the value chain). Executives in an organization determine the relevant objectives and weightsat a given point in time, which are subject to revision if there are changes in the environment.These factors and weights are then used to evaluate IT alternatives; the highest scores go tothe items that have the greatest potential to improve organizational performance. Note thatthis approach can incorporate both tangible and intangible benefits. If there is a strong con-nection between a benefit of IT investment (such as quicker decision making) and an organi-zational objective (such as faster product development), the benefit will influence the finalscore even if it does not have a monetary value. Thus, the information economics model helpssolve the problem of assessing intangible benefits by linking the evaluation of these benefits tothe factors that are most important to organizational performance.

Approaches like this are very flexible. The analyst can vary the weights over time forbetter analysis; for example, tangible benefits may receive heavier weights at times whenearnings are weak. The approach can also take risk into account by using negative weightsfor factors that reduce the probability of obtaining the benefits.

Most information systems projects are not stand-alone applications. In most cases, theydepend on enabling infrastructures already installed in the organization. These infrastructuretechnologies include mainframe computers, operating systems, networks, database managementsystems, utility programs, development tools, and more. Because many of the infrastructurebenefits are intangible and spread over many different present and future applications, it is difficultto estimate their value or to evaluate the desirability of enhancements or upgrades. In other words,it is much more difficult to evaluate infrastructure investment decisions than investments inspecific information systems application projects (see Lewis and Byrd 2003). Two methods arerecommended for evaluating infrastructure investments: benchmarks and management by maxim.

USING BENCHMARKS TO ASSESS INFRASTRUCTUREINVESTMENTSOne approach to evaluating infrastructure is to focus on objective measures of performanceknown as benchmarks. These measures often are available from trade associations within anindustry or from consulting firms. A comparison of measures of performance or of an organiza-tion’s expenditures with averages for the industry or with values of the more efficient performersin the industry indicates how well the organization is using its infrastructure. If performance isbelow standard, corrective action is indicated. The benchmark approach implicitly assumes thatIT infrastructure investments are justified if they are managed efficiently. Benchmarks come intwo very different forms: metrics and best-practice benchmarks.

Metric benchmarks provide numeric measures of performance; for example: (1) IT expensesas percent of total revenues, (2) percent downtime (time when the computer is unavailable),(3) central processing unit (CPU) usage as a percentage of total capacity, and (4) percentage of ISprojects completed on time and within budget. These types of measures are very useful to man-agers, even though sometimes they lead to the wrong conclusions. For example, a ratio of ITexpenses to revenues that is lower than the industry average may indicate that a firm is operatingmore efficiently than its competitors. Or it may indicate that the company is investing less in ITthan it should and will become less competitive as a result. Metric benchmarks can help diagnoseproblems, but they do not necessarily show how to solve them.Therefore, many organizations alsouse best-practice benchmarks.

scoring methodologyA method that evaluatesalternatives by assigningweights and scores tovarious aspects and thencalculating the weightedtotals.

management by maximA five-step process thatbrings together corporateexecutives, business-unitmanagers, and IT execu-tives in planning sessionsto determine appropriateinfrastructure investments.


With best-practice benchmarks, the emphasis is on how information system activitiesare actually performed rather than on numeric measures of performance. For example, anorganization may feel that its IT infrastructure management is very important to its perfor-mance. It could then obtain information about best practices on how to operate and manageIT infrastructure. These best practices may be from other organizations in the same industry,from a more efficient division in its own organization, or from another industry entirely. Theorganization would then implement these best practices for its entire IT infrastructure tobring performance up to the level of the leaders.

MANAGEMENT BY MAXIM FOR IT INFRASTRUCTUREOrganizations with multiple business units, including large, multidivisional ones, frequentlyneed to make decisions about the appropriate level and types of infrastructure that their individ-ual operating units will support and share. These decisions are important because infrastructurecan amount to over 50 percent of the total IT budget and because it can increase effectivenessthrough synergies across the organization. However, because of substantial differences amongorganizations with regard to their culture, structure, and environment, what is appropriate forone will not necessarily be suitable for others.The fact that many of the benefits of infrastructureare intangible further complicates this issue.

Broadbent and Weill (1997) suggest a method called management by maxim to deal withthis problem. This method brings together corporate executives, business-unit managers, andIT executives in planning sessions to determine appropriate infrastructure investmentsthrough a five-step process. In the process, managers articulate business maxims—shortwell-defined statements of organizational strategies or goals—and develop corresponding ITmaxims that explain how IT can support the business maxims. This approach can work wherethere is no shared infrastructure or where the infrastructure category is a utility.

REAL-OPTION VALUATION OF IT INVESTMENTA promising new approach for evaluating IT and EC investments is called real options. Itsobjective is to recognize that EC investments can increase an organization’s performance inthe future. This is especially important for emerging technologies that need time to matureand may involve sequential investments in EC to place the firm to gain major future benefits.The concept of real options comes from the field of finance, where financial managers haveapplied it to capital budgeting decisions. Instead of only using traditional measures, such asNPV, to make capital decisions, financial managers are looking for opportunities that may beembedded in capital projects. These opportunities, if taken, will enable the organization toalter future cash flows in a way that will increase profitability.

These opportunities are called real options (to distinguish them from financial optionsthat give investors the right to buy or sell a financial asset at a stated price on or before a setdate). Common types of real options include the option to expand a project (to captureadditional cash flows from such growth), the option to terminate a project that is doingpoorly (to minimize loss on the project), and the option to accelerate or delay a project(e.g., the delay of an airport expansion cited in Section 15.2 of the textbook). Current ITinvestments, especially for infrastructure, can be viewed as another type of real option.Such capital budgeting investments make it possible to respond quickly to unexpected andunforeseeable challenges and opportunities in later years. If the organization waits in itsinvestment decisions until the benefits have been established, it may be very difficult tocatch up with competitors that have already invested in the infrastructure and have becomefamiliar with the technology.

By applying just the NPV concept (or other purely financial measures) to an investmentin IT infrastructure, an organization may decide that the costs of a proposed investmentexceed the tangible benefits. However, if the project creates opportunities for additionalprojects in the future—that is, if it creates opportunities for real options—the investment alsohas an options value that should be added to its other benefits (see Benaroch 2002; Devarajand Kohli 2002).

Benaroch (2002) illustrates a real-options approach in the investment in an electronic saleschannel. The four-step options-based process attempts to understand and plan for the risk

best-practicebenchmarksBenchmarks thatemphasize how informa-tion system activities areactually performed ratherthan on numeric measuresof performance.

balanced scorecardmethodAnalysis of a variety ofmatrices (finance, inter-nal operation, agility,customer opinions) forevaluating the overallhealth of an organization.


involved while attempting various configurations to maximize the value of the investment.The four steps are:

1. Define the investment and identify the risks.2. Recognize shadow options (i.e., mapping the risks and options to control them).3. Identify investment configurations.4. Identify the most valuable configurations.

The mathematics of real-option valuation are well established but unfortunately are toocomplex for many managers (see Dixit and Pindyck 1995). For a discussion on usingreal-option pricing analysis to evaluate a real-world IT project investment in four differentsettings, see Li and Johnson (2002). Rayport and Jaworski (2004) applied the method inevaluating EC initiatives.

THE BALANCED SCORECARD AND DASHBOARD METHODSBALANCED SCORECARDThe balanced scorecard method evaluates the overall health of organizations and projects.Initiated by Kaplan and Norton (1996), the method advocates that managers focus not onlyon short-term financial results but also on four other areas for which metrics are available.These areas are: (1) finance, including both short- and long-term measures; (2) customers(how customers view the organization); (3) internal business processes (finding areas inwhich to excel); and (4) learning and growth (the ability to change and expand). The keyidea is that an organization should consider all four strategic areas when considering ITinvestments.

The balanced scorecard (BSC), which is similar to information economics, assumes that inaddition to financial results, IT investments in people, skills and capabilities, databases,knowledge, and so forth are the leading indicators of an organization’s success. In their frame-work, van Grembergen et al. (2003) relate the BSC to the results of IT investment.

Kaplan and Norton (2006) applied the method to corporate strategy as summarized inChapter 14, the BSC approach proposes that organizations develop metrics, collect data, andanalyze it from several perspectives beyond the financial outcomes.

Plant et al. modified the BSC for EC application by incorporating four additionalperspectives—brand, service, market, and technology—and found them to be critical to thedevelopment and execution of e-business strategies. They applied their modified BSC tothe e-business strategies of 44 companies in the United States and Europe. Identifying thecompanies as either leaders or laggards in their industries, their research indicated thatthe leaders possessed three characteristics:

◗ Leaders had the ability to understand their own value proposition and put in placerobust, relevant, and timely measurement systems that enabled them to judge the real-time effectiveness of their strategy.

◗ Leaders understood the value proposition from multiple perspectives: both internal tothe organization (e.g., from a financial or process perspective) and external to the orga-nization (e.g., the customer perspective).

◗ Leaders continually monitor their position relative to their objective goal criteria, adjust-ing the criteria, metrics, and strategy as necessary.

Sawhney (2002) attempted to use the BSC to measure the performance of EC systems,including intangible benefits. He examined the EC systems from two perspectives: that ofthe e-business and that of the user. For more on the BSC, see Lawson et al. (2004).

PERFORMANCE DASHBOARDRayport and Jaworski (2004) developed a variant of the BSC called the performance dash-board, which they advocate for the evaluation of EC strategy. Several other attempts to fitthe BSC approach to IT project assessment have been made (e.g., see van Grembergen et al.[2003] and balancedscorecard.org) The methodology actually is embedded in severalvendors’ products (e.g., sas.com/solutions/bsc). For demos, see corvu.com.


OTHER METHODSSeveral other methods exist for evaluating IT investments. For example, most large vendorsprovide proprietary ROI calculators. However, according to King (2002), proprietary calcula-tors may be biased and may lead to a sometimes-unjustified decision to adopt a project. Tomake the decision less biased, some companies use a third-party evaluator, such as IDC(idc.com) or META Group (metagroup.com), to conduct ROI studies. An example of such acalculator is SAP Business Case Builder (see sap.com/solutions/casebuilder). Several vendorsoffer nonproprietary ROI calculators (e.g., CIO View Corporation). CIO.com (2004) offersmany tools via Nucleus Research Inc. for calculating the ROI of different IT systems.

According to Rubin (2003), every IT project must be tied to a specific business objective,with its priority indicated, so as to measure the project’s success in terms of a specific primarybusiness value. Rubin developed a special “whiteboard” that includes metrics and their stake-holders. For details and examples, see Rubin (2003). Two methods follow.

THE EXPLORATION, INVOLVEMENT, ANALYSIS, AND COMMUNICATIONS MODELDevaraj and Kohli (2002) proposed the exploration, involvement, analysis, and communica-tions (EIAC) model for evaluating IT projects. The method is composed of nine phasesdivided into four categories: exploration (E), involvement (I), analysis (A), and communica-tion (C). For details, see Devaraj and Kohli (2002).

ACTIVITY-BASED COSTINGGerlach et al. (2002) and Roberts (2003) proposed another approach for assessing IT invest-ment—suggesting the use of an activity-based costing (ABC) approach to assist in IT invest-ment analysis. For details on how ABC works, see a management or managerial accountingtextbook. Using a case study, Gerlach et al. (2002) showed that the company that utilizedABC derived significant benefits from a better understanding of IT delivery costs and arationale for explaining IT costs to department managers. Mutual understanding of IT costsis a necessary condition for shared responsibility of IT, which, in turn, leads to effective eco-nomic decision making that optimizes resource utilization and the alignment of IT withbusiness strategy. In addition, the use of ABC helps in reducing operational costs.

KEY TERMSBalance scorecard method 7Benchmarks 5Best-practice benchmarks 6

Information economics 4Management by maxim 6

Metric benchmarks 5Scoring methodology 5


Online File W15.4 E-Procurement Complexities in Marketplaces

Setting up e-procurement metrics is difficult because e-procurement may require significant investment in technology, redesignedprocesses, and employee training. In addition, purchasing or procurement capabilities in businesses typically evolve from simpleonline buying of supplies and materials to full-scale involvement in e-marketplaces. This evolution often occurs in four phases:

1. Internal buy-side system. In this phase, the purchasing department conducts its buying activities online. Buyers can workfrom consolidated catalogs, featuring products from multiple, preferred suppliers, and then complete transactions on theWeb. This phase builds the foundation for expansion of the e-procurement initiative.

2. Direct purchasing system. In this phase, the purchasing organization and the supplier network become more closely aligned.Leveraging any prearranged purchasing contracts with suppliers, the purchasing departments share detailed information withsuppliers over the Web to eliminate wasted steps for purchase order confirmation, credit checks, and shipping address verification.

3. E-marketplace involvement. In this phase, the purchasing company either joins or develops an e-marketplace. This Web-basedintermediary unites buyers, sellers, and brokers to both increase competition among suppliers and give suppliers access to a largerpopulation of buyers. E-marketplaces usually offer dynamic pricing, aggregation of orders, multiple suppliers, price visibilityacross suppliers, and opportunities to collaborate. E-procurement activity in a marketplace can take two forms:

◗ Participation in a consortium of trading exchanges (CTEs)◗ Creation of private trading exchanges (PTEs)

E-procurement allows one to search for buyers or sellers. Within these e-marketplaces, buyers or sellers may specify prices orinvite bids and initiate and complete transactions. Many e-marketplaces can also handle management of payables, settle-ment, customer care, and other administrative services.

4. Collaboration. In this last phase, the company connects internal procurement processes and systems with those of its suppliersvia a partner extranet—basically, a secure connection between systems accomplished over the public Internet. When supplies ormaterials are needed, these collaborating systems automatically communicate orders, check availability, schedule shipments, andexchange payment—all without requiring involvement from the purchasing staff. E-marketplaces can provide an easy way fororganizations to integrate their systems with many suppliers at once by establishing mutual standards for e-procurement.

REFERENCES FOR ONLINE FILE W15.3Benaroch, M. “Managing Information Technology

Investment Risk: A Real Options Perspective.” Journal ofManagement Information Systems, Vol. 19, No. 2 (2002).

Broadbent, M., and P. Weill. “Management by Maxim: HowBusiness and IT Managers Can Create IT Infra-structures.” Sloan Management Review, (Spring 1997).

Devaraj, S., and R. Kohli. The IT Payoff: Measuring BusinessValue of Information Technology Investment. UpperSaddle River, NJ: Financial Times Prentice-Hall, 2002.

Dixit, A. K., and Pindyck, R. S. “The Options Approachto Capital Investment.” Harvard Business Review(May–June 1995).

Fine, C. H., et al. “Rapid-Response Capability in Value-Chain Design.” MIT Sloan Management Review (Winter2002).

Gerlach, J., et al. “Determining the Cost of IT Services.”Communications of the ACM (September 2002).

Kaplan, R. S., and D. P. Norton. Alignment: How to Applythe Balanced Scorecard to Corporate Strategy. Cambridge,MA: Harvard Business School Press, 2006.

Kaplan, R. S., and D. P. Norton. The Balanced Scorecard:Translating Strategy into Action. Boston, MA: HarvardBusiness School Press, 1996.

Keen, P. G. W.“Value Analysis: Justifying DSS.” ManagementInformation Systems Quarterly (March 1981).

King, J. “User Beware.” Computerworld, March 18, 2002.

Lawson, R., et al. “Automating the Balanced Scorecard.”CMA Management, February 2004.

Lewis, B. C., and T. A. Byrd. “Development of a Measurefor IT Infrastructure Construct.” European Journal ofInformation Systems ( June 2003).

Li, X., and J. D. Johnson. “Evaluate IT Investment Opportu-nities Using Real Options Theory.” Information ResourcesManagement Journal ( July–September 2002).

McKay, J., and P. Marshall, Strategic Management of e-Business.Milton, Australia: Wiley, 2004.

Plant, R., L. Willcocks, and N. Olson. “Measuring E-BusinessPerformance: Towards a Revised Balanced ScorecardApproach.” Information Systems and eBusiness Management,Vol. 1, No. 3 (2003).

Rayport, J., and B. J. Jaworski. E-Commerce, 2nd ed. NewYork: McGraw-Hill, 2004.

Roberts, A. “Project Aquarius: Measuring the Impact ofTechnology.” Management Services, 2003.

Rubin, H. A. “How to Measure IT Value.” CIO Insight,May 1, 2003.

Sawhney, M. “Damn the ROI, Full Speed Ahead.” CIOMagazine, July 15, 2002.

van Grembergen, W. V., et al. “Linking the IT BalancedScorecard to the Business Objectives at a Major CanadianFinancial Group.” Journal of Information Technology Casesand Applications (2003).


Online File W15.6 Assessing eCRM ROI

A formal business plan must be in place before the eCRM project begins—one that quantifies the expected costs, tangiblefinancial benefits, and intangible strategic benefits, as well as the risks. The plan should include an assessment of the following:

◗ Tangible net benefits. The plan must include a clear and precise cost-benefit analysis that lists all the planned project costsand tangible benefits. This portion of the plan should also contain a strategy for assessing key financial metrics, such as ROI,NPV, and IRR. It also should specify a payback period.

◗ Intangible benefits. The plan should detail the expected intangible benefits, and it should list the key performance indicators(KPIs) that will measure successes and shortfalls. Often, an improvement in customer satisfaction is the primary goal of theeCRM solution, but in many cases this key value is not measured before and after the project.

REFERENCE FOR ONLINE FILE W15.5Minahan, T. “The E-Procurement Benchmark Report: Less

Hype, More Results.” Aberdeen Group, September 29,2004. ketera.com/pdf/Aberdeen%20Whitepaper%20

on%20eProcurement%20Benchmark%20Reports.pdf(accessed February 2007).

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Online File W15.5 Web Services for E-Fulfillment

The supplier side of e-procurement is called e-fulfillment. It is important for suppliers to integrate their e-fulfillment systems withtheir buyers’ e-procurement systems. Some companies choose to take greater control over the e-procurement process by developingtheir own EC systems. However, new applications must be developed and integrated into existing IT infrastructure, which requiresexpensive custom coding and time. To free themselves from coding and integration, companies can outsource this function to e-fulfillment providers who are increasingly using Web services to quickly develop and enhance e-fulfillment systems.

Webservices.org defines Web services as self-contained business functions that operate over the Internet. They are writtento strict specifications to work together and with other similar kinds of components. Web services are important to businessesbecause they enable systems in different companies to interact with each other more easily. The Web services architectureallows the packaging of Web applications that e-fulfillment providers can rapidly develop in response to buyers’ needs and useacross a variety of legacy systems retailers already have in place.

Linens ’n Things, a home goods retailer, outsourced its e-fulfillment so that it could concentrate on its core retail salesbusiness. Besides e-fulfillment, the service provider generated warehouse forecasts by analyzing Linens n’ Things’s historicaldata, reducing the critical metric of put-away time, the time elapsed between arrival of the inventory and availability for onlinesale. Another Web services provider utilized click-to-release time as a metric for a consumer electronic retail order fulfillment.Click-to-release is the time elapsed from when a customer clicked to buy an item online until a warehouse staff had a ticket(“green light”) to begin packing the order.

For Linens ’n Things, the Web services-based e-fulfillment system proved useful when it decided to allow customers to pickup online orders from the local store, thus, prompting a change in the system. Similarly, in response to security concerns, thee-fulfillment provider was able to quickly add CVV2 codes (four-digit codes on the back of credit cards) as part of the onlineorder process. The bad debt due to fraudulent online orders was tracked as half that of the previous year.

A 2004 e-procurement benchmarking research study by the Aberdeen Group found that more businesses were using e-procurementto manage more requisitions, spend categories, and suppliers than in the past, resulting in reduced requisition-to-order cycle time aswell as reduced costs, resulting in lower overall prices.

Source: Compiled from Minahan (2004).


◗ Risk assessment. The risk assessment is a list of all the potential pitfalls related to the people, processes, and technology thatan eCRM project involves. Having such a list helps to lessen the probability that problems will occur.

Implementation CostsImplementation costs often are split between EC and IT costs and business-unit costs.

EC and IT costs include the following:

◗ eCRM software licensing and support contracts◗ Licensing and support contracts for EDI and extranet tools, databases, operating systems, and other software◗ Hardware purchases and support contracts, specifically server-, storage-, and network-related expense◗ Software integration and customization, including design, development, testing, and maintenance◗ Implementation labor◗ Ongoing administration and support labor

Business-unit costs include the following:

◗ Planning and requirements meetings◗ User training and learning time◗ Process change management

Tangible and Intangible BenefitsBenefits typically include increases in staff productivity, cost avoidance, revenues, and margins, and reduced inventory costs(due to the elimination of errors). The following are some of the objectives that should be considered:

◗ Reduce the cost of sales.◗ Reduce sales administration overhead.◗ Improve the lead-to-sale closure ratio.◗ Increase customer retention.◗ Improve customer satisfaction and loyalty.

Potential Pitfalls and RisksSome potential pitfalls of eCRM include the following:

◗ Taking on more than can be delivered. The eCRM solution should target specific sales or service business functions or specificgroups of users. Additionally, it is essential to manage the project’s scope, goals, and objectives throughout the project life cycle.

◗ Getting over budget and behind schedule.◗ Ease of use and adequate training are essential to minimize poor user adoption.◗ Expensive maintenance and support may occur.◗ Isolation. The effectiveness of a project may suffer if the CRM data are not used throughout the company.◗ Garbage in, garbage out. Because eCRM systems require so much data entry, users often put in placeholders, misguided

estimates, or inaccurate information, which leads to poor analytical results and decision-making errors.◗ Failure to measure success. Measurement of preproject status and postproject achievements is essential for a company to

show success.

Teradata Corp. (teradata.com) offers an approach for measuring the ROI for CRM that begins with setting ROI objectivesand ends with tracking CRM performance over time, analyzing it, and revising and refining CRM efforts accordingly.

Sources: Compiled from Pisello (2004), Alter (2006), and baselinemag.com (accessed November 2006).

Online File W15.6 (continued)

REFERENCES FOR ONLINE FILE W15.6Alter, A. “The Bitter Truth About ROI.” CIO Insight,

July 2006.Pisello, T. “CRM ROI: Facts or Fiction?” CIO.com,

February 3, 2004.


Online File W15.7 The ROI on RFID

RFID (Radio Frequency Identification) is a technology that incorporates the use of the radio frequency (RF) portion of theelectromagnetic spectrum to uniquely identify an object. RFID is increasingly used in industry as an alternative to the bar code(Chapter 7). The advantage of RFID is that it does not require direct contact or line-of-sight scanning.

Thus far, RFID technology has basically been used in smart bar codes to track shipments. Recently, in response to madcow disease, the U.S. government has considered tagging cows with RFID tags to track their movement. RFID is likely to gainmomentum; Wal-Mart and the U.S. Department of Defense are among the early adopters. However, Brennan (2005), of theAlwaysOn Network, suggests that the early wave of RFID adoption overlooks the true capabilities and potential of the technol-ogy—and doesn’t allow adopters to reap the full benefits because of the mandate from a major customer, such as Wal-Mart.The true ROI of RFID will involve comprehensive implementations with real opportunities on behalf of all participants in thesupply chain because it is part of the wider movement toward sensor-actuator, always-on devices. The capabilities of smarttags range from monitoring the date of perishable goods and automatically reducing the price as the expiration approaches tosounding an alarm when a careless forklift operator places a palette of flammable chemicals in a restricted area. According toBrennan, in order for RFID to progress to more advanced functions, organizations will have to restructure their systems—fromapplication software to servers to administration.

True ROI will only come with a complete redesign of business processes to make better use of this new RFID technology,as opposed to integration with legacy systems that will not last very long. Over one-third of respondents in an October 2004RFID survey said that integration with legacy systems was their “biggest expense”; less than 10 percent were spendingcomparably on the new infrastructure that will soon be necessary. Worse yet, more than half the respondents answered thattheir largest investment was solely in the peripheral hardware needed for RFID implementation (tags, readers, etc.). Vempati(2004) offers many reasons why proceeding with a less-than-optimal system architecture can lower the ROI by increasingthe total cost of ownership (TCO) over time. Increased costs from legacy system maintenance and IT staff training composethe higher TCO.

This will create some challenges for the traditional corporate infrastructure. RFID tags usually hold information about aproduct in the standard Electronic Product Code (EPC) format. The EPC identifies the individual item, but additional informationis written in the Physical Markup Language (PML), which is based on the more commonly known eXtensible Markup Language(XML). The vast amount of RFID data can easily overwhelm any database. But native XML databases are not only more capableof handling the deluge of information, they also are better at searching and sorting data in order to filter it and only processwhat is necessary. IBM’s next-generation database will contain both relational and native XML storage engines, and Oracle andMicrosoft are likely to respond with their own product offerings.

The real need for XML databases is when EPC information is combined with other PML data from sensor actuators in abusiness context. Imagine an item moving through the supply chain: It is scanned as it leaves the warehouse and again as itenters the truck; its temperature is monitored in the truck; and it is continually tracked at all possible points down the lineuntil it is sold. The challenge is how a single place can store all this data. In the most likely scenario, separate databases willhold the information about a given item at every point in the supply chain. This means that the whole network, not just adatabase, will need to be queried in order to get all the product information. This implies that all the databases would needto be connected to each other; XML databases will likely be most capable of doing that. Effective standards for this type ofcommunication are being developed, and the infrastructure build-up will be huge. Cisco predicts that by 2010, 80 percent ofthe traffic on its network will be EPC related.

RFID will eventually revolutionize business processes throughout the supply chain and result in greater efficiency andvalue. However, simply adding smart tags before shipping will not exploit the full potential of the RFID benefits.

Sources: Adapted from Brennan (2005) and Baseline (2006).

REFERENCES FOR ONLINE FILE W15.7Baseline. “How to Calculate ROI.” September 6, 2006.

baselinemag.com/article2/0,1540,2012723,00.asp(accessed November 2006).

Brennan, I. “ROI on RFID: Now That’s the Future.”AlwaysOn Network, January 11, 2005. alwayson-network.com/comments.php?id=7849_0_11_0_C(accessed February 2005).

Vempati, S. S. “RFID Architecture Strategy.” Infosys.comwhite paper, December 2004. infosys.com/wpm/bitpipe/infosys_white_paper_on_rfid_architecturestrategy.pdf(accessed February 2005).


ONLINE FILE W15.8

ALLIANCE INSURANCE EXERCISEAIC is a national insurance company that provides B2Bautomobile, property, and industrial insurance in major U.S.metropolitan areas. It has 16 field offices that support 450field inspectors who visit insured sites to conduct inspec-tions and settle insurance claims. About 250 auditors overseetransactions to ensure that the business is running smoothly.

With the current system, inspectors get preliminaryproperty or damage information over the phone. Aftercollecting the information, they make site visits to assessthe nature of the customer’s needs, return to the office torun the numbers and prepare the paperwork, and then makeanother on-site appointment to finish the transaction.Inspectors fill out weekly activity logs and audit theirtransactions to ensure accuracy and high quality of service.Oftentimes, the field inspectors come back to the office onlyto find out that their next visit is in the same general loca-tion that they just returned from.

One major limitation of the current system is that fieldinspectors must frequently return to the office to consult thevolumes of manuals to accurately insure clients or settle claims.Frequent updates of insurance rates and risk estimates and aconstant flow of new products have made it impossible for theinspectors to carry these manuals with them.

AIC is considering a mobile computing infrastructurethat will enable field inspectors to access online manuals aswell as other information necessary to conduct business. Thesystem will also enable the central office to make appoint-ments for the field inspectors as well as conduct mailingsand other official business. In other words, the field inspec-tors will work from a virtual mobile office.

Team Assignment1. Divide the class into two teams. One team will identify

the costs metrics—tangible as well as intangible—of themobile computing system. In determining costs, considerhardware, software, application development, integrationwith back-office applications, and other implementationcosts. The second team will identify the benefit metricsof the mobile computing system. The teams should con-sider productivity, cost reduction, reduced duplication,and so on when determining benefit metrics.

Use a spreadsheet program to create a spreadsheetand assign your team’s costs and benefits estimates.Share these with the other team for their comments.

Each group should identify specific metrics to recommendto AIC so that it can conduct a postimplementation ROI.

As the speed of change in the global e-marketplaceincreases, collaboration and coordination costs along thesupply chain will increase (Lewis and Byrd 2003). Further,meeting increased demands for the introduction of newproducts and services will be a challenge.

Team Assignment1. Form teams to study the role and status of RosettaNet.

Assign each member to one area of activity performedat RosettaNet. Prepare a report on the potential valueof e-hub partnerships.

Cisco Systems’ leadership role in the creation andexpansion of RosettaNet standards and eHub are visionaryinitiatives that will reduce friction in e-marketplaces throughthe collaboration of partners across the supply chain.Evidence from industrywide initiatives by Procter & Gambleand Baxter with similar visions indicates that such collabora-tion can lead to cost reductions for all partners throughimproved forecasting and planning and waste reduction.

The success of such EC initiatives depends on the numberof partners that join. Many potential partners are sitting onthe fence and waiting for reassurance that their investment ineHub will lead to some business value. After all, implementa-tion of each eHub Partner Interface Process (PIP) will cost thepartner up to $500,000 (Rayner 2001). However, the supplychain only becomes a “value chain” after ERP systems inte-grate internal processes. In addition, suppliers and customersalso must be integrated into the supply chain, which requiresfurther expense and effort on the part of the partners tointegrate their internal systems with eHub.

For additional information on eHub and Rosetta Net, seeMark Schenecker’s article, “Inside RosettaNet’s AutomatedEnablement,” which is available at ebizq.net/topics/b2b/features/5487.html.

1. What metrics can Cisco use to demonstrate the potentialopportunities resulting from the eHub partnership tocurrent and prospective partners?

2. How will prospective partners weigh the benefits againsttheir concerns over sharing pricing and inventory infor-mation with everyone on eHub?

Sources: This assignment is based on material compiled fromTwentyman (2001), Lewis (2001), and Rayner (2001). The studentsare encouraged to review these sources and explore recent sources inregard to RosettaNet.


REFERENCES FOR ONLINE FILE W15.8Lewis, N. “Cisco Closes the Gap with eHub.” EBN,

February 16, 2001. my-esm.com/showarticle.jhtml?article id=2910958 (no longer available online).

Rayner, B. “The Power of the Hub.” EBN, June 27, 2001.my-esm.com/showarticle.jhtml?articleid=2912371(accessed February 2005).

Twentyman, J. “Private Members’ Club.” Information Age,December 16, 2001. information-age.com/article/2001/december/private_members_club adp (accessedJanuary 2007).

online file w15.1 nucleus research’s roi...

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