Value Creation and StrategicInformation Systems

© Gabriele Piccoli

Chapter 7

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. 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

Creation and appropriation of economic value

© Gabriele Piccoli

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

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

© 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)

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

Transformation process

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

© 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

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

© Gabriele Piccoli

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

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

© 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

Value continuum

Supplier opportunity

cost

Coffee Shop willingness to pay

Total value created in the cake-making transformation process:

$9

$20 $11

© 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

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

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

Your Firm

Supplier Opportunity

Cost

Coffee Shop willingness to

pay

Cousin Bettie’s

Firm

$20 $11

$23 $13

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

Supplier opportunity cost

Customer willingness to pay

© 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

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

© 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

No Need for Proprietary IT

© Gabriele Piccoli Source: Imagebroker/Glow Images

Tactical Systems

• HR/PR systems– Used to process employees pay

• Restaurant Point-of-sale (POS) system– Used to manage

• Reservations• Seating• Order taking • Delivery• Billing

© Gabriele Piccoli

© Gabriele Piccoli

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

Initiative

• Specific projects • Clear boundaries • Examples:

– Tracking shipping• Fed Ex• USPS

– Tracking pizza• Papa Johns• Dominos

© Gabriele Piccoli

Used with permission from Dominos

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

© Gabriele Piccoli

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

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

© 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.