WEEK 3

What is a Business Model?

 Composite and coordinated answer to four broad questions

– What forces are driving the marketplace and industry in which the business is
competing?
– How has the business defined itself?
– What are the competitive advantages that enable the business to prevail in a
competitive marketplace?
– How does the business make money?

Models based on Management Type

 Hierarchical
- A group of persons or things arranged in order of rank, grade, class, etc.
- Form when a concentration of specialized knowledge or assets is required to produce
and market a product
- Achieve economies of scale and scope by combining numerous competencies into one
large organization
 Entrepreneurial
o Entrepreneurship is the recognition and pursuit of business opportunity:
 - without regard to the resources you currently control

- with confidence that you can succeed

- with the flexibility to change course as necessary

- with the will to rebound from setbacks

o Focus on creativity & “thinking outside the box”

o Quick responses to changes due to small size & direct, face-to-face

management/employee interaction
o Decisions made by every person as necessary

 Network
o Big organizations structured and geared-up to act small (Big-small companies)

o Focus on speed, connectivity, execution, and offer

o Heavy use of IT to facilitate entrepreneurial-style communication

o Goal is to combine precision and process control inherent in large hierarchical firms
with nimbleness, “learn-by-doing” style and flat management structure of
entrepreneurial enterprises
o Spurred & facilitated by computer networking integration in operations

 eBusiness Models by Roles

o Focused Distributor
 Retailer (ToysRUs.com)
 Aggregator (Autoweb.com)
 Marketplace (LendingTree.com)
 Exchange (eBay.com)
o Portal
 Horizontal Portals (Yahoo.com)
 Vertical Portals (WebMD.com)
 Affinity Portals (iVillage.com)
o Producer
 Manufacturers (Ford)
 Service Providers (American Express)
 Educators (University of Phoenix)
 Advisor (Accenture)
 Information Providers (New York Times)
 Producer Portals (Global Healthcare Exchange)
o Infrastructure Distributor
 Retailers (Egghead)
 Infrastructure Marketplaces (Tech Data)
 Infrastructure Aggregators (ZDNet)
 Infrastructure Exchanges (Converge)
 o Infrastructure Portal
 Horizontal Infrastructure Portals (American Online)
 Vertical Infrastructure Portals (GE Global eXchange Services)
o Infrastructure Producer
 Equipment/Component Manufacturers (IBM/SONY)
 Software (Sap/Microsoft)
 Custom software and integration service providers (Accenture)
 Infrastructure Services (Federal Express)

E-Commerce Business Model

 B2C: Business to Consumer

o Consumer driven
o Earliest e-Commerce
o Initially was retail - computers
o Books, CDs, travel, and entertainment
o 500,000 commerce sites in all verticals
- many “click-and-mortar” strategies
- driven by large “Web only” players
o Examples:
- Amazon.com
- Drugstore.com

 B2B: Business to Business

o The Big Mover
o e-Business driven
o EDI and Internet based
o 80% of “e-Commerce” $s
o Estimated $1 trillion spent annually
- Growing to 2.5 trillion by 2005
- Will be nearly all of digital commerce by 2010

 C2C: Consumer to Consumer

o Auctions
- Facilitated at a portal
o Peer-to-peer
- Napster model
- file exchange
- transaction optional
o Classified ads at portal sites

 C2B: Consumer to Business

o Reverse auction
o Post a “wanted” message
o Businesses will bid on message
 o Can be automated at an exchange
o Creates very large consumer markets
- a way to liquidate distressed inventory
or participate in a “C2M2B2C” exchange
o Priceline.com / Autobytel.com

 B2B2C: Business to Business to Consumer

o Supplier of product / services to B2C
o Large back end players:
- financial services
- distribution, replenishment
- payments, EDI, supply chain
o Can include direct commerce
o Examples:
- Yahoo!
- Fed-Ex

 C2M2C
o All currently existing “C2C” is really C2M2C
- M = Market Intermediary
o Dynamic pricing / collaborative commerce
- Large buy-side / sell-side portals / exchanges
o eBay / KaZaa / Bearshare

 Market Intermediaries
 Internet Exchange
o Large B2B component
o Estimated 33% of all B2B in 2003
o Dynamic pricing
- Prices set by buyers and sellers
- Multiple buyers and sellers
o Marketplace Model
- Many buyers and sellers present
- Usually organized around a specific vertical market
 E-Hubs / e-Market places
o Adds process to portals
- Community, content, and commerce
- Creating process share from member value
o Closely akin to exchanges
o Supply chain solutions
o Channel partners
o Vertical Net / I2 / Manugistics / ANX

 Direct Commerce
Business Model Evolution

Example of Evolution:
• Mail-order Direct Marketer  B2C
• Lands’ End
– Near-term Goal:
“Make it easier for business customers to purchase products from Lands' End over the
Web.”
– Long-term Goal:
“Provide business customers with a flexible, highly customized e-commerce
environment.”
Land’s End
• Logical transition from mail-order to
online ordering
• Among the first to make the leap (1995), also among most successful
 • Enhance and expand strategy
– Enhance: Improved performance, improved functionality
– Expand: New markets (worldwide, includes everyone not on the mailing list…)

So why do we care?

• Large percentage of managers/ employees in eBusiness are technical

• Promotion and success requires clear understanding of business models
• Understanding the business model allows IT management:
– To be proactive in management of IT
– To seek solutions to problems before enterprise management has defined the problem
(or perhaps even noticed it!

Business Activities

• Financing Activities
– Obtaining capital from owners and creditors
– Repaying creditors and paying a return to owners
• Investing Activities
– Spending the capital it receives in ways that are productive and will help the business
achieve its objectives
– Buying and selling assets to be used in the business
• Operating Activities.
– Selling goods and services to customers
– Employing managers and workers
– Buying and producing goods and services
– Paying taxes

Performance Measurement

• Use of quantitative tools to gauge an organization’s performance in relation to a specific goal

or expected outcome
• Product or service quality is NOT a measure; it is what management wants to measure
– Quantifiable measures are necessary to measure quality
• Key measurements typically financial
• Quality measurements usually in terms of defects
• Information technology performance measurements often non-financial and consequently
difficult to quantify

Financial & Managerial Accounting

• Accounting’s role: assist decision makers by
– Measuring information
– Processing information
– Communicating information
• Usually divided into two categories
– Managerial or Management accounting
– Financial accounting
• Distinguished by the principal users of their information

 Financial Accounting
o Financial accounting bound by rigid rules
 GAAP – Generally Accepted Accounting Principles
 Financial Accounting Standards Board
 Securities and Exchange Commission
o Normally requires services of Certified Public Accountants (CPA)
o Provides information to external constituencies on past performance
o Information in the form of
Financial Statements
 Report directly on the goals of profitability and liquidity
 Used extensively both inside and outside a business to evaluate the business’s
success
o Four Financial Statements
 Balance Sheet
 The balance sheet is based on the following fundamental accounting
model:
 Assets = Liabilities + Equity
 Shows what a company owns and what it owes
 Fair market value of assets may be very different from “book values”
shown
 Always “balanced”, hence the name

 Income Statement
 The income statement shows the “bottom line”: earnings or profit
 May be called the “earnings statement”, “statement of operations”, “profit
and loss statement” or “revenue and expense statement”
 Reports on the financial results of operating the business for a specified
period of time

 Statement of Owner’s Equity

 Reports changes in the owners' interests (equity)
o Details changes in net earnings or dividends paid to stockholders
o Stockholders' equity statement shows
paid-in capital invested in the business in exchange for stock as of
the beginning of the accounting period
o Also called a “statement of changes in equity”, “statement of
retained earnings” or “equity statement”

 Cash Flow Statement

  Useful in evaluating a company’s ability to pay its bills
 For a given period, the cash flow statement provides the following
information:
o Sources of cash
o Uses of cash
o Change in cash balance
 Positive numbers represent cash flowing in, negative numbers (xxx)
represent cash flowing out
 Even profitable firms occasionally experience negative cash flow

Managerial Accounting

o Oriented toward the needs of internal decision makers

o Provides managers and employees within the organization with information regarding how they
have done in the past and what they can expect in the future
o Companies have discretion to design systems that provide information in order to make
decisions about the organization’s financial, physical, and human resources.
o Provides information to internal constituencies
• Current and future oriented
• No regulations
• Subjective and disaggregate
• Financial, operational, and physical measures

Management Cycle

o Traditionally, management operates in four stages:

 Planning
- Long and short term
- Support decision-making and
set expectations
 Executing
- Hiring, scheduling, acquiring assets (including inventory), reducing waste,
generating revenues
 Reviewing
- Controlling operations
-
 Reporting
- To stockholders, creditors, other managers, other interested parties
Planning and Controlling

Managerial Accounting Reports

• Product and service costing information

• Information for planning of and control over operations
• Special reports and analyses to assist in managerial decision making
• No “standard” reports as in financial accounting

Reports Use
• Managerial accounting information is used for:
– Operational control
• Provide feedback to employees and managers about efficiency of activities being
performed

– Product costing
• Measure and assign costs of activities performed to design and produce
individual products and/or services

– Customer costing
• Assign marketing, selling, distribution, and administrative costs to individual
customers so cost of serving each customer can be calculated

– Management control
• Provide information about the performance of managers
  Uses of Cost Information: Planning:
o Operating cost information and product costs used to:
 Develop budgets
 Determine selling prices or fees for services and products
 Plan human resource needs

 Uses of Cost Information: Executing

o Operating cost information and product costs used to:
 Make decisions about dropping a service line, product line, or segment
 Evaluate outsourcing opportunities
 Estimate margins and income
 Bid on special orders
 Negotiate a selling price or fee

 Uses of Cost Information: Reviewing

o Operating cost information and product costs used to:
 Calculate variances between estimated and actual costs
 Help managers determine the causes of cost overruns and enable them to adjust
future actions to reduce potential problems

 Uses of Cost Information: Reporting

o Operating cost information and product costs used to:
 Report actual results of operating activities on the income statement
 Report the value of inventory on the balance sheet
 Report performance related to products or service

Types/uses of Operating Cost Info

Cost Classifications

 Cost Traceability
o Direct Cost
 Conveniently traced to a cost object
o Indirect Cost
 Cannot be conveniently traced to a cost object

 Cost Behavior
o Variable Cost
 Changes in direct proportion to a change in volume
o Fixed Cost
 Remains constant within a range of activity or for a defined time period

 Value-Adding Attributes
o Value Adding Cost
 Increases the market value of a product or service
o Non-Value Adding Cost
 Adds cost to a product or service but does not increase its market value

 Cost for Financial Reporting

o Product (Inventoriable) Costs
 Costs such as direct materials, direct labor, and manufacturing overhead that are
assigned to inventory as an asset until sold
[Product Costs may be Prime Costs (Direct Materials and Direct Labor) or
Conversion Costs (Direct Labor and Manufacturing Overhead)]
o Elements of Product Costs
- Direct materials
 - Can be conveniently and economically traced
to specific units of product
- Direct labor
- Can be conveniently and economically traced to specific units of
product
- Manufacturing overhead
- Includes all manufacturing costs that are not direct materials or direct
labor costs
- Also called factory overhead or indirect manufacturing costs

o Period (Non-inventorial) Costs

 Costs of resources consumed, expensed as incurred during the accounting
period and not assigned to products

 Information Technology Costs

o Typically indirect costs
 But eCommerce costs are direct costs
o As in service organizations, major cost component is labor
o Service-related overhead costs include:
 Equipment (computers & peripherals, networking infrastructure, etc.)
 Software
 Connectivity expense

 Activity-Based Management (ABM)

o An approach to management that includes:
 Identification of all major operating activities
 Determination of what resources are consumed by each activity
 Categorization of activities as either adding value to a product or service or not
adding value
o Focuses on reduction or elimination of non-value-adding activities.

 Budgets
o Quantitative expressions of plans of action
 Aid to coordinating and implementing the plans
 May include both financial & non-financial elements
o Chief devices for compelling and disciplining management planning
o Budgeting is the process of:
 Identifying
 Gathering
 Summarizing
 and Communicating
Financial and nonfinancial information about an organization’s future activities
Types of Budget

• Cash Budgets
– Establish target levels of cash receipts and limits on cash spending for particular
purposes

• Production Budgets
– Show planned production in units

Service Organization Budget Planning

• Managers of service organizations must know the types and amounts of:
– Services to perform
– Labor hours required
– Level of expertise of employees
– Labor rates

• For information technology, add:

– Connectivity requirements
– Software licenses
– Age and replacement cycle of equipment

• Operating budgets for service organizations include:

– Service revenue
(for IT may be internal chargebacks i.e. IT services billed as overhead costs to other
departments)
– Labor
– Services overhead
– Selling and administrative budget

• For information technology, add:

– Purchase costs
(and probably subtract selling budget)

 Standard Costing
o Budgeting control technique with three components:
 A standard, predetermined performance level
 A measure of actual performance
 A measure of the variance (the difference between the standard
and the actual)

 Standard Cost
o Standard costs are predetermined costs that are developed from analyses of both
 Past operating costs, quantities, and times
 Future costs and operating conditions

 The Balance Scorecard

o A framework that links the perspectives of an organization’s 4 stakeholder groups:
  Financial (investors)
 Learning and growth (employees)
 Internal business processes (management)
 Customers
With the organizations:
 Mission and vision
 Performance measures
 Strategic plan
 Resources
o To succeed, an organization must add value for all stakeholders
 Determine each group’s objectives
 Translate their objectives into performance measures that have specific,
quantifiable performance targets

 Net Present Value

o Used in calculation of multi-year investments or income
o Time value of money means money received (or expended) now is worth more than
money received later
o Net Present Value is the answer to the question “What sum of money must I have today
to equal the $X I will receive a year from now?”
o Calculated using discount rate (reverse interest) so the present value of $X in one year
(assuming 6% interest) would be X/1.06
o Example: Net Present Value of $5,000 received in one year would be
$5,000/1.06 = $4,716.98