Value Innovation from Value Chain to Revenue Management

Value Innovation: from Value Chain to Revenue Management Jason C. H. Chen, Ph. D. Professor and Coordinator of MIS Graduate School of Business, Gonzaga University Spokane, WA 99258 USA chen@jepson. gonzaga. edu

Outline of the Topic • Stages of E-Business • Internet Impact on Economy and Industry • Value Creation – Business Models and Value Chain – Applications • Revenue Management – Models and Applications • Conclusion 2

Comparison of adoption rates for Internet, PCs, TV and radio Internet (4) (16) PCs TV (13) (38) Radio 0 10 20 30 40 Time to reach 50 millions users (years) Figure 1. 4 (p. 5) 3

Stages of Moving to E-Business Wilcocks, Sauer and Associates (2000) 4

Percent IT-producing industries share of economy 5

Distribution of Internet Users Worldwide # Country or region 1. USA 2. China 3. Japan 4. Germany 5. UK 6. South Korea 7. France 8. Italy 9. Canada 10. India 11. Brazil 12. Spain 13. Australia 14. Taiwan 15. Netherlands 16. Malaysia 17. Sweden 18. Russia 19. Turkey 20. Thailand 21. Mexico 22. Hong Kong 23. Switzerland 24. Argentina 25. Indonesia Top 25 in users Net 208 countries Total world (users) Population (est. 2003) 291, 639, 900 1, 311, 863, 500 127, 708, 000 81, 904, 100 59, 040, 300 46, 852, 300 59, 303, 800 56, 209, 900 31, 720, 400 1 -067, 421, 100 179, 712, 500 41, 547, 400 19, 978, 100 23, 614, 200 16, 258, 300 24, 014, 200 8, 872, 600 141, 364, 200 73, 197, 200 63, 393, 600 101, 457, 200 6, 827, 000 7, 376, 000 36, 993, 000 217, 825, 400 4, 096, 094, 200 2, 259, 449, 610 6, 355, 543, 810 Internet users, Latest date 184, 447, 987 68, 000 59, 203, 896 44, 139, 071 34, 387, 246 26, 270, 000 22, 039, 401 19, 250, 000 16, 841, 811 16, 580, 000 14, 322, 367 13, 986, 724 12, 823, 848 11, 602, 523 10, 351, 064 7, 800, 000 6, 726, 808 6, 000 4, 900, 000 4, 800, 000 4, 663, 400 4, 571, 936 4, 319, 289 4, 100, 000 4, 000 606, 127, 392 76, 292, 120 682, 419, 512 Growth (2000 -2003) (%) 93. 4 202. 2 25. 8 83. 9 123. 3 38 159. 3 45. 8 32. 6 231. 6 186. 4 159. 6 94. 3 85. 3 165. 4 110. 8 66. 2 93. 5 145 108. 7 71. 9 100. 3 102. 4 64 100 91. 4 72. 3 89. 1 Population (penetration) (%) 63. 2 5. 2 46. 4 53. 9 58. 2 56. 1 37. 2 34. 2 53. 1 1. 6 8 33. 7 64. 2 49. 1 63. 7 32. 5 75. 8 4. 2 6. 7 7. 6 4. 6 67 58. 6 11. 1 1. 8 14. 8 3. 4 10. 7 Users (%) 27 10 8. 7 6. 5 5 3. 8 3. 2 2. 8 2. 5 2. 4 2. 1 2 1. 9 1. 7 1. 5 1. 1 1 0. 9 0. 7 0. 6 88. 8 11. 2 100. 0 6

Internet Penetration by Country # Country or region 1. Sweden 2. Hong Kong 3. Australia 4. Netherlands 5. USA 6. Denmark 7. Iceland 8. Switzerland 9. UK 10. South Korea 11. Singapore 12. New Zealand 13. Germany 14. Canada 15. Finland 16. Norway 17. Taiwan 18. Bermuda 19. Japan 20. Estonia 21. Austria 22. Slovenia 23. Belgium 24. Luxembourg 25. Portugal Top 25 in users Net 208 countries Total world (users) Population (est. 2003) 8, 872, 600 6, 827, 000 19, 978, 100 16, 258, 300 291, 639, 900 5, 387, 300 294, 300 7, 376, 000 59, 040, 300 46, 852, 300 4, 225, 000 3, 785, 600 81, 904, 100 31, 720, 400 5, 215, 100 4, 551, 100 23, 614, 200 64, 500 127, 708, 000 1, 268, 300 8, 037, 400 1, 951, 500 10, 339, 300 451, 700 10, 366, 900 777, 729, 200 5, 577, 814, 610 6, 355, 543, 810 Internet users, Latest date 6, 726, 808 4, 571, 936 12, 823, 869 10, 351, 064 184, 447, 987 3, 375, 850 175, 000 4, 319, 289 34, 387, 246 26, 270, 000 2, 308, 296 2, 063, 831 44, 139, 071 16, 841, 811 2, 650, 000 2, 300, 000 11, 602, 523 30, 000 59, 203, 896 560, 000 3, 340, 000 800, 000 3, 769, 123 165, 000 3, 700, 000 440, 922, 600 241, 496, 912 682, 419, 512 Population (penetration) (%) 75. 8 67 64. 2 63. 7 63. 2 62. 7 59. 5 58. 6 58. 2 56. 1 54. 6 54. 5 53. 9 53. 1 50. 8 50. 5 49. 1 46. 5 46. 4 44. 2 41. 6 41 36. 5 35. 7 56. 7 4 -3 10. 7 7

Distribution of users by language. Online language populations (total 680, 000 as of September, 2003) 8

Impact of e-commerce on selected industries: manufacturing (based on figures from US Census Bureau) 9

Impact of e-commerce on selected industries: wholesale (based on figures from US Census Bureau) 10

Impact of e-commerce on selected industries: services (based on figures from US Census Bureau) 11

Industry Profitability, 1981 -2001 Industry ROE ROA 1. Pharmaceuticals 25. 87% 10. 27% 2. Chemicals and allied products 21. 70 7. 88 3. Food and kindred products 24. 78 7. 25 4. Printing and publishing 16. 30 6. 68 5. Rubber and miscellaneous plastic 15. 07 6. 25 6. Fabricated metal products 19. 00 5. 58 7. Paper and allied products 13. 77 4. 70 8. Electronics and electrical equipment (no computers) 9. 63 4. 67 9. Nonferrous metals 10. 39 4. 23 10. Machinery, except electrical 15. 69 3. 80 11. Petroleum and coal products 13. 25 3. 76 12. Textile mill products 5. 11 3. 71 13. Aircraft, guided missiles, and parts 14. 02 3. 57 14. Stone, clay, and glass products 9. 16 3. 44 15. Motor vehicles and equipment 11. 91 3. 16 16. Iron and steel 6. 40 3. 14 Source: Compustat. Grant (transportation explored ROEs for these M. Grant, Contemporary 17. Airlines byindustries air) for the years 1985 -1997: R. 2. 68 2. 05 Strategy Analysis: Concepts, Techniques, Applications (Oxford, U. K. : Blackwell, 2002) p. 68. 12

Firm Profitability, 1981 -2001 Firm ROA Pharmaceuticals Firm Airlines Bristol Myers Squibb 13. 71% Southwest Airlines 4. 85% Merck 13. 37 AMR 1. 51 Schering Plough 12. 89 Delta Airlines 1. 50 WYETH American Home Products 0. 96 12. 52 UAL Eli Lilly 10. 23 US Air Pfizer 9. 66 America West Holdings-3. 27 Pharmacia & Upjohn 7. 98 Continental Airlines -4. 97 American Cyanamid 3. 57 TWA -5. 37 Source: Compustat Northwest Airlines -3. 40 0. 31 13

Determinants of Profitability WHY? Business Models Core Competence Execution 14

Four Elements for a Successful Enterprise • • Capital Technical Human Information （资本） （技术） （人才） （信息） 15

Cooperating to Create Value Revenue Customer Value Competitive forces (coopetitors) -Suppliers -Customers -Rivalry -Threat of Entry -Substitutes -Complementors Relative Positioning (influence) Firm’s Decisions 1. Differentiation 2. Low-cost 16

Why New Models? • We need some new models – for how we go about exploring IT for competitive advantage, – for IT infrastructure how we create it and manage it – for how we acquire, manage and deploy the skills that are needed to run that infrastructure – Profitability ___________ (making money) 17

Business vs. Revenue Model Business Model Value creation It describes the way in which a company enables transactions that create value for all participants, including partners, suppliers and customers. Revenue Model Value appropriation It can be realized through a combination of - subscription fees, - advertising fees, - transactional income (e. g. , fixed transactional fees, referral fees, fixed/variable commissions, etc) 18

Striving for Competitive Advantage • Firm level: Industry & Competitive Analysis – Competitive Forces Model – Competitive Strategy – D’Aveni’s Hypercompetition Model (New 7 Ss) • Business level – Value-Chain Analysis 19

The Five Forces Model and IS • The Five Forces Model provides a way to think about how information resources can create competitive advantage. • Using Porter’s Model, General Managers can: – Identify key sources of competition they face. – Recognize uses of information resources to enhance their competitive position against competitive threats – Consider likely changes in competitive threats over time N 20

PORTER’S FIVE COMPETITIVE FORCES MODEL NEW MARKET ENTRANTS • Switching cost • Access to distribution channels • Economies of scale THE FIRM • Selection of suppler • Threat of backward integration SUPPLIERS SUBSTITUTE PRODUCTS & SERVICES Threats INDUSTRY COMPETITORS • Cost-effectiveness • Market access • Differentiation of product or service Bargaining power • Redefine products and services • Improve price/performance • Buyer selection • Switching costs • Differentiation CUSTOMERS 21

Porter’s Model vs. Hypercompetition Model Industries Competitive Advantage (Characteristics) Competitive Advantage (How to) Porter’s Model Relatively stable Establish a strong, Attain a fit with the long-term position environment as in and defend it. traditional markets Hypercompetition Model Dynamic 1) Everincreasing competition 2) Changing power between players 22

Porter’s Generic Strategy Framework – 3 Strategies for achieving Competitive Advantage Competitive Scope Lower Cost Position Industry-wide (Broad Target) Particular Segment only (Narrow Target) Overall Cost Leadership Uniqueness Perceived by Customer Differentiation Focus Competitive Mechanism 23

Porter’s Competitive Advantage Strategies • Cost leadership: be the cheapest • Differentiation: focus on making your product and/or service stand out for non-cost reasons • Focus: occupy narrow market niche where the products/services can stand out by virtue of their cost leadership or differentiation. 24

Hypercompetition and the New 7 -S’s framework (D’Aveni) • Every advantage is eroded. • Sustaining an advantage uses too much time and resources that can be a deadly distraction. • The goal should be disruption, not sustainability of advantage. • Initiatives are achieved with a series of small steps. 25

D’Aveni’s Disruption and 7 -S’s Vision for Disruption Old 7 Ss: structure, strategy, system, style, skills, staff, and superordinate goals. Identifying and creating opportunities for temporary advantage through understanding • Stakeholder satisfaction • Strategic Soothsaying directed at identifying new ways to serve existing customers better or new customers that are not currently served by others Market Disruption Capability for Disruption Sustaining momentum by developing flexible capacities for • Speed • Surprise That can be applied across actions to Build temporary advantage Tactics for Disruption Seizing the initiative to gain advantage by • Shifting the rules • Signaling • Simultaneous and sequential strategic thrusts With actions that shape, mold, or influence the direction or nature of the competitor’s response N 26

Example: • At General Electric, Jack Welch, implemented a DYB (“Destroy Your Business”) approach by placing employees in the shoes of competitors to highlight weaknesses and find fresh ways of meeting customer needs. • Similarly GE’s Medical Systems Division used DYB (and GYB strategy) to respond to the challenges posed by the Internet. – – Speed, Stakeholder satisfaction Strategic Soothsaying Shifting the rules 27

Porter’s Model vs. Hypercompetition Model Industries Competitive Advantage (Characteristics) Competitive Advantage (How to) Porter’s Model Relatively stable Establish a strong, Attain a fit with the long-term position environment as in and defend it. traditional markets Hypercompetition Model Dynamic 1) Everincreasing competition 2) Changing power between players Short-lived, take advantage of any small window of opportunity that arises. 1) change rules of competition 2) create disruptions (during which temporary advantages can be exploited) 29

The Value Chain: Process View of the Firm e tiv eti mp Co Ad va nta ge (Value) 30

The Value System • The value chain model can be extended by linking many value chains into a value system. • Much of the advantage of supply chain management comes from understanding how information is used within each value chain of the system. • This can lead to the formation of entire new businesses designed to change the information component of value-added activities. 31

The Value System: Interconnecting relationships between organizations Upstream value Firm value Downstream value N 32

Business Strategies and its Competitive Advantage Differentiation Cost Focus Differentiation Focus Industrial economy Growth Particular Segment only (Narrow Target) Cost Leadership Alliance Industry wide (Broad Target) Uniqueness Perceived by Customer Innovation Competitive Scope Lower Cost Position Knowledge-based economy Competitive Mechanism 33

Business Models and Revenue Management • The framework for making money. • It is the set of activities which a firm performs, how it performs them, and when it performs them so as to offer its customers benefits they want and to earn a profit. 34

Business Models and Revenue Management (Business Model) ula tes Industry Factors Fo rm -Competitive forces -Cooperative forces -Industry value drivers Firm FIRM-SPECIFIC FACTORS Resources Ex ec ACTIVITIES ut es Costs Value Chain (Business Systems) Which, How, When create and appropriate value Profitability Positions • Customer value • Market segments • Revenue sources • Relative positioning Value Systems 35

When to Perform Activities • Two firms can perform similar activities in similar ways but still end up with business models whose profitabilities are different if the timing of when they perform the activities is different. – First-mover advantage – Windows of opportunities • periods within which some activities are best performed 36

Keen’s Six-Stage Competitive Advantage Model Stimulus for action First major move Customer acceptance Competitor catch-up moves First-mover expansion moves Commoditization 37

Profits relative to competitions (%) Relationship between profits and time of market introduction 300 250 200 150 100 50 0 Time of market introduction relative to competition (months) 38

When to Perform Activities • First Movers Advantages Disadvantages • Build brand recognition • Newer technology • Control scarce resources • Higher development costs • Establish networks • Reverse engineering by competitors • Early Economies-of-Scale 39

Case Example: Wal-Mart • Analysis: Which, How, and When in Wal. Mart’s Success – Which: • moved into small towns that its competitors shunned – How: • Wal-Mart saturated contiguous towns and built distribution centers and logistics systems – When: • First mover advantage by capturing scarce resources, locations, and loyal employees and customers 40

Revenue Management (a. k. a. yield management) Expanding or Saving?

Revenue Management (RM) • RM focuses companies on revenue growth, not cost-cutting and downsizing. • RM drives bottom-line increases through top-line improvements. • Growth comes from the marketplace, not the workforce. • The key to real growth is learning how to deal effectively and proactively with a constantly changing markets. 42

Revenue Management (RM) vs. MIS • MIS is to deliver – the right information, to the right people – at the right time, with the right form • RM is to sell – the right product, to the right customer – at the right time, for the right price – Thereby maximizing revenue from a company’s products 43

Examples on Revenue Management • A No-Tech approach to RM – Barbershop • A Low-Tech approach to RM – Opera House • A High-Tech approach to RM – Airlines 44

Other Examples • • Hotel Car rental Golf Broadcasting Shipping Restaurant Etc. How about your ideas? 45

Some U. S. airline industry observations • Since deregulation (1978) 137 carriers have filed for bankruptcy. • From 95 -99 (the industry’s best 5 years ever) airlines earned 3. 5 cents on each dollar of sales: – The US average for all industries is around 6 cents. – From 90 -99 the industry earned 1 cent per $ of sales. • Carriers typically fill 72. 4% of seats and have a break-even load of 70. 4%. 46

Matching supply to demand when supply is fixed • Examples of fixed supply: – Travel industries (fixed number of seats, rooms, cars, etc). – Advertising time (limited number of time slots). – Telecommunications bandwidth. – Size of the MBA program. – Doctor’s availability for appointments. • Revenue management is a solution: – If adjusting supply is impossible – adjust the demand! – Segment customers into high willingness to pay and low willingness to pay. – Limit the number of tickets sold at a low price, i. e. , control the average price by changing the mix of customers. 47

Revenue management and margin arithmetic • Small changes in revenue can have a big impact on profit, especially for high gross margin and low net profit % industries: 48

Ugly reality: cancellations and no-shows • Approximately 50% of reservations get cancelled at some point in time. • In many cases (car rentals, hotels, full fare airline passengers) there is no penalty for cancellations. • Problem: – the company may fail to fill the seat (room, car) if the passenger cancels at the very last minute or does not show up. • Solution: – sell more seats (rooms, cars) than capacity. • Danger: – some customers may have to be denied a seat even though they have a confirmed reservation. 49

Winners vs. Losers utility al ig n • What separates winners from losers in creating (ultimate) strategic competitive advantage is neither bleeding-edge technology nor “timing for market entry. ” • It is from “value innovation” Firm Innovation price Value Innovation cost 50

Conclusion • • • Value innovation and business models Revenue management and overbooking give demand flexibility where supply flexibility is not possible. Concept and powerful tools to improve revenue: – American Airlines estimated a benefit of $1. 5 B over 3 years. – National Car Rental faced liquidation in 1993 but improved via yield management techniques. – Delta Airlines credits yield management with $300 M in additional revenue annually (about 2% of year 2000 revenue. ) 51

The Twenty-first Century will. . . • The twenty-first century will witness only two kinds of companies: – those that exploit Information Technology (IT) – those that are out of business 52

Revenue Management • If you are interested in the issues of RM • International Journal of Revenue Management • http: //www. inderscience. com/ijrm 53

The Seven Core Concepts of Revenue Management 1. 2. 3. 4. 5. 6. 7. Focus on price rather than costs when balancing supply and demand. Replace cost-based pricing with market-based pricing. Sell to segmented micro markets, not to mass market. Save your products for your most valuable customers. Make decisions based on knowledge, not supposition. Exploit each product’s value circle. Continually reevaluate your revenue opportunities. 54