Value Innovation: from Value Chain to Revenue Management

1. 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

2. 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

3. Comparison of adoption rates for Internet, PCs, TV and radio Internet PCs TV Radio 0 10 20 40 30 Time to reach 50 millions users (years)

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

5. IT-producing industries share of economy Percent

6. Distribution of Internet Users Worldwide

7. Internet Penetration by Country

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

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

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

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

12. 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 17. Airlines (transportation by air) 2.68 2.05 Source: Compustat. Grant explored ROEs for these industries for the years 1985-1997: R. M. Grant, Contemporary Strategy Analysis: Concepts, Techniques, Applications (Oxford, U. K.: Blackwell, 2002) p. 68.

13. Firm Profitability, 1981-2001 Firm ROA Firm ROA Pharmaceuticals 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 12.52 UAL 0.96 Eli Lilly 10.23 US Air 0.31 Pfizer 9.66 America West Holdings -3.27 Pharmacia & Upjohn 7.98 Continental Airlines -4.97 American Cyanamid 3.57 TWA -5.37 Northwest Airlines -3.40 Source: Compustat

14. Determinants of Profitability WHY?

15. Four Elements for a Successful Enterprise

16. (influence) • Competitive forces (coopetitors) • Suppliers • Customers • Rivalry • Threat of Entry • Substitutes • Complementors Firm’s Decisions 1. 2. Cooperating to Create Value Revenue

17. 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 • __________________

18. Business vs. Revenue Model Business Model Revenue Model Value ________ Value _________ 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) It describes the way in which a company enables transactions that create value for all participants, including partners, suppliers and customers.

19. Striving for Competitive Advantage • Firm level: Industry & Competitive Analysis • Competitive Forces Model • Competitive Strategy • __________________________ (New 7Ss) • Business level • __________________ Analysis

20. 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

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

22. Porter’s Model vs. Hypercompetition Model

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

24. 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.

25. 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.

26. Vision for Disruption • 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 • 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 • Capability for Disruption • Sustaining momentum by developing • flexible capacities for • Speed • Surprise • That can be applied across actions to • Build temporary advantage D’Aveni’s Disruption and 7-S’s Old 7Ss: structure, strategy, system, style, skills, staff, and super-ordinate goals. N

27. 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

28. Porter’s Model vs. Hypercompetition Model

29. Competitive (Value) Advantage The Value Chain: Process View of the Firm

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

32. Business Strategies and its Competitive Advantage Uniqueness Perceived by Customer Lower Cost Position Industrywide (Broad Target) Cost Leadership Differentiation Competitive Scope Particular Segment only (Narrow Target) Cost Focus Differentiation Focus Knowledge-based economy Industrial 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. Formulates Executes Business Models and Revenue Management (Business Model) • __________ Factors • Competitive forces • Cooperative forces • Industry value drivers create and appropriate value Firm Profitability ________________ FACTORS • ___________ • Customer value • Market segments • Revenue sources • Relative positioning ACTIVITIES Resources Costs Which, How, When ______ Chain (Business Systems) 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. First major move Keen’s Six-Stage Competitive Advantage Model Stimulus for action Commoditization

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

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

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?

41. 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 _______, to the right ______ • at the right _____, for the right _____ • 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 • ________ • Car rental • _______ • Broadcasting • Shipping • _______ • 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. align Innovation Winners vs. Losers • 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” utility Value Innovation Firm price 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 $1.5B over 3 years. • National Car Rental faced liquidation in 1993 but improved via yield management techniques. • Delta Airlines credits yield management with $300M in additional revenue annually (about 2% of year 2000 revenue.)