STRUCTURE AND COMPONENTS OF THE E-COMMERCE BUSINESS MODEL

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1 STRUCTURE AND COMPONENTS OF THE E-COMMERCE BUSINESS MODEL APPENDIX B INTRODUCTION A successful e-commerce venture requires a viable business model and a long-term sustainable strategy. When planning and implementing e-commerce ventures, business executives must address several strategic questions, such as: What are the functions and components of a viable business model? How does one capture and capitalize on the unique features of the Internet and e-commerce to achieve sustainable competitive advantage and profits? How are values being created in the digital economy? How can network effects and scope economies change a company s competitive position in e-commerce? How can cost, revenue, and growth models in e-commerce differ from those for traditional businesses? This article extends Lee (2001) and Lee and Vonortas s (2004) works on business model and strategy to discuss the structure, components, and key issues of a viable e-commerce business model. BACKGROUND A business model describes the basic framework of a business. It is the method of doing business by which a company can generate revenue to sustain itself (Rappa 2003; Turban et al. 2004). It also identifies the market segment that is being served (who), the service that is being provided (what), the means by which the service is produced (how) (Chaudhury and Kuilboer 2002), and how it plans to make money over the long term using the Internet (Afuah and Tucci 2003). A firm s business model should also describe how the organization is positioned in the industry value chain. Timmers (1998) defines business model as an architecture for the product, service, and information flows, including a description of the various business actors and their roles, a description of the potential benefits for the various business actors, and a description of the sources of revenues. Weill and Vitale (2001) define an e-business model as a description of the roles and relationships among a firm s consumers, customers, allies, and suppliers that identifies the major flows of product, information, and money and the major benefits to participants. In terms of business areas, Rappa (2003) identifies nine basic Internet business models: brokerage, advertising, infomediary (e.g., recommender system, registration model), merchant, manufacturer (direct marketing), affiliate (provide commission for online referrals), community (voluntary contributor model or knowledge networks), subscription, and utility (e.g., pay by the byte). Turban et al. (2004) identify several types of Internet business models, including name your price, find the best price, dynamic brokering, affiliate marketing, group purchasing, electronic tendering systems, online auctions, customization and personalization, electronic marketplaces and exchanges, supply chain improvers, and collaborative commerce. An e-commerce business model should consist of multiple components that perform different functions. Rayport and Jaworski (2001) argue that a new economy business model requires four choices on the part of senior management. They include the specification of a value proposition or a value cluster for targeted customers; a scope of marketspace offering, which could be a product, service, information, or all three; a unique, defendable resource system that is, the associated resource system to deliver the benefits; and a financial model, which includes a firm s revenue models, shareholder value models, and future growth models. Chesbrough and Rosenbloom (2002) identify the functions of a business model: (1) articulating the value proposition; (2) identifying a market segment; (3) defining the structure of the firm s value chain; (4) specifying the revenue-generation mechanisms(s) for the firm; (5) describing the position of the firm within the value network; and (6) formulating the competitive strategy to gain advantage over rivals. Other scholars, such as Dubosson-Torbay et al. (2002) and Alt and Zimmermann (2001), also have made significant contributions to the theoretical discussions and business practices of e-commerce business models. digital economy The economy for the age of networked intelligence. The digital economy is also a knowledge economy. Information, in all forms digital, is the input of an organizational transformation or value-creation process. network effects Products or services whose value to an individual buyer increases when many other people also consume the same products or services. business model The method of doing business by which a company can generate revenue to sustain itself. Source: C.-S. Lee, Y. Ze, Y. G. Chen, and Y.-H. Fan. Structure and Components of E-Commerce Business Model, in Encyclopedia of E-Commerce, E-Government, and Mobile Commerce, M. Khosrow-Pour (ed.), pp Copyright IGI Global, igi-pub.com Reprinted by permission of the publisher. B-1

2 B-2 Appendix B: Structure and Components of the E-Commerce Business Model MAJOR COMPONENTS AND KEY ISSUES OF AN E-COMMERCE BUSINESS MODEL In order to sustain a successful business venture, a viable business model should address a number of issues and the dynamics of the respective elements, including what value to offer customers (strategic goals and value proposition), which customers to provide the value to (scope of offerings), what capabilities are needed to build a successful and unique resource system, how to price the products or services and generate streams of revenues, how to increase the scale and the scope of the venture, and what strategies and processes are needed to build and sustain a successful e-commerce business model. STRUCTURE AND COMPONENTS OF A VIABLE E-COMMERCE BUSINESS MODEL Exhibit B.1 identifies the major components of and several key issues affecting a viable e-commerce business model. It can be used to assist business executives and entrepreneurs in planning and implementing e-commerce business ventures. It also serves as a basic framework for further study of the e-commerce business model and strategy. VALUE CREATION IN E-COMMERCE In the physical or traditional industrial economy, the inputs to a value-creation process are the raw materials or the necessary physical inputs that are required to produce the finished products or services. Outputs are finished goods or intermediate goods used as inputs to the subsequent downstream valuecreation processes. In the value-creation process, information serves as a supporting element. Information, such as design and engineering know-how, as well as production methods and procedures, is applied to facilitate the physical transformation process, which involves one or more of the four value-adding activities describe in Meredith and Schaffer (1999): inspect, alter, transport, and store. Under this paradigm, management s main focus is to make the transformation process more efficient. In contrast, input to the value-creation process in the digital economy (Tapscott 1996) is information (e.g., customer information or digital assets, and the status of production and distribution process) that firms gather, organize, select, synthesize, and distribute (Rayport and Sviokla 1995) in the transformation process to provide individual customers a customized solution. In the digital economy, information is a source of value, and every business is an information business (Earl 1999). Organizations in the Digital Economy should understand and be able to apply the concept and practice of virtual value chain (Rayport and Sviokla 1995) to create value and to generate new business opportunities. Because physical and digital economies coexist within a firm and across an industry supply chain, business executives must go beyond focusing on improving the transformation process itself to concentrate on leveraging information assets and capitalizing on the unique features of e-commerce and the Internet to create more value for the customers. FIVE STEPS TOWARD E-COMMERCE SUCCESS Lee (2001) proposes five essential steps toward e-commerce success. First, companies must redefine their competitive advantage in the Digital Economy, because e-commerce is changing the basis of competition. Business executives must redefine their competitive advantages in terms of cost, differentiation, marketing, and distribution. For example, Compaq built the best retail-distribution network in the computer industry in the 1990s but was unable to compete with Dell s fast and light direct-sales approach enabled by Internet technology (Browning and Reiss 1999). Second, companies must rethink the traditional ways of formulating business strategy. Executives must generalize thinking beyond building a Web site to designing an architecture that will support the company s e-commerce strategy. They must take a comprehensive look at how their companies can focus of an investment behind a single winning strategy that makes it easy for customers to do business with them. For example, Edmunds.com offers customers assistance throughout the automobile-purchase process. Third, business executives must reexamine the traditional business and revenue models. For example, information itself is a source of value and presents opportunities to develop new relationships with customers at very low cost (e.g., UPS and FedEx). It also presents opportunities to create new services and to improve internal efficiency (e.g., Boeing s intranet). Fourth, companies must reengineer the organization structures and processes to capitalize on the benefits of e-commerce. For example, to implement a customer-centered e-commerce model, a company needs to integrate its suppliers, back-office functions, and front-office functions in order to achieve the organizational flexibility necessary to move at Internet speed and to satisfy customer demand. Finally, companies must be able to reinvent customer services by building cost-effective total experience and loyalty-enhancing relationships with the most profitable customers. Companies can involve customers in the product development process through initiating technology-facilitated dialogue. In addition, companies can gather knowledge

3 Appendix B: Structure and Components of the E-Commerce Business Model B-3 EXHIBIT B.1 Components and Key Issues of the E-Commerce Business Model Component Element Key Issue Value propositions Choice of focal customer benefits Core products/services: What value or benefit do we provide for our customers? How unique is the value or benefit? Do those values satisfy customer s demand? Do the products or services have strong network effects? Are there substitutes for our products or services? Supplement products/services: How important are the supplement products or services? How do we increase customer value by improving or redesigning business processes? How important is it to provide product instructions, user training, and customer services? Target segment Market attractiveness: How substantial is the market segment? Is the market under- or overserved? What is the growth rate of the market segment? Which stage is the product in the product lifecycle? Intensity of market competition: What is the market or industry structure? How intense is the competition? How large are the entry and exit barriers? Scope of offerings Customer decision process Prepurchase: How do we make it easy for customers to obtain and compare product- or service-related information? How important is the advertising to inform or persuade customers to make the purchase? Do we need to obtain a third-party certificate or verification (e.g., VeriSign) in order to build a trust relationship with our customers? Purchase: When, where, and how do customers make the purchase? What kinds of service are required to assist customers in purchasing the product or service? Is the delivery of products or services efficient? Postpurchase: Do we understand customer s evaluation and satisfaction of the product or service? Do the majority of the customers make repeat purchases? Purchasing process: How important is it to offer customer assistance in the whole process of purchasing a product? Can we identify the customer decision process and be able to provide effective assistance? (continued)

4 B-4 Appendix B: Structure and Components of the E-Commerce Business Model EXHIBIT B.1 (continued) Do we have an effective e-commerce site that is user friendly? How do we lower the transaction costs to make it easy for customers to do business with us? Product or service contents Core product or service: Do we understand which business we are in? Do our products or services solve the customers problems? Supplementary product or service: Do we build and maintain a set of digital assets in order to know our customers better? How do we leverage on a single set of digital assets to provide value across many different and disparate markets? How do we increase customers switching costs from using our company s products or services? Core delivery process: Do we understand and take advantage of the economies of scope in production and distribution of the product or service? What kinds of channel (digital and/or physical) do we need to deliver our products or services? How efficient and effective are the products or services being delivered? transaction costs Costs associated with contractual relationships in a market economy; that is, costs that the consumer or the producer pays to make the market transaction happen. digital assets The information (in digital form) a company collected about its customers. Companies that create value with digital assets may be able to reharvest them through a potentially infinite number of transactions. switching costs Refers to costs incurred by buyers when they switch to a different supplier. economies of scope Supply-side economies of scope Cost of the joint production of two or more products can be less than the cost of producing them separately. Demand-side economies of scope A single set of digital assets can provide value for customers across many different and disparate markets. Unique resource system Resources and capabilities Specifying a resource system: Do we identify the resources (e.g., labor, capital, assets) needed to build our core competencies or capabilities? Do we have all the necessary core capabilities to support our scope of product or service offerings? Do we need to outsource and/or partner with others to gain missing capabilities? Can we identify key players who can fill out the missing capabilities? (continued)

5 Appendix B: Structure and Components of the E-Commerce Business Model B-5 EXHIBIT B.1 (continued) How important is the role of intellectual property rights (e.g., patents and trademarks) in building capabilities? Assessing the quality of the resource system: How unique is our resource system? How difficult is it for competitors to imitate our system? Do each of the capabilities support the delivery of a customer benefit? How well do the capabilities complement and support each other? Are the specific resources mutually reinforcing? Are they complementary? Does the online resource system support the offline system? Logistics and delivery systems Integration: Can we deliver a unique customer experience through e-commerce? Are we able to achieve supply chain integration and synchronization (e.g., applying Internet-based collaborative planning, forecasting, and replenishment, CPFR)? Are we able to collaborate with business partners across a common technical platform using common e-business applications? Fulfillment: Can we match the performance of the physical activities to the virtual world? Can we develop a flexible and reliable channel to reach the end customers? Can we radically reduce the order-to-delivery time to customers? Revenue and growth Revenue models Product/service sales: models Are our revenues primarily deriving from product sales or from complementary products or services? Can we generate revenues from utilizing intellectual properties? E-commerce-related revenues: How do we identify new sources of revenues from e-commerce (e.g., advertising, referrals, subscription, membership, commissions, transactions, etc.)? How do we use information to create value both online and offline (e.g., FedEx s packaging tracking system)? How do we develop cross-selling opportunities to achieve synergy? Do our customers value the benefit of one-stop shopping? Pricing: How do we test prices, segment customers, and adjust to changes in supply and demand in real time? (continued)

6 B-6 Appendix B: Structure and Components of the E-Commerce Business Model EXHIBIT B.1 (continued) How do we analyze digital assets and experiment with new ways of pricing? Are we able to implement innovative e-commerce pricing methods (e.g., reverse auction, one-to-one bargaining)? How do we build online brand equity to enhance loyalty and to reduce price sensitivity? Financial growth models Growth strategy: How should we develop new revenue growth (e.g., deeper penetration into the current market, new product development, new market development, and/or completely new products and markets)? Growth model: Do we need to spin off an online division to establish a new company? Do we need to establish strategic alliances or merge with other online/offline companies? Competitive strategy Value chain positioning Value system or network Where do we position our products or services in an industry value chain? Can we integrate or move upstream or downstream to increase added values? How do we create value? Do we create customer value as a partner in a supply chain (e.g., manufacturer or retailer), as a value shop (e.g., professional service), or as a central player of a network (e.g., intermediary service)? Can we join a business ecosystem (Gossain and Kandiah 1998) (e.g., online mega sites such as Amazon.com) as a member to provide products or services to the final customers? Generic Strategy Competitive advantage: business ecosystem A system in which companies work cooperatively and competitively to support new products, satisfy customers, and create the next round of innovation in key market segments. Do we have advantages over our competitors in terms of marketing, cost structure, and product or service differentiation? Do e-commerce and the Internet redefine the competitive advantage in the market or industry we are in? Generic strategy: Which strategy should we pursue in order to sustain our competitive advantages (e.g., increase entry barriers or block strategy, innovation or run strategy, and/or alliance or team-up strategy)?

7 Appendix B: Structure and Components of the E-Commerce Business Model B-7 about their customers by building and controlling a comprehensive customer database (i.e., digital assets). For example, mega retailing sites such as Amazon.com, Yahoo!, and ebay are able to redefine economies of scope by drawing on a single set of digital assets to provide value across many different and disparate markets to maximize customer value. FUTURE TRENDS Business models are largely believed to determine the success of an e-commerce venture. Alt and Zimmermann (2001) argue that business models are perhaps the most discussed and least understood area of e-business. Business scholars have been conducting research in the e-commerce business model for more than a decade to assist business executives and entrepreneurs in formulating and implementing innovative business models. We now have a much better understanding of the taxonomy, components, and architecture of business models. Future research on the analysis, design, development, implementation, and controlling of the e-commerce business model include, but are not limited to, the following areas: Innovation in the e-commerce business model and the continuing business model innovation process to achieve competitive advantage Convergence of strategy and business model Models and modeling techniques of e-commerce business models Trust-building in the e-commerce business model Sustainable business models for services, digital contents, mobile commerce, collaborative commerce, and peer-to-peer architecture Other specific industry perspectives on implementing e-business models CONCLUSION A viable business model in the digital economy must transform value propositions and organizational structures and systems to enhance value creation. It must be able to take advantage of the Internet network effects and other unique attributes to achieve and sustain a critical mass of installed base of customers. Companies must also build and maintain a large set of digital assets and leverage them to provide a scope of offerings or value across many different and disparate markets to satisfy customers demands. That is, companies must identify customers latent needs and transform their business models from a product- or component-based model to a knowledge- or solution-based model. To achieve those goals, companies must be able to build a unique resource system that supports their value propositions and product or service offerings. Companies should also be able to use the Internet to make pricing more precise, to be more adaptable in responding to fluctuations in supply and demand, and to segment customers more effectively (Baker et al. 2001). In addition, companies need to understand the impact of e-commerce that has redefined a company or industry s competitive advantages and be able to formulate and implement competitive strategies to gain and sustain new competitive advantages in the digital economy. KEY TERMS Business ecosystem 6 Business model 1 Digital assets 4 Digital economy 1 Economies of scope 4 Network effects 1 Switching costs 4 Transaction costs 4

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