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Evaluation of Business ModelsProfessor Joshua Livnat, Ph.D., CPA

311 Tisch HallNew York University

40 W. 4th St.NY NY 10012

Tel. (212) 998-0022 Fax (212) 995-4230jlivnat@stern.nyu.edu

Web page: www.stern.nyu.edu/~jlivnat

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Overview

– The underlying logic for an E-Commerce company.

– A five-step process to assess the business model.

– Classifications of E-Commerce companies.– Various business models.– Implications of the business model.– Long-term viability of business models.

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The Underlying Logic

• “Old Economy” contains market failures or transaction costs:– Examples:

• Information is not freely available, and is costly to gather and process.

• Markets may be too fragmented and too dependent on local population (personal items for sale).

• The “New Economy” company eliminates or reduces market failure or transaction cost.

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The Underlying Logic• Note: The deficiency in the “old” economy is

actually the opportunity for the “new” economy company.

• However, for the opportunity to be profitably exploited:– It should be significant.

– The company should have adequate resources.

– The company should have the ability to generate revenues from customers.

– The company should be able to deter competition, or differentiate itself from its competitors.

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Sellers’ Transaction Costs• Order Taking Costs:

– Reduce physical facilities and number of employees dedicated to process orders by accepting and processing orders electronically.

• Recording Costs: – Avoid the manual data recording process by connecting the users

electronically and allowing them to enter the data themselves.

• Display Costs: – Eliminate stores, employees in these stores, and paper catalogues, by

maintaining a virtual store.

• Mailing Costs: – Reduce physical mail sent to customers by sending E-mail instead.

• Marketing costs: – Replace mass marketing channels by direct marketing to relevant

customers only.

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Buyers’ Transaction Costs• Transportation Costs:

– Avoid waste of time and money spent on travel to a physical store.

• Timing of Transactions: – Buyers do not need to change their schedule according to

the opening hours of the business. Web access to the entity’s virtual site is available 24 hours a day, seven days a week.

• Information Gathering Costs: – Avoid the costly activity of gathering information, by

using information on the Web and Shopbots.

• Information Processing Costs: – Buyers can save time and effort in understanding and

processing information, or by using online software and tools.

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Other Benefits of E-commerce• Personalization:

– By identifying customers, it is possible to offer each individual customer a personalized service and special offerings.

• Price Transparency: – The Web allows consumers to compare prices more

efficiently and more effectively, anywhere and at any time.

• Market Making: – The Web allows the creation of efficient new markets by

the ability to aggregate cheaply many buyers and sellers from different locations and time zones.

• Network Externalities: – The larger is a network the more valuable it may be to its

members, rather than a smaller network.

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The Five-Step Process

• What market failures or transaction costs are addressed by the business model?

• How effective can the E-Commerce firm be in reducing the market failures or transaction costs?

• Will the E-commerce company be able to expropriate benefits from customers?

• What are the necessary resources to conduct the business?

• Can competitors erode profits?

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Application Egreetings Network, Inc. (EGRT)

• EGRT is in the E-Card business:– Customer selects a card from an online selection of

cards.

– Customer personalizes the card.

– Customer specifies a recipient.

– EGRT delivers the card, which can be opened by the recipient.

– EGRT also notifies the customer that the E-Card was sent.

• Compare EGRT to paper card companies.

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EGRT – Transaction Costs

• Buyers (customers) save the following transaction costs:– Transportation to a physical store.– Timing of transaction (24/7).– Mailing costs.– EGRT retains recipient’s address, so there is

lower data-entry costs.

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EGRT – Transaction Costs

• EGRT saves the following transaction costs (as compared to a paper card company):– Display costs (no need for a retailer).– Order-taking costs (no need to communicate

with a retailer).– Data-entry costs (customer enters the data

directly).– Inventory costs (no need for physical

inventory).– Printing costs (same card can be used by more

than one customer).

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EGRT – Transaction Costs

• Marketing costs:– Savings through personalization (customer

tastes).– Complementary products.

• No network externalities.

• No price transparency.

• No creation of a new market.

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EGRT – Ability to Generate Revenues

• Customers are willing to pay for paper cards. They should also be willing to pay for E-Cards.

• However, the marginal cost of an E-Card is very low!

• Fixed costs of content and systems are high.• Competition may drive the price of an E-Card to

zero.– Over 100 E-Card companies!

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EGRT – Ability to Generate Revenues

• Revenues:• 1997 $ 505,000

• 1998 317,000

• 1999 3,100,000

• 2000 (6 mon.) 5,900,000

• Converted from fee-paying customers to free service in November 1998.

• Advertising revenues in 1999 and 2000!• E-commerce sales negligible in 1999.

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E-Greeting Traffic

0.01.0

2.03.04.05.0

6.07.0

Reach

0

500000

1000000

1500000

2000000

2500000

3000000

3500000

4000000

4500000

5000000

Reach Unique Visitors

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EGRT – Traffic and Expenses

• In December 1999, a high traffic month:– 21 million visitors

– 184 million web pages viewed

– 10 million E-Cards sent

• Spent about $50 million through the end of 1999.• Selling and marketing $20 million 1997-9.• Operations and development (R&D) $15 million

in 1997-9.

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EGRT - Content

• Gibson supplied 34% of cards and held 20% of equity.

• In March 2000, Gibson was purchased by American Greetings, which has its own E-Card business.

• NBC owns stock in return for advertising. EGRT can use NBC shows in content.

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EGRT - Resources

• Raised $60 million through preferred shares in 1999.

• Raised $54 million in issuance of common stock in December 1999.

• Had about $58 million cash and liquid assets as of the most recent public filing (6/30/2000).

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EGRT - Survival

• EGRT generates most of its revenues from advertising.

• Can it survive for the long run on advertising?

• Which companies are likely to generate higher advertising rates?

• Does EGRT have a comparative advantage in E-commerce?

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Summary

• Understand well the current business model.• Assess the opportunities for changes and

transformation in the business model.• Assess long-term revenue sources for the E-

business.• Assess long-term costs to operate the business.• Is the business viable? Can competitors erode

profits?