Week 2, Lecture 4

[Page 15] Financial Impact of IT: Break-Even Analysis

 When considering the use of any resource in an organization, you must ask questions like:

o What sort of financial impact will this resource have on the organization?

o What is the return on our investment (ROI)?

o Is this going to help reduce costs or increase revenue, or perhaps both?

 The above kind of questions addresses the financial impact of a resource. Technology is
NO deferent; you must be able to financially justify the use of technology.

 A simple, yet very powerful, tool for assessing the financial impact of a resource is called
“break-even analysis”. In the break-even analysis, you consider and chart the following
financial information (See Figure 1.7 in the textbook):

o Fixed cost: The total of all costs that you incur whether or not you sell anything.
For example, rent for office or retail of space is a fixed cost; even if you don’t sell
a single thing, you still have to pay the monthly rent. Other fixed costs might
include utilities, insurance, employee salaries, and so on.

o Variable cost: The amount it costs to acquire/produce one unit that you well
eventually sell to your customers.

o Revenue: How much you sell that one unit for.

Page 1 of 4
 Let us assume that you sell movie posters. Each poster you buy for $4 from studios. You
then sell the poster online for $9.

 It costs you $2 to ship the poster to a customer.

 Your online store, product catalog, credit card processing, domain name registration, and
search engine placement are all provided by GoDaddy (www.godaddy.com) for a cost of
$1,500 per year. So your financial information then is this:

o Fixed costs: $1,500 per year for GoDaddy services. Whether you sell or not. This
cost remains fixed.

o Variable costs: $6, which is $4 the cost of the poster when you buy it and $2 the
cost of shipping the poster to a customer.

o Revenue: $9, or the price at which you sell the poster.

 Using break-even analysis, you answer an important question: “How many posters do I
have to sell to break even?”

o You make a net profit of $3 per poster ($9 sale price - $6 variable cost).

o Break-even point = Fixed cost / (Sale price – Variable cost)

 Break-even point = 1500/(9-6) = 500

 To cover your costs and your $1,500 of fixed costs, you have to sell 500 posters.

 If you sell less than 500 then you lose money. If you sell more than 500 then you gain
money.

 500 is then your break-even point.

 Why this is important from a technology point of view? Because technology can help you
and your organization do one or any combination of the following three:

1. Reduce fixed costs;

2. Reduce variable costs; and/or

3. Increase revenue (sales)

[Page 16] Reduce Fixed Costs

 One financial and operational goal of any organization is to have no fixed costs. Why?
Because when you have no fixed costs, your break-even point moves to zero. So, you

Page 2 of 4
 actually, begin generating a profit with the very first unit you sell because the only costs
you have are variable costs.

 Technology can definitely play a part in helping your reduce fixed costs. Below are some
examples:

1. Digital storefronts: Companies like Amazon and eBay that only have
presence in the virtual world have significantly lower fixed costs in terms of
retail space than companies that have to pay for retail space, like retail store
you would find in a mall.

2. Telecommuting: This is a popular trend in most industries. If you can create a

technology infrastructure that allows your employees to work from home (or
anywhere for that matter, as long as it is not in the office), you can reduce your
expenses related to office space, which would also include utilities, insurance,
parking, etc.

3. VoIP (Voice over IP): Again, this is another one of those initiatives gaining in
popularity. VoIP allows you to use the Internet for making phone calls instead
of leasing traditional telephone lines from the phone company. A popular
variation on VoIP is Skype.

4. Cloud Computing: One of the hottest topics in the business world right now
and one that’ll we explore more in Chapter 7. With cloud computing, you
don’t buy hardware infrastructure like servers or perhaps software site
licenses. Instead, you rent them on an as-needed basis “in the cloud”.

[Page 17] Reduce Variable Costs

 Variable costs basically define your profit margin. That is, the smaller the variable cost
the higher the profit margin. Your break-even point is smaller (moves to the left on the
Figure 1.7) as you increase your profit margin by reducing variable costs.

 Two interesting IT-enabled variable costs reduction initiatives are given:

1. Virtual goods: As the name implies they don’t exist in the physical world.
These are the best types of goods to sell in financial terms because you have
no variable costs. Examples are items sold in virtual worlds such as weapons
on World of Warcraft online game. What you get is a virtual good that has no
variable cost associated with it because it is purely digital. So, the organization
might charge you $1 and that $1 was pure profit.

2. Crowdsourcing: This is a great way to create value for free. Using

crowdsourcing you get non-paid non-employees to do your work. Think about
eBay. eBay doesn’t employee anyone to buy or sell in its marketplace. Instead,
crowds of people do all the work of listing items, taking photos, bidding, and
Page 3 of 4
 even shipping goods and merchandise. Likewise, YouTube doesn’t hire people
to post videos. Instead, you do all the work to capture and upload a video, for
free.

[Page 17] Increase Revenue

 You can also impact your break-even point by increasing revenue. When you increase
revenue or price per unit, your break-even point comes earlier. In over movie poster
example, if you increased the price from $9 to $11 for a poster, your break-even point
would be 300 units instead of 500. Of course, if you raise prices too much, your
competition will undercut you, and then you are in real trouble.

 Technology can help increase revenue. Some of the ways are:

o Recommendation engines: These engines make recommendations to you

based on your likes, dislikes, and past purchases. For example, Apple’s Genius
tool for iTunes recommends additional music selections based on your
purchases. Amazon uses a recommendation engine to offers you additional
books based on the books you are considering buying.

o Long-tail economies: Technology can help your organization overcome the

80/20 rule, which basically states that only 20% of the total available products
are worth selling. These are the big hits that everyone wants and that all
physical retail stores carry. But there is money to be made in niche products
too. That is why iTunes offers millions of songs. (Compare that to the rather
sparse inventory of a brick and mortar music store.) It is also why Amazon has
over 1 million book titles for sale and most brick and mortar book stores carry
in the neighborhood of 25,000 to 50,000.

Page 4 of 4