Will cost per transaction kill your business?
Imagine a business, Major Widgets Plc, that makes money by selling things in bulk, they sell a batch of 20,000 widgets on to a high street retailer who then sells the individual units. Each time Major Widgets sells a batch it costs them $1.5 to process that sale, as the overall cost of a batch is $20,000 that is less than 1 tenth of a percent cost overhead, pretty good. As they only sell 1000 batches per month they also process all the orders at the end of month in a legacy batch processing system. They are feeling pretty pleased with themselves.
Now imagine a new business, Overlooked Upstart Inc., who also sell widgets. They do something rather different though, they sell widgets directly to the consumer as individual units. They currently sell only around 10% of the total number of widgets per month of Major Widgets, so instead of 1000 transactions per month this means they have to do 2 million. It actually costs them $0.001 to process each transaction and as they charge only $1 per widget that is actually more cost overhead in percentage terms than Major Widgets. Overlooked Upstart also process each transaction as and when it happens; as their business is spread reasonably over the month that is about 66000 per day or around 47 per minute. They run this system on a couple of commodity blade servers and know they can scale up to a few hundred orders per minute without too much cost. They too are feeling pretty pleased with themselves because.....
...in this hypothetical universe it turns out consumers really like the convenience of buying widgets online directly without the high street retailer taking a cut. Major Widgets sees a downturn, the retailers only want 15,000 widgets per month, this is a problem and if it continues they'll be in serious trouble in a few years time.
So Major Widgets decides to launch online sales themselves and set the goal of having 10% of total widget sales online. The first challenge is that all the orders are currently keyed in by hand at the rate of about 30 per day, there is no electronic way to capture the orders at the required rate of 66000 a day without hiring a few new people(!). The second challenge is that the legacy billing system can only run on the last Monday of the month within a 4 hour time window - which comes out at around 140 transactions per second (around 130 per second faster than their current system can do). The harsh truth is that they cannot currently compete selling individual widgets due to their high cost per transaction and aged infrastructure.
Ok, not the end of the world, they just need to spend money on a few new systems. But it turns out it's not that simple, they'd been seeing IT as a inconvenient cost for some time and over the past few years have been cutting both operational and capital spending as well outsourcing the support as part of a multiyear contract. To make things worse all the people who knew how all the systems were tied together have left, the person who wrote the cobol transaction processing system retired and all the web developers have been poached by some company called Overlooked Upstart Inc.
Major Widgets come to realize that they are best off being taken over by someone who has infrastructure with low cost per transaction and high scalability........
Of course this is a simplified made up example and I'm lucky enough to work with clients who see IT as an integral part of what they do, they are well aware of their legacy systems and what online offerings can require in terms of scaling and cost.
However I am still amazed to hear of some companies who talk as if the internet is going to go away and that IT is just a cost to be controlled. What are they going to do when someone new moves into their market? This isn't really a new phenomena either, market de-regulation in equity trading led to a massive up turn in volumes that put some small brokerages out of business. I'm sure there are other examples as well.
Now imagine a new business, Overlooked Upstart Inc., who also sell widgets. They do something rather different though, they sell widgets directly to the consumer as individual units. They currently sell only around 10% of the total number of widgets per month of Major Widgets, so instead of 1000 transactions per month this means they have to do 2 million. It actually costs them $0.001 to process each transaction and as they charge only $1 per widget that is actually more cost overhead in percentage terms than Major Widgets. Overlooked Upstart also process each transaction as and when it happens; as their business is spread reasonably over the month that is about 66000 per day or around 47 per minute. They run this system on a couple of commodity blade servers and know they can scale up to a few hundred orders per minute without too much cost. They too are feeling pretty pleased with themselves because.....
...in this hypothetical universe it turns out consumers really like the convenience of buying widgets online directly without the high street retailer taking a cut. Major Widgets sees a downturn, the retailers only want 15,000 widgets per month, this is a problem and if it continues they'll be in serious trouble in a few years time.
So Major Widgets decides to launch online sales themselves and set the goal of having 10% of total widget sales online. The first challenge is that all the orders are currently keyed in by hand at the rate of about 30 per day, there is no electronic way to capture the orders at the required rate of 66000 a day without hiring a few new people(!). The second challenge is that the legacy billing system can only run on the last Monday of the month within a 4 hour time window - which comes out at around 140 transactions per second (around 130 per second faster than their current system can do). The harsh truth is that they cannot currently compete selling individual widgets due to their high cost per transaction and aged infrastructure.
Ok, not the end of the world, they just need to spend money on a few new systems. But it turns out it's not that simple, they'd been seeing IT as a inconvenient cost for some time and over the past few years have been cutting both operational and capital spending as well outsourcing the support as part of a multiyear contract. To make things worse all the people who knew how all the systems were tied together have left, the person who wrote the cobol transaction processing system retired and all the web developers have been poached by some company called Overlooked Upstart Inc.
Major Widgets come to realize that they are best off being taken over by someone who has infrastructure with low cost per transaction and high scalability........
Of course this is a simplified made up example and I'm lucky enough to work with clients who see IT as an integral part of what they do, they are well aware of their legacy systems and what online offerings can require in terms of scaling and cost.
However I am still amazed to hear of some companies who talk as if the internet is going to go away and that IT is just a cost to be controlled. What are they going to do when someone new moves into their market? This isn't really a new phenomena either, market de-regulation in equity trading led to a massive up turn in volumes that put some small brokerages out of business. I'm sure there are other examples as well.
posted by Ian Cartwright at 10:17 AM
2 Comments:
I'm not sure I can fully agree with you.
I can imagine that from certain point of view might be business decision about minimizing cost on IT very well economically supported. I would see now at this point at least two cases where this might be well justified.
One is where “Major Widget” company owns majority share on the market. If someone from the “follower“companies in same segment getting traction than “Major Widget” can simply buy it and therefore “kill” competition.
Second case is when “Major Widget” can respond on “Overlooked Upstart” success with creating new fully owned company say “Major Widget Retails” which will sell exclusively over Internet and therefore compete with Overlooked Upstart”. In new company you can select/build transaction system exactly according business model you need to support. This would even create advantage for “parent” company as their business model does not change -> batch sale between parent/child companies. Not to mention advantages for tax and financial expenses as both companies work in standard supplier/consumer relationship.
All above is of course based on assumption that top management of “Major Widget” knows what they doing and that minimization of const on IT was rational decision and not just short sight choice.
Fair points and I think your final caveat is the key to the argument, if you view IT as just a cost then you are being short sighted.
In fact if the market has already moved to a different model it is probably already too late - will there ever be a serious competitor to iTunes or have they simply built such a strong brand and momentum as to make it impossible? I certainly don't think it is any coincidence that it was a technology company that led the way.
So in some cases the change in the market can be so fundamental as to permanently put older firms out of business. Something similar happened in London with the so called "big bang" when the financial markets were deregulated and went electronic. The trading volumes jumped so dramatically as to make the old style of trading impossible, a lot of smaller brokerages simply could not afford the investment needed to compete and disappeared (often taken over by the bigger firms).
Could they have done anything different? It is certainly true that whoever had systems that could cope with electronic trading had a huge (unassailable?) advantage.
Are we seeing a similar thing happening with the music industry? Are there other sectors where similar seismic shifts could take place? If so the current players need to be investing now.
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