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Managerial Economics Research Paper on Role of the internet in the modern day employment cycle.
I have already completed the abstract (attached) and the paper will need to go along with that and be based on microeconomics NOT macro.
The paper should be 10 – 15 pages in length, double spaced, and follow generally accepted APA guidelines for college papers. It should contain a bibliography, and references should be properly noted. Analyze the microeconomics aspects of the topic chosen using sound Managerial Economic theory. Provide a description of what you are writing about, but your paper is not the description, but the research and analysis.
I have included some sample papers as well.
Role of the internet in the modern day employment cycle:
Abstract:
The economy, presently, is going through a lot of changes. New economic trends have been emerging, worldwide, at a rapid pace. Most corporations are looking to cut costs and optimize their procedures. Amidst these drastic changes, the employment landscape is also changing. There are newer, more innovative programs and procedures that employers/corporations are adopting. The extent to which organizations can optimize depends largely upon the availability of technology. This particular research paper will focus on the different internet based tools and applications that have brought a revolution to the modern day employment cycle.
The entire employment cycle consists of numerous parts: Application, Recruitment, Training, Deployment, internal and external organization communication, Termination, and Retirement. The purpose of this paper is to research the technological usage in each of these phases and to analyze the effects, both positive and negative, of this new found technology. The intention of this research is to thoroughly understand the employment cycle and its dynamics. We will also be able to evaluate how these new internet technologies will impact cost, effectiveness, and how they will fit into the current employment cycle. It will also touch upon the influence that the internet based social networking phenomenon has had on the employment cycle of an organization.
Outline:
1
. Introduction
2. Human Resource: Employment cycle
3. Traditional employment cycle implementation VS technology enabled employment cycle implementation
4. Industry trends
5. Analysis: Impact of internet on efficiency and effectiveness
6. Results
7. Conclusion
1
Student X
Research Paper
2
Student X
Research Paper:
Oil Versus the Airlines
Presented to:
Professor Thomas C. Makemson
In Partial Fulfillment of the Requirements of:
Managerial Economics
Fall 2, 2012
Section QS
ABSTRACT
For an industry whose success is based on seemingly price alone, the airline industry faced yet another economic setback during 2008. Since the Airline Deregulation Act of 1978, an airline’s survival is derived from ticket price. Such a phenomenon seems intuitive, yet it is not. From a non airline manager’s perspective, setting the ticket price for a flight is simple; calculate the marginal cost for the seat and apply an appropriate markup. The result is the ticket price for a flight. However, such price determination is not the case. Airline managers are faced with the challenging of meeting or beating the ticket price for each competing carrier in the markets they compete in. For example, when setting the ticket price for a flight between St. Louis, MO and Chicago, IL, an American Airlines manager is most likely concerned with Southwest Airline’s ticket price for a flight between the same two cities rather than American’s marginal cost for the ticket.
The above example presents a problem for airline managers; the ticket price is less a function of the cost for a flight than the competition’s ticket price for that market. Although the same is true for many industries, most firms outside of the airline industry are better able to differentiate their product thus allowing prices to be set according to cost. The traveling public has made product differentiation nearly impossible for the airlines by purchasing a ticket on price alone, not any particular feature of a carrier. For example, two separate individuals, Joe and Jill, find him and herself hungry for dinner. Joe wants something quick and cheap while Jill would like formal dinner. Given these distinct preferences, it is easy to see how restaurants can differentiate their food based on more than price alone.
A fast-food drive-through, such as McDonald’s or Burger King, appeals to Joe but not Jill; a sit down establishment, such as Olive Garden or Cheesecake Factory, appeals to Jill but not Joe. As a result, McDonalds can focus on delivering its food fast with a low price and appeal to the many “Joes” while Olive Garden can focus on providing an eloquent evening while charging a higher price and appealing to the many “Jills.” While restaurants have the ability to differentiate their product and charge different prices than the competition, airlines cannot. Consider again Joe and Jill. Each needs to travel from Houston, TX to Las Vegas, NV for business, leaving on December 23, 2008 and returning December 26, 2008. The only selection criterion for Joe and Jill is the cheapest direct flight between the two cities; neither is concerned with leg-room, snacks, video-entertainment, pillows, blankets, or any other amenities.
Armed with his and her travel dates, Joe and Jill each compare airlines online and find two direct flight options between Houston and Las Vegas. Continental Airlines offers non-stop service for $704.00 while Southwest Airlines serves the same route for only $412.50.
Which airline will be awarded Joe and Jill’s travel dollar? Southwest Airlines will most likely be picked by each but not because Southwest has differentiated its product from Continental. Continental looses two potential passengers because its ticket price is nearly $300 more than Southwest.
Given the highly competitive and price sensitive market the airlines operate within, how do they adjust their prices when extraordinary expenses arise? More specifically, what if a budgeted expense nearly doubles within several months? How do air carriers react? Do entire business models change? These questions in response to the hypothetical cost escalation were asked during the Summer of 2008 when the price of oil spiked to record highs; as the cost of a barrel of oil grew exponentially so did every airlines’ largest expense – fuel. How did each carrier react?
Through this paper, this question will be answered. Additionally, research will be provided to highlight the crippling affect the oil price run-up had on the airline industry.
OIL CRISIS of the SUMMER OF 2008
Nearly every American was affected by the wildly escalating oil prices during the Summer of 2008. Whether it was higher gas bills to travel to work or increased shipping expenses to get product to market, personal and business budgets were stretched thin. Whereas the objective of this paper is not to determine the reason for the oil crisis, a brief overview of the price run-up is required in setting the foundation for a closer look at the airlines’ response.
Twenty-one years of historical oil prices were analyzed; in the early 2000s, the price found equilibrium between $20 and $30 per barrel.2 As a result of this relative price stability, only 5 years of historical data will be presented. The following graph presents a rather shocking picture of oil from December 9, 2003 to December 9, 2008:
Graph 1: Constructed based on oil prices Dec. 9, 2003 through Dec. 9, 2008
At the beginning of the five year period, oil was $30.27 per barrel. The following December 9, 2004 brought $36.77 oil; December 9, 2005 saw $57.23 oil; December 8, 2006 experienced $63.67 oil; December 10, 2007 was the start of a slow increase in price at $87.33 per barrel; the price topped at $143.95 on July 3, 2008; however, the price rapidly declined to $39.77 a barrel on December 9, 2008.3 The next graph highlights the spike in oil prices beginning one year prior to July 3, 2008 (the date of the record price) through December 9, 2008:
Graph 2: Highlighting oil prices from one year prior of the highest price per barrel (July 3 2008)
As previously noted, the record price of oil was on July 3, 2008 at $143.95. One year prior, on July 3, 2007, the price per barrel was $74.26.3 This was a $69.69 jump in oil price in one year. This 93.85% jump in price affected many companies across many industries. However, the focus of this paper is oil’s near doubling in price over one year and its effect on the airlines. More importantly, how did each airline react to the price increase and to the reaction of each competitor? Before continuing, it should be noted that numerous airlines go in to and out of business on a yearly basis. As a result, the top seven airlines will be analyzed as a representation of the industry as a whole. These airlines are American Airlines, Continental Airlines, Delta Airlines, Northwest Airlines, United Airlines, and Southwest Airlines.
OIL’S EFFECT on the AIRLINES
Before discussing each of the “Big Seven’s” reactions to the skyrocketing oil prices, the bottom line effect on each carrier will be presented. By comparing 2008 financial results to 2007 financial results, the relationship between an airline’s income or loss and the price of oil will become evident. For the observer who is unclear as to why oil has such a dramatic effect on airlines, the following analogy should clear up any confusion. An automobile burns gas to drive; an aircraft burns gas to fly. Both automobile gas and aircraft gas (jet fuel) are a direct byproduct of oil. However, an airplane burns substantially more gas than a car does, thus as the price of oil skyrockets so does one of the primary expenses of an airline. Given that comparison, the following table presents the quarterly operating results for the “Big Seven” for 2008 compared with 2007:
|
NET INCOME (LOSS) of the “BIG SEVEN” |
(in millions) |
||||||||||||||||||||||
|
Airline |
1st Qtr. |
2nd Qtr. |
3rd Qtr. |
9 Months Ended Sept. 30 |
|||||||||||||||||||
|
Year |
|
|
|||||||||||||||||||||
|
2008 |
2007 |
Change |
|||||||||||||||||||||
|
American |
($328) |
$81 |
($409) |
($1,448) |
$317 |
($1,765) |
$45 |
$175 |
($130) |
($1,731) |
$573 |
($2,304) |
|||||||||||
|
Continental |
($80) |
$22 |
($102) |
($3) |
$228 |
($231) |
($236) |
$241 |
($477) |
($319) |
$491 |
($810) |
|||||||||||
|
Delta |
($6,390) |
($6,260) |
($1,000) |
$1,600 |
($2,600) |
($50) |
$220 |
($270) |
($7,440) |
$1,690 |
($9,130) |
||||||||||||
|
Northwest |
($4,139) |
($292) |
($3,847) |
($377) |
$2,149 |
($2,526) |
($317) |
$244 |
($561) |
($4,833) |
$2,101 |
($6,934) |
|||||||||||
|
United |
($537) |
($152) |
($385) |
($2,729) |
$465 |
($3,194) |
($779) |
$334 |
($1,113) |
($4,045) |
$647 |
($4,692) |
|||||||||||
|
U.S. Airways |
$66 |
($302) |
($567) |
$263 |
($830) |
($865) |
$177 |
($1,042) |
($1,668) |
$506 |
($2,174) |
||||||||||||
|
Southwest |
$34 |
$93 |
($59) |
$321 |
$278 |
$43 |
($120) |
$162 |
($282) |
$235 |
$533 |
($298) |
|||||||||||
|
Total |
($11,676) |
($312) |
($11,364) |
($5,803) |
$5,300 |
($11,103) |
($2,322) |
$1,553 |
($3,875) |
($19,801) |
$6,541 |
($26,342) |
Table 1: Comparison of 2008 and 2007 Financial Performance the “Big Seven”
Although a direct correlation cannot yet be drawn between oil price and each airline’s performance, each carrier performed substantially worse in 2008 than in 2007. By concentrating on the “Nine Months Ended September 30,” American Airlines showed a $2,304,000,000 negative turn in income for 2008 than in the same period in 2008. Continental went $810,000,000 in the wrong direction. Delta’s earnings fell victim to the same fate; they dropped by $9,130,000,000 in one year. Northwest, United, and U.S. Airways fell from positive earnings by -$6,934,000,000, -$4,692,000,000, and -$2,174,000,000, respectfully. Southwest Airlines was the only carrier among the “Big Seven” that showed a profit for the nine months in 2008; however, they too showed a negative turn from 2007 earnings. By contrast to the other six carriers, Southwest’s negative turn of $298,000,000 signifies either better luck or better management. That distinction is also too early to determine.
At this point, the only certain conclusion from the above graph is that each airline performed worse, period-for-period, in 2008 than 2007. Each airline earned net income in the second and third quarter of 2007 but quickly turned negative in 2008. In order to better associate fuel cost with earnings, the table on the following page presents each airline’s increase in fuel expense for the first three quarters of 2008 over the same periods in 2007:
|
FUEL EXPENSE of the “BIG SEVEN” |
||||||||||
|
1st Quarter |
2nd Quarter |
|||||||||
|
Dollar |
% |
|||||||||
|
$2,050 |
$1,410 |
$640 |
45.4% |
$2,423 |
$1,644 |
$779 |
47.4% |
|||
|
$1,048 |
$684 |
$364 |
53.2% |
$1,363 |
$821 |
$542 |
66.0% |
|||
|
$1,422 |
$958 |
$464 |
48.4% |
$1,678 |
$1,112 |
$566 |
50.9% |
|||
|
$1,114 |
$704 |
$410 |
58.2% |
$1,207 |
$855 |
$352 |
41.2% |
|||
|
$1,575 |
$1,041 |
$534 |
51.3% |
$1,848 |
$1,206 |
$642 |
||||
|
$823 |
$550 |
$273 |
49.6% |
$1,086 |
$658 |
$428 |
65.0% |
|||
|
$753 |
$564 |
$189 |
33.5% |
$894 |
$607 |
$287 |
47.3% |
|||
|
$8,785 |
$5,911 |
$2,874 |
48.6% |
$10,499 |
$6,903 |
$3,596 |
52.1% |
|||
|
3rd Quarter |
||||||||||
|
$2,722 |
$1,743 |
$979 |
56.2% |
$7,195 |
$4,797 |
$2,398 |
50.0% |
|||
|
$1,501 |
$895 |
$606 |
67.7% |
$3,912 |
$2,400 |
$1,512 |
63.0% |
|||
|
$1,952 |
$1,270 |
$682 |
53.7% |
$5,052 |
$3,340 |
$1,712 |
||||
|
$1,912 |
$882 |
$1,030 |
116.8% |
$4,233 |
$2,441 |
$1,792 |
73.4% |
|||
|
$2,461 |
$1,324 |
$1,137 |
85.9% |
$5,884 |
$3,571 |
$2,313 |
64.8% |
|||
|
$1,110 |
$692 |
$418 |
60.4% |
$3,019 |
$1,900 |
$1,119 |
58.9% |
|||
|
$1,000 |
$660 |
$340 |
51.5% |
$2,647 |
$1,831 |
$816 |
44.6% |
|||
|
$12,658 |
$7,466 |
$5,192 |
69.5% |
$31,942 |
$20,280 |
$11,662 |
57.5% |
Table 2: Comparison of 2008 vs. 2007 Fuel Expense of the “Big Seven”
The relationship between oil price and airline earnings is beginning to develop considering the staggering percentages that each airline’s fuel expense rose in 2008 over the previous period in 2007. Northwest Airlines suffered the most, with a 73.4% increase in fuel for the first three quarters in 2008 over 2007; although, all but Southwest Airlines suffered at least a 50% increase in fuel expense for the same period. Recall the day of the record high price per barrel, July 3, 2008. The high began the third quarter 2008, with oil remaining above $100 per barrel until two days prior to the end of the third quarter; this time period was the worst in 2008 for the airlines. Northwest saw the highest fuel expense increase of 116.8%; United followed with a 85.9% increase; Continental’s 67.7% increase was third; U.S. Airways increase of 60.4% ranked it fourth; American saw its fuel expense increase 56.2%; Delta experienced a close 53.7% increase; the best performer was Southwest. Although, its fuel expense increase still exceeded 50% of the previous year. Some carriers were affected worse than others.
For the observer who is familiar with operating data, the question arises, “what about the remaining expenses? Airlines have other expenses other than fuel.” This observer is correct in his remark regarding additional expenses the airlines incur; such is why there is yet one missing link directly proving oil price as the culprit behind 2008’s airline plight. The following chart ties fuel expense together with each airline’s total expenses for 2008 over 2007:
|
INCREASE in OPERATING EXPENSES of the “BIG SEVEN” ATTRIBUTABLE to INCREASE in FUEL EXPENSE |
||||||||||||||
|
2008 vs. 2007 |
||||||||||||||
|
Increase |
% |
Increase |
||||||||||||
|
Total |
Fuel |
Due to |
Fuel |
|||||||||||
|
Expense |
||||||||||||||
|
$705 |
90.8% |
$2,057 |
37.9% |
$1,010 |
96.9% |
$3,772 |
63.6% |
|||||||
|
$521 |
69.9% |
$668 |
81.1% |
$768 |
78.9% |
$1,957 |
77.3% |
|||||||
|
$6,941 |
6.7% |
$2,073 |
27.3% |
$814 |
83.8% |
$9,828 |
17.4% |
|||||||
|
$4,508 |
9.1% |
$1,052 |
$1,095 |
94.1% |
$6,655 |
26.9% |
||||||||
|
$687 |
77.7% |
$3,389 |
18.9% |
$1,185 |
95.9% |
$5,261 |
44.0% |
|||||||
|
$420 |
$927 |
46.2% |
$1,116 |
37.5% |
$2,463 |
|||||||||
|
$328 |
57.6% |
$409 |
70.2% |
$468 |
72.6% |
$1,205 |
||||||||
|
$14,110 |
20.4% |
$10,575 |
34.0% |
$6,456 |
80.4% |
$31,141 |
37.4% |
Table 3: Percentage of operating expenses caused by increase in oil price
Now the picture is clear: American, Continental, Delta, Northwest, United, U.S. Airways, and Southwest’s poor financial performance in 2008 is nearly 100% attributable to the rapid increase in oil price. Several carriers, such as Delta and Northwest had several non-cash expense items that increased total expenses
; however, 70 to 95 percent increased fuel expense to total expense increase ratios tell most of the story. Continental suffered the worse over the entire nine month period, while American suffered two of the worst quarters of any carrier in the first and third quarters.
Although it is not the only objective of this paper to equate increased oil price to decreased oil price, it is important to present the severity of the oil versus earnings dilemma. More critical is developing a managerial plan to combat oil prices. Once the problem has been identified, each carrier has one of two decisions: 1 – do nothing and hope for the best; or 2 – implement a revised strategic plan to compensate for the problem. The remainder of this paper addresses the strategic plans of the “Big Seven.” Throughout the planning process, managers have to be cognizant of economic theory and the potential demand reaction to every decision, especially pricing decisions.
DEMAND ELASTICITY and AIRLINE TICKET PRICES
The obvious solution to an increase in a business’ expenses is an increase in the price of the company’s product; for the airlines, the answer to rising fuel prices is not quite as simple. As the opening story about Joe and Jill alluded to, the average airline passenger is quite sensitive to ticket price. Most travelers pick a flight based solely on price; the airline with the lowest ticket price for a given route will win a potential passenger’s travel dollar. Secondly, many potential travelers are finding viable substitutes to air travel, exacerbating the pricing problem. More specifically, leisure travelers are relying on alternate modes of transportation, such as bus, train, or driving, or not traveling at all. Business travelers are beginning to rely on video-conferencing, telephone-conferencing, or less meetings altogether.
Consumer price sensitivity is the primary factor airline managers must take into account when implementing strategic plans; however, how sensitive is the consumer to a price change, and how much will quantity demanded shift when ticket prices are increased? Consumer price sensitivity to a change in a products price is expressed by the product’s own price elasticity. Multiplying the own price elasticity of a product with the percentage increase in price of a product will provide a manger with the percentage change in quantity demanded for his product.
For example, if a manager knows the own price elasticity for his product is -1.5, and he must increase the products price by 12% to cover increasing expenses, quantity demanded for the product will decrease by 18% (-1.5 x 12%).
If armed with this information, airline managers can estimate the effect a ticket price increase will have on quantity demanded for their airline. Since the most likely option to combat rising fuel prices is to charge higher ticket prices, airline managers must derive an estimate of the own price elasticity for their airline. However, such a task is well beyond the economics expertise of the average airline manager and the author of this paper; an entire branch of economics is dedicated to estimating demand functions and demand elasticities. These econometrics pofessionals use sophisticated analysis and computer software to develop accurate estimates of the own price elasticity for a firms products.
As such, airline managers should not “guesstimate” such an important variable for their company; either internal economists or external consultants should be trusted for and accurate estimate of the own price elasticity.
Just as airline managers should rely on economics professionals for their data, so will the author of this paper. Over the past several years, numerous economics professionals have researched airline pricing and consumer reaction. Kenneth J. Button of the Center for Transportation Policy, Operations, and Logistics compiled much of this elasticity research while studying the effects of taxation on air transportation. His findings show that the elasticity of demand for ticket prices varies on many factors ranging from personal to business travel and domestic to international travel. Additionally, length of a particular route affects the elasticity of ticket prices.
The following table presents Button’s findings:
Table 4: Own price elasticity for airline ticket prices12
Button’s compilation brings about another dilemma for airline managers; elasticity can vary dramatically based on the type of flight. Business travel has the lowest values; most business travel elasticities presented are inelastic in that business travel demand will not fluctuate as much as the increase or decrease in price. However, economy, discount, or pleasure travel present larger values and are elastic in that demand will fluctuate more than the increase or decrease in price. For example, if American Airlines needed to raise prices 20%, how would demand be affected? For international business travelers, own price elasticity is -.26, thus a 20% increase in price leads to only a 5.2% decrease (-.36 x 20%) in business travelers. However, for cross country leisure travelers, own price elasticity is -1.52, thus the same 20% increase in ticket price leads to a 30.4% decrease (-1.52 x 20%) in leisure travelers.
As can be seen, airline managers must be aware of the different elasticities affecting each market segment; each type of customer and type of route will react differently to price changes. A detailed route and customer analysis is beyond the scope of this paper, but non-the-less it is important to note the complex demand structure an airline faces. More specifically, American Airlines faces own price elasticities ranging from -1.58 to -2.34.
While a 10% price increase only causes a 15.8% decrease (-1.58 x 10%) in demand on the low end, the same price increase causes at 23.4% decrease (-2.34 x 10%) in demand on the high end. Considering this demand variability, combating increasing prices presents a rather difficult dilemma. Armed with elasticity data for the industry as a whole, the following analysis aims to present solutions for rising oil prices.
DEMAND ELASTICITY and OIL PRICES
Considering the potential price sensitivity of airline travelers, combating increasing oil prices is not as simple as raising ticket prices to cover the increased price of fuel. Mangers must cover the increasing price of oil but at the same time must be cautious about decreasing passenger demand. As a starting point to address the increasing losses associate with fuel, the first step is to determine how much passenger revenue must be increased to compensate for increased fuel. However, demand effects must be considered before raising ticket prices by this percentage, thus approximating an own price elasticity for each airline is required. With these two values, the decrease in demand associated with the increase in price can be determined. The following table presents this information:
|
PRICE INCREASE REQUIRED to COMPENSATE for FUEL |
|||||||||
|
(and subsequent demand decrease) 9 MONTHS ENDED SEPTEMBER 30, 2008 |
|||||||||
|
Passenger |
Price |
Approximate |
Demand |
||||||
|
Revenue |
Decrease |
||||||||
|
(000,000s) |
Required |
Elasticity |
|||||||
|
$14,060 |
$2,398 |
17.06% |
-1.50 |
-25.58% |
|||||
|
$10,633 |
$1,512 |
14.22% |
-21.33% |
||||||
|
$13,848 |
$1,712 |
12.36% |
-18.54% |
||||||
|
$7,529 |
$1,792 |
23.80% |
-35.70% |
||||||
|
$14,270 |
$2,313 |
16.21% |
-24.31% |
||||||
|
$8,594 |
$1,119 |
13.02% |
-19.53% |
||||||
|
$7,927 |
$816 |
10.29% |
-2.00 |
-20.59% |
Table 5: Demand decrease associated with an increase in ticket price
In calculating the demand decrease associated with each airline’s price increase, the approximate price elasticities were estimated as follows: American, Continental, Delta, Northwest, United, and U.S. Airways all focus on both leisure and business travelers on short through long distances. As a result, the price elasticity was estimated from Sutton’s table presented earlier; since all six operate similar structures, the best approximation for price elasticity was a combination of the various market segments served. As a result, the best own price elasticity approximation is -1.50. Since Southwest focuses primarily on leisure, budget minded traveler’s, the best approximation from Sutton’s table is an own price elasticity of -2.00.
Given the information presented, each airline’s management team has a problem on its hands. To cover fuel expenses with passenger revenue, demand will fall dramatically; this scenario would have the opposite effect, declining revenues. Several solutions are available to counteract the associated demand decrease; they are as follows:
-Supply can be decreased.
-Alternate forms of income can be established.
-Inefficient aircraft can be replaced with fuel efficient aircraft.
-Mitigate fuel expense through fixed contracts.
One or more of the above strategies should be used to compensate for the estimated decrease in demand associated with price increases. Interestingly enough, each carrier in the “Big Seven” responded to rising oil prices with a mixed strategy. The following sections highlight the response of each carrier to the oil induced financial distress of 2008.
AMERICAN AIRLINES’ STRATEGY
Led by CEO Gerald Arpey, American Airlines instituted several changes in an effort to combat rising oil prices. Fares were increased but not at the rate shown above. Instead, additional stream of revenue were created. For example, beginning on June 15, 2008, they began charging $15 for the first checked bag. Airlines have historically charged $25 for a second bag but charging for the first bag was a rather unprecedented move. Other additional fees include $125 to $699 for traveling with pets and from $3 to $6 for food on-board.
Perhaps the most notable fee, a fuel surcharge will be added to each ticket. Capacity cuts of 11 to 12 percent in the fourth quarter of 2008 were also planned; as a result of capacity cuts, 8,000 jobs will also be shed.
The company also placed 34% of its anticipated jet fuel on contracts for 2008. The final move by American Airlines is to retire 85 of its inefficient aircraft.
CONTINENTAL AIRLINES’ STRATEGY
Larry Kellner, CEO of Continental Airlines, and his team responded quite similar to American. Capacity reductions of up to 11% by the end of the fourth quarter, 2008 were announced during the summer of 2008. Sixty-seven older aircraft will be retired. These old Boeing 737 aircraft will be replaced with new, more fuel efficient 737s; however, the fleet will still be reduced from 375 aircraft to 344 aircraft at the end of the transition. Associated with the capacity reductions, Continental announced layoffs of 3,000 employs.17 All of these changes were on top of ticket price increases and fuel surcharges. Also, Continental implemented a $15 first bag fee.16
DELTA AIRLINES’ STRATEGY
With perhaps the boldest of all moves, Delta Airlines CEO Richard Anderson announced plans to merge with Northwest Airlines in order to share expenses and expand global capacity; as this paper is being written, the merger has passed.
Will the intended cost-savings emerge? Only time will tell. Along with the merger, Delta also announced capacity cuts of 8% to 10% by the end of the fourth quarter, 2008. Along with the capacity reduction comes 4,000 layoffs.17 Delta joined with other domestic carriers in implementing a $15 first bag fee; fuel surcharges and price increases were also put in place on many routes.
NORTHWEST AIRLINES’ STRATEGY
As discussed above, Northwest Airlines merged with Delta Airlines in an attempt to share expenses and expand global capacity.
Prior to the merger, Northwest CEO Edward Bastian announced capacity cuts up to 9.5% by the end of 2008. However, in contrast to other carriers, he hoped to reduce the workforce through natural attrition instead of layoffs.
The company tried to fend of rising oil prices by hedging 54% of its anticipated 2008 fuel needs.
Along with higher fares and fuel surcharges, Northwest implemented a $15 first bag fee, fees for food ranging from $3 for a snack to $10 for a meal, and a $5 – $35 fee for extra leg room and seat choice for domestic flights and $15 – $75 for international flights.20
UNITED AIRLINES’ STRATEGY
Glenn Tilton, CEO of United Airlines, announced the largest capacity cuts of any carrier, with 17% to 18% capacity reductions by the end of 2008 in to 2009. Whereas Northwest Airlines hopes to trim employment through attrition, United reduced its workforce by 1,100 employes. Other drastic measures by United include retiring 70 older jets from its fleet and eliminating its discount carrier, Ted.22 The company also has a list of new fees including the $15 first bag fee, fees for food ranging from $3 for a snack to $9 for a fresh meal, increased fees for pets ranging from $175 to $250, and fees to upgrade to “economy plus” of $14 to $109. These recent charges are on top of fare increases and fuel surcharges.20
U.S. AIRWAYS’ STRATEGY
CEO Doug Parker and the entire U.S. Airways management team have followed suit with the previous carriers. Fare increases and fuel surcharges were the first of several revenue generating steps. Additionally, U.S. Airways instituted the $15 first checked bag fee of its counterparts. Along with the bag fee, U.S. Airways also charges $5 to $7 for food, $5 for choice seats, and $100 to travel with pets in the cabin. A fee unique to U.S. Airways is a charge for drinks, $2 for non-alcoholic drinks and $5 to $7 for alcoholic beverages.
Capacity reductions are also underway of 2% to 4% by the end of 2008; the company will also allow leases to run out on 28 aircraft. These will be replaced with fourteen Embraer-190s and five Airbus-321 aircraft. Associated with the capacity reductions will come 1,700 job losses.
SOUTHWEST AIRLINES’ STRATEGY
As the financial tables above show, Southwest Airlines survived the fuel crisis better than any of its “Big Seven” counterparts. Incredibly, while the other six carriers mounted huge losses for the nine months ended September 20, 2008, Southwest earned a profit. Initially, Southwest CEO Gary Kelley not only announced no cut-backs but additional capacity would be added in 2009. Although, it now appears oil prices were slow to catch up with Southwest. As of the beginning of December, 2008, Southwest announced a 4% to 5% reduction in flying for the first quarter, 2009. The airline plans to keep its fleet the same size.25 Another considerable difference between Southwest and the other carriers is the lack of additional fees. Southwest has increased fares but has not added fuel surcharges, bag fees, snack fees, drink fess, or cabin upgrade fees.24
Instead of charging additional fees, Southwest attempted to control rising costs through fuel contracts. According to Kelly, his company saved $1.3 billion through the end of the third quarter 2008 from its fuel hedging program. Even with the recent decline in crude oil prices, Southwest’s program is still in the money; as of October 15, 2008, it was valued at $550 million. The airline has such faith in its finance department that it has fuel contracts through 2012. 85% of Southwest’s anticipated fuel requirements of the fourth quarter of 2008 is contracted at $62 per barrel; 75% of 2009 at $90 per barrel; 50% of 2010 at $90 per barrel; 40% of 2011 at $93 per barrel; and 35% of 2012 at $90 per barrel.
DIFFERENCES in STRATEGIES
After reviewing each of the “Big Seven’s” survival strategies, it becomes quite evident that one of the airlines is not like the others. Whereas Southwest Airlines has focused on controlling its costs through fuel contracts, the other six have focused on increasing revenue. The better strategy is apparent after reviewing the financial data presented in the beginning of this paper; Southwest Airline’s strategy has resulted in positive earnings for the first nine months of the year while the others are all in the red. However, Southwest’s strategy has been set for many years. American, Continental, Delta, Northwest, United, and U.S. Airways have been on the defensive against oil in the past year. Southwest, on the other hand, has been on the offensive against fuel prices for nearly twenty years. Since the time when current CEO, then CFO, Gary Kelly took office in 1989, he began locking in fuel contracts to stabilize the airlines income statement.
Given Southwest’s huge success with its fuel hedging program, why do other airlines not have such programs in place? If one airline can save over one billion dollars in three quarters, the average person would assume others would follow suit. However, the hidden side of contracts, such as Southwest’s fuel contracts, is the cost. For example, commodities clearing houses require a margin of nearly 10% of the contract price to be paid at contract signing. A contract of 100,000 barrels at $100 per barrel is worth $10,000,000, thus to hedge at that price, an airline would face an upfront cost of $1,000,000.
Additionally, airlines (and other such investors) incur transaction costs for each contract; Southwest incurs one more cost as well. What if oil prices fall below the contract price? In a traditional contract, the airline is still responsible for the contracted amount at the contracted price resulting in a loss on the hedge. To protect against such an occurrence, Southwest pays premiums offering downward price protection. If the spot price drops below the contract price, Southwest can and will let the option expire and not pay the higher price. While the airline saves on fuel costs, it still loses the premium paid for the contract. These fees are paid as an insurance policy for the airline. As with all insurance, there is risk involved. Southwest is willing to pay a premium to protect itself against rising fuel costs in spite of the financial risk involved with the contacts.28
This additional information regarding contracts, such as fuel hedging, is the underlying factor preventing every other airline from participating in the same fuel cost saving measures as Southwest. Given the huge upfront costs of hedging – 10% margins, transactions costs, and potentially downward price protection – airlines are faced with an expensive proposition, and as any reader of the USA Today knows, the average airline does not have much additional cash lying around to cover such additional expenses. According to Peter Fusaro, founder of an energy-trading information firm, “Facing higher energy prices and billions of dollars in debt, most airlines can’t afford to hedge.”28
Secondly, as discussed above, if the spot price of oil falls below the contract price, the airline will face losses associated with the hedge. As a result, many airline managers view such financial contracts as risks and most are striving to eliminate as many risks as possible these days. Energy consultant Stephen Schork agrees: “I think airlines have been reluctant to hedge because corporate culture views futures as a gambling tool.” However, he adds, “but they’ve been reluctant to their own detriment. If you’re an airline without a significant hedge, you’re in a difficult spot.”
Although it would seem easy to copy Southwest’s fuel hedging program and save over a billion dollars in fuel, many airlines simply cannot afford to do so, or their management is reluctant to do so based on speculative reasons. Either way, Southwest will remain to have a significant cost advantage over nearly every other competitor. If the other six continue to raise prices, will additional capacity cuts be required? Only time will tell.
CONCLUSION
Two important conclusions can be drawn from this research. First, regardless of the cause, the oil crisis of the Summer of 2008 drove the airline industry into some of the worst financial performance in recent times. Even though the increase in oil price heightened during the summer months of 2008, data clearly shows that high oil prices began before 2008 began. Second, one airline was better prepared to handle escalating oil prices than others. Some may call it luck, others may call it superior management, but either way, Southwest Airlines, through long standing fuel contracts, survived the oil crisis better than its competitors.
Whereas American, Continental, Delta, Northwest, United, and U.S. Airways have been on the defensive for many months, Southwest has been on the offensive for nearly twenty years. Southwest focuses on controlling fuel costs; the other six focus on increasing revenue. Which strategy will prevail in the long-run? Although no manager can predict the future, it is simple to tell which airline has prevailed thus far. Will the rapidly declining oil prices of the Fall of 2008 bring better financial results to the airlines? Most would assume yes, but some of the toughest economic times in years might decide otherwise. However, that is a topic for another paper on another day. For now, the airlines will continue their battle against oil.
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� Net Income(Loss) presentation calculated based on each airline’s quarterly SEC 10-Q filings.
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� Total expense and fuel expense presentation and calculation based on each airline’s quarterly SEC 10-Q filings.
� Non-cash expenses/write-offs from each airline’s quarterly SEC-10Q filings.
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� Oum, Zhang, and Zhang’s own price elasticities as presented by Sutton.
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� American Airline’quarterly SEC 10-Q filing.
� Delta Airline’s quarterly SEC 10-Q filings.
� Kayak.com: Airline Fees. Copyright 2008.
� Delta Airline’s quarterly SEC 10-Q filings.
� MSNBC.com: “Airlines Move to Make a Bad Situation Worse.” June 4, 2008.
� Northwest Airlines quarterly SEC 10-Q filings.
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� MSNBC.com: “Airlines Move to Make a Bad Situation Worse.” June 4, 2008.
� “Southwest Airlines Reports Third Quarter Financial Results.” Forbes.com. October 16, 2008.
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� Moira Herbst. “Hedging Against $200 Oil.” Business Week Online. May 7, 2008.
MANAGERIAL ECONOMIC ANALYSIS OF SOCIAL COMMERCE
Research Paper
Managerial Economic Analysis of the Impact of Social Commerce on E-commerce
Submitted by
Student
Prepared for
Professor Thomas C. Makemson
BUSN 6120, Managerial Economics
Spring 1, 20XX
Section: XX
Webster University
March 2, 20xx
CERTIFICATE OF AUTHORSHIP: I, xx, certify that I am the author. I have cited all sources from which I used data, ideas, or words, either quoted directly or paraphrased. I also certify that this paper was prepared by me specifically for this course.
____________ 03/02/20xx
Signature Date
Today, Facebook, Linkedin, Twitter, MySpace are well-known social networking brand names that many of us have grown accustomed to making part of our daily routine, whether it be for staying in touch with friends, networking, or micro-blogging. Social networking tools have the potential to revolutionize e-commerce as we know it today through “social commerce” platforms. A 2011 study by Booz & Co estimates that social commerce is currently a $5 billion market with the potential to grow to $30 billion in five years. Social commerce’s transformational power lies in its personalization of the internet experience, connectivity with an individual’s network, and the dynamic customer data collection that can drive current and future marketing and sales efforts. In this paper, the author will introduce the social commerce concept, examine the social commerce market, explore the effect of social commerce on consumer behavior, discuss social commerce pricing strategies and valuation of social commerce networks, evaluate the industry concentration and look at the future of the social commerce.
What is Social Commerce?
Even though today we equate social networking with Facebook and Twitter, social networking itself is not a brand new concept. “Early forms of social networks include the guilds in medieval Europe, trade groups, and unions, which can be traced back to the early 18th century, and more modern venues like the Chamber of Commerce and Rotary Clubs, which have emerged over the last 10 decades as accepted forums for professionals in similar industries and business communities to meet and further commerce, business relationships, and advocate for changes in business practices”. These early systems evolved into the social networks of today and more recently integrated with modern e-commerce capabilities to develop a new marketing and sales channel known as social commerce.
Because it is a nascent field, the term “social commerce” has many definitions depending on consumer and provider viewpoints. However, the author has chosen to use this definition throughout this paper: social commerce is a “subset of electronic commerce that involves using social media, online media that supports social interaction and user contributions, to assist in the online buying and selling of products and services”.
Today, social commerce is a field that allows firms to harness existing social networking platforms to personalize sales and advertising experiences based on reviews, ratings, recommendations, networks, personalized groups, and location. Vendors are able to provide individualized platforms and encounters driven by data provided through external social networking sites or internal data collection.
Groupon is an example of a social commerce firm that uses internal and external data collection to provide users with coupons for businesses local to a user. Groupon allows users to submit gender, biographical data, residence location information, favorite industries (e.g. health and beauty, food and drink, or retail and services stores), educational background, employment status, income range, home ownership, marriage status, and children status. Combined with analysis of past purchases through Groupon, this sociographic data provides the firm with a wealth of knowledge to predict a user’s spending habits. Therefore, this information allows Groupon to present coupons/deals based on predicative analysis, which is analogous to the “Customers Who Bought the Item You Added Also Bought” feature on Amazon. Groupon customers can also easily share coupons by email or social networking sites (i.e. Twitter, Facebook) by clicking on the share feature located on each potential coupon page (See Figure 1).
(
The Facebook “Like” button
)
Figure 1: Screenshot of Groupon.com based on selection of Baltimore, Maryland as a home location.
Firms like Resource Interactive have developed end-to-end marketing solutions for companies looking to take advantage of social commerce platforms. Through their “Resource Distributed Commerce Platform”, Resource Interactive provides their customers with a vehicle to engage in Facebook Commerce (also known as “F-Commerce”), where firms can sell their merchandise through Facebook status updates and tab stores. Resource Interactive manages over 18 million of their clients’ fans on Facebook and use this data to drive develop fan engagement, brand loyalty, and social commerce strategies. Figure 1 above shows the “Like” button seen on many websites today and with the over half a billion Facebook members worldwide, the market potential of firms that engage in F-commerce is tremendous.
Social Commerce Market Analysis
In this section, we will conduct a social commerce market analysis, specifically decomposing the supply and demand potential for this marketing and sales platform. According to Social Commerce Today, currently, there are more than 2 billion internet users worldwide and this figure presents a tremendous market opportunity as people on average spend 30% of leisure time online.
Many demographic groups also present opportunities to exploit their social networking habits for social commerce revenues. For example, among 11-14 year olds, high-use social networkers (defined as accessing social networking sites three times a day or more) are “50% more likely to be asked for advice by their school friends about toiletries and cosmetics, 40% more likely to be asked about mobile phones or fashion, and 20% more likely to be asked about new music.”
According to Facebook, more than 250 million people engage with Facebook on external websites every month. Moreover, an average of 10,000 new websites integrate with Facebook every day and more than 2.5 million websites have already integrated with Facebook. Furthermore, the “Like” button feature for websites unveiled by Facebook in 2010 has presented higher website traffic and increased sales after websites installed the tool. This tool lets users signal their affinity for a brand, item or product and broadcast that back to the social networking site. As an example of the power of the Like button tool, a film database website saw its traffic double since it installed the Like button throughout the site. Separately, Facebook is tasking its members to use the Like button in an effort to compile smart search engine using “likes” to determine what is most relevant on the web, which is in direct competition to Google’s algorithm search method.
Social commerce is also attracting additional share of overall marketing budgets. A recent American Marketing Association and Duke University’s Fuqua School of Business survey predicted that social media advertising will account for over 18% of total marketing budgets in the next five years (See Figure 2). In addition, this survey indicated that service companies (See Figure 3) are planning the biggest social media advertising increases, “as both B2B and B2C service companies have a higher percentage of their budgets set aside for social media than their product-focused counterparts” (eMarketer, 2011).
(
Figure 3: Source
(eMarketer, 2011)
) (
Figure 2: Source:
(eMarketer, 2011)
)As mentioned previously, a 2011 Booz & Co study indicated that the social commerce market is estimated to grow to $30 billion by 2015 (See Figure 4). The $30 billion estimate scratches the surface for social commerce’s market potential as it only estimates hard goods sold through this platform. The services industry has a great deal of potential in the social commerce space, especially in cases where existing technologies can be integrated as in the case of mobile phone internet and social media advertising. Booz & Company also conducted a separate survey in 2010 focusing on consumers who spend at least one hour a month on social networking sites and who had bought at least one product online in the last year. This survey indicated that 27 percent of respondents said they would be willing to purchase physical goods through social networking sites.
Figure 4: Source is Booz & Co. (2011, Jan 19). Turning “Like” to “Buy” Social Media Emerges as a Commerce Channel.
When compared to Booz & Co’s estimated social commerce current and future market levels, U.S. consumer aggregate spending in 2009 provides an indication as to the growing importance of social commerce across discretionary spending categories. Table 1 illustrates a hypothetical situation where social commerce could have the potential to account for over 35% of the Apparel and Services (Girls, 2 to 15) market today and
1.54%
of the entertainment market. Table 1 also shows 2015 estimated social commerce market figures compared to 2009 consumer expenditures to illustrate the growth potential of social commerce based on current consumer expenditures.
|
Item |
U.S. Consumer Aggregate Spending in 2009 |
U.S. Social Commerce Market as % of 2009 Aggregate Spending (Est. 2011 Levels of the Social Commerce Market) |
U.S. Social Commerce Market as % of 2009 Aggregate Spending (Est. 2015 Levels of the Social Commerce Market) |
|
Average annual expenditures |
$5,929,795 |
0.08% |
0.24% |
|
Apparel and services Total |
$208,496 |
2.40% |
6.71% |
|
Apparel and services (Girls, 2 to 15) |
$14,219 |
35.16% |
98.46% |
|
Apparel and services (Boys, 2 to 15) |
$9,499 |
52.64% |
147.38% |
|
Entertainment |
$325,412 |
1.54% |
4.30% |
|
(Aggregates in millions of dollars) |
Table 1: Source: 2009 Consumer Expenditure Survey, BLS.gov
Demographics of social media users also plays an important role for retailers and marketing staff as they aim to harness the power of social commerce. A recent Gallup poll found that both Google and Facebook pages tend to attract young, affluent, and educated Americans disproportionately (See Figure 5). The study found men and women are about equally likely to have a Facebook page. Gallup also highlighted the overlap of new services between Google and Facebook as a source of increased competition for the two internet innovators. Gallup cites Google’s recent announcement that “will more prominently display ‘social search’ results akin to Facebook’s ‘like’ and ‘share’ features, and it also has its own social networking feature, Buzz.” Facebook is following suit by including in-site chat and e-mail options to meet Google on its own turf. This survey sheds interesting light on social media users and could be followed up with a study focusing on non-U.S. users of Facebook and other social media sites considering that 70% of Facebook’s users live outside the United States .
Figure 5: Source: Gallup.com; “Google and Facebook Users Skew Young, Affluent, and Educated” (Morales, 2011).
Effect of Social Commerce on Consumer Behavior
Consumers operate in a world with imperfect information and must make purchase decisions based on that imperfect information. As such, these transactions involve risk on the part of the consumer, especially for new products. Attitudes toward risk vary among consumers with some consumers acting as risk loving, risk neutral, or risk averse. Most individuals are risk averse in situations with nontrivial outcomes. Therefore, the author will consider that most consumers in the U.S. are risk averse as they consider most of their nontrivial purchases of discretionary and non-discretionary goods.
Given the risk averse nature of U.S. consumers, social commerce provides a mechanism to reduce consumer uncertainty by exploiting their social networks as they consider factors like product quality. As an example of the power of networks on purchasing decision, a 2010 study was conducted by Varsity and published by eMarketer.com (See Figure 6). It showed that when purchasing clothing or footwear, 81 percent of girls, ages 13 to 18, use their friends and peers as a source of trend information and 45 percent list this group as “very influential”. Therefore, the girls surveyed appear to relying on their social networks to lower their uncertainty prior to making purchases.
Figure 6: Source: How to Influence Teen Girls Online; www.eMarketer.com
Social buying sites like Kaboodle, take advantage of these risk averse and imperfect information considerations that consumers face. Kaboodle is a social shopping site where networks can recommend, share products, discover new products from people with a similar style. Members of Kaboodle also “create and join groups, share advice, feedback and product suggestions and personalize their profiles with polls and other widgets”. As of February 2011, Kaboodle had over 14 million monthly visitors and had over 900,000 registered users that have added 10 million products to the site.
Another retailer, Wet Seal, harnessed the power of social commerce by developing a social buying experience through a “virtual runway where site visitors can put together outfits to share with their friends or to present to the community to be voted on. A pair of friends shopping at Wet Seal can use a service powered by Sesh.com to view the same product pages, chat in real time, and use a drawing tool to notate or highlight products they are considering”.
In summary, social commerce sites can help minimize consumer perceived risk and lower consumer search costs. Going beyond traditional price comparison sites, social buying sites can further reduce the reservation price for consumers, who can now also take their friend’s advice on searching for a particular good when deciding whether to purchase from a particular store at a certain price or continuing to searching for a lower price.
Pricing Strategies used by E-commerce and Social Commerce Firms
Amazon, one of the major pioneers of e-commerce, has continued to innovate the online retail space through the integration of social commerce into its sales and marketing mix. Amazon recently invested $175 million in and partnered with the social commerce firm, LivingSocial to draw customers to the Amazon.com site. LivingSocial is similar to Groupon in that they provide users with coupons based on their location. Unlike Groupon, LivingSocial does not offer users to provide deeper demographic information as part of their customer intelligence system. Instead, LivingSocial provides one deal in a user’s area per day. The site encourages users to share the deal to their contacts by offering users the “deal of the day” for free if three additional contacts purchase the deal through a unique link that a user shares with them. To generate buzz, in late January 2011, LivingSocial partnered with Amazon to provide shoppers with a $20 Amazon.com gift card for just $10. LivingSocial sold 1.3 million Amazon gift cards in this promotion.
Social commerce firms are still in their infancy even compared to the e-commerce giants that arose following the internet evolution in the mid-1990s. However, by joining forces with existing e-commerce sites, social networking/commerce firms have developed pricing strategies that indicate that they have market power. Social commerce companies are also able to use that market power to charge higher and vary markups among groups through mechanism such as price-discrimination.
A 2006 study looked at the price-discrimination question as it relates to the e-commerce sites and specifically, choices that Amazon makes in an effort to “empirically assess the optimality of their [price-discrimination] choices” (Ghose & Sundararajan, 2006). To conduct the price discrimination evaluation, the team converted the “sales ranks” reported by Amazon.com into actual demand levels by estimating how the variation in prices was associated with variation in demand. They then took random “samples” of data by checking prices at random times over a set time period. They specifically looked at software packages for sale on Amazon. One of the examples presented in the paper was their study of the sale of the Microsoft Office suites (Professional and Standard suites). The study found that that the sign of the own-price elasticity of the difference suites were positive while the signs of the cross-price elasticities were negative. The study also found that the sales of products decrease over time. The group discovered that the “cross-price elasticity of the Professional version of Microsoft Office with respect to the low-quality [Standard] version (p-standard), was actually higher than the own-price elasticity” (Ghose & Sundararajan, 2006). This result highlighted that in the Amazon case, Microsoft Office Professional was very sensitive to the price of Microsoft Office Standard. Furthermore, to demonstrate their test model for the optimality of pricing, the team used estimates for own- and cross-price elasticities derived for both the Professional and Standard versions of Microsoft Office. The estimated derivative of profits of each version were negative, which suggested that they were both overpriced, “since they are priced at a point where the slope of the
profit function is negative” (Ghose & Sundararajan, 2006). This study shows that it is possible to analyze price discrimination and price elasticity models for e-commerce sites and should be followed up with further research on the effects of social networking/commerce firms on price discrimination and price elasticity of e-retailing. This could help firms develop better pricing models and increase revenues.
Because they have market power, e-commerce firms like Amazon can partner with social commerce companies to introduce additional third-degree price discrimination strategies into their sales mix. For example, some social commerce sites use a “group buying” technique where a specific set of consumers must “buy-in” to a particular deal to get a particular discount and occasionally, the higher amounts of deal-takers result in higher discounts. Through the use of “group” buying, social commerce firms are able to give discounts to users that have ready-made networks of contacts that can be exploited to generate additional revenue. For example, it is less economical for a retailer to discount a product by 10% (thereby reducing profit margins by 10%) to just one consumer, but the same firm could benefit from economies of scale if the one consumer resulted in bringing in an additional 50 buyers, all with a 10% discount. While profit margins have shrunk on individual sales in this scenario, the increase volume from “group” sales to 50 buyers can more than make up for the decreased margins.
Moreover, e-commerce sites can “reward” social commerce users with deals based on how much detailed information they provide as part of their customer profile, the amount of “Likes” used on Facebook, and through mobile internet positioning. In summary, price discrimination is a powerful tool that can be used to increase revenues for both product and service companies that partner with social commerce firms.
Deriving value from Social Commerce Networks
A mid-2010 study in the Journal of Marketing Research (JMR) examined the question of how firms can derive value from social commerce networks. The study considered the following questions: Does allowing sellers to connect to each other create economic value (i.e., increase sales)? What are the mechanisms through which this value is created? How is this value distributed across sellers in the network, and how does the position of a seller in the network (e.g., centrality) influence how much the seller benefits or suffers from the network?
The study found that by allowing sellers to connect generates considerable economic value and that the value primarily is linked to making stores more accessible to customers browsing the marketplace (i.e. a “virtual shopping mall”). Interestingly, the study also found that “sellers that benefit the most from the network are not necessarily those that are central to the network but rather those whose accessibility is most enhanced by the network”.
Social commerce industry concentration and possible vertical and horizontal integration possible scenarios
Two of the top three social networking sites, Facebook and Twitter, have received a great deal of attention lately as buzz increase about possible IPO scenarios. Concerns with possible horizontal or vertical mergers could follow closely behind as these sites enhance their current monetization efforts. These monetization strategies become more important as the number of social network users continues to grow in leaps in bounds.
In early 2011, Goldman Sachs and Russian investment firm Digital Sky Technologies invested $450 million and $50 million, respectively. Digital Sky Technologies previously invested $500 million in Facebook and places an overall $50 billion value on Facebook. Facebook has estimated revenues of $2 billion annually.
A separate valuation of Facebook by Seeking Alpha contributor, Albert Babayev, states that “Goldman Sachs [is] paying 25x-28x revenues for [Facebook], while Google and Apple are getting 4-8x revenue [for their own companies]” (See Figure 7). Babayev projects that Facebook’s current stock value of $25 will grow to $111 by 2014. Babayev bases this valuation on membership growth rates (expected to hit ~1 billion users by 2014), revenues (from advertising, gifts, credits, etc), operating margins, tax structures, and earnings. Babayev states that “Facebook did something no other company has ever done. They somehow managed to take control of 600 million users, placing just about every corporation and organization at Facebook’s behest. A minimal fee structure for the corporations to reach these customers, increases valuations by hundreds of millions”. Furthermore, with a current estimated 2 billion internet users in the world, Facebook would account for roughly 30% of all internet users today.
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Figure 7:
Source:
How Much Is Facebook Really Worth?
(Babaye, 2011 )
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As another example of the growing potential value of social networking sites, Twitter was recently valued at $4 billion by J.P. Morgan Chase, who is currently in talks with Twitter Inc. to take a minority stake in that firm. Twitter is still working on monetizing its business and is estimated to generate about $150 million in revenue in 2011, versus Facebook’s revenue projections of $4 billion. Twitter boasts 200 million users, but some estimates place active accounts within the U.S. at only 16 million. According to a recent WSJ article, the “best hope for J.P. Morgan’s fund may be if Twitter is acquired. Google and Facebook may be interested. Facebook’s popular status updates are threatened by Twitter. And Google trails badly in social media”.
A possible horizontal merger between Facebook and Twitter could present interesting HHI implications as Facebook is the king of social networking sites and Twitter rules the microblogging subspace in that market. Based on estimated user counts, a combined Facebook-Twitter firm could potentially reach 40% of all internet users (a 33% increase over Facebook on its own). Moreover, as discussed previously, Booz & Co’s study on the social commerce market estimates it at $5 billion worldwide. With Facebook’s projected revenues for 2011 heading toward $4 billion, the HHI in this industry is very high. If we consider Facebook and Twitter revenues in the HHI equation (i.e. 10000*(4/5)^2+(.2/5)^2), the HHI value is 6416. As such, horizontal merger activity by Facebook would likely bring on attention from Federal Trade Commission anti-trust regulators.
Figure 8 provides another example of Facebook’s reach and market size, which demonstrates how any major horizontal merger activity would likely draw regulator attention. Developed by a Facebook intern in late 2010, the map provides a visualization of users and connectivity around the world.
Figure 8: Source: Visualizing Friendships, Facebook.com (Butler, 2010)
A possible vertical merger (or conglomerate depending on how the combined firm was to be structured) could exist between Facebook and a major smartphone (e.g. Blackberry) or wireless cell phone provider. By combining a smartphone’s wireless internet and geolocation capabilities and Facebook’s growing social commerce business, a company could develop some very interesting and potentially lucrative synergies of effort in the social commerce space.
Mobile internet: The future of social commerce
Recently, AT&T announced the creation of a location-based marketing service where local companies can send text messages to cell phone users who choose to receive special offers. This program is called ShopAlerts and relies on a location system called a “geo-fence”. In this geo-fence, marketers can develop ads based on user location and aim to increase interest based on proximity. Estimates peg spending on US mobile ads approximately $743.1 million in 2010 and are expected to grow 48% in 2011 to $1.1 billion.
Figure 9: (Reese, 2011).
Social networking and social commerce have also integrated their services with mobile internet capabilities. Foursquare, one of the leading social networking/commerce, is a location-based mobile internet application that allows friends to “check in” to a location and share that location with friends. Once “checked in”, users can see what friends are in the local area and can be approached with deals by merchants in their vicinity. Users also can receive “badges” and other discounts to award them for return visits to business locations. As of February 2011, foursquare had over 6.5 million users (Foursquare, 2011).
The integration of wireless internet technology and social networking/commerce platforms provides the consumer with a completely customized shopping experience. Advertisements can be tailored to not only an individual’s location, but to their patterns around town. The delivery of these proximity “deals” offers a new stage to attract a growing “mobile” population. As indicated in JMR study on valuation of social networks discussed previously, sellers that benefit the most from the network are those whose accessibility is most enhanced by the network. The customized and targeted vehicle that social commerce platforms like foursquare offer, serve to enhance that accessibility. These systems also have the potential to drive significant additional revenue for retailers and social commerce vendors.
Conclusion
This paper provided an introduction to social commerce concept covering an analysis of the market, the effects of social commerce on consumer behavior, pricing strategies industry concentration and look at the future of the social commerce as mobile internet technologies are further integrated. Social commerce is a nascent and evolving field with a great deal of room to grow across all markets. Furthermore, as mobile internet and e-commerce services penetrate deeper into emerging markets, the growth prospects for social commerce increase dramatically. Seventy percent of Facebook’s users based outside of the U.S. and many developing economies have developed regional/language-specific social networking sites. Integrating these non-U.S. social networking sites into effective social commerce platforms could drive unprecedented future e-commerce sales growth in these largely unchartered waters.
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