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548 Making Key Strategic Decisions materials. Lastly, some companies use EDI to transmit their invoices and then to receive the subsequent payments. While industries use different versions of EDI in different ways, their goals are always the same: minimize the processing time and lower inventory costs and overhead expenses. An industry organization in Washington, D.C., developed and maintains a standard format that dictates how all transactions are sent, ensuring that all companies that wish to imple- ment EDI can be assured that all vendors’ and customers’ computers will un- derstand each others’ transactions, without requiring any custom programming. EDI, while still used quite extensively, has been eclipsed by electronic com- merce, which will be discussed later in this chapter. The 1990s has also seen the advent of virtual organizations. Virtual orga- nizations are formed when companies join together to create products or en- terprises that they could not have created individually. In most cases, information technology allows companies to create these partnerships and share information as if they were one company. Using communications and groupware products like Lotus Notes, the partners can share information with each other about their individual progress to ensure the best possible success. This will be discussed further in the section on IT strategy. DATA BASE The following scenario depicts what information systems looked like prior to the use of database management systems. Imagine a physical office in which each person has his or her own file cabinet. The information in the file cabinets belongs to the people whose desks are closest to them. They decide what infor- mation will be in their file cabinets and how it will be organized. For example, sales might refer to gross sales in one worker’s cabinet and net sales in an- other’s. Yet, the discrepancy would be unimportant, because there was actually very little sharing of data. Database management systems assume that information is a corporate asset to be shared by all workers in the enterprise. Database technology, there- fore, allows a company to have one integrated location for the storage of all company data. These systems create a standard vocabulary, or data dictionary, by which all references are consistent (e.g., sales always means net sales). They also enable each user to have her own individual view of the data as if the in- formation were still in the file cabinet next to her desk. Users need not concern themselves with the physical location or physical order of the data either. Data- base management systems are capable of presenting the data as necessary. In fact, with distributed databases, the data does not even have to reside in the same location or computer. It can be spread around the world if necessary. Database systems are sufficiently intelligent and can find the data and process it as if it were located directly on the user’s personal computer. Most of the software that was developed in the earlier years relied on data structures called flat files. While some companies utilized database tech nology Information Technology and the Firm 549 to store information, those database management systems were, in many cases, unwieldy and very expensive to both acquire and maintain. They were usually hierarchical or network database systems that, alone, cost in excess of $200,000 and frequently required special database administrators just to constantly fine- tune the system. Today’s database technology is based on a relational model, and, on a very simplistic basis, it resembles a spreadsheet. In a relational database, there are a series of tables or files. Similar to a spreadsheet table, each table has columns with attributes and rows of data. The difference is that there is only one table in a spreadsheet, whereas there can be an almost unlimited number of tables in a database. In addition, there is a practical limit to the size of a spreadsheet, but databases can contain thousands of columns and millions of rows of data. In addition, databases also allow users to relate or connect tables that share common columns of data. Exhibit 16.6 is an example of a very simple portion of a payroll applica- tion. There are two different tables. The employee table contains data about each of the company’s employees: name, address, marital status, number of de- pendents, and so on. The pay table contains data about every time each of the employees is paid: their gross payroll, social security taxes, federal withholding, state tax, and so forth. First, notice the common column between the two tables, the employee number. This column enables the database management system to relate the two tables. It allows the system, for example, to print a payroll journal that has both the weekly payroll information from the pay table and to access the em- ployees’ names from the employee table. Why not combine all the data into one table? Not only would the employees’ names, social security numbers, and other information appear multiple times, requiring the unnecessary use of data storage, but also multiple versions of the truth might occur. If one of the em- ployees should happen to change his name or address (if address were included in the employee table), the database would show one name for part of the year and another for the rest of the year. Redundant data creates opportunities for data corruption; just because data is changed in one table, that same data is not necessarily changed in all tables. Prudent systems design eliminates data field duplications wherever possible. DATE WAREHOUSE Data warehousing attempts to reconcile and live with past applications soft- ware, while still benefiting from today’s newer technology. As mentioned earlier, industry is rife with older legacy systems that are currently cost pro- hibitive to replace. Most of these older systems are mission critical operational control systems (see Exhibit 16.3) and satisfy most of the operational needs of the company. However, they are built on technology that cannot support the kinds of decision support tools that management requires. Many of these 550 EXHIBIT 16.6 Database example. EMPLOYEE TABLE Social Date of Hourly Employee Security Marital Number of Date of Date of D ate of Last or Number First Name Initial Last Nam e Number Status Dependents Birth Hi re Termination Pay Raise Pay-Rate Salary 1 Mary E Smith 123456789 M 4 4/1/63 7/21/91 9/1/96 8.505 H 2 Tom T Day 234567890 M 3 3/2/55 11/15/91 1/15/96 750.000 S 3 Harry F Jones 345678901 S 1 11/30/71 1/15/92 9/24/96 11/6/94 12.500 H 4 Sally D Kraft 456789012 S 0 10/5/65 3/6/92 3/5/96 14.755 H 5 Charlie Malt 567890123 S 1 6/6/80 6/2/93 6/17/96 900.000 S 6 John K Free 678901234 M 5 8/5/49 11/1/94 12/15/95 17.500 H PAY TABLE Number of Number of Social Federal Employee Regular Overtime Security Medicare Withholding Check Number Date Hours Hours Gross Payroll Tax Tax Tax Net Pay Number 1 1/7/96 40.0 4.0 391.23 24.26 5.67 101.1642534 21.52 238.62 1 2 1/7/96 40.0 0.0 750.00 46.50 10.88 193.935 41.25 457.44 2 3 1/7/96 40.0 0.0 500.00 31.00 7.25 129.29 27.50 304.96 3 4 1/7/96 40.0 4.0 678.73 42.08 9.84 175.5060034 37.33 413.97 4 5 1/7/96 40.0 0.0 900.00 55.80 13.05 232.722 49.50 548.93 5 6 1/7/96 40.0 2.5 765.63 47.47 11.10 197.9753125 42.11 466.97 6 1 1/14/96 40.0 12.0 493.29 30.58 7.15 127.5549282 27.13 300.87 7 2 1/14/96 40.0 0.0 750.00 46.50 10.88 193.935 41.25 457.44 8 3 1/14/96 40.0 8.0 650.00 40.30 9.43 168.077 35.75 396.45 9 4 1/14/96 40.0 7.9 765.05 47.43 11.09 197.8257886 42.08 466.62 10 5 1/14/96 40.0 0.0 900.00 55.80 13.05 232.722 49.50 548.93 11 6 1/14/96 40.0 0.0 700.00 43.40 10.15 181.006 38.50 426.94 12 1 1/21/96 40.0 0.0 340.20 21.09 4.93 87.968916 18.71 207.49 13 2 1/21/96 40.0 0.0 750.00 46.50 10.88 193.935 41.25 457.44 14 3 1/21/96 40.0 2.4 545.00 33.79 7.90 140.9261 29.98 332.41 15 4 1/21/96 40.0 6.7 738.49 45.79 10.71 190.9581624 40.62 450.42 16 5 1/21/96 40.0 0.0 900.00 55.80 13.05 232.722 49.50 548.93 17 6 1/21/96 40.0 5.0 831.25 51.54 12.05 214.944625 45.72 507.00 18 Information Technology and the Firm 551 systems use older file structures or obsolete database management systems and are almost incapable of accessing and manipulating data. As an alternative to replacing these systems, data warehousing provides a state of the art database management system that is fed data from the older legacy systems. However, data does get duplicated, which can potentially cause a synchronization problem between the data in the warehouse and the data in the older legacy systems. Consequently, IT management must put stringent controls in place. Still, the benefits outweigh the potential problems, for the data warehouse comes with all of the high tech tools that will enable manage- ment to create a plethora of queries and reports. Most of the newer Decision Support Tools and Executive Information Systems, which will be discussed later, require a storage capability similar to the data warehouse. CONTROLS Because the initial software applications that were developed in the 1960s and 1970s were accounting oriented, data processing, which is what information technology was then called, typically reported to the Chief Financial Officer, creating a control atmosphere consistent with accounting controls. A central group of trained data entry operators was responsible for entering and verify- ing data. Access to the “glass house” was restricted, and in some cases access to the data entry and report distribution areas was also restricted. Because every- thing was self-contained, control was not a major issue. In the late seventies and early eighties, online terminals began appearing on users’ desks, outside of the glass house, allowing them access to data. Ini- tially, these terminals were used for information inquiry. Yet, even this limited function was tightly controlled by strict software access control and password protection. While workers were getting additional capabilities, they were also creating opportunities for lapses in control. This was just the beginning of the Trojan horse. Eventually, data entry moved out of the glass house to the ware- house receiving dock to be used for inventory receipts; the order entry desk to be used for new orders; the purchasing department to be used for purchase orders; and, in the case of retailing, on to the sales floor for point of sale pro- cessing. No longer were trained data-entry operators responsible for the qual- ity of the data; others were responsible for entering data, and it was just an ancillary part of their job, for which they were not necessarily even trained. The control environment was breaking down, and the introduction of the personal computer only complicated the issue. No longer was control central- ized. While access to data could be controlled, control over the use of data and the content of reports was lost. For example, two people could each issue a re- port on sales, and the numbers could easily be different. Yet, both reports could be accurate. How is this possible? Simple. One of the reports may have been about gross sales and the other about net sales, or one may have been based on data through Friday and the other on data through Saturday. 552 Making Key Strategic Decisions When all programming was controlled by a small professional group, con- trol was much easier. Because today’s spreadsheet programs are user friendly, however, and software does not require programming knowledge, everybody is his or her own programmer. Thus, it is difficult to control the consistency of the information that is being distributed. The problems only become more complicated. Now companies allow their business partners, vendors, and even outsiders to access their computers, using the Internet and EDI. Data is interchanged and moneys are exchanged elec- tronically often without paper backup. While technology can prevent most unauthorized access to data, as recent history has shown, even the U.S. De- fense Department has not successfully prevented the best hackers from ac- cessing its computers and wreaking havoc. What was relatively simple to control before 1990 is now a nightmare. Accountants, systems professionals, and auditors must remain forever vigilant against both inadvertent and inten- tional unauthorized use and abuse of company data. INFORMATION TECHNOLOGY STRATEGY How do companies decide how to invest their IT money? What projects get funded? Which projects are of higher priority? IT strategy is not created in a vacuum. Rather, like all of the other operational departments within a corpo- ration, IT must support the direction and goals of the company. The Chief In- formation Officer’s job is to educate the rest of senior management about IT’s ability to create opportunities for the company and help it move in directions that make sense. IT architecture is developed to support the IT and corporate strategy. If additional networks, workstations, or data warehouses are required, they are either acquired or developed. In the late 1980s and early 1990s, Wal-Mart adopted an everyday low pricing strategy. To accomplish this goal, Wal-Mart needed to change the man- ner in which it both conducted business with its suppliers and managed the in- bound logistics, warehousing, and distribution of merchandise to its stores. It needed to abolish warehousing as much as possible and quicken the process by which stores ordered and received merchandise. Also, Wal-Mart needed to eliminate any unnecessary inventory in stores and allow stores to order mer- chandise only as needed. Lastly, lags in its distribution centers needed to be prevented, enabling goods to be received from their suppliers and immediately shipped to stores. As a result, Wal-Mart designed a systems and technology infrastructure that, through EDI, enables the stores to order goods, as needed, from their suppliers. Moreover, Wal-Mart permits manufacturers to access computer- ized sales information directly from its computers, which, in turn, allows them to gauge Wal-Mart’s demand and then stage production to match it. Wal-Mart effectively shifted the burden of warehousing merchandise from its own Information Technology and the Firm 553 ware houses to the vendors, eliminating the costs of both warehouse mainte- nance and surplus inventory. The distribution centers were automated, allow- ing cross docking, whereby goods being received for specific stores were immediately sent to the shipping area designated for those stores, thus putting an end to all time lags. Wal-Mart now has the lowest cost of inbound logistics in its industry. Its selling G&A is 6% below its nearest competitor, enabling it to be the most aggressive retailer in its industry. Wal-Mart aligned its IT strategy and infra- structure to support the company’s overall strategy. IT was the agent for change. Without the newer information technologies, none of the newer strate- gies and directions could have been successful. JUSTIFYING THE COST OF INFORMATION TECHNOLOGY Should companies take that giant leap of faith and invest millions of dollars in new machines and software? Can we measure the return on a company’s in- vestment in technology? These are questions that, for years, have concerned professional technology managers. Today, information technology consumes an increasing share of com- panies’ budgets. While we cannot live with the cost of technology, ultimately, we cannot live without the technology. Thus, when every new version of the per- sonal computer chip or Windows hits the market, companies must decide whether it is a worthwhile investment. Everyone wants the latest and greatest technology, and they assume that, with it, workers will be more productive. While IT is the medium for change, its costs and soft benefits are diffi- cult to measure. As technology gets disbursed throughout a company, it be- comes increasingly difficult to track costs. As workers become their own administrative assistants, each company must determine whether its workers are more or less productive when they type their own documents and prepare their own presentations. These are many of the issues that companies are fac- ing now and will be in the future as they struggle with new IT investments. INTERNET/INTRANET/EXTRANET The Internet, intranets, and extranets provide companies with a plethora of opportunities to find new ways of transacting business. An alternative to some of the older technology, an intranet, a subsystem of the Internet, was devel- oped in 1996 to allow employees from within a company to access data in the company’s system. A “firewall” prevents outsiders from accessing any data that a company wishes to keep confidential. An intranet refers to those sys- tems that are inside the firewall. Employees have the access authority to break through the firewall and access information, even though they might be using 554 Making Key Strategic Decisions a com puter outside of the company. Remember, the Internet is just one large party line on which everybody is sending around data. One manufacturing company provides an intranet facility for its employ- ees to learn about their health, life and disability insurance, and educational benefits. The system allows them to sign up for these programs and, in the fre- quently asked questions (FAQs) section, to inquire about some of the most common issues specific to the programs. When online, employees can also ac- cess and sign up for a list of in-house training courses, read an employee newsletter, and check the current price of the company’s publicly traded stock. An extranet is a version of the intranet that allows external users to access data inside of the firewall. For example, part of Wal-Mart’s ordering and logis- tics system allows its vendors and suppliers to access Wal-Mart’s store sales data directly from Wal-Mart’s computer systems. If these transactions oc- curred over the Internet, they would be referred to as extranet transactions. ELECTRONIC COMMERCE Electronic commerce is changing the entire landscape in how business is transacted. While most consumers think just about business to consumer (B2C) e-commerce, the greatest potential lies in business-to-business (B2B) e-commerce. International Data Corporation estimates that B2C e-commerce will generate $300 billion annually by 2004, but B2B e-commerce will generate $2.2 trillion annually by 2004. Most of the focus of the investor community during 1999 and 2000 was on the B2C space, with millions of dollars made and lost as a result of people not understanding the business model. Most of the money raised in venture capital was used for advertising to gain brand recogni- tion, whereas very little was invested in infrastructure. As a result, the B2C landscape is littered with the corpses of failed ventures. Those that have sur- vived are spending money on the traditional back office functions that brick and mortar retailers have developed over the years. All the while, bricks-and-mortar retailers have been experimenting in selling on the Internet and have adopted a hybrid model for doing so. Cus- tomers are able to order over the Internet, but they can also return merchan- dise to traditional stores. The Internet can also make a significant difference when products, such as music and software, can be ordered—and delivered— electronically. These new opportunities create new challenges for those involved in the operations, accounting, and finance of these virtual-marketplace companies. The order is being not only processed electronically but also shipped automati- cally, sometimes from a third party’s fulfillment center. Also, the payment is being processed electronically. The electronic payment, usually through a third-party clearance house, must conform to various security standards in order to protect credit card information that is transmitted over the Web. Fre- quently, the company selling the goods never receives the credit card number Information Technology and the Firm 555 of the consumer, only an authorization number from the credit card clearance house. The tracking of the merchandise, as well as the payment, not to mention the processes for handling customer returns and credits, will present signifi- cant angst for the auditors and controllers of these firms. Nonetheless, the financial services industry has embraced e-commerce and now offers most of its products over the Internet. Online services include, among others, the purchase of stocks and bonds, online mortgages, and life insurance and online banking. Because they are nontangible, these products and services lend themselves well to e-commerce. The Internet works well in many cases, because, while it is not delivering the product itself, it is delivering information about the product, often in levels of detail and consistency that were never available in the physical world. As noted earlier, the real action is and will be in B2B e-commerce. Com- panies of every shape and size are realizing the opportunities for both ordering and selling their products over the Internet. Businesses are or will be using the Internet for both the purchasing of direct and indirect materials and MRO (maintenance, repair, and operations). General Electric runs its own auction site on which suppliers bid to provide GE’s operating divisions with millions of dollars of materials per day. Their private e-auction is squeezing hundreds of millions of dollars out of purchases annually and opening their purchasing to many new vendors. Some companies, such as W. W. Grainger, long known as a supplier of MRO materials through its network of physical distribution cen- ters, have established a giant Internet presence for the sale of MRO materials called Total MRO. They are attempting to supply any nondirect material a company could use, including office equipment and supplies. Other marketplaces have been created to offer products for specific in- dustries (vertical marketplaces) or across industries (horizontal marketplaces). These marketplaces provide not just buying opportunities, but selling opportu- nities as well. Many utilize auctions or reverse auctions. Hundreds of millions of dollars are or will be changing hands on a daily basis, totally electronically. As per legislation passed by the U.S. government in 2000, it is now possible to electronically sign purchase commitments and contracts over the Internet. Some companies are using their Internet site to process orders, create and price custom configurations (similar to what Dell Computer is doing on its site), track orders, and assist with customer service. Some industries are creat- ing their own marketplaces for the cooperative purchase of goods and ser- vices. The most notable of these marketplaces, Covisint, is an online auto parts exchange created by major automobile manufacturers Ford, GM, and Daimler- Chrysler. There are multitudes of B2B marketplaces and exchanges. Some are vertical, servicing specific industries like Metalsite.com for the steel industry, retailexchange.com for the retail industry, or paperexchange.com for the paper industry. Others are horizontal marketplaces, like staples.com or wwgrainger .com. There are also some hybrid models, like Verticalnet.com, that address multiple industries. Companies like Ariba and Commerce One provide the necessary software that facilitates these marketplaces and exchanges. 556 Making Key Strategic Decisions APPLICATION SERVICE PROVIDERS (ASPS) ASPs are companies that provide hosted access to software applications like Microsoft Office and ERP systems. In effect, a company rents the application while the data is processed on the ASP’s computer. Companies typically pay a per-user fee along with a cost-per-storage unit and access-time unit. This cost structure is similar to a model from the 1960s and 1970s, when computers were very expensive and companies used service bureaus to process their data. The difference today is that much of the data is accessed over high speed data lines or over the Internet. The downside of using an ASP is that the user is placing its destiny in another company’s hands and is dependant on its security and financial health. The upside is that users are not responsible for purchasing the application, maintaining it, and having to provide the computer power to process the data. WEB HOSTING While many companies host their own Web site, others prefer to contract that job out to other companies. These companies provide the communications lines, Web servers, data backup, and, in some cases, Web design and mainte- nance services. Companies that choose to outsource their Web hosting are also protecting their main network from security breeches. However, they are still placing a great deal of their data on the Web hosting company’s computer, which is still subject to security hackers. Many large companies such as Earth- link, AT&T, Qwest, along with many smaller companies, provide Web hosting services. These companies provide speed, reliability, and cost advantages, along with redundancy and technical service. DECISION SUPPORT SYSTEMS/ EXECUTIVE INFORMATION SYSTEMS A class of software that is used mostly by middle-level and senior executives to make decisions, this software combines many of the features of traditional ex- ception reporting with the graphical display tools available in spreadsheets. It allows users to make their own inquiries into large volumes of data, stored in databases or data warehouses, and provides for drill down reporting, or “slice and dice” analysis. Typically, most data in a database or data warehouse is three dimensional and looks something like a Rubic’s cube. Consider a database model for a chain of 300 retail stores. The first dimension may be the company’s merchandise; the second dimension may be its store locations; and the third dimension may represent different points in time. An executive might examine the men’s de- partment sales. Not satisfied with the results, she might then probe to learn 557 EXHIBIT 16.7 Example of options screen for a dec ision support system. . create these partnerships and share information as if they were one company. Using communications and groupware products like Lotus Notes, the partners can. 10.88 193.935 41.25 457. 44 8 3 1/14/96 40.0 8.0 650.00 40.30 9.43 168.077 35.75 396.45 9 4 1/14/96 40.0 7.9 765.05 47.43 11.09 197.8 2578 86 42.08 466.62 10