Assignment

PART I

The information technology shop of Globus Enterprises is planning a project to upgrade their data center. As part of the project, the engineering team is trying to determine the number of new servers required to optimize productivity for their web site. The result of their analysis is shown in the following table:

1. Draw the graph showing marginal cost and benefits for different numbers of servers deployed.

2. If Globus's goal is to optimize productivity, how many servers should they deploy as part of this project? Explain your rationale.

PART II

Case Study

The attached Washington Post article describes Amazon.com's ability to buck the dot-com trend and become profitable.

washingtonpost.com

Amazon Posts Profit for 2nd Time

Firm May Prove to Be a Rare E-Commerce Site With Staying Power By Jonathan Krim and Dina ElBoghdady

Washington Post Staff Writers

Amazon.com Inc. posted its second-ever quarterly profit yesterday, bolstering its position among an elite handful of Internet companies that are showing strength in the dot-com world's post-boom years.

Although analysts predicted that lower prices and free shipping would doom Amazon's bottom line, the Seattle-based retailer eked out net income of $3 million, or 1 cent a share, in the fourth quarter. That was down from $5 million a year ago, when the company posted its first profit since it went public in 1997. For the full year, Amazon reported a loss of $149 million, narrower than its $567 million loss in 2001.

Amazon's performance, and the rebound in its stock price since last summer, might surprise those who assumed Internet companies were better left for dead after the dot-com implosion. But analysts say Amazon and a core group of Internet companies, including eBay Inc., Expedia Inc. and Yahoo Inc., have built what look like workable long-term businesses for the Internet era.

"We've seen the worst of the shakeout" of companies that were long on hype and short on profit, said stock analyst David Kathman, who follows Amazon and eBay for Morningstar Inc. in Chicago. "Now there are some behemoths starting to emerge."

The stock prices of several Internet companies have climbed to lofty levels. Analysts caution against running out and buying the shares because the recent surge has left them pricey.

Still, the big dot-com survivors have found the sweet spot of business on the Internet: facilitating transactions for a community of sellers and buyers, and taking a cut of the action along the way. And they are a reminder that although many Internet stocks have crashed or disappeared, the Internet itself remains a powerful and growing force.

"The acceptance of the Internet is now well established and growing, and there is increasing use of broadband," or high-speed connections, said Mark Zandi, chief economist for Economy.com Inc.

Analysts point to several reasons that these companies, if they are generating a profit, can become even more successful. With many competitors falling by the wayside, these firms gain the power to raise prices. And many carry little debt and have low capital expenses except for computer equipment.

Amazon, for example, has a market value of $8.3 billion and carries only about $2 billion in long-term debt. By contrast, Sears, Roebuck and Co., with a market value of $8.9 billion, has $20.7 billion in long-term debt.

But many factors work against the success of Internet companies. Many of the firms are young, with largely unproven management teams. They have yet to show a clear stream of profit. And when a concept works, rivals emerge to replicate it because barriers to entry on the Internet are low. There's also the challenge of winning over reluctant consumers still grappling with privacy concerns.

Nonetheless, Zandi said some Internet businesses that have failed to catch on may get a second chance. Financial services is one area with potential. And with the growing popularity of faster Internet connections, downloadable entertainment and game playing could prove fertile business areas, he said.

Some companies, such as Google and Yahoo, have found ways to make Internet advertising more successful, with ads linked to search results.

Amazon attributed its fourth-quarter performance in part to its strategy: increasing sales by offering low prices and free shipping to win new customers and keep the old ones from running out to traditional stores for a quick purchase.

In the past 18 months, the company has cut prices five times on merchandise and shipping.

Some analysts have criticized Amazon's aggressive pricing, arguing that it unnecessarily eats into the bottom line. Amazon, they said, should abandon the approach because the company has no real competition.

But instead of backing away from the strategy, Amazon further embraced it. Yesterday, the company said it would offer free shipping year-round on orders exceeding $25, with a few exceptions, such as products offered on its site by partners such as Toys R Us.

Company executives agreed that free shipping is expensive for Amazon. Shipping costs increased 11 percent, to $151 million, in the fourth quarter. But Jeff Bezos, Amazon's founder and chief executive, told analysts yesterday that it remains an effective marketing tool.

Sales for the quarter were up 28 percent from a year ago at $1.43 billion. For the year, sales hit $3.9 billion, a company record.

Also in the fourth quarter, sales at each of Amazon's major segments grew from a year ago. Books, music, DVD and video sales were up 13 percent to $606 million. Electronics, tools and kitchen supplies increased 21 percent to $262 million. And sales at sites in the United Kingdom, Germany, France and Japan grew 76 percent to $461 million.

"It's working," Bezos said. "It's the right investment to make, and it's in the long-term best interest of shareholders and our customers."

SafaRatschy, an analyst with U.S. Bancorp Piper Jaffray Inc., said Amazon's success goes beyond the discounts. The retailer's investment of half a billion dollars in infrastructure is finally paying off, he said.

"More than a year ago, Amazon was the favorite stock to hate because it had $2 billion in debt on its balance sheet, it was losing investors, and it had not proven that its model works," Ratschy said. "But gradually people became believers."

In November, Amazon launched an online store that sells about 450 well-known brands of apparel and accessories. In its first 60 days, the store became Amazon's most successful launch based on unit sales. For instance, the store has sold 153,000 shirts and 106,000 pairs of pants.

Amazon also sells products on its sites for Toys R Us, CircuitCity and Target but does not handle the inventory or fulfill the orders, helping it save some expenses while extending its reach. Those service agreements account for about 8 percent of Amazon's sales.

Ratschy said Amazon and the other 15 Internet companies he tracks have outperformed the Nasdaq Stock Market as a whole in the past two years in terms of return on investment. "But it's just becoming apparent to investors," Ratschy said. "It takes awhile for the bad taste of the dot-com era to go away from people's mouths."

The Washington Post Company

1. The following statement is contained in the article:

Some analysts have criticized Amazon's aggressive pricing, arguing that it unnecessarily eats into the bottom line. Amazon, they said, should abandon the approach because the company has no real competition.

A little reflection shows that this statement is off-target. Provide an argument demonstrating why it is incorrect.

2. By discounting book prices and absorbing shipping costs, Amazon.com is in effect reducing the price of the books its customers are charged. If Amazon.com hopes to make money through such a discounting policy, it must reduce its costs of operations to offset shipping charges. But perhaps more important, Amazon.com can realize larger income owing to a phenomenon explained by the economic concept of price elasticity of demand. Explain how the right price elasticity conditions can justify Amazon.com's discounting policy.

The length of your response to the two questions should be no longer than two pages, single spaced.