Copyright
N Venkatraman.

Strategies for electronic integration : lessons from electronic filing of tax-returns online

. (page 1 of 3)
Online LibraryN VenkatramanStrategies for electronic integration : lessons from electronic filing of tax-returns → online text (page 1 of 3)
Font size
QR-code for this ebook


»*!




nil



3 T060 00bDlS22 3



WORKING PAPER
ALFRED P. SLOAN SCHOOL OF MANAGEMENT



Strategies for Electronic Integration: Lessons from Electronic Filing of

Tax-Returns

N. Venkatraman and Ajit Kambil

Massachusetts Institute of Technology

Sloan School of Management

Cambridge, MA 02139

Working Paper #31 27-90-BPS
Draft: 2/27/90



MASSACHUSETTS

INSTITUTE OF TECHI^OLOGY

50 MEMORIAL DRIVE

CAMBRIDGE, MASSACHUSETTS 02139



t^rr^.q^ft'



Strategies for Electronic Integration: Lessons from Electronic Filing of

Tax-Returns

N. Venkatraman and Ajit Kambil

Massachusetts Institute of Technology

Sloan School of Management

Cambridge, MA 02139

Working Paper #31 27-90-BPS
Draft: 2/27/90



Telephone:
(617) 253-5044
(617) 258-5582



a'^^^^q







Strategies for Electrotuc Integratioiu Lessons from Electronic Filing of Tax-Returns 2

Introduction

Information technology (FT) is emerging as a key force in shaping the basis of
competition in many markets'. While information systems have long been
considered critical for effective management, a major reason for the current interest
in IT lies in the capability to change the basis of competition through the
deployment of innovative IT-based applications. This phenomenon has attracted
the attention of researchers and management professionals and the current
literature discusses the nature and levels of systems and applications^, descriptive
and normative frameworks for managers to assess the role of these applications in
their business contexts^, and theoretical propositions on the role of I.T. in changing
the basis of competition"*.

The frameworks offered for managerial decision-making are typically
justified by a set of popular and perhaps over-used collection of examples such as
American Airlines' SABRE reservation systems^, Baxter's ASAP system^ and
Foremost McKesson's Economost System''. Indeed, the role of these systems on the
competitive characteristics of the respective markets is generally considered
legendary. However, even a casual perusal of the emerging literature would indicate
that the underlying linkage between these systems and the changes in market has
not been adequately explained, resulting in a rather blind acceptance of the validity
and importance of such systems.

This paper seeks to develop a richer link between the deployment of I.T.
across multiple organizations and the changes in the competitive marketplace.
Specifically, it describes the impacts of electronic interconnection among multiple
players on the market for individual tax-return preparation services (hereafter,
return-preparation). Its purpose is three-fold: (a) to present a detailed study of
changes in the characteristics of a marketplace influenced by a significant electronic
integration initiative; (b) to examine the pattern of strategic responses to this
initiative, and the consequent impact on the competitive characteristics of the
marketplace; and (c) to derive strategic implications of electronic interconnections,
termed here as electronic integration.

The Marketplace for Return-Preparation Services

Background. In a typical tax-year, approximately 100 million individual tax
returns are filed with the Internal Revenue Service (IRS). Figure 1 illustrates the key
business processes involved in the preparation and filing of individual tax returns
(i.e.. Form 1040 and associated schedules). The individual taxpayer either prepared



Strategies for Electronic Integration: Lessons from Electronic Filing of Tax-Returns 3

his or her own tax-retiam or received services from a professional return-preparer
(like H«StR Block, TaxMan or independent tax accountants). The tax-return was
mailed to the IRS using the U.S Postal Service (USPS), which was then processed by
the IRS and if the taxpayer was owed a refund, a refund-check was delivered
through the USPS. In a typical year, approximately 75% of the taxpayers receive
refund checks with an average refund of $900.

Characteristics of the Market. The market for return-preparation services is
characterized by high fragmentation at the local level with H&R Block, Kansas City^
occupying a leading position at the national level. The market growth has been
relatively flat during the recent years with the percentage of taxpayers opting for the
professional return-preparation service (link, B) stable around 50%. The reasons for
the existence of link (B) are many: First, many taxpayers find it difficult to prepare
their returns themselves due to the perceived complexity of the tax laws and the
forms. Second, many believe that the professional preparer can identify subtle tax
deductions, thereby increasing the size of their refund. Finally, many tax payers fear
making errors that may result in penalties from the IRS, and seek the services of the
professionals. The business is obviously seasonal, with many offices functioning for



Figure 1: A Schematic Representation of the Key Business
Processes in the Market for Tax Return-preparation Services



















Taxpayers












^




CA)


r




Tax-Return
Preparers








ruTSi










(D)












(E)




US
Postal Service










i




IRS


(C)












T














Ser
Institi


vice
Litions







Key:

(A): Mailing the self-prepared return

through USPS
(B): Mailing the return prepared by a

professional preparer through USPS
(C): Delivering the returns to IRS;
(D): Refund checks mailed to taxpayers

through USPS
(E): Deposit of refund checks at the

financial institutions



about five months in a year during the tax-filing season and closed for the rest of the
year.



Strategies for Electronic Integration: Lessons from Electronic Filing of Tax-Returns 4

Although the return-preparation is a seemingly simple, standard service,
many related-services are offered in the marketplace. Figure 2 illustrates the
positioning of the key players along two key dimensions ~ (i) the business scope (a
narrow view given by tax-return preparation as a stand-alone business activity or a
broader view given by tax-return preparation as a part of larger financial and tax-
related activities) and (ii) the size of operations (relatively small, single-CPA
operations to large, multi-location, multi-persormel operations). The four distinct
positions that emerge from this analysis are: (a) H&R Block the leading tax preparer
with more than a third of the market, but with a narrow business scope of only tax-
return preparation; (b) the 'Big Eighf Accounting firms who provide a wide range of
accounting, investment and tax advice to their clients; (c) smaller (i.e., single-to-few
CPAs) firms, who generally maintained a narrow business scope of only tax-return
preparation; and (d) a niche segment with small boutique-type operations for high-
income clients requiring personalized service involving investments and taxes.

Our research indicates that these groups are quite independent with little
mobility across these four 'strategic groups'^. This is because each group served
distinct market segments and was constrained by mobility barriers arising from
differential strategic assets and distinctive competencies such as: personalized
financial service to high-income clients (i.e., boutique advisors), a carefully
developed image of refund- enhancement through high levels of advertising (H&R
Block), specialized tax and legal knowledge ('Big Eight Accountants), as well as
economies of scale and scope in return-preparation. The major sources of mobility
barriers are identified in Figure 2 for the different groups.

The Role of Information Technology. The return-preparation activity is
characterized by limited applications of information technology, despite its high
information-intensity. Computers are generally deployed in the back-office of larger
preparers, while the smaller preparers accessed them through service bureaus for
return-processing and error checking. Although larger businesses had adopted
computerized operations, it was not commonplace to observe computerized tax-
return preparation as airline ticketing or banking transactions. Three major reasons
for the limited use of computer technology are: One, based on market research, the
return-preparers concluded that the use of computers in the front office reduced the
quality of service perceived by the customer. Two, since return-preparation is a
seasonal business, investments in fixed capital with uncertain efficiency-oriented
benefits could not be routinely justified. Finally, the use of computers for return-
preparation significantly alters the skill-requirement of the workforce - which is



Strategies for Electronic Integration: Lessons from Electronic Filing of Tax-Returns 5

unattractive given the relatively tight labor market for computer-literate workforce.
Collectively, the impetus for the widespread adoption of computers did not appear
to exist.



Large



Size of
Operations



Small



Figure 2: A Schematic Representation of the Key Strategic Groups
in the Market for Tax Return-Preparation Services



H&R Block



Brand Image



Independent
CPAs



Narrow
(e.g., return-preparation)



'Big Eight'
Accounting Firms




Specialized Tax
owledge

'ersonal
advisors



'Boutique'

Personal Financial

Consultants



Broad
(e.g., financial services)



Scope of Business Operations



Business Networks. A schematic representation of a network of business
relationships among the key players in this marketplace is shown in Figure 4. The
network is defined as the pattern of roles, positions and interdependencies between
various players and represented in terms of two basic elements: nodes and linkages.
Nodes refer to the independent players who perform critical, interdependent
activities, and linkages refer to the existence and characteristics of the nature of
relationships between each pair of nodes. Note that 'X' indicates the absence of a
linkage between a pair (i.e., independent activities in the marketplace), while 'xx'
refers to the diagonal cells. The rows and columns depict the nodes, while the cells



Strategies for Electronic Integration: Lessons from Electronic Filing of Tax-Returns 6

indicate a stylized representation of the linkage based on a simple conceptualization
of the type of relationships derived in Figure 3.

Adapting Williamson's^^ work, we specify a framework depicting different
types of relationships using two dimensions - nature of linkage and frequency of
exchange. As Figure 3 indicates, the common linkage with infrequent relationship is
termed as market exchange (A), a typical transaction between a buyer and a seller or
service-provider; the common linkage with frequent relationship is termed as
standard contracts (B), which is best exemplified by the use of ATMs in a bank. The
third type is specialized linkage with infrequent relationships is termed as
specialized contract (C), where unique resources are committed for this transaction,
as in the case of transactions between physicians and different patients, lawyers with
various clients, etc. Finally, the fourth type is the frequent transaction with
specialized assets, termed as strategic partnerships (D). We use labels (A) through (D)
to represent the type of relationships in the business network.



Figure 3: A Schematic Representation of
Different Types of Relationships



Specialized


Specialized


Strategic


(unique)


Contract


Partnerships




(C)


(D)


Nature






of






Linkage


Market


Standard




Exchange


Contract


CoDnnon


(A)


(B)


(undifferentiated)







Infrequent



Frequency of Exchange



Frequent



As Figure 4 indicates, most of the relationships are characterized by either (A)
or (B) type indicating undifferentiated relationships. The existence of many empty
cells indicate the absence of opportunities for developing interrelationships, and



Strategies for Electronic Integration: Lessons from Electronic Filing of Tax-Returns 7

given that the five types of players have their distinct roles, there is limited reasons
for vertical integration. Subsequently, we use the above framework to discuss
changes in the business network, enabled by electronic integration initiatives in the
marketplace.

Figure 4: A Schematic Representation of the Network of Relationships in the

Marketplace



Taxpayers


Taxpayers


Return
Preparers


USPS


IRS


Banks


[xx]


A/B


A


A


A/B


Return
Preparers


A/B


[xxl


X


X


X


USPS


A


X


[xx]


X


X


IRS


A


X


X


[xx]


X


Banks


A/B


X


X


X


[xx]



The box (appended at the end of this manuscript, but may be inserted at the
appropriate place) describes the evolution from paper-based filing towards electronic
filing. In simple terms, electronic filing enables the return-preparer and /or
authorized 'filer' to electronically transmit the return to the IRS (using a pre-
authorized protocols). This enables the filer to obtain confirmation of receipt as well
as arrange for direct deposit of refunds, if due. This seemingly simple automation of
data exchange has significant implications for the market for return-preparation and
related services. The changes in strategic directions and the consequent impact on
the business network reconfiguration is discussed below.



Strategies for Electronic Integration: Lessons from Electronic Filing of Tax-Returns 8

Strategic Responses to the Electronic Filing Initiative

Figure 5 is a framework that recognizes two dominant approaches to
developing strategies in response to the electronic filing initiative, namely: (a)
information exploitation, and (b)technology exploitation. This allows us to identify
two major strategies with two strategic trajectories in the changing marketplace.



Figxue 5: A Framework for Isolating Key Strategies to Exploit Electronic Filing

Opportunities



High



Degree of

Information

Exploitation

in Strategy

Formation



Low



Information-Leverage



Electronic
Integration




Strategic
Adjustment



Technology-Leverage



Low



Degree of Technology

Exploitation in Strategy

Formation



High



The strategy defined by the low-low position is termed, strategic adjustment —
representing minimal changes in response to the electronic filing initiative. The
basic product-market definition is unaltered, but some adjustments are made to
offer electronic filing options to the customers. This is because until electronic filing,
the non-existence of I.T. capabilities was transparent to the customers as long as the
service quality and price was unaffected. However, the electronic filing initiative
compels the return-preparers to adopt the I.T. platform as it becomes the standard
business infrastructure. Thus, while hardware and software have long been
available for automating return-preparation, the critical impetus is its potential role
as a visible differentiating factor in the marketplace. Indeed, our research indicates



Strategies for Electronic Integration: Lessons from Electronic Filing of Tax-Returns 9

that although electronic filing initiative by IRS is not necessary for exploiting
benefits from software advances, it did provide a powerful impetus for the
computerization of the return-preparation activity ^^.

Electronic filing capabilities provides a major source of differentiation given
the importance of quicker refunds to the 75% of the taxpayers who are eligible to
receive refunds in any given taxyear. Thus, we see strategic adjustment manifested
in product-offerings like: Rapid Refund (H&R Block) — which is an extension of the
traditional product of return-preparation but with electronic filing of those returns
that are eligible for refunds. This allows the firms with this capability to differentiate
themselves from those who do not have the electronic filing capabilities. We term
this as strategic adjustment since the definition of the service ~ namely, tax-return
preparation ~ has not been changed by the participants adopting this strategy.

At the other end is the strategy termed as electronic integration — which
maximally exploits both the technological and the information capabilities. The
shift from strategic adjustment towards electronic integration can be conceptualized
in terms of two major trajectories, termed as technology-leverage and information-
leverage. The former represents the array of options to efficiently and creatively
leverage technology capabilities to redefine the characteristics of products and
services as well as create new sources of competitive advantage, while the latter
represents the array of alternatives to creatively leverage the information content to
redefine products and services and create new sources of competitive advantage. We
first discuss these two trajectories as a way of leading into the strategy of electronic
integration.

Technology leverage realizes the fundamental sources of value that lie in the
technology infrastructure — including data processing, storage, communication and
input-output capabilities ~ which are central assets in any electronic integration
initiative. In the present context, it is reflected in the innovative offering of
electronic filing as a fee-based service as an alternative to the role played by the
USPS (see Figure 1 and 3). Specifically, we are witnessing the emergence of 'return-
filing' as a fee-based service distinct from 'return-preparation.' This is potentially
attractive business opportunity for banks and other institutions, that can leverage
their existing technology platforms and commercially available return-preparation
software to file tax-returns with the ERS without necessarily preparing them.
Alternatively, they could serve as the 'electronic filers' for professional return-
preparers, who may not find it advantageous to invest in the necessary I.T.
infrastructure for electronic filing.



Strategies for Electronic Integration: Lessons from Electroruc Filing of Tax-Returns 10

Two manifestations of technology leverage in this changing marketplace
illustrate the potential along this trajectory. One pertains to the role of retail
financial institutions as potential electronic filers. This is facilitated by Electronic
Filing Center, Inc. — a new business entity, which provides turn key service to the
financial institutions to enable them to leverage their existing technology
infrastructure for new sources of revenue. As an example. Citibank offers its
customers the capability to file their returns electronically through Electronic Filing
Centers, Inc. for a fee of $30 with the specific benefits of accuracy and completeness of
the returns in addition to faster refund. This could ultimately serve as the
mechanism to consolidate several retail banking services [such as: checking account,
savings account, salary direct-deposit, investments, mortgages and credit-card into
one integrated account with possible assistance in tax-return filing] with the
potential to become the equivalent pf Cash Management Account (CMA)^2 of the
90s.

The other pertains to the potential role of non-financial retail outlets as
electronic filers. We see this manifested in Instatax which has created an electronic
infrastructure through retail outlets such as 7-eleven stores, Revco drugstores, and
Mail Boxes, Etc"^^. The tax forms ~ either self-prepared (link A in Figure 1) or
professionally-prepared for mailing through USPS (link B in Figure 1) — are
collected at these outlets and faxed to the Instatax headquarters in San Diego,
California for checking their accuracy as well as their completeness before
electronically filing them with the IRS^^

With reference to Figure 1, it is now possible to provide 'return-filing' service
to the 50% of the taxpayers who presently do not require return-preparation service
as well as to those who use the return-preparers without the electronic filing
capability. More importantly, it has the potential to shift the focus away from
'return-preparation,' towards 'return-filing' ~ especially given the increased
proliferation of return-preparation software that codifies the knowledge required to
complete simple tax-returns.

An obvious question pertains to the price-cost relationship in the technology
leverage trajectory. The present price for filing a return electronically and providing
the confirmation of its receipt by the IRS is in the range of $25-30 as against 25 cents
for mailing through the USPS. We expect the prices to drop as the demand picks up
and the availability of outlets increases. However, as long as the taxpayers are
prepared to pay a significant premium for electronic filing, business responses
through price-skimming strategies will remain attractive during the early stages of



Strategies for Electronic Integration: Lessons from Electronic Filing of Tax-Returns 11

life-cycle. As the market eventually matures, the financial institutions could benefit
through their integrated product offering and leveraging return-filing activities.

The Information-leverage trajectory is predicated on exploiting the
information assets available to the firm. This realizes the information content
embedded both in the product as well as in the larger delivery channel as a
fundamental sources of value. While it is complementary to technology leverage, it
has been a relatively underdeveloped idea in the discussion of benefits through
electronic integration. It is important to recognize that McKesson's ability to enlarge
their business scope [beyond distribution to include insurance and other related
services] reflects their ability to leverage information assets and attributes derived
from integrating their business processes. Similarly, Baxter's attempt to leverage
their ASAP infrastructure to provide stockless-inventory to hospitals rests on their
ability to exploit the information processing capabilities relating to their
understanding of the stock-levels in different locations within a given hospitaP^

In the context of electronic filing of tax-returns, information-leverage is
reflected in the possibility that investment products can be customized based on the
individual tax-return as well as comparisons with a benchmark group^^ xhus, the
information on the taxpayer's financial profile singly as well as in combination with
other information serves to leverage return-filing for other value-added services.
Ameritax — a subsidiary of American Express IDS Division — is well positioned to
exploit the information content in the tax-returns (of consenting taxpayers). In such
a setup, information on earnings and tax liabilities of a taxpayer could be
benchmarked against a comparative sample to create the capability to customize
specific investment products that reduce tax liabilities in the subsequent year. The
results of a pilot test indicates that this could be a potentially attractive approach.

While electronic filing is not necessary to leverage the information content in
the return, it is dear from test market reactions that taxpayers feel comfortable to let
an organization whom they trust not only file their returns electronically but also
capture the relevant data [with their consent] to provide additional value-added
services. Traditionally, the return-preparers saw their service as a stand-alone,
annual event with little potential for offering other information-based services.
With electronic filing, return-preparation is being bundled with other value-added
services given the richness of information contained in the tax-return. Although
the economic benefits of the strategic options along this trajectory cannot be
obtained, one banking executive remarked during the research, "The one thing that
Americans do diligently is to file their tax-returns, which is the most accurate profile



Strategies for Electronic Integration: Lessons from Electronic Filing of Tax-Returns 12

of their financial health that I can get; if I can leverage that activity to provide
additional services, it would be the single best source of competitive advantage."

As depicted in Figure 5, the two trajectories are con^plementary and that the
strategy at the other end is termed as ~ electronic integration - which maximally
exploits the capabilities of the technology infrastructure as well as the information
content of the exchange to influence the nature of products and services.

The taxpayer considers the filing of tax-return as a statutory requirement as
well as a means to receive the refund due. Indeed, one can argue that the basic
function of the return-preparation service pertains less to the fulfillment of the


1 3

Online LibraryN VenkatramanStrategies for electronic integration : lessons from electronic filing of tax-returns → online text (page 1 of 3)